Readers of this blog know one of my favorite bloggers, Bionic Mosquito, graciously lets me republish many of his blogposts on this site. I agree with him on pretty much all things Austrian Economics and Libertarian political theory.
I have for some time known that he and I fall on different sides of the free banking/ 100% reserves debate. As far as I know, this is probably one of the only things on which we dissent from each other. I write this post with much affection for my libertarian comrade and the reader should know that I look up to BM and consider him an excellent proponent of the Austro-libertarian ideal.
First, let me summarize in rough form what is meant by the two positions here. What is relevant to our present conversation is the fact that the “free banking” position allows banks to extend “fiduciary media” (money substitutes that are not backed up by the money itself –see my money essay here). For example, if, say, gold was money and there was a set amount of gold in the bank, the free banking system would allow that bank, if it desired (it certainly doesn’t have to), to extend more claims on that money (like in the form of our green paper dollars) than can be redeemed at the same time. Conversely, the “100% reserve” position is that the above is contractually illegitimate and therefore, fiduciary media should be seen as fraudulent and illegal; worthy of a response by the institution in society that enforces contracts and such. There are more nuances here in both positions –and these of course are necessary in picking one side or the other– but for now, this is the gist of it.
Bionic takes the free banking side and I the 100% reserve. (I should note here that his view being called the free banking view is sort of misleading: I believe my view to be entirely consistent with laissez-faire free markets.)
Bionic comments on two articles –the second one (by Joe Salerno) being a response to the first (by George Selgin)– centered about F.A. Hayek’s views on free banking. Before he goes there, he begins by writing:
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.
He rightly keeps libertarianism and Austrian Economics relegated to their distinct spheres: libertarianism being an ethical view of individual rights and property, economics being about the logic of human action and freedom of exchange, aside from ethical concerns. Example: an economic analysis concludes that slavery is inefficient, while a libertarian analysis concludes that slavery is immoral.
Before going much further, I should say that Bionic’s article is pretty much agreeable. I think his insight into the Selgin/Salerno blogs are great. He touches on the important points and he is mostly eye to eye with me. Any disagreement I have is only slight, but will be brought up toward the bottom.
When we talk about free banking, there is going to be both a libertarian, as well as an Austrian economic, viewpoint. Bionic states that:
So on the subject of banking (and money and credit and currency), I approach the topic from a free-market viewpoint [economic –CJE]; 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.
In other words, his position on free banking is a result of his position on the freedom of markets in general. This is fine, and fair enough.
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.
What he means by this is not that he likes inflation or hates gold. What he means is that the phenomenon of inflation, and the possibility that gold may not be the chosen money on the free market, does not cause him to change his position on free banking. If the outcome is “not what we want” then so be it (by way of example: it distresses me that beef is more expensive than turkey, but the market has spoken). This stance is entirely agreeable. In other words, he is not an “ends justify the means” type of thinker on this issue. This is good news, and we should all nod our heads in affirmation.
For Bionic, then, he says let the banks be free to issue fiduciary media and let the market sort out the consequences. I actually don’t mind this position and think Rothbard and Mises have quite ably pointed out why this wouldn’t have the same effect as our central banking system, and in fact could survive quite well.
In interacting with the Selgin/Salerno exchange, Bionic points out that predicting what the free banking system would end up looking like is sort of silly. We can’t know such things. Only the market process can pull back this veil. So the debate is not about “what’s the market going to choose in the ideal libertarian paradise?” although that may be a fun conversation. Economic theory cannot tell you the tendency of the bankers in relation to their customer demands. However, Austrians can tell you what may happen if, other things being equal, fiduciary media is allowed or outlawed. I think Bionic and I agree on this point, and we especially agree that the market will work it all out.
The more important debate between us, though, would be whether libertarian philosophy can support the free banking position. Bionic writes:
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.
Here things get a bit tricky. On its face, I agree that we must choose between free markets and a pre-determined vision. But what is meant by free market? For the libertarian, all “free” means is that one is not legally prevented from using his person or property in any non-aggressive manner. While it is to be left to a future article to prove it, fraud is included in the “aggression” category and is therefore outlawed in a free society. Bionic agrees with this. But I do articulate this reflection for the simple reason that I want to make it clear that even the 100% reserve advocate can agree with the above quotation, as stated. In other words, assuming that fractional reserve banking is fraudulent (a point on which, until I can convince him otherwise, Bionic and I disagree), it could not be included in a “free market.” That, of course, would be the position I’d have to prove.
Now, Salerno argues that Ludwig von Mises taught that “free banking” (a 100% reserve is not legally mandated) was acceptable on the basis that it would actually not result in the expansion of fiduciary media all that much (just because something is legally allowed, does not mean that it will take place). As Bionic points out, this is an “ends justifies the means” type argument. And it is not a very solid one on libertarian grounds. So Bionic simply retorts that, for him, it does not matter what the market will do, banks should be free to have the option to extend fiduciary media.
Perhaps, as Mises taught, the expansion of fiduciary media would necessarily lead to tiny boom-bust-cycles (of course they would be small and rare compared to the results of our centralized banking system, due to the various aspects of bank competition). For Bionic, this does not matter. The market will sort it out. He writes:
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.
Here then lies my disagreement with Bionic. Something should be done about it. No, not the boom-bust-cycle, but rather, the cause of the boom-bust-cycle (BBC). The boom-bust-cycle is not the thing in need of a remedy as if the phenomenon itself were the crime. Rather, the boom-bust-cycle, I am convinced, in friendly disagreement with Bionic, is a result of a particular situation in which there are more money substitutes outstanding than can be redeemed by the gold stock held in the bank. If there are more legal claims to money than the money can satisfy, this is an example of fraudulent behavior. And it is on this ground that I take the 100% reserve position. For how can a contract be legitimate that cannot be possibly enforced? This is the case Philipp Bagus makes in his Mises University lecture on Free Banking just last week: can a contract be considered legitimate if one party is to pay another party $1000 on the condition that the second party produce a squared circle? In a free society, this is not an enforceable contract. And neither is one which promises to redeem that which cannot be redeemed.
So then, my decision to support the full-reserve system is libertarian in nature, not economic. I agree with Bionic– and Mises and Rothbard– that economically, things would work themselves out in the free market. But I take Rothbard’s position on top of the economic position. I believe simply that fractional reserve banking is at odds with the implications of libertarian theory:
My reasons for advocating 100 percent banking cut much closer to the heart of our whole system of the free market and property rights. In my view, issuing promises to pay on demand in excess of the amount of goods on hand is simply fraud, and should be so considered by the legal system. For this means that a bank issues “fake” warehouse receipts—warehouse receipts, for example, for ounces of gold that do not actually exist in the vaults. This is legalized counterfeiting; this is the creation of money without the necessity for production, to compete for resources against those who have produced. In short, I believe that fractional-reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy.
For a believer in free enterprise, a system of “free banking” undoubtedly has many attractions. Not only does it seem most consistent with the general institution of free enterprise, but Mises and others have shown that free banking would lead not to the infinite supply of money envisioned by such Utopian partisans of free banking as Proudhoun, Spooner, Greene, and Meulen, but rather to a much “harder” and sounder money than exists when banks are controlled by a central bank. In practice, therefore free banking would come much closer to the 100 percent ideal than the system we now have. And yet if “free trade in banking is free trade in swindling,” then surely the soundest course would be to take the swindling out of banking altogether. Mises’ sole argument against 100 percent gold banking is that this would admit the unfortunate precedent of government control of the banking system. But if fractional-reserve banking is fraudulent, then it could be outlawed not as a form of administrative government intervention in the monetary system, but rather as part of the general legal prohibition of force and fraud. Within this general prohibition of fraud, my proposed banking reform would leave the private banks entirely free.
For the record, I’d be happy to publish any response BM writes to the above. But actually, I think it would be better if I responded to an earlier defense of his against the claims of us full-reserve folks. That way he isn’t repeating what he has previously written. To echo what should have been implied above: I have no qualms with his position, I agree that it was Mises’s, and I consider his view very orthodox in the Austrian tradition. It’s a slight disagreement due to political philosophy technicalities, not economics; and in this way, I follow Rothbard, Hoppe, and Salerno.
And also, my fellow TRL contributor Brian Jacobson may take Bionic’s position on this. Not exactly sure. Perhaps he will reveal his stance in the comments. But either way, this is a healthy and enthusiastically invited disagreement.