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The uses of the past

Larry White is apparently too modest or too busy to mention here that he has a new book, The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years, so I will mention it for him. Free banking is not prominent in the book because because it has not been prominent in policy debates, despite the revival of the idea that Larry himself has led.

Larry’s book has been reviewed by Perry Mehrling. Mehrling is the author the author of a fine biography of the late Fischer Black, an unorthodox thinker who was one of the key figures in modern finance; he also has some connection to modern free banking theory, which perhaps I will discuss in a future post. Mehrling remarks that in contrast to Larry’s view that central banking is “just another example of government stepping in to do what free markets do better,” “I align myself with [Walter] Bagehot, who famously stated that ‘Money will not manage itself, and Lombard Street has a great deal of money to manage.’”

A couple of posts ago I remarked that the most important reason for studying the history of economic thought is that sometimes the present has forgotten what the past knew. Mehrling’s quotation from Walter Bagehot’s Lombard Street is a case in point. Bagehot wrote his book as a proposal for improving England’s central banking system, and it was within that context that he wrote the famous sentence that Mehrling quotes, at the end of the book’s first chapter. In the next chapter, though, Bagehot made it clear that he considered central banking a second-best system, and that under free banking, which he considered the best system, money does manage itself.

Another example I recently came across in which the past knew what the present had until recently forgotten concerns John Stuart Mill. His treatise Principles of Political Economy contains a chapter called “Of Credit, as a Substitute for Money.” Using modern terminology, much of what he is talking about in the chapter we would today call “shadow banking” – the extension of credit outside of banks, but in a way intended to provide high liquidity rather than being linked to particular trading relationships, as business do with trade credit. In particular, Mill briefly discusses bills of credit and promissory notes, and how they have sometimes circulated widely.

Mill provides a third example of how the the recent  past knew what the present, in this case Mill himself, has forgotten. The first edition of Principles of Political Economy was published in 1848, and the last edition revised by Mill was published in 1870. By 1848 the debate on whether Britain should have free banking or central banking had been finished for several years, having been decided in favor of central [note: original post mistakenly said "free"] banking. Mill’s analysis of the subject is weak, basing itself on the supposed advantages of concentrating gold reserves in a single bank, and lacks the depth of analysis that had been attained by English monetary writers earlier in Mill's own adult life.