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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.

  • Paul Marks

    A new book on the history of ideas, by a pro freedom person, is always welcome.

    However, this post (not the book – I have not read the book) is troubleing.

    Walter Bagehot did not attack the Bank of England for being too interventionist – he attacked it for not being interventionist ENOUGH.

    Indeed the then Governor of the Bank of England engaged in written debate with Bagehot – because Bagehot favoured bank bailouts (although on a much more limited scale than today) and the Governor of the Bank of England did NOT.

    Joining in the cult-of-Bagehot with the "mainstreamers" (but claiming he is "one of us really" – or words to that effect) will not do.

    Walter Bagehot did not (for example) get the editorship of the Economist magazine because he was a wonderful defender of laissire faire – he got it by marrying the daughter of the boss.

    "Personal attack" – perhaps so, but it goes to the issue.

    Walter Bagehot was a "concede" man – "we must concede all that it is safe to concede" (quote from his work on the British Constitution).

    "concede" to who?

    Concede to the collectivists – to their demands for ever bigger government.

    Of course only in a moderate way (not what it was "unsafe" to concede – to create some sort of "poor man's paradise"), but still concede.

    Walter Bagehot is not a roll-back-the-state man.

    He is a man who gives in – who makes concessions to the collectivists.

    Sure he would be HORRIFIED by the modern level of collectivism (I do not deny that).

    But his policy (when under pressure – retreat) leads step-by-step to ever bigger government (in size and scope).

    Still I agree that J.S. Mill is wildly over rated.

    The, much hyped, "On Liberty" is fatally flawed (not the libertarian classic it is supposed to be) – but that is political philosophy so I will not start attacking it here.

    But also as an economist Mill is wildly over rated.

    Let us leave aside banking for a minute and deal with basic theory of value stuff.

    Samual Bailey, Richard Whately (and many others) had refuted the labour theory of value years (decades) before the "Principles of Polticial Economy" of Mill.

    Yet Mill just pretend that the "theory of value is settled" – along (the quite false) lines of David Ricardo and his friend James Mill (yes – J.S. Mill's own father).

    [And, in a different context, we are told that the problems of production are solved the problem is now "distribution" (ouch – a thousand times ouch).]

    J.S. Mill does not refute counter arguments he just pretends they do not exist.

    Everyone agrees on the theory of value (even though they do not).

    Just as everyone agrees that local government should take over …… (even though that was not true either).

    It is very unfortunate that the works of J.S. Mill eventually came to be seen as the central works of "liberalism" in Britain.

    He (and others – such as Walter Bagehot) really mark where liberalism in Britain started to go badly wrong.

  • MichaelM

    Bagehot wasn't saying the Bank of England was interventionist, he was saying that the very existence of the one-reserve system (that is, the Bank of England and its special privileges) was an intervention that caused serious problems. His solution, as a second-best to simply removing the special privileges of the Bank, was to have the Bank act as a lender-of-last-resort.

  • Paul Marks

    Sorry Micheal this will not do.

    THe arguement that Walter Bagehot was saying that if there was no Bank of England banks would not get into trouble – but as there is a Bank of England it should bail out banks (although in a far more limited way than it does now) if they get into trouble.

    This is bending over backwards (and doing flips) in order to try and justify the unjustifyable (Bagehot's interventionism).

    Why should it matter if a bank gets into a trouble anyway?

    In a free market if a business makes mistakes (or is just unlucky) then it GOES BANKRUPT.

    So why should the powers that be (including Walter Bagehot) get all upset and jump about concerning a bank that gets into trouble?

    Your own language provides the clue – talk of "reserve" and so on.

    Banks (even then) were NOT engaged in just "putting people's savings to work" – i.e. getting savings (the savers of their owners and their "depositors" – although the word "depositor" is highly misleading as the money is lent out not "deposited").

    Banks (even then) were engaged in CREDIT EXPANSION – i.e. the boom-BUST, shell game. Depending on smoke and mirrors (book keeping tricks) to make it appear that they were just lending out real savings (not creating credit-money out of thin air).

    The fear of Walter Bagehot was that if major banks (he did not really care about little country ones) were allowed to go bankrupt – then the credit bubble would burst, with terrible effects on the general "financial system" and the economy generally.

    In short the same "argument" (although on a much more limited scale than today) that we hear today.

    Once you start supporting a scam (a credit bubble) you are led step-by-step to depending on state interventionism.

    And please no one reply with the PLATITUDE about (if only there was no Central Bank) banks would only engage in credit money expansion (i.e. the book keeping tricks that "create money" beyond real savings) to "meet the needs of trade".

    The "meet the needs of trade" platitude was the stock-in-trade of the "Banking School" refuted by the "Currency School" in the early 19th century.

    The great error of the Currency School was to think that if they prevented banks issuing "bank notes" they had stopped the scam. Sadly (as Ludwig Von Mises points out) there are other ways to use book keeping tricks to lend out "money" that DOES NOT REALLY EXIST – to build credit bubbles (fairy castles in the air). Bubbles that inevitably burst.

    A scam is a scam is a scam. And waffle about the "needs of trade" does not alter its status as a scam.

    Either avoid scams – or admit (as Bagehot did) that the state needs to stand behind them.

    Accept, in the long term, even state intervention will not save the scam – a system based on book keepting tricks (a shell game hidden by smoke and mirrors) can not be the foundation for a sound "financial system".

    And we are now living in the long term.

    If you want to lend out money then SAVE money – or convince other people to entrust their SAVINGS to you (to be lent out).

    "But I want to lend out more money than that – and I want lower interest rates…."

    Then you are a bubble builder (a scam artist) – and the bubble inevitably burst.

    An honest banker ("free" or otherwise) can not lend out money that was never saved. Any more than an honest baker can sell bread that was never baked.

    For someone to get a loan someone else must GIVE UP THE MONEY (their savings) – in the hope of getting the money back (plus interest) when and IF it is repaid. Whilst the loan is outstanding the saver and the bank does NOT have the money.

    Moderate interventionism (Bagehot style) will not "work" in the long term – and the extreme interventionism of today will not work either.

    This is the long term – as will become clear over the next year.

    No more bubbles – no more "credit expansion for the needs of trade".

  • Kurt Schuler

    Paul, you seem to look at the history of economic thought as a story of heroes and villains. Such an attitude impedes one's ability to understand the subject thoroughly. Bagehot took the situation of the Bank of England as he found it, and made suggestions for ameliorating its defects within the existing framework, while at the same time acknowledging that a better framework existed. Mill was one of the most creative economists who has ever lived, to say nothing of his accomplishments as a logician, philosopher of ethics, political theorist, autobiographer, and essayist. Our age has no one to equal him in breadth and depth of thought. If Bagehot and Mill got some things wrong, well, so has every other great economist. So have we lesser economists.

  • Paul Marks

    Kurt I did not use the terms "heros and villains" on banking.

    All I have said is that money lenders must have real savings to lend – their own savings or the savings that other people have entrusted to them to be invested (to be lent out) with the clear understanding that the people who hand over their savings do NOT have the money any more till when and IF it is paid back by the people who borrow it.

    It does no good to try and hide the basic issues, or to make compremises in the hope of appeasing the powerful (they will not be appeased), or appearing "moderate" (a person who opposes the vested interests will be attacked as "extreme" whatever he says or does not say – so he might as well TELL THE TRUTH, i.e. actually be "extreme").

    As for Walter Bagehot – perhaps "got the job because he marrried the daughter of the boss" was a low blow, I accept that. And I withdraw those words – and apologize for them.

    However, the fact remains that Water Bagehot made the Economist a worse publication than it had been before, it would have been better (from the free market point of view) had he not become editor.

    As for banking and the Bank of England….

    Bagehot did NOT suggest that the Bank of England become less interventionist he suggested it become MORE interventionist.

    I have now written that times three times – and I am am becomming irritated that there seems to be an effort (I believe a deliberate effort) to miss the point.

    As for Walter Bagehot's other contributions……

    For example, I have read the "English Consitution" – I read it 25 years ago because I was told it was a "classic".

    Actually it is a terrible work – a twisted mess.

    It is factually wrong (for example assuming that the Queen had a lot less practical power than Queen Victoria actually had – and used), it contains terrible advice – for example the whole "concede anything that it safe to concede" death trap.

    And it even becomes silly.

    For example, I assumed that Bagehot was making a joke when he says (about some person's proposal) that "we" (he uses the word "we" the same way that J.S. Mill does, all rational people are ASSUMED to agree with Bagehot) should take every opportunity to explain and push for the consitutional reform and then says "there is no room to set it down here".

    What I assumed Bagehot was doing was mocking the Constitutional suggestion (i.e. sarcastically saying people should back it whilst saying, in a backhanded way, that it was so long and complex that it could not even be fitted into a book on the consitution).

    I actually felt some good will towards Bagehot – at least he had made a good joke.

    Then I found out he was serious.

    He actually did support the proposed polticial change, wrote that it should be explained and supported at "every opportunity", and then wrote that "there is no room to set it down here".

    He was not being sarcastic – he was just being an IDIOT.

    Like J.S. Mill saying there is a big moral difference between regulations concerning freedom to buy and freedom to sell. Or that freedom of trade was not a moral matter.

    Sadly many "19th century classics" turn out to be like this.

    They turn out to be terrible – a twisted mess.

    Perhaps that is why 19th century liberalism collapsed into 20th (and 21st century) statism.

    Socialists did not so much defeat liberals in debate – the liberals defeated themsleves, they collapsed into the absurd "new liberalism" long before T.H. Green (and so on) are supposed to have developed it, indeed right back in the days of J.S. Mill and Walter Bagehot.

    The "new liberalism" logically (step by step) leads to collectivism. Indeed there are signs of that even in the mid 19th century.

    For example, in 1875 unions were placed above the law (although this was disputed and the position had to be pushed by the even more extreme 1906 Act) and the various powers of local government were (in the same year) made COMPULSORY.

    Instead of local ratepayers (if only indirectly – via the people they elected) having some choice about what local councils, now it was the position that local government HAD TO do X,Y,Z.

    "But Paul – Dizzy was responsible for these terrrible measures, and Dizzy was a Tory".

    Quite true – but I do not remember "advanced" liberal opinion (i.e. liberal opinion that was influenced by such people as J.S. Mill and "concede whatever is safe to concede" Bagehot) denouncing these measures (although I stand open to correction – perhaps the Economist magazine, at least, did denounce the measures).

    And was not J.S. Mill saying that "everoyone agrees" that local government should do X,Y,Z, not at least partly responsible for the national government (only a few years later) makeing it COMPULSORY for local councils to do X,Y,Z.

    It is called creating a "climate of opinion".

    A climate of opinion created (in this case) by DISHONESTLY pretending that everyone else agrees with one's position (Mill knew perfectly well that many people did NOT agree – but that is not what he wrote).

    And what of the Scots Poor Law Act of 1845?

    Before this time most of Scotland did not have a compulsory "poor rates" (i.e. welfare taxation) – this Act imposed it. And it was supported by "advanced" liberal opinion (as was so much else).

    Still back to Bagehot.

    I will confess that I am not just put off by the content of his works, I (like the voters who turned him down) am also irritated by his style of writing.

    This timid (indeed castrated) and contradictory prose style.

    It may be typical of a 19th century writer (although not everyone in the 19th century wrote this way). But it is still irritating for people who actually take the trouble to read what the man wrote.

    Say what you believe, and say it plain.

    And be prepared to die for it.

    Or shut your mouth, and lay down your pen.

  • Paul Marks

    Although, to be fair, I would guess that Bagehot would be a lot more careful with the physical use of a pen (or a keyboard – if he had been around in more recent times) than I am.

    As I only really care about content, I tend to neglect form.

  • joepeera

    Bagehot states in the second chapter of his book, "Lombard Street", that central banking is the second best system and that the first best is the free banking system because it can essentially manage itself. I believe that this simple argument and example alone can explain why free banking serves to be more productive. Free banking is the evidence that money can manage itself through the simple specifications that are required for banking to occur. When a central bank has control over banking, policies and requirements might be put into place that may have the potential to distrupt the efficient forwardness of the system entirely.