Economics

What type of Free Banking do we want?

The article below represents the intellectual endeavours of two of the young stars of the Austrian School to address some of what they describe as “quibbles” with one of the more senior members of the School, Professor George Selgin and to some extent Prof Horwitz and our own Founding Fellow, Prof Anthony Evans.

I have taken great inspiration from all of the people mentioned above, some more than others, but I fall on the side of the 100%FB for some of the reasons advocated by the two writers. Debates get heated and we get hot under the collar, but one thing is for sure: with an eye on practical politics, we must remember that the true enemy is the monetary socialism that we have today. We may have currency failure in Europe soon. In the USA we may have a final realisation that, as in the UK at the dawn of the First World War, the baton of economic leadership has moved on.

These are the most uncertain of times.

If we in the free market movement are to have any hope of getting anywhere, we must be able provide positive policy solutions. I would urge all mentioned here to turn attention to just that going forward, if no further understandings can be made between FRFB and 100%FB. I know for sure, I would bite your hand off today if any one of those systems was offered in exchange for an end to state supported FR banking! There is even a small chance that as this Great Recession rolls out, that is all the powers that be may be left with as policy solutions. We must be ready to provide solutions to our political masters.

Unanswered Quibbles with Fractional Reserve Free Banking

Abstract: In this article we reply to George Selgin’s counterarguments to our article “Fractional Reserve Free Banking: Some Quibbles”. Selgin regards holding cash as saving while we focus on the real savings necessary to maintain investment projects. Real savings are unconsumed real income. Variations in real savings are not necessarily equal to variations in cash holdings. We show that a coordinated credit expansion in a fractional reserve free banking (FRFB) system is possible and that precautionary reserves consequently do not pose a necessary limit. We discuss various instances in which a FRFB system may expand credit without a prior increase in real savings. These facets all demonstrate why a fractional reserve banking system – even a free banking one – is inherently unstable, and incentivized to impose a stabilizing central bank. We find that at the root of our disagreements with Selgin lies a different approach to monetary theory. Selgin subscribes to the aggregative equation of exchange, which impedes him from seeing the microeconomic problems that the stabilization of “MV” by a FRFB system causes.

Read the whole article (PDF).

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5 comments to What type of Free Banking do we want?

  • Richard Allan

    I don’t understand the question. “What type of Free Banking do we want? The kind with government regulation, or without?” Surely the question answers itself.

    Yes, credit expansion is possible on a free-market regime. Of course it is! If I write an IOU, I’ve just expanded credit. Whether or not that note circulates as currency is entirely a matter for the holder and whoever he wishes to trade with. Bills of credit have always circulated as currency, and always will. Any attempt to stymie this with government regulation is anti-libertarian and doomed to failure.

    Yes, sometimes people who voluntarily hold debt lose their money when the debtors default. And yes, sometimes prices fall when holders of the circulating medium collectively (and coincidentally) decide to voluntarily reduce their cash balances. And yes, sometimes employers who voluntarily contract with their workers for a given money wage may find that the money prices of their product fall to the point where they have to lay off some of their workforce. But to the extent that this is the product of voluntary decisions, how is this “bust” any different from, say, the bust caused by an oil shock? Sometimes businesses go under and it’s nobody’s fault; and sometimes government intervention to restore the price level (or preventive regulation to keep it from dropping in the first place, as the 100% reserve advocates demand) could have stopped it. But I thought the point was to argue against violations of liberty for the sake of “economic security”.

    By the way, I don’t understand the apparent antagonism between Austrians and Keynesians. The argument that a fall in the price level (ie. a rise in the interest rate) caused by a reduction in stock of the circulating medium will cause increases in real wages (ie. a reduction in the return to capital) and therefore unemployment is 100% Keynesian.

    • Good Evening Richard,

      Well no, as there are two types of free banking offered, FRFB and 100% FB, but I would actually say maybe even a third, that both traditional FB Schools may well conclude out at.

      A party entering into a pooling of their property rights with others to form a fractional reserved bank deposit with the bank could well be something very consistent with 100% reserve banking and not fall foul of the cherished liberties we all seek to advocate to allow freely consenting adults to do just what they like to do, so long as they harm no one else.

      A bank can be a custodian of deposits for depositors who want safe keeping. They can be a lender of savings for those people who want their money lent out for what ever duration.

      They can allow a fractional reserve account with all parties knowing what is going on.

      These three distinct silos , if people are fully contractually aware of what they are getting involved with would satisfy most 100% reserve people. The first two types of contract would be called banking and the later would be gambling / hedge fund type activities.

      We established via a survey of 2,000 people conducted by ICM, that only 8% of people really new what happened to their money when deposited in a bank. The staggering ignorance and confusion lends itself to honest and clear reform like this, clear labelling of accounts. With regard to the third type of account, I do not see why people engaged with acts of custody and or savings / timed lending would need to suffer when the third type of contract goes belly up. Hence if common law judges did not separate the latter from the former by way of strict legal walls, I would think this would lead to a violation of the first two type of contracting parties property rights, hence I think this style of banking is the only really effective type of pro property rights , pro liberty free banking.

      Fractional reserve free banking can’t absolve itself from these property rights violations unless it does split its business up into custody , lending and FR accounts and advocate a clear contractual labelling policy so people can make informed choices about what they are doing. Therefore, I do think that the logical conclusion for all free bankers is the above. This to me is 100% FB and others may call if FRFB. Who cares in a name?

    • Robert Thorpe Current

      But I thought the point was to argue against violations of liberty for the sake of “economic security”.

      I support the “consequentialist” argument. That is, I want to see liberty increased only if I think it will improve human welfare in the long term. That’s why I support free banking and many other “libertarian” policies. But, if I thought free banking would make human life worse in the long run then I wouldn’t support it.

      The argument that a fall in the price level (ie. a rise in the interest rate) caused by a reduction in stock of the circulating medium will cause increases in real wages (ie. a reduction in the return to capital) and therefore unemployment is 100% Keynesian.

      It is Keynesian, though people made the same argument before Keynes. The reason for the antagonism is mostly the other aspects of Keynes’ economics.

  • Toby Baxendale Toby Baxendale

    http://www.cobdencentre.org/2010/06/public-attitudes-to-banking/

    Richard, the above link has the survey.

    http://www.cobdencentre.org/2010/03/free-banking-the-balance-sheet-and-contract-law-approach/

    This link explains the contract law points I make.

    I hope this is helpful.

    I do think dare I say it there is a third way that will satisfy both 100% and FR Free Bankers.

  • Corrigan

    I have to confess to having mixed feelings upon reading this paper.

    Boldy marked in the plus column, I wholly share their scepticism about the supposedly self-regulating abilities of fractional reserve free banking (FRFB) and, by extension, I am equally as dubious about its advocates selective reading of history (for example, were Venetian banks – who all went bust by over-expanding in the quattrocento – not just as representative of the breed as those Scottish paragons of the 18-19th century allegedly were?) as I am convinced of their naivete in believing that non-owner, limited liabilty banking execs will not attempt to maximise short-term returns on equity with or without the backstop of a central bank.

    In the negative column, however, I believe a number of their arguments suffer from what Henry Hazlitt would have categorized as the inability to consider effects beyond the immediate.

    For instance, in asking about what happens if saver A buys a bond instead of making a bank deposit with his saved income, they forget that either the issuer of the bond (if it is a primary purchase), or those upon whose goods of labour that issuer spends the money (etc, etc, ad infinitum), or the seller of the bond (if it is secondary market instrument) will also end up needing to park cash in the bank.

    Thus, to confine the analysis to the first round actors is needlessly to offer up a flaw in the overall logic for the FRFB crowd to exploit.

    Perhaps the authors should read a little Machlup before they enter in to this particular line of reasoning in future!