George Selgin and the Rothbardians are having quite a lively exchange regarding 100% reserve banking. It has got to be the most entertaining exchange I have seen in a while, complete with colorful barbs. What I find most interesting about it is that George is doing what I have been waiting for someone to do for quite a while – letting others take a peek behind the mask of the modern Rothbardian movement, particularly regarding 100% reserve banking.

I don’t intend to address reserve banking theory here, only to toss out facts as I know them. Fractional reserve banking has been a part of banking in the United States since the very early days of our republic. Without it, water projects that were undertaken in the early 1800s that helped fight malaria along the northeastern seaboard would never have materialized. The creation of the Bank of Manhattan (which is now a part of JP Morgan Chase) to handle the financing for these projects was a part of the political deal that allowed Thomas Jefferson to become President.  I posted other information about banking in the early 1800s and the historical role of gold here and here. When I wrote those posts, however, I didn’t directly challenge some of the basic tenants of, as George puts it, “the moronic cult” regarding the gold standard and 100% reserve banking, but rather put some anecdotal historical evidence out there for others to look at, digest, and see how well it fits the modern narrative.

It is my opinion that the Rothbardian movement of today has nothing to do with freedom in banking, freedom of choice in money or free markets. They rail against the Federal Reserve, but I wonder how 100% reserve banking and a gold standard would be enforced without some government entity to set the standards and police it.

During the century before the establishment of the Federal Reserve, the number one political complaint about banks was suspension of the redemption of their notes for specie during economic downturns. Since the pre-Fed “gold standard” meant that government would only accept gold in payment of taxes and fees, it was not a broad-based domestic monetary standard, when people could not exchange their general-use bank notes for gold, they could not pay their taxes. This became a particularly large problem during the Panic of 1907 when the Federal Government was consequently put into financial dire striates which was the driver for the creation of the Federal Reserve, the government monopoly on money, and the broad-based domestic gold standard in 1914.

It might seem that perhaps I am making their argument for them, but what I wish to point out is that there has never been enough gold in our economy to serve our economic interests even when only the eastern seaboard was economically developed, hence the free market creation of bank notes and other money substitutes with widespread use of fractional reserve banking. It did create periodic problems, but I wonder if those problems were worth what we got from it when to move to a strict gold standard and 100% reserve banking would necessarily move society back to the Stone Age. We’ve already tried something close to that with the beginnings of the Federal Reserve and prohibition of private money substitutes that lasted only 15 years before it broke down and ended with the Great Depression which was much worse than any of the prior downturns. It might even be reasonable to assume that if free banking had still been in existence, there would have been no “Great” in the Great Depression. Of course the Rothbardian view is there wouldn’t have been a downturn at all because the preceding extension of credit would have never taken place.  I wonder if they could have sold that line of reasoning to Henry Ford; nothing at all good comes from extension of credit. And this highlights our differences. I say the Federal Reserve was irresponsible for tightening and causing deflation. They say everyone else was irresponsible with credit and it is better for everyone if we never have any money or credit at all because, when we have these, we take it to the casino called capitalism of which they are terrified.

It is very easy to look at the front end of what we have going on today through the bias of information lens and call it evil without any coherent understanding of the kind of economic world the Rothbardians advocate where living standards would be much lower. They wish to prevent all of the evils of economic downturns by suppressing all activity for which there is no gold to match. No excess activity, no bust (one cannot lose what one never had). No excess activity, extremely slow economic development. All I have to say to these people is, “You first! Give up that SUV and the cozy little digs you bought with your counterfeit money during the artificial boom (you never paid real money for them or you financed them through fractional reserve banking so they aren’t yours); and grab a pitchfork on your way out because you’re certainly going to need it in order to scratch a living off rocks.”

Imposition of that kind of world on the rest of us will never fly. Most of us are having problems swallowing the economic effects of tight fiat money, and it is quite doubtful we would enjoy the rabid Rothbardian world that would be unfathomably tighter. It is sad that they bottle and sell their snake oil as a remedy for all of our economic problems without telling the truth about the trade off.

[Update] Evan Soltas found this Keynes quote from 1932 that is too true about today and I couldn’t let it go without fitting it in somewhere.

In the United States it is almost inconceivable what rubbish a public man has to utter to-day if he is to keep respectable. Serious and sensible bankers, who as men of common sense are trying to do what they can to stem the tide of liquidation and to stimulate the forces of expansion, have to go about assuring the world of their conviction that there is no serious risk of inflation, when what they really mean is that they cannot yet see good enough grounds for daring to hope for it.