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Loyal readers know the drill. All quotes are in italics; everything in regular font is me speaking.

Someone over at reddit claimed I misrepresent Mises in my articles, that Mises was in love with fractional reserve banking in general and monetary disequlibrium theory in particular.

I already presented his views many times, complete with extensive quotes, about monetary dis. theory. Short version; he thought it nonsense, and dangerous nonsense at that. The redditor, however, linked to an article by Selgin and White claiming Mises was in love with free banking, aka fractional reserve banking, aka producing fiduciary media:

…the view you provide does not really represent mises perfectly, as argued in “In Defense of Fiduciary Media — or, We Are Not Devo(lutionists), We Are Misesians! ” ([1] http://mises.org/journals/rae/pdf/rae9_2_5.pdf).

That article is as full of holes as a swiss cheese, but today I’m going to treat only one aspect of it, the claim that Mises was in favor of fiduciary media. I’ll quote at length all their proofs about Mises’s opinions on the subject, and show how mistaken they are.

1. Mises (1966, p. 433; 1980, appendix B) referred to that portion
of  redeemable money  substitutes backed by  assets other than base
money as “fiduciary media,” not as any kind of fiat money.

They are right. He called bank notes with no backing whatsoever by the name “fiduciary media”, and did not call them “fiat money” unless the govt forces people to accept them.

But it is misleading to say they are backed by “assets other than base money”. They are not backed by anything according to Mises [as well as according to reality], as is made plain in the tree diagram in Appendix B [of Money and Credit], where they are called “Uncovered bank deposits and notes”. Indeed, in Part 3, Chapter 1, Section 3 of Money and Credit, Mises describes them as “greater obligations than he [= the banker] would ever be able to fulfil“.

2.  We  side with Mises…by acknowledging the legitimacy and practical
advantages of fiduciary media  and fractional-reserve banking.

Hold thy horses, guys. Mises did not acknowledge the legitimacy or practical advantage of fiduciary media and fractional reserve banking.

If you read Chapter 17, Section 12, of Human Action, Mises’s position becomes very clear. It’s not that he loves free banking, meaning allowing the banks to undertake “greater obligations than they would ever be able to fulfill”. He just thinks it is a lesser evil than giving the govt any control whatsoever over banks. And he certainly does not think it has any practical advantage to the economy per se. The practical advantage is merely that it prevents a bigger problem, govt meddling.

He talks about the Banking School, which made the mistake of thinking that ” the  requirements  of business rigidly limit the maximum amount of convertible banknotes that a bank can issue.” He says the Currency School was right, when it claimed that banks can, if allowed to get away with it, inflate the money supply as much as they want:

The Currency School gave a quite correct explanation of the recurring
crises as they upset English business conditions in the ’thirties and ’forties
of the nineteenth century. There was credit expansion on the part of the Bank
of England and the other British banks and bankers, while there was no credit
expansion, or at least not to the same degree, in the countries with which
Great Britain traded. The external drain occurred as the necessary conse-
quence of this state of affairs. Everything that the Banking School advanced
in order to refute this theory was vain.

But the Currency School made a mistake:

It never realized that the remedy it suggested, namely strict legal limitation of the amount of banknotes issued beyond the specie reserve, was not the only one. It never gave a thought to the idea of free banking.

In other words, he’s saying right here that 100% reserve requirements are a good solution. In fact later on he writes that:

Banknotes  are  not  indispensable.  All  the  economic  achievements  of capitalism would have been accomplished if they had never existed.

So if 100% reserves are so great, why does Mises prefer free banking? Because 100% reserve requirements would be a law unfavorable to the govt, which is in love with inflation. Meaning the law would be rescinded at the drop of a hat:

But even if the 100 percent reserve plan were to be adopted on the basis of the unadulterated gold standard, it would not entirely remove the drawbacks inherent in every kind of government interference with banking…every restriction imposed upon the issuance of fiduciary media depends upon the government’s…good intentions. They may limit the issuance for periods which are called normal. The restriction will be withdrawn  whenever  a  government  deems  that  an  emergency  justifies
resorting  to  extraordinary  measures.  If  an  administration  and  the  party
backing it want to increase expenditure without jeopardizing their popularity
through the imposition of higher taxes, they will always be ready to call their
impasse an emergency.

That’s why he likes free banking. There is no law to cancel, because there is no law about banking in the first place.

He also likes free banking, meaning no govt interference in banking, because then people would not trust banks, and would cash their checks right away, negating to a large extent the possibility of inflating the money supply. He gives historical examples of exactly that happening.

The point is, unlike the quacks [or as Mises called them, monetary cranks] who think inflation is good, and that it solves some fictitious problem of monetary disequilibrium, Mises thought of free banking as a good political [not economic] strategy. Yes, there is a price to pay economically. There will be some amount of inflation, and that is a bad thing. But it’s the price the country has to pay to keep the govt out of banking, which is a certain catastrophe. As opposed to Selgin and White, who try to pin on him the mistaken view that free banking is just lovely, and indeed healthy and vital for a modern economy because of its beneficial economic effects.

3.  …a standard economic argument we accept concerning fractional-reserve banking: that it reduces the resource costs associated with indirect exchange, by partially substituting bank-issued exchange media for commodity money, thereby reducing (inframarginally) the resource costs of producing money. The resource-cost-saving view is expounded not only by Adam Smith but also by Ludwig
von Mises.

In The Theory of  Money and Credit, Mises (1980, p. 333) ob-
serves that, thanks to the development of fiduciary media and clearing
systems among their issuers, a “tremendous increase in the exchange
value of money, which otherwise would have occurred. . . has been avoided,
together  with its undesirable  consequences.” The “undesirable conse-
quences” are the diversion of capital and labor “from other branches of pro-
duction to the production of the monetary metal.” Had it not been for the
development of fiduciary media, Mises points out, “the welfare of the com-
munity would have suffered” because “a smaller quantity of economic goods
would have been available for the direct satisfaction of human wants.”21

Guys, Mises was talking about how printing money is cheaper than digging for gold. But in today’s world, where money is paper, a check has no advantage over another piece of paper. Indeed, the very quote provided in the article talks about the production of the monetary metal. Metal. As in gold and silver. Not paper. Paper is not a metal.

So much for proving Mises thought fractional reserve banking helps the economy at all. He was talking about when the money is gold. So the claim that he thought free banking was good is false in today’s world.

The authors then proceed to give an argument of their own, one not made by Mises at all, that even with paper as money free banking is good stuff. Their argument is foolish, because it assumes that free banking does not cause inflation, that only govt printed money does. What an egregious error, which Selgin at least has admitted to in later works, where he says it only causes inflation “once”.

And by the way, in that very section of Money and Credit the authors quoted, Mises writes that any amount of money will serve the economy just fine. In other words, he once again explicitly disagrees with the Monetary Disequilibrium nonsense.

EDIT: Look what I found guys.

From Marxism Unmasked, at the end of the Seventh Lecture, there is a Q and A period. There Mises says [all emphasis is in the original]:

What happened in the past with credit expansion has been, by and large, absorbed and adjusted to by the market. I would say, take as “given” the conditions as they have happened in the past, and say only that for the future there should be no more credit expansion. In the future no additional banknotes should be issued, no additional credit should be entered on a bank account subject to check, unless there is 100 percent coverage in money. This is the 100-percent plan. With respect to today’s situation, we should leave everything that has happened in the past alone—we should not attempt to reverse it because that would be deflationary. Deflation is not as dangerous, not as bad, as inflation. Deflation is expensive for the government, while inflation is profitable for the government. But deflation, too, must be avoided.

If there hadn’t been any privileged banks and if government had not forced citizens to take the banknotes by making them “legal tender,” banknotes would never have become popular. The average citizen today in every country of the world, with the exception of the most backward countries, considers as money every scrap of paper upon which the government or an institution privileged by the government has printed the magic words “legal tender.” But it was different in the past. It was not easy to make people accept banknotes. They took them because the banknotes were better than nothing. If a person didn’t want the banknotes he could take them back to the bank that issued them; and if the bank couldn’t redeem them the bank went broke. The “wonderful” thing about government-issued banknotes, from the point of view of the government and the banks, is that the bank is not required to redeem them, except perhaps in legal tender money, which is again banknotes.

If the governments had never interfered with money and banking, it would be possible to leave every citizen free to issue his own banknotes. I want to give everybody the right to issue his own banknotes. The problem then would be to get other men to accept such private banknotes; maybe nobody will take them. I am not against banknotes as such; I am only against banknotes that are protected by some government privilege. I want the banknotes issued in the past to retain their privilege, but no more legal tender banknotes and no more credit expansion!

If I say that the return to the gold standard is necessary it is because it makes inflation impossible. Under the gold standard the amount of money depends on geological factors that cannot be controlled by the government. It is not an unreasonable standard because it is the only alternative to making money completely dependent on the government. If King Charles I [1600–1649] had had the power to print paper money he would probably have been in a much better position in his fight against the government.

Under the gold standard, the supply of money is independent of the changing whims and political programs of governments and political parties. For centuries there were struggles on the part of the predecessors of our parliamentary bodies against the princes who wanted to debase the currency. The princes said, “What counts is only the name which I give to money.” But their silver money got a “red face” when the princes adulterated it with copper, all the while declaring that their new alloyed money, which contained less silver than the old money, still had the same purchasing power and the same legal tender power as the old money. If the government is in a position to provide for some of its expenditures by creating money, it no longer needs to depend, let us say, on Congress. Historically and politically the gold standard is an implement in the system of legislation that limits the power of government and makes government dependent on the will of the people.

Case Closed.

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