All Commentary
Monday, May 8, 2017

Central Banking Is the Health of the State

A review of "Money Free and Unfree," by George Selgin.

Badass former BB&T banker John Allison’s short tenure as CEO of Washington, D.C.’s often-libertarian leaning Cato Institute (Cato) will probably be best remembered as the reign that finally gave George Selgin his due.

Criticism is everywhere about central banking’s looming role in the world’s economic life.

Whereas prior, Mr. Selgin’s essays were scattered among gaggles of institutes and professional journals, Mr. Allison helped to create Cato’s Center for Monetary and Financial Alternatives in October of 2014, in part, I suspect, to give Mr. Selgin’s vital work on Free Banking a somewhat permanent platform.

Mr. Selgin is its Director, and he posts frequently at the newly formed division’s blog, Alt-M, along with other monetary economist heavies.

And it’s probably true too it took someone intimately familiar with Federal Reserve (Fed) policy in particular, and central banking in general, such as Mr. Allison, to see a giant hole in liberty scholarship.

It’s a queer gap no matter how one approaches criticism of the Fed so popular in the present era thanks to Ron Paul’s presidential campaigns and social media creating waves of celebritarians.

Criticism is everywhere about central banking’s looming role in the world’s economic life. Geeze, even Bernie Sanders has stumbled on the issue. But when liberty-minded critiques occur, they come across now as rote, stale. It’s one of the major talking points sure to gather applause and nods – just whack the Fed and its influence. Easy.

As always, it is seductive to intellectually smash what we’re against, to rail against perceived evils. What is considerably more difficult is formulating a positive vision, a replacement.

Check and see if I am correct. Return to your favorite Fed critic and search, in vain, for their substitute of central banking in any real depth or verve. You won’t find one. If you’re lucky, you’ll get ham-fisted guesses and cursory allusions.

Mr. Selgin quietly, along with mentor Lawrence White, has become a preeminent student of central banking’s alternative, Free Banking: the theory and history of banking without central planning and comparatively few government regulations.

He has built a solid career on a laser essay style, a linear progression as a grand syllogism. Mr. Selgin’s writing is warm, laced with convincing scholarship, and he’s become something of an economic historian (he would eschew that later description).

Covering three decades of scholarship, Mr. Selgin’s scaffolding of Free Banking theory and history is finally put down in an exciting volume, Money Free and Unfree (Cato 2017). I understand a reference volume on monetary economics, indexed, with graphs and charts, usually isn’t described as ‘exciting,’ but Free Banking holds a promise liberty thinkers have long ignored in the philosophically positive sense.

Money Free and Unfree sets the table for liberty thinkers to imagine a world without central monetary planning, giving enough historical/empirical examples to make a convincing case to those who understand the truism: Free Banking alone does not a free society make, but no society is really free when money, credit, finance are centrally controlled. 

Higgs’ Ratchet

At the turn of the present century, a rather obscure book by an economics academic made heads turn within liberty scholarship. Robert Higgs’ Against Leviathan quietly shook foundations of political science theory.

Governments never let a good crisis go to waste. 

It’s one of those insights so seemingly obvious, empirically, historically, that it begs to be made, yet appears irregularly for whatever reason.

Mr. Higgs termed his insight the Ratchet Effect. Essentially, governments hasten to not waste a crisis or a disaster. Governments use these crises as pretext for upping control and power over people and resources.

Eventually, when the problem subsides or is answered, governments cannot maintain crises’ levels of control(s), and so they cede back some power. Some.

The salient point, and Mr. Higgs’ masterful analysis is the trend this reveals. Graphed Cartesian style, the line of government power-grabs jut ever upward with slight dips, but the rate of increase remains and never glides back to pre-crisis levels.

Not unlike a particularly pernicious cancer, government metastasizes, ratcheting up its power a click at a time.

When central banking achieves its monopoly, all bets on fiscal discipline are off.

Mr. Selgin has connected the historical end of Free Banking, especially in the 20th century, with Mr. Higgs’ Ratchet Effect in the sense once governments gobbled up final control over credit, super states as we now know them come into existence and flourish.

Governments have always cajoled and hectored bankers to finance their schemes beyond a bank’s means, especially during wartime and even within Free Banking systems.

What prevented, or limited, Higgs’ Ratchet with regard to banking participation in governmental delusions of grandeur was a reputational discipline enforced by a Free Banking regime.

Surely banks were tempted to acquiesce, but they most often refused. Had they issued notes beyond their gold reserves, in an effort to appease governments, competitors would only be too happy to circulate them right back to the issuer, depleting remaining reserves and effectively destroying the complicit bank for good. 

When central banking does finally achieve its monopoly, all bets on fiscal discipline are off, gone. Governments simply debase the currency through inflation, even with a gold standard of some kind, and refuse to redeem at a later point. Those last note holders are stuck without recourse. And thus begins ratcheting of control and power.

Crisis and Central Banking 

Mr. Selgin’s quarter century thesis remains steadfast and resolute: mainstream economic insistence on central banking’s essential function to an economy’s stability is false, both in theory and practice. Rather than prevent or soften a crisis, central banking initiates them and deepens them.  

The ills of central banking folly are probably reasonably known by regular readers. What might please them to learn is the Free Banking alternative existed in history. It can be studied and gleamed from in terms of what might happen should a given society wish to scrap central monetary control.

Instead of a monopoly on currency issuance, banks compete. Commercial banks can supply a nation’s money, unregulated; they’re not insured by the government and are never bailed out.

Around the time of Adam Smith, the Scottish banking system approached something akin to Free Banking in the way spoken of here.

Until the mid 19th century, when English law began to chip-away at the Scottish experiment, Scottish banks were without special privilege to issue paper currency. Even under a gold standard system, paper currencies can be considered desirable.

For a host of practical reasons, the Scottish preferred bank notes to gold when given a choice. But there were natural limits on Scottish Banks’ ability to issue notes, limiting the expansion of notes in circulation. There was a kind of invisible discipline imposed upon Scottish banks in this regard. Overly generous banks would lose reserves to rival banks when such markers were called (similar to a modern checking system), and such occurrences were a regular feature of Scottish banking.

“War is the health of the state.”

That Ratchet Effect was kept in check, relative to the expansive powers of the last 100 years, because governments had fewer recourses to credit. Once Free Banking’s natural discipline was broken, swallowed up by government banking monopolies, the incredible growth of states was unleashed.  

Free Banking Challenge 

The move to separate bank from state becomes less abstract when one considers war. In Randolph Bourne’s famous quip formulation, war is the health of the state. But what is truly at the heart of war is finance. Munitions, assorted arms, uniforms, troops, and their care, all take resources. And if a war is anything other than defensive, Free Bankers have little-to-no incentive to make war happen. This, of course, is exactly opposite the case for governments.

Crisis grows state power and influence in every aspect of ordinary peoples’ lives, and few disasters galvanize a public more than martial calls to war.

The thought of having to pay, almost upfront, for a citizen’s share of a foreign intervention or offensive US-style strike, to the tune of tens of thousands of private dollars per person, seems on its face to limit future forays into war adventurism.

And that’s Free Banking’s grave challenge. Less government intervention in credit and monetary policy in the macro sense means fewer Ratchets, which inevitably means less government, which means more freedom (the classic inverse relationship).

The book has requisite Austrian School tendencies, but Mr. Selgin is famously undogmatic.

The longer government controls one-half of all exchanges (money), access to and the amount of credit, and dictates the terms of finance, the faster the light of liberty extinguishes. That much liberty-minded thinkers understand. The impossibility, seemingly, of changing such arrangements in any meaningful way is lessened severely by the torch of Mr. Selgin in Money Free and Unfree.  

A library claiming to promote liberty and a free society is courting genuine ignorance and is woefully incomplete without such a volume.

Money Free and Unfree is handsomely divided into three parts, each of which builds toward the next, promoting balance between Free Banking theory and history.

If the Scottish example above doesn’t move you, Mr. Selgin delves into Canadian experiences which, to be quite honest, blew me away. But I’ll save the details for your reading.

For liberty to thrive, it needs a positive vision.

To be sure, the book has requisite Austrian School tendencies, but Mr. Selgin is famously undogmatic, and he takes on some sacred cows such as fractional reserve arrangements and whether such automatically necessitate a lender of last resort. He also might rub Austrians wrong with the inclusion of charts and graphs, but none is too “mathy” or indecipherable. In fact, I found them illuminating and worth the bother.

My only disappointment with Money Free and Unfree is that it didn’t include modern inventions such as crypto-currencies. Mr. Selgin can be counted among the skeptics, at least as far as I have read him, but a full flushing out of, say, Bitcoin’s potential with an eye toward Free Banking theory might have made the book that much more relevant.    

In any case, it is still mandatory reading for liberty-minded folks. Liberty can survive on attacking the state here and there, but for it to thrive it needs a positive vision, positive visions of what can be. Money Free and Unfree both generates and answers that challenge.