Oh no: I’ve gone and punched the 100-percent wasp’s nest again, and the wasps are responding predictably. Among them Joe Salerno stands out like a hornet among gall wasps, for Joe is an outstanding historian of monetary thought, and no mean monetary economist generally. Besides, you just can’t dislike the guy. Were I forced by a libel suit to defend my claim about 100-percent reservers constituting a “moronic cult,” he would probably be defense exhibit F, to be resorted to only if exhibits A through E all managed somehow to evade the process servers.

One reason why Joe woudn’t do my case much good, besides the fact that he doesn’t come across as a moron and is capable of charming jurors, is that he is not among those 100-percenters who insist that fractional reserve banking is fraud. On the contrary: he’d rather not talk about that, and goes so far to avoid doing so as to claim, at the end of his post, that the fraud argument is something I’m “fixated” on, as opposed to one that Rothbard himself and Salerno’s MI colleagues have repeatedly raised, as well as one that has been particularly influential in building popular opposition to fractional reserves. Just search “fractional reserves” and “fraud” on Google and you will see the vast harvest of misunderstanding that this Mises-Institute fractional-reserves = fraud campaign has yielded. Even Congressman Paul has been taken in.

So why doesn’t Joe want to talk about the fraud argument? My hunch, based in part on some past exchanges with Joe on the subject, is that he doesn’t want to talk about it because he himself doesn’t subscribe to it. But if that’s the case, instead of pretending that it hasn’t been a prominent and particularly influential component of his colleagues’ criticisms of fractional reserve banking, why does he not join myself and others in discrediting it? His criticism would, after all, go much further in debunking the absurd claim than my own or that of other non-MI insiders.

In any event, it is the fraud argument that I particularly have in mind when I speak of a moronic cult. What I mean by “moronic” is what everyone means by it. A “cult,” if you ask me, is a group that defines its members-in-good-standing as those who never publicly question certain core beliefs, where the core beliefs are in fact irrational or otherwise false. The last requirement is crucial, for otherwise the beliefs would not serve to distinguish loyal members from the great unwashed. You can’t, for instance, form a cult around the belief that 2 + 2 = 4 or that that the earth is a sphere. But you can form one around the claim that space aliens are about to save the chosen from Armageddon, or that a drug-addicted commie charlatan is really Mahatma Gandhi’s reincarnation, or that banknotes are really property titles.

Another sign of a cult is that, when publicly confronted with irrefutable evidence against their core claims, members respond, if they respond at all, by presenting modified versions of the claims designed, like so many planetary epicycles, to evade the original falsification, though only by erecting a different falsehood. Thus when the patent absurdity of their original fraud claim, to the effect that bankers were ripping-off their own depositors, was exposed (e.g., by pointing out that the “ripped off” depositors were receiving interest on their supposedly embezzled funds, and that were fraud really in play entrepreneurs ought to have been able to make a killing by exposing it while offering ironclad 100-percent alternatives), the “fraudists” (as I’ll call them to save space) responded with a new theory, to the effect that, rather than defrauding their own clients, bankers and clients together took part in a conspiracy to defraud the rest of the money-holding public, by reducing money’s equilibrium purchasing power. (Those conversant with welfare economics will recognize in this argument, among more obvious absurdities, a confusion of pecuniary and non-pecuniary externalities. In plain English, if by coming up with a new mousetrap, A reduces the market value of old-fashioned mousetraps owned by B and C, that effect is a “pecuniary” externality, and as such would generally not be considered evidence of a violation of B and C’s property rights.) Confronted by arguments to the effect that the difference between either demand deposits or demandable bank notes and time deposits is a difference not in kind but merely in degree, the fraudists reply by claiming, as Rothbard himself never did, that fractionally-backed time deposits are also fraudulent, and should therefore be banned as well. (Cf. Emerson on foolish consistency.) By hook or by crook, in short, the fraudists remain wedded to their core beliefs, shrinking from no argument or ground-shifting, however fatuous, that might appear to rescue them from otherwise damning criticisms, if only by exposing them to others equally if not more damning.

So much for fraud and cults. What about the criticisms Salerno aims at me? He says that I’ve become a sort of “‘standing joke” among young students of Austrian economics. Perhaps I have become such among students who have been drinking too much MI kool-aid; but most of the comments and correspondence I get after doing one of my wasp-nest acts, itself mainly from students, suggests a rather different reaction. Unless I’m mistaken what Salerno is observing is evidence of a self-selection process that is, shall we say, not lighting-up Mises Institute seminars and forums with only the brightest of sparks. (I’ve no doubt that for the same reason any reference to “globe-ists” at Flat Earthers’ annual conventions is always good for a belly laugh.)

Turning to a (somewhat) more substantive criticism, Salerno tries his best to blacken me with the “Keynesian” brush by observing that I believe in money wage rigidities. Although the observation itself is perfectly true, the Keynesian tag is a calumny, and one that for once has Joe displaying a very faulty grasp of the history of economic thought. For as he ought to know, and as Auburn’s own Leland Yeager has gone to great pains to make clear in his usual, eloquent manner (see his essay “New Keynesians and Old Monetarists,” in The Fluttering Veil), Keynesians didn’t discover or invent the idea that wages may be inflexible, which was a commonplace long before the General Theory was published, and one that played and continues to play a central role in the writings of both “Old” and “Market” Monetarists. What’s more, if Axel Leijunhufvud is to be believed, Keynes himself based his own, peculiar arguments for expansionary monetary and fiscal policies not on the (then conventional) assumption that wages were sticky downward, but on his claim that, even if they weren’t sticky, full-employment could not be recovered by simply letting them adjust downward. (As Yeager points out the beliefs of “New” Keynesians in this respect resemble not those of Keynes himself but those of “old” Monetarists.) Finally, Rothbard, who before the advent of New Classical economics was almost unique in supposing that there was nothing to prevent wages from quickly moving to their new equilibrium values following an adverse demand shock, was never able to hold this view consistently. In America’s Great Depression, for example, he dishes it up in his early, theoretical chapters, only to go on to claim that Hoover contributed to the depression by resorting to policies that…kept wages from falling! Well, wage rigidities didn’t suddenly make their appearance during Hoover’s term, although he certainly made them worse, as did FDR to a still more destructive degree. Nor did they disappear when Truman took office. That wages did come down rapidly, along with other prices, following the post-WWI boom, thereby making for a short-lived bust of 1920-21, was partly due to the far less important role of labor unions in those days, and partly due to the fact that people had good reason to anticipate, and to therefore go along with, a post-war decline in equilibrium prices and wages.

The question whether wages are in fact rigid or not is, in any case, not one that can be settled by simply labeling the claim that they are rigid “Keynesian.” It is an empirical claim, and as such one that can be settled only by referring to empirical evidence. I happened so supply some such evidence in the course of a recent exchange with the Market Monetarists, in which I posted the following graph:

Here, it seems to me, is rather compelling evidence of wage stickiness, as indicated by the utter failure of hourly compensation to adjust downward in response to a massive collapse of spending–a collapse that presumably ought to have meant a corresponding re-alignment of other equilibrium nominal values. If what Joe calls the “Keynesian” view of things is correct, the failure of wages to adjust with spending should have been associated with a corresponding rise in unemployment; if on the other hand Joe’s own view is correct, there should be no close correlation between the “gap” between the series above and the rate of unemployment. I suppose my readers can guess which view squares most readily with the evidence, but here for good measure is the unemployment plot:

Don’t get me wrong: I know that one can also tell a story about labor mis-allocation and consequent structural (as opposed to ordinary cyclical) unemployment; moreover I believe that that story gets to part of the truth. But why make it the whole story? Why pretend that unemployment only did what it would have done even if nominal spending had never collapsed?

As for the collapse in spending itself, allowing that it reflected “the voluntary decisions of individuals to alter the amount of money they desire to hold,” it hardly follows that that made it harmless. On the contrary: the increased demand for money would, unless accompanied, and accompanied relatively swiftly, by a compensating decline in prices and wages, would necessarily imply a shortage of real money balances. By Walras’ Law that money shortage would have as its necessary counterpart a matching surplus (excess supply) of things-other-than-money, including goods and labor. In other words, it would mean recession and unemployment.

As for my seeing (“like any garden variety Keynesian”–ouch!) “fluctuations in aggregate demand as a market failure that must be offset by Fed policy”…well Joe, I’m afraid that’s really quite a howler, isn’t it? I might have expected it from some others of the anti-fractional reserve persuasion, but from you? Say it ain’t so Joe! Say that you haven’t forgotten that I’ve written a thing or two about how AD wouldn’t be so unstable were ours a free banking system. Say that you really do know the difference between a claim of market failure and one of government failure! Admit that when you suggest that I “want” the Fed to manage the money stock, it’s to score a cheap point against me in the hope of impressing gullible reader’s of The Bastiat Circle, and not because you really aren’t aware of my desire to see the Fed abolished, along with all other central banks. As for my betraying my cause by endorsing Fed activism as a second-best solution, if that seems so, it is only because it’s damn hard to point out that the Fed has screwed up without implying some “ideal” conduct that would have been better, which is surely not the same thing as imagining that the Fed can ever be expected to behave in such an ideal fashion. If that’s betraying my ideals, call me guilty.

Joe’s account of my ideas concerning how free banks evolve also bristles with misrepresentations. True, I say that eventually the banks might make do with very little monetary gold. But the transition to such a state of affairs would presumably be a very gradual one, and would proceed, not from some fictional 100-percent reserve starting point, but from that of established fractional-reserve ratios already in low double-digit (if not single digit) territory. So there’s no reason to assume that it would involve substantial, let alone “massive,” inflation. Neither is there any reason to suppose that bank money would “in effect become” fiat money. Nothing in the evolutionary process I describe points to a change in the status of note and deposit contracts as redeemable claims to standard money, and it is impossible to see how competing banks might convince their customers to voluntarily agree to any such change.

Fiction is also the word for Joe’s predictions concerning other likely consequences of a move to free banking. Like many of his MI colleagues and followers, he here speculates as if the possibility being contemplated were a perfectly hypothetical one, for which actual empirical evidence is lacking. But that’s just not so. Free banking has existed, not in some pristine version of course, but in approximations close enough to allow reasonable conclusions to be drawn about unregulated reserve ratios and such. So, did the most free of all banking systems, lacking central banks but also lacking any barriers to 100-percent reserve banking or subsidies to fractional reserve banks, exhibit the high reserve ratios to which Joe referred in testifying to Congress? Not at all. On the contrary, the freest systems, including Scotland’s (ca. 1750-1845) and Canada’s (ca. 1873-1914), had remarkably low reserve ratios. If 100-percent reserves are your thing, freedom in banking doesn’t appear like a good way to have them. Better to call out the anti-bank vigilante squads, or just have the law itself set things right (as the fraudists would presumably empower it to do).

Concerning Joe’s frenzied final paragraph, all I can say is that I hope he had himself a good stiff drink after writing it, and that he’s feeling a lot better now.

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George Selgin

George Selgin is a Professor of Economics at the University of Georgia's Terry College of Business. He is a senior fellow at the Cato Institute. His writings also appear on www.freebanking.org. His research covers a broad range of topics within the field of monetary economics, including monetary history, macroeconomic theory, and the history of monetary thought. He is the author of The Theory of Free Banking, Bank Deregulation and Monetary Order, and several other books. He holds a B.A. in economics and zoology from Drew University, and a Ph.D. in economics from New York University.