A Hayekian Case for Central Banking?

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Over at Liberty & Power, historian Jeffrey Rogers Hummel discusses a lecture he recently gave entitled "Why Fractional Reserve Banking is More Libertarian than the Gold Standard." Delivered at one of the Foundation for Economic Education's summer seminars, the audience included a number of econ heavyweights, including reason contributor Bryan Caplan, who posed the following question: "Agree or disagree: In developed countries during the last 10-15 years, central banks have become (close to) the most efficient state enterprises."

Hummel's answer was a reluctant yes, given despite his "unequivocal advocacy of the Fed's abolition." Caplan, who of course agreed with the answer, followed-up on his own blog, offering this as one reason for such efficiency:

The people who run central banks are usually economists. Whatever their problems, economists are—compared to other government officials—unusually likely to adopt economically efficient policies if you give them a chance. So contrary to [Murray] Rothbard's populist complaints, giving independence to central bankers has relatively good results.

This pro-economist position is certainly in keeping with Caplan's thesis in The Myth of the Rational Voter, though the following response from Hummel strikes me as more convincing:

Globalization and international competition have approximated Hayek's world of competing private banks issuing fiat money. The major difference is that we have competing central banks. Investors can fairly easily move from one currency to another, which means the market immediately prices changes in central bank policy and punishes them when necessary. Central banks are still the major noise traders in the interest-rate and foreign-exchange markets. But whenever a central bank goes up against speculators and tries to seriously misprice its currency, the central bank almost always loses and the speculators almost always win. This tends to discipline central banks.

Hummel's post (with a podcast of his lecture) here. Caplan's here.

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  1. “The most efficient State enterprise” is like being the prettiest pig.

  2. What’s the measure of efficiency Hummel uses?

  3. “The most efficient State enterprise” is like being the prettiest pig.

    It’s gotta be one charming motherfucking pig…

  4. One thing that I’ve never understood about the goldbug libertarians is their insistence that fractional reserve banking should be illegal.

    Um – step off. In Libertopia, if I want to open a fractional reserve bank, you can’t tell me I can’t.

  5. whenever a central bank goes up against speculators and tries to seriously misprice its currency, the central bank almost always loses and the speculators almost always win. This tends to discipline central banks.

    This is too fucking awesome to be true.

  6. economists are-compared to other government officials-unusually likely to adopt economically efficient policies if you give them a chance.

    What a crock of shit!

    Economists are usually the chicken-shits of government who allow themselves to get bullied by presidents, congress-critters, and lobbyists (aka bankers) begging for more leniency and liquidity.

    Where was the economic efficiency in Federsal Withholding?? Social Security? The Fannie/Freddie bailout? Economists are just as capable of rationalizing idiotic policy as any other walk of life.

    But whenever a central bank goes up against speculators and tries to seriously misprice its currency, the central bank almost always loses and the speculators almost always win. This tends to discipline central banks.

    Baloney. It tends to make central banks collude. The European Union, for example.

  7. Fluffy, I’ve never met a libertopian who suggested fractional reserve banking be illegal, just that it’s a poor idea.

  8. Um – step off. In Libertopia, if I want to open a fractional reserve bank, you can’t tell me I can’t.

    The argument has laways been that the government should not run a fractional reserve bank. Private operators should be free to operate as they choose and the market will price poorly-backed fractional reserve currency out of existence. Google “obsolete bank notes” or start with this:

    http://reviews.ebay.com/Understanding-Obsolete-Currency_W0QQugidZ10000000003654677?ssPageName=BUYGD:CAT:-1:LISTINGS:4

  9. It looks as if the credit crisis is going to be pretty damn expensive, and I’m not the only one (link) pinning the blame for it on overly activist central banks. If central banking is the most efficient government enterprise, then the rest have $trillions of losses to catch up on.

  10. And for the record, I’m a Free Banker. I don’t think it’s the government place to run the currency and banking system of a free economy. That separates me from the gold bugs and the status quo crowd.

  11. Nigel Watt, Invisible Finger, et al. The Mises folks argue that fractional reserve banking is fraud and immoral, and that it shouldn’t be practiced by anyone. They reconcile this with their anarchism by saying that in a free society, whatever bodies that were in charge of protecting people from force and fraud would prohibit the operation of fractional reserve banks, or they argue that fractional reserve banks could not exist because of market forces.

  12. Its libertarian except for the whole printing-money-on-demand-to-pay-for-endless-war-and-welfare-state thing, yeah, i guess its libertarian.

    Jesus $#%$# christ, where do you find these people?

  13. How does Hummel explain the implosion of the dollar and the complete reluctance of the Fed to do anything about it?

    Oh, he doesn’t. Next!

  14. Yes, globalization has created pseudo-free-market style system of competing currencies but that is not solid justification for central banking. There’s the added cost of dealing with multiple currencies in a globalized world. Then there is the incentive to for central banks to collude (or act similarly without deliberate intent) or buckle to political pressure, doubly so with the increase in strong international organizations. Besides, how many of the international worlds competing currencies are legitimately viable for international commerce? Three? Four? Hardly an ideal market.

  15. Free Banking is inherently more libertarian than a state run central bank. Even if the gummit requires 100% reserves in gold-pressed latinum. You see, it’s about getting the gummit OUT OF THE FREAKING MONEY BUSINESS!

    I can understand many Ron Paulites wanting a government gold standard, because many of them are still brainwashed into thinking that government is the answer. But it drives me nuts when the self-professed anarcho-capitalists at the LvMI demand a gold standard. Their insistance that fractional reservers are fraudulent is wrong. As long as their lending practices are disclosed to depositors, there is no fraud.

  16. But it drives me nuts when the self-professed anarcho-capitalists at the LvMI demand a gold standard. Their insistance that fractional reservers are fraudulent is wrong.

    Brandybuck, I think you are misunderstanding the position of most, if not all, LVMI’ers on the gold standard and monetary policy.

    1) They are opposed to legal tender laws. This means that the government does not force anybody to use a particular currency. If tomorrow most Americans decide that pickled anchovy tins will be the medium of indirect exchange, then that is what will be used as money.

    2) The calls for a return to a gold standard are an attempt to rein in government spending. They want the U.S. government to only coin gold money. This does not forbid other organizations from printing other forms of money, for example, I could issue a currency backed by tins of anchovies and try to get people to do business in them.

    They do not do this because they are fans of gold per se (other than observing, wrongly in my mind that gold was the currency of choice in free markets (I think the insistence of kings and strongmen that they be paid taxes in gold influenced the dominance of gold)). No, they observe that a government that cannot print money, but is limited in the amount of currency it can generate by the physical limitations imposed by the need to mine gold out of the ground, would be far less able to engage in deficit spending.

    Every LVMI article I have ever read on the subject of “gold standards” has emphasized this limiting aspect on government spending as the primebenefit of the standard. Most of the articles bend over backwards to make the point that making gold legal tender is a bad idea.

    To sum up, we LVMI anarchists hate the government and want it out of the money business. But since governments will be around for the foreseeable future, and since they will be in the money business, we advocate a course that will limit their capacity to intervene on the economy.

  17. It never fails, should I need a reality check on paranoid ideological American liberalism (aka Libertarian), any given comment on the financial sector suffices. It’s rather amazing how bloody idiotic supposed market driven people are – of course the comment supra demonstrate that the lot of the loons here have but the barest understanding of markets and especially financial markets, and have almost by accident (and sadly probably for the wrong reasons) fallen onto the economic liberal side of the equation.

    It’s nice to have you idiots behind economic liberalism, for the smallest government reasonable (not the smallest government, but the smallest government possible to protect free markets from the rather fundamental human fear of change, etc. that make markets work, but rather is unpopular) but it is rather clear that for 99% of you, it’s because you’re bloody whankers giving irrational paranoid reactions, rather than a reasoned cost-benefit choice between statism and free market.

    Really pitiful, in then, that the discussion is at the same level at the Left loons who see corporate conspiracy behind oil pricing

  18. Jacob,

    The Mises folks argue that fractional reserve banking is fraud and immoral, and that it shouldn’t be practiced by anyone.

    Source?

    I was under the impression that the Misesians know that it is fraud and immoral, and that a free market in money (means of exchange) is unlikely to tolerate fractional reserve banking when full reserve banking is available.

    Or in other words, why would anyone use fiat money if sound money was available?

  19. Communist Manifesto Plank 5:

    Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

    A real libertarian does NOT endorse a plank of the Communist Manifesto as preferable to gold -and by extension- our Constitution. The Republicans have that job filled.

    The power to print money is the unlimited power of taxation. Without a central bank, there is no collectivism. Gold and silver restrains the state to physics. No unnecessary wars or social programs. This is why the Constitution states (even still…) that only gold and silver are to be used as repayment of debt. Jefferson knew even then that inflation is tantamount to theft.

    I suggest that Jeffrey Roger Hummel put away the Keynes and reads Von Mises.

  20. Or in other words, why would anyone use fiat money if sound money was available?

    Mm,…because bad money drives good out of circulation?

  21. “Whankers” is spelled with an ‘h’.

  22. Wow, Lounsbury! 178 words. Almost zero content. I suppose you would know wanking when you see it.

  23. a priori said:

    “Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

    “A real libertarian does NOT endorse a plank of the Communist Manifesto as preferable to gold -and by extension- our Constitution.”

    But Hummel (if you actually LISTEN to his mp3 lecture) does NOT in ANY way advocate a state central bank monopoly! He advocates the separation of money and state, and argues for ALTERNATIVES (which the free market is filled with, created by entrepreneurs) to a 100% gold standard.

  24. The people who run central banks are usually economists. Whatever their problems, economists are-compared to other government officials-unusually likely to adopt economically efficient policies if you give them a chance.

    The last time a political system designed by an economist was implemented, it got 30 million+ people killed, and nearly started a world war.

    Given that the predictions of economists, notoriously, have historically been only slightly less accurate than those of their coreligionists, the astrologers, why would anyone sane greet their policy prescriptions with anything besides a resounding Bronx cheer?

    Economics == astrology for yuppies.

  25. I listened to the lecture. For the most part, Hummel explains why the “free banking” view of Selgin and White is correct in contrast to the “100% reserve banking” position of Rothbard and Block.

    Rockwell, who runs the Ludwig Von Mises Institute, promotes the Rothbardian position.

    Caplan, agrees with Hummel that the free banking position is correct, and then states that cental banks haven’t been don’t a bad job recently compared to other government organzations.

    This is relevant to Hummel’s lecture because Hummel points out that money creation is a poor source of revenue for modern governments because everyone mostly holds private money. The “base” of the inflation tax is “base money” that is directly issued by the Fed. (About 800 billion.)

    Several points in this thread are mistaken. It is almost impossible for the prices of bank notes to reflect the reserve ratios of the issuing banks. As long as they are currently being redeemed, banknotes trade at par. (As do checks that are being cleared or cashed.) If people care about reserve ratios, what adjusts is the amount that people hold.

    Because of the regulatory scheme in the U.S. during the 1840’s, banknotes did trade at discounts from par. But it had to do with the distance from the issuing bank and, then, really big discounts if the issuing bank was not redeeming its notes at all. Then you had to get paid off by the sale of pledged collateral (usuall state bonds) held by the state treasury. How much money would appear and how long it would take to receive the pro-rata share of the proceeds created a discount for the notes of banks that were in default.

    None of these banks kept much in the way of gold reserves, and in their home regions, as long as they were redeeming their notes on demand (as they were legally required to do) they traded at par. However, if you carried them to another city or state, they would generally need to be sold at a discount for money used in that area. People apparently did this enough that there were organized markets for this. So, carrying gold was less conventient than taking a loss on banknotes.

    If nationwide branch banking had been allowed, this wouldn’t have been an issue. The notes of all banks not currently in default would circulate at par everywhere. (As would checks.) But, the U.S. regulatory scheme prevented interstate branching, and few states allowed any branching at all.

    Again, if people care about reserve ratios, then people would only use the notes and deposits of banks with high reserve ratios. Only those people who cared more about other things (like interest on deposits) would hold those of banks with low ratios. But the prices of notes and checks can be expected to remain at par–unless a bank is in default.

  26. “Hayekian central banking”? Why not read what the great economist wrote himself?
    http://www.mises.org/store/Prices-and-Production-P520.aspx

  27. Would you leave your car in parking lot that lends your car to other people while you’re away?

    What if Bryan Caplan says that the parking lot is going to be economists that are really really efficient at it?

  28. @ Parking Bob:

    Depends. Most parking lots charge you to keep your car there, and even then there is still some risk (car theft, etc.). Presumably the parking lot that rents out your car will charge you much less, or possibly even pay you, as the costs of securing your car are offset by the profit made by renting your car.

    Of course, there is still the question of security. Clearly people can run a business that rents cars without being robbed into bankruptcy (in fact, while turning a profit), so it is certainly feasible that your car will be safe in your little co-op Hertz.

    The question is whether the parking lot has incentive to protect your car, and also what happens to you if it is stolen. A fair co-op car rental won’t let the loss fall solely on you, but would rather compensate you for the loss of the car and take it from their profits, thus also ensuring they have roughly the same incentive to protect your property as a normal rental has to protect its property. You would be made whole unless they A) cheated on their obligation to reimburse you, which would be reflected in diminished trust from car owners, or B) they lost cars at such a rate they were unable to make owners whole.

    While B) is certainly possible, we know that it is feasible to run a rental business without that happening, and so your willingness to stow your car there should reflect your assessment of the likelihood of situation B, compared to the savings of using the renting parking lot over the normal one.

    For the analogy to really work, of course, we have to make the unrealistic assumption that your car experiences no expected loss of value (wear and tear, gas use), as loaning money doesn’t damage it.

  29. For one example of a market mechanism that developed to prevent rampant private bank note inflation, see: http://en.wikipedia.org/wiki/Suffolk_Bank

  30. Speaking of inflation and central banking, etc., here’s an interesting photo and article I’ve just run across. I wonder if the photo is the beginning of a trend?

  31. For the analogy to really work, of course, we have to make the unrealistic assumption that your car experiences no expected loss of value (wear and tear, gas use), as loaning money doesn’t damage it.

    That isn’t necessarily so. Loaning money can “damage it”. If it is loaned out several times at once, it expands the money and/or credit supply with the result that by the time it is repaid, it has lost purchasing power. In other words … inflation.

  32. @perilisk

    You missed the point. If the parking lot rents your car away, it might not be there when you need it back, (this is called, in banking terms, a bank run) which is the entire reason you put it in the parking lot in the first place.

    This is why there is no such thing as a parking service that pays you to rent your car away.

  33. That isn’t necessarily so. Loaning money can “damage it”. If it is loaned out several times at once, it expands the money and/or credit supply with the result that by the time it is repaid, it has lost purchasing power. In other words … inflation.
    You don’t even need to dig that deep. If the bank makes a bad loan with your money, it will be unrecoverable, which is why the mortgage debacle is killing banks all over.

  34. if I want to open a fractional reserve bank, you can’t tell me I can’t.

    I’m OK with fractional reserve banking, as long as they don’t pretend to be able to redeem all of their liabilities on demand. That would be fraud, of course.

    -jcr

  35. The impact of fractional reserve banking on the purchasing power of money is similar to the impact of a construction firm building new homes on the value of existing homes.

    Bank deposits (and bank notes) are useful as money. By creating a substitute for other kinds of money (fiat currency under current conditions or gold coins, under a gold standard) the creation of bank money reduces the demand for the other sorts of money. If the supply of those sorts of money don’t respond, or don’t respond enough, demand falling more than supply leads to a loss in value. With prices being quoted in terms of money, this is refelcted in a higher price level.

    This consequence of fractional reserve banking is no more an argument for banning it than is the decrease in the value of existing homes an argument for banning new construction.

    I think, however, that this gets to the crux of the problem. The Rothbardians want to avoid this consequence of fractional reserve banking. Rather than just say that they favor government intervention to maintain the pruchasing power of nonbank money (gold coins, in their preferred scenario) they grasp at straws to try to show that there is an inherent fraud in banks issuing financial instruments that can be used as money.

    Advocates of free banking have no problem with banks making a disclosure that they are not storing money and that they lend out deposited funds. Our view is that everyone knows this. Banks make loans. For whom is this supposed to be news? How can anyone believe that banks pay you to store your money?

    If someone pays you to park your car at the location of their used car rental facility, I think you have the burden of proof to show that you assumed that they were operating a parking facility. Go to your bank. Ask them what they do with the money you deposit.
    Will they tell you that they are storing it for you in the vault?

    However, if there were a business of rerenting cars. certainly, there is no problem with having those renting used cars (for rerental to others,) specifically stating this is what is going on.

  36. ” Rather than just say that they favor government intervention to maintain the pruchasing power of nonbank money (gold coins, in their preferred scenario) they grasp at straws to try to show that there is an inherent fraud in banks issuing financial instruments that can be used as money.”

    Their “their preferred scenario” is for the government to not be involved in currency at all. Perhaps that is your misunderstanding of their position. They support a commodity-based currency to reign in government power.

  37. I think, however, that this gets to the crux of the problem. The Rothbardians want to avoid this consequence of fractional reserve banking. Rather than just say that they favor government intervention to maintain the pruchasing power of nonbank money (gold coins, in their preferred scenario) they grasp at straws to try to show that there is an inherent fraud in banks issuing financial instruments that can be used as money.

    This is a completely incorrect statement of what Rothbardians are going on about, to the point that I wonder if you’ve actually read anything that Rothbard has written on the subject.

    No, the concern about fractional reserve banking is rooted in the Austrian Theory of the Business Cycle.

    The concern is that by repeatedly loaning out the same coin to lots of different people, the banks are sending a signal to entrepeneurs that the rate of saving is higher than it actually is. This results in entrepeneurs making more risky investmeents in factories or businesses that produce higher order goods and neglecting lower order goods for immediate consumption.

    Of course, the consumer demand is unchanged, so you get a malinvestment. Consumers want more toothpaste, and fewer efficiencly consultants than entrepeneurs are producing.

    So you get wa wave of business failures as these malinvestments go bust. Now, if that were the end point, everything would be fins.

    Except, when a bank loans out the same deposited dollar to eight different people (group A), and they pay other people (group B) for stuff with their borrowed money, the money shows up a s demand deposits in Group B’s bank accounts.

    Which means that when the bad loans to failing businesses are written off as a loss, the banks collectively no longer meet their reserve requirements. Three things can happen: the banks can tighten up on lending and call in existing loans, or the banks can go bust if the depositors start to question its solvency, or they can get the money they need to keep from going bust via taxes (government bailout) or inflation (the central bank runs the printing presses and donates/loans the money to the banks).

    The first two, while not good, are acceptable. The latter two have monstrous consequences and are the way modern western governments react to the inevitable fallout of banks loaning out money they don’t have.

    Please note, Rothbard has no problem with banks loaning out money deposited into them as CD’s.

    It is the loaning out of demand deposits -> telling a depositor that they can take out their money at any time, when the bank cannot actually honor this obligation to all its customers that Rothbard calls fraud. If a bank is upfront that if you deposit money in an account with them that the money may not be there, I don’t think he would be calling it fraud.

  38. The rational voter is indeed a myth.

    “Average IQ of 100” is all you need to know about that!

  39. Thank you very much, Tarran. As usual your conciseness cuts straight to the heart of the matter, and as usual you seem to know what you’re talking about.

  40. Aren’t bonds the basis for deficit spending? As long as markets are willing to lend money to government, then deficit spending can occur regardless of monetary systems.

  41. “Or in other words, why would anyone use fiat money if sound money was available?”

    “Mm,…because bad money drives good out of circulation?”

    Actually, Gresham’s Law only operates in the presence of legal tender laws.

  42. Actually, Gresham’s Law only operates in the presence of legal tender laws.

    I don’t believe so; people tend to spend the less desirable money, if it’s acceptable at all, and retain the more valuable. While legal tender laws certainly exacerbate that, I don’t see why they would be necessary for the phenomenon to occur. Even in barter people will tend to trade off the less desirable goods and keep the better ones.

  43. smartass…”people tend to spend the less desirable money”……. but what do people tend to accept?
    unless of course you forbid them from discriminating/choosing with legal tender laws…

    In black markets the effect is very visible, also in euro-accepting swiss cities and airports.

  44. but what do people tend to accept?

    They tend to accept the best that they can get or the best that is offered to them. And no one is likely to offer more than what is necessary. I do know that often one will receive a discount for paying with more desirable money (or products.)

  45. On a side note, many years ago I bought something and paid for it with a $20 gold piece. Although the coin was worth about $75 at the time, the person who accepted it would only allow me it’s face value. Unfortunately it was all I had on me at the time.

  46. Actually, Gresham’s Law only operates in the presence of legal tender laws.

    I just now went and read the Wikipedia article on Gresham’s Law to refresh my memory. Actually you are technically correct:

    Gresham’s law says that any circulating currency consisting of both “good” and “bad” money (both forms required to be accepted at equal value under legal tender law) quickly becomes dominated by the “bad” money. This is because people spending money will hand over the “bad” coins rather than the “good” ones, keeping the “good” ones for themselves.

    However, I still contend that even in the absence of legal tender laws, people will pay no more and no better than just what they have to for something.

    In any event this thread probably qualifies as a “dead thread.” Pity – I remember there once was much more economic discussion in this publication.

  47. markets are willing to lend money to government,because bad money drives good out of circulation.

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