Tuesday, July 28, 2015

Selgin and Salerno on Free Banking

When it comes to issues of either libertarian philosophy or Austrian economics, I have a very simple approach to each of these two topics – certainly not very doctorial. 

Regarding libertarian philosophy, I develop my views based on a strict interpretation of the non-aggression principle, grounded in an absolute view of property rights.  This makes theory relatively easy for me, and helps resolve many – but not all – questions of application.  It also helps keep me disciplined regarding topics that are or aren’t within the confines of libertarianism.

Regarding Austrian economics, perhaps it is more appropriate to say that my views are grounded in free markets; Austrian economics happens to be the closest thing to free market economics that exists.  Free markets means, to me, any transaction between two or more willing participants. 

I put these two together and conclude: a legal or valid free market transaction is one that does not violate the non-aggression principle.  Even this may be compatible with Austrian economics, I don’t know.

In neither case have I read every work of the great masters; in fact, I have read only a little work of any of these – Mises, Rothbard, Hayek, etc.  I build my views from the very simple foundations as identified above – nothing more complicated than this.  I sometimes find after the fact that what I have concluded does…or does not…coincide with the views of one of these masters.  I can live with either, although I always test my conclusions if I feel there is something presented that I have missed.

So on the subject of banking (and money and credit and currency), I approach the topic from a free-market viewpoint; as long as two or more people are gathered in whatever name – and they do not initiate aggression against a third party – they are free to contract in any manner they choose. 

Regarding money and banking: I don’t care about inflation, I don’t care about gold, I don’t care about shadow banks, I don’t care about fractional reserves, I don’t care about business cycles; these are all issues for entrepreneurs in the free market to deal with.  It’s called life.  Competition, pricing, and profit and loss will send the necessary signals and separate the profitable wheat from the loss-making chaff.

In other words, leave money and credit and banking and currency to the market; thereafter, whatever will be, will be.  Unless someone has a convincing argument as to why introducing force is both appropriate and not a violation of the NAP…well, there you have it.  Initiating force and the NAP are not compatible; initiating force and free markets are not compatible.

With that as background, I would like to consider two posts on the topic of free banking.  The first is by George Selgin, entitled Hayek and Free Banking; the second is by Joe Salerno – in response to Selgin – entitled Selgin on Hayek on Free Banking.

I guess I could have titled this post “Bionic on Salerno on Selgin on Hayek Free Banking.”  But that would have been a bit much, I think.  In any case, I do not fall on one side or the other in these dueling posts; I find much to agree with both, and some items where I disagree.  It will be on the disagreements where I focus (otherwise it would make for a pretty boring post to write…and read, I believe).

Selgin begins by pointing to Hayek as his inspiration to look into and develop his (Selgin’s) free banking views.  After introducing two pamphlets by Hayek that got Selgin to thinking about this topic, he offers:

Yet Hayek himself was no free banker.  For starters, his own vision of "choice in currency" had little if anything in common with historical free banking arrangements.  In those arrangements, banks dealt in established, precious-metal monetary units,  like the British pound and the American dollar, receiving deposits of metallic money, or claims to such, and offering in place their own readily-redeemable liabilities, including circulating banknotes.  In Hayek's scheme, in contrast, competing firms issue irredeemable paper notes, with each brand representing a distinct monetary unit. 

Competition, Hayek claimed, would force private issuers of irredeemable currencies to maintain those currencies' purchasing power, or else go out of business.  An overexpanding free bank, in contrast, is disciplined, not by an eventual loss of reputation, but by the more immediate prospect of running out of cash reserves.

But isn’t this the benefit of competition in a free market?  The market may very well settle on free banking in a redeemable environment.  As long as the possibility for any arrangement remains open, the market will sort this out.  I do not understand why this suggests that Hayek was no free banker.  Just because he outlined a scheme different than anything Selgin is aware of in history does not mean that Hayek’s proposal is not “free.” 

I guess I will suggest that no one is a free banker unless they actually support fully free banking – this may result in redeemable, not redeemable, whatever; but free banking in only redeemable currencies or free banking only in non-redeemable currencies isn’t free banking.  For those certain that the result will be currency redeemable in gold…we have no beef, as long as we agree that the market be left free to sort it out.

Hayek's claims have always been controversial, even among persons (myself among them) who are inclined to favor competitive currency arrangements over monopolistic ones.  It isn't clear that a Hayekian money issuer would ever manage to get its paper accepted, or that it would resist the temptation to hyperinflate if it did.

Gaining acceptance and hyperinflation – two things that the market, if left free, is very good at resolving.  I don’t care that “it isn’t clear.”  In fact, “it isn’t clear” is at the heart of entrepreneurial decision making.  True free banking will allow for many experiments in money and credit.  I say leave it to the market to sort out winners and losers – to sort out “acceptance” and police “hyperinflation.”

Selgin points out that Hayek, in a 1945 radio interview and in a 1977 lecture, suggested that a monetary system must be under central control.  This, of course, seems contradictory to both the above comments attributable to Hayek’s views as well as to Hayek’s Pretense of Knowledge.  But Hayek, to my understanding, could be inconsistent when it came to free markets and government intervention.

One last comment from Selgin:

Whereas for Mises, who did favor free banking….

This is consistent with my reading of Mises as well, to the extent I have read anything of his on this topic.

On to Salerno:

Selgin characterizes Hayek's scheme of "choice in currency" as referring to

"…competing firms issu[ing] irredeemable paper notes, with each brand representing a distinct monetary unit.  Far from resembling ordinary commercial banks, Hayek's 'banks' resemble so many modern central banks in that they issue a sort of 'fiat' money."

But this is a fair description only of Hayek's later booklet, Denationalisation of Money.  In Choice in Currency, Hayek presents a very different, and much sounder, proposal for monetary reform--one that is still useful today as a plan for restoring the gold standard.    The crux of Hayek's proposal for free choice in currency is the abolition of legal tender for the currency issued by the domestic government and the restoration of the right of citizens to freely contract in foreign currencies or even ounces of gold or silver.  There would thus emerge competition among different currencies, with those depreciating relatively rapidly falling out of use.  Hayek does not foresee the establishment of private banks issuing private fiat currencies as a result of free choice in currency.  Far from it, as he concludes:

It seems not unlikely that gold would reassert its place as 'the universal prize in all countries, in all cultures, in all ages'. . . if people were given complete freedom to decide what to use as their standard and general medium of exchange.

Likely, unlikely, not unlikely…Why not just leave it all to the market?  And if Hayek leaves room for (presumably) irredeemable national currencies, on what basis would a free-market economist deny this possibility to private banks? 

Further, Salerno seems to take Hayek’s proposal for competing currencies of various types (with the market sorting out winners and losers) into a proposal for restoring a gold standard – and labels this a “sounder” proposal. 

There are only two possibilities for money and banking: leave it to the market…full stop, or pre-determining one’s version of a “sound” proposal, for example gold or central banking with fiat at two ends of the spectrum.  The soundest proposal (and only “sound” proposal), in my opinion, is the one freely determined – and continually disciplined – by the market.

…Selgin correctly points out that Mises favored free banking and cites a 1992 article by Larry White, "Mises on Free Banking and Fractional Reserves."  But he fails to take of account of the great deal of careful investigation of Mises's views on free banking that has occurred since then.  From this research it has become clear that Mises favored free banking precisely because he believed that it would lead to the complete suppression of additional issues of "fiduciary media,” that is, unbacked notes and deposits.  

What I am reading is that Mises accepted the means only because it would lead to the ends of which he approved.  The ends justify the means.  For some reason, this does not sound consistent with other Austrian principles – and certainly not libertarian principles (at least not for me).  But Mises certainly has earned the right to believe this, if this is what he, in fact, believed.

But what if free banking does not lead to the complete suppression of additional issues, as Mises “precisely” believed?  I don’t know if Mises would then be for or against free banking.  It matters not a bit to me if this “suppression” occurs; I will remain in the “for” camp.  

Salerno sheds some light for me on what might thereafter be Mises’s view:

Thus Mises was not a forerunner of the Modern Free Banking school as Selgin seemingly implies, but rather the founder of the Neo-Currency school that attributes business cycles to the issue of fiduciary media by fractional-reserve banks.  I present an exhaustive review of Mises’s views on free banking in my book chapter "Mises as Currency School Free Banker" published in 2013.

I have every reason to believe Salerno’s take on Mises in this regard.  What light has Salerno shed for me?  Mises’s concern was the business cycle caused or induced by fractional reserve banks – it seems, whether or not those banks were supported by a government-enabled central bank.

I have no quarrel with this as an economic truth.  But I just don’t know what to do about it – and more importantly, if anything should be done about it – in a free market.  Of course, I personally believe that nothing should be done about it.

Somewhere I read a quote (and now cannot find it), I believe by Mises but maybe not, paraphrasing: the only way to avoid inflation is death.  Anyway, if no one important ever said it, someone should have.  As I suspect most of us would not choose death as a solution, all that is left is to determine the most effective means to deal with inflation.  Truly free markets make the best regulator; this works for me.

As long as all aspects of money and credit are left free, the market will discipline itself just fine.  As long as currencies are left free to compete, an entrepreneur’s choice of currency will be a business decision just like any other he faces – one of many factors that determines the future success or failure of his enterprise, no different than the grade of steel he chooses, or the quality of management he hires. 

As long as currencies are left free to compete, I don’t think we will ever again discuss inflation; business cycles will be limited in both length and breadth given the decentralization in banking. 

All that will remain will be nothing more than good and bad decisions regarding money, banking, currency, and credit.  In other words, entrepreneurial decision-making.

And isn’t the entrepreneur and his decision-making at the heart of Austrian economics?


  1. Austrian economics is just recognizing free market dynamics also apply to money. Summarized with something like, "Supply and demand drive everything. Counterfeiting distorts."

    BM: "...as long as two or more people are gathered in whatever name – and they do not initiate aggression against a third party – they are free to contract in any manner they choose....I don’t care about business cycles; these are all issues for entrepreneurs in the free market to deal with. It’s called life. Competition, pricing, and profit and loss will send the necessary signals and separate the profitable wheat from the loss-making chaff."

    Correct and properly deontological. But somewhat unkind and underappreciative of how the careful study of free markets gives rise to adoption of non-aggression in the context of how human psychology operates.

    Practically speaking, how did you arrive at your position of absolute understanding and respect for non-aggression? From birth? Don't answer that, you are probably unique. But most people grow up implicitly accepting at least some parts of their surrounding culture which presumes government coercion of free markets, especially money, to be necessary and valuable. This has to be unwound somehow.

    Thus it is perhaps sad, but also true, that far more often those arriving at non-aggression do so by backing into understanding its importance for success in life. They are intrigued by the superior outcomes to be had.

    Great economists like Mises indirectly deliver untold advantage for the cause of non-aggression and freedom in their Herculean efforts exhaustively describing the actual laws of economic reality. These reveal the economic and human devastation wrought by coercion. Yes, I know, I know, in theory such utilitarian considerations shouldn't matter, but to most people they very much do. If the practical economic nuts and bolts of how and why socialism causes mass starvation and devastation are made plain, people are more likely to seriously question the legitimacy of coercion compared to just reading an abstract philosophical treatise on its immorality.

    1. "Great economists like Mises indirectly deliver untold advantage for the cause of non-aggression and freedom in their Herculean efforts exhaustively describing the actual laws of economic reality."

      And we are all in their debt (figuratively, of course) because of such efforts.

  2. Where do you stand on fraud as a violation of NAP? Fractional reserve banking is fraud - issuing claims on cash which does not exist. Your typical savings (as opposed to investment) bank promises to return a depositor's money but is not able to actually deliver on this contractual obligation. All such banks are constantly bankrupt. Knowingly making false statements and impossible promises to your customers is fraud.

    It's true that bankruptcy, when it comes to light, will be its own punishment, but I do think that this sort of fraud requires criminal penalties, as well. Wouldn't you say?

    1. “Where do you stand on fraud as a violation of NAP?”

      Fraud is a very squishy term. Is advertising for makeup “fraud”? Is there any hope that I will look anything like that athlete with the six-pack abs if I buy the protein drink? Where do you draw the line?

      Define fraud in a black and white manner. It can’t be done. The best I can do is via the terms of a contract (implicit or explicit) – a violation of the terms of a contract. This is reasonably straightforward.

      Fraud is not a very meaningful term for the use of identifying an NAP violation.

      “Fractional reserve banking is fraud…”

      Hold it right there, cowboy. Read all of these, then let me know (don’t worry, there are only 55 posts that I have written on the matter). Until then, I am not buying what you are selling….and you need not do your preaching here.


    2. BM is right elsewhere when he points out fractional reserve banking is not fraud if fully disclosed as such. That is, in exchange for depositing money, one is given not a warehouse receipt, but a claim check on that money explicitly labeled to be in competition with other claim checks for that very same money. Obviously, one would need to be paid interest for giving up an exclusive claim on money, and one would need to know the terms and conditions by which competing claims were settled including underlying risks of default on the loaned out money.

      The beauty of this is that in no uncertain terms the claim one holds would never trade on par with actual money. It would be valued for trade in goods and services only after applying a discount for the probability of it not being redeemable. Turns out, lo and behold, that discount would (approximately) match the actual chances of redeemability such that the net money supply would not be altered in any way.

      No fraud here. No inflation of money supply here.

    3. I'll do that, thanks. That's quite a bit of reading, but I'll go through it.

      Just to clarify what I meant, though, maybe I should have said "theft" rather than "fraud". The bank entered into a contract with me which stipulates that they will keep my money safe and will return it to me - this is critical - on demand. Then they took that money and lent it out, meaning that it is no longer possible for them to fulfill the contract's terms. The note they have on their books is not collateral - I cannot seize the note in lieu of cash owed me. I say that means they stole that money from me.

      Maybe I'll register so you can keep track of my posts. Hopefully we can keep our discussions cordial.

    4. "The bank entered into a contract with me which stipulates that they will keep my money safe and will return it to me - this is critical - on demand."

      This is not what the contract says.

    5. @BM

      "This is not what the contract says."

      Really? So modern day banks do not hold out to the public that savings account balances are demand deposits, payable in cash at any time on demand? If I asked a bank teller or any bank employee this I think they would say, "Of course you can always withdraw your money."

      If I insisted, saying, "I heard you are only able to redeem up to 10% of deposits. I heard beyond that you have no more money to pay the remaining 90% of depositors money, and they are out of luck," I'm pretty sure the bank employees would say, "Huh? What the hell are you talking about? If you deposit money with us, you can withdraw it. What kind of bank would we be if that weren't true."

      - Anonymous July 30, 2015 at 7:33 AM

    6. No? What does it say? Does it say that if they don't have the money to pay me, they have the de jure right to refuse my withdrawal request? I'm not trying to be clever, I really don't know. I tried looking at something from Chase I found online but can't find anything one way or another.

      Last I heard, checking accounts were "demand deposits" and banks were required to honor such demands, subject to reasonable time constraints for large cash withdrawals. Is that not correct?

      Igor Karbinovskiy

    7. 55 posts, I suggest you all start reading. Read the comments as well. Your questions and criticisms have all been dealt with numerous times.

    8. @Igor

      I found the Citibank contract online, they call it "Client Manual: Consumer Accounts."

      The pertinent element in it I saw was: "Unless otherwise expressly agreed in writing, our relationship with you will be that of debtor and creditor. That is, we owe you the amount of your deposit. No fiduciary, quasi-fiduciary or other special relationship exists between you and us."

      I'll admit, this is craftily written to cover their tail. It says when customers deposit money in a savings account with them, they are not holding the money for us. Instead, we transfer full ownership of the money to them. We are loaning the money to them. Thus they can turn around and do anything they want with it. They can behave as irresponsibly as they want with the money because it's not ours, it's theirs and they have no fiduciary duty toward us (funny thing for a bank to say).

      So we've established their legalese covers their tail. No surprise since their lawyers at corporate headquarters certainly understand how the Federal Reserve Act works, even if their branch employees and customers don’t. I'd say the fact that 99.999% of the population (including me until just now) does not understand that a savings account is legally a loan to a bank, and would insist that's not true, suggests banks and the government have taken great pains to misrepresent what a savings account is in their words, marketing materials, and educational programs trusting few people have PhD's in economics or reads the fine print of these contracts.

      I still think there is a case for fraud here. In any other sphere failure to prominently disclose a fact so glaringly contrary to common wisdom would be considered fraud. For example, a restaurant not prominently disclosing in advance that its menu prices are not denominated in U.S. dollars but in ounces of gold could be considered to be committing fraud, so contrary to commonly understood practice is that contract term.

      - Anonymous July 30, 2015 at 7:33 AM

    9. Anon,

      It's always been a false paradigm world. Power corrupts and people continue to acquiesce to the concentration of power that they will never (without selling their souls to the devil) acquire the levers to control. Liberty or security is a spectrum upon which the closer you get to one, the further you get from the other. The banks provide a clearing house for government expenditures to grow without end and thus are a greater asset to those in government than individuals who wish contracts to legally bind parties to the same degree and magnitude. Knowledge of the world seems is important for human action but truth of the universe will not be found in the laws of men.

    10. Anon, thanks for that. However, even if I'm considered a creditor of the bank, it's a credit with zero maturity. In other words, I can call it at any time and they'd be obligated to pay. And yet they are not able to do so, and they know it.

      If I enter into a contract with Mr Mosquito as a borrower, and affirm that I will pay him back on demand, but then turn around and walk away with it so that it is not possible for him to collect, in what way is this not theft?

      So I believe that merely putting those words into the contract does not, in fact, shield them from criminal liability.

      Igor Karbinovskiy

    11. "...in what way is this not theft?"

      It is not theft because it is bankruptcy. Perhaps a moral issue, but certainly not a legal one.

      You extend credit. What do you think, this is done without risk? On what planet?

    12. Bankruptcy is not theft..?

      You're saying, I think, that a checking account is a lousy deal but not a crime. All risk, little to no reward. But I'm saying that it is a contract, and as such has to be negotiated in good faith by all parties. The bank is not negotiating in good faith when they promise to make money available to me on demand, knowing that they cannot.

      All I'm asking is that they make it clear that, just as with a CD, the depositor's money will be invested and will not necessarily be available for withdrawal.

      A borrower in general does so with the intention to repay the loan. The bank does not. The lender makes the loan only with the understanding that the borrower will pay. I'm no lawyer, but if the borrower takes out a loan fully intending to default on it, I think this should be called theft. Practically speaking, the court would nullify the contract and restore the parties to the original state: the bank would have to repay the loan in other words.

      Igor Karbinovskiy

    13. Igor, it is clear and the contract language was offered to you already. Second, it isn't all risk and no reward. If you don't like the reward, you are free to deal only in cash.

      Finally: "The bank is not negotiating in good faith when they promise to make money available to me on demand, knowing that they cannot."

      Again, you seem to ignore the plain language in the above. But I will accept that you believe contracts don't matter: 99.9999% of the time, banks make good on this so-called promise. Please tell me in what industry you will find a better record of performance?

      You ignore plain language and you make statements unsupported by facts.

  3. If the Catholic church where intelectually consistent, What position would take in this debate?

    Personally, I believe the Church would claim they should control all the banking, and would invento something to justify that. Governments do the same thing, and they all copy the Church model of aspiration to absolute control of everything under the Sun. Somehow, people seem to believe such intentions are evil from religious organizations, but not evil at all when coming from "secular" organizations. Fools.