History is Clear, Central Banks Fail to Assure Economic Stability
The world has been plagued with periodic bouts of the economic rollercoaster of booms and busts, inflations and recessions, especially during the last one hundred years. The main culprits responsible for these destabilizing and disruptive episodes have been governments and their central banks. They have monopolized the control of their respective nation’s monetary and banking systems, and mismanaged them. There is really nowhere else to point other than in their direction.
Yet, to listen to some prominent and respected writers on these matters, government has been the stabilizer and free markets have been the disturber of economic order. A recent instance of this line of reasoning is a short article by Robert Skidelsky on “Why Reinvent the Monetary Wheel?” Dr. Skidelsky is the noted author of a three-volume biography of John Maynard Keynes and a leading voice on public policy issues in Great Britain.
Skidelsky: Central Banking Equals Stable Prices and Markets
He argues against those who wish to denationalize and privatize money and the monetary system. That is, he criticizes those who want to take control of money and monetary affairs out of the hands of the government, and, instead, put money and the monetary order back into the competitive, private market. He opposes those who wish to separate money from the State.
Skidelsky sees the proponents of Bitcoin and other “cryptocurrences” as “quacks and cranks.” He says that behind any privatization of the monetary system reflected in these potential forms of electronic money may be seen “the more sordid motives” of “Friedrich Hayek’s dream of a free market in money.” The famous Austrian economist had published a monograph in 1976 on theDenationalization of Money, in which Hayek insisted that governments have been the primary cause behind currency debasements and paper money inflations through the centuries up to our own times. And this could not be brought to an end without getting government out of the money controlling and the money-creating business.
In Skidelsky’s view, any such institutional change would be a disaster. As far as he is concerned, “human societies have discovered no better way to keep the value of money roughly constant than by relying on central banks to exercise control of its issue and to act directly or indirectly on the volume of credit created by the commercial banking system.”
Robert Skidelsky is a highly regarded scholar and is knowledgeable about many of the important political and economic ideas and events of the twentieth century, about which he has often written. But one cannot help wondering if his views of central banks and the governments behind them over the last one hundred years don’t concern life on some other planet; because they do not reflect the reality of monetary systems and government management of them on Planet Earth.
The Pre-World War I Gold Standard
The twentieth century began with all the major nations of the world having monetary systems based on a gold standard. Gold was money, the medium of exchange through which goods and services were bought and sold, and by which the savings of some were transferred to the hands of interested and credit-worthy borrowers for investment purposes through the intermediation of banks and other similar financial institutions. There were money-substitutes in the form of banknotes and checking accounts to ease the inconveniences and transaction costs of using metal coins and bullion in many everyday exchanges. But they were recognized and viewed as claims to the “real money,” that is, specie money.
Yes, this was, in general, a central banking managed gold standard. And the gold standard “rules of the game” were not always followed, the essential general principle of which being that banknotes and deposit accounts should only increase for the banking system as a whole when there were net increases in the quantity of gold deposited in bank accounts, for which new banknotes would be issued as additional claims to that greater quantity of gold-money. And vice versa, if there was a net outflow of gold from the banking system due to banknotes being returned to the issuers for gold redemption, then the net amount of those banknotes in circulation was to be reduced.
Though this core “rule” of the gold standard was not always rigidly followed by national central banks, the consequence of which were occasional financial crises and “panics,” the system worked amazingly smoothly, in general and on the whole, in providing a relatively stable monetary environment to foster and assist domestic and international trade, commerce and global investment. When the monetary system did periodically suffer disruptions, the mismanaging hand of the government and their central banks could usually be seen as the primary, or certainly a leading, cause behind it.
Monetary Madness During and After World War I
This came to an end with the coming of the First World War in 1914. All the belligerent nations in Europe went off the gold standard, with banknotes and other bank accounts no longer legally redeemable in gold. Governments used various direct and indirect methods to have their central banks finance growing amounts of loans in the form of created quantities of paper money to cover the costs of their, respective, war expenditures. To use British economist, Edwin Cannan’s, somewhat colorful mode of expression concerning the currency situation of his own country, Great Britain was soon suffering from a “diarrhea” of paper money to feed the cost of the British war machine.
This culminated in the catastrophic hyperinflations that gripped many countries on the European continent in the years immediately following the end of the First World War in 1918. The worst of such instances were experienced in countries like Germany and Austria. Especially in Germany, the paper money had become virtually worthless by the time the hyperinflation was ended in November 1923, by shutting down the money printing presses and introducing a new currency promised to be linked to gold.
However, the new postwar monetary systems that one country after another attempted to introduce were not like the gold standard that has existed before the war. Nominally, currencies were linked to gold at new official redemption rates of so many banknotes in exchange for a unit of gold. But gold coins rarely circulated in daily transactions, as had often been the case before 1914; gold was redeemable only in larger quantities of bullion (gold bars); and few countries kept significant quantities of gold on deposit in their own central bank vaults any more. (See my articles, “War, Big Government, and Lost Freedom,” and “Lessons from the Great Austrian Inflation”.)
The Federal Reserve and the Coming of the Great Depression
The short-lived return to seeming economic “normalcy” with growth and stability in the mid and late 1920s, however, came to an end with the American stock market crash of October 1929, which began to snowball into the “Great Depression” in 1930 and 1931. But why had this happened? In the United States, a major cause was the Federal Reserve’s attempt to “stabilize” the general price level at a time of economic growth and productivity gains that otherwise would have likely brought about a slowly falling general price level reflecting greater outputs of goods and services produced at decreasing costs that would have enabled an increasing number of those goods to be sold at lower prices. In other words, what has sometimes been called a “good deflation.” That is, rising standards of living through a falling cost of living, which need not be detrimental to the profitability of many firms since their ability to sell at lower prices is due to their ability to produce more at lower costs of production.
The Federal Reserve’s “activist” monetary policy to counteract this “good” deflationary process in the name of price level stabilization required an increase in the supply of money and credit in the banking system that pushed interest rates below market-determined levels and therefore brought about an imbalance and distortion between savings and investment in the American economy. When the Federal Reserve cut back on monetary expansion in 1928 and early 1929, the stage was set for a collapse of the unsustainable investment house of cards created by investment patterns out of sync with the real savings in the economy to sustain them.
What might have been a relatively short, “normal” recession and recovery process was disrupted first by the fiscal and regulatory policies of the Herbert Hoover Administration (including a trade-killing increase in U.S. tariffs that soon brought about retaliation by other countries). The was magnified to a degree never seen before in American history with the coming of Franklin Roosevelt’s presidency and the New Deal in 1933: the imposition of a fascist-type system of economic planning in industry and agricultural; increases in taxes far exceeded by massive growths in government spending through budget deficits for “public works” and relate federal projects that increased the national debt; the abandonment of what nominally still remained of the gold standard, followed by foreign exchange instability and paper money expansion.
Matching this were wage and price rigidities due to trade union resistance to money wage adjustments in a post-boom environment, and goods prices frozen due to the regulations of the fascist-modeled National Recovery Administration (NRA); there was also a downward spiral in international trade resulting from the revival of global protectionism; and there was a monetary contraction exacerbated by a fractional reserve system built into the workings of the Federal Reserve that set off a multiplicative decrease in money and credit inside and outside the banking system as bank loans went bad and depositors “panicked” leading to bank runs. All this brought about the tragedy of the Great Depression, which dragged on through most of the 1930s.
How the disruptive inflations during and immediately after the First World War, or the misguided monetary policies of the 1920s which led to the Great Depression whose severity was due to Federal Reserve mismanagement and anti-market government interventions and controls can be laid at the feet of the ”free market,” as Skidelsky asserts, is beyond me.
Post-World War II Monetary and Government Mismanagements
But, perhaps, he means the more “enlightened” central banking policies of the leading nations of the world in the post-World War II period. The immediate years after 1945 saw “dollar shortages” due to government manipulation of foreign exchange rates, experiments in nationalization of industries, forms of “soft” planning, periodic currency crises, and often misguided fiscal policies. Does Mr. Skidelsky not remember how in the 1960s Great Britain was considered the “sick man” of Europe due to government fiscal, monetary, and regulatory policies; or the Lira crises in an Italy that seemed to have a new government every other week? Is all this to be put at the doorstep of the “free market”?
What about the era of “stagflation” in the 1970s, with its seeming anomaly of both rising prices and increasing unemployment that so confused the Keynesian establishment of the time? In America this had been set off by the Federal Reserve’s accommodation starting in the 1960s to create the money to finance the “guns and butter” of the Vietnam War and LBJ’s “Great Society” programs. Was it not the wise and trustworthy hands of the Federal Reserve Board of Governors whose monetary policies created in the late 1970s and early 1980s one of the worst price inflations experienced in American history, with nominal interest rates in the double-digit range? Another “win,” clearly, for the steady monetary central planning of the Federal Reserve!
What about the high-tech bubble of the late 1990s that went bust, or the recent financial and housing crash of 2008-2009 What had caused them? Alan Greenspan – the central banking “maestro” – set the stage for these with his “anti-deflation” policies at a time when prices were not falling, but which created unsustainable savings-investment imbalances not much different than the disastrous monetary policy followed by the Federal Reserve in the 1920s.
Under the additional guiding hand of Ben Bernanke at the Federal Reserve, interest rates between 2003 and 2008 in real terms were zero or negative; and government housing agencies subsidized tens of billions of dollars in home loans to uncredit-worthy borrowers made possible though monetary expansion and artificially low-cost lending backed with government guaranteed mortgage assurances. Was this all the fault of the “free market”? No. The fingerprints of the Federal Reserve and the agencies of the Federal government are all over this “economic crime.”
Government’s Hand Off the Monetary Printing Press
Yet, according to Robert Skidelsky it is the free market that cannot be trusted to competitively and privately integrate and coordinate the monetary system. How much worse of a track record could a private, competitive banking system create, compared to the monetary disasters of the last one hundred years under the control of central banks, including the American Federal Reserve?
It is not a matter of whether or not Bitcoin or other forms of cryptocurrencies end up being the market-chosen money or monies of the future. What is the fundamental issue is: monetary central planning – with its embarrassingly awful one hundred year track record with paper monies – or getting government’s direct or indirect hand off the handle of the monetary printing press.
Governments cannot be trusted with this power and authority, whether it is done directly by them, or through their appointed central banks. Back in 1986, Milton Friedman delivered the presidential address at the Western Economic Association. He declared that after decades of advocating a “monetary rule,” that is, a steady or “automatic” two or three percent annual increase in the supply of money in place of a more discretionary Keynesian approach, he had concluded that it was all spitting into the wind. Public Choice theory – the application of economic reasoning to analyze the workings of the political process – had persuaded him that the short-run self-interests of politicians, bureaucrats and special interest groups would always supersede the goal of long-run monetary stability, with the accompanying pressures on those in charge of even presumably “independent” central banks.
In this article and others written by him around the same time, Friedman never went as far as calling for the abolition of the Federal Reserve or a return to a gold standard. But he did say that, in retrospect, looking over the monetary history of the twentieth century, it would have been better to never have had a Federal Reserve or to have gone off the gold standard. The traditional criticisms of the costs of a gold standard, he said – mining, minting, storing the gold away, when the resources that went into all this could have been more productively been used in other ways – paled into almost insignificance compared to the costs that paper money inflations and resulting recessions and depressions had burdened society.
Skidelsky’s Straw Man and Evasions
Robert Skidelsky creates a straw man when he tries to put fear into people about unregulated cryptocurrencies threatening the monetary and price stability of the world. He cannot even get his argument completely straight. On the one hand, he says that Bitcoin has an eventual built-in limit on how much of it might be mined; and he warns that a Bitcoin money, then, would reach an maximum that would not have the “elasticity” to meet growing monetary needs of the future. And in the next breath he warns that a Bitcoin-like currency might not have a built-in check against inflation. Well, which is it: the danger of Bitcoin price deflation or Bitcoin price inflation?
There has emerged during the last three decades an extensive and detailed literature about the possibilities and potentials of a private, competitive free banking system. The economists who have devoted themselves to serious analysis and exposition of such as a free banking system, people such as Lawrence H. White, George Selgin, and Kevin Dowd, to merely name three of the more prominent ones, have demonstrated that a market-based commodity money and a fully market-based banking system would successfully operate with greater coordinating ability and with far less likelihood of any of the monetary and price instability experienced under central banking over the last one hundred years.
It is unfortunate that a scholar usually as careful and thorough as Robert Skidelsky has chosen to downplay the historical reality of the failure of central banking, and not grapple with the serious and real literature on the private competitive free banking alternative.