Friday Flashback: We Are All Free Banking Theorists Now*

free banking, Diamond and Dyvbig, Alternative Money University, monetary education, economic education

free banking, Diamond and Dyvbig, Alternative Money University, monetary economics education

(Originally appeared December 7, 2014)

(*And we always have been.)


Yesterday, while giving Cato's interns an impromptu talk about my work, I found myself saying something that seems worth putting in writing. This was that the difference between me and Larry White and Kevin Dowd, among others, and most other monetary economists, isn't that we theorize about free banking, and they don't. It's that we're mindful of our free-banking theories, whereas they're mostly heedless of their own.

Consider: an economist says that central banks prevent or limit the severity of financial crises, or that without mandatory deposit insurance even sound banks are likely to face runs, or that banks can never be expected to hold enough capital unless we force them to, or that commercially-supplied banknotes will tend to be discounted. All such claims–which is to say any claims about the need for or consequences of government intervention in banking–depend, if not on an explicit understanding of the nature and workings of a laissez-faire banking system, then on some implicit understanding. And this understanding in turn implies a theory of some sort, for reference to experience alone won't suffice for drawing the sort of sweeping conclusions I'm talking about. It follows that all economists who have anything to say about the effects of government intervention in the banking system are either self-proclaimed free banking theorists or are free banking theorists who don't admit (and perhaps don't realize) it.

The rub is that tacit or subconscious theories of free banking–the sort people rely upon when they are "doing" free banking theory without being conscious of it–are likely to be bad theories because, being unstated, they can't be challenged, and, being unchallenged, they don't tend to be systematically corrected. A self-conscious free banking theorist confronted with some claim of banking-market failure might point to his own theory suggesting that no such failure exists, and might also point to contrary evidence. But he can't generally infer, and therefore can't directly contradict, the theory behind the claim.

If even economists who've never heard of free banking, or who dismiss both it and the people who take it seriously, nevertheless subscribe to some free banking theories of their own, where do their theories come from? As I can't read other economists' minds, I can't pretend to know the answer. However, I can, and I will, hazard a guess or two.

Consider, if you will, your typical fresh PhD, having monetary or (more commonly) macroeconomics as a specialty, as might have been disgorged by any save a handful of the doctoral programs in the U.S. sometime during, say, the last 30 years. In all likelihood that graduate never took a class on economic history, let alone one on monetary history or (least likely of all) the history of economic thought. Nor is he or she likely to have become familiar with even present day monetary institutions through any other coursework, most of which is devoted to mastering either statistical methods or highly abstract models. As for the monetary sequence itself, it is likely to have involved toying with Overlapping Generations models, which don't even get the definition of money right, or Woodford-style neo-Wicksellian economics, which (unlike the Swedish real McCoy) strives to avoid using the "m" word altogether. Some better students, to be sure, will make up for the lack of institutional meat in their bland graduate-school porridge by grabbing the occasional vitamin from the library. But even when I went to school (NYU, class of '86), that sort of thing was relatively rare. Today, to judge from the many grad students I talk to, a student who dare's to do it, besides risking failure by having less time left to study for prelims, is sure to be regarded as a weirdo.

After graduation, perhaps? So far as most economists employed in research universities are concerned, Fuggedaboudit. Publish or perish means, for the vast majority, polishing up the three-articles that comprise their dissertation, and then milking the same highly-specialized human capital that sufficed for producing those "chapters" for all it's worth, which, with luck, will be additional articles enough to get one over the tenure threshold. With the tenure clock ticking inexorably, and journals taking their sweet time to return reports, who can afford to be intellectually curious? After tenure? Not likely, since most tenured faculty, having developed a shtick which, with the help of some elegant variations, may serve as well in getting them promoted again as it did in getting them tenured, still won't get around to learning stuff that they now regard, with perfect justice, as perfectly irrelevant to mastering their profession. Better to angle for department head, or (for those with higher aspirations) to take up golf.

The upshot of all this is that most of what our monetary economist knows or believes about monetary institutions he or she learned as an undergraduate. And what was that? To infer from the contents of most principles and money and banking textbooks, very little, and much of it misleading. Of monetary history, in particular, such books (1) say very little, if anything at all; (2) refer (if written for the U.S. market or by U.S.-trained economists) only to U.S. experience; and (3) get that wrong. Reading such books, you are quite likely to learn (for examples) that banking started out as a big swindle, that before the Civil War U.S. banks were hardly regulated at all and that, for that reason, American's were saddled with all sorts of banknotes, most of which were worth far less than their face values; that the Federal Government nationalized the currency supply, forcing state banks out of the business, during the Civil War because it was suddenly inspired to establish a uniform currency; that post-Civil War panics were inevitable given that we still lacked a central bank; that during the Great Depression people staged runs willy-nilly on good and bad banks alike until, in early 1933, they lost confidence in every last one of 'em, thus proving beyond doubt the necessity of nationwide deposit insurance; and that the Fed is an independent central bank, having become so in 1951. My conjecture, in short, is that tacit theories of free banking are most likely cobbled together, unconsciously and therefore haphazardly, from such substandard undergraduate building material.

So much for academic economists, or at least for the vast majority of them under the age of 60. If you want an academic economist who really knows his monetary institutions, a good rule of thumb is, the older the better. Try Dick Timberlake (92), or Leland Yeager (90), or Alan Meltzer (86), or Axel Leijonhufvud (81), or Charles Goodhart (78), or David Laidler (76). But beware that, even among Laidler's cohort, there are plenty who don't seem to be know a bank from a hole in the ground, or a redeemable banknote from (say) a durable good.

True, economists who work for the Fed, or at least for research departments of the various reserve banks, are another matter. Their jobs tend to encourage them to be familiar with at least some real-world monetary institutions; and I know quite a few, not all of them yet 60, who know their monetary history pretty well, including a fair bit about free banking. Having actually heard of it and thought about it, their theories of free banking, if still implicit, are at least reasonably well informed. They also tend to be rather more interested in, and favorably disposed to, what we avowed free-banking theorists have been saying, than their academic counterparts.

Would that this were also true of the Fed's higher ups, including its highest-ups of all. Alas, officially at least, their understanding of free banking is not much better than that of our lowly tenure-grubbing assistant professor. Consider even Ben Bernanke, a Fed chair regarded as an expert monetary history. To judge from his GWU lectures, at least, his general take on U.S. monetary experience doesn't seem all that different from the conventional textbook wisdom I mentioned a few paragraphs ago. The Fed's other "educational" productions, aimed at general readers (as opposed to its research intended for other experts) are for the most part even worse.

Some persons hearing me claim that many economists, including those who want nothing to do with free banking theory, are free banking theorists themselves, albeit ones who don't know it (and whose theory is likely to be the poorer for it) will, I imagine, think to themselves, "What in the blazes is Selgin thinking? Of course free banking's critics have a theory, and not just a tacit one. They've got a theory and they know it. They've got…Diamond and Dybvig! What's more, it's a real theory, a rigorous theory, with equations and optimization and all, not like the loosey-goosey stuff free-bankers churn out. What more can Selgin possibly want?"

A lot more, actually. Because, notwithstanding all its bells and whistles and tweakability (the quality of lending itself to publishable variations), the Diamond-Dybvig model isn't a formal representation of free banking at all. It's a formal representation of the same cartoon version of free banking that, if I guess correctly, informs most tacit free banking theories. More precisely, it's a formal model that takes as its starting point the assumption than an unregulated banking system is one that might at any moment fall victim to random yet system-wide runs.

I'm not saying that the D-D model is anything less than ingenious. In fact, it isn't easy at all to come up with a model that obeys the rule of not having agents do anything that doesn't increase their expected utility, and yet have it imply occasional if not frequent disasters. In this case, it took some doing. Diamond and Dybvig had to assume away, among other things, (1) the difference between a bunch of idiosyncratic banks and a single representative bank; (2) bank equity, which would otherwise drive a wedge between adverse shocks and bank insolvency; (3) any distinction between banks' reserves and an economy's consumption goods (which makes consumption equivalent to disintermediation); (4)…well, read Kevin Dowd's excellent survey if you want the whole rather long list. The gist of it all, anyway, is that in Diamond and Dybvig we have, not a formal model explaining the workings of some actual banking system, laissez-faire or otherwise, but a formal and in that sense only "rigorous" re-telling of a hackneyed textbook banking myth.

Does any of this prove that the self-aware free banking theorizing of myself, Kevin Dowd, Larry White, and others is any good? Of course it doesn't. Our theories might be perfectly lousy, and I suppose some of them are so. But at least we've arrived at these theories deliberately, after consulting evidence from actual free (or at least relatively free) banking systems, and with due attention to criticisms that our attempts have elicited. Of course it's possible nonetheless that some of the tacit theories informing the case for intervention are, for all their slap-dashed-ness, closer to the mark. But what are the odds? Better, I'm sure, than those of a chimp typing War and Peace. But not nearly enough to bet on.

But the point of my remarks isn't to pass judgement on the views of critics of free banking. It is merely to encourage more of them to join in a more explicit debate concerning what a free banking system would look like, and how well it might perform.

  • I don't believe I've ever seen the genetic fallacy delivered from higher stilts. The idea that an proposition is wrong because it is probably wrong is stunning. Why bother to offer a theory of anything if it can be dismissed as "probably" wrong on account of its provenance? I can live with "unproven" to the extent that empirical evidence might be available, but when it comes to a simple narrative theory, I would expect something more than "not invented here" to be offered in defense.

    I have a theory about why free banking – as conceived by its advocates – is a bad idea, but I do not, apparently, have a forum in which to air it, as I lack the credentials to be right, and so my theory, infected with my own inadequacies, must be wrong, too. Luckily for me and those readers who like to think about challenges to free banking – again, as conceived by its advocates – on a less "meta" level, I am completely impervious to verbal bullying, and so will offer my theory here for the simple joy of seeing myself talk.

    Having foreshadowed the importance of the qualifying parenthetical "as conceived by its advocates," let me offer my conception of free banking. Imagine a free banking system of the sort the advocates of free banking prefer. Then, one day, a guy attends a bankers' convention and says to the assembled barons:

    "My friends and I are getting tired of shopping for a bank every time we need to make a deposit. Each new deposit confronts us with the risk that the financial condition of the banks with which we deal may have changed. The due diligence is a real resource hog. We could rely on branding, but we don't want the best brands to become too big to fail, and we suspect that some maxim like "No one ever got fired for putting the corporate treasury at TBTF National" would leave us in precisely that position. We see the competitive banking marketplace as a commons: we users benefit from the competition, but we are actually prone to destroy that competition by all using the bank or three with the best reputation, because we don't really understand banking very well. And we would really, really, like to devote the resources we now devote to vetting our bank to something more profitable.

    "So we have a proposal, based on the work of Elinor Ostrom. We would like to NEGOTIATE an arrangement between an association of bank depositors and an association of banks, whereunder the banks would agree to cover each others' failures to honor deposits, and we would give all of our business to banks in the association. The bankers' association would be free to set up its own rules and admit members and boot them out (but keeping a departing members whole). Our only condition is that membership be rule-based and that there be enough members in good standing to give us confidence that our deposits are as safe as they can be without government intervention." Banks can compete for our business on the basis of their underwriting services and depository services, but solvency would simply be off the table.

    Is our man not proposing "Free banking"? Is he not proposing a rational way to reduce depositors' unnecessarily duplicative and costly effort – sort of like buying an ETF – by NEGOTIATING an arrangement with FREE economic actors? I have no doubt that this proposal runs afoul of the antitrust laws (ignoring McCarran-Ferguson, which, if I remember correctly, only provides exemptions to industries regulated by states). But anti-trust laws are themselves interventions, and a theoretical approach to "free" anything cannot take any intervention into account except as an erosion of freedom to be justified after analysis. On a purely theoretical basis, is the duplication of effort in connection with an arcane business (insurance would be another) used by nearly every average Joe not a phenomenon of economic value that free bankers might not seek to convert to profit in the form of lower gross interest rates (and higher loan volume)?

    One more thing. The essential difference between a democracy, including a representative one, and an authoritarian state, is the extent to which laws are produced by negotiation among competing interests. In the economic realm, the electorate in a well-functioning democracy, subsumes the depositors' association and the bankers' association. The "negotiation" in my hypothetical "free" banking arrangement can be had in the political arena, where free banking advocates will try to raise a dichotomous bar, claiming that my negotiated association and the FDIC are qualitatively different things. But economics is indifferent to forms. To the extent that the democratic process in fact mimics a private negotiation, it is a philosophically sound alternative TO a private negotiation, allowing precisely the kind of cartelization that bank customers prefer, for ease-of-shopping reasons, to any other form of free banking.

    In short, I suspect that so-called "free banking" is an arbitrarily defined form of inefficient banking, and that modern centralized banking IS free banking, because the laws that govern it are enacted by a free people after negotiation, and because it enables a genuine cost saving by all participants in the market. (And all of this without once raising the specter of a bank run.) But never mind. I'm probably wrong…

    • George Selgin

      "The idea that an proposition is wrong because it is probably wrong is stunning." No doubt. But I never say it. Nor do I ever say that only persons with the right "credentials" are fit to criticize me and other free bankers. Finally, my complaint is precisely that the critics of free banking to whom my remarks refer never "offer" any theory to respond to. The whole pint of my post, repeated umpteen times, is that their theories are tacit ones only, and by implication impossible to refute, or to declare "wrong."

      Nor, finally, do I think your hypothetical vision of free banking necessarily at odds with that of free banking "as conceived by its advocates" so far as it is a voluntary arrangement. I do reject, on the other hand, your suggestion that outcomes of the democratic process "mimic" private negotiations. Consider, for instance, that lovely democratic version of negotiation known as eminent domain.

      • " The whole p[o]int of my post, repeated umpteen times, is that their theories are tacit ones only, and by implication impossible to refute, or to declare 'wrong.'"

        Prof Selgin –

        Thank you for the reply. I was responding to the following words:

        "The rub is that tacit or subconscious theories of free banking–the sort people rely upon when they are "doing" free banking theory without being conscious of it–are LIKELY to be bad theories …"

        "Of course it's possible nonetheless that some of the tacit theories informing the case for intervention are, for all their slap-dashed-ness, closer to the mark. But WHAT ARE THE ODDS?"

        My problem is that the probability of a tacit theory being wrong is not a useful metric. Yes, if a theory is typed by a monkey, it is likely to be "wrong," but that's because we would be talking about what the monkey typed and not what the monkey thought. In this case, we are talking about what professional economists are thinking, and you are judging them PROBABLY wrong because they have not been subjected to criticism. I use facts and theories I accept to make decisions. What decision can we make based on the "probability" that a tacit theory about free banking is wrong? Should we refuse to try to infer it, as that would probably be a waste of time? Should we reject anything the economist in question has to say about banking, because his tacit theory on free banking is probably wrong and infects anything else he might say?

        "Consider, for instance, that lovely democratic version of negotiation known as eminent domain."

        Governments do lots of things. Some are better proxies for negotiation than others. Eminent domain is perhaps the best evidence that all "ownership" exists at the sufferance of the non-owners. Property rights are respected because they are essential to personal security and the creation of economic wealth, but if the people, acting as a collective and not as criminals, respect the VALUE created by the exercise of those property rights, while treating the tokens of value as fungible, neither personal security nor the incentive to create wealth is lost, but resources are more efficiently used to feed the trough we all drink from. It is very much a negotiated arrangement.

        • George Selgin

          I'm obliged, in response to your reply, to refer to the first sentence of your original comment, which complains of my claiming that what is probably wrong is therefore wrong in fact.

          As for my grounds for saying that tacit theories of free banking are probably wrong, they consist of my belief that those who hold them probably have neglected, not merely to write them down anywhere, but to think all that much about them. I admit that this is sheer conjecture on my part, but my complaint is precisely that, not being privy to the theories in question, I cannot otherwise assess their merits.

          • Prof. Selgin –

            "… my complaint is precisely that, not being privy to the theories in question, I cannot otherwise assess their merits."

            Precisely. Why, then, have you said that these theories are also probably wrong? I am not asking why you think so – you have made that clear. I am asking why you are SAYING so, what decision are you seeking to influence, what decision have you taken on account of thinking so? I know what to do with the observation that a theory is unstated: I can try to ferret the theory out, or I can leave my current beliefs intact and fry bigger fish. Are you suggesting the latter, on the grounds that the unstated theory is probably wrong? I do have other fish to fry, but I would think an audience of economists interested in free banking theory might not.

          • George Selgin

            That's easy, Lawrence (if I may): I want more monetary economists to become conscientious free banking theorists, so that we can debate the topic more fruitfully, and so that everyone ends up with he better understanding of the true consequences of monetary and banking interventions.

            Note that I am not saying that I want or expect everyone to accept my own or anyone else's particular free banking theories.

          • George (you may, if I may! – I actually answer to "Larry," but the name "Larry Kramer" is confusing as a screen name.) –

            So the "likely to be wrong" is a goad to explicit statement and not a rejection of the ideas? Cool. I agree that we cannot have as much confidence in an unstated argument as a fully articulated one. When I was in the legal biz, I often told clients "I won't know what I think until I write it down." It may well be that I have over-lawyered your position, treating "likely to be wrong" as a more severe judgement than "less likely to be right," which is how I might have described the unstated theories.

            I would also be interested in your reaction to my substantive point, which I might abstract a bit further to this: "free" banking is a binary concept that draws bright lines where none exist. If you accept that my cartelized banking system, in which the risk of failure to honor a deposit is socialized, is ok if voluntary, I think you have to entertain two additional possibilities. The first is that the free, competitive banking system you envision arises from the fact that the bank-using public is unable to unionize. IF all depositors could negotiate around a table with all bankers, I submit that the parties would "voluntarily" agree that the risk of deposit failure should be socialized for the benefit of all parties (in which case, a uniform transferrable evidence of liability – a single currency – would emerge. The inability to have that conversation is a technological issue: we simply do not have the means to enable it. The second possibility is that, in this context (and irrespective of any other), Government is not central planning but merely negotiation continued by other means, which is to say that centralized banking is just free banking as best it can be done when the users cannot collaborate.

    • Ron Warrick

      For my own simple "joy of seeing myself talk", for I have zero credentials also:

      "My friends and I are getting tired of shopping for a bank every time we need to make a deposit. Each new deposit confronts us with the risk that the financial condition of the banks with which we deal may have changed."

      Not that you claimed that this is an insurmountable problem by means other than government intervention (though that would seem to be your working hypothesis), but isn't this problem faced by an investor in equities as well? The usual and usually successful method is to diversify investments over time and among various equities. The more of these one invests in, the less research is required on any one of them in order to achieve a total market return. One can even do essentially zero research and invest in a broad-based mutual fund (or several of them), granting that in a free market even a mutual fund might go belly up if run by a crook or incompetent.

      Under free banking, I can imagine that there would be enough large depositors who would collectively have the power to negotiate the sorts of transparency, safeguards, and standards needed to keep their banks as stable as can be. Assuming the same benefits would accrue to small depositors, I can imagine this system being a viable alternative to centralized control. In order for such a free banking economy to fail, a lot of banks would have to make a lot of mistakes. For a centralized system to fail, it only takes one mistake (which mistake could even be the premise of central banking itself). I speculate that residual uncertainty in the free banking system would preclude the creation TBTF banks, since the creation of TBTF banks would seem to be a product of misplaced faith in centralize banking.

      • "… but isn't this problem faced by an investor in equities as well?"

        It's the problem faced by the buyer of any product. But when a product is ubiquitous and generic as a bank deposit, where the buyer really wants only custodial and checking services, and doesn't understand the innards anyway, eliminating the need to shop has social utility, if only in that it permits the shopper to devote more energy to selecting equities more carefully. There are people who will buy equities for you. Who buys checking accounts?

        "Under free banking, I can imagine that there would be enough large depositors who would collectively have the power to negotiate the sorts of transparency, safeguards, and standards needed to keep their banks as stable as can be."

        My take on game theory suggests to me that any such depositor would hoard information rather than share it. They would not demand transparency but instead demand information of proprietary value to them as depositors, and let their competitors see what they can get. It's like buying a car. The dealer's poorest negotiators subsidize his best negotiators. I see no reason why transparency would emerge.

        Of course, word gets out that big depositors use a bank, but who knows why? Maybe there are kick-backs involved. If you bank at the biggest bank, the odds are pretty good that you won't get screwed. But that's the problem: free banking is ipso facto big banking, and big anything suppresses innovation and competition. So, oddly enough, free banking in the information age is anticompetitive.

        "For a centralized system to fail, it only takes one mistake (which mistake could even be the premise of central banking itself)."

        What one mistake caused the all of those banks to issue of all that bad paper in 2000-2007? Maybe repealing Glass-Steagall was one, big mistake, but that's deregulation, so I'm not sure where that gets us. The argument that central banking itself is the mistake that refutes central banking has a nice Godelian ring to it, but it seems a bit circular to be persuasive.

        "I speculate that residual uncertainty in the free banking system would preclude the creation TBTF banks, since the creation of TBTF banks would seem to be a product of misplaced faith in centralize banking."

        And I speculate precisely the opposite, as only a TBTF bank would be big enough to have the respect of your biggest depositors. Also, I don't worry about TBTF. I think it's a red herring. The TBTF banks DID fail, and their shareholders felt the pain. That the banks are still standing is a tribute to our ability to make capitalism's nuclear option – bankruptcy – a neutron bomb that leaves the infrastructure in place to provide banking services to the recovering economy. Title XI is all about companies that are too big too fail being allowed to stay in business with new equity owners (usually, former creditors). The bank bail-outs were not terribly different in their economic outcomes. Even the GM bail-out was a bankruptcy proceeding except in name.

        • Ron Warrick

          Thanks for the reply. Unfortunately, I'm out of my depth (which, with respect to high finance, roughly corresponds to wet pavement), so I will leave further comment to those more knowledgable.

  • Much main stream theory regarding money and banking is that of technocracy. That one can legislate and regulate, through central authority, a system that never fails (all actors never lose). The basis being that one indeed actually understands all aspects of money and banking and also can predict with great certainty the time and circumstance of all actors. Hence X, Y and Z legislation leading to regulation and viola, problem is solved, as the central planner indeed knows all. Yet the centralized expert system continues to fail quite often and in big ways.

    “Rather than the smooth – running engine promised by turn-of-the-century progressives, technocratic governance has been a Rube Goldberg device at best and, more often, a misfitting hodgepodge that grinds gears, shoots out sparks, and periodically breaks down entirely” – Virginia Postrel, The Future and its Enemies, paperback edition, 1999, pg. 20


    “This is a useful anecdote to remind people what "regulation" means. I get asked all the time, "doesn't the financial crisis mean we need more regulation?" They seem to think "regulation" is something you pour in like gas in the tank. Or maybe they envision "regulation" as a simple set of impartial rules. You know, there is a 50 mph speed limit, which everyone routinely violates, a huge crash, so we enact a 30 mph speed limit and put a lot of cops on the road.

    No, we put 50 cops in your car. And how long can this possibly go on before the cops start asking where you're going and why?”

    Banking News, John Cochrane, 09/10/2013

  • Yoshifumi

    Your post struck a nerve, I'm an academic economist, 35, and about to be non-tenured and ejected from the profession because I spent too long reading free-banking blogs. The profession is set up to actively discourage true scholarship.

    • George Selgin

      Yoshifumi, I'm truly sorry to hear this. Getting tenure these days is terribly difficult even for those who never veer from the narrow path I describe in my post. For those like yourself whose curiosity tempts them to expose themselves to ideas they never could encounter in grad school, it is even harder. Still, I hope you won't give up your preferred career too easily. The profession badly needs people who genuinely wish to understand the economic reality that surrounds them, as opposed to those who merely enjoy playing childishly with formal models having only the most tenuous connection, if any connection at all, to that reality. I very much hope that you might still find a place in one of the shrinking number of schools that realizes this.

  • kevindowd

    Excellent posting George! You hit more than a few home truths on the head. I would add two things. (1) Even at UG level we long since saw basic economics principles – the core of the subject – crowded out by nonsensical math modelling. I heard of one major UK university in which they had replaced principles with DSGE modeling, so the students end with gobbledegook instead of any sense of abiding principles at the end of their second year. (2) The problems you refer to are mostly getting worse.


  • nomorecranks

    Dr. Selgin –

    Help me reconcile something: David Henderson says he is of the view the fed is destructive and his ultimate solution is to abolish it, then he says in the same interview (RT) that solution to the current crisis is the fed should start the printing presses and get counterfeiting – A. B – He also says that it is his understanding that Scott Sumner work is based upon a pragmatic of taking the fed-as-is and working within the context but that he also believes ideally the fed should be abolished.

    A. Do we need the fed to print money? How is that free banking? and
    B. Would Scott Sumner abolish the fed if he could?

    and for extra credit: Why is it not not (double negative) kooky to think that after you and Dr. White demonstrate so conclusively revisiting the fed after 100 years of their complete incompetence and unwavering demonstration of forecasting and operational imbecility to assign them the task of NGPD targeting? What is the difference in gross naivety between a Taylor rule and a NGDP rule? And/or electing Obama thinking he is going to change anything Bush screwed up?

    In other words, spending ones professional career on trying to tweek how econometric targeting by central planners could fit into a stable system the most egregious waste of an intelligent persons time?

    You write
    how would a monetary and banking system operate under laissez faire? An answer to this question is essential for a proper, critical understanding of the effects of government intervention in the monetary system. Just as it would be impossible to understand the full implications of restrictive tariff policies without reference to a theory of free trade, so to is it impossible to understand the full implications of legal restrictions in banking without reference to a theory of free banking–an understanding that is crucial both to understanding monetary history and to making predictions concerning the likely consequences of future deregulation and financial innovations. Surprisingly, monetary economists did not begin to construct such a theory until the mid 1970s, and there is still much work to be done."

    I agree which is why you are well known and highly regarded behind economic academia. Nitpicking on pragmatic solutions that can only come with unintended consequences that are impossible to put into practice anyways because of the institutional incentives of the banking cartel is why I think Scott Sumner is playing kooky. When the time comes that the system crashes, having laid a foundation of a free market model to pick up the vacuum of ideas will a lot more beneficial than wasting time on trying to reform the central bank from within – that sounds like a bad joke.

    Clearly most are NOT free-banking theorists but closet policy hacks whose only gripe is not the bureaucracy itself but that they are not part of it and so act the rebel for attention.

    I just don't hope Dr. Selgin you do not sell out or become tempered by association because that would be grave loss. Trust me, no one will read or remember Paul Krugman like no one reads John Galbraith and no one cares or even knows about, say, Kermit Gordon. – you still have hope.

    • George Selgin

      Nomorecranks, as long as the Fed exists, and we are all compelled to use its money, we all have every reason to want to put some limits on the degree to which it mismanages that money. That means complaining when we think it is creating too much of the stuff. It also means complaining when we think is creates too little. Scott Sumner and I don't necessarily agree on what constitutes the "least bad" management of money on the Fed's part, but we do agree that monetary expansion is sometimes warranted. The gold standard itself provided for such expansion, and a free banking system allows for it even with a fixed reserve stock. So to imagine that a central bank is "mimicking" laissez faire simply by holding the money stock constant is incorrect. In fact, a central bank that "does nothing" according to this criterion is using discretion to limit money growth artificially and excessively.

      My ultimate desire remains, as it has always been, to see he state withdraw altogether from the business of managing the supply of money. But holding this view doesn't absolve me from a responsibility to recommend incremental steps which, though they don't individually succeed in achieving this ultimate end, take us further in that direction, and do so in a non-disruptive manner. Holding the Fed to a strict rule is one such step–and a big one in so far as it paves the way for abolishing the FOMC altogether and replacing it, as Milton Friedman suggested might be done, with a computer. Abolishing restrictions on any sort of private alternatives to the present dollar standard is another such step.

      So no, I do not think I am "selling out." in the least. I simply would rather not have to hope that "the system crashes" in order for there to be any progress toward monetary freedom. Indeed, I believe it very likely that such a crash would itself result in more rather than less heavy-handed government involvement in monetary affairs.

  • SpontaneousOrder

    Excellent article by one of the few remaining economists of our time.

    Caroll Quigley describes the decay of society when the ends of its institutions become the perpetuation of the institution itself. How more self-evident then of a first principle is it when monopoly counterfeiters upheld by the monopoly violence of the state who finance and uphold the monopoly of intellectual priesthood, that academics will necessarily become not a pathway to the discovery of truth and a liberation of the mind – which is the ostensible and intuitive purpose of education – but as Pavlovian, self-regulating, sheep-herders who drone slogans by rote vomited from their predecessors who acquired all the same in the service of legitimizing the murder, theft, rape and pillage by the political class that secures for itself access to this machinery?

    Speaking of John Kenneth Galbraith, I would argue he should be read today; for was it not he himself who put it the most accurately: "The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. "

    Joseph Schumpeter's "History of Economic Analysis," would be well suited for a revision since 1950 through the present to include the influence of Magritte, "Ceci n'est pas une banque centrale" on the economic academic establishment and capture the challenges to the post-Kantian realm from the object-oriented-ontologics of leverage and credit of which the popularity of out-of-nowhere best-sellers – Thomas Piketty only the recent manifestion – like David Harvey and Neil Smith – who blame the housing crisis on an "Urbanization, we may conclude, has played a crucial role in the absorption of capital surpluses, at ever increasing geographical scales, but at the price of burgeoning processes of creative destruction that have
    dispossessed the masses of any right to the city whatsoever…and the hitherto successful neoliberal, postmodernist and consumerist phase of capitalist surplus-absorption through urbanization" and "The lasting effect of Margaret Thatcher’s privatization of social housing in Britain," which only a return to Uno Marxism a la Costas Lapavitsas and the total irradication of any notion of natural rights that only the complete exposure of Toqueville, Jefferson, and Locke as racist, and of classical liberalism in general as fraud will do – ask Domenico Losurdo.

    Let me caution: if you think I am Alan Sokol(ishing) you are not paying attention. It is precicesly this literature that lay-people at Barnes and Noble, and academics elsewhere to be sure, are buying and absorbing as the latest trendy fashion.

    In his review of Thomas Piketty's "Capital," Allan Meltzer asks why do academics who otherwise should know better insist on embarrassing themselves, shamlessly, like Robert Solow, when he says "Thomas Piketty Is Right?"

    Israel Kirzner answered this when he consoled Russ Roberts genetic skepticisms(Q and A Mercatus 40th Hayek..) reassuring the usefulness of supply-demand curves, and formalism in general, as a valid heuristic, useful and important even; further qualifying: that focus on the heuristic was precisely the genealogical turn of the mainstream where the kool-aid in the frat house, set-aside to get sorority girls drunk, became mistaken for the gatorade cooler in the sports gym.

    Economics as a social science has a methodological and epistemological root of all evil. Ludwig von Mises made this potent and deduction will have to be taken seriously or challenged, and only very seriously and very sincerely, maturely challenged, if proponents of mainstream formalism want to hold sway. They have proven fruitless for decades in this endeavor.

    It is time to stop being afraid to say openly what we all know: the reliance on a positivist methodological reductionism applied to economic social science is a result of the malingering of scientific socialism, old-aged mercantilism dressed in new-aged technocratic garb, whose reactionary collectivism becomes more desperate in fitful lashes of ad hominem a la Paul Krugman and his acolytes, which have been artificially subsidized by Government Interference in this market (; who now represent an emasculated form of academic economist who previously may have been taken seriously but now only propagandizes for the state.

    Signs of this reality often bubble to the surface in intuitive searches, somewhere, anywhere, for the problem:
    What we have here is a classic text-book case of market interference described no better than by Jeffrey A Singer when he talks about the consequences of the same in health:

    "increased regimentation and regularization of medicine is a prelude to the replacement of physicians by nurse practitioners and physician-assistants, and that these people will be even more likely to follow the directives proclaimed
    by regulatory bureaus. It is true that, in many cases, routine medical problems can be handled more cheaply and efficiently by paraprofessionals. But these practitioners are also limited by depth of knowledge, understanding, and experience."

    And so what we have now in economic phd land is a degree that represents a glorified MBA, applied to by prospective students not quite skilled enough in mathematics to work as quants in hedge funds or investment banks yet more specifically interested than your typical corporate salaried career climber.

    As a risk professional who has made a living in mathematical finance for 11 years I can tell you with clarity, popular mainstream propaganda notwithstanding, investment managers – entrepreneurs who actually make their living risking their own livlihood instead of theorizing about it – are well aware of formalisms heuristic-only function and take very seriously the array of imposing assumptions in quantitative models such as Black-Scholes, Cox-Rubenstein, Adaptive Mesh, Finite Difference, Heston, etc.. which is why as a rule look to hire mathematicians who they can teach their economics to (front-run the fed, bond yields are only a function of the relative cost of financing – inflation outlook and economic growth expectations are for ivory tower dissertations, business cycle as an intentional consequence of the central bank and fiscal
    (mis)direction) as against hiring economists and trying to teach them mathematics.

    If risk firms do not hire economists who hires economists? Those firms and state actors looking to fulfill their demand for propagandists. Fred Mishkin and Glen Hubbard command high pay here; Jonathan Gruber of course takes the cake. And so like processed food, as Jeff Singer says, economic academia today is now the carcass of what was otherwise nutritional that not even the insects will eat thanks to the legacies of Alvin Hansen and Paul Samuelson who wrote the text books of their day, and from which textbooks of today follow, Kenneth Arrow, Hyman Minksy, Robert Solow – all openly avowed socialists, Stalinists or sympathizers, right up the their progeny Stanley Fischer, James Tobin(FX tax by a world government as a
    pragmatic first step to taxing, globally, all business – and people still think Piketty is ORIGINAL?), Paul Krugman, Ben Bernanke, Larry Summers (St. Pauls Nephew), whose nepotism and collectivist rent-seeking has infiltrated the Treasury, Economic Council, Federal Reserve and University.

    Truth speaks.

    • nomorecranks

      Greshams Law –

      Bad economists drive out good economists

      The most pathetic thing I find about it all, however, is not the crime and b.s. we all have to put up with now because of statist pumpernickels, but that it is the pumpernickels themselves who never learn from history: they sell out for pennies on the dollar, they are always the very first thrown under the bus, and if their criminal schemes do come into fruition – it is always the useful-idiots who are the first ones killed by the people they put into power! Talk about pathetic.

      The economics academic community most drive people like Selgin and others nuts! How do you constantly deal with a community of fraud hacks using fraud models; knowing all you are going to get for discovering truth is ridicule and a bunch of government boot-lickers hacking phlegm at you all day who in their right mind would ever go into this field? Which is why you are left the a bunch of grubers.

      for crank-sake!

  • If the advocates of free banking are to get their message across, I suggest they publish some sort of 1k – 2k word introduction to the subject. There is no obvious introduction on this site. Nor is there anything obvious to be found by Googling.

    • George Selgin

      It's a good suggestion, Ralph. I will see to it as soon as I find some time.

  • John S

    Yes, there needs to be some kind of simple, easy-to-navigate primer. Something short & sweet with graphics, like the Ripple knowledge center:

    • George Selgin

      For the time being, see Larry White's essay, "Competitive Money: Inside and Out." and (if you can get hold of it offline), his "Free Banking as an Alternative Monetary System" in Barry Siegel, ed., Money in Crisis.

  • "All such claims–which is to say any claims about the need for or consequences of government intervention in banking–depend, if not on an explicit understanding of the nature and workings of a laissez-faire banking system, then on some implicit understanding. "

    But first, let us define "laissez-faire." Where does the law that is preventing "laissez-faire" banking end? Let's allow for government enforcement of contracts and a governmental monopoly on the legitimate use of force. A case could be made that either of these could be obviated in a free state, but I'm assuming that you don't want to go that far.

    In earlier exchange, I suggested that free banking would look different from what is currently envisioned by its advocates if depositors and banks could negotiate at the representative level. On reflection, maybe all that would be required is adjustment of the antitrust laws and their state analogues. If free banks were allowed to form cartels, I believe that they would agree to share deposit obligations, putting all of their deposits in, dare I say it, a central bank, where they could simply draw on them to meet deposits, with some formula for determining who owns which reserves on liquidation, and who has to pay whom how much for the use of money in the pool. They would then issue a single transferable claim against the central bank rather than a multitude of claims against the member banks. In other words, banks would really rather not compete on the quality of their deposit obligations. They would rather share in cost reductions associated with a reliable deposit obligation and compete on other things. A common deposit obligation reduces the cost of funds, which is really all a bank cares about on the deposit side. A common deposit obligation is a plus-sum opportunity; game theory suggests that a coordinating authority is required. I would define laissez-faire banking to include a legal environment in which such a private, voluntary coordinating authority is possible, and then I would submit that creating such an authority is a waste of effort when a representative democracy is already available to serve that purpose. (My guess is that the central bank could operated a discount window as well, in effect borrowing from other banks not just reserves, but creditworthiness itself, to permit expansion of the money supply beyond ordinary fractional reserve banking limits).

    The problem I see with the Fed is its dual role. The Fed is not just the central bank that private banks use to make their industry more efficient. The Fed is also the government's "banker." The Fed decides to what extent the government's spending should be monetized. That decision impacts banks, but it does not regulate them or interfere with the freedom of bankers to act voluntarily. In this regard, the Fed is a taxing authority, determining the extent to which government spending will be funded by dilution of the money stock. I don't object to this function – I think it is a technologically brilliant way to have taxes paid out of excess capacity (i.e., by printing money that does not cause inflation, as it does not chase "too few goods.)" Because I believe the Fed should be seen as "the government" when it monetizes (or doesn't) Federal spending, and because I believe that monetization is a sound form of taxation, I believe that "laissez-faire" banking would have to co-exist with a governmental structure in which such a tax could still be imposed. Thus, the ban on the Treasury's printing money might need to end if the Fed were not permitted to engage in Open Market Operations, i.e., did not exist. Either way, the Treasury would be able to spend a liability (it's own or the Fed's) that would compete with the free banks' notes to be currency, making it even more likely that the banks would not compete in that arena.

    • George Selgin

      The suggestion that seigniorage (a monopolist's profit from money creation) ought to be regarded as part of an efficient tax program is not one to be dismissed out of hand. However, two important objections should be noted. First, many economists would argue that, even when it isn't inflationary, seigniorage isn't an efficient tax. People would be better off were such a tax replaced with an excise placed on on competitive currency suppliers–and that's apart from the great risk that the monopolist will mismanage the money supply. Second, it is hard to square the seigniorage tax, over which Congress has no direct control, with the view that among federal agencies it alone is supposed to command authority to levy taxes.

      • I am not sure that I am talking about seigniorage. Isn't that when the maker of the money sells it to users of the money? I am talking about the government printing money and spending it into circulation in competition with the private economy's demand for goods and services. Today, that is done through the Fed's open market operations, but in a Fedless laissez-faire world, I believe the government would print the money itself. But it would not sell it to banks to collect seigniorage; it would simply spend it into circulation. Economically, government spending by printing has the same effect as counterfeiting, and, like counterfeiting, done to excess, it would destroy the currency. But done in small doses, money printing coaxes excess capacity out of the economy without causing anyone to do without anything. It's hard to imagine a more efficient tax, when it is working, i.e., when it is not inflationary. (That a practice has the same macro implications of counterfeiting does not render it scurrilous, since the "counterfeiter" is all of us acting, if one believes in our form of government, for our collective good.)

        I see the Fed's role as deciding when and to what extent government spending should be funded by printing, borrowing, or taxing (by Congress) in response to supply and demand for goods and services and money and credit in the private economy. Mismanagement is always a risk, but it's not a binary event: most often, a bit of mismanagement results in a bit of dysfunction. Blaming the Fed's unilateral monetary policy alone for major crises is very difficult to do. Even in 1937, when monetary policy contributed to the return of the depression, FDR cut the deficit, and the Fed's action can be seen as part of a premature full-court press, and not "mismanagement" by the central bank. If anything, the Fed was insufficiently independent in 1937, and probably should have loosened policy to fight Congress, as Bernanke did. But that was then, and who knows if a 24-year-old Fed could have survived the political blowback that might have ensued.

        Congress has, wisely, I think, delegated to the Fed the decision regarding how much national spending to monetize. Surely, we would not want the guys who spend the money to decide whether they need to tax or borrow to raise the funds. That decision should be left to those who would be up the creek if the currency went splooey, viz., bankers. At the same time, the "owners" of the Fed have a minimal profit interest in it, so their interests are best served by creating a robust economy. Congress created the Fed, and Congress can uncreate it. But, thinking about the Fed as an additional check on spending in boom times and enabler of spending in bad times, i.e., as a Keynesian coordinator, it seems to me a pretty good idea.

        • George Selgin

          (1) Seigniorage refers to any monopoly money issuer's profits; (2) most do not share you understanding of monetary laissez faire as involving direct government issuance of money; (3)the idea that money creation releases "excess capacity" is not generally the case. It does so if the cause of the excess capacity is a shortage of money, but not otherwise. The normal state of affairs is one where there is no shortage.

          • (1) Are you saying that the inflation tax is seigniorage? I don't see how a tax on the printing of money could be "more efficient" than inflation.
            (2) See 3.
            (3) I am not talking about money-creation releasing excess capacity. I am talking about government spending doing so – simple Keynesian "stimulus" (a term I dislike because I don't believe in spending for spending's sake, but I do believe in spending when the time is right). I am also saying that printing money is the optimal way to pay for deficit spending, except to the extent that there is not enough excess capacity to meet the government's needs without unacceptable escalation in prices. I'm not a thoroughgoing MMTer, but I accept enough of MMT to reject any system in which the sovereign cannot choose to monetize at least some of its spending. That's why "my" laissez-faire bankers would be free to compete with the government, but not free of competing with it. If your laissez-faire banking system can permit the government to monetize deficit spending without the government printing money, then I stand corrected.

  • LifesJourney

    Perhaps add to the home page or about section a definition of 'Free Banking'. Outside of this website you have defined 'free banking' as "the competitive issue of money by private banks" i.e without nations central banks and perhaps I suspect without regulatory intervention. I can think of a number of definitions of what free banking could mean, it does help to understand understand the premise and also the key assumptions.

    Also relevant would be to state what the authors of this website agree should be the goals of banking. Then a discussion on the goals and definition including visitors could flesh out an even better platform from which can be a platform for meaningful discussion, i.e. at least there might be some shared goals and common language and a better understanding of where each other is coming from. My suggestion is that the goals of banking should align first to humanities highest shared goals, which also have not been arrived at, which is part of why we are in the mess we are in today, also because of a lack of arriving at critical aggregated, shared and collaborative measures that matter most as opposed to individual and competitive goals and measures (which of coarse have a place too).

    This may sound like nonsense to some but let me draw a relevant comparison for you. The world of engineering unanimously agrees the calculations relevant to determine the design so that a bridge or building stays up and around the world almost all bridges do stand up. The reason engineering can do this is because the goals of engineering have always been obvious, to make the bridge stand up and to make things go and so no time is wasted on debate of merit as it is but waste instead it is put to test, that is why it has had a lot to do with improving the lot for humanity. Comparatively the world of banking and economics appears more like politics where not only are their different opinions but entirely opposing ones. As banking, even with it's unfair advantage is yet to arrive at a point where banks, currencies and economies stand up, you really need to humbly get the basics right with agreed definitions and goals, to sufficient test and model so you know your ideas work. It's not a matter of whose argument is most compelling or who is most popular as to whether a building or bridge will stand up it comes down to provable tested science. I suggest it is equally important that banking which deals with peoples life savings, the wealth of nations and enables the flow of funds to happen with fiscal sensibilities be expected to do the same rather than reduce itself to smoke, mirrors and corruption as it does now.

    I don't think formulas based on arbitrary ideals are worth much. Emperical evidence leading to rational models and subsequent tests of the various boundaries and relationships is where the true insights are made.

    The practical use of today's government is arguable regulatory based on perhaps 2 premises: (1) that the ideal that free markets competition either has not been arrived at or has insufficient fit (e.g. diverse, equal competition etc); (2) As yet capitalism does not equally serve to all stakeholders including the ecosystem, the wellbeing of local community, worker rights, and even the wellbeing of consumers because the goal of quarterly profits as yet does not include 'óther costs' (e.g. future costs, ecosystem etc) and for large corporations and super rich, given today's political climate can sponsor party politicians to sweep such matters under the rug. The Milton Friedman ideal is just that an ideal. In practice it falls short as humans are imperfect, irrational and so far some 43 cognitive dysfunctions are latent or active in each of us to various degrees. I suggest that the banking community stick to addressing sufficiently to safegaurd against these emotional and congnitive dysfunctions.

    Perhaps efforts to be able to put measure and value on things currently treated as not having to be responsible for to be built into the system of monetary, banking, economic and business decisions could then begin to justify the removal of government from the equation of regulatory enforcement to stop self serving capitalism from screwing things up as the things they are currently not accountable for are now factored into the equation by tightening the feedback loops where future and other values are factored in. There is no doubt that overcentralised regulation has weaknesses.

    When you have won this argument at least for a roadmap towards your goal of 'free banking' you could be on your way for winning people into the idea of 'free banking'. However there is then the other hurdle, to compare the extremes of the other alternatives. Currently we have a problem that private banks who create no consumable value have such unfair advantage they often hold the most wealth. This just doesn't seem right. So that it is not just some elitist entitlement to have the sole right to create money (equivalent of bankers being the kings) you also need to win the arguments against the question why shouldn't anyone be able to learn the craft (now science) to create money and apply fiscal sensibilities to their own bank, even perhaps lending to themselves, otherwise some people are more equal than others. The equality question.

    The alternative extreme for you to argue against (and seek elements of merit if there) is that no one has the right and perhaps a system should create currency/money in some automated fashion based on some tested and agreed rules, where the correct non bankers are lent money on say a needs basis at no interest (or etc) in a way that no bank profits from it and for which those lent the money must in turn use it to give others a start. Where everyone else are just investors but no banker gets the right to create money or to profit from money creation.

    So there's my argument. First the science including the relevant emperical evidence and subsequent scientific measures that justify what the freemarket fails to address now, then the considerations of the alternative extremes to be disproved. Good luck.

    I really want to clarify something important here. I suspect there is much useful work to be done to at least get missing measures into place. I suspect for example that most people don't stop to think hey we should have all aggregated our measures of water use for those using a river along with rainfall and catchment so we would not run the river dry. For your information rivers continually dry up around the world and surprise us as one example. The reality is that if we had systems in place that measured the collective use of a rivers water right from the get go, those people coming to set up a farm, or manufacturing etc based on the river as a resource, will then see the availability of resource and risk and so be able to value this asset and also be more likely to avoid catastrophe. No investor or lender can rightly make a clear risk assessment of a business that uses water without understanding the availability of the resource. The question then is what responsibilities must banks take regards the risks and wellbeing of whom they lend to (that they dont now) and what demands must be made to ensure a less fragile and more robust economy such that the bumbling efforts of government and regulatory can justify banks to operate freely as you wish. With freedom comes responsibility without which things fail. Such is the argument that the higher the ethics of a civilization the greater the wealth of the civilization. Let us strive towards measuring, understanding the relationships between things, especially in this attempt at sensible globalised success that we fail at in so many ways, so that we actually can begin to have sufficient understanding and method that we can take responsibility for the reach, freedoms and technologies we are using. Clearly to move further towards 'free banking' is more then than just a banks responsibility to reach the level of competency to deserve such, the markets and their measures share the responsibility. Let us move towards this or else we must instead move backwards to local communities where the feedback loops and measures are clearer and for which we have competency. I hope humanity can move forwards to competence as we have long since taken this globalization ride on and are yet to get beyond ignoramous.

  • LifesJourney

    The comments I just placed regards the challenges to justify free banking, and the idea of creating a roadmap towards such had left out 3 challenges. That being the challenge of sufficiently catering to the ethical, emotional and long term payback aspects of the market. Not that governments or central banks do that particularly well. Whilst they do not sit purely as a banking responsibility they are phenomena worthy of design considerations. First I will explain the premise then the challenge for free banking.
    Regards ethics, there is an argument that a self serving capitalistic view can not arrive at optimizing for either long term or higher denominator cause for greater good because it is self serving. However once in place it can create greater wealth for the rich and poor alike. For example the idea of open source is not a self serving idea. To get such kick started it took the vision, free effort and sponsorship of the few. Something most bankers would not have been willing to sponsor in its infancy. However once higher denominator designs take hold the self serving often have to play the game or miss out. There is no way Microsoft would have given their programs free to developers prior to open source, but once sufficiently part of the market there was no way Microsoft was going to not participate or else the rate of free software development would leave Microsoft out of the market.

    THe argument that government sponsorship of long term investments in research and future technologies has enabled much. For example much of the functions of the internet today was paid for by government e.g. paid to MIT and universities etc. The whole internet economy would not even exist if it was not for that investment. That's the premise regards ethical and long term. So the question for free banking is how would free banking become incentivised to invest in long term plays for humanities future where a lot of the research would of course have dead ends. Essentially the payback is so long and spreads across so many organisations sharing or leveraging information that it would often be hard for free banking to find a place for it in it's cause of limited self servedness. There are plenty of long term issues humanity will face that we have not designed for yet e.g. stopping asteroids, super volcanoes, EMP from solar flares, ice ages etc. The short term model of free banking just doesn't seem to be the model for investing in such important meaningful cause. So should governments have a role to provide free money or should free banking be in charge of such investment?

    That leaves the question of emotional aspects. Currency is a promise whose value is a unit of trust. Or rather at least where there is a choice of currencies, and they are floating fiat currencies. Ironically trust not being an objective measure is largely ignored, instead a system of futures and other derivatives and gambling, insurance hedging and war of currencies occurs. The huge effort that goes into this, something like 98% of all trade being this, creates absolutely no production of goods. On the face of it this appears to be emotional madness being unnecessarily complex and inefficient. Another concept that is arguably emotional is unconditional love, the idea of intrinsic value. Imagine if we were living several centuries ago and a small nation of people living tribally are discovered. An investment banker might peruse details of the countries resources to steal and not consider intrinsic value. Someone with heart would consider the wealth of culture and the potential for education of these people which if followed would create a greater future wealth as the potential for tourism, curiosity and learning from these people's ways and the income for those educating them might in turn be paid in labour. LIkely the locals know how and knowledge of native plants, medicines and living all being additional potential to the short term raping of the countries resources. How would 'free banking' account for intrinsic value to create greater long term wealth for all? Not that governments have been particularly good at realizing such potential accept small minorities and in hindsight.

    These questions might seem unfair, but non the less if free banking is to replace central banking how then are higher denominator long term causes catered to when a government has to pay free bankers for the funds at interest. Where is the upward spiral for humanity in scarcity based economics?

  • Thank you for republishing! As always, wonderful work George!

  • Warren

    The tacit-understanding folks are legion. Even when confronted with actual for-reals history they stick to their "theories".

    Even when I explain the clearing-house as both the engine and the first safeguard of a free-banking system they just don't get it.

    And I'm pretty sure I'm speaking English and haven't lapsed into some sort of ur-gibberish as I go along in my explanation.

    What would be both fun and educational is a game app where your goal is to earn as much money as you can as a banker while not having to shift reserves to other players or worse getting kicked out of the clearing house for over-issue of notes.

    Market it to people who like business-like things, people with OCD, role-playing gamers who like to min-max (you'll have to look that up) and people generally interested in banking.

    Have a bunch of sidebars in there explaining that this is an actual historical model and if you want to learn more then go here….

    That would be one way of getting people on board the Free Banking Express.

  • Hu McCulloch

    George –
    You may be interested in my 1998 article, "Government Deposit Insurance and the Diamond-Dybvig Model" with Min-Teh Yu refuting Diamond and Dybvig. It's at .

    Here's the abstract:
    The apparent banking market failure modeled by Diamond and Dybvig [1983] rests on their inconsistently applying their “sequential servicing constraint” to private banks but not to their government deposit insurance agency. Without this inconsistency, banks can provide optimal risk-sharing without tax-based deposit insurance, even when the number of “type 1” agents is stochastic, by employing a “contingent bonus contract.” The threat of disintermediation noted by Jacklin [1987] in the nonstochastic case is still present but can be blocked by contractual trading restrictions. This article complements Wallace [1988], who considers an alternative resolution of this inconsistency.