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?