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Paper bugs, or, Stupid Arguments Against Gold

Persons familiar with my writings on monetary reform know that, far from being anyone's idea of a gold bug, and despite my conviction that those monies work best that governments govern least, I've always shied away from arguing that we ought to re-establish a gold standard. Instead, I've favored reforms aimed at preserving our existing fiat standard while eliminating the role of bureaucrats, and increasing that of competitive market forces, in regulating that standard.

I respect nonetheless those who, having given serious thought to the matter, conclude that gold remains our best hope. Alas, such people make up but a small fraction of self-described gold bugs. My standard reaction to finding myself within earshot of any of the rest is to look for a more remote and unoccupied bar stool.

But there's one thing that's guaranteed to bring out the gold bug in me, and that is ill-informed arguments against the gold standard. No, make that stupid arguments, because the ones I have in mind aren't merely ill-informed. They are ill-informed in a way that suggests that the persons who make them don't even think about what they're saying.

An example of the sorts of arguments I have in mind is this opinion piece from yesterday's New York Times, in which Eduardo Porter responds to recent pro-gold testimonials of various Republican presidential candidates and conservative talking heads. Such persons aren't exactly heavyweights when it comes to making good arguments for returning to gold. Yet in trying to show just what lightweights they really are, Mr. Porter mainly succeeds in revealing his own featherweight grasp of monetary economics and history.

For his opening salvo Mr. Porter turns to R.A. Radford's famous article on the employment of cigarettes as money in German P.O.W. camps, noting how, according to Radford, the prices of other goods sometimes fluctuated dramatically in response to new cigarette deliveries or to cigarettes' gradual disappearance in the absence of such. This experience, we are assured, proves that a gold standard is a dumb idea since gold, "as money,…share's tobacco's basic drawback" of being a commodity.

This would be an unanswerable argument against the gold standard were it not for two minor issues: first, gold isn't tobacco; second, P.O.W. camps aren't ordinary economies. Those who plead for a return to gold have a right to be understood to be extolling the merits of a gold standard rather than those of a tobacco standard or a cowrie shell standard or some other commodity standard; and the instability exhibited by any standard in a P.O.W. camp might not supply an accurate indication of the same standard's likely performance in a more usual economic setting. I would bet, for example, that the real price of cigarettes was subject to more violent changes within the confines of Stalag Luft III than in the surrounding German economy; and after the war the real price of a pack of cigarettes net of taxes, in the U.S. at least, was more-or-less constant until the early '80s, when it started to rise gradually. (It is now about twice what it was then). Finally, there isn't even any good reason for supposing that cigarettes were a poor monetary medium for P.O.W. camps, given the available options. Indeed, having often assigned Radford's article myself in teaching monetary economics, I have always understood its lesson to be, not that cigarettes make crummy money, but that markets are remarkably clever when it comes to expediting exchange. The logical implication of Mr. Porter's argument, on the other hand, seems to be that by relying on the market the P.O.W.s blew it: it would have been wiser, according to his point of view, for them to have invited their captors to supply, in exchange for some of their precious Red-Cross parcel contents, fiat money especially designed for their use, and backed by a solemn promise to manage the stuff scientifically, so as to best provide for the prisoners' macroeconomic well-being.

And gold itself? Is its supply in fact subject to the sort of shocks to which P.O.W. camps' cigarette endowments were exposed? Though Mr. Porter seems to assume so, he offers no proof. Had he bothered to inquire into actual facts he might have learned that by far the most notorious of all precious metal "supply shocks"–the one following Spain's conquest of the New World–led to the sixfold increase in European prices that has since come to be known as the great European "Price Revolution." Q.E.D. for Mr. Porter? Well, not quite, because that sixfold increase occurred over an interval of over 150 years, which translates into a continuous rate of inflation of just 1.1 percent–a rate that would have Ben Bernanke and many other modern central bankers squawking about being on the brink of a deflationary crisis.

And what about that other famous gold supply shock started by a lucky discovery at Sutter's Mill? Well, have a look if you will at a chart showing the progress of the U.S. CPI since 1800 or so, and see if you can pick out the rise in prices this discovery caused. Unless you happen to be on drugs, you can't, because it isn't there: there are price jumps, sure enough–in or around 1812, 1862, and 1918–but they all mark moments when the U.S. temporarily abandoned the gold standard, which is to say moments when it embraced the sort of paper standard Mr. Porter thinks so obviously superior to gold. (During WWI, although the U.S. didn't suspend the gold standard outright, it limited gold exports.) Wars are exceptional, of course. But then what about the CPI lift-off after 1971, when the dollar's last link to gold was severed once and for all? Is the CPI a Republican plot?

If not, are we not entitled to wonder why Mr. Porter, in assuring us that "the Fed can print dollars at will to meet the growing demand for money as the economy grows," does not seem to realize that it can, and often does, "print" too many dollars? Are we not entitled to wonder why, in making a case against gold and in favor of paper money, he supplies us with an almost perfectly irrelevant story about tobacco-plus-paper inflation, without so much as hinting at the many far more serious inflations fueled by paper alone? Is "Zimbabwean" inflation to him nothing other than a bogeyman invented by some right-wing talking head? Perhaps Mr. Porter was so absorbed by his vision of P.O.W.s struggling to carry on despite occasional cigarette windfalls that he managed to overlook the damage irredeemable paper monies have done at one time or another to the entire populations of Angola, Argentina, Bolivia, Brazil, Bulgaria, China, France, Germany, Greece, Hungary, Israel, Mexico, North Korea, Nicaragua, Peru, the Philippines, Poland, Romania, Yugoslavia, and Zaire–to offer but a very incomplete list.

But why harp on inflation? After all, fiat money at least has the virtue of hardly ever being in short supply, so that economies need not fear being unable to grow for want of it. In contrast under a gold standard, Mr. Porter assures us, "the economy couldn't grow faster than the supply of gold." Evidently Mr. Porter here overlooks another relevant episode in economic history. This episode is known as "the 19th century."

It's hardly surprising under the circumstances that Mr. Porter should share the very widespread opinion that the gold standard was to blame for the United States Great Depression. Yet even by his own telling it wasn't the gold standard as such, but the particular rules by which the Fed administered that standard, that led to the Fed's failure to prevent the post-1930 collapse of the U.S. money stock. In fact the Federal Reserve's requirement of a 40 (not 60) percent gold cover for its outstanding notes was not a necessary part of the gold standard but a regulation based on naive ca. 1840 British Currency-School thinking. (In Scotland's free-banking based gold standard, in contrast, banks managed quite well with specie reserve ratios that varied little from one or two percent.)

The stipulated gold minimum was, moreover, something that the Fed itself had statutory authority to lower, had it considered doing so worthwhile. In fact, it didn't, because (as Dick Timberlake points out) the Fed never ran up against the 40 percent limit during the crucial, early years of the depression: in August 1931 the Fed's gold holdings of $3.5 billion were over twice what it needed to meet that requirement; and even at the time of the Bank Holiday in March 1933, despite having endured a run on gold triggered by fear of an impending devaluation, the Fed was sitting on more that $1 billion in excess gold reserves. What the Fed was short of wasn't gold but what clueless Fed officials, subscribing to the bogus "real-bills doctrine," considered good private securities, which until 1932 were the only assets eligible for backing its notes other than gold. If Mr. Porter knew his Friedman and Schwartz, he'd know that those authors, among several others, conclude on the basis of such facts that the gold standard was not the cause of the Fed's failure to combat the Great Depression. Since Christina Romer is among the authors in question, I trust that Mr. Porter will not be tempted to declare that they must all be Republicans.

While the general thrust of Mr. Porter's essay is that one has to be daft to say nice things about the gold standard, he is generous enough to allow that this might not be the only reason for Ron Paul's defense of gold. After all, Porter informs us, "much of his [Paul's] wealth is tied up in gold-mining stocks." Consequently, Porter reasons, Paul "would certainly benefit if even more American's caught the gold bug." But would he? Have a look at any plot of the real price of gold, and ask yourself whether, if you had "much of your wealth" in gold mining, you would be pleading for a return to the gold standard, or pulling hard for a continuation of the fiat-money status quo. Besides not making sense, and being nasty, Porter's argumentum ad hominem is profoundly silly. Would he have us conclude that Paul is pro-life only because he's a pediatrician an obstetrician, or that, since he favors drug legalization, he must be long on marijuana, coca, and poppies?

What I find most obnoxious about Mr. Porter's arguments isn't that they are arguments against reviving the gold standard (for I recognize good arguments for not attempting such) or even that they are bad arguments. It is that they are both bad and smug; indeed they are bad because they are smug. Starting from the premise that only idiots can favor a gold standard, Mr. Porter imagines that no great effort is required to prove that such a standard is deeply flawed. He then cobbles up his proof, by plucking up a fistful of old anti-gold canards from the murky bottom of, by recalling an old article describing inflation that wasn't the fault of some central bank, and by simply asserting his own a priori beliefs. After all, he reasons, why bother to use a tower or ram or even a ladder to assail something that mere wind ought to topple? In fine, Mr. Porter falls victim to the tempting but evidently mistaken assumption that he surely knows more about money than the average right-wing nut.

  • jmh530

    This was a good post.
    In other gold-related news, Eichengreen put out a piece against returning to the gold standard back in August. I thought it had some smuggishness as well, but was argued a quite bit better than Porter's article (he talks a lot about Hayek and Denationalization of money as an alternative).

  • Martin

    George, on a different though not less interesting note, have you heard about this:

    In short some members of the city council of a Dutch municipality want to introduce their own currency to boos their economy: they reason that it will lead to more spending in their economy. The currency would exist next to the Euro. The proposal will be discussed today in the city council.

  • Paul Marks

    Mr Porter shows a total failure to understand that the problem was NOT the fall in the broad money supply after 1929 – it was the rise in the credit money supply (the credit money BUBBLE of the late 1920s).

    This is the problem with the "gold standard" – either the gold is the money (in which case the book keeping tricks of the New York Federal Reserve under Ben Strong, and the book keeping tricks of the private banks are NOT money) or the credit money is money – in which case talking about gold is pointless.

    Clue when the supply of goods and services is rising and the supply of gold is not rising (at least not in proportion) then the prices of goods and services should be FALLING. If general prices are not falling – then something is very wrong.

    What happened in the late 1920s is that the supply of gold did not increase did not increase much – but "money" did.

    This happened because the banks (pushed every step of the way by Ben Strong of the New York Federal Reserve) increased the size of "broad" (credit) money.

    The gap between the monetary base (the gold) and the credit money (the "broad money") got bigger and bigger, and (of course) bubbles formed in asset prices (such as real estate and the stock market).

    Something had to give – and in 1929 it did.

    But instead of understanding the broad money supply should have been allowed to contract back to the monetary base (the gold) with prices and WAGES adjusting in line with this (by falling). Mr Porter sees the phony credit bubble boom as sustainable prosperity – if only more money can be produced.

    "But a sudden major decline in prices and wages is going to cause economic problems".

    Of course it will – but the solution to that is to prevent the credit money bubble forming in the first place.

    For example, a loan must be a transfer of money from real saver to borrower – not a creation of "new" (i.e. credit) money by "crediting money to the account of the borrower" rather than transfering money from real saver to borrower.

    And this is just as true if NO GOLD IS INVOLVED AT ALL.

    With a fiat money system – then the monetary base is fiat notes and coins (not gold), so bank credit ("broad money") must not be allowed to get out of line with this monetary base. Otherwise a boom/bust will be created.

    "But we can simply print more Dollars when the banks get into trouble".

    Classic missing-the-point.

    Loans must be from real savings, interest rates must reflect real time preferences.

    If lending money is simply a matter of book keeping tricks (for example treating requests to transfer money as if they were "new money") then malinvestments will get totally out of control – and the capital structure of the economy will get more and more distorted.

    Andrew M. was right (and Hoover was wrong to go against him) – the rotteness (the corrupt structure) should have been allowed to be purged from the system as fast as possible (as it was in 1921).

    If the above is a "moral theory" (as Paul Krugman sneers) then I have no problem with that – but then I do not regard the word "moral" as something to look down upon.

    By the way – if you want to avoid a sudden collapse in prices and wages – then (yet again) allow prices to fall gradually over time (as new better ways of doing things are developed and capital is accumilated).

    This will happen without economic harm – if credit bubble "broad money expansion" is avoided.

    If it is not……

    Then you will get a credit money "boom" (even if the "price level" remains the stable) and then (sooner or later) a bust – and a crash. As the credit money bubble (the "broad money") goes back down to the monetary base. The "new money" being exposed for what it really is – a scam.

    • George Selgin

      Paul, the decline in nominal values after 1930 wasn't necessitated by the prior boom; it was the result of a combination of Fed ineptitude and sharp increases in currency demand fueled by widespread bank failures. The assumption that an Austrian-type boom calls for a general downward adjustment of the general price level, rather than mere re-adjustments in relative prices, is a misunderstanding of the theory.

      As you and Rick presumably also know, I am not impressed by arguments to the effect that you haven't really got a gold-based money system unless you ban bank lending. Having engaged the argument so many times, I won't engage it again now.

      And it is not at all certain that Mellon said what you quote him as saying. The common mis-attribution refers to Hoover's caricature of Mellon;s views in the former's memoirs.

      • RickDiMare

        George, I'm not opposed to bank lending, which I believe is a legitimate function of banking, along with the safekeeping of money.

        I find the "gold standard" (whatever that really means when the rubber hits the road) objectionable on the grounds that it's just another excuse to keep people enslaved to the current system, and to delay legal recognition that a mechanism exists now, with Treasury-Direct currencies, for people to opt out of the private, profit-seeking, rent-seeking aspects of the central banking system.

        It's as if the financial/political/legal elite are on the high seas in luxury cruise ships amidst drowning people, and instead of stopping to use their onboard life rafts and preservers, come up with some stupid excuse like "the life rafts aren't the right color."

        I recently found this quote by Henry George (1839-1897) which I think more accurately reflects my view of the proper role of banking:

        "The evils entailed by wildcat banking in the United States are too well remembered to need reference. The loss and inconvenience, the swindling and corruption that flowed from the assumption by each State of the Union of the power to license banks of issue ended with the war, and no -one would now go back to them. Yet instead of doing what every public consideration impels us to, and assuming wholly and fully as the exclusive function of the General Government the power to issue money, the private interests of bankers have, up to this, compelled us to the use of a hybrid currency, of which a large part, though guaranteed by the General Government, is issued and made profitable to corporations. The legitimate business of banking – the safekeeping and loaning of money, and the making and exchange of credits, is properly left to individuals and associations; but by leaving to them, even in part and under restrictions and guarantees, the issuance of money, the people of the United States suffer an annual loss of millions of dollars, and sensibly increase the influences which exert a corrupting effect upon their government." The Complete Works of Henry George. Social Problems, page 178, Doubleday Page & Co, New York, 1904

        • George Selgin

          Paul, your (and Henry George's) claim that, to avoid abuses, the central government must monopolize the issuance of paper currency, is, first of all, inconsistent with your claim to be unopposed to bank lending, and especially so w.r.t. the 19th-century context, for banks can only be free to lend to the extent that they are also free to borrow, and back then freedom to borrow meant freedom to issue circulating paper IOUs. That is why, when state banks became subject to a 10% tax on their circulation effective August 1866, state banking came within an inch of disappearing altogether. To suggest that banking is fine so long as banks are prevented from engaging in "the issuance of money" (where as here "money" refers not to base money but to close substitutes) is akin to the suggesting that hunting is fine so long as hunters refrain from actually discharging their guns.

          Second, the suggestion that government monopoly is the answer is so patently contrary to the evidence that it hardly deserves to be taken seriously.

          Third, the tacit assumption that the performance of US state banks of issue prior to the Civil War supplies a useful basis for assessing the merits of competitive note issue generally betrays a very serious ignorance of both the nature and the actual performance of the banks in question. That "wildcat banking" was in fact rare has now been established in half a dozen careful studies of the subject. As for the genuine infirmities of the banks in question, those have been traced, not to competitive note issue per se, but to the effects of legal restrictions imposed by bank regulatory authorities, including bond deposit requirements and laws against branching. Check out the works on this subject by Rockoff, Rolnick and Weber, Dwyer, and Bodenhorn, among others, if you need convincing on this. Also, read about genuine free banking systems like that of Scotland if you want to understand how competitive note issue performs when the government doesn't muck it up.

          • RickDiMare

            George, I'm suggesting that the federal government only monopolize the issuance of coinage, which I regard as "base money" (and for the small percentage of people who legally demand coin-only accounts, to allow them to do so), but I don't see that as saying I want gov't to control money substitutes that will inevitably be issued based on the coinage. Does that make sense?

          • RickDiMare

            I should add, that in regard to paper and electronic money (i.e., money substitutes), in addition to having the option to select Treasury-Direct coin-only accounts, depositors should also have the option to hold only Treasury-Direct money substitutes. So, again, in other words, there is no monopoly of money substitutes, only a monopoly of Article 1, Section 8, Clause 5 coinage.

  • Paul Marks

    By the way I hate the term gold "standard".

    If the gold (or the silver or the …..) is not the money (if it is just some vague "standard" for something else – which is the money) then the virtue of commodity money is lost.

    The point of commodity money is to guard against both political increase of the money supply – and against banker book keeping tricks (creating "money" from NOTHING – by such corrupt practices as "crediting to the account" of the borrower, rather than moveing actual money from real saver to borrower).

    If commodity money does not guard against political (and banker) book keeping tricks (because the commodity is not the money – it is just a "standard") then it is pointless.

    Indeed it is worse than pointless – because it lulls people into a false sense of security, by making them think their money is a commodity, when (in fact) it is nothing at all.

    Just the smoke and mirrors (the book keeping tricks) of a political and financial elite.

    A shell game.

    • RickDiMare

      Paul, I never thought I'd be agreeing with you about something, but I hate the words "gold standard," too.

      Either the metallic gold (in terms of "dollars") is the money, or it's not. Otherwise, it's just another pro-banking trick to maintain the status quo and lull "people into a false sense of security, by making them think their money is a commodity, when (in fact) it is nothing at all" … just the age old "smoke and mirrors … of a political and financial elite."

      • It's not. Selgin is tired of this debate, and I understand why, but I'll take up the mantle here. Educating people about money and credit is a never ending process.

        Extending credit is a bank's business, but it's not a trick.

        You may sell me your house through a rent-to-own arrangement, allowing me to purchase the title from you gradually, by purchasing shares of the house while paying rent on the unpurchased shares. This arrangement is not a trick, and it doesn't require a political or financial elite. As long as no one else disputes your title, you and I can work out this arrangement exclusively between ourselves.

        Under a gold standard, rather than issuing notes representing shares of your house directly, a bank extends credit by issuing notes promising gold equal in value to the market value of your house at the time of sale (or lesser in value given a down payment), and the bank holds the title until the purchaser pays so much gold or its equivalent in value plus interest. The interest is equivalent to the rent in the first arrangement.

        The problem with the second arrangement is that the market price of a house can fall so much that the bank cannot exchange the title for as much gold as he promised when he issued the notes. In this scenario, the value of the bank's circulating notes falls.

        But the value of house shares can also fall. Market values change. People holding things with a falling market value lose the value. That's life in a free market, and I wouldn't have it any other way.

  • Paul Marks

    If people want to improve the economy……

    Invent new technolgy, technology that is actually used to make better and cheaper goods and services.

    Find new resources (money is NOT a resource in this sense).

    Organize better ways of using existing techology.

    Run your business better – reduce costs, work more sensibly.

    Accumilate capital (factories and so on) over time – and maintain and improve it.

    Save (real savings) and invest.

    And now…….

    How NOT to improve the economy.

    Create more money.

    Money is not real wealth – one of the first things the Classical economists tried to explain to people.

    And increasing the amount of money does not create more real wealth.

  • On this we all agree. I do not the term gold "standard" either.

  • Nikolaj

    Paul, you are so unsophisticated, almost a "Rothbardian". You don't understand the elementary things: that we must not allow the "nominal income to fall" and that we must "increase the quantity of money to offset the increased demand for it" and "to prevent the dangerous deflation and collapse of spending"! What a Neanderthal you are: "money is not wealth", "save not use the printing press", "reduce costs, invent new things" blah blah. How is talking like that anymore? What place for macroeconomics remained in your Neanderthal worldview? 🙂

    • We must expand the money supply when demand increases, but "we" does not describe a central authority. This usage of "we" is Orwellian. A central authority is not us. A central authority is the opposite of us.

      "We" describes you and me. When you and I need more money, we create more money, and others use our money if they wish. We don't need a central authority commanding a particular medium of exchange, and we certainly don't need a central authority commanding a medium of exchange that it alone may create. Why would we?

      A central authority creating a fiat currency and commanding its use for all exchange, or effectively commanding its use for most exchange, is an incredibly powerful authority, and it cannot possibly exercise so much authority wisely, because it can never possess enough information to exercise it. The wisest, best-intentioned authority cannot well manage the money supply centrally, and central authorities are not the wisest or the best-intentioned of men anyway.

    • We must also decrease the money supply when demand for money decreases. When promissory notes extending credit (or roughly equivalent shares of collateral securing credit) are the medium of exchange, this contraction of the money supply occurs automatically as people repay the credit extended, so the supply of money rises when demand increases and falls when demand decreases, and the only authorities regulating the supply are the individuals offering and accepting credit on agreeable terms.

  • Paul Marks


    I am, perhaps, the least sensitive person on the planet – but I do see your use of irony (very good).

    Of course that is George Selgin's point also – i.e. it does not matter if nominal wages rise (over the 19th century – or any other century) what matters is whether people can buy more (and better) goods and services over time. The "real wage".

    As for Dr Selgin's attacks upon me…..

    NO I do not believe that government should have a monopoly of issuing paper money – actually I do no think governments should issue paper money at all.

    However, if a bank (or you Dr Selgin) wish to issue paper money – that is fine by me. As long as it is honest.

    For example, if your note says "this note stands for one ounce of gold" upon it, then you had better have that ounce of gold (as your property), one ouce of gold for every note you issue.

    Ditto if the note says "this note stands for one ounce of copper" – or whatever.

    If you do not have the gold (or the copper – or whatever) then, of course, you should go to prison. But that goes almost without saying – after all no one forces you to be dishonest you CHOOSE to be so.

    And, also of course, if you wish to issue a note with writing upon it that says "this note only represents itself" that is FINE (TOTALLY FINE

  • Paul Marks

    Totally fine – I have no objection (whatever).

    And if you find people willing to accept the "George Selgin note" (i.e. a piece of paper with the words "George Selgin" upon it) in return for goods and services – that is fine by me (again – totally fine, I have no objection).

    Of course most people do NOT regard a cheque or a credit card as "private money" – they regard such things as a request to move money from the account of the person who is buying the good or service (for example you – George Selgin) to the person providing the good or service.

    But, again, if you can go up to someone and say "I have no money in my account – just accept this bit of paper with my name printed on it as private money, not a promise of future payment but as full and final payment right now" – I have no objection.

    Of course, there is no reason why "banks" should have a monopoly on producing such bits of paper – anyone should be allowed to do it. And if they can find suckers (I mean willing trading partners) – good luck to them.

    The Great Depression:

    The actual crash was indeed caused (as ALL such crashes are) by the precedeing credit money expansion.

    If you want to prevent the bust then you must not have a credit money boom. In short prices should have been allowed to fall in the late 1920s (in line with rising output). I know that price indexes are fairly useless but…. "you know what I mean".

    If you do not know that credit bubble crashes are caused by the previous credit money boom Dr Selgin – then it is you (not me) who is in error.

    HOWEVER – the actual crash (of 1929) was made vastly worse by the government reaction to it.

    The efforts of the Hoover Administation to actvely PREVENT the adjustment of wages and prices to the level they should be (i.e. vastly lower than where the credit money boom had put them) caused terrible damage – as did such things as the vast increase in taxes on imports (in 1931) and general increase in government spending and taxation.

    It was the policies of Herbert "The Forgotten Progressive" Hoover that turned the crash of 1929 into the Great Depression.

    Otherwise it would have been like the crash of 1921 – or every other crash going back to the crash of 1819 (see Rothbard's doctorial thesis on that subject – which I am sure you have read).

    However, the bust of 1929 (NOT the Great Depression after it – but the bust itself) was inevitable – sooner or later.

    And the cause was indeed the credit money expansion of the years before it.

    Want to prevent the bust?

    Then prevent the credit money boom.

    There is no other way.


  • Paul Marks

    Bottom line.

    A bank should not be allowed to do anything that a private individual is not allowed to do.

    For example, if I lend you money – I must have the money to lend you.

    Either my own money – or money entrusted to me by other people.

    Either I or they (or both) must be REAL SAVERS – people who have chosen to give up goods and services now, to lend money to you.

    In the hope that when and IF you pay the loan back – I (or we – if I am working with money that other people have entrusted to me) will have more money to spend on goods and services – because we will have your interest payment as well as the original loan.

    Loans must be from real savings.

    Savers can not make a loan and still have the money – that is HAVING YOUR CAKE AND EATING IT AS WELL.

    And no "crediting to the account" – no, money that is lent must be real (not created from thin air). No fairy castles in the air – honest finance instead.

    And, of course interest rates must be determined by time preference – the time preferences of real savers and borrowers.

    Not the govenrment printing press (or a bank printing press) – or the book keeping tricks of governments (or the book keeping tricks of banks).

    • Either I or they (or both) must be REAL SAVERS – people who have chosen to give up goods and services now, to lend money to you.

      You're right. I lend you money, and you give me the money in exchange for a valuable good. I am the saver in this scenario until I exchange the money for another valuable good.

      Savers can not make a loan and still have the money – that is HAVING YOUR CAKE AND EATING IT AS WELL.

      I can make a loan and still have the money when I lend you the money to purchase something from me. The money is only a record of the transaction. It records your obligation to me.

      But if you prefer to barter with gold, you can do that too. You needn't trust anyone by extending credit. You needn't take these particular risks, but if you will not take these risks, then you may not expect any of the profits of extending credit.

  • MichaelM

    "A bank should not be allowed to do anything that a private individual is not allowed to do."

    Or, alternatively, private individuals should be allowed to do anything a bank can do 😉

    Really, I don't see why a necessary component of free banking shouldn't be the capacity of private individuals to print their own, personal bank note style instruments. It was certainly a big thing in the major example of free banking in 18th century Scotland.

    Paul, I'm curious why every single post that's made to this blog has to eventually turn into a discussion about 100 percent reserves? Even when it's only tangentially related?

    • I agree Michael, but individuals do not create promissory notes. A promissory note is essentially a contract. A contract requires at least two individuals. It's not like any individual may create money at will. My promissory note is not money until someone else accepts it in exchange for a valuable good.

      The role of a bank is not so much to issue the notes as it is to police the integrity of the promises. Much of this policing can be automated, or it can be decentralized with the aid of automation. Ebay is a good example. At Ebay, people routinely do business with people they've never met personally, but they can know these people by reputation. The reputations emerge from buyer reviews. A similar system of money and credit is certainly possible.

      • MichaelM

        Martin, I wasn't saying that an individual can somehow create promissory notes without a counter-party, just highlighting the fact that free banking should involve institutions (that is, banking corporations) circulating their notes as well as individuals doing the exact same thing. It was a reply to Paul's seeming conviction that banks should have no more rights and powers than individuals have, which I agree with, but in a different way than Paul probably meant.

  • For example, if your note says "this note stands for one ounce of gold" upon it, then you had better have that ounce of gold (as your property), one ouce of gold for every note you issue.

    Banknotes under a gold standard do not say, "stands for one ounce of gold". They say, "bearer is owed one ounce of gold". They are not warehouse receipts. They are promissory notes or bills of credit.

    That I owe you something does not imply that I possess what I owe you.

  • MichaelM

    So, George, I'm curious: What do you think a good argument against gold is?

    • George Selgin

      Michael, you will find a brief discussion of some arguments against returning to gold that I consider "good" on pp. 42-3 of "Has the Fed Been a Failure?"

  • MichaelM

    That is indeed a good paper. However, I'm more wondering what you think some of the…imperfections of gold might be. After all, no monetary system is going to be actually perfect, so what do you think some of the shortcomings of a re-adopted gold standard would be?

    Let's say that the world's governments make a committed return to gold, on a wide enough basis that it becomes, as you put it 'truly international'. Let's say that this commitment is strong enough that markets consider it to be 'credible'.

    What issues do you see arising that gold using banks will have to deal with over time? Are there any, if not negative, ambiguous macro-economic indications?

  • RickDiMare

    I suspect that many others, like myself, are still struggling with what "free banking" really means, but having said that, I also feel like there's some form of it I could accept, probably based on the Scottish unlimited liability model.

    Anyway, I recently read Stephan Zarlenga's "Henry George's Concept of Money":

    Zarlenga admits that George died before his theory was fully developed, but I'd like to post the following to see if there's a reaction to some of Zarlenga's comments:

    "The term “free banking” is vague, because its supporters have not uniformly defined it. We take it to mean a system where bankers are allowed to create the money supply in the form of their credits, or notes, which are allowed to circulate without restriction or regulation, to the extent that the markets will allow. But isn’t it really up to these advocates to define their own terms?

    The present day call for free banking is among the least informed of monetary proposals yet to be put forward in our nation. It seems that to promote an idea without real examination today all one has to do is put the word “free” into its name. This has even enabled them to ensnare Milton Friedman (who had been resisting) among their tentative supporters.

    The strident anti government attitude of many of those promoting free banking has created a prejudice in them to view all regulation as bad and, contrary to our experience and our history, to place their trust in the bankers to act honorably!"

    Finally, in Appendix 1, Zarlenga lists 5 major current problems with free banking arguments:

    "Problem # 1: They have not carefully defined their terms. They have not accurately and uniformly defined money. Some use a primitive commodity concept of money, others not. Their definition of “free banking” is not uniform, but varies greatly from writer to writer.

    Problem # 2: They have miss-classified the period from 1836 to 1862 as the free banking period. The correct free banking period is pre 1836, before the state regulations on banking were increased. Naturally the post 1836 period gives better banking results, but anyone can see that its a period of increased government regulation:

    A) Bank note issues by banks were restricted to specific percentages of the bank’s real capital.
    B) The bank’s capital reserves were improved, moving toward government bonds rather than the worthless personal notes of the banks stockholders.
    C) A double liability was imposed on Bank stockholders, where they were liable to be called to pay an additional twice the par value of their stock, if their bank got into trouble.
    E) More efficient systems of bank examination and reporting were established.

    Problem #3: Partly because statistics on the banks are very patchy, the free banking advocates have focused on certain measures which cannot convey a full and accurate picture of banking. For example, they try to evaluate banking performance by the percentage of depositors money that was lost. But that treats the banks as deposit institutions, when they were in fact banks of issue, creating new money in amounts approaching 10 times their deposits.

    The free bankers work thus ignores the bank stock frauds which observers tell us was an important part of banking. Recent history of the crash of 1929 indicates losses through stock markets, from a banking created crisis was about 40 times as much as the direct losses in bank deposits(see chapter 20). It also ignores the effect of the banks activities on the rest of the community.

    Problem # 4: They think that they have theoretically “proven” that bankers can be trusted to act honestly, because they say in the long term, it will build banker’s reputations and therefore be profitable. They don’t consider that often in the short term, the potential for loot is so great that it will be taken without regard to honesty. They also ignore that reputation can be influenced by public relations expenditures and advertising. That is in fact the history of business immorality. Men don’t always do the right thing when they are tempted by the opportunity to grab a great amount quickly.

    Problem # 5: Starting with this a’priori position, they have briefly looked through history for empirical support for their theory. But using history in that manner was not likely to yield accurate results. The lessons of history have to be viewed more dispassionately within their own context to see what picture emerges from several sources. It doesn’t work to force a modern day template onto the facts; to attempt to force a “fit” with favorite theories.

    Nor is it acceptable to use a modern created filter through which agreeable facts are retained and disagreeable facts are ignored. One cannot ignore the universal condemnations of the banks from qualified observers of many different persuasions: Knox, Gouge, Condy Raguet, Bullock, and Sumner quickly come to mind.

    John Jay Knox, a Controller of the Currency and generally friendly to banker interests wrote in his 1876 Treasury report:

    “The history of banking in the various states before the (civil) war will make plain to anyone that the note issuing privilege was much abused to the great detriment of individuals and the public. Banks were started for the sole purpose of foisting worthless notes upon a trusting public….”
    “The idea that the government should issue the paper money, as well as coin the gold and silver has taken a firm hold of the American mind” Knox wrote."

  • MichaelM

    The post makes me wonder just how familiar with the author is with the actual work of the Modern Free Banking School, considering that a definition of free banking is included in the very first paragraph of, say, Dr White's Free Banking in Britain, there's an actual whole section of the first chapter of Kevin Dowd's book dedicated to defining free banking, and similar things can be found throughout the works of adherents to the modern school.

    Over all, I'd say there's some serious projection going on here.

    I mean, I can't help but notice that, through out that whole article, he never bothers too define money.

    • RickDiMare

      Michael, I haven't read Dowd's book, but regarding Zarlenga's Problem #1 with free banking, the big unaddressed question in my mind is whether free banking should mean limited or unlimited liability.

      It's very confusing to me that advocates of free banking point to the 19th century Scottish experiment with unlimited liability as one the most successful in free banking, but neglect emphasizing the unusually strict Scottish bankruptcy laws (that was the key factor in its success).

      But I think Zarlenga raises another big issue with Problem #2. Is he correct that the post-1836 period gave better free banking results because that was a period of "increased [state] government regulation"? In other words, which pre-Civil War period are we aspiring to? If slavery had begun being phased out in 1808, as the original framers had planned, would the Second BUS have been unnecessary, and therefore the pre-1836 period is the goal?

      If the original framers really did underestimate how difficult it would be to break the slaveholder/slave relationship (now the employer/employee relationship), and it now seems obvious they did, will we always need heavy federal tax and monetary regulation over the relationship? So, does this mean we're aspiring to the post-Civil War period, prior to the central banking era, where federally-chartered free banks dominated?

      Regarding your comment about George's (and Zarlenga's) definition of money, he was a Treasury-Direct "greenbacker" who favored Knapp's view of full government fiat, but felt strongly that private banking corporations should not issue money. However, in his latter years, he noticed an important relationship between money and human labor that caused doubts about relying solely on a fully fiat paper currency.

  • David Stinson

    Hi George. Good and very informative post. Thanks. Sorry for the very late comment but …. does the point about the gold cover ratio never being a binding constraint also imply that devaluation against gold was not a necessary precondition for substantial monetary easing (even in a legal sense, let alone an economic one)?

    • George Selgin

      Devaluation certainly wasn't necessary prior to 1933, at least in the simple sense that the Fed had room to expand without it (and, according to Romer and others, without a great risk of triggering a run). After 1933 the counter-factual gets very tricky, because the very fear that FDR would devalue triggered panics that must ultimately have made the fear self-fulfilling, and because you have many other countries devaluing, thereby putting more pressure on those that resisted doing so.

      • David Stinson


  • Paul Marks

    One thing that I should always been kept in mind….. (and, in my default state of rage against bankers, I often fail to formally state it – without even the excuse of not knowing it).

    Bankers (under free banking) can NOT increase the real money supply. Therefore to blame them for long term inflation (the increase in the money supply) is wrong (flat wrong).

    All bankers (under free banking) can do is increase the supply of CREDIT (by treating checks/cheques as if they were deposites – or by many other book keeping tricks) – this does indeed create a boom/bust event, but it does NOT increase the real (long term) money supply. This is because the boom (the credit money bubble) inevitably collapses (the bust) – thus bringing back bank credit (loans and so on) bank towards the monetary base.

    Only with external support (via Central Banking and so on) can bank credit bubbles (increases in the credit money supply) be turned into a long term increase in the real money supply.

    That is why it is wrong to blame inflation (i.e. a long term increase in the real money supply over time) on fractional reserve banking – which can only create boom/bust events (an increase in the supply of CREDIT over and above real savings – this "boom" leading to a bust, when the credit falls back down towards the monetary base).

    Only government (via Central Banking – or some other means) can turn bank credit into long term real money – the curse of almost total desctruction of the Dollar that has come upon the United States since 1913 (and is still continuing).

    This does not mean the credit bubble antics of bankers are not damaging (of course such boom/bust events are damaging), but they are NOT capable of destroying the value of money, destroying the currency.

    Only governments (directly or indirectly) can do that – which, of course, is exactly what governments are presently doing.

    "But the governments are doing this to save the credit bubble bankers".

    That may, or may not, be true – but it does not alter the FACT (and it is a fact) that only governments (directly or indirectly) that can create the sort of inflation that countries (including the United States) have seen in the 20th and 21st centuries. Or the destruction of the monetary system – which is what we are presently seeing.