I couldn’t help being glad to see The Economist refer to Carl Menger’s theory of the origins of money just as I was about to explain that theory to my undergraduate classes. Nor did I at all mind having Menger’s ideas contrasted with those of another of my favorite economists, Charles Goodhart. I was, however, sorry to see that venerable publication, whose first two editors, James Wilson and Walter Bagehot, were among the more important 19th-century proponents of free banking, embrace Professor Goodhart’s “Cartalist” theory of money, and do so on grounds that won’t stand up to critical scrutiny.

Menger, of course, famously argued that commodity money, far from having to be deliberately designed, can evolve spontaneously or, as The Economist puts it, “is a market-led response to barter costs.”

But while The Economist allows that Menger’s account offers “a good description of how informal monies, such as those used by prisoners, originate,” it claims that the theory comes up short when it comes to explaining the origins of the most convenient of all commodity monies: those consisting of precious metals. Why? Because metals only make for convenient money once they have been packaged into coins, and “history shows that minting developed not as a private-sector attempt to minimize the costs of trading, but as a government operation.” Consequently, the article continues, “another theory is needed, in which the state plays a bigger role.” Cartalism is one such theory, according to which money, and efficient money especially, is a creature of the state, which invented coins with the ulterior motive of enhancing its revenues by making taxes payable in them and by occasionally resorting to debasement.

But is it true that minting developed, and could only develop, as a government operation? Goodhart’s article is supposed to offer proof that this was so, by pointing to two instances in which the collapse or withdrawal of government coinage gave way, not to private coinage but to barter (in the former Roman empire) or to the use of a non-metallic money (rice in 10th-century Japan).

One needn’t be a logician to recognize the inherent shortcomings of such a “proof by example.” That the withdrawal of state-run mints has sometimes failed to prompt the establishment of private ones hardly establishes that private mints have never existed, much less that they never could exist. One may, on the other hand, disprove the claim that private mints have never existed by means of a single, contradictory example.

As a matter of fact, there have been numerous episodes of private coinage, including some very successful ones. What’s more, it is far from clear that the very first coins ever made–the famous electrum lumps of Lydia, in Asia Minor–were government products. On the contrary: according to Thomas Figueira, one of the leading experts on the subject today, “It is uncertain whether it was someone endowed with political authority acting on behalf of his community or an individual acting on his own behalf who conceived of the idea of coinage.” Indeed, no one is even sure what those early coins were for, or even whether they ought to be called “coins” at all, since they were uniform in weight alone, but varied considerably in their gold and silver blend.

Of course it’s hardly likely than any Tom, Dick, or Harry would have been able to have his markings treated as credible certifications of weight or purity or anything else. Whoever made the first coins had to be some sort of big shot, or its corporate equivalent. Being a tyrant might suffice; but that hardly means that it was essential. Nor does the fact that almost every coin produced since the obscure beginnings of coinage has come from a government mint mean that only governments were fit to coin money. It could instead mean that governments found the fiscal gains to be had by monopolizing coinage too good to pass up. That governments frequently took advantage of their coinage monopolies, not to mint good coins, but to mint lousy ones that they then compelled their citizens to accept, would seem to favor the latter hypothesis.

It ought to go without saying that there is no technological reason why coins couldn’t have been a private invention, or couldn’t have been privately manufactured at any time to the same standards, if not better ones, than their government-made counterparts . “A mint, Sir” Edmund Burke once reminded Parliament, “is a manufacture, and it is nothing else.” A factory, we would now say. And since when are governments very good at, let alone uniquely capable of, running factories? As for state-sponsored enterprises generally doing a better job of quality control than their private-sector counterparts, if you believe it I must see about coming up with a few tons of ca. 1958 Chinese steel to sell to you.

In fact, all of the most significant coinage-related inventions–the manual screw press and its steam-powered counterpart are only the most famous examples–came from the private sector, and most were taken up by governments only reluctantly and after (sometimes deadly) resistance from government mint authorities. How often, on the other hand, have government authorities themselves been responsible for technological breakthroughs? (No, Tang wasn’t invented by NASA.) Were it to come to a wager, I for one would much sooner keep a grip on my money than stake it on Croesus or Pheidon or any other ancient king.

But why speculate? In fact, Goodhart’s contrary suggestion notwithstanding, there have, as I’ve already noted, been occasions on which coinage was handled by the private sector, and in the best documented ones the coins that resulted were not only as good as but superior to those from the government’s own mints. That was certainly the case in the U.S. after the Appalachian and Californian gold discoveries, when private mints sprung up to supply convenient coining services to miners who would otherwise have had to send their gold to Philadelphia or (after 1835) to either Philadelphia or Charlotte for coining. The high quality of the private gold coins produced during these episodes is attested to, both by the extant coins themselves, and by the fact that the U.S. Mint, having failed to put the West Coast mints out of business merely by finally opening a San Fransisco branch, relied instead on coercion to do the trick.

Another instance of successful private coinage is one with which Professor Goodhart is now familiar, though he didn’t know of it in 1998, when he published the article to which The Economist refers. It is the episode of private token coinage in Great Britain that is the topic of my book, Good Money. Professor Goodhart did me the honor of writing that book’s introduction. And although he makes clear there that the story I tell did not at all cause him to abandon Cartalism, I am sure that he would agree that it proves that, in at least one instance, the state’s withdrawal from coining did in fact lead to private entrepreneurs rushing in to fill the void.

That private coiners didn’t always or even often rush in whenever governments failed to supply coins is itself hardly surprising in light of the fact that unauthorized coining, even of coins not meant to imitate official ones, has almost always been illegal, and has more often than not been a capital crime. So the absence of acknowledged private mints following both the fall of Rome in the 5th century and the Japanese government’s abandonment of copper coinage in the 10th might prove nothing more than that no one wanted, literally, to stick his neck out.

Might. Except for the fact that the claim that no private coinage took place in either of these instances doesn’t seem to be true. I do not merely mean that there was surreptitious private coining, that is, counterfeiting: despite the death penalty Japanese copper coins were aggressively counterfeited. I mean that after the Japanese government got out of the business of making coins–after having, that is, debased its coins until they were more-or-less worthless–legitimate privately minted substitutes, manufactured by local clans and wealthy merchants, did in fact take their place, along with Chinese coins and (yes) rice. That, at least, is what it says on the website of the Bank of Japan’s Currency Museum. Nor is it true that coinage simply gave way entirely to barter after Rome fell. No doubt it did so to some degree everywhere, and perhaps to a large degree in some places; but private coinage also took place, and did so notoriously in Merovingian Gaul, where thousands of local mints supplied coins modeled (sometimes crudely) on their Roman predecessors, and bearing the names of coiners very few of whom were known rulers. In short, it seems that, even as proofs by example go, those offered by The Economist are rather paltry.

Yet I suppose that we will never see the end of the myth that only governments are fit to coin money. Were bread a government monopoly long enough, Herbert Spencer once remarked, people would react with horror to the suggestion that it might instead be supplied, and supplied with better results, by the private sector. Spencer was probably right. I’m just glad I’ll never live to see The Economist prove it.

For an upcoming conference I’ve been writing a brief history of the gold standard in the United States. So naturally I’ve been reading or re-reading books on the subject, both new and old, and discovering or rediscovering their merits. My overarching discovery is, not to put too fine a point on it, that almost all of the newer books are a great bore, and none too informative at that.

Why is that so? A clue is that these books are all written by academics, and mainly by academic economists and historians, whereas at least some older ones were written by amateurs, which is to say, by people who considered writing itself their craft, and who had no reason to expect their books to be purchased and read if the books weren’t reasonably entertaining as well as informative. But even the older books by academics aren’t so bad. It’s only relatively recent academic books (which for me means ones written during the last twenty years or so) that are almost uniformly godawful. And the reason for this, I suddenly realized, is that the real subject of recent academic books is, not the subject their titles advertize, but the books themselves.

To be clear: if the title of a modern academic book is “The History [or theory or whatever] of X,” the real subject is “My book on the History [or whatever] of X.” Such books are, in other words, not so much contributions to history or economics or whatever as they are exercises in literary criticism where the critic just happens, conveniently, to be the author of the book under appraisal, or (more accurately) the would-be author of the “urbook” that the actual book appraises, which urbook has not actually been written, and generally never can be, because if it were it would be an article rather than a book, and most likely a trite or banal article at that.

Once you realize what most academic books today are about, recognizing one of this sort is a piece of cake. You might, of course, infer that you’re reading one from the fact that, as you slog through it, you don’t seem to learn much at all about X, and so are tempted to skip, first paragraphs, then pages, and finally entire chapters in the hope or finding the place where the author gets to the point. What’s more you may never find that place, or it may prove so fleeting that you skip past it. That of course shouldn’t happen if the book you are reading really is about X; but if the book is really a critique of a book about X, what you are looking for, without realizing it, is what critics sometimes disparagingly call a “plot summary”–disparagingly because it’s the sort of thing one finds in mere book “reviews” rather than in works of “higher” criticism; and academics’ criticism of their own urbooks strives to be nothing if not “high.”

But as the test above, besides being painful to administer, doesn’t distinguish the true academic book-about-itself from a merely thoroughly bad book about X, there are other, surer clues to look for. These include endless throat-clearing introductory materials, announcing over and over again the book’s “purpose” and telling how the author intends to go about achieving it (“though maybe not just yet,” an honest author might add), followed by a no less endless disquisition on how the book’s arguments differ importantly–really!–from those to be found in other (also academic) books, followed at last by concluding chapters saying more or less the same thing as the introductory ones, only tossing in a little sprig of “told you so!” triumphalism.

Imagine, for a still clearer picture, a great, classic work that really is about X. Once upon a time, though far less often today, a genuine critical undertaking might have consisted of the preparation of a new edition of the work, undertaken not by the (usually deceased) author but by an editor well-versed in the whole literature on the subject. That editor might author a lengthy introduction to the new edition, and numerous footnoted commentaries on the text, some perhaps rather arcane, and an explanatory appendix or two.

Well, your modern academic book writer erects the same sort of critical scaffolding, but does it, not for someone else’s book, but for a ‘classic’ that exists only in his own head. He then serves up the scaffolding alone, packaged to look just like the imagined classic, much as the scaffolds one occasionally sees around Baroque buildings in Europe are disguised by tromp l’oeil curtains meant to fool people into mistaking them for the buildings themselves. The difference is that those tromp l’oeil-curtained scaffoldings disguise a real work in progress, whereas the academic equivalent surrounds so much hot air.

In June, 2010 the Cobden Centre in London released a report on “Public Attitudes on Banking,” based on a questionnaire to which 2000 Britons responded. The findings of that report have since been offered, both by the Cobden Centre itself and by others, as proof that many people today believe that banks store rather than lend money surrendered to them in exchange for deposits payable on demand.

This week, for instance, a blogger named James Miller (whose article appears as well at Mis​es​.ca and ZeroHedge, among other sites) wrote:

[U]sually depositors don’t fully realize that their funds are not really there in whole. In a 2010 study commissioned by The Cobden Center, it was found that 74% of U.K. residents polled believed they were the legal owners of their banking deposits. And while 61% answered that they wouldn’t mind if their money was used for additional lending, 67% responded that they wanted convenient access to what they saw as their money. Whether or not one regards fractional reserve banking as a clear case of fraud, it seems that a good portion of the public is wrongly informed on the mechanics of modern day banking.

But as even a careful reading of Miller’s own summary of it should make clear, whatever else the Cobden survey may demonstrate, it most certainly does not demonstrate that most depositors think that the money they hand over to banks sits in the banks’ vaults (or perhaps in those of a central bank) until some or all of it is either withdrawn or transferred to specific others by order of the original depositors.

Unless the questions they pose are chosen very carefully, survey results can easily mislead, and are indeed sometimes designed precisely with that end in mind. That isn’t to say that the Cobden survey was intended to mislead–I am in fact inclined to believe that it wasn’t. But it misleads nonetheless, thanks to the utter ambiguity of several of the questions it poses.

Consider the first survey question: “Why do you keep some of your money in a current account?” 15% of respondents answered “For safekeeping” and 67% answered “For convenient access,” while only 10% answered “Because it earns interest.” The predominance of the first two replies over the third might appear to suggest that most people suppose that their money is being stored. But the responses may be just as readily interpreted to mean that they consider fractionally-backed deposits to be both more convenient and safer than cash kept on one’s person, at home, or in a cash register. Indeed, in these days of deposit insurance, it is hard to see why anyone concerned with safety, even exclusive of other considerations, would hesitate to prefer a fully-insured demand deposit balance to cash, while being perfectly indifferent to the dangers stemming from the lending of “their” deposits.

In reply to the survey’s second question, “Who do you think owns the money in your current account(s)?”, 74% answered “The account holder,” while only 8% said “The bank.” Another 20% answered, “Both the bank and the account holder.” Proof that many British bank depositors don’t know what their banks are about? Hardly. The responses instead prove nothing more than that the question posed can be interpreted in two different ways, depending on the meaning given to the word “money.” Cobden Centre types, steeped in Austrian monetary economics, may insist that “money” ought to mean what others call “base” or “high-powered” money; but the fact remains that for most people, including most economists, a fractionally-backed bank deposit or note is itself “money.” The latter, more common usage is implicit in standard working measures of national money stocks such as M1, M2, and so forth.

So, who owns the “money” in someone’s current account? Well, it is in fact owned by the account holder, or by the bankers, or by both depending on how money is defined. If “money” is taken to mean “base money,” than when someone accepts a demand-deposit credit from a banker in exchange for “money,” that person surrenders ownership of the “money” to the banker, while becoming the owner of a deposit credit–a claim against the bank–of the same nominal value as the surrendered sum. But now suppose that by “money” we mean money in the broader sense, including demandable bankers’ IOUs. By this definition, of course, the depositor continues to “own” the deposited sum, because instead of merely surrendering ownership to “money” he must now be understood to have merely exchanged one kind of money for another. The banker now owns the surrendered base money, while the depositor owns broad money consisting of a redeemable deposit balance. It thus follows that all of the respondents to the survey question, including the 2% who said “I don’t know,” may have been perfectly well informed of what their banks were up to, differing only in their interpretation of the question, or in the extent to which they were (understandably) baffled by it.

The survey’s third question is equally ill-posed. It asks respondents to say what percentage of their current accounts is (1) held as reserves; (2) lent; (3) used to speculate on financial derivatives. That 66% answered “I don’t know” is surprising only because one would expect the percentage replying so to such a question, calling as it does for a specific magnitude of which even many expert economists must have been unaware, while posing as alternatives two possibilities that are not in fact mutually exclusive (money might be simultaneously “lent” and “used to speculate on financial derivatives”), to have been closer to 100! The response proves, in any event, that at least two-thirds of those surveyed were not convinced that their “deposits” were fully backed by reserves.

Oddly, we are not given (as we are with regard to the other questions) a breakdown of the other responses to question 3, and so cannot say more than this. But it is at least possible that none of the 2000 respondents actually believed that his or her current account was backed 100% by reserves. If anything, the fact that we are not told what percentage of those surveyed answered this key question in accordance with the presuppositions of the anti-FR crowd ought to lead one to suspect that the percentage was in fact very low. Survey question 4, however, asks respondents to indicate “how they feel” about their banks making loans using current account deposits, and finds that 33% think the practice wrong because “they have not given [their bankers] permission to do so.” Thus support appears to be given to the upper-bound ignorance quotient of 2/3.

But here once again the question is ill-conceived, not to be sure because it is ambiguous, but because it is what survey designers call a “suggestive” question, and as such one that nudges respondents in a particular direction. The question, in full as it appears in the report, reads as follows:

You may or may not have been previously aware that banks lend out some of the money deposited within current accounts by their customers to fund loans [sic]. Which of the following best describes how do [sic] you feel about the fact that your bank lends out some of the money in your account as loans [sic]?

The subtle, implicit suggestion here, perhaps unintended, is that banks are not systematically informing their customers about what they do (so that customers “may or may not” be aware of it), and that their conduct is such as might be expected to arouse some definite “feelings” among those customers.

If you doubt that the manner in which the question is posed favors the most-frequently offered response–that is, if you doubt that the question is such as tends to favor expressions of dismay regarding what bankers’ regard as business as usual–imagine getting the following message in your voicemail, where the words indicated by **** are inaudible: “Hello. You may not be aware of it, but **** has been **** your ****. How do you feel about that?” Forced to say either “fine” or otherwise, I venture to guess that you’d admit that such a message leaves you “feeling” like someone who has been decidedly, albeit mysteriously, snookered.

Addendum (August 4 at 5:05PM): I had not bothered to comment on the Cobden survey’s fifth and final question, because I found it so loopy that I hardly knew where to begin. I ought to have observed, nonetheless, that 26% of those surveyed responded to it by choosing, of several alternatives, the one that said “We should ensure that banks keep reserves equal to 100% of deposits.” Would the respondents have made the same choice had the response in question been lengthened by adding the words “while allowing them to collect from us annual fees of somewhere between 5% and 10% of our average balances”? Unless Cobden redoes the survey, I suppose we’ll never know.

I’ve long been meaning to write something about the bearing of free banking on the problem of counterfeiting—a topic I addressed only very briefly in Theory of Free Banking. Since that time, although quite a lot has been written about the general subject of counterfeiting, hardly anything has been said about whether or not having competing banks of issue would make matters worse.

Conventional wisdom has it that having many banks of issue instead of just one makes life easier for counterfeiters. This wisdom draws heavily on the United States’ antebellum experience, while overlooking the experiences of arrangements more representative of genuine free banking, including those of Scotland between 1770 or so and 1845 and of Canada during the late 19th and early 20th century. Evidence from these other episodes points to a rather different conclusion, while suggesting that extant theoretical models of counterfeiting overlook ways in which competitive note issue can actually make counterfeiting less rather than more lucrative than it is when currency is supplied monopolistically.

I hope readers of this forum will forgive my setting forth, as a framework by which to gain a better understanding of the ways in which plural note issue bears upon the problem of counterfeiting, a very simple formal representation of a prospective counterfeiter’s anticipated profit, π. Let

π = ND – CcN – FP,

where P = g(Cc, Ca, N, D, T, B), Cc = c(Ca), F = f(N,B), Ca = d(B), and T = t(B). Here N stands for the number of counterfeits placed into circulation, D for their denomination, Cc for counterfeits’ average unit cost of production, F for the penalty or a counterfeiter incurs if caught (which may depend on the number of counterfeits he is found guilty of having uttered), P for the probability of detection, Ca for the unit cost of a genuine note, T for a note’s average “turnover” time, that is, time spent in circulation before returning to its (purported) source, and B, finally, for the number of legitimate banks of issue. The presumed derivatives are Cc’ > 0, f’(N) > 0, f’(B) < 0, g’(Cc) < 0, g’(Ca) > 0, g’(N) > 0, g’(T) > 0, g’(B) < 0, d’ > 0, and t’ < 0.

Standard treatments of the counterfeiting problem, to the extent that they allow for the possibility of plural note issue at all, have tended to treat the number of banks of issue, B, as increasing the anticipated profitability of counterfeiting by directly reducing the likelihood of prosecution, an effect allowed for here by the last element in P: this effect stems from the extra information costs that must be incurred by persons seeking to distinguish genuine from counterfeit notes as the variety of genuine notes increases. The practically exclusive emphasis upon this influence reflects the tendency of researchers to look upon antebellum U.S. experience, with its huge numbers of relatively small banks, and consequent need for “Counterfeit Detectors” to keep bankers and retailers informed of the correspondingly large numbers of known counterfeits, as representing the typical consequences of plural note issue.

As anyone who is familiar with the free banking literature, or simply with more informed writings on U.S. banking history, knows, the U.S. case was a by-product of legal restrictions, chief among which were laws prohibiting most banks from having branches, while prohibiting banking altogether in some states and territories. These circumstances turned under-banked regions into dumping grounds for the worst of the authentic banknotes from other parts of the country, while in turn creating easy opportunities for counterfeiters to add their products to an already disorienting melange.

But the U.S. experience was unique. Other plural note issue systems, like those of Scotland and Canada, involved not thousands or even hundreds but no more than a few dozen banks of issue, most of which had extensive branch networks. The number of distinct banks was small enough to allow retailers to familiarized themselves with legitimate note varieties. Yet in combination with branching it was more than large enough to provide for notes’ active redemption, that is, for their regular absorption by the clearing and settlement system, by which they were sent back to their reputed sources. In the Scottish system, for instance, it took eleven days or so for a note to return to its source after having first been paid out—a speed not so different from that for modern checks. This translated into a high annual turnover (T) of about 33. In contrast, notes of a monopoly issuer might remain in circulation for several months, if redeemable in specie. If not, they might remain afloat until too badly worn to circulate, which could mean years.

What difference does turnover make? That it matters a great deal becomes apparent as soon as one considers that in the vast majority of instances counterfeits are discovered, or at least discovered and then reported, not by members of the general public or by non-bank merchants, but by bankers themselves, and especially by the banks whose notes have been counterfeited. There are two simple reasons for this. First, the tellers at these banks are the persons best equipped to distinguish their banks’ authentic notes from even clever counterfeits. Second, they have the strongest incentives both to be on the lookout for fake notes and to report fakes that they discover instead of merely refusing them or attempting to fob them off on others. The last point is true in part because, if persons other than a bank’s employees report a counterfeit of a bank’s notes, they may suffer a loss equal to the value of the reported notes. (Importantly, although this last deterrent has generally been in effect in monopolistic currency arrangements, it was sometimes absent in competitive ones.)

The significance of turnover, then, is that, the higher the rate of turnover of any bank’s notes, the greater the risk a counterfeiter faces of having, first his counterfeits, and then himself, discovered. High turnover means a greater chance that counterfeits will be detected within any given span of time, and consequently a greater chance of them being detected after a small number of transfers only, which increases the odds of their original “utterers,” and therefore the counterfeiters themselves, being caught.

A second, indirect way in which currency competition deters counterfeiting, which also has something to do with turnover, is by inducing note issuers to devote more resources to making their notes counterfeit-resistant. This follows from the fact that especially convincing counterfeits can fool even a bank’s own expert tellers, causing it to suffer losses by redeeming counterfeits. The extent of such losses will be greater, for any given volume of counterfeiting, the greater the turnover (and hence the lower the float) associated with an issuer’s currency. In the extreme case of a monopoly issuer of fiat money, which is of course never called upon to redeem its notes, the risk in question is nonexistent, and the incentive to invest in counterfeit-resistant notes is correspondingly low.

Finally, the presence or absence of competing issuers can influence would-be counterfeiters’ expected profits in at least one other way. This is by having some effect on the penalties or fines to which successfully prosecuted counterfeiters are subject. Here the difference is not so much economic as political, consisting of the fact that counterfeiting of the notes of a monopoly bank of issue has often been treated as a crime equivalent to the counterfeiting of official coin, and often, therefore, as a capital offense, whereas the counterfeiting of competitively-supplied banknotes has in contrast generally been a misdemeanor, if indeed it has been considered a crime at all.

The upshot of all this is that competition in currency can serve either as a deterrent or as a stimulus to counterfeiting. Whether it serves one way or the other depends on the importance of the “turnover” and “anti-counterfeiting investment” effects on one hand and those of “information cost” and “reduced penalty” effects on the other. Theory alone—at least the sketch of a theory considered here–therefore doesn’t warrant the conventional conclusion that currency competition means more counterfeiting. The matter calls for a closer look into the historical evidence, to which I will turn in a second installment of these “notes.”

“[B]anks have habitually created warehouse receipts (originally bank notes and now deposits) out of thin air. Essentially, they are counterfeiters of fake warehouse-receipts to cash or standard money, which circulate as if they were genuine, fully backed notes or checking accounts. Banks make money by literally creating money out of thin air, nowadays exclusively deposits rather than bank notes. This sort of swindling or counterfeiting is dignified by the term ‘fractional-reserve banking,’ which means that bank deposits are backed by only a small fraction of the cash they promise to have at hand and redeem.”

Murray Rothbard, “Fractional Reserve Banking.”

A clear, testable implication of the above quote–one of the loci classici of the belief, now widespread among fans of a certain sort of Austrian economics, that fractional reserve banking is fraudulent–is that the notes issued by fractional reserve banks have been indistinguishable from warehouse receipts. After all, if you are going to swindle people by “counterfeiting” something, you wouldn’t be inclined to make the fakes obviously unlike the genuine articles, right?

Here are some images of (1) various warehouse receipts and (2) various banknotes. I draw my readers’ attention to the language common to the specimens in each set. They will note how items in the first all make specific mention of the fact that valuables have been received “for storage” (or something like that); while those in the second merely “promise to pay” a sum on demand, making no reference to storage at all.

I leave it to those readers to then determine for themselves whether the evidence is consistent with the “clever swindle” theory of fractional reserve banking.

1. Warehouse Receipts:

2. Banknotes

Over at the ultra-Rothbardian EconomicPolicyJournal one finds the following among other comments (some favorable to yours truly):

So, Selgin calls fractional reserving deposits ‘Monetary Freedom’. This is a very interesting position.

So, I have $50,000 in a savings account. The bank can lend $45,000 out of my money and still maintain a 10% reserve.

It could also arguably loan out $450K while holding the entirety of my $50K as the 10% reserve. It would simply expand the balance sheet for $450K in liabilities for the loan, $50K liability to me and $450K receivable as an asset from the loan plus the $50K cash asset from me. The result is a 10% cash reserve either way…

…Selgin says this is Monetary Freedom?

Actually I say it is wretched economics, involving the elementary error (one that would earn any student in my undergrad Monetary Economics class an F) of confusing what individual, competitive bankers can get away with with what ordinary central bankers get away with on a routine basis. An individual bank can’t get away with lending more than its excess reserves; in the example, if our ultra-Rothbardian makes a fresh deposit of $50,000, and his bank seeks to maintain a 10% reserve, it can in fact only lend $45,000. That is, it is limited to lending rather less than the savings brought to it, which means there’s no “thin air” lending. As for lending $450K, the possibility is “arguable” only in the sense that anyone who doesn’t argue with it doesn’t know how banks work. For their sake: when banks make loans, the borrowers tend to spend the proceeds. In a competitive banking system that means writing checks that are likely to end up with other banks, which then return them to the lending bank for settlement in reserve money. All this tends to happen within days. So our banker in this case would soon be confronted with a $450K clearing debit, which he’d have to cover somehow. He can’t cover it with a mere $50K of new deposits. So unless he was sitting on another $400K of excess reserves beforehand (which possibility of course begs the question, why hadn’t the greedy shyster lent those already?), his bank will go bye-bye, or at least would do so in a free banking system in which there was no alternative of a central bank rescue.

Though Rothbard himself never dove to quite the depths of silliness involved in this example, the example is nonetheless representative of poor grasp of basic theory typical among those of Rothbard’s devoted followers who swallow his facile equating of fractional reserve banking with fraud.

Oh no: I’ve gone and punched the 100-percent wasp’s nest again, and the wasps are responding predictably. Among them Joe Salerno stands out like a hornet among gall wasps, for Joe is an outstanding historian of monetary thought, and no mean monetary economist generally. Besides, you just can’t dislike the guy. Were I forced by a libel suit to defend my claim about 100-percent reservers constituting a “moronic cult,” he would probably be defense exhibit F, to be resorted to only if exhibits A through E all managed somehow to evade the process servers.

One reason why Joe woudn’t do my case much good, besides the fact that he doesn’t come across as a moron and is capable of charming jurors, is that he is not among those 100-percenters who insist that fractional reserve banking is fraud. On the contrary: he’d rather not talk about that, and goes so far to avoid doing so as to claim, at the end of his post, that the fraud argument is something I’m “fixated” on, as opposed to one that Rothbard himself and Salerno’s MI colleagues have repeatedly raised, as well as one that has been particularly influential in building popular opposition to fractional reserves. Just search “fractional reserves” and “fraud” on Google and you will see the vast harvest of misunderstanding that this Mises-Institute fractional-reserves = fraud campaign has yielded. Even Congressman Paul has been taken in.

So why doesn’t Joe want to talk about the fraud argument? My hunch, based in part on some past exchanges with Joe on the subject, is that he doesn’t want to talk about it because he himself doesn’t subscribe to it. But if that’s the case, instead of pretending that it hasn’t been a prominent and particularly influential component of his colleagues’ criticisms of fractional reserve banking, why does he not join myself and others in discrediting it? His criticism would, after all, go much further in debunking the absurd claim than my own or that of other non-MI insiders.

In any event, it is the fraud argument that I particularly have in mind when I speak of a moronic cult. What I mean by “moronic” is what everyone means by it. A “cult,” if you ask me, is a group that defines its members-in-good-standing as those who never publicly question certain core beliefs, where the core beliefs are in fact irrational or otherwise false. The last requirement is crucial, for otherwise the beliefs would not serve to distinguish loyal members from the great unwashed. You can’t, for instance, form a cult around the belief that 2 + 2 = 4 or that that the earth is a sphere. But you can form one around the claim that space aliens are about to save the chosen from Armageddon, or that a drug-addicted commie charlatan is really Mahatma Gandhi’s reincarnation, or that banknotes are really property titles.

Another sign of a cult is that, when publicly confronted with irrefutable evidence against their core claims, members respond, if they respond at all, by presenting modified versions of the claims designed, like so many planetary epicycles, to evade the original falsification, though only by erecting a different falsehood. Thus when the patent absurdity of their original fraud claim, to the effect that bankers were ripping-off their own depositors, was exposed (e.g., by pointing out that the “ripped off” depositors were receiving interest on their supposedly embezzled funds, and that were fraud really in play entrepreneurs ought to have been able to make a killing by exposing it while offering ironclad 100-percent alternatives), the “fraudists” (as I’ll call them to save space) responded with a new theory, to the effect that, rather than defrauding their own clients, bankers and clients together took part in a conspiracy to defraud the rest of the money-holding public, by reducing money’s equilibrium purchasing power. (Those conversant with welfare economics will recognize in this argument, among more obvious absurdities, a confusion of pecuniary and non-pecuniary externalities. In plain English, if by coming up with a new mousetrap, A reduces the market value of old-fashioned mousetraps owned by B and C, that effect is a “pecuniary” externality, and as such would generally not be considered evidence of a violation of B and C’s property rights.) Confronted by arguments to the effect that the difference between either demand deposits or demandable bank notes and time deposits is a difference not in kind but merely in degree, the fraudists reply by claiming, as Rothbard himself never did, that fractionally-backed time deposits are also fraudulent, and should therefore be banned as well. (Cf. Emerson on foolish consistency.) By hook or by crook, in short, the fraudists remain wedded to their core beliefs, shrinking from no argument or ground-shifting, however fatuous, that might appear to rescue them from otherwise damning criticisms, if only by exposing them to others equally if not more damning.

So much for fraud and cults. What about the criticisms Salerno aims at me? He says that I’ve become a sort of “ ‘standing joke” among young students of Austrian economics. Perhaps I have become such among students who have been drinking too much MI kool-aid; but most of the comments and correspondence I get after doing one of my wasp-nest acts, itself mainly from students, suggests a rather different reaction. Unless I’m mistaken what Salerno is observing is evidence of a self-selection process that is, shall we say, not lighting-up Mises Institute seminars and forums with only the brightest of sparks. (I’ve no doubt that for the same reason any reference to “globe-ists” at Flat Earthers’ annual conventions is always good for a belly laugh.)

Turning to a (somewhat) more substantive criticism, Salerno tries his best to blacken me with the “Keynesian” brush by observing that I believe in money wage rigidities. Although the observation itself is perfectly true, the Keynesian tag is a calumny, and one that for once has Joe displaying a very faulty grasp of the history of economic thought. For as he ought to know, and as Auburn’s own Leland Yeager has gone to great pains to make clear in his usual, eloquent manner (see his essay “New Keynesians and Old Monetarists,” in The Fluttering Veil), Keynesians didn’t discover or invent the idea that wages may be inflexible, which was a commonplace long before the General Theory was published, and one that played and continues to play a central role in the writings of both “Old” and “Market” Monetarists. What’s more, if Axel Leijunhufvud is to be believed, Keynes himself based his own, peculiar arguments for expansionary monetary and fiscal policies not on the (then conventional) assumption that wages were sticky downward, but on his claim that, even if they weren’t sticky, full-employment could not be recovered by simply letting them adjust downward. (As Yeager points out the beliefs of “New” Keynesians in this respect resemble not those of Keynes himself but those of “old” Monetarists.) Finally, Rothbard, who before the advent of New Classical economics was almost unique in supposing that there was nothing to prevent wages from quickly moving to their new equilibrium values following an adverse demand shock, was never able to hold this view consistently. In America’s Great Depression, for example, he dishes it up in his early, theoretical chapters, only to go on to claim that Hoover contributed to the depression by resorting to policies that…kept wages from falling! Well, wage rigidities didn’t suddenly make their appearance during Hoover’s term, although he certainly made them worse, as did FDR to a still more destructive degree. Nor did they disappear when Truman took office. That wages did come down rapidly, along with other prices, following the post-WWI boom, thereby making for a short-lived bust of 1920–21, was partly due to the far less important role of labor unions in those days, and partly due to the fact that people had good reason to anticipate, and to therefore go along with, a post-war decline in equilibrium prices and wages.

The question whether wages are in fact rigid or not is, in any case, not one that can be settled by simply labeling the claim that they are rigid “Keynesian.” It is an empirical claim, and as such one that can be settled only by referring to empirical evidence. I happened so supply some such evidence in the course of a recent exchange with the Market Monetarists, in which I posted the following graph:

Here, it seems to me, is rather compelling evidence of wage stickiness, as indicated by the utter failure of hourly compensation to adjust downward in response to a massive collapse of spending–a collapse that presumably ought to have meant a corresponding re-alignment of other equilibrium nominal values. If what Joe calls the “Keynesian” view of things is correct, the failure of wages to adjust with spending should have been associated with a corresponding rise in unemployment; if on the other hand Joe’s own view is correct, there should be no close correlation between the “gap” between the series above and the rate of unemployment. I suppose my readers can guess which view squares most readily with the evidence, but here for good measure is the unemployment plot:

Don’t get me wrong: I know that one can also tell a story about labor mis-allocation and consequent structural (as opposed to ordinary cyclical) unemployment; moreover I believe that that story gets to part of the truth. But why make it the whole story? Why pretend that unemployment only did what it would have done even if nominal spending had never collapsed?

As for the collapse in spending itself, allowing that it reflected “the voluntary decisions of individuals to alter the amount of money they desire to hold,” it hardly follows that that made it harmless. On the contrary: the increased demand for money would, unless accompanied, and accompanied relatively swiftly, by a compensating decline in prices and wages, would necessarily imply a shortage of real money balances. By Walras’ Law that money shortage would have as its necessary counterpart a matching surplus (excess supply) of things-other-than-money, including goods and labor. In other words, it would mean recession and unemployment.

As for my seeing (“like any garden variety Keynesian”–ouch!) “fluctuations in aggregate demand as a market failure that must be offset by Fed policy”…well Joe, I’m afraid that’s really quite a howler, isn’t it? I might have expected it from some others of the anti-fractional reserve persuasion, but from you? Say it ain’t so Joe! Say that you haven’t forgotten that I’ve written a thing or two about how AD wouldn’t be so unstable were ours a free banking system. Say that you really do know the difference between a claim of market failure and one of government failure! Admit that when you suggest that I “want” the Fed to manage the money stock, it’s to score a cheap point against me in the hope of impressing gullible reader’s of The Bastiat Circle, and not because you really aren’t aware of my desire to see the Fed abolished, along with all other central banks. As for my betraying my cause by endorsing Fed activism as a second-best solution, if that seems so, it is only because it’s damn hard to point out that the Fed has screwed up without implying some “ideal” conduct that would have been better, which is surely not the same thing as imagining that the Fed can ever be expected to behave in such an ideal fashion. If that’s betraying my ideals, call me guilty.

Joe’s account of my ideas concerning how free banks evolve also bristles with misrepresentations. True, I say that eventually the banks might make do with very little monetary gold. But the transition to such a state of affairs would presumably be a very gradual one, and would proceed, not from some fictional 100-percent reserve starting point, but from that of established fractional-reserve ratios already in low double-digit (if not single digit) territory. So there’s no reason to assume that it would involve substantial, let alone “massive,” inflation. Neither is there any reason to suppose that bank money would “in effect become” fiat money. Nothing in the evolutionary process I describe points to a change in the status of note and deposit contracts as redeemable claims to standard money, and it is impossible to see how competing banks might convince their customers to voluntarily agree to any such change.

Fiction is also the word for Joe’s predictions concerning other likely consequences of a move to free banking. Like many of his MI colleagues and followers, he here speculates as if the possibility being contemplated were a perfectly hypothetical one, for which actual empirical evidence is lacking. But that’s just not so. Free banking has existed, not in some pristine version of course, but in approximations close enough to allow reasonable conclusions to be drawn about unregulated reserve ratios and such. So, did the most free of all banking systems, lacking central banks but also lacking any barriers to 100-percent reserve banking or subsidies to fractional reserve banks, exhibit the high reserve ratios to which Joe referred in testifying to Congress? Not at all. On the contrary, the freest systems, including Scotland’s (ca. 1750–1845) and Canada’s (ca. 1873–1914), had remarkably low reserve ratios. If 100-percent reserves are your thing, freedom in banking doesn’t appear like a good way to have them. Better to call out the anti-bank vigilante squads, or just have the law itself set things right (as the fraudists would presumably empower it to do).

Concerning Joe’s frenzied final paragraph, all I can say is that I hope he had himself a good stiff drink after writing it, and that he’s feeling a lot better now.