WEBVTT NOTE Gold and Free Market Banking 1 00:00:00.000 --> 00:00:06.000 The title assigned to me suggested a conjunction between gold and free banking, and that naturally 2 00:00:06.000 --> 00:00:12.440 suggested to me two questions. First, is it necessary to have free banking in order to 3 00:00:12.440 --> 00:00:18.300 have a successful gold standard? And conversely, is it necessary to have a gold standard in 4 00:00:18.300 --> 00:00:25.160 order to have a successful free banking system? So what I do in this paper is try to explore 5 00:00:25.160 --> 00:00:40.160 I'm going to start with the answers to these questions and try to see whether there is in fact a natural affinity between the principles of the gold standard and the principles of a freely competitive monetary order, what I'm calling free banking. 6 00:00:40.160 --> 00:00:50.160 Metaphorically, we might say the question is whether we really ought to think of gold and free banking as the warp and woof of the fabric of a proper monetary order. 7 00:00:50.160 --> 00:01:04.160 Now, in the paper, I apologize to people who don't take gold seriously for writing a paper that's of no interest to them, but I trust I don't have to apologize to this audience for focusing the paper in this way. 8 00:01:04.160 --> 00:01:15.160 When you ask the question of whether it's necessary to have free banking in order to have a successful gold standard or a successful gold-based monetary order, 9 00:01:15.160 --> 00:01:21.160 naturally raises another question, namely, what do you mean by a successful monetary system? 10 00:01:21.160 --> 00:01:25.160 And this is a difficult question to answer. 11 00:01:25.160 --> 00:01:30.160 The one way in which a lot of economists seem to answer it is clearly inadequate. 12 00:01:30.160 --> 00:01:35.160 Namely, they simply presume that what makes a desirable monetary system 13 00:01:35.160 --> 00:01:39.160 is a monetary system that fulfills the following criterion, 14 00:01:39.160 --> 00:01:43.160 and then they bring out a list of what a monetary system ought to do for you. 15 00:01:43.160 --> 00:01:48.160 One economist, Jerry O'Driscoll, has described this as a laundry list 16 00:01:48.160 --> 00:01:51.160 that most macroeconomists carry around with them. 17 00:01:51.160 --> 00:01:58.160 And the sort of things that are on the laundry list are that the monetary system should provide for stable purchasing power of the monetary unit. 18 00:01:58.160 --> 00:02:01.160 And it should provide for high real output in the economy. 19 00:02:01.160 --> 00:02:06.160 And it should provide for high real growth, and so on and so forth. 20 00:02:06.160 --> 00:02:12.160 The desirability of these sort of goals is usually taken for granted. 21 00:02:12.160 --> 00:02:24.160 I don't mean to suggest that they aren't desirable things in and of themselves, but it's usually assumed that it's desirable to have the monetary system devoted to achieving them. 22 00:02:24.160 --> 00:02:40.160 What's worse, it's assumed, without a second thought, that the way to achieve these goals that we all agree are desirable is to have the state create institutions which can then be programmed to produce the sort of behavior we want. 23 00:02:40.160 --> 00:02:50.160 That is, these sort of economists approach the question of monetary institutions not with any respect for the idea that they may be market institutions. 24 00:02:50.160 --> 00:02:59.160 Instead, they view them purely in instrumental terms. That is, they're just devices that are properly the subject of monetary bureaucrats, 25 00:02:59.160 --> 00:03:06.160 things that government policy makers ought to be perfectly free to design and redesign however they see fit, 26 00:03:06.160 --> 00:03:12.160 and things that are to be judged solely by the statistical time series they generate. 27 00:03:12.160 --> 00:03:22.160 So this view is that a desirable monetary system is one that produces the outcomes that the analyst just presumes are desirable. 28 00:03:22.160 --> 00:03:34.160 To a lot of economists this seems like, if not a reasonable approach, not only a reasonable approach, but perhaps the only way to approach monetary questions. 29 00:03:34.160 --> 00:03:45.160 Their view is we have to have a monetary policy, and so the only thing to debate about is what the monetary policy ought to be aimed at pursuing. 30 00:03:45.160 --> 00:03:53.160 Well, there's a curious thing about this way of approaching money, namely that it's not the way economists approach any other good in the economy. 31 00:03:53.160 --> 00:04:02.160 An alternative approach, which in the paper I call, I don't know whether it's a good phrase or not, the micro sovereignty approach, 32 00:04:02.160 --> 00:04:09.280 approach, namely the idea that you approach things on a microeconomic basis and an individual 33 00:04:09.280 --> 00:04:17.040 sovereignty basis, doesn't ask for a system, I think it's important to recognize, it's 34 00:04:17.040 --> 00:04:23.520 simply a set of institutions for supplying a particular economic good which we call money. 35 00:04:23.520 --> 00:04:31.120 When we approach other economic goods, an example I use in the paper is playing cards. 36 00:04:31.120 --> 00:04:36.040 Nobody approaches the question, do we have a proper playing card system in the United 37 00:04:36.040 --> 00:04:41.680 States by drawing up a list of what a playing card system should look like, what sorts of 38 00:04:41.680 --> 00:04:46.480 playing cards ought to be produced, what ought to be the behavior of the relative price of 39 00:04:46.480 --> 00:04:51.440 playing cards from year to year, or what sort of uniformity ought to exist between different 40 00:04:51.440 --> 00:04:55.440 producers of playing cards. 41 00:04:55.440 --> 00:05:00.320 A proper economist, speaking as an economist, ought to ask whether the playing card system 42 00:05:00.320 --> 00:05:05.120 is providing the kind of cards people want, the kind of cards people are willing to pay for. 43 00:05:07.840 --> 00:05:11.600 And what he would look for if he thinks that there's something wrong with the system is some 44 00:05:11.600 --> 00:05:19.280 reason for what economists call market failure. Is there some kind of monopoly being granted to 45 00:05:19.280 --> 00:05:23.120 the producers of playing cards so that they're not responsive to the needs of the market? 46 00:05:23.760 --> 00:05:29.200 Or are there some kind of property rights violations going on that are sometimes called 47 00:05:29.200 --> 00:05:42.200 The Theory of Money and Credit is called externalities by economists, but the important point is that an economist analyzing this wouldn't try to second-guess consumer preferences and take them for granted and ask whether the system is delivering the kind of goods people want. 48 00:05:42.200 --> 00:05:54.200 Now, why is money treated differently? Well, probably because few economists are accustomed to thinking of money as a private good. It's another example of the tyranny of the status quo. 49 00:05:54.200 --> 00:06:04.200 The idea that government has to provide money really has come to be taken for granted, and especially so in the 20th century, in an era of government fiat monies throughout the world. 50 00:06:04.200 --> 00:06:18.200 Well, given the institution of fiat money, and there clearly has to be some definite policy for limiting its quantity, and given the inescapability of having a monetary policy under a fiat regime, 51 00:06:18.200 --> 00:06:23.700 The government clearly needs the opinion of experts regarding what goals ought to be pursued 52 00:06:23.700 --> 00:06:29.460 by monetary policy and what's the best way to control the quantity of money. 53 00:06:29.460 --> 00:06:34.260 The reason that's true is that unlike a private firm producing playing cards, the government 54 00:06:34.260 --> 00:06:39.020 monetary authority doesn't face any profit and loss signals to tell it when it's behaving 55 00:06:39.020 --> 00:06:40.980 well and when it's misbehaving. 56 00:06:40.980 --> 00:06:45.700 There isn't any bottom line that the Federal Reserve system has that holds it accountable. 57 00:06:45.700 --> 00:06:55.700 And of course that's a major part of the explanation for why the Fed's performance has been so poor by almost anyone's standards over the past decades. 58 00:06:55.700 --> 00:07:06.700 Or the idea of free banking that I address in the paper, if it means anything, it means that we oughtn't to take for granted the necessity of government providing money. 59 00:07:06.700 --> 00:07:13.340 Now, it may be a fact that if government produces money, you need monetary policy, but it's 60 00:07:13.340 --> 00:07:18.220 also true that if the government produced playing cards, you need a playing card policy. 61 00:07:18.220 --> 00:07:21.380 But that doesn't prove the government ought to produce playing cards, and it certainly 62 00:07:21.380 --> 00:07:24.180 doesn't prove the government ought to produce money. 63 00:07:24.180 --> 00:07:30.260 The provision of all forms of money, from coins up to bank forms of money, can be left 64 00:07:30.260 --> 00:07:32.420 to the marketplace. 65 00:07:32.420 --> 00:07:49.420 And if you respect the idea of individual sovereignty, then to argue that either good, playing cards or money, ought to be produced by government rather than the market really requires you to make a case that there's something wrong with market provision. 66 00:07:49.420 --> 00:07:59.420 That market provision leaves some subset of individuals frustrated and unable to achieve the kind of money or playing cards that they want to have. 67 00:07:59.420 --> 00:08:06.420 If you want to make that case, it seems to me you have to rely on more than just sheer presumption as to what consumer preferences are. 68 00:08:06.420 --> 00:08:17.420 You can't just say consumers want a money that produces an absolutely flat price level from year to year and they're not getting it and therefore there's something wrong with the monetary system. 69 00:08:17.420 --> 00:08:28.420 If you're going to attribute those kind of preferences to consumers, it's incumbent upon you to come up with some evidence that those are the kind of preferences people have. 70 00:08:28.420 --> 00:08:38.420 The only way I can think of coming up with some kind of evidence is to look at the preferences actually demonstrated by people who have a choice between monetary standards. 71 00:08:39.420 --> 00:08:53.420 This problem of evaluating monetary systems according to economic statistics that may or may not be relevant to people who want to choose between different monies 72 00:08:53.420 --> 00:09:15.420 is relevant to the gold standard in particular because economists who are critical of the gold standard are often criticized by producing a price index of the behavior of the gold standard in the 19th century and say, look, this isn't the best behavior of the price index that we can imagine, therefore there's something wrong with the gold standard. 73 00:09:15.420 --> 00:09:22.420 But on a micro sovereignty approach, there's something wrong with the gold standard in that sense, only if there's some feasible alternative, 74 00:09:22.420 --> 00:09:31.420 feasible in the sense that people would be willing to adopt it, and people really care about this issue of, for example, 75 00:09:31.420 --> 00:09:37.420 performance of the price level enough that they would rather switch over to this different money. 76 00:09:37.420 --> 00:10:00.420 Now certainly, gold standard advocates don't need to be committed to viewing gold in these macro-instrumental terms, and I think they ought not, that is, viewing the gold standard as a clever device for producing low inflation or low interest rates or high growth in real output. 77 00:10:00.420 --> 00:10:07.020 I'm not saying that the gold standard isn't conducive to those sort of goals, 78 00:10:07.020 --> 00:10:12.680 but it shouldn't be regarded as a tool or as a device for producing those sort of things. 79 00:10:12.680 --> 00:10:18.720 Rather, the case to be made for the gold standard is that it provides the kind of money people want. 80 00:10:18.720 --> 00:10:26.220 And I noticed yesterday in Ron Paul's arguments, he had four points that he made on behalf of the gold standard, 81 00:10:26.220 --> 00:10:35.220 And I noted that none of them, or not one of them, was the case that the gold standard will produce less inflation, or will produce a stable purchasing power of money. 82 00:10:37.220 --> 00:10:54.220 I think this is important because some monetarists, in particular I cite Thorpe Kagan in the paper, have misinterpreted the gold standard case as simply being a case for a particular institutional arrangement that's supposed to produce a stable purchasing power of money. 83 00:10:54.220 --> 00:11:24.220 and I think that's really a misinterpretation. Some people who call themselves gold standard advocates have recently been calling for what they call a price rule whereby the fiat money authority is supposed to peg the price of gold through open market operations or in some other way to vary the quantity of fiat money in order to produce a stable price level that strikes me not as part of the traditional gold standard camp 84 00:11:24.220 --> 00:11:28.220 but rather a variant of early monetarism. 85 00:11:28.220 --> 00:11:38.220 Now, if this is our rationale for the gold standard, the idea that it is consistent with individual sovereignty, 86 00:11:38.220 --> 00:11:45.220 then free banking clearly is necessary to have the system behave in the way we want it to behave. 87 00:11:45.220 --> 00:11:52.220 Individual sovereignty in economic affairs simply amounts to the freedom of people to make their own bargains. 88 00:11:52.220 --> 00:11:57.500 for buyers and sellers to get together without the impositions of third parties telling them 89 00:11:57.500 --> 00:12:02.500 what they may or may not do. In other words, free trade. And what free banking entails is 90 00:12:02.500 --> 00:12:08.420 simply free trade in the market for bank issued monies or bank demand liabilities, namely 91 00:12:08.420 --> 00:12:12.940 bank notes and demand deposits. There aren't any barriers placed in the way of people dealing 92 00:12:12.940 --> 00:12:18.820 with whatever banks they want to deal with or for banks pursuing any policies that they 93 00:12:18.820 --> 00:12:25.820 that they want to pursue, constrained by the fact that they have to attract customers who want to deal with them. 94 00:12:25.820 --> 00:12:33.820 So free banking subjects banks to no other legislative rules or no other laws other than those imposed on every industry, 95 00:12:33.820 --> 00:12:41.820 which is namely a general legal prohibition against fraud or breach of contract. 96 00:12:41.820 --> 00:12:47.820 In particular, under free banking, people aren't limited to dealing with the notes only of a central bank. 97 00:12:47.820 --> 00:12:53.820 Monopolization of the note issue is a defining characteristic of central banking in the United States, 98 00:12:53.820 --> 00:13:00.820 it was achieved to a partial extent under the National Banking Act, but fully by the Federal Reserve system, 99 00:13:00.820 --> 00:13:08.820 and even when it was accomplished by the Bank of England through legal suppression in both cases of alternative issuers of currency. 100 00:13:08.820 --> 00:13:34.820 There's no evidence that there's a natural tendency toward monopoly in issuing banknotes, nor is there evidence that private producers can't produce banknotes in a satisfactory way so that we need to monopolize the issue of currency, which is something I think Mr. Partiz suggested yesterday. It seems to me clear that he doesn't have his facts straight on this. 101 00:13:34.820 --> 00:13:44.820 It seems to me the only way to ensure that people get the kind of bank liabilities they want, the kind of inside money as economists call it, 102 00:13:44.820 --> 00:13:49.820 is to allow open competition between different issuers of banknotes and demand deposits. 103 00:13:49.820 --> 00:13:57.820 And the liabilities that banks issue can vary on different quality dimensions, and so there is a real choice involved. 104 00:13:57.820 --> 00:14:01.500 One bank's notes may be easier to redeem than another's. 105 00:14:01.500 --> 00:14:05.560 The issuer may be more reputable in the opinion of some people. 106 00:14:05.560 --> 00:14:10.780 And the bank may take greater steps against the counterfeiting of its notes. 107 00:14:10.780 --> 00:14:16.080 The most important characteristic, of course, is the ability of a banknote to circulate. 108 00:14:16.080 --> 00:14:19.860 And that's what the competition among banknote issuers tends to promote. 109 00:14:19.860 --> 00:14:23.640 The competition is very similar to the competition we see today between issuers of 110 00:14:23.640 --> 00:14:27.240 Travelers' Checks or Checking Accounts or Credit Cards. 111 00:14:29.840 --> 00:14:32.800 So if we respect microeconomic criteria 112 00:14:32.800 --> 00:14:34.920 and the idea that economic institutions 113 00:14:34.920 --> 00:14:37.740 ought to provide the sort of goods people want, 114 00:14:37.740 --> 00:14:40.420 then that requires the government doesn't limit 115 00:14:40.420 --> 00:14:43.300 people's choices among banknote issuers. 116 00:14:45.940 --> 00:14:46.780 Okay. 117 00:14:47.720 --> 00:14:52.080 Now, the rationale of free banking 118 00:14:53.640 --> 00:15:03.640 To put it another way, is the freedom to discover which brands of banknotes and what types of banknotes and demand deposits best suit consumer preferences. 119 00:15:03.640 --> 00:15:11.640 It's based on avoiding what was yesterday called the synoptic delusion, or what Hayek would call constructivism, 120 00:15:11.640 --> 00:15:16.640 the idea that experts can determine what the best sort of money is for everybody else to use. 121 00:15:16.640 --> 00:15:23.640 The Central Bank is a system where we allow people to choose the kind of money they prefer. 122 00:15:23.640 --> 00:15:31.640 If you let the central bank monopolize the supply of currency, you eliminate people's ability to accept different kinds of money. 123 00:15:31.640 --> 00:15:39.640 Now the discussion of free banking usually focuses, as I've focused up to this point, on the liability side of the bank's balance sheet. 124 00:15:39.640 --> 00:15:45.000 of Money, namely particularly the freedom to issue banknotes. But there's also the 125 00:15:45.000 --> 00:15:49.320 asset side of the bank's balance sheet to consider. And there are basically two kinds 126 00:15:49.320 --> 00:15:54.440 of assets a bank on a gold standard holds. One is VC, right, its reserves that it uses 127 00:15:54.440 --> 00:15:59.720 to redeem its liabilities on demand. And the other is its interest earning assets, its 128 00:15:59.720 --> 00:16:10.200 Loans and Securities. Historically, both sorts of assets have also been subject to regulation. 129 00:16:10.200 --> 00:16:13.480 So the idea that banks ought to be free to hold whatever assets they like has also been 130 00:16:13.480 --> 00:16:24.240 controversial. The so-called free banking system in the United States between 1838 and 131 00:16:24.240 --> 00:16:31.960 1863 in various states in the United States, included as part and parcel of the system 132 00:16:31.960 --> 00:16:35.480 very definite restrictions on the freedom of banks to hold the assets they wanted to 133 00:16:35.480 --> 00:16:36.480 hold. 134 00:16:36.480 --> 00:16:40.600 Namely, the rule was that you can open a bank and issue bank notes, provided that you buy 135 00:16:40.600 --> 00:16:43.080 some state government debt. 136 00:16:43.080 --> 00:16:47.920 Part of the scheme was a way of creating a market for state government debt. 137 00:16:47.920 --> 00:16:55.920 Incidentally, this helps to explain why there were such frequent failures among banks in certain states, 138 00:16:55.920 --> 00:17:00.920 namely that they weren't free to spread their portfolios, but they were required to own a large bulk of, 139 00:17:00.920 --> 00:17:03.920 a large part of their assets in the form of state government debt, 140 00:17:03.920 --> 00:17:11.920 and recent historical work has shown that the times when there were a lot of bank failures were the times when the price of state debt was falling, 141 00:17:11.920 --> 00:17:14.920 and so these banks were running into trouble. 142 00:17:14.920 --> 00:17:21.400 A second sort of restriction on asset-holding options by banks goes under the name of reserve 143 00:17:21.400 --> 00:17:26.640 requirements, the idea that banks can't hold whatever amount of specie reserve they see 144 00:17:26.640 --> 00:17:33.440 fit, but rather they have to hold some amount that's mandated by a regulator and based upon 145 00:17:33.440 --> 00:17:39.160 the quantity of its liabilities. These have been part of federal regulation for over a 146 00:17:39.160 --> 00:17:44.440 century. Both these sort of regulations on the asset side, again, restrict individual 147 00:17:44.440 --> 00:17:48.080 of Sovereignty. They restrict people's ability to choose among banks that offer different 148 00:17:48.080 --> 00:17:54.800 deals, that offer different packages of risk and return particularly. Now people don't 149 00:17:54.800 --> 00:17:59.440 want risk, as I read the historical record, people don't want risky banknotes. That is 150 00:17:59.440 --> 00:18:06.700 they want banknotes whose value in terms of specie is fixed, which suggests that most 151 00:18:06.700 --> 00:18:13.440 of the competition is going to be on providing reputable banknotes. And in the clearest example 152 00:18:13.440 --> 00:18:20.600 in history we have of competition, free competition, free banking, namely the banking system of 153 00:18:20.600 --> 00:18:26.000 Scotland, we see quite definitely banks competing in order to establish reputations in the eyes 154 00:18:26.000 --> 00:18:27.000 of the public. 155 00:18:27.000 --> 00:18:31.760 And the second thing banks are going to compete on is, as they do today, paying competitive 156 00:18:31.760 --> 00:18:34.160 rates of interest on their deposits. 157 00:18:34.160 --> 00:18:39.360 So banks have to weigh in considering whether to hold more interest earning assets or more 158 00:18:39.360 --> 00:18:48.360 or gold, whether they want to run a greater risk of being illiquid by holding less gold, 159 00:18:48.360 --> 00:18:55.360 or they want to be a little less competitive in paying interest by holding more gold and less interest earning assets. 160 00:18:55.360 --> 00:19:02.360 Now some gold standard advocates, and I believe Murray is in the room, Murray Rothbard, 161 00:19:02.360 --> 00:19:08.360 have argued for 100% reserve requirements against demand deposits and banknotes. 162 00:19:08.360 --> 00:19:23.360 Of course, this is not urged as some kind of paternalistic intervention into the banking system, but rather as a matter of jurisprudence on the grounds that holding less than 100% reserves is per se fraudulent. 163 00:19:23.360 --> 00:19:28.360 And I believe Ron Paul suggested that he held that view yesterday. 164 00:19:28.360 --> 00:19:36.360 In Rothbard's view, bank notes are the legal equivalent of warehouse receipts and ought to be treated as such. 165 00:19:36.360 --> 00:19:58.360 This view is not based on what legal practice actually is, or ever was, and in Murray's recent book on the mystery of banking, he in fact takes note of court decisions that decided that the contract written on a bank note was not in fact a bailment or not in fact a warehouse receipt, but something different. 166 00:19:58.360 --> 00:20:12.360 I find it difficult to understand why somebody committed to individual sovereignty would want to prevent banks and their customers from making whatever sorts of contractual arrangements they find mutually beneficial. 167 00:20:12.360 --> 00:20:26.360 And it seems to me that court decisions to the effect that banknotes do not contractually bind their issuers to holding 100% reserves are perfectly reasonable if you look at the contract that's actually written on the face of the banknote. 168 00:20:26.360 --> 00:20:35.640 A typical banknote would say the bank of whatever promised to pay the bearer on demand one pound sterling. 169 00:20:35.640 --> 00:20:38.320 In the United States it would say one dollar. 170 00:20:38.320 --> 00:20:43.240 There's no promise made about reserve holding behavior. 171 00:20:43.240 --> 00:20:48.680 There's nothing to indicate that it establishes a warehouse receipt or a bailment contract. 172 00:20:48.680 --> 00:20:52.920 Now, if people want a warehouse receipt or a bailment contract, 173 00:20:52.920 --> 00:20:57.720 Of course, I don't think that there should be any obstacle in the way of arranging it. 174 00:20:57.720 --> 00:21:04.820 And of course, nothing in a free banking system prevents people from dealing with 100% reserved banks if they want to. 175 00:21:04.820 --> 00:21:12.320 And of course, banks today offer safety deposit boxes for people who want to retain unconditional title to the species they deposit. 176 00:21:12.320 --> 00:21:20.320 But I think it would be silly to suggest that historically banknotes and demand deposits only gained acceptance 177 00:21:20.320 --> 00:21:30.640 When people who helped them were misled by the bank, that is that they were misrepresented as being bailments and warehouse receipts. 178 00:21:30.640 --> 00:21:36.880 I think it's evident that people knew that banks held fractional reserves and voluntarily accepted the notes on that basis. 179 00:21:36.880 --> 00:21:48.600 And I agree with the remark that Professor Yeager made yesterday that there's no way to suppress fractional reserve banking without heavy government intervention. 180 00:21:48.600 --> 00:22:00.600 If you interpret a bank note contract the way I do, then prevention of breach of contract by a bank only requires that it actually redeem all notes that are presented for redemption. 181 00:22:00.600 --> 00:22:04.600 Fractional reserves don't constitute a breach of contract, per se. 182 00:22:04.600 --> 00:22:12.680 Well, I'm talking about fractional reserves. Let me add a footnote to Roger Garrison's 183 00:22:12.680 --> 00:22:18.920 paper. He talked about the resource cost of the gold standard as estimated by Milton Friedman, 184 00:22:18.920 --> 00:22:24.740 for example. I also looked at Friedman's estimate and discovered that his estimate 185 00:22:24.740 --> 00:22:30.120 of the resource cost, which came to something like two percent of yearly GNP, was based 186 00:22:30.120 --> 00:22:37.960 based on assuming that there was a 100% gold reserve held against all forms of money. 187 00:22:37.960 --> 00:22:46.120 Not only gold coin was 100% gold, and not only were demand deposits backed 100% by gold, 188 00:22:46.120 --> 00:22:52.200 but also time deposits, in his estimate, were backed 100% by gold. 189 00:22:52.200 --> 00:22:59.240 If you take the sort of reserve ratios that banks actually held in a free banking system 190 00:22:59.240 --> 00:23:05.040 The estimate of the resource cost falls by about a factor of 100. 191 00:23:05.040 --> 00:23:10.420 So the estimate I came up with of the resource costs, and we now know the limitations of 192 00:23:10.420 --> 00:23:14.760 that sort of estimate, which I freely admit, that anyway instead of being 2% of annual 193 00:23:14.760 --> 00:23:19.880 GNP, it's more like 2 one-hundredths of 1%. 194 00:23:19.880 --> 00:23:25.760 These resource cost savings are important in the sense that they suggest, again, a reason 195 00:23:25.760 --> 00:23:42.760 In addition to this micro sovereignty case, there is a macro case to be made for free banking, and I don't want to leave the impression that you can't defend free banking on the grounds that it's better for the economy in some aggregate sense. 196 00:23:42.760 --> 00:23:51.760 In fact, I think it is better that a gold standard is likely to perform better with a free banking system than if it's regulated by a central bank. 197 00:23:51.760 --> 00:23:57.760 and a lot of economists have the impression that a gold standard is a very dangerous thing 198 00:23:57.760 --> 00:24:06.760 and if it worked well in the 19th century it's only because the Bank of England and other central banks acted in an artful manner to manage it 199 00:24:06.760 --> 00:24:10.760 and provide it with some flexibility that it otherwise would not have had. 200 00:24:10.760 --> 00:24:18.760 My view is almost diametrically opposed to that, that is there's a large body of literature and economics 201 00:24:18.760 --> 00:24:22.760 not just the Austrian School but also the Monetarist School 202 00:24:22.760 --> 00:24:28.760 that identifies the major source of business cycle disturbances with money supply errors 203 00:24:28.760 --> 00:24:30.760 let us call them. 204 00:24:30.760 --> 00:24:34.760 The advantage of free banking is that by having a plurality of money issuers 205 00:24:34.760 --> 00:24:39.760 you minimize the chance that there will be a major money supply error. 206 00:24:39.760 --> 00:24:45.760 One reason is obvious, if you have a lot of issuers and each one is only a small part of the circulation 207 00:24:45.760 --> 00:24:50.760 that nobody controls a large enough share to make a major impact on the money supply. 208 00:24:50.760 --> 00:24:55.760 But what's equally important is something that Richard Ebeling just emphasized 209 00:24:55.760 --> 00:24:58.760 as part of Mises' conception of free banking, 210 00:24:58.760 --> 00:25:02.760 is that there are automatic checks on the overissue of notes by any particular bank 211 00:25:02.760 --> 00:25:05.760 in the form of the interbank clearing mechanism. 212 00:25:05.760 --> 00:25:10.760 The clearing house works on a decentralized basis to give issuers the information they need 213 00:25:10.760 --> 00:25:14.760 and the incentives they need to avoid money supply errors, 214 00:25:14.760 --> 00:25:19.640 correct promptly any deviation of the quantity of money they supply from the quantity people 215 00:25:19.640 --> 00:25:25.840 in the market want to hold. It's a negative feedback process that isn't present in central 216 00:25:25.840 --> 00:25:31.360 banking because the supply of banknotes is monopolized by a central bank. It doesn't 217 00:25:31.360 --> 00:25:38.840 have any rivals who will collect its notes and return them to it. So my point in sum 218 00:25:38.840 --> 00:25:43.840 The problem is that only with free banking is a gold standard fully self-regulating. 219 00:25:48.840 --> 00:25:57.840 The problem of a central bank in regulating a gold standard is akin to the problem of a central planner in regulating any other sort of industry. 220 00:25:57.840 --> 00:26:09.840 The way in which a central bank is in fact disciplined is only through the outflow of gold from the country as a whole. 221 00:26:09.840 --> 00:26:15.840 Flows of gold between banks don't take place as a result of an overissue by a central bank. 222 00:26:15.840 --> 00:26:21.840 Instead, it doesn't find out that it's overissued until gold begins to flow out of the country. 223 00:26:21.840 --> 00:26:29.840 This is a relatively slow and drawn out process and it's one that has major macroeconomic complications to go with it. 224 00:26:29.840 --> 00:26:37.840 That is, there's enough time, there's a long and variable lag, to use Milton Friedman's summary of the historical evidence, 225 00:26:37.840 --> 00:26:44.840 between money supply shocks issued by the central bank and their impact on prices and the performance of the economy. 226 00:26:44.840 --> 00:26:49.840 So the central bank has enough leeway, even under a gold standard, to create business cycles, 227 00:26:49.840 --> 00:27:01.840 to make money supply errors so great that they drive an artificial boom which has to be followed by a bust when the central bank discovers the error and reverses it by contraction. 228 00:27:01.840 --> 00:27:11.840 So there is a regulating mechanism on a central bank. The trouble is that it's not sensitive enough and doesn't operate quickly enough. 229 00:27:11.840 --> 00:27:21.600 The check that does operate on a central bank operates only because there is some competition left in an attenuated form, mainly between different central banks in different countries. 230 00:27:21.600 --> 00:27:25.040 If you had a world central bank, even that check would be attenuated. 231 00:27:25.040 --> 00:27:52.040 In a paper like this prepared for the Mises Institute, it's only appropriate to note that this basic argument that free banking is the way to prevent the money supply errors of central banking under a gold standard is an argument that comes from Ludwig von Mises. 232 00:27:52.040 --> 00:28:09.040 Mises wrote, let me quote him just briefly, that under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular, one is tempted to say normal, feature of the economic system. 233 00:28:09.040 --> 00:28:14.040 Only free banking would have rendered the market economy secure against crises and depressions. 234 00:28:14.040 --> 00:28:29.040 So Mises saw quite clearly and emphasized that free banking is an essential barrier against the experience of business fluctuations driven by over expansionary central bank policy. 235 00:28:29.040 --> 00:28:39.040 Now today we have basically two monetary problems superimposed on each other, or we can divide our problems into two categories. 236 00:28:39.040 --> 00:28:44.040 One is cyclical instability. We have the central bank driving us through business cycles. 237 00:28:44.040 --> 00:28:50.040 Second, we have a long-term problem in the unpredictability of the purchasing power of the money. 238 00:28:50.040 --> 00:28:57.040 The overwhelming source of our cyclical disturbances has, of course, been the money supply shocks emanating from the Federal Reserve system 239 00:28:57.040 --> 00:29:02.040 and in other countries emanating from the other central banks. 240 00:29:02.040 --> 00:29:07.040 On the other hand, we have a major threat to the ability of our economy to coordinate long-term plans 241 00:29:07.040 --> 00:29:15.040 Based on the fact that the purchasing power of money has become impossible to predict with any accuracy more than a few quarters into the future. 242 00:29:17.040 --> 00:29:24.040 The reason being that the quantity of money isn't anchored to anything other than the discretion of a monetary bureaucracy. 243 00:29:24.040 --> 00:29:33.040 In this sort of environment, I don't think it's surprising that the gold standard, which as we know Keynes once derived it as a barbarous relic, 244 00:29:33.040 --> 00:29:39.560 has attracted new attention as a device for limiting the discretion of central banks. 245 00:29:39.560 --> 00:29:44.840 My point is that I think we ought to go beyond thinking of gold as a device for limiting central banks 246 00:29:44.840 --> 00:29:49.840 and think of it as providing the possibility for eliminating central banks. 247 00:29:49.840 --> 00:29:51.640 There isn't any question that 248 00:29:51.640 --> 00:29:56.640 committing a central bank to a fixed gold definition of the monetary unit 249 00:29:56.640 --> 00:30:00.480 would anchor the nominal quantity of money, that is, the central bank 250 00:30:00.480 --> 00:30:02.920 as long as it maintains its commitment 251 00:30:02.920 --> 00:30:05.960 which central banks have been pretty fickle about doing, 252 00:30:05.960 --> 00:30:08.560 especially when they have to finance a war. 253 00:30:08.560 --> 00:30:11.640 Anyway, as long as they do maintain that commitment, 254 00:30:11.640 --> 00:30:14.560 it is true that they can't expend the quantity of money 255 00:30:14.560 --> 00:30:16.480 to any extent they want. 256 00:30:16.480 --> 00:30:19.280 Eventually, discipline does exert itself. 257 00:30:21.960 --> 00:30:23.920 And thereby, if you had a gold standard 258 00:30:23.920 --> 00:30:27.480 with a central bank, you would have improvement 259 00:30:27.480 --> 00:30:29.000 in this long-term predictability 260 00:30:29.000 --> 00:30:31.680 of the purchasing power of money, 261 00:30:31.680 --> 00:30:33.360 as there was in the 19th century. 262 00:30:34.880 --> 00:30:37.000 But this doesn't go far enough 263 00:30:37.000 --> 00:30:38.840 because it doesn't dam up the source 264 00:30:38.840 --> 00:30:41.120 of cyclical disturbances, right? 265 00:30:41.120 --> 00:30:43.960 So for the purpose of eliminating the central bank's 266 00:30:45.020 --> 00:30:47.800 ability to cause a business cycles, 267 00:30:47.800 --> 00:30:51.720 the gold standard is inadequate without free banking. 268 00:30:53.280 --> 00:30:55.600 A central bank can manipulate in the short run 269 00:30:55.600 --> 00:30:58.680 the quantity of what economists call high powered money 270 00:30:58.680 --> 00:31:01.340 because the central bank's liabilities serve as reserves 271 00:31:01.340 --> 00:31:04.140 for Commercial Banks in a System. 272 00:31:04.140 --> 00:31:06.460 And therefore the central bank can subject the economy 273 00:31:06.460 --> 00:31:09.100 to what Mises called credit expansion 274 00:31:09.100 --> 00:31:10.940 with all its inevitable consequences. 275 00:31:13.100 --> 00:31:15.780 Okay, let's say that it's taken for granted 276 00:31:15.780 --> 00:31:18.580 that you accept the argument that central banks 277 00:31:18.580 --> 00:31:21.140 can create business cycles. 278 00:31:21.140 --> 00:31:23.500 Is it inevitable that they will? 279 00:31:23.500 --> 00:31:24.340 Well, I think it is. 280 00:31:24.340 --> 00:31:25.900 I think there are two reasons. 281 00:31:27.540 --> 00:31:30.740 First, central bankers like other central planners 282 00:31:30.740 --> 00:31:39.740 don't have the information that would be necessary for them to perform as skillfully as a market system does in matching supplies with demands. 283 00:31:39.740 --> 00:31:47.740 And so they're almost inevitably prone to make errors because they don't have the information that would be necessary to avoid errors in the money supply. 284 00:31:47.740 --> 00:31:54.740 Second, the incentive structure surrounding monetary authorities is important, 285 00:31:54.740 --> 00:32:00.740 Because the inflation and recession we're suffering under today, I think, can be understood as a by-product, 286 00:32:00.740 --> 00:32:07.740 perhaps an unintended by-product, but a by-product of policies that they do intentionally pursue. 287 00:32:07.740 --> 00:32:16.740 The public choice approach to government agencies suggests that if you entrust government policy makers with control over money, 288 00:32:16.740 --> 00:32:21.740 you ought to expect them to succumb to the temptations of easy money. 289 00:32:21.740 --> 00:32:27.620 that is to succumb to the concentrated interests that are brought to bear on them and to ignore 290 00:32:27.620 --> 00:32:31.260 the diffuse interests of the general public which are not in any way brought to bear on 291 00:32:31.260 --> 00:32:41.260 them or not at least in an effective way. A central bank on a gold standard to get back 292 00:32:41.260 --> 00:32:47.220 to the information problem has to rely on such things as price indices, interest rate 293 00:32:47.220 --> 00:32:52.900 Indices, exchange rate movements within the gold points and finally international gold 294 00:32:52.900 --> 00:33:01.180 flows to find out how its behavior is affecting the economy. The trouble is that this sort 295 00:33:01.180 --> 00:33:06.180 of feedback again is too slow or too ambiguous and it's only after the damage has been done 296 00:33:06.180 --> 00:33:11.980 that the central bank finds out that it's been pursuing a policy that can't be maintained. 297 00:33:11.980 --> 00:33:19.980 In the few minutes left, let me then turn to the question, is gold necessary for free banking? 298 00:33:19.980 --> 00:33:24.980 Let's look at it the other way. It's conceivable that you can have a free banking system, 299 00:33:24.980 --> 00:33:30.980 that is a system where government is not involved in the provision of money, 300 00:33:30.980 --> 00:33:34.980 with an outside money, a basic money, other than gold. 301 00:33:34.980 --> 00:33:37.980 Silver is an obvious alternative candidate. 302 00:33:37.980 --> 00:33:47.980 If you suppose that bank liabilities are redeemable for silver rather than gold, it doesn't change any of the analytical properties of a free banking system. 303 00:33:47.980 --> 00:33:52.980 And once you open the field to silver, well, you can open it to a lot of other candidates. 304 00:33:52.980 --> 00:34:00.980 And there are several sorts of non-fiat currencies that in the past have had their advocates, and I suppose still do today. 305 00:34:00.980 --> 00:34:08.980 A third candidate, besides gold and silver, is what used to be called simmetallic currency. 306 00:34:08.980 --> 00:34:13.980 If you like, you can call it the Vermeel standard, Vermeel being gold plated silver. 307 00:34:13.980 --> 00:34:21.980 The idea is that you define the monetary unit as so many ounces of gold plus so many ounces of silver. 308 00:34:21.980 --> 00:34:25.980 I believe Alfred Marshall was an advocate of that. 309 00:34:25.980 --> 00:34:36.980 A fourth sort of currency you can think of is currency redeemable for some basket of commodities, some non-metallic or non-monetary commodity or basket of commodities. 310 00:34:36.980 --> 00:34:45.980 A fifth would be currency whose redemption rate is indexed to some basket in order to provide stable purchasing power. 311 00:34:45.980 --> 00:34:51.980 You can also think a sixth alternative is inconvertible currency that's privately issued. 312 00:34:51.980 --> 00:34:57.980 This is something that Hayek's denationalization of money booklet suggests. 313 00:34:57.980 --> 00:35:05.980 Then there are two further possibilities for eliminating government control over the quantity of outside currency. 314 00:35:05.980 --> 00:35:17.980 One is to freeze the stock of fiat money, that is, don't retire Federal Reserve notes, but simply freeze the stock of them and dismantle the Fed and don't let anybody touch the quantity of Federal Reserve notes. 315 00:35:17.980 --> 00:35:23.740 of Notes, and second is to have a payment system that doesn't use money at all. It doesn't 316 00:35:23.740 --> 00:35:30.620 have any outside money. Well, what's a person who's committed to the individual sovereignty 317 00:35:30.620 --> 00:35:36.380 and microeconomic approach supposed to do when faced with this wide array of choices 318 00:35:36.380 --> 00:35:43.660 of monetary standards? It seems to me the only way to cut through this welter of proposals 319 00:35:43.660 --> 00:35:47.780 is to let the potential suppliers of these kind of competing currencies compete. In other 320 00:35:47.780 --> 00:35:56.780 In other words, lift any prohibitions, taxes, regulations, or accounting rules that serve as barriers to competition among outside monies. 321 00:36:00.780 --> 00:36:10.780 It seems to me that none of these historical evidence suggests, none of these alternatives would lead people to voluntarily abandon the gold standard if there were a gold standard initially. 322 00:36:10.780 --> 00:36:15.780 But I don't think that question ought to be foreclosed. We ought to leave that question open. 323 00:36:15.780 --> 00:36:18.780 Let the market decide. 324 00:36:18.780 --> 00:36:25.780 Now in a sense, by establishing gold as the initial standard, we're giving a very significant head start. 325 00:36:25.780 --> 00:36:29.780 This is a point that Professor Yeager made yesterday. 326 00:36:29.780 --> 00:36:34.780 For the reason, which was explained by Carl Menger, the founder of the Austrian School, 327 00:36:34.780 --> 00:36:39.780 that everybody in the economy tends to converge on a single monetary standard, 328 00:36:39.780 --> 00:36:43.500 it's very difficult for any new monetary standard to get established 329 00:36:43.500 --> 00:36:50.660 it's very difficult to convince any individual trader that he should start using a money that nobody else uses yet 330 00:36:50.660 --> 00:36:54.900 something that's neither a claim to money nor itself a money 331 00:36:54.900 --> 00:36:58.580 the reason people accept fiat currency 332 00:36:58.580 --> 00:37:01.200 as much as they may ideologically dislike it 333 00:37:01.200 --> 00:37:03.600 is that it is in fact 334 00:37:03.600 --> 00:37:06.240 the most marketable 335 00:37:06.240 --> 00:37:07.860 item in the economy 336 00:37:07.860 --> 00:37:15.320 that is, the thing that it's easiest to buy things from other people with, we accept it because we know the next person will accept it 337 00:37:15.320 --> 00:37:21.580 we don't accept other things because we're not sure the next person will accept it 338 00:37:21.580 --> 00:37:26.960 so if you're thinking about the transition from the system we have now to a new system 339 00:37:26.960 --> 00:37:29.860 there isn't any a priori reason 340 00:37:29.860 --> 00:37:34.260 to favor gold or silver over other things 341 00:37:34.260 --> 00:37:38.620 in an a priori sense of what's the best monetary system, 342 00:37:38.620 --> 00:37:41.860 that is, if you completely disregard history, 343 00:37:41.860 --> 00:37:45.340 the question is completely open. 344 00:37:45.340 --> 00:37:51.460 However, there may be a historical argument for making gold or silver the initial choice, 345 00:37:51.460 --> 00:37:57.840 and that is that it's gold and silver that emerged historically, at least in the advanced nations of the West, 346 00:37:57.840 --> 00:38:02.060 out of the invisible hand convergence process, 347 00:38:02.060 --> 00:38:08.060 driven by individual preferences by which a money emerged out of barter. 348 00:38:08.060 --> 00:38:15.960 It was gold and silver that were chosen by market participants as money before governments got into the act of restricting monetary options. 349 00:38:15.960 --> 00:38:20.760 So they are, in a sense, the money of the market. 350 00:38:20.760 --> 00:38:26.660 There are historical cases where gold and silver voluntarily displaced other monetary standards 351 00:38:26.660 --> 00:38:29.920 by a more or less gradual diffusion 352 00:38:29.920 --> 00:38:35.200 because they represented superior monies in the eyes of people using money. 353 00:38:35.200 --> 00:38:40.120 In areas that were using other monies that came into contact with gold and silver areas, 354 00:38:40.120 --> 00:38:43.900 traders abandoned the other monies and adopted gold and silver. 355 00:38:43.900 --> 00:38:46.760 One example that is kind of amusing is that 356 00:38:46.760 --> 00:38:51.160 in Sweden, there historically evolved a copper standard 357 00:38:51.160 --> 00:38:55.100 because I guess there weren't supplies of gold and silver in Sweden. 358 00:38:55.100 --> 00:38:58.480 Anyway, copper became the monetary commodity. 359 00:38:58.480 --> 00:39:28.480 Well, the purchasing power of copper per ounce of copper is fairly low, so to make a big payment in copper requires a fairly large slab of copper, and there are museums, I'm told I haven't seen these personally, there are museums in Sweden where there are displays of huge slabs of copper that were used to make payments, and there were young boys whose entire job was to carry big slabs of copper around in order to help people make payments. Well, it's fairly obvious that that's a rather cumbersome way to run your 360 00:39:28.480 --> 00:39:35.480 and the monetary system, and if faced with a choice between that and gold and silver, people might voluntarily abandon copper. 361 00:39:35.480 --> 00:39:45.480 Well, to summarize, it's not logically necessary that we have gold and silver in order to have a free banking system, 362 00:39:45.480 --> 00:39:53.480 but it seems to me that if you wish to respect consumer preferences, and you believe that the historical record demonstrates that 363 00:39:53.480 --> 00:39:57.480 that gold and silver were the outcome of consumer preferences. 364 00:39:57.480 --> 00:40:01.480 Then it seems to me that even though what we ultimately want to do 365 00:40:01.480 --> 00:40:06.480 is throw the competition open to all private comers, 366 00:40:06.480 --> 00:40:10.480 a species standard seems to me to be the natural place to start.