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Free Banking and the Dollar

I've been getting some flak lately from hard-core free market types for occasionally saying some nice things about NGDP targeting, and especially for suggesting, in the course of a recent Cato forum contribution, that we might improve upon the present U.S. arrangement by replacing the FOMC with a tamper-proof Bitcoin-type protocol that automatically adjusts the output of base dollars so as to maintain a steady NGDP (or, better, Domestic Final Demand) growth rate. Call the dollar thus reformed the "Bitdollar."

My Bitdollar proposal, my hard-core critics maintain, places me firmly in the ranks of apologists for state "manipulation" of the money supply. Consequently I am, by their reckoning, a turncoat in the fight for monetary freedom, and (since I still have the brass gall to post on a site called "") a hypocrite to boot.

What have I to say in response to such charges? Considering their sources, I'm tempted to settle for a Bronx cheer. But as some others may wonder if there isn't some merit in their accusations, I think I'd better indulge my critics by entering a plea of "Not Guilty."

My defense? It is simply this: that while I'm all for monetary freedom and competition, I'm also for reforming the U.S. dollar, which for me means freeing it from control by discretionary central bankers. Like it or not, the dollar is presently the standard money, not just of several hundred million U.S. inhabitants, but of many millions of inhabitants of other countries. What's more, these millions, unlike holders of U.S. securities, hold fiat dollars under some degree of duress, because a combination of network externalities and legal restrictions makes it almost impossible for them–my hard-core critics included–to survive without equipping themselves with dollar-denominated exchange media, or because they live in places where the dollar seems rock-solid compared to anything local authorities have to offer.

Consider, then, some other purportedly free-market strategies for monetary reform, and the alternative fates to which each would consign the world's hapless dollar holders. There is, first, the inevitable catastrophe strategy, according to which, in the wake of a long-forestalled but nonetheless inevitable hyperinflation, a state of monetary freedom (gold version, usually) emerges Phoenix-like from the dollar's ashes. Then there's the level playing field strategy, which supposes that mere elimination of legal tender laws and other government-erected impediments to free choice in currency would provoke a spontaneous switch from dollars to other currencies, leaving to the Fed the choice of either shedding assets to preserve the dollar's value, or letting it become worthless. Next there's the back to gold strategy, in which the Fed (or some replacement agency) is compelled to turn present "IOU nothings" back into redeemable claims to gold. Finally, there's the frozen Fed strategy, which equates any change in the stock of base dollars with monetary interventionism, and therefore treats a frozen base as the closest fiat-money equivalent to monetary laissez-faire.

Unless you happen to live in a bomb-proof shelter equipped with a lifetime supply of canned goods, the catastrophe strategy will, I trust, strike you as undesirable both because you might be among the people wiped-out by the anticipated hyperinflation, and also because that hyperinflation could be a long-time coming. A long delay is also likely to be in store for those banking on the level-playing field strategy, which downplays, I think severely, the likelihood that the dollar will stay in the saddle so long as catastrophe doesn't strike. As for a return to gold payments, I've explained elsewhere why I doubt such a return could be sustained, assuming it might be achieved at all.

That leaves the frozen Fed strategy. For this alternative I admit to having considerable sympathy: I can hardly do otherwise, having proposed the idea myself in my first book (see chapter 11). Besides, unlike the other plans this one could preserve the dollar network whilst safeguarding dollar holders from the Fed's machinations. But in what sense is this strategy any less of a cop-out than my now favorite plan for replacing the present Federal Reserve dollar with an NGDP- (or Domestic Final Demand) stabilizing Bitdollar? If a tamper-proof Bitdollar is a form of monetary central planning, then so is a frozen Fed dollar. The difference between the schemes is, not that one involves a planned base money stock and the other doesn't, but that one involves a fixed base money stock and the other doesn't.

But, you may ask, isn't a fixed stock of base money more consistent with laissez-faire than a stock that grows at some constant rate while also adjusting, albeit automatically, in response to changes in the real demand for base money? No, it isn't. Consider the classical gold standard, or any commodity-money regime for that matter. Such a regime involves, not a constant monetary base, but one that tends to expand along with growth in the real demand for base dollars. Thus the long-run price-level stability that was one of the gold standard's most noteworthy achievements. Whatever else it might be doing, a discretionary Fed that insisted upon keeping the monetary base constant would not be emulating a gold standard. Instead, it would be pursuing a policy that might well lead to disturbances as serious, if not considerably more serious, than those that could be justly attributed to the historical gold standard or (for that matter) than those that might arise today under a discretion-based regime that yielded low and steady inflation. In any event the belief that a central bank is "doing nothing" when it chooses to maintain a constant monetary base (or constant stock of any monetary aggregate) is my personal choice for top honors (and, take my word for it, the competition is stiff) in the "crudest free market monetary fallacy" contest.

Free banking would, to be sure, go a long way toward reducing the risk of money shortages, and consequent downturns, in a frozen-base regime, both because it would allow changes in the relative demand for currency to be accommodated through greater emissions of private banknotes (or their digital counterparts) without need for more base money, and because changes in the free-banking base-money multiplier would tend (for reasons also given in The Theory of Free Banking) to automatically compensate for changes in the velocity of money. But these tendencies would still not suffice to avoid some risk of unwanted deflation–which is to say, deflation that's not just a reflection of productivity gains.* In particular, they would not allow for monetary expansion to accommodate growth in the supply of factors of production, and of labor especially. An automatic and tamper-proof regime providing for a constant spending growth rate would come closer to avoiding both monetary excess and monetary shortages. And that's why I favor such a regime, now that Bitcoin has suggested a means for implementing it.

It would be unnecessary for me to say, where it not for certain contrary animadversions, that, far from being a monetary freedom apostate, I remain as committed to free banking, and to monetary freedom in the more general sense, as ever. I still pine for truly unregulated banking, minus all the regulatory red-tape but also minus government safety nets and the prospect of Fed (or Treasury) bailouts. I still oppose all artificial restraints upon free trade in currency. I still would rather have private mints coining and private firms issuing our small change, for goodness sake! But I also want to see the dollar made safe and sound, and the sooner the better; and I can think of no better way of making it so than by replacing the present discretion-based version with one that provides for an automatically-determined supply of dollars–an automatic mechanism not unlike the one that characterized the gold standard, though one both more conducive to short-run stability and less dependent upon untrustworthy promises.

*I can hear certain self-styled Austrian economists grumbling to themselves, "but there's nothing wrong with any sort of deflation!" Here is another good candidate for the previously-mentioned contest. Like it or not, in today's world, many prices, and wage rates especially, are notoriously "sticky" downwards, which means that a plunge in general spending is bound to result in otherwise avoidable unemployment. True, Murray Rothbard says otherwise in the theoretical part of America's Great Depression. But then he spends the rest of the book explaining how Hoover changed everything with his silly high-wages doctrine. Whether or not price stickiness originated with Hoover, it certainly didn't end with him!