Economists and the Myths of Central Banking

0:00My topic today is Economists and the Myths of Central Banking. The important point about the whole notion of central banking is that it was developed by basically free market economists, economists we would think of as free market economists. And also the case itself was pretty much comprehensively presented during the 18th century, the early 18th century. And it was demolished throughout the 18th century. The individual who is known as sort of the father of central banking is John Law. And I'll get to a few events of his life in a moment, since it seems that the morals of bankers are now fair game. We can go a little into some of the adventures in Law's life.

0:48But later on in the century, as I'll go through briefly, other economists, almost all other economists of note that wrote during the 18th century, certainly British economists and some French economists demolished the case for central banking not only were they opposed to central banking but the best economists of the 18th century were completely opposed to fractional reserve banking completely they all favored 100% banking in fact some went as far as to say that every man should be his own banker they even opposed the issuing of paper banknotes backed by 100% gold In particular, an individual named Vandalin wanted a complete gold and or silver currency, okay?

1:35So, given that the case for central banking was destroyed intellectually in the 18th century, how is it that today, right now, we're in the midst of our third and hopefully our final crisis of central banking of the 20th century? As we see, every crisis in central banking brings forth arguments and apologies by economists for central banking and proposals to extend it even further. It's sort of like the welfare state or even civil rights legislation. If it fails, if some of it fails, well then it must be that there's too little of it. We have to have more of it. Now the exception that I mentioned, the person who was not opposed to, in fact, favored fractional reserve banking, was Adam Smith, who was known as someone with impeccable free market credentials.

2:30So let me go through some of the early arguments, and then we'll talk about some of the crises of central banking and how economists have responded. In particular, how economists are today responding to the SNL we're living through and we have been living through in the 80s. Some very interesting responses. In fact, as we'll see, there are calls for a global central bank now on the part of Keynesians. And we'll go through some of those ideas. As I mentioned, John Law was the first central banker. Not only did he develop the first intellectual case, but he actually was, in practice, a central banker.

3:16Let me just go through some more notable incidents in his life. He was born in Edenburg in April of 1671. In 1871, he inherited a great deal of money from his father and wasted it on riotous living so that by 23 he was broke. Shortly thereafter, still in his early 20s, he killed a man and a dual over married woman who was convicted of murder and sentenced to death. He was pardoned by the king. He had a silver tongue, so he persuaded everyone. But then on appeal he was thrown back in jail and finally bribed the jailer and escaped to the continent. This was all before he could print money up on his own. He remained in jail for six, rather he remained on the continent for six years earning money by gambling.

4:07In 1705 he wrote his best known work, proposing reform of the Scottish currency, which basically call for what is now a modern central bank. In 1708, while gambling in Paris, he met the duke of Orléans who became the regent to the young king. So that when the king was having problems with his finances, he took to law's scheme. He asked law to set up what in effect became a central bank. of the Central Bank, and within four short years, law had set off a massive speculative orgy in France and had caused a hyperinflation, almost single-handedly destroying the French currency.

4:52So the Central Bank, the first Central Bank, there was the Bank of England, which was quasi-Central Bank at the time, but the first sort of full Central Bank collapsed within four years. So what were some of Law's doctrines? They're very recognizable. First of all, Law claimed that the king was the owner of the money supply, meaning that money should be used by the king as a tool, as a tool of policy. He also believed that money is a voucher for buying goods. No one should hold money. As soon as you've got money, you should go out and spend it right away. It was illegitimate to stop up the money supply, so he was very, very against hoarding.

5:37He believed, in fact, when people spent less, it thrusts the economy into a deep recession. Also, he believed that the fact that prices went up and down under a gold and silver standard, gently, but still the fact that prices changed, that prices weren't completely and rigidly stable, He believed call for government action, as most economists today believe. And because he believed that gold and silver would always be somewhat unstable, because they are determined by supply and demand. The price of apples fluctuates, the price of McDonald's hamburgers fluctuates, the price of everything fluctuates. Anything that's bought and sold on a market is going to fluctuate in price, as people's values change, as the supplies of the goods change.

6:25And this of course is true of gold and silver. So, he was against gold and silver, and in fact he believed that they represented a massive waste of resources. He was in favor then of paper money. Now, how to get paper money into circulation? He believed that the way to do so was by an institution that had already been established in the 17th century, and certainly in the English speaking world, banks. People tended to trust banknotes, so he wanted to use banks as a way of inflating the money supply. In fact, he was one of the first economists that pointed out that when banks lend money, they increase the money supply, okay?

7:11That took most economists, the economic profession as a whole, didn't fully realize that until the early 20th century. And on top of the banks, he wanted a central bank. He believed that the central bank would issue notes by buying and selling mortgages and land, which is very comparable to today's open market operations, buying and selling government securities. And in that way, it would manipulate the money supply and assure stability, stability of the price level. So his ideas are very, very modern. He wanted to stabilize the price level, also something I didn't mention. He believed that interest rates were always too high. You always had to push them down. Now, if you push them down, you would increase investment spending and that would increase income. So he was in favor, as modern Keynesians are, of continuously pushing down interest rates.

7:58So the seeds of both the two great schools of macroeconomic thought in today's world, the monetarists, who were in favor of stabilizing the money supply, and the Keynesians, who were in favor of pushing down interest rates, were in law's writings and thought. Now, as I mentioned, the 18th century, the later 18th century, saw a number of writings by economists that looked at the law's practical experience, the experience of the bank, and opposed it, and opposed its intellectual case for banking. I'll just name some of the writers, some of the more important writers are Richard Cantillon, Jacob van der Linde, David Hume especially, and a French economist named Turgot, T-U-R-G-O-T Basically, their writings were a reaction to law, and they were very, very hard money, okay, they wrote throughout these writings, outpouring of these writings throughout the 18th century Let me just focus on Turgot, briefly give you his response to law.

9:05He was a French economist and a statesman. He was staunchly in favor of laissez-faire, laissez-faire economy, and he was also staunchly opposed to all but 100% banking. Not a tool of government to be used. It arises on the market from barter, it arises always as a useful good. He said that all money is essentially merchandise. All of the merchandise, supply and demand determines and should determine the value of money. And gold and silver were chosen by the market for good reason. They had all the qualities that fit them to be a good money. They're very durable, their supply increased very slowly over time, and so on.

9:51And finally, he said to the lawyer, he said, look, he responded directly to the lawyer, he said, You claim that money is always in short supply, but the point is, if there really is a shortage of money, the market will immediately respond by increasing the value of money, that is, lowering prices. There's nothing wrong with lowering prices. We see, for example, in the high tech industries in the 80s, that as the supplies of goods and services have increased due to technological innovation, we've had a fall in costs and prices. This is a natural development or evolution of the market economy. We don't have to be worried about falling prices. In particular, we don't have to turn over the whole monetary apparatus to the government to prevent them. And he said that nothing can ever be stable. Nothing that's exchanged on the market can ever be perfectly stable in value.

10:37It's not something that we desire. Regarding paper money, he said that it can never be issued by the king in a way that gives everyone who wants more money that exact amount. In other words, what he was getting at was that when you issue paper money, you're going to redistribute people's incomes. The people that get it first are going to find their real incomes going up. People who get it last or people on fixed incomes are going to be defrauded. So he made that very important point. And he also pointed out that fractional reserve banking is unsound. He said, look, what if a merchant who needed to invest more in his business took out call loans, loans that could be called in by the lenders at any time, and then invested this money in his business in a one-year or two-year program of expansion.

11:26He'd go bankrupt very quickly, Virgo pointed out. He says this is exactly what fractional reserve bankers do. So the case for central banking was pretty much demolished by the end of the 18th century and for fractional reserve banking in general. How was it revived? It was really revived by Adam Smith, interestingly enough. Adam Smith, like his predecessors in the 18th century, opposed most of law's ideas, to be fair. When it came to banking, and I'm quoting here, he referred to law's splendid but visionary ideas, which contributed to an excess of banking. So he only was worried about an excess of banking. He thought that fractional reserve banking was great. He thought it was great for the following reason.

12:14He felt that all the gold and silver that were lying in people's cash balances, their money holdings, were simply wasted resources. He said that we can save our resources just as if we could build a wagon. He called it a wagon way through the sky. If instead of a costly highway we could somehow have a wagon way through the sky which didn't absorb any resources, which allowed wagons and carts to simply fly over the land, which is fine fantasy, but the metaphor itself is crazy. And then applying for money is doubly crazy. So he believed that we could save our resources by having banks print up money. Now here, he said, well, when banks print up money, he knew the 18th century analysis, which was that when you print up money, you raise prices in the economy, in the economy, you redistribute incomes, and that drives gold and silver out of the country in the form of balance of payments deficits.

13:12So you get rising prices, you get a depreciating currency, but Smith, this is what he believed was a theoretical innovation. He said, no, we're not going to get rising prices. He said, sound banks, he uses the term the judicious operations of banking. If banks just restrict the amount of money that they inject into the economy to the needs of business, well then what will happen will be that the gold and silver will automatically leave without raising prices. We won't have an increase in prices. So here he diverged from law and from the other 18th century economists. So the point is that his prestige and influence now legitimize fractional reserve banking after its intellectual supports have been completely destroyed and, in effect, he really changed the course of British monetary theory which would have continued to develop in a very hard money fashion without his writings now what's interesting is that he then said that he was in favor of free banking that is, he wanted to get the government completely out of banking

14:20he believed that the banks followed sound rules of finance, that everything would be fine He never really criticized the Bank of England. In fact, he called it a great engine of state. He seemed to be comfortable with it. In fact, he sort of whitewashed it. He said, there's any inflation, it's not really the Bank of England's fault. It's the fact that the government's putting too much pressure on them to loan the government money, finance deficits. And this is going to come up again later in the 19th century, where central bank, Three bankers aren't necessarily opposed to central banking.

15:00Let me just mention, so we can get to the 20th century, just let me briefly mention how the idea of central banking developed in the 19th century. In the early 19th century there was a debate between hard money, anti-inflation type economists called the bullionists in Great Britain. The Bank of England began to refuse to pay gold and silver out for their notes in 1797, it was legitimized by the government, it was called a bank restriction or suspension. And predictably prices began to rise rapidly in the early 1800s, exchange rates depreciated, the price of gold went above its mint par, and the bullionists said well that's the result of inflation. The Bank of England is now not restrained by paying out gold for its notes and therefore it's inflating as we would naturally predict.

15:54The anti-bullionists oppose the bullionists and they claim that anything and anybody but the Bank of England was responsible for the rising crisis. Bad harvests, military spending, country banks and so on. Now out of this debate came one of the most, what I consider to be the most overrated and muddled thinkers in the history of monetary thought, a guy named Henry Thornton, and without really going through in detail what he had to say, basically what Thornton said was that fractional reserve banking is great, and central banking is great, however fractional reserve banks will tend time to time to get into difficulty, they won't be able to to always pay out gold for their notes.

16:41And central banks then should stand behind these fractional reserve banks. The central bank should operate as what has come to be called a lender of last resort. The central bank should always stand ready to bail out the fractional reserve banking system. He disagreed with Smith. He said, when the banks issue paper money, gold will flow out of the country. But basically, if you see balance of payments deficits, it's generally not due to inflation, okay? So he denied what the 18th century writers had kept pushing on, that balance of payments deficits, outflows of gold and so on are basically due to inflation. Thornton said, no, they're not really due to inflation, there's various things changing in the real economy that cause gold to flow out and the bank should be there to bail out the fractional reserve banks.

17:33Later on, and especially if the public lost confidence, he was very, very fearful, being a banker himself, a thorn, he was very fearful of the public losing confidence in the banks when gold began to flow out. If gold was leaving the country, the public had a tendency to rush in, turn in their notes, pull out their gold, and that would cause an internal drain of gold, even more gold would flow out and the banks would collapse. So he wanted a lender of last resort. So throughout the 19th century, this idea of central banking as a lender of last resort developed. There was another controversy later on in England by the banking and currency school, in which it was emphasized by the banking school that the gold standard is great. None of these guys opposed the gold standard. What they didn't like was the fact that whenever the banks inflated too much, gold would leave the country and the money supply would shrink.

18:26would shrink and that would cause recession. So they were opposed to deflation, they wanted the government always to stand ready to stop the central bank, to stand ready to stop the deflation of the money supply. So they wanted, in other words, as opposed to people in the 18th century who said, well, when you have an outflow of gold and you have a recession and so on, you should stop the increase in the money supply and that will get the gold The banking school people said, no, no, no, we should do the exact opposite. We have to keep the price level stable and so on. And finally, this ended with this development, it was consummated of this idea of lender of last resort by a writer named Walter Badgett, who said, not only should the central bank stand ready to be a lender of last resort, but it should let the public know, let the banks know in advance that if the banks are in difficulty, they'll always be there to lend money to bail the banks out.

19:35And what was interesting is that, like Smith, Walter Badgett, this proponent of central banking, said, well, the ideal system is a free banking system, of course. But the next best is central banking with a lender of last resort. All right, now, at least during the 19th century, as I said, people were in favor of the gold standard. Even the pro-central bank types, almost all of them, were in favor of the gold standard. It was just that they were definitely fearful of deflation. Let me jump to the 20th century. So now what we have is well-established economic thought that the central bank, you need a central bank to act as a lender of last resort. The alternative, at least in Great Britain, of 100% gold standard, in which the banks will not fail, because every liability, dollar or pound of liability issued is backed up 100% by gold, that alternative just dropped out, dropped in sight, at least in Great Britain pretty much.

20:36Even the people who oppose central banking, such as the currency school, were in favor of fractional reserve banking. And in fact, sort of against their own best judgment, were in favor of central bank to operate the gold standard in the same way that it would operate if there was no bank money. So everyone sort of was tied into a central bank. Let me just put a footnote. That's not true in the United States. In the United States, Thomas Jefferson, his favorite economist was a French economist named Count de Tracey, and de Tracey in his writings was one of these hard money 18th century typewriters. Jefferson had or himself translated de Tracey's book early in the 19th century and a whole tradition of 100% banking grew up in the United States And it was very, very vibrant until the 1880s even.

21:36One of the most famous American economists, monetary theorists of the late 19th century, was Francis A. Walker. He believed in 100% banking. So it was a whole tradition, which was anti-central banking, anti-fractional reserve banking in the United States. Now, what happened? Well, the dawning of the 20th century was really the dawning of the era of the fear and loathing of gold. Okay, we can call it chrysophobia or aurophobia. What began to happen was that economists began to say, look, central banks, we need more than a lender of last resort to actually control the money supply, to manipulate the money supply, not just to supplement the banking system, but to manipulate it.

22:24So what evolved now was the idea of the central bank, not only the lender of last resort, but it's more than that, okay, as the political authority that controls the money supply and this involves the dumping of the gold standard. Now, one of the most prominent economists, certainly in the U.S. at the turn of the century, was Irving Fischer, okay, and he's been called the greatest economist that America has ever produced by Milton Friedman in Milton Friedman's latest book and in his famous book written in 1911 it was called The Purchasing Power of Money and basically what it was was just a book-length attack on the gold standard arguing that the purchasing power of money must be stabilized the gold standard is incapable of doing this and a lot of formula formulas in that book So it had an air of scientific authenticity.

23:25In fact, the quantity theory, or the equation of exchange, MV equals PT, was, I guess, characterized by Fisher as equivalent to the law of the expansion of gases in the natural sciences. So he really sort of found, in fact, in his latest book, Milton Friedman equates it with the law of gravity. The equation of exchange is to the social sciences with the law of gravity is to the physical sciences. So based on this equation and the manipulations of this equation, what Irving Fisher told us was that basically that gold will never be stable. It was a series of historical accidents that caused gold to be chosen as money.

24:12It wasn't the result of an evolutionary market process, but just simple accidents. yes you have to ask Murray about that what was he tied into the yeah he has a Well, the point is, and with this equation of exchange, what you do is, if your goods and services are growing by 3% per year, okay?

25:02With more goods and services, the natural result will be that prices on the market fall. Well to prevent that, you would have government increase the money supply approximately at three percent per year, a flaky amount of paper currency, and that would prevent the fall in prices. I mean that's the argument that Fisher made, very simply put. We'll get to it in a few more minutes, I'll come back to this. And basically the purpose of the book was to educate the public to the need for alternative, some alternative to the gold standard. In fact, Fisher is the father of what I call the ABG standard, anything but gold. The last chapter of his book is just filled with various schemes to replace the gold standard.

25:48And very interestingly, he himself preferred pure fiat money as an ideal standard, but he feared the government would abuse it. and that the public wouldn't buy it, the public was still too tied into gold. So he offered a bizarre alternative, he said, look, let's have Austria-Hungary stabilize its currency unit, the Goulding, Austria-Hungary was not on the gold standard at the time and they seemed to have a stable price level, so he said, let's trust them to take a basket of commodities and stabilize the prices of those commodities, that's called the tabular standard. Then the rest of us will go on to the Goulding standard, we'll all have fixed exchange rates with the Goulding. So that was his practical alternative. He believed that pretty much get rid of gold. And that was in 1911. Now, in Great Britain, John Maynard Keynes, who was a famous gold hater or orophobe, was writing against the gold standard from 1913 onward.

26:47Early on, he said we should have a scheme similar to Fisher's, what's called a gold exchange standard, in which one or two currencies keep the price of gold fixed and other currencies tie-on. We had that in the 1920s. It didn't work. Later on, though, Keynes began to believe that, or change his focus. He didn't believe it was enough to economize on gold and to stabilize the price level. In the late 1920s, his philosophical thinking developed, and he believed that Great Britain could actually abolish scarcity. We could get rid of scarcity. that everyone could be in a position of a Vanderbilt in the United States if the British government and central bank could drive the interest rate down to zero.

27:33So he really believed that the high interest rate was what was preventing this dawning of an era of a paradoxical era. We have no more scarcity. So then he became much more eager to have some sort of scheme for pay for money. He really believed that the future of British culture depended on this and he began to defame gold, really nutty terms, he actually anthropomorphized the gold standard and talked about it as coming down from heaven in a golden coat and he referred to the aura sacra famis, which I guess is sort of a pun, it could mean the sacred reputation of gold or at the same time the accursed reputation of gold. He wanted to defame the gold standard and get rid of it. He believed that when you have If you try to lower your own interest rates by pumping money into the economy, all you're going to do is cause capital to flow out and gold to flow out.

28:31And he hated that. He hated it with a purple passion, the fact that the British government was stopped by the gold standard from pushing down the interest rate. Alright, so what did he propose? He had three different proposals. First, he believed we should have international bank cooperation. In the early 30s, he believed that all central banks were the important central banks to get together and all inflate together and drive down the interest rate. When this cooperation wasn't forthcoming, he then turned to a system of economic nationalism devised by the Nazi economic czar, Dr. Helm R. Schott. He wanted high tariffs, bilateral trade agreements, where you don't have free trade, but you have governments of each country agreeing on barter, bartering different goods. He wanted government centralization of foreign exchange, and he wanted complete political Control of the Domestic Investment Decisions and Foreign Investment Decisions.

29:24Now he changed his mind in the early 40s and his disciples claim that he changed his mind because he basically saw the errors of his way, that he was panicked by the Great Depression into proposing the scheme of economic nationalism. That's not really true. A free market economist, Michael Halperin, pro-gold standard economist, did some detective of Work, talked to people at the U.S. State Department in the 1940s, and he found out that there was a meeting between Keynes and some State Department officials in the 1940s. Great Britain would follow after the war, and he felt that he could convince the American officials that this was very reasonable for Great Britain to do.

30:13But the State Department officials reacted and said if you do that, we're going to have an economic war. The U.S. will respond by economic warfare. So Keynes was taken aback by that. And also another State Department official named Leo Poslowski told him that when he spoke to Helmore Schock, Keynes' hero, in the early 1930s, and Schock was just implementing his program of economic nationalism, Poslowski said what would you do if all the democracies respond by economic warfare and shock them, well then I have to give up my program. And so Keynes, that shock Keynes, that shock himself would give up the program. So then he brought forth his third proposal.

31:00And that was that we'd have an international currency union in which we'd have basically a central bank, a world central bank which would issue do something called Bancor, these paper reserves, and on the basis of those paper reserves which had a nominal link to gold, they had some link to gold but it could be changed, all the other currencies, all the other countries would inflate their paper money and push down interest rates. What he wanted was for the rest of the world to inflate as quickly as Great Britain so that Great Britain could push down interest rates. He also, now even at that stage after proposing this, he really didn't give up the idea of of Economic Nationalism, until this plan was in place. In fact, he said that anyone who opposed exchange control and high tariffs and so on for England was as much of a traitor to Great Britain as people who proposed getting rid of the British Navy before they secured a peace with Germany and Japan. So he was still tired of economic nationalism. He never

31:59really fully gave it up, despite what his followers claimed. Let me go through some of the failures of central banking. We had the first failure in the 1930s, basically the Fed did follow a Fisher rule, whether deliberately or not, during the 1920s, the US price level was stabilized, and this involved a massive inflation because we had a tremendous amount of technological innovation and accumulation of capital goods during the 1920s, so that meant that prices would have naturally fallen and possibly fallen by a substantial rate. But that was offset by the Fed inflating the money supply. So we had the Fed ready to operate as a lender of last resort and operating to control the money supply in such a way that we had stable prices.

32:52And in fact, Irving Fisher was so pleased with this that he really dubbed this as the era of permanent prosperity, that we would never have another depression. Okay, now, the Austrian economists, as mentioned in the film last night, Ludwig von Mises and also Hayek pointed out that they follow, by the way, the 18th century tradition, in which they believe that when you inflate bank money, it redistributes incomes, it distorts prices, it causes resources to be changed around, and that, in fact, the U.S. was setting itself up for a possibly great depression. The Austrians were right, Fisher was terribly wrong, and we had a depression, and that was the first failure. So monetary control, All by central bank failed and by 1931 the public had lost confidence in the U.S. banking system and there was a run on the banks that lasted for two years.

33:44We had a collapse of banks, people losing their checking accounts and so on. The Fed continued to pump reserves into the banking system trying to operate as long as last resort but they couldn't offset the public's loss of confidence and we had the Glass-Steagall Civil Act coming in which allowed the Fed to pump even more reserves in, so we had a failure. A failure of central banking. What were the economists' reactions? The early Chicago school, the course of Milton Friedman, in particular Henry Simons, who was the most influential monetary theorist among them, attacked gold. They said, well look, the problem is that the central bank didn't have enough elbow room to maneuver.

34:33What they needed to do was to aggressively support the price level. If you support the price level, you'd never have this recession. We would have had a small recession in 1929, 1930, but it wouldn't have turned into this route in which your banks began collapsing and so on. And Simon basically harked back to Fisher and claimed that the value of gold rests on Hocus Pocus. and the production of gold is a squandering of world resources and it's an utterly inadequate standard of rules to guide monetary policy I'm quoting Simon's there and so he basically blamed the Great Depression on deflation caused by the fact that the central bank didn't operate competently as a controller of the money supply now he preferred as Fischer did a purely fiat money, but once again he saw that you couldn't sell this to the public, so he wound up proposing a standard, what he called a dollar standard disguised as a gold standard, and in fact he supported Keynes' plan for the International Currency Union, he said that, Keynes' plan seems to be the best thing around right now, people will be fooled by the link to gold, there's some link to gold there, and therefore he was

35:52in favor of this. And also very interestingly, the plan that was finally accepted for the post-war world was that of Edward M. Bernstein, who described himself in a recent book as a qualified monetarist. So the Bretton Woods system was sort of a second best policy for the Fisher-Simons types. The second failure occurred when Bretton Woods broke down. The U.S. dollar was linked to gold at the price of $35 per ounce. All the other currencies were linked to the dollar at fixed exchange rates. Now, since the U.S. government owned a stock of gold that far exceeded the amount of outstanding dollars in 1949, 1950, the U.S. gold stock was something like $40 billion.

36:43Now, Americans had no planes on that gold stock. We could not convert dollars for gold. Only foreign central banks and governments could. and there are only 12 billion dollars outstanding. So there was more than enough gold to cover those liabilities. Now what sort of incentive did that set up? What the US government did then was to run what was called a deficit without peers. The US government just printed up new money to pay for its deficits, especially during the Vietnam War. We had great society programs and big defense expenditures being paid for by just printing up new money. printing up new money, and the other countries that were tied into the U.S. dollar would accept these dollars as good as gold. They would hold these dollars to back their own currency. So the U.S. generated a worldwide inflation, especially during the 60s. Eventually, of course, the dollar liabilities rose to something like $75 billion, and the U.S. gold stock fell to around $12 billion. In 1971, when President Nixon slammed shut the gold window,

37:44The rate at which gold is flowing out, we had about two weeks left of gold reserves. So this didn't work. The central bank didn't have the will to stabilize the price system. Simon's and Fisher would have liked. They certainly had the opportunity there. Now to be fair, you had the Keynesian connection here. The Keynesians wanted low interest rates. They wanted cheap money. They didn't want stable prices. and they tended to prevail, especially during the 1960s. Now, the Keynesians, during this period, after the gold window was shut, pretty much had a system that they were comfortable with from 1971 to 1979, right? We didn't really have a dollar linked to gold by fixed rate, especially after 1973.

38:30The dollar wasn't fixed to anything. The central bank had a lot of elbow room to operate, and what did we get? So what did we get? We got the double-digit inflation rates of the quarter years, extremely high inflation, so high that it scared the Fed, and the Fed began to aggressively tighten money in 1979-1980. Carter appointed Paul Volcker as the chairman, and Volcker began to implement what are called monetary policies. Now let me just say a few words about Milton Friedman. Milton Friedman, from the 50s onward, was in favor of implementing the hardcore Fisher-Simons program. That is, getting rid of any dollar standard disguised as a gold standard, getting rid of any fixed exchange rates, having a pure fiat money that was controlled by the Fed.

39:23Now Milton Friedman didn't trust the Fed to do this without any sort of a rule. So what Milton Friedman wanted was not... he made it very easy for the Fed. He said, look, you don't have to worry about stabilizing the price level on a day-to-day basis or even a long-run basis. According to his research, the velocity of money, the rate at which an average dollar would turn over, is spent in the economy, was stable. So all that meant was that the Fed would simply have to increase the money supply at a steady rate. rate. Simply add maybe 3%, 4% to the money supply every year and that would offset the fall in prices of goods in general and we'd have a stable price level. And he was also against any sort of fixed exchange rate. He was in favor of a pure floating exchange rate so that the Fed had only one goal, simply to keep the money supply growing at a fixed interest rate. Now, what happened in the early 80s was that we had a recession when Paul

40:22Volcker implemented monetarist policies, which do tend to work to the extent they are followed. When you strain the money supply, you do reduce the rate of inflation, and that did occur. So the monetarists were riding high for a while, but what occurred was that we had a We had a number of things. We had financial deregulation, which made it very difficult to focus on the correct money supply. The money supplies were growing at different rates and giving off different signals. We had now money market mutual funds people were holding, and some economists counted that as part of the money supply. We had people more widely holding small certificates of deposit, which were counted by some economists in the money supply. So we had different monetary aggregates giving different rules, giving different indications about whether money was growing quickly or slowly.

41:11So we had a problem with measuring the money supply. Also, velocity, which is also really the demand for money more correctly, was changing. During a recession, people tend to hold money, to hold more money in relation to their income than they do during normal times. So velocity was falling, demand for money was rising, and it continued to change even if we came out of the recession. So that Milton Friedman had predicted a recession in the mid-80s, which never came about. So to some extent the monetaries were discredited for that reason, and also freely floating exchange rates. The monetaries, Milton Friedman in particular, told us that with freely floating exchange rates, Governments would never have to worry about their exchange rates going up or down, they wouldn't have to worry about the effects of their monetary policies on their balance of payments, whether they're in surplus or deficit.

42:09And therefore, if you don't have to worry about money flowing out of the country, gold flowing out of the country, then there's much less reason to implement protectionism. So with freely floating exchange rates, monetary policy would be very easy to implement and we wouldn't have a lot of appeals to Japanese bashing and protectionism. But in fact we got the opposite. In fact we did get that, excuse me. From 1981 to 1985, the US dollar appreciated greatly in value, making our goods much more expensive for the rest of the world. World. And in fact we heard calls for protectionism, widespread calls for protectionism. Also the exchange rates tended to be more volatile, they moved much more rapidly than anyone tended to expect. So theoretically you would expect that if countries are are inflating at different rates, greatly different rates, you would have very rapidly changing exchange rates. But no no one quite expected events to play out that way so there was, true or not, the perception

43:12that monetarism had failed and we then, the crisis continued, the crisis of central bank continued, the feds failed as a lender of last resort, it could not prevent the savings and loans, loan debacle, in fact federal deposit insurance which was instituted in the 1930s to restore public confidence in the banking system added to the problem. It gave the managers of banks an incentive to invest in very high-risk loans in exchange for the promise of high returns, high profits. And they were permitted to do this by legislation in the early 80s, which deregulated them.

43:58This deregulation in the face of continued federal deposit insurance was really the downfall of the SNL. Now where are we today? What are economists' reactions to the latest failure of central banking? Well, we have a Keynesian reaction, we have a monetarist reaction, we have a free banking reaction. Reaction. Basically the Keynesians claim that that the full Keynesian program was never really tried, okay, that if they go back to Keynes's third proposal they say look we really can't have we really can't have fiscal policy and monetary policy in a world where there's no cooperation because for example if the U.S. wants to push down interest rates to stimulate income and production here in in the U.S. The result will be, especially in today's world, occurring very quickly, the result will be capital flowing out of the U.S., interest rates jumping back up. If the Fed continues to try to push down interest rates, we'll have a capital flight out of the U.S. That is, investors will be

45:03spooked and they'll pull money out of the U.S. so that we really can't have an independent monetary and fiscal policy. Or if we try to have a fiscal policy, So if we try to deficit-spend, that may very well push up interest rates, draw capital in, and push up the American exchange rates. So what many of these Keynesians argue now is for international bank cooperation. Two of them, John Williamson and C. Fred Bergsten, who are both former, one is a former IMF advisor, British treasury consultant, and the other is the former Assistant Secretary of Treasury under President Carter. They advocate a crawling target zone with or without soft buffers. They can't really tell if they're ex-bureaucrats.

45:51Basically what that means is that they want some bureaucrats to set what they call fundamental equilibrium exchange rates between different countries, set these fixed exchange rates and permit them only to change as a result of differing rates of inflation among the different currencies but what they want is that all cooperating governments will agree to target their, what's called aggregate demand, the amount of spending in the economy via deficits. So what they want to do is push down interest rates together so that they can operate with fiscal policy. So they want to reimpose fiscal policy on the world economy, a policy that failed, the Keynesian policies failed badly in the 60s and 70s. They want to re-impose it, but now with international bank cooperation, central bank cooperation.

46:42There's another individual named Richard N. Cooper, professor of economics at Yale, member of the Council of Foreign Relations. His goal is to really have a global central bank. He makes no bones about that, to have a global monetary authority. He wants them to issue currency by purchasing securities of member countries, that is to operate, as central banks do today, nationally, through open market operations. He wants national governments then to be able to use fiscal policy again. In other words, they would then be able to deficit spend again, but only to the extent of their allocation of this new currency. In other words, they would print up government bonds and sell them to the central bank for this world currency.

47:32Each person would have an allocation, so the amount, each country would, so the amount of the inflation would be coordinated. Nobody would get out of step. Finally, we have James Tobin, an old-line Keynesian, who keeps putting forth this proposal for monetary reform, 1972, 1978, 1982, and he never gives up on it. Basically, he wants to go back to Keynes' proposal of economic nationalism. He said that he would welcome a world currency and common monetary and fiscal policy, but that's just impossible in today's world. So instead, he advocates, regretfully, I'm quoting, throwing some sand into the wheels of our excessively efficient money markets. What he wants to do is to put a 1% tax on all spot conversions of currency from one currency to another, which would mean that you would have on a three month, if an American wanted to invest in a Japanese treasury bill, the differential would have to be 8%, that is You have to have an 8% higher return on the Japanese bill than on the U.S. bill to justify that 1% tax on that transfer.

48:49What's the monetarist's response to this latest crisis? I was recently at a conference on liberty and banking, which Milton Friedman's long-time co-author Anna Schwartz attended. She said that basically Milton Friedman has thrown in the towel on monetarism in the sense of having the central bank fix a steady rate of monetary growth. And he's now in favor of simply freezing the monetary base forevermore, never allowing it to change again. That is, the Fed can never go in and issue currency and deposits against securities, no more open market operations.

49:36We freeze that and then he would completely deregulate the financial system so that we would have basically free banking stock of base money. And in that way he feels that we could approximate stable price level. Okay, some other monetarists, interestingly enough, well, a quasi-monitorist, Robert Mundell, and also Humphrey and Kelleher, two monetarists, are in favor of sort of a global central bank. I was surprised to read this, but they believe that we have a dirty floating system where governments intervene to buy and sell the dollar, so the dollar is really the basis, is really a reserve currency, the base of national currencies throughout the world.

50:23So that to keep the dollar growing at a fixed rate, or to keep world reserves growing at a fixed rate, they would consider a world central bank, as proposed by Robert Mundell. Finally, some Austrian economists have reacted to the crisis of the 1970s and 80s. I'm thinking here of Larry White and George Selgin by going back to 18th century thinking, but not the good hard money 18th century thinking, but the thinking of Adam Smith. Their claim is that fractional reserve banking is unstable because we have a central bank, so that they're afraid of getting rid of the central bank.

51:09Basically, they reject Adam Smith's versions of why under fractional reserve banking we We would not have a rise in the price level. What they claim is that, to make a long story short, Smith is right, gold is too costly to serve as money. It's a massive waste of resources to have people holding idle gold, so that George Selgin in particular is in favor of increasing bank liabilities, raising the price level and driving gold out of monetary use. Now in the stylized account of how fractional reserve banking arises, how free banking would Arise, they both believe that, since it was a jointly written article, that starting with 100% gold reserve, that under free banking, the reserves would go down to one half of one percent.

51:58This would involve a massive inflation, it would involve stimulating an Austrian business cycle and instability of the banking system. But they claim that that wouldn't be so, that in fact there are many mechanisms that would that develop on the market to prevent the instability of free banking. In fact, it seems that they're very, very interested, their primary interest is in keeping the free banking system stable, not really on the effects on the overall economy. So also I find in just one or two more little criticisms, Selgin and White in saying that that the reserves of the free banking system would be determined by the market, okay? The market would give the owners, the entrepreneur owners of the banks, information about exactly what level of reserves is required, okay?

52:53That really relies on a theory of entrepreneurship that comes from Israel Kirzner, okay? And that doesn't really offer much scope for uncertainty and error and mistakes, okay? So I think the whole free banking case is based on a defective theory of entrepreneurship. Also, it seems that they bring back central banking to the back door. They say, well, look, if some banks do get into trouble, if they do make mistakes, we'll have these super clearing houses that evolve on the market that are able to print up currency and act as lenders of last resort. So they're introducing central bank type institutions here. here. Also, they're very in favor of option clauses, which exist in Scotland. They're called post notes here in the United States. Basically, what the bank would do is to say, look, if we get into trouble, we have the right to refuse payment for six months or a year. So people's money balances are wiped out. They now are holding short-term liabilities against the gold standard, against the banks rather. And again, how's that different from

54:01and the Central Bank's suspending specie payments when they get into trouble, right? And finally, they're very in favor of, where you wouldn't own a fixed dollar claim against the bank, but they would issue you an equity share, okay, as the Money Market Mutual Fund does today. The value of that share would depend on how well the investments of the bank or the mutual fund does. And they claim that that's another way of protecting against bank runs, but I see that That simply is giving up banking. That's not really banking. It's a mutual fund institution, so it's a lot different from banking. So I don't see free banking as the answer. I see as the answer the original 18th century tradition in which you have 100% banking with full financial deregulation. Murray Rothbard, for example, supports that. I support that. Hans Hoppe Hoppe supports that approach, and I think that is the correct approach, and that is the development of the Turgot-Hume tradition.