Last Thursday was the annual Hayek Lecture at the LSE, this time given by Jesus Heurta de Soto (see here for clips and here for the mp3). As others have noted the lecture was packed, with a very strong turnout that I think surprised a few. And the audience seemed to lap it up - despite generally cautious questions from the audience, there was spontaneous outbreaks of applause and a little hooping and yelling. I suppose hearing someone passionately denounce central banking and propose a return to the gold standard is an all too rare event.
The talk was a tour de force: wideranging, bold, delivered with verve and humour. HDS is a great public speaker and stepped up to the plate.
The problem though is that I'm left reflecting on the impact of the talk. If this is seen as an opportunity for engagement, to get radical and underrepresented ideas reflected on by those who might not otherwise hear them, we should express disappointment. I'm reminded of Israel Kirzner's discussion about Wertfreiheit:
In his 1884 Untersuchungen Carl Menger included an appendix that briefly but very clearly
criticized the tendency of the German “historical” economists to confuse ethical positions with the conclusions of economics. At that time holders of chairs of economics at the German universities considered themselves social reformers. They fused their economics with their personal views on social justice and morality. In their lectures they reportedly permitted their emotions free rein. Adolf Wagner, for example, would shake his fist at imaginary opponents of his proposals. Other professors would lecture as if addressing preelection meetings, to the cheers of their students. It was with this style of economic discussion that Menger was expressing his disenchantment.
Israel M. Kirzner, “Philosophical and Ethical Implications of Austrian Economics” in Edwin G. Dolan, The Foundations of Modern Austrian Economics 
I do think there's an important distinction between public lectures and how we conduct ourselves in the classroom, but surely we should judge these sorts of events in terms of how much their educate us, as opposed to entertain us.
I thought it was disgusting and deeply concerning to see people handing out flyers about "the Fascist Institution known as the E.U.", and bashing bankers in the crudest and most naive way ("Banking was conceived in iniquity, and born in sin... if you want to be the slaves of bankers, and pay the cost of your own slavery, then let bankers continue to create money, and control credit"). I'm not suggesting that this was permitted (or even known), but why would such odious people think this talk was an opportune moment to release propaganda? I think this should be reflected on seriously.
Indeed I have issues with HDS' monetary theory, and I therefore found it frustrating that he directed his full attention to fractional reserve banking instead of the state apparatus of deposit insurance, lender of last resort privileges, legal tender laws, monopolisation of base currency, and faulty regulation. To be sure he did mention these towards the end of his speech, but there is no doubt he views fractional reserve lending as the root cause of the problem. To such an extent that he actually claimed that "the great depression was caused by the fractional reserve free banking system". Should we really absolve the Fed from any responsibility?
He cited the Bank of Amsterdam as running a 100% reserve policy for over 150 years, but if the years 1723-1761 are included, this claim is disputed (.pdf).
My problem with HDS is the starting position: that demand deposits are illegitimate purely because of the way he defines them. It is clear that like Murray Rothbard before him his ethical and legal arguments are driving the economics, and whilst these shouldn't be ignored or assumed away, they have the potential to create issues where none exist. If Bank A offers an account that isn't referred to as a "demand deposit" anywhere in it's literature, the case against fractional reserves disintegrates.
Indeed in my theoretical working paper about sound money (and the corresponding policy proposal) I talk about how option clauses and notices of withdrawal are examples of contractual provisions that make anti-fractional reserve arguments mute. I intend for this to unite the two schools of thought, and show how 100% reserve arguments can be dealt with seriously. My concern is to find solutions that all Austrian school economists (and indeed all "good" economists) can get behind and support, rather than to further unnecessary antagonism.
But one of the most fascinating parts of the talk was when HDS discussed the Carswell bill, and suggested that any deposit due within 1 month should be treated as a demand deposit and thus subject to 100% reserves. My main argument against 100% reserves is that there's no neat dividing line between what does and doesn't constitute "fully backed" deposits. In my working paper I talk about a "spectrum of funds", because we can consider the following:
- Account backed 100% by gold sat in the vault
- Account backed 90% by gold sat in the vault and 10% by government gilts with a repo facility
- Account backed 89% by gold sat in the vault and 9% by government gilts with a repo facility and 2% by short term commercial paper of highly liquid companies with high credit ratings
My point is that once you move away from the literal definition of "100% reserved" (and put aside the question about whether it must be reserved on a branch by branch basis, or whether you leave open the possibility that a customer goes into a local branch of a 100% reserved bank and is told they'd need to travel to London where the central vault is...) - I don't see a clear dividing line.
And indeed when HDS advocates an entirely arbitrary definition of 1 month it is clear that his aim is to outlaw anything he considers to be "demand deposits", as opposed to generating a rule-based and rational banking system. By introducing this detail the internal logical consistency of the 100% reserve argument falls apart.
He also talked about his reform proposal, populist by Toby Baxendale. My problems with this plan are several, and I regret that it's not yet been spelled out in detail. However I believe it is flawed in the following ways:
- It ignores the demand for money. The claim that "it is not inflationary" assumes a stable demand for money. Given that such a dramatic overhaul in the monetary regime will certainly alter the demand for money it cannot be said to not cause inflation. Yes, the money supply doesn't change, but it will have an impact on the general level of prices.
- Fractional reserve banking does not create money out of "thin air". It is an exchange of something for something else. This might be hard to grasp for those who think value must stem from physical artifacts, but when banks grant credit they are constrained by the corresponding debt they have incurred.
- I do not understand how the national debt can be paid off "immediately". I do not see how the liabilities that the banks have will be available to the government to immediately pay off the debt.
I followed the original discussions, and haven't encountered the above. I try to focus on matters of internal consistency rather than whether it is on balance advisable (e.g. what would happen to the share price of the banks? If it would fall does this imply appropriation?), but this is why I don't support the plan.
I am strongly in favour of people being able to freely use custodial accounts should they wish, and I applaud the Carswell bill for focusing on this issue. My preference would be to open a debate about the fact that the emergency provisions offered to the banking system need to be removed at some point, and chief of these is the rise in deposit insurance. The general public understand the moral hazard argument, and the bill should be centred on this. Of course the danger is that the public might be concerned about the safety of their money when such provisions are removed, so by all means mandate that custodial accounts are publicly available.
However the status quo should be considered the default option, and the aim of any bill should be to reduce barriers to opening custodial accounts. It should not treat the status quo as illegitimate and force people like myself to have to open new accounts and change all my existing arrangements.
HDS also praised the Glass-Stegall act, saying it was a "tragedy it was eliminated" (nb: has anyone found any evidence at all that it might have prevented the recent financial crisis??), and this demonstrates a fundamental difference between those who wish to mandate activity and those who want open markets and competition to deliver results. For me the debate about narrow banking is great in that it turns attention towards monetary regimes, but ultimately not something we should adopt.
I've held off on writing this report because I've wanted to see how it was covered by the mainstream media, and professional academic economists. Seeing people who already went along with it tweeting about how great the turnout was should not be considered a sign of success. This was a golden opportunity to intellectually engage with opinion leaders, and to make a persuasive case for free banking. I'm worried that it was missed.
- Do banks mislead their customers?
- Are "normal" business 100% reserved?
- Is this a new era of economic disaster?
- Public attitudes to banking
- Narrow banking and other alternatives
Cross posted at The Cobden Centre.