Monetary Elephants in the Living
Room
by Nelson Hultberg
October 5, 2005
In a recent article, Robinson
Crusoe and the Curse of 'Real Bills', Sean Corrigan of the
Mises Institute writes that all the hoopla that the "real bills
doctrine has lately drawn does show that a fundamental misperception exists
about monetary matters." [Emphasis added]
This is certainly true. In fact there are several fundamental misperceptions,
and unfortunately they are held by Corrigan and the followers of
Murray Rothbard, about which Dr. Antal Fekete, Dr. Vasilios Koures,
and I have written quite extensively.
What exactly are these "fundamental misperceptions?" To start with,
Rothbardians have not adequately researched history because they
believe so deeply in the rationalist myth that truth can be discerned
solely through the spinning out of deductive logic. Consequently
they have confused the Financial Bills Doctrine of central government
banking with the Real Bills Doctrine of Adam Smith. They misunderstand
the nature of credit, for they perceive it as monolithic, rather
than dual. They misunderstand interest, believing that there is no
difference in the interest rate and the discount rate. They fail
to grasp the difference between the propensity to save and the propensity
to consume. They think the distribution of consumer goods can be
financed like the production of fixed capital assets through borrowing
and lending. They presume in their ivory tower world of deductive
logic that gold will easily adjust prices down to accommodate expanded
productivity. But only in the Middle Ages was this done, and it resulted
in a primitive level of economic activity. History fails totally
to corroborate their fanciful deduction. Because they cling to such
pure rationalism without bothering to seek historical corroboration
they are ignored by big league scholars and much of the intelligentsia
that is beginning to doubt the Keynesian paradigm. This is impeding
the cause of gold and freedom, not helping it.
As a result of these misperceptions, they fail to see that under
a 100% gold system we would have to endure a much lower standard
of living because the trillions of dollars of credit necessary for
the production and distribution of consumer goods would have to be
taken out of savings, i.e., gold reserves, and thus could not be
used to finance factories, technology, plant and equipment, etc.
This makes their 100% gold paradigm unworkable for any society that
wishes to achieve modern levels of capital accumulation.
Seeing that the Rothbardian ideology has been constructed over many
decades upon 100% gold, Rothbard's present day followers are not
about to deviate from this sacred belief. But for those more open
minded in their thinking processes who seek reasons as to how the
restoration of gold as money can be brought about in the upcoming
years, the place to begin is with Antal Fekete's remarkable works
on the subject, Monetary
Economics 101 and 102. He demonstrates that what is needed is
a new theory of interest and credit in order for gold to become
a viable monetary system again.
It is regrettable that Rothbardians continue to evade the glaring
misperceptions listed above. Perhaps they hope these gigantic flaws
will not be noticed by the intelligentsia if they are never talked
about. But silence in face of the elephant in one's living room does
not make the elephant go away.
Answers to Corrigan Misperceptions
What follows are some more misperceptions that Corrigan's article
puts forth, which only make the elephant in the Rothbardian living
room bigger and smellier. Accompanying each of them are my answers.
* * * *
Corrigan: "The moment we allow the legally-favoured bankers
to issue fiduciary media (by which we mean bank-created money entirely
unbacked by previously-saved final goods) against such credit, we
are doomed to end up with too many instantly-payable claims on the
stock of goods currently in existence."
Answer: This is one of the dogmas on which Rothbardians have
built their case for a 100% gold system. But what the history of
monetary economics demonstrates is that, if central banking is disallowed,
and if contractual law is upheld consistently regarding fraud, then
fiduciary media to discount real bills will NOT result in "too many
instantly-payable claims on the stock of goods." This is because
real bills, though not backed by "previously-saved final goods," are
backed by already-produced goods that are urgently needed
and in the pipeline. This negates any price inflation. In addition
when real bills are discounted by the banks, the notes issued to
do so are backed 100% by bank reserves of gold and real bills that
mature into gold within 90 days. Thus we are not talking about the
conventional concept of fractional reserve banking that government-backed
banks have practiced so abusively in the past. In a truly free-market
banking system that prohibited fraud (such as borrowing short to
loan long), banks would have to keep 100% reserves in gold and gold
instruments (i.e., real bills). The real bills are as good as
gold because they can be sold in the bill market for gold at
any time by a banker to meet any demands from depositors for specie
redemption. On this point, see my article, Musings
on Fekete and Rothbard.
This is how real bills worked throughout history and would do so
again if not for government centralizers intervening into the marketplace
to corrupt the banking industry. Rothbardians need to understand
that there is a BIG difference between free-market banking
that deals in real bills and central government banking that
deals in the vast array of financial bills that it is able to conjure
up. The two practices will be governed by totally different laws,
and they will result in totally different outcomes. The former is
governed by the "competition for reputation," a natural law of the
free-market, which mandates that bankers constantly operate in a
high-minded (liquid) manner in order to attract customers. The latter
is governed by coercive monopoly and privilege, the tyrannical contrivances
of bureaucrats, which allow bankers to operate in a disreputable
(illiquid) manner.
Corrigan's treatment of these two forms of banking as the same and
declaring the problem to be "fractional reserve banking" itself is
a huge flaw. To not make the distinction between the two different
types of banking is most unscientific. Moreover it is inconceivable
that any free-market advocate would blank out so on the principle
of "competition for reputation," which is the cornerstone of laissez-faire
political economy. It seems that Corrigan and his cohorts would prefer
to only employ their principles selectively when it serves their
interest.
In other words, you can't have it both ways. You can't preach the
power of competition for reputation (which all Rothbardians do emphatically
in their defense of laissez-faire), but then ignore the principle
in the arena of banking as irrelevant because it detracts from your
agenda. For an explanation of how "competition for reputation" would
keep the use of real bills from being abused, see my article, Real
Bills vs. Rothbard's 100% Gold System.
A thorough perusal of the history of 19th century banking shows
us that its inflationary booms and busts were not the result of free-market
banks dealing in real bills, but were the result of government centralization
of banking, government paper issuance to fight wars, government intervention
to convey privileges to banks, and government refusal to prosecute
fraud.
* * * *
Corrigan: "Nor can any such tinkering ever be enough to extend
the operation of [fractional reserve banking] beyond the speedy collapse
it would otherwise endure were it not underwritten by the terms of
that tyrannical Devil's bargain of the kind most famously drawn up
between the corrupt Whig financiers of the 'Glorious' Revolution
and their importunate, invited overlord, William of Orange, for the
'better prosecution of the war with France'."
Answer: If Corrigan is trying to say that the discounting
of real bills would collapse if not for the "Devil's bargain" of
government banking "underwriting" them, this is preposterous, for
it's precisely the opposite. The writing and discounting of real
bills spring from the free-market and precede banks. Government banking
is what destroys their integrity. It doesn't shore them up.
But Corrigan apparently assumes that government created financial
bills are the same as Smith's Real Bills. Dr. Koures paper, Real
Bills: an Emergent Market Phenomenon, discusses at great length
why this is not so. Mr. Corrigan needs to go back and do his homework.
To j ust repeat ad infinitum his ornate ad hominems and Rothbardian
mantras is not legitimate argumentation. A large, smelly elephant
is standing in his living room. A truth seeking scholar would be
attempting to confront the elephant rather than spinning out spiteful
inanities.
* * * *
Corrigan: "Not to be discouraged either by reason or experience,
however, these good [Feketian] souls roundly declare that
'real bills' have never been given a true test, having always
been adulterated by the prolific rediscounting of all sorts of other,
less worthy bills - a crime perpetrated, of course, by exactly the
same coterie of foolish and greedy bankers that the Feketians want
to foist upon the ideal future Commonwealth of their promises!"
Answer: Not so! We in the Fekete camp want to rid the Commonwealth
of the "coterie of foolish and greedy bankers." This coterie is made
up of government bankers, however, and Corrigan is failing to distinguish
between free-market bankers and central government bankers. But,
of course, he has to blank out on the difference, for to draw the
distinction would call attention to the fact that fractional-reserve
banking in real bills is not the problem. It is fractional-reserve
banking practiced by government bureaucrats with their coercive monopolies,
their privileges, and their myriad of bogus financial instruments
that is the problem.
* * * *
Corrigan: "To the first group of [Feketians], we can only
say that to make a fuss about the fact that 'price levels' at either
end of the 19th century were more or less equal - and to disregard
the vertiginous topography they mapped out within it - is to say
that because America's sea level is the same on its Atlantic coast
as at its Pacific one, one can safely fly between the two at an altitude
of fifty feet!"
Answer: Calling attention to the fact that prices were slightly
lower at the end of the 19th century than they were at the beginning
is hardly "making a fuss." It is one of the most crucial elements
of this era, and it is very important to delve into why.
Moreover the "vertiginous" prices during the 19th century were clearly
the result of central government banking through the 1st and 2nd
U.S. Banks between 1791 and 1833, and through the National Banking
System (the quasi central bank forerunner to today's FED) established
from 1863 to 1913. In addition, our government flooded the country
with paper during the War of 1812 and the Civil War. Even in the
so called "free banking era" from 1835 to 1860 initiated by Andrew
Jackson, there were special privileges galore conveyed to banks by
government.
Such price volatility that was experienced during the 19th century
was due precisely to the factors that we in the Fekete camp have
been shouting about -- government banking, government privileges
conveyed to bankers, government winking at bank fraud, etc. Yet Corrigan
ignores this totally and acts as if the price volatility was just
due to "fractional-reserve banking" itself. It is inexcusable to
consider the problem so crudely and simplistically. If we had had
a truly free-market banking system that discounted real bills during
the 19th century, we would have never had the price volatility that
was experienced under the government privileged systems.
* * * *
Corrigan: "To the second group [of Feketians], we can only
confess that they seem most like the hapless plague doctors of Pepys'
London; quacks who well recognise the symptoms of the disease, but
who are unable to identify its root cause - in our case, fractional
reserve bankers, rather than the equally pestilential rats and
fleas! - and instead opt for a truly Hermetic mysticism in treating
it." [Emphasis added]
Answer: On the contrary, it is Corrigan who fails to identify
the ROOT CAUSE of our monetary disease because of his crude defining
of the problem as just "fractional reserve bankers." Without drawing
the distinction between free-market bankers and government managed
bankers, he obfuscates the issue in the worst way and misleads his
readers. But what else can he do since he insists on clinging to
the myth that a 100% gold monetary system is mandatory? In order
to maintain such monetary rigidity, he must paint fractional reserve
banking per se as "diabolical," rather than do as a true scientist
would do -- analyze the two different forms of fractional reserve
banking, which would demonstrate that the use of real bills is not
only not diabolical, but immensely beneficial. He must blank out
on the fact that government intervention into the mix is the real
ROOT CAUSE of our problems. If he were to face up to these quite
demonstrable facts, then he would have to face the distasteful realization
that his 100% gold monetary paradigm is not mandatory at all. This,
of course, is not going to happen. He and his cohorts have an agenda;
and if facts of reality get in the way, then damn the facts.
* * * *
Corrigan: "So, we are left to wonder just how that Feketian
Pietist, Mr. Hultberg, proposes to prevent the fractional reserve
bankers he so ardently defends from once again debauching his new
Jerusalem of 'real bills' and from inexorably transforming it into
an inflationary Sodom and a speculative Gomorrah of monetized credit
instruments... without himself having to resort to an appeal to the
same violence of authority which he falsely supposes his opponents
to endorse."
Answer: How are we to "prevent fractional reserve bankers
from debauching" the system? By means of three quite effective legal
/ regulatory methods: 1) the objective implementation of contractual
law, i.e., no special privileges dispensed to bankers, 2) consistent
prosecution of fraud, and 3) the principle of competition for reputation.
Mr. Corrigan should certainly know that the beauty and genius of
the free-market is that it contains powerful and natural regulatory
mechanisms with which it polices itself. In this case, the natural
mechanism would be the COMPETITION FOR REPUTATION among bankers.
This is understood by all free-market advocates as the reason why
we do not need government intervention to manipulate and regulate.
All we need on the part of government is an objective system of law
(i.e., the proper prosecution of fraud and no privileges dispensed
to market participants) to complement this natural regulatory principle.
With such a complement, the discounting of real bills would not get
out of hand. Reason and the study of economic history show us this
if we approach the issue with an open mind.
Thus we do not need to utilize government regulatory coercion to
prevent "real bills" from debauching the Commonwealth. As long as
the government will do its legitimate job of prosecuting fraud and
objectively implementing contractual law, then the marketplace will
take care of the regulatory job naturally through "competition for
reputation," which will mandate that bankers remain highly liquid
and responsible in order to attract customers. Our problem lies in
the fact that government did not do its job during the 19th century.
It privileged bankers by allowing them to deal in irresponsible banking
practices and hide their irresponsibility from the public, which
resulted in boom / bust economic swings. If Mr. Corrigan had thoroughly
researched this era, he would realize this. But such research and
recognition of the true source of the problem would not support the
100% gold agenda with which he and his fellow Rothbardians are so
obsessed. Thus it is far better to gloss over the era and spin its
boom / bust volatility in more simplistic terms that support the
agenda.
Of course, Rothbardians don't "endorse the police power of
government authority" to mandate their 100% gold monetary system.
But that is what they will have to tolerate if they ever want
to actually implement it rather than just bandy their busy little
blogs back and forth about it. They will have to make use of government
police power to mandate it because a free-market would never choose
such a system. Free men would not opt for it. Free men would make
use of real bills. And free bankers would discount them in a non-inflationary
manner via competition for reputation.
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