Is private currency history repeating itself?

As I and others have said before, free banking & competitive currency provision either completely ignored, or unfairly dismissed by opponents who really don't know too much about the system. A recent example came on the FT's Alphaville blog. By author Izabella Kaminska, and entitled "Private money vs totally-public money, plus some history", it purported to show how cryptocurrency was just a rerun of earlier monetary struggles, looking specifically at the formation of the Bank of England:

As the BoE’s historical timeline helpfully points out, the BoE came into being when a private syndicate decided to risk all in 1688 by providing the UK government with funding when no-one else was prepared to do so. This ultimately proved to be a very good decision. It turns out lending money to government on terms you can enforce and control can be very profitable, especially if it leads to wise public investments that improve the wealth of the nation and make it easier to collect taxes as a result.

Soon enough the Bank’s success meant it could raise financing for both the government and private interests from almost anyone, issuing notes and deposits to all those who were prepared to do so.

Before the Bank knew it, its notes had become the most liquid and trusted in the land.

Open and shut then—free banking evolves naturally into superior central banking! Or maybe not. As George Selgin pointed out in the comments.

Ms. Kaminska goes out of her way to dismiss the famously efficient and stable Scottish system as an "oligopoly" without even bothering to offer any evidence that the banks in that system colluded or otherwise behaved differently than they might have had entry into the industry been unrestricted. (For her information on the Scottish system Ms. Kaminska relies on a single blog post that in turn draws on some untrustworthy sources, happily ignoring the extensive literature on the other side of the question.)

Ms. Kaminska then imagines that the English system's only fault lay, not in the dangerous concentration of privileges in the Bank of England, awarded it not owing to any enlightened concern about stability but simply in return for its fiscal support of the English government, but to the fact that that monopoly was as yet not complete!  In fact a currency monopoly is extremely dangerous because it immunizes the monopoly bank from the normal discipline of routine settlement, making it capable of acting as a sort of Pied Piper to less privileged banks.  (Peel's Act itself, in turn, caused trouble by undermining the English system's ability to accommodate changes in the British public's demand for currency.)

In light of these facts, Ms. Kaminska's claim that English banking crises were caused by smaller joint-stock note issuing rivals, which were at last allowed to compete with it, albeit only outside of the main, metropolitan market, beginning in 1833, is utterly--I was going to write "laughably" except there's nothing fun about it--mistaken, as she might have discovered had she bothered to read, say, Walter Bagehot's Lombard Street, say, instead of copying and pasting from the Bank of England's own self-serving web pages. She would there have come across Bagehot's careful account of how England's artificially centralized "one reserve" system, dominated by the Bank of England in consequences of its accumulated privileges, exposed it to financial crises to which Scotland and other less centralized ('"natural") banking systems were immune.

Regulation seems to cause bank crises, not prevent them

City AM's Pete Spence (formerly of this parish) reminded me of Mark Carney's claims in January that free banking systems are more unstable than regulated ones. I'm not so sure. Take a look at these two charts from George Selgin's Are Banking Crises Free-Market Phenomena?, which mark an x for every instance of a banking panic. The first chart is for unfree systems, the second for free systems:

In this case at least, it looks like the evidence is against Mark Carney.

How Scotland could flourish by unilaterally keeping the pound

Between 1716 and 1844, Scotland had one of the world’s most stable and robust banking systems. It had no central bank, no lender of last resort, and no bank bailouts. When banks did fail, it was shareholders who were liable for paying back depositors, not taxpayers. Scottish GDP per capita was less than half of England’s in 1750; by the end of the era in 1845 it was nearly the same. Now that George Osborne has ruled out a currency union if Scotland votes for independence, the Scots have an opportunity to return to this system more seamlessly than any other place in the world could.

As I said to the press this week, there’s nothing really stopping Scotland from continuing to use the pound unilaterally. (Unless the remaining UK introduced strict foreign exchange controls, which would be absolutely crazy.)

What the Chancellor's announcement actually means is that the Bank of England (BoE) would no longer consider Scottish interests when it determines monetary policy and that illiquid Scottish banks would no longer be able to use the BoE as a Lender of Last Resort.

I’m not sure that the first point really matters at all. Scotland’s five million people can’t have much of an influence over the BoE’s policy for the UK’s 63 million people as it is. And, frankly, I’m not sure the BoE knows what it’s doing well enough for it to matter whether it cares about you or not.

The second point is the interesting bit. George Selgin has pointed to research by the Federal Reserve Bank of Atlanta about the Latin American countries that unilaterally use the dollar. Because these countries – Panama, Ecuador and El Salvador – lack a Lender of Last Resort, their banking systems have had to be far more prudent and cautious than most of their neighbours.

Panama, which has used the US Dollar for one hundred years, is the most useful example because it is a relatively rich and stable country. A recent IMF report said that:

By not having a central bank, Panama lacks both a traditional lender of last resort and a mechanism to mitigate systemic liquidity shortages. The authorities emphasized that these features had contributed to the strength and resilience of the system, which relies on banks holding high levels of liquidity beyond the prudential requirement of 30 percent of short-term deposits.

Panama also lacks any bank reserve requirement rules or deposit insurance. Despite or, more likely, because of these factors, the World Economic Forum’s Global Competitiveness Report ranks Panama seventh in the world for the soundness of its banks.

I suspect that there would also be another upside. Following Walter Bagehot, central banks are only supposed to lend to illiquid banks, not insolvent ones. Yet since the start of the Eurozone crisis the ECB has clearly made significant bond purchases to prop up both insolvent banks and insolvent governments. This may have been a lesser evil than letting them collapse altogether, but it’s hard to say that this kind of moral hazard is not present.

So, given that some countries do survive and even flourish without a central bank, how would Scotland do it?

The basic mechanics, I think, would be this: in a hangover from the old free banking period, Scottish banks currently issue their own banknotes. After independence, they could continue issuing their own notes that entitle the bearer to GBP on demand. BoE pounds, in other words, would be the 'base money' that Scottish banks use to back their own private currencies, in the same way gold was used during the last Scottish free banking era.

A banknote from a Scottish bank would be, in effect, a promissory note redeemable on demand in BoE-issued pound sterling. (Scottish notes are already promissory notes, but issuance is closely regulated by the BoE.) Of course, there should be nothing stopping banks from issuing notes redeemable in something else, like US Dollars, gold, Bitcoins, or Tesco Clubcard points. Scottish banks would have to arrange private clearing houses, as they did in the last free banking era, to provide loans to illiquid banks, or they could follow Panama in simply maintaining very high reserves.

No bank would have monopoly privileges: any ‘bank’ could issue notes and it would be up to the market to decide whether to accept them as money or not. As Selgin explains here, banks free to issue their own notes will set their reserve ratios according to people's demand for money, stabilising nominal spending.

With respect to other regulations, I quote Selgin again:

It is, in any event, desirable that there be no Scottish public authority capable of bailing out insolvent banks and of thereby introducing a moral hazard. Deposit insurance should be resisted for the same reason. Foreign banks should be admitted, by way of branches rather than subsidiaries, and should enjoy the same rights as Scottish banks. (Of course the major "Scottish" banks are themselves no longer really Scottish anyway.) Finally, re-establishing some form of extended liability (though not necessarily unlimited liability) wouldn't be a bad idea.

We take no position on Scottish independence — it is up to Scottish voters to decide. And while a return to free banking in Scotland may seem fanciful, this week’s announcement makes it much more likely. Keeping the pound and treating it as the ‘specie’ on which banks can base their notes would make the transition virtually seamless for the average Scot, while giving them a banking system that is unrivalled anywhere in the world for being stable, open, and free.

Allister Heath lays out his Mark Carney wishlist

In a video out this morning, City A.M. editor Allister Heath calls on Mark Carney to bring the Bank of England into the twentieth century by reforming regulation to emphasise greater interaction with the financial sector, opening up its culture to something less dictatorial, and monetary policy to something more like Nominal GDP Targeting or a Productivity Norm.

The rise and fall of the Gold Standard

George Selgin, prominent monetary theorist and blogger at Freebanking.org, who recently gave an excellent talk at the ASI on "good deflation", wrote a history of the gold standard in the USA, explaining that there is no one narrative or theme throughout the history, with the fortunes of gold rising and falling with the times. While he pokes holes in some of the common garden arguments against a return to gold he also has his own reasons for distrusting a new regime founded on the yellow metal:

The claim that the real price of gold has become too volatile to allow that metal to be relied upon as a standard, for example, overlooks the extent to which gold’s price depends on the demand for private gold hoards, which has become both very great and very volatile precisely because of the uncertainty that fiat money regimes have inspired. The claim also overlooks the tendency for a metal’s price to become more stable as it becomes more widely adopted as a monetary standard.

Nor is it the case that there is not enough gold in the United States to support a new gold standard. According to Lawrence White, the Treasury’s gold stock, assuming that it is indeed what the Treasury itself claims, would at an official gold price of $1,600 per troy ounce be worth almost 20 percent of 2012 M1, making for “a more than healthy reserve ratio by historical standards.”

There are, however, some more compelling reasons for doubting that a return to gold would prove worthwhile. One is the prospect that any restoration of the convertibility of dollars into gold might be so disruptive that the short-run costs of the reform would outweigh any long-run gains it might bring. A second compelling reason has to do with the specific disadvantage of a unilateral return to gold. Here, once again, it must be recalled that the historical gold standard that is remembered as having performed so well was an international gold standard, and that the advantages in question were to a large extent advantages due to belonging to a very large monetary network.

Finally and perhaps most importantly, it is more doubtful than ever before that any government-sponsored and -administered gold standard would be sufficiently credible to either be spared from or to withstand redemption runs.

Read the whole thing.

Video of George Selgin's talk "Could deflation be salvation?"

George Selgin spoke the tuesday before last, 28th May, on the possibility some deflation—that coming from improvements in the supply side—is not harmful to the economy, but good. He made an extremely convincing case, pointing out that the so-called Long Depression of 1873-1896 was actually the site of a vast improvements in living standards and social welfare. And he pointed out that the problems attendant with deflation, that economists are fond of pointing out, only obtain when that deflation comes from a demand shock, not a change in supply.

A question for market monetarists

Market monetarism, as propagated most prominently by Scott Sumner's (excellent) blog The Money Illusion, argues that recessions come about due to a collapse in demand. This is a problem because prices cannot adjust downwards quickly. Instead of a costly adjustment period we can simply boost demand by announcing a target and credibly committing to do the necessary quantitative easing (buying gilts to inject money in the system) to achieve that target.

This makes a lot of sense. Markets are finding it hard to clear; we boost AD to put the situation back where it was; now markets find it easier to clear. But lots of the best market monetarists, including Scott, Lars Christensen and many others, argue that right now what we need is more stimulus, because the economy is still in a bad shape, and it is still due to a shortfall of demand.

Last Tuesday Professor George Selgin delivered an extremely interesting lecture at the Adam Smith Institute making the case for productivity driven deflation. He said he agreed with the market monetarists that there is "bad deflation"—the sort that means nominal rigidities stop markets from clearing—but there is also "good deflation", from productivity improvements—and this is not associated with unemployment, stagnant or falling GDP, or any other cyclical issue.

After the talk I quizzed him on whether he agreed with the market monetarists that even though the ideal is a rule-based system, as opposed to the current discretionary way policy is set, right now the best discretionary policy is more easing, because that's probably what the ideal rule would require.

Prof. Selgin disagreed, arguing that we didn't need easier policy, and if you look at the graph above there's at least apparent reason to agree with him. Nominal GDP—aggregate demand—is not only well above its pre-recession peak in the US, but is growing at an apparently steady rate, roughly in line with its long-term trend. If the high unemployment in the US is down to insufficient demand combined with nominal rigidities then why hasn't a long period of higher-than-pre-crisis demand brought unemployment back down.

According to Selgin, policy uncertainty and pro-cyclical strictness in enforcing regulations (particularly risk-weighted lending rules that rate Greek bonds as zero but loans to small business at 100%) are holding firms back from investing their cash piles in capital and it is this that is stopping the robust recovery. He made the point very convincingly and despite trying hard to argue against it I couldn't find a good reason to disagree, except that I hadn't seen a good measure of the importance of these two factors so it was hard for me to compute how big their influence really was.

But many market monetarists—along with New Keynesians and most others—seem very sure that insufficient demand is the overriding factor holding back recovery, in the US as much as the EU, UK and Japan (where NGDP growth is further below trend). So my very genuine question is: upon what arguments and/or evidence do they rest this belief?