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Every day, we use money and engage in transactions, without necessarily asking ourselves how the monetary system works. The notion that it depends on government is rarely called into question in modern society. Yet certain serious economists think that this governmental control is very harmful to the economy, and that it would be preferable if the currency were managed privately.
This is notably what Nobel Prize-winning economist Friedrich Hayek defended in a small book devoted to the issue (The Denationalization of Money, 1976). But the credit for having made this idea respectable goes to economist Lawrence H. White, who has shown through historical examples how free banking could exist, without government interference. His articles on banking and monetary history have been published in the most prestigious journals and have challenged the very foundations of central banking.
The basic idea White developed is that central banks, which depend on government, introduce imbalances into the market for bank loans, and this creates harmful economic distortions; they create instability for economic actors, and irresponsibility among bankers, since the value of a given currency ultimately depends on the central bank. Conversely, in a free banking system, there would be competition between banks, in which the most responsible (those that manage their clients’ money with care) would see their currency be more widely used.
Indeed, as in other sectors, competition ensures that companies offering good services (in this case, a stable currency) drive out the bad. In a competitive system, banks have every reason to reinforce confidence and properly manage their clients’ money, or they will lose them as clients. The currencies offered by banks would be convertible into precious metals (like gold, whose price varies little). According to Lawrence White, the economy would be more stable with such a system.
In one of his books, he recounts that during a certain period (1716-1844), in Scotland, banks operated freely and completely independently. Scotland enjoyed a remarkable economic situation, and very stable currency, during this period. This was not the case in the United Kingdom, where banks were highly dependent on the Bank of England and its policies, and where there were more bank failures and greater monetary instability. Lawrence White also made an important contribution to the history of economic thought by showing that, until the 19th century, there was a school of thought in England that defended the free banking system.
The economic and financial crisis of 2008 gave renewed relevance to White’s theses. According to him, the Great Recession is related to the various currency manipulations of central banks, which contributed to the irresponsibility of banks. The imprudence and errors of some were encouraged by a policy of easy credit that fuelled an excess of non-viable investments in certain sectors. Among other things, White assessed the performance of the American central bank (i.e., the Federal Reserve), since its creation, and observed that there had been more monetary and macroeconomic instability during its existence than in the decades preceding it.
The Fed notably failed to achieve one of its primary purposes: price stability. Indeed, the purchasing power of the dollar has fallen since the 1970s (when dollar convertibility to gold ended) due to inflation, and the evolution of prices has been unpredictable. Recessions are now longer and deeper. They have not reduced the frequency of banking crises—quite the contrary. For this reason, Austrian school economists like Lawrence White think that the 2008 crisis offered an opportunity to propose alternative solutions to the current banking system that would probably have achieved better economic results.
White thinks that we could return to a free banking system in order to avoid new crises in the future. He also recently took an interest in cryptocurrencies like Bitcoin, which he considers to be a kind of private currency providing an alternative to the public currency monopoly. This is very timely given that in certain countries like Venezuela, a growing number of people are turning to cryptocurrencies, which are seen as more reliable than the money printed by their government.
Jasmin Guénette is Vice President of Operations at the Montreal Economic Institute. The views reflected in this op-ed are his own.