Problem: Fiat Money vs. Fractional Reserve Banking

[Throwback280s]

I have been a big supporter of Ron Paul's plans to challenge the Federal Reserve's control over our nation. I was also big into his call for a dual currency system in which individuals could deal in gold standard-based currency if they so wished.

However, I watched the excellent film The Money Masters and it's caused me to rethink my position on this issue and question Ron Paul's proposed solution for this problem.

Ron Paul often criticizes fiat currency, paper money created out of thin air. He argues that the eventual goal would be to move towards a hard money system such as the gold standard. The Money Masters argument agrees with the need to abolish the Federal Reserve, get out of the IMF, World Bank, and BIS. And they also criticize a private central bank. However, the film contends that fiat currency is not the ultimate problem facing our nation's economic woes. It is fractional reserve banking (ex. banks loaning out $10,000 based on $1,000 in reserves it has).

The film argues that a Gold Standard is not the way to solve the monetary crisis. Apparently, the IMF and other central banks own approx. 2/3rds of the world's gold supply. By returning to the gold standard at this time, we would be at the mercy and manipulation of these bankers. Also, the film shows that Ben Franklin and other founding fathers felt that the Revolutionary War was fought in part over Great Britain forcing the colonies onto a gold standard and then hoarding their gold through taxation. Instead, the fiat currency the colonies used previously had apparently been a prosperous system.

Rather than adopt a gold standard, the key is to return power of issuing money away from a private bank and back to the US Treasury. The US Treasury notes would be printed interest free and would coincide with a gradual phasing out of fractional reserve banking in the nation's banks.
Here's a summary of the proposed solution put forth by the film:

Monetary Reform Act

By way of conclusion, the film presents an option for a different kind of monetary policy for the United States, the Monetary Reform Act. The film suggests that fractional-reserve banking and the Federal Reserve System be abolished in favor of 100% reserve banking. These reserves would come from the government, which would issue non-interest generating money to repay the public debt to the banks. This would happen over a gradual period of one year. As the government repaid its debt, the banks would be required to hold the government's new money as reserves and the reserve rate would slowly be increased to 100%. Thus, there would be no inflation or imbalance in the amount of money in circulation. The issuing of new money would then be controlled. In order to prevent inflation, issuance would be according to population statistics. After the public debt was repaid, money that would previously have been interest on the debt would be distributed by the government as a tax refund, leading to the abolition of income tax.

The film shows that Lincoln's use of this US Treasury Greenback system was an extremely successful and prosperous model. Whereas gold standard-based economies have consistently been manipulated by world banking powers.

I would like to see a detailed rebuttal of this alternative solution to the Federal Reserve if it exists. Any other discussion of various points, strengths and weaknesses, of both approaches would be great.

It seems as if the dual currency proposal Ron Paul wants to offer is a simple bandaid. I am a firm believer in gold and encourage everyone I know to invest in it. But I'm wary of a gold standard with the realization that private bankers have consolidated vast portions of it and can manipulate the value of it as well.

Sometimes I wonder if free market proponents of a gold standard, while they are absolutely courageous and right about exposing the dangers of our Federal Reserve private bank, are acting more in their own self-interest in the desire to remedy the situation with a gold standard. Many of them often heavily invest in the gold market.

I feel like a sound fiat currency issued by the Treasury Dept as the Constitution requires sounds like the better alternative.

[fsk]

If you want a good analysis, check out my blog. I'm not going to repost all the details here.

Leave a comment on my blog or PM me if you still have questions after reading it.

[jon_perez]

I like Money Masters and found its explanation of the money creation system very educational, however I do not necessarily agree with their conclusions.

A strict Rothbardian would argue that all government supplied money (whether fiat or commodity based) will lead to the State to becoming more oppressive over time. There are certainly convincing arguments to support such a view. Fiat money is especially prone to such abuse.

In fact, one of the primary reasons given for the Fed not being fully under government control is precisely due to concerns that money creation power will otherwise be under undue influence of the political process.

Anyway to go back to Rothbard, if we are to follow what he prescribes, what we should actually have is 'privately minted' money. But if you look at the Fed, it IS actually quasi-private money created by a cartel of bankers! It is actually a balance between money controlled by 'private' interests versus money controlled by the supposedly public interest.

[fsk]

In fact, one of the primary reasons given for the Fed not being fully under government control is precisely due to concerns that money creation power will otherwise be under undue influence of the political process.

Anyway to go back to Rothbard, if we are to follow what he prescribes, what we should actually have is 'privately minted' money. But if you look at the Fed, it IS actually quasi-private money created by a cartel of bankers! It is actually a balance between money controlled by 'private' interests versus money controlled by the supposedly public interest.


The problem with having the Federal Reserve under the control of bankers instead of the government is that the bankers will manipulate policy for their own benefit.

Let's try this in other industries.

A handful of oil executives should get together and decide what the price of oil is.

A handful of doctors should get together and decide how much health care should cost. (The AMA already does this, by restricting the supply of doctors.)

A handful of auto executives should get together and decide how much a car should cost.

All of the above would be decried as an outrage, but when you say:

A group of bankers should get together and decide how much money should cost. (inflation is the price of money)

For some reason, putting control of the money in the hands of bankers is sound policy.

[Channing]

I think the key is to allow a free market of currencies and to allow anybody to create a bank.

If made aware of the problem of fractional reserve banking then people would probably steer clear of banks who use fractional reserve banking. Or else if people continued to accept fractional reserve banking then you are free to start your own bank and create money out of nothing by giving out unbacked IOUs (which is what fractional reserve banking is all about).

[jon_perez]

The problem with having the Federal Reserve under the control of bankers instead of the government is that the bankers will manipulate policy for their own benefit.True, but the problem with having the Federal Reserve under the control of government is that it will be under control of the government (or generally, the party in power... or both... they're in collusion anyways aren't they??) !

It all boils down to who you trust more, statists or free-marketers (which always tends to agglomerate into cartels and monopolies anyway)?

The people calling for 'free market' money do not understand that we already did come from such an era. It was found to have led to abuses which ended up with massive failed banks and calls for greater state control of money. On the other hand, the astute knew enough not to cede full control of money to the political process either, and thus the compromise known as the Fed was born.

Whether the mechanisms governing how the Fed operates were wisely chosen or not is admittedly a matter of great debate. Certainly, you hear Ron Paul complaining that Congress fails to exercise its right *and* duty of oversight over the Fed adequately. The solution could just be to educate and wake up members of Congress into doing their jobs.

Or, if RP gets elected and can indeed manage it, bust up all the cartels and level the playing field again. Do a Reagan again, but even more pervasively and deeply.
The Fed arose as a reaction to some need in the past, and that situation must be understood otherwise you risk giving rise to the same environment again. Relying on "evil intentions and conspiracies" as motivations behind its creation is quite naive and won't really help to explain anything.


I provided the link below which essentially outlines the same structure of international money that the Rotschilds conspiracy theorists espouse:

http://www.antiscia.com/wizardsofmoney

The site, unsurprisingly, lambastes it with equal intensity. While it doesn't fall into the same trap of presenting some dubious history, you can can see that it also tries to promote its own agenda, a left-leaning one at that.

A lot of people now understand the inbuilt-biases of the global money structure but few people really know what to replace it with. They blame it for everything from income inequality to environmental destruction, but neglect to realize that we are all complicit with it, and that in fact, we can't live or function with it. Despite its flaws that we are now beginning to see, it is actually quite a marvelous and precision creation and evolutionarily speaking, fit enough to replace all previous systems and -isms we have been living under.

[Bradley in DC]

How many times are you going to post the same BS contrary to Dr. Paul's message?

http://www.ronpaulforums.com/showthread.php?t=41404

Troll?:(

[terryhamel]

"It all boils down to who you trust more, statists or free-marketers (which always tends to agglomerate into cartels and monopolies anyway)?"

Gov't protection of corporations in the guise of "regulation" creates the opportunity of cartels and monopolies. Remove gov't protection and you get a free market - the best price and product wins.

[jon_perez]

"It all boils down to who you trust more, statists or free-marketers (which always tends to agglomerate into cartels and monopolies anyway)?"

Gov't protection of corporations in the guise of "regulation" creates the opportunity of cartels and monopolies. Remove gov't protection and you get a free market - the best price and product wins.Someone has to explain how and why government be accused of coddling cartels (via subsidies) but at the same time be the only entity acknowledged to have authority enough to break up monopolies (via regulation) ?

Rothbard I recall, says that it is ok for monopolies to arise (in a theoretically completely free market) and that they are not a worry. He has to of course, because without government, there is no other force that can break up any concentration of power that might arise in free enterprise. Except the competition, of course, but as we have seen, it is possible for a handful of suppliers to collude to form a cartel...

I submit that the libertarian belief that free markets will bring the most prosperity is ultimately more an article of faith than a 100% rationally defensible one. However, I do happen to share that faith to a good degree.

I have to state that my questioning of the correctness of libertarian economic assumptions has little to do with whether or not I think RP is a good candidate. To me, he is far and away the best candidate because he exhibits remarkable humility, intelligence and compassion, and I think those qualities of his are sufficient to override any ideological inflexibility. I'm also quite convinced that Ron Paul does not confuse principledness with inflexibility.

[jon_perez]

How many times are you going to post the same BS contrary to Dr. Paul's message?

http://www.ronpaulforums.com/showthread.php?t=41404

Troll?:(Kindly explain how and why you consider what I posted as BS.

I am just trying to think for myself instead of waiting to be spoonfed ideas and conclusions. I'd certainly be interested in hearing explanations of how my reasoning is wrong.

Calling it BS without explaining why just means you subscribe to dogma.

[jon_perez]

Someone also explain to me how some Ron Paulites could be so enamored of the gold standard, when in the 1890s, it was accused to be as much a tool of financiers back then as the fiat money system of today is accused to be:

http://www.webofdebt.com/excerpts/chapter-1.php

[Channing]

The people calling for 'free market' money do not understand that we already did come from such an era. It was found to have led to abuses which ended up with massive failed banks and calls for greater state control of money.

I doubt the money markets were really free then, but probably controlled by a banking cartel.

The key is to allow anybody to open a bank with few, if any, hurdles.

Computers and the Internet would make it really easy nowadays to start a bank, and it would be much harder to maintain a money cartel due to the free flow of information.

[fsk]

I'm with bradley in calling jon_perez a troll.

Jon_perez is an expert in trollspeak. In another thread, you said "If you advocate for a gold standard, you undermine your own credibility". That's trollspeak.

The conclusion that "free markets lead to monopolies" is FALSE. False-free markets lead to monopolies. The market in the USA is NOT A FREE MARKET.

I'm not expecting to convince jon_perez. I'm writing for the other people who might read this thread, so they aren't fooled by trolls.

[fsk]

The problem in the 1890s is that the banking industry was dominated by a few large banks that acted as a cartel. Regulation of banking restricted the ability of small banks to compete with the large banks.

There *NEVER* was true unregulated free banking in the USA.

[mordechai]

Think about the reality of the statement "gold standard." It implies that the government sets standards of value based upon gold. We just used that bad word. You know... government.

Yes, it is true. Fractional reserve banking is a form of fraudulent activity the way it is practiced now. My belief is simply that it works as a form of investment, like the stock market or bonds. If I buy a corporate bond, there is no guarantee that I'm getting my money back. We treat fractional reserve banking like a guarantee. In fact, in the form of CDs, accounts are insured up to $100,000. In reality, it is an investment like any other which entails risk. Our laws don't reflect the reality though.

Now, legal tender laws existed back then and applied to the currency we used. Paul is for a very old idea, and a very good one. Money should compete the same way everything else does. In other words, gold isn't guaranteed in value by the government, or required for tax payments.

It simply competes along with fiat currencies, and other kinds commodities.

Because at the end of the day folks, in a free market, all everyone is doing is simply trading things. Labor, resources, and capital. The common lubricants of the economy (ie, it's money) should be just as subject to competition as anything else.

Gold has often been a good "lubricant" (ie a method of conveniently trading valuable products and services), but so has silver, sea shells, rare woods, etc. etc. etc.

If gold were too manipulated, we would switch to something else of value.

The problem is manipulation, and force. Just as it always is.

[fsk]

Actually, one of the reasons the gold standard "didn't work" was that, in 1789, the European central banks had a near-monopoly on the worldwide gold supply. It was like the new US government handed the keys to their monetary system to the European central banks.

People were FORCED to use gold as money. Regulation of banking made it hard to break this monopoly.

Before 1913, a lot of the world gold supply started slipping out of the control of the European central banks. They managed to get the Federal Reserve created to corrupt the gold standard.

[Bradley in DC]

Someone also explain to me how some Ron Paulites could be so enamored of the gold standard, when in the 1890s, it was accused to be as much a tool of financiers back then as the fiat money system of today is accused to be:

http://www.webofdebt.com/excerpts/chapter-1.php

Bimetalist inflationist propaganda. Instead of such shallow analyses, why not read actual books with substance?

Or at least a crib sheet?
http://www.auburn.edu/~garriro/lselect.ppt

http://www.mises.org/books/puretheory.pdf

http://www.mises.org/books/pricesproduction.pdf

http://www.mises.org/books/monetarytheory.pdf

Plus Mises' The Theory of Money and Credit linked in my signature.

[jon_perez]

People were FORCED to use gold as money. Regulation of banking made it hard to break this monopoly.So what do you call a "gold standard", if not forcing people to use only gold as money???

[jon_perez]

I doubt the money markets were really free then, but probably controlled by a banking cartel.Doesn't free market necessarily imply that participants are free to collude?

If, on the other hand, you say that you will enact regulations to prevent cartels and monopolies from arising then that would count as a statist/socialist move, which is precisely the bane of libertarian/laissez faire thinking. It is also going to take some very astute legislation to define what counts as cartel-like/monopolistic behaviour.

According to Rothbard's analyses though, in a truly free market without government subsidies, a so-called monopoly would not prove to be harmful. I don't quite understand the analysis (yet), but like I have mentioned before, my personal inclinations favor a more laissez faire system over a socialist one so I'm willing to take it more or less on faith for now.

I'm just playing devil's advocate here...

[jon_perez]

Bimetalist inflationist propaganda. Instead of such shallow analyses, why not read actual books with substance?By resorting to the term "bimetallist inflationist propaganda", are you saying you don't believe in a gold+silver standard at all, and that you believe in a gold only standard?

What is your take on commodity money then? Wouldn't the definition of commodity money expand to include not only silver but any other commodity found acceptable?

By that logic, if bimetallism were inflationary, then wouldn't a multi-commodity standard be even more inflationary?

[jon_perez]

I'm with bradley in calling jon_perez a troll.

Jon_perez is an expert in trollspeak. In another thread, you said "If you advocate for a gold standard, you undermine your own credibility". That's trollspeak.Excuse me... are you trying to imply that the above was a direct quote???

[Bradley in DC]

The people calling for 'free market' money do not understand that we already did come from such an era. It was found to have led to abuses which ended up with massive failed banks and calls for greater state control of money. On the other hand, the astute knew enough not to cede full control of money to the political process either, and thus the compromise known as the Fed was born.

Historical and global examination of the free banking episodes shows that they fail only when government intervenes. Their failure in our era was mostly the result of poor government regulation: forcing the "wildcat" banks to hold assets in state-issued bonds as a way of forcing a market for their irresponsibility, etc.

[jon_perez]

Their failure in our era was mostly the result of poor government regulation: forcing the "wildcat" banks to hold assets in state-issued bonds as a way of forcing a market for their irresponsibility, etc.So poor government regulation is to blame, and not the presence of government regulation per se. How exactly then would this "truly free" banking that you often speak of operate?


Should I now stop asking questions for which you have no good answer, lest I be accused of trolling again?

[Bradley in DC]

So poor government regulation is to blame, and not the presence of government regulation per se. How exactly then would this "truly free" banking that you often speak of operate?


Should I now stop asking questions for which you have no good answer, lest I be accused of trolling again?

There is no such thing as an unregulated market--that said, private market regulation is better than governmental regulation for a variety of reasons (captive interest of regulators, undermining the price signaling mechanism of the market, special interest collusion, slower to adapt to market changes, inability to adapt to variation of market realities--one size fits all approach, "baptists and bootleggers" problem, etc.).

[jon_perez]

There is no such thing as an unregulated market--that said, private market regulation is better than governmental regulation for a variety of reasons (captive interest of regulators, undermining the price signaling mechanism of the market, special interest collusion, slower to adapt to market changes, inability to adapt to variation of market realities--one size fits all approach, "baptists and bootleggers" problem, etc.).Fair enough.

What then, is wrong with the the Fed Reserve system, considering that it is "privately regulated" to a pretty large extent? Moreover, anyone is ostensibly free to buy shares in the banks that themselves have shares in the Fed, so that would count as a free market system.

Wouldn't the participants in a so-called free banking / free money system be likely to evolve into a similarly regulated cartel as the Fed anyway?

[fsk]

There has never been a truly free market at any time in the past. Will that happen maybe in the future?

Cartels ONLY evolve with help from the government. Government violence is required to force everyone else to use worthless money.

Name *ONE* cartel that could survive without help from government violence.

The only stable systems are (1) a REALLY free market (2) someone seizes absolute control of the entire world's resources.

[Bradley in DC]

What then, is wrong with the the Fed Reserve system, considering that it is "privately regulated" to a pretty large extent?

No, the Federal Reserve System is not "privately regulated (http://www.federalreserve.gov/regulations/default.htm)."


Wouldn't the participants in a so-called free banking / free money system be likely to evolve into a similarly regulated cartel as the Fed anyway?

No, the experience of free banking historically (http://economics.about.com/cs/moffattentries/a/scot_banking.htm), as Austrian theory confirms (http://iang.org/free_banking/), is the opposite.

It is your ignoring of our arguments and restating them with faulty premises that lead us to believe you're a troll here to misinform and cause trouble, not engage in honest debate.

[Bradley in DC]

So what do you call a "gold standard", if not forcing people to use only gold as money???

The gold standard evolved over centuries through market competition as people, not governments, chose it as the best money. See the last chapter of Carl Menger's Principles of Economics (http://www.mises.org/etexts/menger/eight.asp) to understand how we got money and how standards developed.

[Bradley in DC]

This article, IMHO, offers a better starting point for some of the issues of your concern and also conforms to Dr. Paul's basic premises (unlike TMM):

http://www.econlib.org/library/Enc/CompetingMoneySupplies.html

Competing Money Supplies (links in the original not hyperlinked here)
by Lawrence H. White

What would be the consequences of applying the principle of laissez-faire to money? While the idea may seem strange to most people, economists have debated the question of competing money supplies off and on since Adam Smith's time. Most recently, trends in banking deregulation and important pockets of dissatisfaction with the performance of central banks (such as the Federal Reserve System in the United States) have made the question of competing money supplies topical again. Some leading economists have become sympathetic to laissez-faire in money, including Nobel Laureates Friedrich A. Hayek and Milton Friedman, as well as Eugene Fama of the University of Chicago, Neil Wallace of the University of Minnesota, and Leland B. Yeager of Auburn University.

Two sorts of monetary competition already exist today. First, private banks and financial firms compete in supplying different brands of checking accounts (also known as checkable deposits) and traveler's checks. Second, each national currency (like the U.S. dollar) competes with others (like pounds sterling, deutsche marks, and yen) to be the currency in which international contracts and portfolio assets are denominated. (Economists refer to paper money that is not convertible into an underlying asset like gold or silver as a "fiat" currency.)

Much more competition in money has existed in the past. Under "free banking" systems, private banks competitively issued their own paper currency notes, called "bank notes," that were redeemable for underlying "real," or "basic," monies like gold or silver. And competition among those basic monies pitted gold against silver and copper.

Today virtually all governments regulate and limit monetary competition. They maintain government monopolies over coinage and the issuance of paper currency, and to varying degrees restrict deposit banks and other financial firms, nationalize the interbank settlement system, restrict or place special taxes on holdings of gold or of foreign-currency assets, and refuse to enforce contracts denominated in alternative currencies. In developing countries, government banks sometimes monopolize the provision of checking accounts as well.

A significant number of economists would like to abolish many or even all of these legal restrictions. They attribute significant inefficiency and instability in the financial system to the legal restrictions on private banks and to poor central bank policy, and they view competition as a potential means for compelling the suppliers of money to be more responsive to the demands of money users. Many economists (most notably, monetarists) would like to restrict the discretion given to central banks, and the small but growing number of free-banking advocates would like to abolish central banks entirely. Most mainstream economists argue, on the other hand, that a return to free banking would bring more instability to the financial system.

Proponents of free banking have traditionally pointed to the relatively unrestricted monetary systems of Scotland (1716-1844), New England (1820-60), and Canada (1817-1914) as models. Other episodes of the competitive provision of bank notes took place in Sweden, Switzerland, France, Ireland, Spain, parts of China, and Australia. In total there have been more than sixty episodes of competitive note issue with varying amounts of legal restrictions. In all such episodes, the countries were on a gold or silver standard (except China, which used copper).

In a free banking system based on a gold standard, competing private banks would issue checking deposits and bank notes redeemable on demand for gold. In a system based on a frozen quantity of fiat dollars, as recently proposed by Milton Friedman and a few other economists, bank deposits and bank notes would be redeemable for paper dollars, as deposits are today.

Requiring private banks to redeem their deposits and bank notes for a fixed amount of gold or a fixed amount of paper currency issued by the government would rule out worries about "floating exchange rates" between rival banks. Citibank's ten-dollar notes, for example, would be redeemable for ten dollars in basic money, and so would notes issued by Chase Manhattan. What's more, competition among banks would compel all banks in the system to accept one another's bank notes at face value. Citibank, for example, would exchange one of its ten-dollar bank notes for ten dollars in Chase notes or Chase deposits. The reason is that by accepting each other's notes at par, both Citibank and Chase would make their own money more useful and, therefore, more widely accepted. This is not just abstract theorizing. The same competitive considerations have led banks to form mutual par-acceptance networks for automatic teller machine cards, so that customers of one bank can get cash at another bank's machines.

What forms of money do households and business firms ordinarily use in a free banking system? When bank notes and checks issued by any bank in the system are accepted nearly everywhere, and when banks pay interest on deposits, the public seldom feels the need to handle basic money (gold or whatever is the asset for which bank money is redeemable). Bank notes and token coins serve the need for currency. Since bank notes do not bear interest, the competition among banks for a note-holding clientele is a nonprice competition.

Each bank in a free banking system is constrained to limit the quantity of its liabilities (the bank notes and deposits it has issued) to the quantity the public desires to hold. When one bank accepts another bank's notes or checks, it returns them to the issuer through a cooperative interbank clearing system for redemption in basic money or in claims on the clearinghouse. An issuing bank knows that it would suffer adverse clearings and a costly loss of reserves if too many of its liabilities came into the hands of its rivals. So banks would have to carefully manage their reserve positions (the funds they use to redeem their bank notes) even if there were no central bank setting minimum reserve requirements.

Most economists (and most everyone else) believe that a free banking system, especially one without government guarantees of deposits or bank notes, would be plagued by overissuance of bank notes, fraud, and suspensions of redeemability, all of which would give rise to runs on banks and, as a result, periodic financial panics. That would happen, the thinking goes, because the inability of any one bank to meet a run would cause runs to spread contagiously until the entire system collapsed.

The evidence from free banking systems in Scotland, Canada, Sweden, and other historical episodes does not support that conclusion. When free banking has existed, the interbank clearing system swiftly disciplined individual banks that issued more notes than their assets could support. In other words, redeemability restrained the system as a whole. Fraudulent and unsound bankers did not find it easy to get their notes into circulation. Rather, banks found that sound management was key to building a clientele. Clearinghouse associations policed the solvency and liquidity of their members. Runs on individual banks were not contagious; money withdrawn from those banks was redeposited in sounder ones. In the view of free banking proponents, the few historical episodes of contagious bank runs occurred in banking systems whose ill-advised legal restrictions blurred the distinctiveness of individual banks, so that troubles at one bank undermined public confidence in the entire system.

Proponents of competing money supplies have suggested several different institutional frameworks under which a competitive system could operate. A few monetary theorists, beginning with Benjamin Klein of UCLA and Friedrich Hayek, have contemplated private competition in the supply of nonredeemable "fiat" monies. We do not have any historical experience with such a regime, but it is doubtful that it would survive. If banks did not have to redeem their notes, they would face a strong temptation to issue money without limit. It would be too profitable for an issuer to break any promise not to overissue and depreciate its money. In contrast, where banks must redeem their notes for something, the holder of bank-issued money has a "buy-back" guarantee against depreciation.

Robert Greenfield and Leland B. Yeager, drawing on earlier work by Fischer Black, Eugene Fama, and Robert Hall, have proposed another kind of laissez-faire payments system that is supposed to maintain monetary equilibrium at a stable price level. Instead of redeeming their notes for gold, silver, or government-issued paper money, banks would have to redeem notes and checking-account deposits for a standard "bundle" of diverse commodities. Instead of a one-dollar or one-gram-of-gold note, for example, Citibank would have a note that could be redeemed for one unit of the bundle. To avoid storage costs, people would redeem a one-bundle claim not for the actual goods comprising the bundle, but rather for financial assets (Treasury bonds, for example) equal to the current market value of one bundle. There would be no basic money, like the gold coin of old or the dollar bill of today, serving both as the accounting unit and as the redemption medium for bank liabilities. This regime also lacks historical precedent. Some critics have argued that it lacks the convenience of having a standard basic money as the medium of redemption and interbank settlement.

It is more likely that a deregulated and freely competitive payments system today would resemble free banking in the traditional sense. Bank money would be redeemable for a basic money produced outside the banks. To place all forms of money beyond government manipulation, the basic money could not continue to be government fiat paper unless its stock were permanently frozen (as Milton Friedman has suggested). The most plausible—and historically precedented—way to replace the government fiat dollar is to return to a private gold-coin or silver-coin monetary standard. But despite all the criticisms of current monetary systems, a return to the gold standard—or to any form of free banking—seems politically implausible today.

Even so, the move toward an economically integrated European Community has made the question of competing money supplies especially relevant. Proponents of a European "monetary union" want to establish a European central bank, perhaps modeled after the U.S. Federal Reserve System, that would issue a single European currency to replace the present national currencies. Advocates of currency competition, whose ranks have included former British prime minister Margaret Thatcher, are concerned that such a central bank could be very inflationary. With freedom to choose among competing national currencies, European citizens and firms can abandon high-inflation currencies like the Italian lira in favor of low-inflation currencies like the German deutsche mark. The threat that people will desert their currencies, thereby causing an embarrassing exchange-rate depreciation, imposes an anti-inflationary discipline on national central banks. No disciplinary pressure as strong would confront a pan-European central bank with a monopoly on supplying money.

About the Author
Lawrence H. White is the F. A. Hayek Professor of Economic History at the University of Missouri, St. Louis.

Further Reading

Dowd, Kevin. The State and the Monetary System. 1989.

Goodhart, Charles. The Evolution of Central Banks. 1988.

Hayek, Friedrich A. Denationalisation of Money, 2d ed. 1978.

Selgin, George A. The Theory of Free Banking. 1988.

White, Lawrence H. "What Kinds of Monetary Institutions Would a Free Market Deliver?" Cato Journal 9 (Fall 1989): 367-91.