Monday, October 17, 2011

Rothbard and Free Banking

From "The Mystery of Banking", Chapter 17, section 3:

HOW TO RETURN TO SOUND MONEY

Given this dismal monetary and banking situation, given a 39:1 pyramiding of checkable deposits and currency on top of gold, given a Fed unchecked and out of control, given a world of fiat moneys, how can we possibly return to a sound noninflationary market money?

The objectives, after the discussion in this work, should be clear:
(a) to return to a gold standard, a commodity standard unhampered by government intervention;
(b) to abolish the Federal Reserve System and return to a system of free and competitive banking;
(c) to separate the government from money; and
(d) either to enforce 100% reserve banking on the commercial banks, or at least to arrive at a system where any bank, at the slightest hint of nonpayment of its demand liabilities, is forced quickly into bankruptcy and liquidation.

While the outlawing of fractional reserve as fraud would be preferable if it could be enforced, the problems of enforcement, especially where banks can continually innovate in forms of credit, make free banking an attractive alternative.

-----------End of quoted passage----------------

It strikes me that Rothbard is contradictory in this conclusion, at least if free banking is defined in the manner that I understand the term "free." Free, to me, means free. No "shoulds", no "musts". Market participants will decide the manners by which they reach agreement for money, banking, and credit - that is "free" in my book. This cannot be reconciled with Rothbard's item (a) and (d) above. Who will return us to a gold standard? How? By what means? Who will enforce 100% reserves, or alternatively quickly "force" violators into bankruptcy? With what enforcement ability?

I will begin at the end.

"While the outlawing of fractional reserve as fraud would be preferable if it could be enforced, the problems of enforcement, especially where banks can continually innovate in forms of credit, make free banking an attractive alternative."

Setting aside the idea that FRB is "fraud" (if it is known, it isn't fraud; if it is fraud, those harmed can pursue recourse in some manner), 100% reserves cannot be "enforced". Enforced by whom? The little I know of Rothbard, he would not recommend the state be the enforcement arm (nor would I). But if not the state, who?

Absent the state as the enforcement arm, what is left besides market enforcement? And if it is market enforcement, what stops any form of banking and credit to evolve, if it acceptable to the market? Nothing should.

What of bad, or "fraudulent" practices? Cannot the market sort this out? It is true, if a bank is found as untrustworthy in its money and lending practices, cannot its customers go elsewhere? Is this not possible in all other aspects of markets where reasonably free from regulation and government interference?

As to item (b), abolishing the Federal Reserve System, I think it would suffice to remove government from money - no legal tender, no FDIC, no tax consequences for choice of currency. In such an environment, the current Federal Reserve System will cease to exist, as it cannot survive in a free market.

But does this mean there will be no bank cartels formed? I think not. Market efficiencies will likely cause banks to form in such cartels. However, absent the state as enforcement and insurance arm, the market will certainly control excess.

Rothbard's final statement (above) is correct, and is what attracted me to this section. Even if one assumes FRB is bad, it is irrelevant in a free banking environment. Market regulation will suffice, by this I mean regulation by the free choices made by market participants. If participants find a bank is inflating, they are free to move to other institutions that adopt other schemes. Free banking is not just an "attractive alternative", it is the only alternative.

Banking is far less complex than most products brought to market. Individuals are quite capable of deciding which car to buy. They certainly can figure out where and how to bank - without any "shoulds" or musts" thrust upon them by strangers.

Items (a), (b), and (d) in Rothbard's list above are not necessary. Item (c) will suffice. Get the government out of banking and money. The market will resolve the remaining issues.

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