Central Banking versus Competitive Free Banking
[25.02.2013, Richard M. Ebeling, CONSERVATIVE LETTERS]

Conservative Letters

One of the primary benefits of economic freedom is that it decentralizes the negative effects that may arise from ordinary human error.

The negative ripple effects from private-sector entrepreneurial mistakes are localized within one corner of the overall market. Other sectors of the market need not be directly penalized or subject to the unfortunate effects of his poor judgment. Profit-making enterprises can freely go about their business hiring, producing, and then selling the goods that they have more correctly anticipated the consuming public actually desires to buy.

Under government central planning, however, errors committed by the central planners are more likely to have an impact on the economy as a whole. Centralized failures in resource use or production decisions more directly affect every sector of the economy, since nothing can happen in any of the government-run industries independently of how the central planners try to fix their mistakes. Everyone more directly feels the consequences of the central planners’ errors and must wait for those planners to devise a revised central plan to correct the problem.

Central Banking as Monetary Central Planning

Monetary central planning suffers from the same sort of defect. Changes in the money supply emanate from one central source and are determined by the monetary central planners’ conceptions of the “optimal” or desired quantity of money that should be available in the economy. Their central decision can indirectly influence the pattern of interest rates (at least in the short run) and the market structure of relative prices and inevitably bring about changes in the general value, or purchasing power, of the monetary unit. The monetary central planners’ policies work their way through the entire economy, possibly bringing about a cycle of an inflationary boom followed by general economic downturn or even depression.

The opponents of central banking have argued that the occurrence of such errors would be less frequent and discovered more quickly under a system of competitive free banking. Any private bank that “over-issued” its currency would soon discover its mistake through the feedback of a loss of gold or other reserves through the interbank clearing process and withdrawal by its depositors. The bank would realize the necessity of reversing course to ensure that its gold- and other-reserve position was not seriously threatened and avoid the risk of losing the confidence of its own customers because of heavy withdrawals by depositors.

Moreover, the effect of such a private bank’s following a “loose” and “easy” monetary policy would be localized by the fact that only its banknotes and check money would be increasing in supply because of the additional spending of those to whom that bank had extended additional loans. It could neither force an economy-wide monetary expansion throughout the entire banking system nor create an economy-wide price-inflationary effect. Any negative consequences, while being unfortunate, would be limited to a relatively narrow arena of market decisions and transactions.

Free Banking and the Benefits of Market Competition

One of the strongest arguments that advocates of the free market have made over the last 200 years has been to point out the benefits of competition and the harmfulness of government-supported monopoly. In a competitive market, individuals are at liberty to creatively transform the existing patterns of producing and consuming in ways they think will make life better and less expensive for themselves and other members of society as a whole. Wherever legalized monopoly exists, the privileged producer is protected from potential rivals who would enter his corner of the market and supply an alternative product or service to those consumers who might prefer it to the one marketed by the monopolist. Innovation and opportunity are either prevented or delayed from developing in this politically guarded sector of the economy.

This general argument in favor of market competition and against politically provided monopoly is no less valid in the arena of money and banking. The benefit from market-chosen money is that it reflects the preferences and uses of the exchange participants themselves. Participants in the market process will sort out which commodities offer those qualities and characteristics most useful and convenient in a medium of exchange. As the Austrian economists such as Friedrich Hayek persuasively demonstrated, while money is one of those social institutions that are “the results of human action but not of human design,” it nonetheless remains the spontaneous composite outcome of multitudes of individual choices freely made by buying and selling in the marketplace.

An Agenda for Monetary Freedom

So what steps might be undertaken to move the American economy in the direction of establishing a regime of monetary freedom? At a minimum, they should include the following:

1. The repeal of all central banking legislation, giving government or its appointed agencies authority and control over the monetary and banking system.

2. The repeal of legal-tender laws, that gives government power to specify the medium through which all debts and other financial obligations, public and private, may be settled. Individuals would determine through contract the form of payment they mutually found most satisfactory for fulfilling all financial obligations and responsibilities into which they entered.

3. Repeal all restrictions and regulations on the free entry into the banking business.

4. Repeal all restrictions on the right of private banks to issue their own bank notes and to open accounts denominated in foreign currencies or in weights of gold and silver.

5. Repeal of all government rules, laws, and regulations concerning bank-reserve requirements, interest rates, and capital requirements.

6. Abolish all government mandated bank deposit insurance requirements. Any deposit insurance arrangements and agreements between banks and their customers and between associations of banks would be private, voluntary, and market-based.

In the absence of government regulation and monopoly control, a free monetary and banking system would exist; it would not have to be created, designed, or supported. A market-based system would naturally emerge, take form, and develop out of the prior system of monetary central planning.

And a system of monetary freedom will have been established as an important complement to the creation of a truly free market society.

Richard M. Ebeling is a Professor of Economics at Northwood University, Midland, Michigan, USA.

Richard M. Ebeling will be our guest and present his lecture at the Conservative Economic Quarterly Lecture Series (CEQLS) to be held by the Conservative Institute of M. R. ©tefánik in Banská Bystrica on March 11, 2013 and in Bratislava on March 12, 2013. More information is available here.

Article was published in Slovak language in Conservative Letters 02/2013, a newsletter of the Conservative Institute.

    RSS English | Slovak










Conservative Economic Quarterly Lecture Series /CEQLS/

Templeton Freedom Award 2009




This website was created also thanks to funding granted by The Trust for Civil Society in Central and Eastern Europe.

Website powered by Metafox CMS from Platon Group.

Institute @ Fecebook

Conservative Institute of M. R. Stefanik
Bajkalská 29F
821 05  Bratislava

Tel.:  +421 258 100 188