The Story of Money in the United States

0:00:00.2 Trevor Burrus: Hi, this is Trevor Burrus, co-​host of Free Thoughts. The show is taking a holiday and we’ll be back with fresh episodes starting January 8th, but we thought it’d be fun to take these next two weeks to resurface a couple of shows from our first year that you might have missed. Our first episode was on October 22nd, 2013. My pick from that first year is the story of money in the United States with our colleague George Selgin, which aired on August 31st, 2014.

0:00:23.8 Trevor Burrus: Monetary theory is not my favorite subject, and it’s a subject that I struggle to fully understand. Something about it just doesn’t grok with me, so I find myself asking what I think are stupid questions. Ends up a lot of those stupid questions are genuinely good questions. As hosts, our job is to direct the conversation, ask clarifying questions and to challenge our guest’s arguments. Many times, especially for legal episodes, I play a little dumb in the questions I ask. With George, I’m never playing dumb, and that ends up producing a pretty good episode, as it did here.

0:01:01.1 Aaron Powell: Welcome to Free Thoughts from lib​er​tar​i​an​ism​.org and the Cato Institute. I’m Aaron Ross Powell, editor of lib​er​tar​i​an​ism​.org and a research fellow here at the Cato Institute.

0:01:08.6 Trevor Burrus: And I’m Trevor Burrus, a research fellow at the Cato Institute Center for Constitutional Studies.

0:01:14.9 Aaron Powell: Our guest today is George Selgin, Director of the Center for Monetary and Financial Alternatives at the Cato Institute. I want to start really basic, as we often do on Free Thoughts by asking, what is money?

0:01:29.8 George Selgin: Money is, economists call it a generally accepted medium of exchange, and what that means is it’s the stuff that we typically use to pay for things and to settle debts, and also the stuff we typically accept in our receipts as compensation for labor and the things we sell.

0:01:52.0 Trevor Burrus: And does that mean it has to have dead world leaders on it and be issued with little tracking mechanisms in it, and magnetic strips and…

0:02:03.1 George Selgin: No, neither, actually, though those things, features are common enough, the latter in recent times and the former since the early beginnings of money. But in fact, money doesn’t have to have either of those features. In its most basic forms, money has consisted of things like cowrie shells and wampum beads and tobacco leaves. Of course, these primitive forms of money don’t have any electronic doodads on them, nor do they represent leaders of specific governments. More sophisticated forms of money and more familiar ones, of course, often do have those features, but even there, they’re not necessary. So you can have coins that have kings’ portraits on them, but coins can be and have been minted privately, and good ones too. One of the myths about money is the idea that you can’t have a good money unless some sovereign power is behind it and monopolizing it. It’s one of the aims of the Center to encourage people to get past that common misconception.

0:03:14.3 Trevor Burrus: But how would you… When wampum or shells or something like that comes into being, did someone say, “Alright, everyone, we’re all using wampum. From now forward, everyone is now using wampum for money. You have to accept wampum as payments.” Or how could that ever happen without some sort of agreed upon method of exchange?

0:03:34.8 George Selgin: Well, actually, it can happen without people agreeing deliberately, and it’s not that difficult to imagine how. You have, first of all, in any small society, you have certain goods that are already treated as especially desirable and widely valued for ceremonial purposes, or perhaps as jewellery or an ornament of some other kind. And you only have to think about the problem every one of us faces when trying to buy a gift for somebody who we don’t know well, we’re thinking what’s something that’s widely popular that everyone wouldn’t mind having a little bit more of that, sort of thing. And the origins of money rest in people making various attempts to figure out the answer to that kind of question. And of course, the more people who come up with any particular answer, the better that answer becomes for everyone else. And so you tend naturally to have a convergence on one or a very small set of commodities that come to earn this status as generally accepted exchange media. So it can be an entirely spontaneous process. That doesn’t mean governments don’t get involved and didn’t get involved in very early times, influencing the outcome of this process and trying to manipulate it, as often as not, though, not in the public interest but in pursuit of their own narrow fiscal interests.

0:05:09.3 Aaron Powell: That ties into my question, which is, so the fact that Trevor asked this question of like, well, how is it that we could have money without the state telling us what the money is. The reason that we ask a question like that is because all the money that we see around us is state-​issued money, it’s dollars and pounds and whatever else. And so, if these things can arise organically, why don’t we see that? Why do we see the states dominating it the way they do?

0:05:38.0 George Selgin: Well, there’s two parts to a full answer to that question. One is that it’s not really true that most money today is issued by governments. It is true that most basic monetary units today have been defined by governments who have manipulated the meanings of those units. But even in the case of most of these units, at one time, governments didn’t have much to do with them. The pound was a pound, tower pound weight of silver at one time in history, it was simply a unit of weight. But in any event, today, most of the media of exchange we use consist of a bank transferable, bank deposits and that sort of thing. And a relatively small part of it is the stuff that the Fed provides directly in the United States.

0:06:30.6 George Selgin: So we should recognize the role of private institutions in supplying money even today. As for why, though, basic monies like the US dollar are monopolised by governments everywhere, the answer to that is not, as most people tend to think, that such monopolies were necessary to make for reliable and safe monies. In fact, most of the government-​controlled monies in the world aren’t particularly reliable or safe. The reason governments got involved was because of the clear fiscal advantages there were in monopolizing money. Because when a ruler monopolizes money, let’s say that money begins as a certain amount of gold, let’s say that you have a gold unit. By monopolizing production of that unit, the government then puts itself in the position to redefine what that unit is. So a unit that used to consist of, let’s say, an ounce of gold, they can say, “Well, from now on that same unit amount we declare will be made up of only half an ounce.” And so, hey presto, debts incurred in the old unit can be settled with half as much precious metal as before. This ability to manipulate monetary units, which is derived from first controlling production of the representatives of those units, monopolizing them, is an incredible fiscal device that governments can abuse and have abused ever since they’ve resorted to it.

0:08:07.0 Trevor Burrus: And when did America first start producing money? Have we been doing it since the beginning?

0:08:11.5 George Selgin: You mean the American government?

0:08:13.1 Trevor Burrus: The American government, yes.

0:08:15.7 George Selgin: They have. It was a decision that was actually a somewhat controversial one during the Founding era, whether there was a decision to establish a US Mint after some considerable discussion of farming out the production of coins to private mints, but it was always understood even then that any coin production would be sanctioned by government authority and that the government would be ordering the coins even if… Whether or not it made them itself. In any event, they set up a US Mint, which like European government mints at the time was a monopoly. So we’ve never really had a free market coinage system in this country.

0:09:02.0 George Selgin: We’ve had episodes of private coinage, important ones and revealing ones. For example, during the Gold Rush, the years subsequent to the Gold Rush as well, in California, a private minting industry flourished because there was no federal mint in the West Coast as yet, people needed to do something with those gold nuggets and powder in order to make that stuff useful without having to send it to Philadelphia or Charlotte in North Carolina to be coined. And so this was an interesting exception to the rule of government monopoly. The quality of the coins produced by some of these private mints was better than what the federal mints actually put out. There were not so good private mints, but guess what? They went out of business. It’s just like any other industry.

0:09:49.5 Trevor Burrus: Now, what about paper money, though, ’cause when you’re using coins, some of our listeners may not know that you’re actually using a term of art in the sense of a coin that has some amount of precious metal in it.

0:10:00.8 George Selgin: That’s right. These coins were made up of what was then the the standard metal, either silver or gold, that defined the monetary unit. But you’re quite right to bring up paper. Paper has been part of our monetary system for a long time, but for many, many decades, the issuance of paper notes, paper currency, which consisted then of real substitutes for these gold coins and silver coins in the sense that you could turn these paper substitutes in and get a definite amount of gold or silver in exchange. The responsibility for issuing such paper money fell on private banks. Now, for brief intervals, starting at the beginning of the republic, and then again starting in the 18 teens, we had a federal bank that issued paper money, the first Second Bank of the United States did so, and then its successor, the Second Bank of the United States. But otherwise, until the Civil War, paper money was issued by state-​chartered banks, and depending on state laws, of course, they ran the gamut from good to indifferent to very, very bad.

0:11:18.9 Trevor Burrus: I’m trying to picture the world here, I’m a merchant living in New Hampshire in 1821, and I’m getting bank notes, and the bank notes are representing… You could go and get coin for those from the bank, if you…

0:11:33.6 George Selgin: In principle.

0:11:35.9 Trevor Burrus: In principle. But the bad ones would be the ones that maybe you couldn’t. So when you said good or bad, that would be the…

0:11:40.7 George Selgin: That’s right. Well, that’s right, you would… And this was a big problem in the United States. I want to emphasize that we had a peculiar situation, because in the United States, unlike most countries, banks were typically one office firms that did not have permission to establish branches, usually not even within their own state boundaries, but especially beyond those state boundaries.

0:12:05.9 Trevor Burrus: That would make their money less valuable, ’cause you would have to maybe go further to… You’d have to go to Providence, if it’s Rhode Island or whatever.

0:12:13.6 George Selgin: Absolutely. That’s right. If a note managed somehow to make its way far away from the bank that originally issued it with the currents of trade, then it often, certainly, if it went far enough, wouldn’t command its full face value at all because at very least, somebody had to cover the cost of getting it back to where… To the bank where you could exchange it for actual gold or silver coin, and then of course, there was possible uncertainty about whether that bank would still be around and whether it was solvent.

0:12:44.1 Aaron Powell: Would banks take each other’s notes?

0:12:47.1 George Selgin: Subject to a discount to cover the cost I just mentioned, unless there was a clearing house that provided for the expedient redemption of the notes, overcoming the lack of branch bank facilities that otherwise posed this problem. So for example, in the very period we’re talking about in the 1820s, in New England, a bank in Boston called the Suffolk Bank took the initiative of becoming a central clearing house for all of the New England banks, offering to receive all of their notes on deposit at face value, if each of these banks agreed to keep a settlement account with it from which it could redeem the notes, ’cause of course it didn’t want to be out of pocket for notes that it might not be able to redeem.

0:13:31.4 Trevor Burrus: That sounds interesting, ’cause that would actually give the clearing house the ability to watch over the solvency of the bank.

0:13:38.0 George Selgin: It did indeed. And in fact, the Suffolk could be very strict about its membership. If it thought a member was misbehaving, it could boot it out of the system. The interesting result of this, though, was two-​fold, three, actually. One, the New England currency, uniquely of all currency in all regions of the country, established very early a uniform value. So what the Suffolk system proved is you didn’t have to have a monopoly of currency to have currency that commanded uniform value in a wide area, even without the ability of banks to set branches up, which normally would have solved the problem.

0:14:18.8 George Selgin: The other thing, though, is it meant, by making currency in New England uniform, it tremendously enhanced the demand, both for the Suffolk Bank’s currency and for that of the other state banks, so this demand is growing at the expense of demand for actual gold and silver, which could therefore be more economized on, and of course the corollary to that was that people’s savings were being more effectively used to promote investment instead of having to be locked up in coin. And it was a big boom to New England.

0:14:51.1 Trevor Burrus: At the same time too, you could have come in with, say, a Spanish Guinea or something too, right? Or pieces of eight or, I don’t know.

0:14:57.1 George Selgin: Well, you could but it was… They would have been treated, of course, as foreign money is treated today. You would have had to exchange it for US money at a bank, and you would have had to incur corresponding fees, ’cause by that time, of course, the pieces of eight no longer were current money in the United States, though at a time, they were as current as anything else, but that time, by the 1820s, had passed.

0:15:24.4 Aaron Powell: On the having money be some sort of commodity, whether we’re talking about shells, or gold, or silver, whatever…

0:15:30.5 Trevor Burrus: Or tea, that’s my favorite one. A big block of tea.

0:15:33.1 Aaron Powell: I’m wondering, so obviously, you said one disadvantage of state-​issued currency is that they can just debase the currency, they can inflate, they can mess with it in ways that are harmful…

0:15:43.3 George Selgin: That’s right.

0:15:44.3 Aaron Powell: But for the commodity, would it incentivize, say, poor behavior in the sense that, let’s say we’re exchanging shells, some particular kind of shell that’s just… Has no… That’s what we settle on. Wouldn’t that potentially incentivize people to say unproductively just, I’m going to grow lots of this type of animal that makes this shell and I’m going to put all sorts of resources into just growing lots of these shells that is A, not terribly productive work, and B, is going to inflate the currency anyway.

0:16:16.1 George Selgin: No, actually, because the whole point of a commodity standard money is precisely that, in equilibrium, the commodity in the form of money isn’t worth more than the commodity in other forms. So the value of your gold coins, if you just figure out the value of the gold of which they’re comprised, is going to be essentially the same in equilibrium is the value of that much gold contained in gold bullion, or some jewelry, it’s just the a market price.

0:16:53.7 George Selgin: So what happens is production continues for gold, whether when it’s money as it would otherwise up to the point where the price equals marginal cost, and that’s that. At that point it’s no more worthwhile going into trying to mine gold than it is to go into any other productive enterprise. It’s paper money that poses the real challenge, because with paper money, of course, if it’s to be worth more than the actual paper it’s made of, which of course…

0:17:24.5 Trevor Burrus: You could wallpaper your house with that, I guess, yeah.

0:17:24.7 George Selgin: Yeah, otherwise, you might as well wallpaper your house with it. So if paper monies are to be worth more than just their raw commodity value, you have to have some artificial, in that case, you have to have some artificial thing… Means for limiting production. In fact, open competition in the production of inconvertible paper money, there is no compelling convincing theory that that wouldn’t have to end with hyper-​inflation. That is with the paper actually, with the money actually being, becoming worth no more than the paper it’s made of, but with commodity money avoids that problem because, in fact, it’s not expected that it should be worth more than the underlying commodity is worth in other uses.

0:18:10.7 Trevor Burrus: Let’s take a step back, take a lay of the land here. So we have some situations where you would actually be trading coins that are the actual money, the actual…

0:18:21.5 George Selgin: Standard commodity. Money commodity.

0:18:22.1 Trevor Burrus: Standard metal, silver, whatever. And so you’re actually trading those. And then you have other situations where banks would hold those, that money, and you’d be trading paper notes that represent a return of some metal or something valuable. So that’s commodity currency, but not a coin.

0:18:40.9 George Selgin: It’s commodity-​based currency. So we mustn’t… We must be careful not to mystify the topic of bank notes and bank currency too much. It just so happens that in the earlier days of banking, circulating paper notes were the more common IOU form that served as money, but they fundamentally didn’t differ very much from the checkable deposits and demand deposits that we’re used to using today. They were also… Those are also bank IOUs that serve in place of basic money in exchange.

0:19:22.9 George Selgin: The advantage of banknotes is that they could be passed from hand to hand among anonymous people. And that was not the case, especially back when, with checks, people were reluctant to accept checks, because you couldn’t really be sure that you could trust the writer of the check to have that much money in his or her account. You also, in that case, of course, had to trust the bank upon which the check was drawn. If you think about it, a banknote is just a little bit less untrustworthy, because if the note is genuine, of course, then you’re concerned with the bank being sound but not with the soundness, as it were, of the person who hands you the note from that.

0:20:05.6 Trevor Burrus: So I’ll make an analogy here. I write Aaron a check, I use an actual paper check, I think I have a few of them in a drawer somewhere. And then Aaron can sign that check over to someone else. Some of these things are illegal, but you could have the system where my check goes to him with my name on it saying, “I guarantee this.” And then Aaron transfers that check, signs it over to someone else. And then four people removed from this, they’re still relying on me to actually be backing up the deposit basically.

0:20:33.6 George Selgin: That’s right. And they know that your deposit may be, all this time, being run down, and the likelihood of the check being good is for all they know has long disappeared. This is why checks don’t… People don’t hold onto checks even today of course, you cash a check, because the sooner you cash it, the less risk you take. Circulating notes are actually a much more straightforward way of using bank-​created substitutes to make payments instead of using some underlying money, whether it’s coins or fiat money from a central bank. I say this because the widespread belief is that having banks issue circulating notes is just something intolerable, that that has to be something that governments monopolize. But the truth of the matter is that, for the most part, any argument you might hear about why it’s impractical to have banks issue circulating currency would apply with even greater strength to the present accepted practice of banks allowing people to write checks off of demand deposits or use debit cards. It’s really just an argument based on ignorance and prejudice.

0:21:47.2 Aaron Powell: We’ve talked about commodity currencies, so coins where there’s some actual stuff sitting there that we find valuable, and that’s what we’re exchanging, whether in reality or through these notes that are good for it. And then we’ve talked about this fiat currency of government just saying, “Here’s the units we’re going to use to exchange.” But I guess…

0:22:04.7 Trevor Burrus: When did that come into play here?

0:22:05.9 George Selgin: Let’s make… Let me… Allow me to tell how we get from one to the other, and then we can pursue the questions that come from that transition. So as I was saying, in the United States, to keep to that case, which is not typical in all respects, of course, but it interests, I’m sure, your listeners more than most, during the Civil War, the policy changed with the Federal Reserve essentially taking over the business of banking by prohibiting… Well, they passed a 10% tax on state-​issued currency, and that was prohibitive, so the state banks had to abandon it, the dividing currency.

0:22:45.1 Trevor Burrus: So they paid the tax? The banks paid the tax when they issued a currency note?

0:22:49.3 George Selgin: Worse than that, yeah. If they had any amount of a state bank’s notes outstanding at the time that tax was assessed, which was annually, they would owe 10% of that money to the federal government.

0:23:01.2 Trevor Burrus: So it killed the whole system.

0:23:02.8 George Selgin: It killed state bank note issue. Now, this was done… I should mention, that went into effect in August, 1866, by which time the… And the federal government had also created, in the course of the Civil War, a new banking system consisting of a large number of federally chartered banks called national banks. So the… By this mechanism, the currency was nationalized, not monopolized, but nationalized, put in the hands of only federal institutions. Now, I don’t have time to go into the details of that, but because these institutions were designed to help finance the Civil War, and this was a real motive for this change, they were required to back their notes with US government securities. Well, the problem is…

0:23:49.4 Trevor Burrus: I’m sorry, what…

0:23:49.5 George Selgin: Yeah?

0:23:49.5 Trevor Burrus: What is a US government security? Just clarifying it.

0:23:52.0 George Selgin: Treasury bills, bonds, notes; but in those days, bonds. So that, whatever its merits as a device for raising money to pay for the war, proved to be a very unfortunate arrangement afterwards, because the federal government was retiring its war debt, it was running surpluses often in the 19th century after the war. And as it did so, of course, the supply of these bonds that were eligible to back national banknotes dwindled. And the next thing you know, you have an inadequate supply of currency and an inelastic supply, as they said in the day, and that was an important cause of occasional financial crisis. The Fed, to make a very long story short, was set up as a way of making up for this inelasticity of the currency supply. You might ask…

0:24:42.2 Trevor Burrus: That’s 40 years later, though, I mean, that was…

0:24:43.8 George Selgin: Well, these problems… This continued to be a problem and a worsening problem for the entire span of time from the 1870s until after… Until the Fed’s establishment. You might ask why didn’t they just deregulate the note issue of the national banks and maybe let the state banks issue notes again? I mean, the Civil War’s over, you don’t need revenue. Good question, you could ask me that if you want. But in any event instead, what they ended up doing was creating the Fed. And the Fed wasn’t anything magical at all at that time, the Fed was essentially a set of 12 banks that were exempted from the rules restricting the currency issue of the national banks so they could issue federal reserve notes on assets other than government bonds. And that’s it, that’s the magic of the Fed.

0:25:28.0 George Selgin: Okay. So now what you’ve got… Well, the Fed was designed eventually to totally supplant the national banks. And now you’ve got a nationalized currency and a monopolized currency, because the Fed is not really 12 banks, it’s a monopoly managed by a central board. Okay, so how did we get from there to fiat money? When once you have a monopoly… It goes back to kings and coinage and debasement. Once you put a monopolist in charge of the basic money, you set up a situation where the monopolist can redefine what the basic unit really consists of. So when the Fed takes over, the basic monetary unit is still a unit of gold. In fact, the Gold Standard Act was passed in just 1900, really securing the gold standard and doing away once and for all with the silver counterpart that had existed until that time.

0:26:21.9 Trevor Burrus: This the great presidential debate that McKinley… They’re hanging a cross of gold?

0:26:25.0 George Selgin: That’s actually… No, that’s before that. That’s before that. That is in the 1890s. Anyway, the Gold Standard Act of 1900 is sort of the culmination of the victory of the gold side. Anyway, now you have the Fed responsible, uniquely, exclusively, for providing paper substitutes for the dollar, but at least in its original conception the Fed is absolutely supposed to protect the gold standard, not alter it. Though all of this changes. It changes tentatively during World War I, when the Treasury puts embargoes on gold. That’s a war time thing, and it’s not really dismantling the gold standard, but when the Great Depression comes, of course, we have a suspension of gold payments and ultimately, various redefinitions of the gold content to the dollar, but most importantly, Americans absolutely lose their right to convert Federal Reserve notes into gold, and so they really have no access to gold at all, and that remains the case more or less permanently, although it’s legal to own gold again after 1976. It’s not a question of owning… Of being able to cash Federal Reserve notes into monetary gold.

0:27:43.5 Trevor Burrus: So is that… Would you say that’s the moment, I think it was ’71 when Nixon took it off the gold standard? Is that when it became a fiat currency?

0:27:51.1 George Selgin: It’s hard to put a moment on it, because you have first the time when American citizens cannot get their gold for their paper. That’s the ’30s, then you have a redefinition of the official value of the dollar, which is of course essentially bilking the foreigners, who still at that point have a right to get gold by saying, “Okay, but now you get less for each dollar.” Finally, of course, there’s a lot more to the story, but the shutting of the gold window in ’71, which itself is the culmination of a number of steps taken to prevent people from getting gold before then results in the dollar’s last connection to gold being severed. And at that point, of course, it’s certainly fiat money. Whether it’s sort of fiat money before then is an open question, and probably just a matter of semantics.

0:28:48.7 Aaron Powell: So now I think we can maybe loop back around to the other question… Yeah.

0:28:54.3 George Selgin: Now that we’ve got ourselves to fiat money, yeah.

0:28:54.7 Aaron Powell: So yes, so now we’ve got this state-​issued fiat money, which is only valuable, so to speak, because the state tells us it’s…

0:29:03.0 George Selgin: I’m going to correct you on that, ’cause it’s a common misconception.

0:29:05.9 Aaron Powell: Sure.

0:29:07.2 George Selgin: If the state could tell us how valuable its money could be, the Fed would have a nice easy job of it. They could avoid inflation by just telling us, “Hey, value this stuff more.” The only thing that preserves the value of a fiat money is restraint on the part of the issuing authorities when it comes to how much of the stuff they put out. They put out too much, it loses value, they put out too little, it can gain. Of course, the overarching tendency of fiat money supply is just to put out too much, hence the continuing depreciation of all world currencies, and then they have to resort to silly little devices like pretending that 2% inflation is really better than zero in order to convince us that they’re doing a whopping good job of protecting their standard.

0:29:54.6 Aaron Powell: Okay, but so we contrast this state-​issued fiat currency, we have been contrasting with this commodity currency, which again is that it’s money based in something real that we consider valuable and will be valuable even if it weren’t being used for money. But that makes me think of, if those are the two things we’ve been talking about, there’s a new thing around that gets a lot of talk right now, which is Bitcoin, and what is that? Because there’s no commodity there. There’s nothing valuable there. It’s not state-​issued, but it seems kind of fiaty in the sense…

0:30:32.9 Trevor Burrus: Fiaty, I like that.

0:30:34.6 Aaron Powell: Yeah. So what… Is that money?

0:30:37.0 George Selgin: So Bitcoin is indeed strange, and it’s so strange that I wrote a paper a few years ago that’s finally coming out soon in the Journal of Financial Stability, classifying Bitcoin as a new kind of basic money, one we didn’t realize could exist before. [chuckle] I call it synthetic commodity money. So I say this mainly to say, you’re on to something here, because Bitcoin really isn’t a fiat money in the standard sense, and it’s not a commodity money in the standard sense. We have to be very careful when we talk about commodity versus money versus Bitcoin and saying that commodities have a use and Bitcoin doesn’t. Of course, in some sense, anything that’s valued by anyone for any reason must be useful.

0:31:31.0 George Selgin: How Bitcoin first came to have value before it could be at all widely accepted, and even today, its acceptability is quite limited compared to other monies is a fascinating question, the best answer for which is that people were playing with it and it was fun and they valued it for that reason, but the valuation’s valuation. There’s no such thing as valuation that counts and valuation that doesn’t count. So anyway, that’s getting philosophical. But what does distinguish Bitcoin from other valued monies is it clearly doesn’t have the usual sort of commodity use value, in that before this stuff was used to trade with, and speculate with, and if you like, play with, you couldn’t do anything else with it. You couldn’t eat it, you couldn’t even, in this case, paper your walls with it, so it’s quite unusual.

0:32:31.6 George Selgin: On the other hand, Bitcoin is not fiat money in one important respect, it’s not like fiat money in that it has a true inherent scarcity, like gold, like silver. The protocol, or software, or whatever you want to call it, that governs the supply of Bitcoin, essentially guarantees that that supply will grow at a certain rate until there are about 21 million Bitcoin out there, and that’s that. There’s no authority that can change its mind about that growth path or rate. There’s no one who can manipulate it. You can start a new cryptocurrency, even the Bitcoin founders themselves could do so, that grows at a different rate, but it will be a parallel cryptocurrency, it won’t be a new Bitcoin, it won’t be a revised Bitcoin currency.

0:33:32.3 George Selgin: And this is fascinating. And so I think it’s fascinating enough to warrant serious study. And that’s why I wrote the paper I mentioned before, because whatever you think of Bitcoin itself, this whole category of synthetic commodity money raises the tantalizing possibility that someone could come up with a synthetic commodity with a growth behavior that is predetermined and since nobody can muck with it, but that it has very nice macroeconomic properties. We know that the supply of gold can sometimes change unpredictably; in principle, it could cause a monetary standard based on goal to misbehave, though I would take such a standard over a fiat standard any day, if we could have one again, but with Bitcoin and currencies like it, we have the prospect of designing the supply function, if you will, so that any macro economist worth his salt would have to admit that this stuff is actually going to behave rather well. So you have the virtue of it not being something that can be abused and manipulated by authorities, but it’s also not something that can behave badly owing to the so-​called blind forces in the marketplace. That’s cool.

0:34:54.5 Trevor Burrus: It seems like the story that we’re telling here, in this interesting way, is about accountability of the money system in a variety of ways that it could be accountable, and the fiat system is the least accountable one, ’cause even the possibility of failure or having competitive banks with different reserves, so they have an incentive not to over-​print their thing, is always just holding people accountable. And you mentioned the gold shocks, for example, creating the system or maybe undermining a gold standard system.

0:35:27.1 George Selgin: In principle.

0:35:27.2 Trevor Burrus: In principle. I was thinking about one of my favorite economic essays, the Economic Organization of a POW Camp by Bradford or Radford.

0:35:36.7 George Selgin: Radford.

0:35:37.9 Trevor Burrus: And it describes how, as a German POW, an economic system originated and cigarettes were the currency in this system, as is often the case, but you could have a shock to the system wherein they just suddenly dumped…

0:35:53.1 George Selgin: Red Cross parcels.

0:35:53.9 Trevor Burrus: A million cigarettes.

0:35:55.1 George Selgin: Yes.

0:35:55.3 Trevor Burrus: Right, right. That is, “Oh, here’s a million cigarettes.” And suddenly, you were holding all these cigarettes, keeping you somewhat rich, and now they just dumped a million cigarettes into the camp because there was extra left over after the war.

0:36:05.6 George Selgin: That’s right.

0:36:06.4 Trevor Burrus: After they conquered the Poles or something, whatever reason, that’s an exogenous shock to the system. So it’s a way of thinking about how these commodity currencies themselves could be undermined.

0:36:15.1 George Selgin: That’s right.

0:36:15.6 Trevor Burrus: And then a competitive currency system, that’s the accountability thing that I think is interesting. There’s accountability there to keep banks honest in a way that is not the case in fiat currency. That’s the ultimate point. That’s the libertarian point. Fiat currencies don’t keep governments honest, right? They can manipulate them, they can do what they want with them.

0:36:32.7 George Selgin: Absolutely, and with impunity. No central banker, as far as I know, has ever been punished for mismanaging a monetary standard, for allowing inflation. There’s talk that there’s a contract according to which the President of the Bank of New Zealand faces certain sanctions if there’s too much inflation and so on, but there’s nothing to that contract. I’ve looked at it, it’s so full of mights, and coulds and perhaps wills, that it has absolutely no teeth at all, and they’ll never do anything. So that’s pie in the sky. With private banks, whatever faults people may attribute to them, the bottom line is, a private banker can’t dishonor his obligations with impunity, it’s very simple. Every bank, and we know it’s a very big deal, if a private bank says to a depositor, “We’ve decided we’re not going to cash your deposit for the nominal value we said it was worth, we’re going to give you less.”

0:37:30.2 George Selgin: You can’t do that, you fail if you do that or you’ve got to get a bail out, so you don’t do it, but one way or the other, you can’t just unilaterally, as a private banker, you can’t do that. The central banks do it 20 times before breakfast. And so for people to think that central banks are where we should put our trust to have sound money is absurd on the face of it, given the incentives at work. Now, having said that, though, if you… Even the best private banking system can’t make for a stable money, if the underlying standard stuff, whether it’s gold or…

0:38:07.7 Trevor Burrus: Cigarettes or tobacco.

0:38:08.9 George Selgin: If that stuff is subject to shocks and misbehavior, then of course, that’s going to be reflected in the value of all these convertible substitutes based on it. Now, people exaggerate dramatically the extent to which the more important past commodity standards were in fact subject to such shocks. The worst known, the most infamous gold supply shock ever was that following the discovery of the New World and all this gold and silver is flowing into Europe and you have something called the Great Price Revolution of the… Approximately around the 16th century. Well, right, but if you look at the annual rate of inflation that the figures add up to, it’s less than… It’s so low, that it would have Janet Yellen today worrying that we’re too dangerously close to the zero lower bound.

0:39:02.5 Trevor Burrus: It’s too low. Yeah.

0:39:06.1 George Selgin: Seriously, it’s nothing, it was less than a 2% target that we have now, so it’s absurd to criticize the gold standard on account of having brought big, positive supply shocks. But we could, in principle, with Bitcoin and some synthetic commodity of money, we could design something that would be guaranteed not to surprise us with such things, and in that sense, it would be a big advance.

0:39:31.4 Aaron Powell: I’m curious about this competitive banking because… So we all… Companies fail all the time, private companies go under all the time, or at the very least, seem to go under more often than governments do, and so doesn’t that… Wouldn’t that make it potentially more dangerous to have a competitive system because I don’t want my bank to fail and take all my money with it, and so if I’m instead using the state’s fiat currency, I can at least think that the United States government is going to be around longer than this random start-​up?

0:40:06.3 George Selgin: Well, you have to remember, though, that by putting your trust in the central bank and issuer of fiat currency, you expose yourself to a daily exaction in the form of the depreciation of the money that that institution is allowing, that you can do nothing about. Now, you have to compare that alternative with the alternative of having a system where the government isn’t involved at all, where your basic money itself doesn’t depreciate the way fiat dollars do. And then, of course, if you’re using bank substitutes, how will those substitutes in that sound money compare to holding fiat money of a central bank?

0:40:51.6 George Selgin: Now, of course, the question of bank failures is very relevant here, but if you look at the history of banking and of bank failures, it’s overwhelmingly clear that the reason why we have major banking crises in the United States is because of the way we regulate banks, we have mis-​regulated them from the very get-​go. I mentioned how we didn’t have any branches of banks, and that remained the case for the most part, right up until the reforms finally were implemented in the 1990s, with regional compacts made some exceptions, but still. Now, look, you don’t have to be a finance expert to know that such a fragmented banking system is going to involve much less diversification and many more failures, other things equal, than a well-​diversified branch banking system.

0:41:43.4 Trevor Burrus: In the short form, if you have one bank and it’s in a corn-​growing economy…

0:41:48.4 George Selgin: If corn goes bad…

0:41:49.3 Trevor Burrus: Then the bank is done.

0:41:50.9 George Selgin: The bank fails and so do all the other banks in the region. Look, in the Great Depression, 5000, 6000 US banks failed and just in the first few years, and the number depends of course on the exact dates you choose, but anyway, Canada had a nationwide branch banking system, and during the Great Depression, which hit Canada very hard in other respects, after all, they were our major trading partner, zero banks failed. Now, there’s a fact, that’s a fact. In the United States, one state alone really had much of a branch banking system by the 1930s, that was California, thanks to the Bank of America, which was different from the modern bank. But in any event, California was one of the few states where no banks failed. These are overwhelming facts, but it’s not just branch banking, governments through their interference with banking have made banks much more failure-​prone in a million ways.

0:42:50.0 George Selgin: Now, the other thing they’ve done, of course, lately, is to define certain banks as being too big to fail, and there again, what is the ultimate outcome of this? The ultimate outcome is that these banks are inclined to take much bigger risks that do ultimately cause them to jeopardize their own solvency, but they do so expecting fully well, and having their creditors expect fully well, and that’s where the real discipline ought to come from, that they’ll get bailed out. You can’t have a system where the creditors of bankers, including regular depositors, are sure that their banks are going to get bailed out if they get… Find themselves in hot water, where market discipline does what it normally would do, which is to take money away from such risky banks and put it only into the risk-​free ones.

0:43:40.1 George Selgin: Finally, I’ll add one little anecdote to this to drive the point home. When I was teaching in the University of Hong Kong, some expert from the Bank of England came there and he was advising Hong Kong to adopt a deposit insurance, which it had not yet done. Now, living in Hong Kong, and not even for that long, it was perfectly apparent to me and to everybody else there, that there were two kinds of banks in Hong Kong. There were the big international banks, the British-​style banks, as they were called, like Standard Chartered and Hong Kong Shanghai Banking Corporation, as it was then known, and then there were a lot of so-​called native banks.

0:44:25.2 George Selgin: The native banks were not very well diversified, they were hardly better than casinos in some cases, but that’s alright, some people liked casinos, they put their money there, they took the risk. If things went well, they did well, if not, they took a big loss when the banks failed. Now, if you imposed insurance on that system, what do you suppose would happen? Well, Honkers and Shankers and Standard Chartered and the other big British banks would be effectively subsidizing these risky banks, and anybody with any brains would put their money in the riskier banks as long as…

0:44:58.2 Trevor Burrus: ‘Cause there’s no actual risk.

0:45:00.3 George Selgin: As long as it was covered. Now, it depends on the scheme, whether it’s 100% coverage or not, but in principle, a 100% coverage, which for example is what we have here, would have this effect of causing everybody to go to the higher risk banks. Do you get fewer failures? No, you get more failures, you get more risk. It’s this sort of interference with the normal operations of banks, interfering with their own devices to minimize risk, like branching, interfering with market incentives to contain risk, like you fail if you make bad investments and your creditors take a hit. These things have undermined the stability and safety of private banks, not anything inherent to the business of banking.

0:45:47.2 George Selgin: And if I may, I must say, I am sick and tired of reading idiotic expert advice from people today, and there’s more of it than ever now, saying, “Well, we’ve just got to stop banks from lending other people’s money, we should just have them have more capital and not allow them to lend, have 100% reserves.” These people who are saying this are utterly ignorant of the actual history of banking, of the history of bank failures, of the role that bank credit plays in sponsoring development, which is extremely important. They would have us living in caves again, just because they don’t understand it. You can have a sound fractional reserve banking system if you only get the government out and thereby stop it from undermining the normal devices the bankers have to keep themselves strong.

0:46:42.7 Trevor Burrus: It seems as though possibly the story here, is about basically trying to socialize risk in some basic way. There are some people who say, if you let people do their banking in a free banking system, they might invest in a bank that fails. So we’re going to put a system that socializes that failure out, and then the failures become systemic and they become more costly, at the end of the day, they become taxpayer-​funded failures, as opposed to being put on the people who made bad decisions by putting their money in a specific bank. So they’ve socialized their failure.

0:47:18.6 George Selgin: You could say that, but you make it sound a lot more benign, in fact, than it was. It really hasn’t… That hasn’t been the story. The story has been one all along of corporate welfare, and it’s not about the depositors. In the 1930s, for example, after all those banks failed, and this was just the culmination of a long history of high failure rates among unit banks at that time, and it would continue later on, people understood that the real problem with the US banking system was its unit banking structure, that if we could just overcome the industry opposition to branch banking, which came both from Wall Street, which benefited from the correspondent system that branch banking made necessary, and from Main Street, which worried about, ironically, Wall Street invading its turf.

0:48:02.3 George Selgin: But in any event, everybody understood that the unit banking was a flop, and of course, after this disaster of the banking crises of the ’30s, no sane person would want to put his money back in the unit banking system, I wouldn’t, but… So the obvious thing to do, is have reform through branching, create a sound system, a safe market-​based system like the Canadian system, but with more entry, Canada had restricted entry, and so it wasn’t ideal.

0:48:34.1 George Selgin: But the politics didn’t allow it. FDR himself recognized that deposit insurance was a very poor substitute. What deposit insurance was, was a way to prop up this fragile, indeed broken, unit banking system, keep it going, with basically… Giving it this infusion of support from the few sound banks in the system that there were, ’cause there are always going to be some strong banks that would end up subsidizing the weak ones, and so this was about saving a corrupt, rotten banking industry.

0:49:09.5 George Selgin: And FDR, to his credit, recognized the inherent dangers of deposit insurance, he had opposed it as governor of New York, he was reluctant to sign the bill, but he eventually signed it for want of anything else. So now, that was the story in the ’30s. What’s the story now? It’s not again about protecting small depositors, it’s corporate welfare now for the biggest banks. The biggest banks are being protected with too big to fail. This idea that the poor depositor won’t know where to put his money or her money has things entirely backwards, by the way. Until fairly recently, anybody could go to a library and pick up a number of publications that… Private ones, that ranked banks according to their safety, it was as easy as buying a copy of consumer reports to decide what stereo system you wanted.

0:50:03.1 George Selgin: Why did these publications exist? Because until too big to fail really came into prominence in recent decades, deposit insurance had only limited coverage, of course, and there were enough business accounts out there that were very big, where you really were taking a risk if you dealt with the wrong bank. So those people had an incentive to make sure they put their money in safe banks, ’cause at that time they felt like they could lose it. Now of course, they just go to the biggest bank in town and they know they’re safe… In the country and you know you’re covered.

0:50:39.2 Trevor Burrus: And everyone probably goes to the biggest bank too.

0:50:41.3 George Selgin: Yeah, that’s over with. But in those days… So the idea that there’s no way consumers can pick good banks, safe banks, that they just have to have… We have to have a safety net, we have to have too big to fail, we have to have the FDIC, that’s just a bunch of bull. And of course, the truth rather is, no one bothers to learn anything about which banks are safer, not in the system we have, because they don’t have any incentive to do it, that’s why our system stinks.

0:51:14.3 Aaron Powell: So the history you’ve described, in this country, of the rise of fiat currency and deposit insurance and all this other stuff, is a history of poor decision after poor decision. If we were going to fix that, if we had the power to just change things to the way that they ought to be, what would that look like? Would it be a return to gold, would it be the embracing of the synthetic currencies, like we’ve talked about, something else? What would money look like, in the US, in the right system?

0:51:41.3 George Selgin: So there are two ways of thinking of your question. One is, how would our system have developed if they hadn’t kept botching it up from the beginning? The other is, how could it develop today, if we stop botching it up and start to undo some of these policies that have been wrecking things? And of course, the answer to each of those questions, is going to be very, very different. And the answer, I should say, to the first question also depends fundamentally on what you imagine is happening in the rest of the world, right, so we can’t really abstract from that.

0:52:21.1 George Selgin: But suppose the United States was the whole world and there had been no tampering with banks and money by the government, I imagine that we could have had a system that, in many respects, resembled the Canadian system of the day that I described, or the Canadian system in its hey day, around the 1870s, ’80s, when it was a notoriously stable system, except Canada, as I mentioned, a very, very narrowly restricted entry into its banking system, was essentially a closed system. Now, studies have shown that it was nonetheless competitive in the sense that, if you look at the structure of interest rates, and spreads, and all that, and it seems like the banks were rivalrous enough for the most part, but still, one could have done better with freedom of entry.

0:53:10.9 George Selgin: It’s very speculative to ponder how many banks that such a free entry system that allowed nationwide branch banking might have supported. I suppose it could have been only dozens, but perhaps it would have been hundreds, I don’t know. It is highly unlikely that it would have been thousands. So we would have had many fewer banks in any case, they would have mostly had very large branch networks, they would have been very diversified. And of course, if the federal government had interfered with who could issue notes, the larger ones anyway would have all issued notes, not all of them. Note issuing is something that requires a particularly good reputation, that is if monopoly privileges don’t support it. So we’d have a handful, perhaps, of banks that would have been issuing notes or a few handfuls at that.

0:54:12.4 Trevor Burrus: And you’d see a Bank of America note, you’d see a Citi Group note.

0:54:15.4 George Selgin: You’d see a Citi Group note.

0:54:16.1 Trevor Burrus: And occasionally, you’d see like Third Bank of Georgia and you’d wonder…

0:54:19.3 George Selgin: Occasionally, perhaps.

0:54:20.4 Trevor Burrus: Could I actually use this Third Bank of Georgia note?

0:54:22.9 George Selgin: But notes that people had those second thoughts about would tend to be weeded out. Banks like that would either go out of business entirely or would certainly leave the currency business, precisely because people would favor the other currencies to theirs, so there’d be a few dozen, perhaps, different brands, nothing difficult to deal with. Canada had a few dozen for many decades. And bank failures would be relatively rare. The stock of currency could respond to fluctuations in the relative demand for it compared to deposits. We know from the Canadian experience how well the currency supply responded to demand, it was elastic, but non-​inflationary.

0:55:05.7 George Selgin: Supply had a nice pattern of spiking in the autumn when you needed more currency for truck crop moving, coming back in and after the harvest, and then doing the same thing the next year. The underlying determinant, of course, of the total supply of money would be the underlying supply of the monetary standard, which again, here, the counterfactual history is complicated by the whole question of bimetallism, would it have been silver or gold or what? And the answer is very difficult because it really, it depends on how… What the market values of the two metals did.

0:55:44.6 George Selgin: Ultimately, we know that the relative decline in the value of gold after the 1850s favored gold monometallism, so it’s easiest to speculate in terms of that. And indeed, we know what would have happened with gold monometallism, ’cause that’s what we did have effectively, and it was mild deflation, generally not exceeding the average rate of productivity growth very much, and so not particularly harmful. That is, the deflation was more or less reflecting declining overall unit production costs, wages therefore didn’t have to deflate and even rose in money wages. And things were not bad.

0:56:29.8 Trevor Burrus: So in that world, you would actually have the fact that my parents paid 70 cents a gallon for gas or maybe 12 cents in 1971, and it would still be 12 cents or even lower.

0:56:39.7 George Selgin: It would be lower. It would probably be lower. You have to look at… If you look at the real… Under this arrangement, if you look at what’s happened to real unit prices as opposed to prices not deflated, and then imagine the nominal prices actually doing that, right? So really, the story would have been one of the actual US economy, let’s say 1870 to 1907 minus all the financial crises, which means you have to not only get rid of the peaks and all the fluctuations, but you can assume a higher trend line because of the losses avoided along the way. I mean, and we’re getting into the area of real speculation, but I think that’s roughly what we would have seen if the government hadn’t continually messed things up.

0:57:32.2 Trevor Burrus: So what do we do now?

0:57:33.1 Aaron Powell: Yeah, given our unfortunate inability to change the past, what can we do today?

0:57:37.4 George Selgin: Ah, well, that’s why I said there are two different questions, because now having botched up and ultimately destroyed the metallic standards of the past, it’s not easy to go back to them, because we come to the original point about the evolution of money. Once you establish a standard, it tends to be self-​reinforcing. And it’s hard to switch. How would we ever get back to a different standard, how could we have a move to gold? Imagining it occurring spontaneously, as some gold advocates do, involves imagining at least some people being the first movers in the process that have to incur all the costs associated with trying to trade with something that no one else is trading with. That’s not easy to do.

0:58:28.1 George Selgin: It’s like having your very own computer operating system or phone network where you’re the only person on it so far. If you can’t get some people to move independently and unilaterally to be first to start this ball rolling, then what’s the alternative? Well, the alternative is we get the… Somehow we get the US government to get on board this idea and make a concerted change. Well, the problem with that is, now we have the federal authorities who we’re trusting to commit to a return to a gold standard, but their credibility has been shot. It’s totally shot. If the Fed announced tomorrow that it was going to once again start redeeming Federal Reserve dollars in a fixed quantity of gold, there’d be a speculative attack on the fed on Saturday, if it were open, or on Monday if not.

0:59:16.4 George Selgin: And that’s all there is to it, and that would be the end of that. I don’t personally know how you get around this dilemma, the dilemma of a private return to gold requiring somebody to start the ball rolling and incur the costs thereof, versus having the government take the lead when its credibility is non-​existent. Maybe someone knows how we can do that, but I don’t.

0:59:46.1 Trevor Burrus: But at the very least, we should stop too big to fail and stop…

0:59:49.7 George Selgin: That doesn’t mean… Yeah. That doesn’t mean there’s not a lot we can do to have a better monetary system, and that… It doesn’t mean we can’t get rid of the Fed as a discretionary manipulator of money. It means going back to a gold standard is really hard. I would like to therefore focus on possibilities for maintaining the dollar standard, but getting the Fed, that is this group of people who can play with it, out of the story. And there we have to think, first of all, about reining in the Fed, doing away with its discretionary powers. Ultimately, I think we can contemplate reforms where we just freeze the stock of Federal Reserve dollars, but frozen stock like that won’t… Talk about an inelastic currency. It would be terribly inelastic, unless the rest of our private financial institutions were capable of supplementing the fixed stock of Federal Reserve money with substitutes, and doing so in a manner that could accommodate changing needs.

1:01:00.0 George Selgin: To do that we first of all have to have sound private financial institutions, which means we have got to get rid of too big to fail. We’ve got to rein in deposit insurance. We’ve got to get rid of the safety net, which is the A number one problem in our financial system today. But of course, at the same time, we have to encourage the kind of financial diversification and flexibility that can make the banks strong in themselves, instead of having to rely on safety nets. Now, the good news is we have branch banking now. The problem is, by the time we got branch banking, we were mucking up the system with these other interventions.

1:01:41.3 George Selgin: So we have a banking structure that could conceivably be a sound structure, but now we’ve got to get rid of the guarantees that have undermined the soundness of that structure. That’s a lot right there. We should allow banks, once they are standing on their own, capable of standing on their own feet, and by the way, some banks are capable and have been along. There’s a lot of loose talk about the whole industry being unsound. It’s certainly false. It was false even in the depths of the crisis. In any event, when we have sound banks, we need to let them issue all kinds of substitutes for Federal Reserve dollars, so the people don’t have to rely on the Fed. We need to break the Fed’s monopoly.

1:02:24.2 George Selgin: So those are just some of the things on the agenda. What about crypto currencies? The best thing we can do with those is to let them flourish. The government shouldn’t play, and it hasn’t played any role in creating them. It has no positive role to play in encouraging them. The hands-​off policy of government towards these currencies, except to the extent of making clear its treatment of them for tax and other purposes, and of course, there are better ways for it to do that and worse ways, but having a set of rules is better than having no rules at all, but otherwise the best thing the government can do with crypto currency is keep the heck out.

[music]

1:03:09.6 Aaron Powell: Thank you for listening to Free Thoughts. If you have any questions or comments about today’s show, you can find us on Twitter @FreeThoughtsPod. That’s Free Thoughts P-O-D. Free Thoughts is a project of lib​er​tar​i​an​ism​.org and the Cato Institute, and is produced by Evan Banks. To learn more about libertarianism, visit us on the web at www​.lib​er​tar​i​an​ism​.org.