My two cents on Free Banking: Why Austrians fail at pitching it and how it could be fixed
I thought I would throw these thoughts to the Mises.org crowd:
Canada, where I work, has only 5 big banks. These banks play a sort of "money distribution" role in the system. Money flows from the Bank of Canada to these banks, which later allocate it as they see fit. At my work, I think I 've had the privilege to see how the whole credit crisis unfolded and will continue.
Having always been on the side of free banking, I've noticed that whenever I suggested the advantages of such system to folks working in the capital markets, their rejection was based essentially on a few points. These points are, as far as I know, not addressed by the Austrian literature. Perhaps I am wrong, perhaps I 've not read enough to base my thesis and if such is the case, please, let me know by responding to this blog.
Below, I elaborate on the issues I think the Austrian school has not done enough to make their case on Free Banking:
1.-Going back to a gold standard is not feasible operationally:
Most people believe that a free banking system would be difficult to establish. From what I read from Rothbard, he calls for the gold convertibility of the USD. This, in my view, does a poor job to the cause, because Rothbard only goes as far as to address the closure of the Fed. There is way more than that. Other authors explain the problem in terms of different banks issuing their own notes, and address the relative value between them. That is certainly not feasible in a dynamic world as the one we live in.
In my view, we need someone to write about how a CLEARINGHOUSE for issuing banks would work, with one single currency being issued. Has anyone at Mises.org ever took the challenge of elaborating on this? (Feedback welcome). I think this is a very timely subject, as banks nowadays get so much stupid scrutiny on their counterparty risks, future regulatory schemes etc. Has Ron Paul come up with something like this? Somebody has to come with a feasible, easy to visualize framework. Otherwise, we Austrians are destined to keep talking to the walls, or maybe to be sent to a nuthouse.
The role of the clearinhouse would be to MARK TO MARKET every loan that is posted as collateral to back the outstanding liquidity.
2.- The transition to free banking
As far as I know, Austrian authors have not addressed how the transition from central banking to free banking should work. Did they really think that the financial community was going to accept having their investments carried on an accrual basis discounted to market? Never! This is a real killer and financial leaders would take 100 times the humiliation of having to speak to a Senate panel asking for forgiveness than seeing their investments discounted.
One alternative here is to suggest a phasing of this transition. Has anyone ever written about this at Mises.org? For instance, a way to do this is to lead banks to keep a 100% reserve on investments as they mature. If the funds are reinvested, they can only be reinvested with a 100% capital allocation. This would create a significant change in the money markets, shape of credit curves etc., but it would be very gradual.
3.-The myth of free banking as a killer of leverage
Every person I have discussed free banking with answers that with free banking there is no leverage. It is a misconception that Austrian authors should specifically address. In my view, leverage is eliminated at the aggregate level. The whole economy cannot leverage itself. But businesses can definitely get as much leverage as the market permits them. The other side of the coin is that someone else will have to save to provide that leverage. But we all know that the interest rate market will fix that problem.
Perhaps an interesting detail here is that the aggregate yield curve of the "economic system" (not that of government debt, because government debt would probably cease to be the benchmark) would ALWAYS be steep or flat, but never inverted. (Think about this proposition and please, provide feedback). This would be consistent with Wicksell's notion of a natural rate of interest. This would be a good selling point to counterattack the idiots that keep telling us that we need regulation or some central bank to fix inverted curves. Inverted curves can only exist under fiat currency/central banking systems.
4. - Issuing banks would also make money!
Both politicians and bankers are united to preserve the status quo. Austrians should seek to break this front by showing bankers that the seignorage that is enjoyed today by central banks would be a new revenue stream for them, if they adhere to free banking. Yes, seignorage would not end, it would simply shift from governments to issuing banks, and it can be very considerable. Has any Austrian author addressed this issue? We need to get bankers against politicians. If Austrians don't get the support from bankers, the cause is dead. And bankers will do no charity. Show them the money, and they will listen!
5. Free banking in a global economy
This may be the least explored issue in Austrian literature, if I am correct. How would flows adjust under a free banking system and free, flexible exchange system? For instance, what would happen if the US adopted free banking? How would China react? How can/would creditors countries react? What about debtor countries? Do we need coordination in monetary policies? What about the gold market?
I think these points are very relevant and if we Austrians ever want to succeed pitching free banking, we must have a clear answer to them. As I said, maybe I have not read enough and this blog exposes my ignorance on the subject. But I am only giving feedback on what one hears about free banking from the guys in the trenches.
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