 Welcome to Free Thoughts from Libertarianism.org and the Cato Institute. I'm Aaron Ross Powell, editor of Libertarianism.org and a research fellow here at the Cato Institute. I'm Trevor Burrus, a research fellow at the Cato Institute Center for Constitutional Studies. Our guest today is George Selgen, director of the Center for Monetary and Financial Alternatives at the Cato Institute. I want to start really basic as we often do on Free Thoughts by asking, what is money? So money is, economists call it a generally accepted medium of exchange and what that means is it's the stuff that we typically use to pay for things and to settle debts and also the stuff we typically accept in our receipts as compensation for labor and things we sell. And does that mean it has to have dead world leaders on it and be issued with little tracking mechanisms in it and magnetic strips? No, neither actually though those things, features are common enough, the latter in recent times and the former since the early beginnings of money but in fact money doesn't have to be, have either of those features in its most basic forms. Money is consisted of things like cowry shells and wampum beads and tobacco leaves, of course these primitive forms of money don't have any electronic do-dads on them nor do they represent leaders of specific governments. More sophisticated forms of money and more familiar ones of course often do have those features but even there they're not necessary. So you can have coins that have King's portraits on them but coins can be and have been minted privately and good ones too. One of the myths about money is the idea that you can't have a good money unless some sovereign power is behind it and monopolizing it. It's one of the aims of the center to encourage people to get past that common misconception. But how would you, when wampum or shells or something like that comes into being, did someone say, alright everyone, we're all using wampum from now forward, everyone is now using wampum for money, you have to accept wampum as payments or how could that ever happen without some sort of agreed upon method of exchange? Well actually it can happen without people agreeing deliberately and it's not that difficult to imagine how. You have first of all in any small society you have certain goods that are already treated as especially desirable and widely valued for ceremonial purposes or perhaps as jewelry or ornament of some other kind and you only have to think about the problem every one of us faces when trying to buy a gift for somebody who we don't know well, we're thinking what's something that's widely popular that everyone wouldn't mind having a little bit more of that sort of thing and the origins of money rest in people making various attempts to figure out the answer to that kind of question and of course the more people who come up with any particular answer the better that answer becomes for everyone else and so you tend naturally to have a convergence on one or a very small set of commodities that come to earn the status as generally accepted exchange media so it can be an entirely spontaneous process. That doesn't mean governments don't get involved and didn't get involved in very early times influencing the outcome of this process and trying to manipulate it as often as not though and not in the public interest but in pursuit of their own narrow fiscal interests that ties into my question which is so the fact that Trevor asked this question of like well how is it that we could have money without without the state telling us what the money is I mean the reason that we ask a question like that is because all the money that we see around us is state issued money it's it's dollars and pounds and whatever else and so if these things can arise organically why don't we see that why do we see the states dominating it the way they do well there's there's two parts to a full answer to that question one is that it's not really true that most money today is is issued by governments it is true that most basic monetary units today have been defined by governments who have manipulated the meanings of those units but even in the case of most of these units at one time governments didn't have much to do with them that the pound was a pound tower pound weight of silver at one time in history was simply a unit of weight but in any event today most of the media of exchange we use consists of a bank transferable bank deposits and that sort of thing and a relatively small part of it is the stuff that the Fed provides directly in the United States so so we should recognize the role of private institutions in supplying money even today as for why though basic monies like the US dollar are monopolized by governments everywhere the answer to that is not as most people tend to think that such monopolies were necessary to make for reliable and safe monies in fact most of the government controlled monies in the world aren't particularly reliable or safe the reason governments got involved was because of the clear fiscal advantages there were in monopolizing money because when a ruler monopolizes money let's say that money begins as a certain amount of gold let's say that you have a gold unit by monopolizing production of that unit the government then puts itself in the position to redefine what that unit is so a unit that used to consist of let's say an ounce of gold they can say well from now on that same unit amount we declare will be made up of only half an ounce and so hey presto debts incurred in the old unit can be settled with half as much precious metal as before this ability to manipulate monetary units which which is derived from first controlling production of the representatives of those units monopolizing them is a incredible fiscal device that governments can abuse and have abused ever since they've resorted to it and when did America first start producing money for was it ever been doing it since the beginning you mean the American American government yes they have it was a decision that was actually a somewhat controversial one during the founding era whether there was a decision to establish a u.s. Mint after some considerable discussion of farming out the production of coins to private mints but it was always understood even then that any coin production would be sanctioned by government authority and that the government would be ordering the coins even if whether or not it made them itself in any event they set up a u.s. Mint which like European government mints at the time was a monopoly so we've never really had a free market coinage system in this country we've had episodes of private coinage important ones and revealing ones for example during the gold rush the year subsequent to the gold rush as well in California a private minting industry flourished because there was no federal mint on the west coast as yet people needed to do something with those gold nuggets and powder in order to make that stuff useful without having to send it to Philadelphia or Charlotte North Carolina to be coined and so this was an interesting exception to the rule of government monopoly the quality of the coins produced by some of these private mints was better than what the federal mints actually put out there were not so good private mints but guess what they they went out of business just like any other industry now what about paper money though because so we're talking when you're using coins some people some of our listeners may not know that you're you're actually using a term of art in the sense of you're a coin that has some amount of that's right precious metal these coins were made up of what was then the standard metal either silver gold that defined the monetary unit but you're quite right to bring up paper and papers been part of our monetary system for a long time but for many many decades the issuance of paper notes paper currency which consisted then of real substitutes for these gold coins and silver coins in the sense that you could turn these paper substitutes in and get a definite amount of gold or silver in exchange the the responsibility for using such such paper money fell on private banks now for brief intervals starting at the beginning of the Republic and then again and starting in the 18 teens we had a federal bank that issued paper money the first second bank in the United States did so and then its successor this the second bank the United States but otherwise until the Civil War paper money was issued by state chartered banks and the depending on state laws of course they they they ran the gamut from good to indifferent to very very bad so I'm trying to picture the world here I'm a merchant living in New Hampshire in 1821 and and I'm getting bank notes and the bank notes are representing you can you could go and get coin for those from the bank if you're in principle in principle but the bad ones would be the ones that maybe you couldn't right when you said good or bad that would be the that's that's right well that's right you you would and this was a big problem in the United States I should I want to emphasize that we had a peculiar situation because in the United States unlike most countries banks were typically one-office firms that did not have permission to establish branches usually not even within their own state boundaries but especially beyond those state boundaries so that would make their money less viable because you have to go further to you have to go to Providence if that's right island or whatever if a note to manage somehow to make its way far away from the bank that originally issued it with the currents of trade then it often certainly if it went far enough wouldn't command its full face value at all because at very least somebody had to cover the cost of getting it back to where you to the bank where you could exchange it for actual gold or silver coin and then of course there was possible uncertainty about whether that bank would still be around and whether it was solvent would banks take each other's notes subject to a discount to cover the costs I just mentioned unless there was a clearing house that that provided for the expedient redemption of the notes overcoming the lack of branch bank facilities that otherwise posed this problem so for example in the very period we're talking about in the 1820s in New England a bank in Boston called the Suffolk Bank took the initiative of becoming a central clearing house for all of the New England banks offering to receive all of their notes on deposit at face value if each of these banks agreed to keep a settlement account with it from which it could redeem the notes because of course it didn't want to be out of pocket for notes and it might not be able to redeem that sounds interesting because that would that would actually give the clearing house the ability to watch over the solvency of the bank it did indeed and in fact the Suffolk could be very strict about its membership if it thought a member was misbehaving it could boot it out of the system the interesting result of this though was twofold three actually one the New England currency uniquely of all currency in all regions of the country established very early uniform value so what the Suffolk system proved is you didn't have to service a monopoly of currency to have currency that commanded uniform value in a wide area even without the ability of banks to set branches up which normally would have solved the problem the other thing though is it had meant it by making currency New England uniform it tremendously enhanced the demand both for the Suffolk banks currency and for that of the other state banks so this demand is growing at the expense of demand for actual gold and silver which could therefore be more economized on and of course the corollary to that was that people's savings were being more effectively used to promote investment instead of having be locked up in coin and it was a big boom to to New England at the same time to you could have come in with say a Spanish Guinea or something too right or I mean we could but it would they would have been treated of course as foreign money is treated today and you would have had to exchange it for US money at a bank and you would have had to incur corresponding fees because by that time of course the pieces of eight no longer where current money in the United States though at a time they were as current as anything else but that time by the 1820s had passed on the having money be some sort of commodity whether we're talking about shells or gold or silver whatever tea that's my favorite one big block of tea I'm wondering so obviously you said like one disadvantage of state-issued currency is that they can just debase the currency they can they can inflate they can mess with it in ways that are harmful that's right but for the commodity would it incentivize say poor behavior in the sense that let's say we're exchange like shells some particular kind of shell that's just you know has no that's what we settle on wouldn't that potentially incentivize people to say unproductively just I'm going to grow lots of this type of animal that makes the shell and I'm going to put all sorts of resources into just growing lots of these shells that is a like not terribly productive work and be is going to inflate the currency anyway no actually because the whole point of a commodity standard money is precisely that in equilibrium the the the commodity in the form of money isn't isn't worth more than the commodity in in in in other forms so the the value of your gold coins if you just figure out the the value of the gold of which they're comprised is going to be essentially the same in equilibrium as the value of that much gold contained in gold bullion the market price it's just the market price so what happens is production continues for gold whether it when it's money as it would otherwise up to the point where the the price equals marginal cost and that's that at that point is no more worthwhile going into trying to mine gold than it is to go and go into any other productive enterprise it's paper money that poses the real challenge because with paper money of course if it's to be worth more than the actual paper it's made of which of course you could wallpaper your wall paper your house with it so if paper monies are to be worth more than just their raw commodity value you have to have some artificial in that case you have to have some artificial think means for limiting production in fact open competition in the production of inconvertible paper money where there there is no compelling convincing theory that that wouldn't have to end with hyperinflation that is with the paper actually with the money actually being becoming worth no more than the paper is made of but with commodity money avoids that problem because in fact it it's not expected that it should be worth more than the underlying commodity is worth in other uses let's take a step back to take take a lay of the land here so we have some situations where you actually be trading coins that are the actual money the actual standard metal silver whatever and so you're actually trading those and then you have other situations where banks would hold those that money and you'd be trading paper notes that represent that a return of some metal or something viable so that's commodity currency but not a coin commodity based currency so we mustn't we must be careful not to mystify but then the topic of bank bank notes and bank currency too much it just so happens that in the earlier days of banking circulating paper notes were the more common IOU form that served as money but they they fundamentally didn't differ very much from the checkable deposits and demand deposits that were used to using today they were also those are also bank IOUs that serve in place of basic money in in exchange the advantage of bank notes is that they could be passed from hand to hand among anonymous people and that was not the case especially back when with checks people were reluctant to accept checks because you couldn't really be sure that you could trust the writer of the check to have that much money in his or her account you also in that case of course had to trust the bank upon which the check was drawn if you think about it a bank note is just a little bit less untrustworthy because if the note is genuine of course then you're concerned with the bank being sound but not with the soundness as it were of the person who hands you than the note from that so I'll make it make an analogy here I write Aaron a check I use an actual paper check I think I have a few of them in a drawer somewhere and then and then Aaron can sign that check over to someone else some of these things are illegal but you could have a system where my check goes to him with my name on it saying I guarantee this and then Aaron transfers that check signs it over to someone else and then four people removed from this they're still relying on me to actually be backing up the deposit right and they know that your deposit may be all this time being run down and the likelihood of the check being good is for all they know has long disappeared is why checks don't people hold on to checks even today of course you cash a check because the sooner you cashed the less risk you take circulating notes are actually a much more straightforward way of of using bank created substitutes to make payments instead of using some underlying money whether it's coins or fiat money from a central bank I say this because the the widespread belief is that having banks issue circulating notes is just something intolerable that that has to be something that governments monopolize but the truth of the matter is that for the most part any argument you might hear about why it's impractical to have banks issue circulating currency would apply with even greater strength to the present accepted practice of banks allowing people to write checks off of demand deposits or use debit cards it's really they're just an argument based on ignorance and prejudice we've talked about commodity currencies so coins where there's some actual stuff sitting there that we find valuable and that's what we're exchanging whether in reality or through these these notes that are good for it and then we've talked about this fiat currency of government just saying here's the units we're going to use to exchange but I guess when did that come into play let's make let me allow me to tell how we get from one to the other and then we can pursue the the the questions that come from that transition so as I was saying in the United States to keep to that case which is not typical in all respects of course but it interests I'm sure your listeners is more than most during the Civil War the policy changed with the Federal Reserve essentially taking over the business of banking by prohibiting well they passed a ten percent tax on state issued currency and that was prohibitive so the state banks had to abandon it so they paid the tax the banks paid the tax when they issued a currency no worse than that yeah if they had any amount of state banks notes outstanding at the time the tax was assessed which was annually they would owe ten percent of that money to the federal government killed the state bank no issue now this was done I should mention that went into effect in August 1866 by which time this and the federal government had also created in the course of Civil War a new banking system consisting of a large number of federally chartered banks called national banks so the by this mechanism currency was nationalized not monopolized but nationalized and put in the hands of only federal institutions now I don't have time to go into the details of that but because these institutions were designed to help finance the Civil War and this was a real motive for this change they were required to back their notes with US government securities well the problem is what is the US government security just this is Treasury bills bonds notes but in those days bonds so that whatever its merits is a device for raising money to pay for the war proved to be a very unfortunate arrangement afterwards because the federal government was retiring its war debt was running surpluses often in the 19th century after the war and as it did so of course the supply of these bonds that were eligible to back national bank notes dwindled and the next thing you know you have an inadequate supply of currency and an inelastic supply as they said in the day and that was an important cause of occasional financial crises the Fed to make a very long story short was set up as a way of making up for this inelasticity of the currency supply you might ask 40 years later though well these problems this this continued to be a problem and a worsening problem for the entire span of time from the 1870s until after until the feds establishment you might ask why didn't they just deregulate the note issue of the national banks and maybe let the state banks issue notes again I mean Civil War is over you don't need revenue good question you can ask me that if you want but in any event instead what they ended up doing was creating the Fed and the Fed wasn't anything magical at all at that time the Fed was essentially a set of 12 banks that were exempted from the rules restricting the currency issue of the national banks so they could issue Federal Reserve notes on assets other than government bonds that's it that's the magic of the Fed okay so now what you've got well the Fed was designed eventually to totally supplant the national banks so now you've got a nationalized currency and a monopolized currency because the Fed is not really 12 banks it's it's a cart it's a monopoly managed by a central board okay so how did we get from there to fiat money when once you have a monopoly it goes back to Kings and coinage and debasement once you put a monopolist in charge of the basic money you you set up a situation where the monopolist can redefine what the basic unit really consists of so when the Fed takes over the basic monetary unit is still a unit of gold in fact it is the gold standard act was passed in just 1900 really securing the gold standard and doing away once and for all with with a silver counterpart that had existed this is the presidential debate the McKinley the hanging car actually know that's before that that's before that that's a the that that is in the 1890s anyway the the gold standard act of 1900 is sort of the combination of the victory of the gold side anyway now you have the Fed responsible uniquely exclusively for providing paper substitutes for the dollar but at least in its original conception the Fed is absolutely supposed to protect the gold standard not alter it the all of this changes it changes tentatively in during World War one when the Treasury puts embargoes on cold that's a wartime thing and it's not really dismantling the gold standard but when the Great Depression comes of course we have a suspension of gold payments and ultimately various redefinitions of the gold content of the dollar but most importantly Americans absolutely lose their right to convert Federal Reserve notes into gold and so they really have no access to gold at all and that remains the case more or less permanently although it's legal to own gold again after 1976 it's it's it's not a question of owning of being able to cash Federal Reserve notes into monetary gold so is that would you say that's the moment I think it was 71 when Nixon took it off the gold standard is that when it became a fiat currency there's it's hard to put a moment on it because you have you have first the time when American citizens cannot get their gold for their paper that's the third then you have a redefinition of the official value of the dollar which is of course essentially bilking the foreign news who still at that point have a right to get gold by saying okay but now you get less for each dollar finally of course there's a lot more to the story but the the shutting of the gold window in in 71 and that itself which itself is the culmination of a number of steps taken to prevent people from getting gold before then results in the dollars last connection to gold being severed and at that point of course it's certainly fiat money whether it's sort of fiat money before then is an open question and and probably just a matter of semantics so now I think we can maybe loop back now that we've got ourselves to fiat money so yes we've now we've got this state-issued fiat money which is only valuable so to speak because the state tells us it's I'm gonna correct you on that because it's common misconception if the state could tell us how valuable that it's money could be the Fed would have a nice easy job of it they could avoid inflation by just telling us hey value this stuff more the the the only thing that preserves the value of a fiat money is restraint on the part of the issuing authorities when it comes to how much of the stuff they they they put out they put out too much it loses value they put out too little it can gain of course the overarching tendency of fiat money suppliers is to put out too much hence the continuing depreciation of all world currencies and then they have to resort to silly little devices like pretending that 2% inflation is really better than zero in order to convince us that they're doing a whopping good job of protecting their standard okay but so we we contrast this state-issued fiat currency we've been contrasting it with this commodity currency which again is that you know it's money based in something real that we consider valuable and would be valuable even if they weren't being used for money but that makes me think of if if those are the two things we've been talking about there's a new thing around that gets a lot of talk right now which is Bitcoin and what is that because that's there's I mean there's no commodity there that's right there's nothing there's nothing valuable there it's not state-issued but it seems kind of fiatty in the sense you know fiatty so what is that money so Bitcoin is indeed strange and it's so strange that I wrote a paper a few years ago that's finally coming out soon in the Journal of Financial Stability classifying Bitcoin as a new kind of basic money when we didn't realize existed could exist before I call it synthetic commodity money so I say this mainly to say you're on to something here because it is Bitcoin really isn't a fiat money in the standard sense and it's not a commodity money in the standard sense it we have to be very careful when we talk about commodity versus the money versus Bitcoin and saying that the commodities have a use and Bitcoin doesn't of course in some sense anything that's valued by anyone for any reason must be useful how Bitcoin first came to have value before it could be at all widely accepted and even today it's its acceptability is quite limited to compared to other monies is a fascinating question the best answer for which is that people were playing with it and it was fun and they valued it for that reason but the valuations valuation there's no such thing as a valuation that counts and valuation that doesn't count so anyway that's getting philosophical but what does distinguish Bitcoin from other valued monies is it clearly doesn't have a the usual sort of of commodity use value in that before this stuff was used to trade with and speculate with and if you like play with you couldn't do anything else with it you couldn't eat it you couldn't even in this case paper your walls with it so it's quite unusual on the other hand Bitcoin is not a fiat money in one important respect it's not like fiat money in that it has a true inherent scarcity like gold like silver the protocol or software or whatever you want to call it that governs the supply of Bitcoin essentially guarantees that that supply will grow at a certain rate until there are about 21 million Bitcoin out there and that's that there's no authority that can change its mind about that growth path or rate there's no one who can manipulate it you can start a new cryptocurrency even the Bitcoin founders themselves could do so that grows at a different rate but it'll be a parallel cryptocurrency it won't be a new Bitcoin it won't be a revised Bitcoin currency and this is fascinating and so I I think it's fascinating enough to warrant serious study and that's why I wrote the paper I mentioned before because whatever you think of Bitcoin itself this whole category of synthetic commodity money raises the tantalizing possibility that someone could come up with a synthetic commodity with a growth behavior that is predetermined in a sense nobody can muck with it but that it has very nice macroeconomic properties we we know that the supply of gold can sometimes change unpredictably in principle it could cause a monetary standard based on gold to misbehave though I would take such a standard over a fiat standard any day if we could have one again but but with with Bitcoin and currencies like it we have the prospect of of designing the supply function if you will so that any macroeconomist worth his salt would have to admit that this stuff is actually going to behave rather well so you have the virtue of it not being something that can be abused and manipulated by authorities but it's also not something that can behave badly owing to the so-called blind forces in the marketplace that's cool it's it seems like the story that we're telling here in this interesting way is about accountability of the money system in a variety of ways that it could be accountable in the fiat system is the least accountable one because even the possibility of failure or having competitive banks with different you know with different reserves so they have an incentive not to over print their thing is always just holding people accountable and you mentioned the the gold shocks for example creating the system or maybe undermining a gold standard in principle in principle I was thinking about one of my favorite economic essays the economic organization of a POW camp by Bradford Bradford and it describes how as a German POW a economic system originated and and cigarettes were the were the currency in this system as is often the case but you could have a shock to the system wherein they just suddenly dumped a million cigarettes right right they just oh here's a million cigarettes and suddenly you were holding all these cigarettes keeping you somewhat rich and now now they just dumped a million cigarettes into the camp because there was extra leftover after the war that's right after they conquered the polls or something whatever reason that's an exogenous shock to the system so it's a way of thinking about how these commodity currencies themselves could be undermined that's right and then a competitive currency system that that's the accountability thing that I think is interesting there's accountability there to to keep banks honest in a way that is not the case in fiat current that's the ultimate point that's the libertarian point fiat currencies don't keep governments honest right they can manipulate them they can do what they want with them absolutely no and with impunity no central banker as far as I know has ever been punished for mismanaging a monetary standard for allowing inflation there's talk that there's a contract according to which the president of the bank of new zealand faces certain sanctions if there's too much inflation and so on but there's nothing to that contract I'd look at it looked at it it's so full of mites and coulds and perhaps wills that it has absolutely no teeth at all and they'll never do anything so that's that's pie in the sky with with with private banks whatever faults people may attribute to them the bottom line is a private banker can't dishonor his obligations with impunity that's very simple every bank we know it's a very big deal if a private bank says to a depositor we've decided we're not going to cash your deposit for the nominal value we said it was worth we're going to give you less you can't do that you you fail if you do that or you got to get a bail out so you don't do it but one way or the other you can't just unilaterally as a private bank or you can't do the central banks do it you know 20 times before breakfast and so and for people to think that central banks are are where we should put our trust to have sound money is is absurd in the face of it given the the incentives at work now having said that though if you even the best private banking system can't make for a stable money if the underlying standard stuff right whether it's gold or cigarettes or tobacco if that stuff is subject to shocks in misbehavior then of course that's going to be reflected in the value of all these convertible substitutes based on it now people exaggerate dramatically the the extent to which the more important past commodity standards were in fact subject to such shocks the worst known the most infamous gold supply shock ever was that following the discovery of the new world and all this gold and silver is flowing into Europe and you have something called the great price revolution of the approximately around the 16th century and well right but if you look at the annual rate of inflation that the figures add up to it's less than it's it's so low that it would have had it would have Janet Yellen today worrying that we're too dangerous to close to the zero lower bound seriously and it's nothing it was less than a two percent target that we have now so it's absurd to criticize the gold standard on the count of on account of it's having brought big positive supply shocks but we could in principle with bitcoin and some synthetic commodity money we could we could design something that would be guaranteed not to surprise us with such things and that in that sense it would be a big advance I'm curious about this competitive banking because I mean so we all companies fail all the time right like private companies go under all the time or at the very least seem to go under more often than governments do and so doesn't that I mean wouldn't that make it potentially more dangerous to have a competitive system because I don't want I don't want my bank to fail and take all my money with it and so if I'm instead using the states you know the state's fiat currency I can at least think that the United States government is going to be around longer than this random startup well you have to remember though that by putting your trust in in the central bank and issuer fiat currency you you you expose yourself to daily to a daily exaction in the form of the depreciation of the money that that institution is allowing that you can do nothing about now you have to compare that alternative with the alternative of having a system where the government isn't involved at all where your basic money itself doesn't depreciate the way fiat dollars do and then of course we if you're using bank substitutes how will those substitutes in that sound money compared to holding fiat money of a central bank now of course the question of bank failures is very relevant here but if you look at the history of banking and of bank failures it's overwhelmingly clear that the reason why we have major banking crises in the united states is because of the way we regulate banks we have we have misregulated them from the very get-go I mentioned how we didn't have any branches of banks and that remained the case for the most part right up until the reforms finally were implemented in the 1990s with regional compacts made some exceptions but still now look you don't have to be a finance expert to know that such a fragmented banking system is going to involve much less diversification and many more failures other things equal than than a well diversified branch banking system in a short form if you have one bank and it's in a corn growing economy if corn goes bad the bank and so do all the other banks in the region look in the great depression five six thousand us banks failed and just in the first few years and the number depends of course on the exact dates you choose but anyway canada had a nationwide branch banking system and during the great depression which hit canada very hard in other respects after all they were our major trading partner zero banks failed now there's a fact that's a fact in the united states one state alone really had much of a branch banking system by the 1930s that was california thanks to the bank of america which is different from the modern bank good thing but in any event california was one of the few states when no banks fail these these are over overwhelming facts but it's not just branch banking governments through their interference with banking have made banks much more failure prone in a million ways now the other thing they've done of course lately is to define certain banks as being too big to fail and there again what is the ultimate outcome of this the ultimate outcome is that these banks are inclined to take much bigger risks that do ultimately cause them to jeopardize their own solvency but they do so expecting fully well and having their creditors expect fully well and that's where the real discipline ought to come from that they'll get bailed out you can't have a system where the creditors of bankers including regular depositors are sure that banks their banks are going to get bailed out if they get find themselves in hot water where market discipline does what it normally would do which is to take money away from such risky banks and put it only into risky risk free ones if i may add one little anecdote to this to drive the point home when i was teaching in the university of hong kong uh some expert from the bank of england came there and he was advising that hong kong to adopt to deposit insurance which it had not yet done and uh now living in hong kong and not even for that long was perfectly apparent to me and to everybody else there that there were two kinds of banks in hong kong there were the big international uh banks the british style banks as they were called like standard uh and charters in hong kong shanghai banking corporation uh as it was and now and uh and then there were a lot of so-called native banks now the native banks were not very well diversified they were hardly better than casinos in some cases but that's all right some people like casinos they put their money there they took the risk if things went well they did well if not they took a big uh uh uh loss when the banks failed now if you imposed insurance on that system what do you suppose would happen well honkers and shankers and standard charter and the other big british banks would be effectively subsidizing these risky banks and anybody with any brains would put their money in the riskier banks uh as long as there's no actual risk as long as it was covered now now depends on the scheme whether it's a hundred percent coverage or not but in principle a hundred percent coverage which for example is what we have here would have this effect of causing everybody to go to the high-risk banks do you get fewer failures no you get more failures you get more risk it's uh it's this sort of interference with the normal operations of banks interfering with their own devices to minimize risk like branching interfering with market incentives to contain risk like you fail if you if you make bad investments and your creditors take a hit these things have undermined the stability and safety of of private banks not the anything inherent to the business of banking and i'm if i may i i must say i am sick and tired of reading idiotic expert advice from people today and there's more of it than ever now saying well we just got to stop banks from lending other people's money we should just have them have more capital and not allow them to lend have a hundred percent reserves these people know who are saying this are utterly ignorant of the actual history of banking of the history of bank failures of the role that bank credit plays in sponsoring development which is extremely important they would have us living in caves again just because they don't understand as you can have a sound fractional reserve banking system if you only get the government out and thereby stop it from undermining the normal devices the bankers have to keep themselves strong it seems as though possibly the story here is about basically trying to socialize risk in some basic way people there's people who say you know if you let people do their banking in a free banking system they might invest in a bank that fails so we're going to put a system that socializes that failure out and then the failures become systemic and they become more costly at the end of the day right they become taxpayer funded failures as opposed to being put on the people who made bad decisions by putting their money in a specific bank so they've socialized you could say that but you make it sound a lot more benign in fact than it was it really hasn't that hasn't been the story the story has been won all along of corporate welfare and it's not about the the depositors in the 1930s for example after all those banks failed and this was just the culmination of a long history of high failure rates among unit banks at that time and it would continue later on people understood that the real problem with the u.s. banking system was its unit banking structure that if we could just overcome the industry opposition to branch banking which came both from wall street which benefited from the correspondent system that branch banking made necessary and from main street which worried about ironically wall street and paying it stir up at any event everybody understood that the unit banking was a flop and of course after this disaster of the banking crises of the 30s no sane person want to put his money back in the unit banking system I wouldn't but so the obvious thing to do is have reformed through branching create a sound system a safe market-based system like the Canadian system but with more entry Canada had restricted entry and and so it wasn't ideal but the politics didn't allow it FDR himself recognized that deposit insurance was a very poor substitute what deposit insurance was was made a prop up this fragile indeed broken unit banking system keep it going with but basically you know giving it this infusion of of support from the few sound banks in the system that they were because they're always going to be some strong banks that will end up subsidizing the weak ones and so this was about saving a corrupt rotten banking industry and FDR to his credit recognized the inherent dangers of deposit insurance he deposed it as government governor of New York he was reluctant to sign the bill but he eventually signed it for one of anything else so now that was a story in the 30s what's the story now it's not again about protecting small depositors it's corporate welfare now for the biggest banks the biggest banks are being protected with too big to fail this idea that the poor depositor won't know where to put his money or her money has things entirely backwards by the way until fairly recently anybody could go to a library and pick up a number of publications that private ones that ranked banks according to their safety it was as easy as buying a copy of consumer reports to decide what stereo system he wanted why did these publications exist because until too big to fail really came into prominence in recent decades deposit insurance had only limited coverage of course and there were enough business accounts out there that were very big where you really were taking risk if you dealt with the wrong bank right so those people had an incentive to make sure they put their money in safe banks because at that time they felt like they could lose it now of course they just go to the biggest bank in town and they know they're safe in the country and you know you're covered and everyone probably that's right biggest bank too yeah that's that's over with but in those so the idea that the that there's no way consumers can pick good banks safe banks that they just have to have we have to have a safety net we have to have too big to fail we have to have the fdic that's just a bunch of bull and and it it of course the truth rather is no one bothers to learn anything about which banks are safe or not in the system we have because they don't have any incentive to do it that's why our system stinks so the history you've described in this country of the the rise of fiat currency and deposit insurance and all this other stuff is a history of poor decision after poor decision if if we were going to fix that if we had the power to just change things to the way that they ought to be what would that look like would it be a return to gold would it be the embracing of this synthetic currencies like we've talked about something else what would what would money look like in the u.s. and the right system so there are two ways of thinking of your question one is how would our system have developed if they hadn't kept botching it up from the beginning the other is how could it develop today if we stop botching it up and start to undo some of these policies that have been wrecking things and and of course the the answer to each of those questions is going to be going to be very very different and the answer I should say to the first question also depends fundamentally on what you imagine is happening in the rest of the world right so we can't really abstract from that but suppose the United States was the whole world and there'd been no tampering with banks and money by the government I imagine that we could have had a system that in many respects resembled the Canadian system of the day that I described or the Canadian system in its heyday around the 1870s 80s when it was a notoriously stable system except Canada as I mentioned a very very narrowly restricted entry into its banking system was essentially a closed system now studies have shown that it was nonetheless competitive in the sense that you look at the structure of interest rates and spreads and all that and it seems like the banks were rivalrous enough for the most part but still one could have done better with freedom of entry it's it's it's very speculative to one to ponder how many banks are such a free entry system that allowed nationwide branch banking might have supported I suppose it could have been only dozens but perhaps it would have been hundreds I don't know it is highly unlikely that would have been thousands so we would have had many fewer banks in any case they would have mostly had very large branch networks they would have been very diversified and of course if the federal government had interfered with who could issue notes the larger ones anyway would have all issued notes not all of them note issuing is something that requires a particularly good reputation that is if monopoly privileges don't support it so we'd have a handful perhaps of banks that would have been issuing notes or a few handfuls at that you'd see a bank of American note you would see a city group and occasionally you'd see like third bank of Georgia and you'd wonder occasionally perhaps could I actually use this third bank of Georgia note but notes that people had those second thoughts about what would tend to be weeded out banks like that would either go out of business entirely or would certainly leave the currency business precisely because people would would favor the other currencies to there so there'd be a a few dozen perhaps different brands nothing difficult to deal with Canada had a few dozen for many decades and bank failures would be relatively rare the stock of currency could respond to fluctuations in the relative demand for it compared to deposits we know from the Canadian experience how well the currency supply responded to demand it was elastic but not inflationary supply had a nice pattern of spiking in the autumn when you needed more currency for crop crop moving coming back in and after the harvest and then doing the same thing the next year the underlying determinant of course of the total supply money would be the underlying supply of the monetary standard which again here the counterfactual history is complicated by the whole question of bimetallism would it have been silver or gold or what and the answer is very difficult because it really depends on what what the market values of the two metals did ultimately we know that the relative decline in the value of gold after the 1850s favored gold monometallism so it's easiest to speculate in terms of that and indeed we know what would have happened with gold monometallism because that's what we did have effectively and it was mild deflation generally not exciting exceeding the average rate of productivity growth very much and so not particularly harmful that is the deflation was those more or less reflecting decline it declining overall unit production costs wages therefore didn't have to deflate and even rose money wages and things were not bad so in that world you would actually have the fact that my parents paid 70 cents a gallon for gas or maybe 12 cents in 1971 and and it would still be it would be lower it would all probably be lower you know you have to look at if you look at the real under this arrangement if you look at what's happened to real unit prices as opposed to prices you know not deflated and then imagine the nominal prices actually doing that right so and really the story would have been one of the actual us economy 18 let's say 1870 to 1907 minus minus all the financial crises which means you have to not only get rid of the peaks and all the fluctuations but you can assume a higher trend line because of the losses avoided along the way I mean we're getting into the area of real speculation but but I think that's roughly what we would have seen if the government hadn't continually messed things up so what do we do now I mean given our unfortunate inability to change the past that's why I said there are two different questions because now having botched up and ultimately destroyed the metallic standards of the past it's no not easy to go back to them because we come to the original point about the evolution of money once you establish a standard it tends to be self-reinforcing and it's hard to switch how would we ever get back to a different standard how could we have a move to gold imagining it occurring spontaneously as some some gold advocates do involves imagining at least some people being the first movers in the process that mean that have to incur all the costs associated with trying to trade with something that no one else is trading with that's not easy to do it's like having your own very own computer operating system or phone network where you're the only person on it so far if you can't get some people to move independently and unilaterally to be first to start this ball rolling then what's the alternative well the alternative is we get this somehow we get the US government to to get on board this idea and make a concerted change well the problem with that is now we have the federal authorities who were trusting to commit to a return to a gold standard but their credibility has been shot it's totally shot if the Fed announced tomorrow that it was going to once again start redeeming federal reserve dollars in a fixed quantity of gold there'd be a speculative attack on the Fed on on Saturday if if it were open or on Monday if not and that's all there is to it and that would be the end of that I don't personally know how you get around this dilemma right the dilemma of a private return to gold requiring somebody to start the ball rolling and incur the costs thereof versus having the government take the lead when its credibility is non-existent maybe someone knows how we can do that but I don't but at the very least we should stop too big to fail and stop that doesn't mean yeah that doesn't mean there's not a lot we can do to have a better monetary system and that it doesn't mean we can't get rid of the Fed as a discretionary manipulator of money it means going back to a gold standard is really hard I would like to therefore you know focus on possibilities for maintaining the dollar standard but getting the Fed that is this group of people who can play with it out of the story and there we have to think first of all about raining in the Fed doing away with its discretionary powers ultimately I think we can contemplate reforms where we just freeze the stock of Federal Reserve dollars but a frozen stock like that won't won't talk about an inelastic currency right it would be terribly inelastic unless our the rest of our private financial institutions were were capable of of supplementing the private the the fixed stock of Federal Reserve money with substitutes and doing so in a in a in a manner that could accommodate changing needs to do that we have first of all have to have sound private financial institutions which means we have got to get rid of too big to fail we've got to rein in deposit insurance we've got to get rid of the safety net which is the a number one problem in our financial system today but of course at the same time we we have to encourage the kind of financial diversification and flexibility that that can make the bank strong in themselves and instead of having to rely on safety nets now we the the good news is we have branch banking now the problem is by the time we got branch banking we were mucking up the system with these these other interventions so we have a a a banking structure that could conceivably be a sound structure but now we've got to get rid of the guarantees that have undermined the soundness of that structure that that's a lot right there we should allow banks once they are standing on their own capable of standing on their own feet and by the way some banks are capable and have been all along there's a lot of loose talk about the whole industry being unsound it's certainly false was false even in the depths of the crisis in any event when we have sound banks we need to let them issue all kinds of substitutes for federal reserve dollars so that people have to rely on the fed we need to break the fed's monopoly so those are just some of the things on the agenda what about cryptocurrencies the best thing we can do with those is to let them flourish the government shouldn't play it hasn't played any role in creating them it has no positive role to play in in encouraging them the the the hands-off policy of government towards these currencies except to the extent of of making clear its treatment of them for tax and other purposes and of course there are better ways for to do that and worse ways but having having a a set of rules is better than having no rules at all but otherwise the best thing the government can do with cryptocurrency is keep the hack out thank you for listening to free thoughts if you have any questions or comments about today's show you can find us on twitter at free thoughts pod that's free thoughts pod free thoughts is a project of libertarianism.org and the Cato Institute and is produced by Evan Banks to learn more about libertarianism visit us on the web at www.libertarianism.org