Sunday, April 6, 2008

Hackonomics: Free Banking Edition

I generally like to read Ilya Somin's posts at the Volokh Conspiracy, even though his politics are quite different from mine. But this post, in which he argues for a Free Banking system (i.e., competing privately-issued currencies), is a real clunker:

"[W]hile I'm no monetary economist, I'm far from persuaded that the economy would suffer serious damage in the absence of an independent Fed. ... I'm not at all convinced that giving a small group of insulated government technocrats control over such an important part of the economy as the money supply is really desirable. No matter how skillful they are, there is always a serious risk that they will commit a devastating error, or even engage in deliberate malfeasance out of partisan motives. I may well be missing something. But I see no reason why socialist central planning of the money supply is likely to be much better than similar central planning of other parts of the economy. As I said, I'm no expert on the subject, but my libertarian instincts suggest that a system of competing privately issued currencies (as advocated by economists such as Lawrence White and F.A. Hayek) would be far less risky. Ineptness or misconduct by the issuers of any one currency could not bring down an entire economy based on free banking. Moreover, as White and Hayek argue, each issuing bank would have a strong financial incentive to maintain the value and reputation of their currency. Not so with our current system, where the errors of the Fed can indeed damage the entire economy, and the members of the Reserve Board cannot profit from making good decisions."
There are so many problems with the free banking argument that I can't possibly catalogue them all. The main problem, obviously, is the impossibility of maintaining a stable and efficient exchange rate system. That in itself is a deal-breaker. However, I'm surprised that a law professor wouldn't immediately recognize the contracts problem. As Milton Friedman wrote in A Program for Monetary Stability (1960):
It so happens that the contracts in question are peculiarly difficult to enforce and fraud peculiarly difficult to prevent. The very performance of its central function requires money to be generally acceptable and to pass from hand to hand. As a result, individuals may be led to enter into contracts with persons far removed in space and acquiantance, and a long period may elapse between the issue of a promise and the demand for its fulfillment. In fraud as in other activities, opportunities for profit are not likely to go unexploited.
Moreover, citing Lawrence White and Hayek as authority strains credulity. Hayek was a great original thinker in his time, but is widely considered a crank by modern economists. And Lawrence White's incessant advocacy for Free Banking is based on a very selective reading of history, to put it gently. Somin admits that he's not a monetary economist, and that his support for Free Banking is based on his "libertarian instincts." This is a case where his libertarian instincts have failed him.


Industrial Investment Banking said...


Free banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency. Thanks...