Monetary Elephants in the Living Room

Nelson Hultberg

October 5, 2005

In a recent article, Robinson Crusoe and the Curse of ‘Real Bills’, Sean Corrigan of the Mises Institute writes that all the hoopla that the “real bills doctrine has lately drawn does show that a fundamental misperception exists about monetary matters.” [Emphasis added]

This is certainly true. In fact there are several fundamental misperceptions, and unfortunately they are held by Corrigan and the followers of Murray Rothbard, about which Dr. Antal Fekete, Dr. Vasilios Koures, and I have written quite extensively.

What exactly are these “fundamental misperceptions?” To start with, Rothbardians have not adequately researched history because they believe so deeply in the rationalist myth that truth can be discerned solely through the spinning out of deductive logic. Consequently they have confused the Financial Bills Doctrine of central government banking with the Real Bills Doctrine of Adam Smith. They misunderstand the nature of credit, for they perceive it as monolithic, rather than dual. They misunderstand interest, believing that there is no difference in the interest rate and the discount rate. They fail to grasp the difference between the propensity to save and the propensity to consume. They think the distribution of consumer goods can be financed like the production of fixed capital assets through borrowing and lending. They presume in their ivory tower world of deductive logic that gold will easily adjust prices down to accommodate expanded productivity. But only in the Middle Ages was this done, and it resulted in a primitive level of economic activity. History fails totally to corroborate their fanciful deduction. Because they cling to such pure rationalism without bothering to seek historical corroboration they are ignored by big league scholars and much of the intelligentsia that is beginning to doubt the Keynesian paradigm. This is impeding the cause of gold and freedom, not helping it.

As a result of these misperceptions, they fail to see that under a 100% gold system we would have to endure a much lower standard of living because the trillions of dollars of credit necessary for the production and distribution of consumer goods would have to be taken out of savings, i.e., gold reserves, and thus could not be used to finance factories, technology, plant and equipment, etc. This makes their 100% gold paradigm unworkable for any society that wishes to achieve modern levels of capital accumulation.

Seeing that the Rothbardian ideology has been constructed over many decades upon 100% gold, Rothbard’s present day followers are not about to deviate from this sacred belief. But for those more open minded in their thinking processes who seek reasons as to how the restoration of gold as money can be brought about in the upcoming years, the place to begin is with Antal Fekete’s remarkable works on the subject, Monetary Economics 101 and 102. He demonstrates that what is needed is a new theory of interest and credit in order for gold to become a viable monetary system again.

It is regrettable that Rothbardians continue to evade the glaring misperceptions listed above. Perhaps they hope these gigantic flaws will not be noticed by the intelligentsia if they are never talked about. But silence in face of the elephant in one’s living room does not make the elephant go away.

Answers to Corrigan Misperceptions

What follows are some more misperceptions that Corrigan’s article puts forth, which only make the elephant in the Rothbardian living room bigger and smellier. Accompanying each of them are my answers.

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Corrigan: “The moment we allow the legally-favoured bankers to issue fiduciary media (by which we mean bank-created money entirely unbacked by previously-saved final goods) against such credit, we are doomed to end up with too many instantly-payable claims on the stock of goods currently in existence.”

Answer: This is one of the dogmas on which Rothbardians have built their case for a 100% gold system. But what the history of monetary economics demonstrates is that, if central banking is disallowed, and if contractual law is upheld consistently regarding fraud, then fiduciary media to discount real bills will NOT result in “too many instantly-payable claims on the stock of goods.” This is because real bills, though not backed by “previously-saved final goods,” are backed by already-produced goods that are urgently needed and in the pipeline. This negates any price inflation. In addition when real bills are discounted by the banks, the notes issued to do so are backed 100% by bank reserves of gold and real bills that mature into gold within 90 days. Thus we are not talking about the conventional concept of fractional reserve banking that government-backed banks have practiced so abusively in the past. In a truly free-market banking system that prohibited fraud (such as borrowing short to loan long), banks would have to keep 100% reserves in gold and gold instruments (i.e., real bills). The real bills are as good as gold because they can be sold in the bill market for gold at any time by a banker to meet any demands from depositors for specie redemption. On this point, see my article, Musings on Fekete and Rothbard.

This is how real bills worked throughout history and would do so again if not for government centralizers intervening into the marketplace to corrupt the banking industry. Rothbardians need to understand that there is a BIG difference between free-market banking that deals in real bills and central government banking that deals in the vast array of financial bills that it is able to conjure up. The two practices will be governed by totally different laws, and they will result in totally different outcomes. The former is governed by the “competition for reputation,” a natural law of the free-market, which mandates that bankers constantly operate in a high-minded (liquid) manner in order to attract customers. The latter is governed by coercive monopoly and privilege, the tyrannical contrivances of bureaucrats, which allow bankers to operate in a disreputable (illiquid) manner.

Corrigan’s treatment of these two forms of banking as the same and declaring the problem to be “fractional reserve banking” itself is a huge flaw. To not make the distinction between the two different types of banking is most unscientific. Moreover it is inconceivable that any free-market advocate would blank out so on the principle of “competition for reputation,” which is the cornerstone of laissez-faire political economy. It seems that Corrigan and his cohorts would prefer to only employ their principles selectively when it serves their interest.

In other words, you can’t have it both ways. You can’t preach the power of competition for reputation (which all Rothbardians do emphatically in their defense of laissez-faire), but then ignore the principle in the arena of banking as irrelevant because it detracts from your agenda. For an explanation of how “competition for reputation” would keep the use of real bills from being abused, see my article, Real Bills vs. Rothbard’s 100% Gold System.

A thorough perusal of the history of 19th century banking shows us that its inflationary booms and busts were not the result of free-market banks dealing in real bills, but were the result of government centralization of banking, government paper issuance to fight wars, government intervention to convey privileges to banks, and government refusal to prosecute fraud.

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Corrigan: “Nor can any such tinkering ever be enough to extend the operation of [fractional reserve banking] beyond the speedy collapse it would otherwise endure were it not underwritten by the terms of that tyrannical Devil’s bargain of the kind most famously drawn up between the corrupt Whig financiers of the ‘Glorious’ Revolution and their importunate, invited overlord, William of Orange, for the ‘better prosecution of the war with France’.”

Answer: If Corrigan is trying to say that the discounting of real bills would collapse if not for the “Devil’s bargain” of government banking “underwriting” them, this is preposterous, for it’s precisely the opposite. The writing and discounting of real bills spring from the free-market and precede banks. Government banking is what destroys their integrity. It doesn’t shore them up.

But Corrigan apparently assumes that government created financial bills are the same as Smith’s Real Bills. Dr. Koures paper, Real Bills: an Emergent Market Phenomenon, discusses at great length why this is not so. Mr. Corrigan needs to go back and do his homework. To j ust repeat ad infinitum his ornate ad hominems and Rothbardian mantras is not legitimate argumentation. A large, smelly elephant is standing in his living room. A truth seeking scholar would be attempting to confront the elephant rather than spinning out spiteful inanities.

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Corrigan: “Not to be discouraged either by reason or experience, however, these good [Feketian] souls roundly declare that ‘real bills’ have never been given a true test, having always been adulterated by the prolific rediscounting of all sorts of other, less worthy bills – a crime perpetrated, of course, by exactly the same coterie of foolish and greedy bankers that the Feketians want to foist upon the ideal future Commonwealth of their promises!”

Answer: Not so! We in the Fekete camp want to rid the Commonwealth of the “coterie of foolish and greedy bankers.” This coterie is made up of government bankers, however, and Corrigan is failing to distinguish between free-market bankers and central government bankers. But, of course, he has to blank out on the difference, for to draw the distinction would call attention to the fact that fractional-reserve banking in real bills is not the problem. It is fractional-reserve banking practiced by government bureaucrats with their coercive monopolies, their privileges, and their myriad of bogus financial instruments that is the problem.

* * * *

Corrigan: “To the first group of [Feketians], we can only say that to make a fuss about the fact that ‘price levels’ at either end of the 19th century were more or less equal – and to disregard the vertiginous topography they mapped out within it – is to say that because America’s sea level is the same on its Atlantic coast as at its Pacific one, one can safely fly between the two at an altitude of fifty feet!”

Answer: Calling attention to the fact that prices were slightly lower at the end of the 19th century than they were at the beginning is hardly “making a fuss.” It is one of the most crucial elements of this era, and it is very important to delve into why.

Moreover the “vertiginous” prices during the 19th century were clearly the result of central government banking through the 1st and 2nd U.S. Banks between 1791 and 1833, and through the National Banking System (the quasi central bank forerunner to today’s FED) established from 1863 to 1913. In addition, our government flooded the country with paper during the War of 1812 and the Civil War. Even in the so called “free banking era” from 1835 to 1860 initiated by Andrew Jackson, there were special privileges galore conveyed to banks by government.

Such price volatility that was experienced during the 19th century was due precisely to the factors that we in the Fekete camp have been shouting about — government banking, government privileges conveyed to bankers, government winking at bank fraud, etc. Yet Corrigan ignores this totally and acts as if the price volatility was just due to “fractional-reserve banking” itself. It is inexcusable to consider the problem so crudely and simplistically. If we had had a truly free-market banking system that discounted real bills during the 19th century, we would have never had the price volatility that was experienced under the government privileged systems.

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Corrigan: “To the second group [of Feketians], we can only confess that they seem most like the hapless plague doctors of Pepys’ London; quacks who well recognise the symptoms of the disease, but who are unable to identify its root cause – in our case, fractional reserve bankers, rather than the equally pestilential rats and fleas! – and instead opt for a truly Hermetic mysticism in treating it.” [Emphasis added]

Answer: On the contrary, it is Corrigan who fails to identify the ROOT CAUSE of our monetary disease because of his crude defining of the problem as just “fractional reserve bankers.” Without drawing the distinction between free-market bankers and government managed bankers, he obfuscates the issue in the worst way and misleads his readers. But what else can he do since he insists on clinging to the myth that a 100% gold monetary system is mandatory? In order to maintain such monetary rigidity, he must paint fractional reserve banking per se as “diabolical,” rather than do as a true scientist would do — analyze the two different forms of fractional reserve banking, which would demonstrate that the use of real bills is not only not diabolical, but immensely beneficial. He must blank out on the fact that government intervention into the mix is the real ROOT CAUSE of our problems. If he were to face up to these quite demonstrable facts, then he would have to face the distasteful realization that his 100% gold monetary paradigm is not mandatory at all. This, of course, is not going to happen. He and his cohorts have an agenda; and if facts of reality get in the way, then damn the facts.

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Corrigan: “So, we are left to wonder just how that Feketian Pietist, Mr. Hultberg, proposes to prevent the fractional reserve bankers he so ardently defends from once again debauching his new Jerusalem of ‘real bills’ and from inexorably transforming it into an inflationary Sodom and a speculative Gomorrah of monetized credit instruments… without himself having to resort to an appeal to the same violence of authority which he falsely supposes his opponents to endorse.”

Answer: How are we to “prevent fractional reserve bankers from debauching” the system? By means of three quite effective legal / regulatory methods: 1) the objective implementation of contractual law, i.e., no special privileges dispensed to bankers, 2) consistent prosecution of fraud, and 3) the principle of competition for reputation.

Mr. Corrigan should certainly know that the beauty and genius of the free-market is that it contains powerful and natural regulatory mechanisms with which it polices itself. In this case, the natural mechanism would be the COMPETITION FOR REPUTATION among bankers. This is understood by all free-market advocates as the reason why we do not need government intervention to manipulate and regulate. All we need on the part of government is an objective system of law (i.e., the proper prosecution of fraud and no privileges dispensed to market participants) to complement this natural regulatory principle. With such a complement, the discounting of real bills would not get out of hand. Reason and the study of economic history show us this if we approach the issue with an open mind.

Thus we do not need to utilize government regulatory coercion to prevent “real bills” from debauching the Commonwealth. As long as the government will do its legitimate job of prosecuting fraud and objectively implementing contractual law, then the marketplace will take care of the regulatory job naturally through “competition for reputation,” which will mandate that bankers remain highly liquid and responsible in order to attract customers. Our problem lies in the fact that government did not do its job during the 19th century. It privileged bankers by allowing them to deal in irresponsible banking practices and hide their irresponsibility from the public, which resulted in boom / bust economic swings. If Mr. Corrigan had thoroughly researched this era, he would realize this. But such research and recognition of the true source of the problem would not support the 100% gold agenda with which he and his fellow Rothbardians are so obsessed. Thus it is far better to gloss over the era and spin its boom / bust volatility in more simplistic terms that support the agenda.

Of course, Rothbardians don’t “endorse the police power of government authority” to mandate their 100% gold monetary system. But that is what they will have to tolerate if they ever want to actually implement it rather than just bandy their busy little blogs back and forth about it. They will have to make use of government police power to mandate it because a free-market would never choose such a system. Free men would not opt for it. Free men would make use of real bills. And free bankers would discount them in a non-inflationary manner via competition for reputation.