Exclusive Interviews
George Selgin on Austrian Finance, Central Banks and the Virtues of Free Banking
By Anthony Wile - April 18, 2010

Introduction: George A. Selgin is a professor of economics in the Terry College of Business at the University of Georgia, a senior fellow at the Cato Institute in Washington DC, and an associate editor of Econ Journal Watch. Selgin formerly taught at George Mason University, the University of Hong Kong, and West Virginia University. Selgin's principal research areas are monetary and banking theory, monetary history, and macroeconomics. He is one of the founders, along with Kevin Dowd and Lawrence H. White, of the Modern Free Banking School, which draws its inspiration from the writings of Friedrich Hayek on denationalization of money and choice in currency. A central claim of the Free Banking School is that the effects of government intervention in monetary systems cannot be properly appreciated except with reference to a theory of monetary laissez-faire, analogous to the theory of free trade that informs the modern understanding of the effects of tariffs and other trade barriers. Selgin is also known for his research on coinage, including studies of Gresham's Law and of private minting of coins during Great Britain's Industrial Revolution, and for his advocacy of a "productivity norm" for monetary policy – a plan that would have policymakers target the growth-rate of nominal gross domestic product at a level that would allow the overall price level to decline along with goods' real (unit) costs of production.

Daily Bell: How did you develop your interest in economics?

George Selgin: The story of my becoming interested in economics is actually rather complicated. My childhood dream was to be a marine biologist or oceanographer, and those remained keen interests of mine through college. I ended up adding an economics major partly at my father's urging. In fact my father absolutely loathed Friedman and Rand and all the free-market people, and looked forward to my becoming a socialist. So he was very disappointed when my beliefs turned the other way.

Daily Bell: Did he eventually relent?

George Selgin: Yes, his own thinking changed after the collapse of socialism, so he was actually proud of me when, a few years before he passed away, I showed him the copy Milton had sent me of his letter recommending me for tenure!

Daily Bell: You studied Ayn Rand's philosophy as a young man. How much of an Ayn Rand fan are you?

George Selgin: Like so many others I became a fan of free markets by reading Atlas Shrugged as an undergraduate. But I didn't consider myself an objectivist for very long, if indeed I ever thought of myself as one. Encounters with self-styled objectivists while I was studying economics at NYU finally settled the matter for me. Their way of arguing reminded me of so many talking dolls – the same catch phrases would keep coming up, that were supposed by the objectivists to be unanswerable, but which mainly left me scratching my head. One I recall was, "You cannot have a market for a market." That was the explanation for why anarcho-capitalism wouldn't fly.

Daily Bell: What did it mean?

George Selgin: I still don't know what it was supposed to prove. Since them I've met many objectivists who seemed perfectly reasonable; but then I also became increasingly unwilling to identify myself with ideologies or labels of any sort.

Daily Bell: Do you consider yourself an Austrian economist?

George Selgin: While at NYU I did consider myself an Austrian and, more precisely, a Misesian. Despite the influence Hayek's Denationalisation of Money had on me, I came to regard him as rather too namby-pamby for me! But that attitude didn't survive my first few years in the profession, which taught me that, if I was really going to be a scholar – and by then that was what mattered to me most – I needed to forget all about schools of thought and such. That is, I decided that I preferred being an independent thinker to being a representative-in-good-standing of this-or-that school or ideology. What's more, I decided that having an ideology or identifying with any school was just going about things the wrong way, by starting with a set of answers before researching a question.

Daily Bell: That sounds like a tough road – "less traveled."

George Selgin: I no longer refer to or even think of myself as an Austrian economist, or as any sort of "free market" economist. If other people think I'm one of those things, that's fine – but I don't conduct my research with any thought of making such labels fit. There's a cost to this, of course: people may think I'm being ungrateful; and I certainly feel very lonely at times. But it's the only way I know in which to stay true to my values.

Daily Bell: Tell us how you developed your interest in free banking.

George Selgin: After college I first tried to combine my main interests by working toward a degree in marine resource economics at the University of Rhode Island. The program turned out to be a disappointment to me – neither fish nor free-markets, you might say; just one Hamiltonian equation after another.

Daily Bell: We have trouble visualizing you as a marine biologist.

George Selgin: To keep my brain from rotting I decided to spend my spare time reading up on economic subjects I hadn't had a chance to study in college. I started with monetary economics simply because I wanted to get what seemed to me the hardest subjects out of the way first. I read everything I could get my hands on, particularly concerning inflation (which was the big issue back then). Some of the books were very bad indeed; others less so. But then I read Henry Hazlitt's The Inflation Problem and How to Solve It, and the scales fell from my eyes! Next came Mises's Theory of Money and Credit, which in turn led to my reading Hayek's Denationalisation of Money. That hooked me.

Daily Bell: You took human action?

George Selgin: I quit URI and applied to the Institute for Humane Studies for a summer grant, which allowed me to write a long essay on "Free Banking and the Monopoly of Money" that contained the germs of much of my later research. While I was working on the project the institute's president, Walter Grinder, sent me a couple chapters from Larry White's dissertation, which was itself still in process then, on the Scottish free banking system. After reading them I wrote Larry, asking him to let me know as soon as he got a job, because I intended to study with him. So we both turned up at NYU at the same time, and have worked together ever since.

Daily Bell: Can you please compare Austrian economics and free banking.

George Selgin: I suppose that all self-styled Austrian economists favor "free" banking, understood to mean banking with no special government regulations or barriers to entry. However, [free-market Austrian economist] Murray Rothbard believed, and his followers continue to believe, that in the absence of special government interference all banks would hold 100-percent reserves – presumably of gold or silver coin or bullion –against any of their notes or deposit balances redeemable on demand.

Daily Bell: You don't hold that view?

George Selgin: Larry and I and other non-Rothbardian students of "free banking" generally take for granted that unrestrained market forces would favor "fractional" reserve banking. The disagreement has given rise to numerous articles from both sides. As these are readily available there's no point in my trying to summarize them.

Daily Bell: It's been a passionate debate because Murray Rothbard has proven a very powerful force in Austrian economics, especially in the US.

George Selgin: I am always shocked when I read some Rothbardian assertion to the effect that "if we had real freedom in banking, banks would be forced to hold 100 percent reserves, or something close to that," as if the question were entirely hypothetical and there was no empirical evidence to draw upon. In fact, there have been many past episodes of free banking, or of banking that was approximately free, and every one of them refutes the claim in question.

Daily Bell: That brings us to Scottish free banking.

George Selgin: In the Scottish free banking system, which flourished from roughly the mid-18th century to the mid-19th, banks often held gold reserves equal to less than 2 percent of their combined notes and demand deposits. Yet the system performed very well, with what were (in comparison to other arrangements both then and since) very meager banknote and deposit-holder losses. The Scottish people were in fact so trusting of their banks that they considered it a nuisance to be handed a gold coin rather than a Scottish banknote.

Daily Bell: Can you be more specific on some points of controversy?

George Selgin: At one point Rothbard wrote an article in which he made several claims to the effect that the Scottish system wasn't truly free. In particular, he suggested that Scottish banks relied upon the Bank of England as a lender of last resort. The claims – particularly the one mentioned here – were generally untrue; and Larry wrote a couple articles pointing this out, the gist of which he later incorporated into the second edition of Free Banking in Britain. Yet several of Rothbard's followers continue to repeat his old arguments, ignoring Larry's detailed rejoinders. This gets pretty tiresome after a while!

Daily Bell: Give us some background on US "free banking."

George Selgin: No less tiresome is some mainstream economists' habit of claiming that free banking was tried in the U.S. before the Civil War, where it flopped. But although its true that a number of U.S. states passed so-called "free banking" laws, those laws didn't provide for "free" banking in the literal sense. They established something like general incorporation procedures. But they also subjected banks to some onerous regulations. For example, they all disallowed branch banking while requiring banks to back their notes with particular assets. Economic historians have since shown that these and other regulatory restrictions were the most important cause of failures among U.S. "free" banks.

Daily Bell: Why hasn't free banking caught on, worldwide in the modern era?

George Selgin: There are two reasons, in my opinion, why genuine free banking has not "caught on," despite its past successes. The first is that central banking, which entails, among other things, the monopolized supply of paper currency, is a boon to national governments, which obtain routine financial favors from their central banks in return for rewarding them with currency monopolies. To the question "qui bono" asked with respect to central banking, the most obvious answer is always: the national treasury. But this doesn't really get to the heart of the matter, for if their fiscal advantages alone could sustain privileged monopolies of any kind, we might still have government-sponsored salt monopolies and such.

Daily Bell: The second reason?

George Selgin: The fundamental reason why central banks, which are essentially mercantilist institutions, survive today is because they have managed to secure economists' blessing. This blessing in turn reflects economists' tendency to treat monetary instability as a problem inherent to free markets, which only central banking can address, instead of seeing central banks themselves as a principle source of monetary instability, as they might were they to study monetary history more carefully than most do. Consequently economists have come to apologize for government currency monopolies, despite having long condemned such monopolies in other realms, and for good reasons.

Daily Bell: How do you see the near-term future of free-banking?

George Selgin: I'm convinced that, if we are ever going to see progress toward free banking, and away from our present reliance upon central banks, we must first work to alter the conventional wisdom among economists. Until that wisdom is itself modified, there's no point in trying to change the minds of policymakers. Policymakers aren't in the business, after all, of adopting radical ideas, that is, ideas that find little favor among academic experts. Free banking can perhaps gain popular support once it ceases to be a radical idea among academics, but not before.

Daily Bell: Give us an update on your current research and professional activities.

George Selgin: Although I remain committed to my original research program, devoted to exploring the workings of market-based monetary systems, I've been increasingly inclined to steer away from the broadly "macroeconomic" topics that were my main preoccupation until a decade ago or so to more specific "microeconomic" inquiries, that is, and especially ones devoted to up-close examination of various historic arrangements.

Daily Bell: What subjects are you writing on?

George Selgin: My most recent book, Good Money, is an example – it explores in considerable detail the origins and workings of a private coinage arrangement that sprung up during Great Britain's Industrial Revolution; and I've recently finished a first draft of a paper examining the circumstances surrounding the turn to fractional-reserve banking by London's 17th-century goldsmiths. But not all of my work is either so focused or so exclusively concerned with history. One of my other projects, which Larry is also working on, is a general assessment of the Fed's performance since its establishment in 1914. We hope it will convince people that, whether free banking seems worth pursuing or not, there's every reason to be dissatisfied with our present arrangement.

Daily Bell: Thank you for taking the time to share your views with our readers.

George Selgin: It was my pleasure.

After Thoughts

George Selgin, along with his mentor Lawrence White, blazed an original trail in the late 20th century that virtually resuscitated the concept of free-banking. Free-banking is simply the idea that a bank (or any entity operating as a bank) is free to accept deposits and loan money beyond the deposits it has on hand. This banking methodology is known as fractional banking and evokes strong feelings within the free-market universe.

The United States economy was in a sense based on free-banking, even after the Civil War, and until the advent of the Federal Reserve in 1913. However, the US never offered an entirely free-banking economy – given the Constitutional definition of money-as-silver – and bank owners often found they could not be chartered without buying a good deal of municipal (local) debt.

Famous free-market economist Murray Rothbard has suggested that local American debt was often questionable and made bank balance sheets unstable – leading to bank runs. This gave American free-banking a bad name, leading to the appellation "wildcat" banking. Thus we could argue that untrammeled free-banking was never implemented in the US.

Where are we now? Today, in America and around the world, banks function with fiat-money fractional reserves, and Ben Bernanke has suggested doing away (recently), even, with those. The idea is that within a central bank money environment, banks are basically distribution centers for debt-based money and it does not matter whether they have additional "funds" within their coffers or not.

Bernanke's position in fact is simply a recognition that the banking system, not based on gold and silver money, is really only an imitation of what once existed. Today, the Fed and other banks could just as easily disburse paper and electronic money directly to businesses and consumers – but that would mean bypassing the banking system that is a main feature of modern societal power and control.

The current system obviously does not work very well. Free banking would be one solution. Yet free-banking – which Selgin and others believe has proved viable for long periods of time in the past, especially in Scotland, and less well in the US (to the degree that it was implemented) – remains a controversial subject.

Free banking arouses strong passions. Anti-free bankers have suggested than anything other than a 100 percent gold standard – when it comes to securing money in banks – would be something of a criminal endeavor, even in a free-market society. Beyond that, and regardless of the degree of criminality, the position of anti-free bankers remains that the marketplace itself would immediately reject a banking system that did not back deposits fully with precious metals.

The crux of the argument within free-market circles, therefore, is whether or not free-banking (fractional reserve banking) is (1) an acceptable behavior and (2) a practical one. Free-banking backers (and we are partial to free-banking) would respond that (1) the market should be allowed to decide whether free-banking is acceptable and (2) the practicality of free-banking has been proven by past episodes.

Ultimately, we don't believe that money is so complicated as people make it out to be. Money, historically, is gold and silver and governments (historically) have done anything and everything in their power to control money and to substitute paper and – now – electronic media in its place. But inevitably substitute money media is abused and inflated and history shows us that sooner or later gold and silver tend to circulate once again within the context of an honest money standard.

So here is the question. What would be a default standard in a truly free-market economy? We would suggest that one answer might be free-banking where anyone is able to offer a warehousing service for gold and silver and issue paper notes (receipts) that may be accepted at least locally as cash. Additionally, we would suggest individuals or entities doing the warehousing would be entitled to pursue fractional reserve banking so long as it was disclosed.

Is it wrong to let the market decide on what kind of banking works? Free-banking, fractional reserve banking, even central banking (or a variant thereof) all seem logical to us so long as they are pursued within a free-market context. It may even be that the marketplace would determine a 100% gold reserve to be ideal. But the point is, let the market decide. The problems begin when government steps in. Then distortions, bad-dealings and destructive inflation (and price-inflation) are inevitable when they do. In our opinion, a private marketplace for money would sort out these problems through competition and people's natural inclination to be prudent (for the most part) about their hard-earned money. See, maybe it's not so complicated after all.

Dr. Selgin's interview was edited on receipt. Bio excerpted from Wikipedia.

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