„One of the advantages of free banking is greater financial stability“ — Interview with George Selgin

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George Selgin is a monetary economist. He is professor emeritus of economics at the University of Georgia and senior fellow and director emeritus of the Center for Monetary and Financial Alternatives at the Cato Institute. He has published several books, for example, Less than Zero, and contributes regularly to the Alt-M blog. Der Freydenker interviewed George Selgin on the 23rd of April during the LibertyCon 2022 in Prague. The interviewer was Alexandre Kintzinger.

Der Freydenker: Inflation is soaring today. Could you explain what inflation actually is?

Selgin: You know, it’s really not such a big question, if you just go by the way economists define it these days, almost all of them. It’s just any positive rate of increase of consumer prices. So it could be very slow. You still would call it inflation, mild inflation. And we measure these things with various statistics that are more or less reliable. I think they’re actually pretty reliable, despite what some libertarians say.

In any event, the consensus among central bankers, not among all economists, is that 2% inflation is tolerable, if not desirable. I don’t think 2% is necessarily ideal myself. But that’s the consensus and anything higher is reason to be concerned. And right now, of course, inflation has been well above 2%. Then the question is, how much of this additional inflation is something that central banks should be held responsible for preventing? And that’s actually a good question that different people have answered in different ways.

Der Freydenker: There are a lot of mainstream economists who discuss deflation. Also, central bankers always argue that deflation is such a bad thing and that a little bit of inflation is always better than this „bad“ deflation. What is your opinion on this?

Selgin: Actually, this period of high inflation is a very good time for thinking about that, because you can ask the reverse question: Is inflation itself ever desirable, and under what circumstances? And I think a lot of economists would agree that to the extent that the recent inflation has been due to supply problems—shortages of goods and services, shortages from COVID or from COVID lockdowns, and now more likely shortages connected to sanctions and the direct effects of war in Ukraine, all things that tend to make goods more scarce and drive their prices up—it’s actually better to leave the inflation alone. That is, if it’s scarcity-related, these higher consumer prices are regrettable, but that’s because the scarcity is regrettable. If the central bank tries to clamp down and prevent this sort of inflation, what does it do? Well, it keeps the prices from going up, but it does so by matching the scarcity of goods with a corresponding increased scarcity of means of exchange, of money. But this doesn’t actually help; the two shortages don’t cancel out. The combination actually makes people more miserable than just letting prices go up. So I would say, in answer to the opposite question, allowing inflation to get higher than usual because of supply side shortages is a good policy.

“To the extent that the recent inflation has been due to supply problems—shortages of goods and services, shortages from COVID or from COVID lockdowns, and now more likely shortages connected to sanctions and the direct effects of war in Ukraine, all things that tend to make goods more scarce and drive their prices up—it’s actually better to leave the inflation alone.“

This doesn’t mean that all of the inflation that we have now is desirable. But some part of it is, and there are ways of trying to figure out what percentage is due to supply shortages and what percentage is due to too much spending because central banks policies have been too easy.

I haven’t answered your question about deflation, but I wanted these comments on inflation to serve as a prelude to answering that. Exactly the opposite applies for deflation. There are circumstances when prices are tending to fall because productivity is growing especially rapidly. You can imagine a situation where output is just growing very fast. Such growth is a source of supply-side driven, downward pressure on prices. It’s not because money is scarce. It’s not because people aren’t spending much. It’s because there are simply more goods and services available. If that’s true, and that availability improves rapidly, some deflation can actually be perfectly desirable.

Unfortunately, if the norm is 2% inflation, it becomes very difficult to convince central bankers that they should ever allow prices to fall on occasion. But the very least they should do is to allow the inflation rate to deviate below 2% sometimes. Just as they should allow it to deviate above. In both cases, though, where these deviations are reflecting changes in the actual scarcity of goods in either direction.

Der Freydenker: Two years ago I interviewed Jeff Booth who had written a book about technology and deflation. Do you think technology is key against this current policy that we now have?

Selgin: Well, Jeff’s position was very different than mine. Jeff is making a positive claim that technology is going to inevitably cause deflation. I don’t think that that’s true. I think that if you have technological improvements, ideally, when these reduce the costs of production of goods, unit costs, the goods‘ prices should get lower or at least shouldn’t rise as quickly as they might otherwise. But I don’t think this is inevitable at all. We know that central banks have prevented deflation for most of the 20th and 21st centuries. Yet we’ve had a lot of productivity gains. We’ve had a lot of technological breakthroughs during this time.

So it’s not at all inevitable that, when you have better technology for producing goods and services, prices are going to start falling, because central banks have the capacity, by issuing more fiat money, not only to offset any deflationary tendencies, but to replace them with inflationary tendencies. And they’ve been doing that. They haven’t always done it quite as much as they‘ve wanted to; Jeff wrote his book at a time when central banks seemed to be struggling to maintain 2% inflation. And it may have seemed plausible then that technology was perhaps part of the reason they couldn’t do it. Well, that’s over with. We now see clearly that technology is not able by itself to counter central bankers‘ capacity to generate excessive amounts of money that lead to more inflation. Technology alone can‘t do that. We need to do something else to get central banks to constrain their own activity.

Our editor Juan D. Estevez (left) in conversation with George Selgin (right) and our regular contributor Jorge Jraissati.

Der Freydenker: You’re known as an advocate of free banking. Could you tell our readers what this means and how it differs from our current monetary regime?

Selgin: Free banking is about the banking regime. What it means, technically, is an arrangement in which the banks are unregulated, or at least one in which they’re not subject to any special regulations. Of course, you have contract enforcement, you have disclosures. You have only such very basic regulations in a free banking system as you might see applied to any industry. And you also allow the banks to issue any form of IOUs. They can create deposits, as they now do. They can issue paper currency that’s redeemable, which they used to do but seldom do anymore. And they could issue digital currency as well. And so the idea is that the banks are as free as possible to offer every sort of substitute for official fiat money, and might do so so effectively that people aren’t relying directly at all on central bank liabilities. 

Now that’s the banking regime. Notice I said fiat in this case, because a free banking system could be based on a fiat standard. It could also be based on a gold standard. And it could be based on a Bitcoin standard were such a standard to emerge somewhere in the future. The point is that, because free banking can co-exist with any more standard money there are no generalizations you can make about how inflation will behave under free banking. The answer depends on whether it’s gold, or Bitcoin or fiat. If it’s fiat, the inflation rate will depend on how the central bank works, so it might be no better than it is today.

Free banking does have advantages, even if the underlying standard is not what you’d like it to be. But it isn‘t a panacea; having it is no guarantee that the overall monetary regime is going to be successful.

Der Freydenker: So why do you believe is free banking the better solution?

Selgin: Well, it’s good at certain things. The money that free banking systems can create, tends to be very efficient. I believe that an unregulated banking system—I know this is contrary to what many people believe, but I will still say it—I think an unregulated banking system or one that’s only regulated the way I suggest, with no guarantees by the government, no bailouts, as well as the absence of various other regulations, would be far more stable than our actual banking systems. Some of these are very unstable. This will strike many people as the very opposite of what they’ve been taught, and it is. But if you look carefully at the history of financial crises and financial instability, you often find that misguided regulations have played a very important role. And it turns out that if you study, as I have, some of the least regulated systems of the past, you find remarkable examples of financial stability. For this reason I say that one of the advantages of free banking is greater financial stability. It’s not going to automatically get rid of inflation by itself or deflation. That depends on the monetary standard. But it can be a more stable system in the sense that it’s less likely to result in periodic crises and collapse.

Der Freydenker: How does crypto relate to this? Is it the solution to our problems in the monetary sphere?

Selgin: Well, it could conceivably help. There are two kinds of cryptocurrency that are important here. One is the Bitcoin type, which is an independent standard money, and an option that’s neither fiat money or gold and not silver. What cryptocurrencies of this sort do is present us with a whole new set of actual and potential alternative standard monies, some of which might behave better than any of these pre-existing alternatives. 

I’m afraid I don’t think Bitcoin is itself an especially good alternative, because when it reaches its fixed supply limit of 21 million bitcoin, that quantity might not prove ideal for macroeconomic stability in the long run. It’s conceivable that, with a free banking system, even a fixed amount of standard money would be sufficient. It’s conceivable, but it’s a bit risky. But continuing innovation in cryptocurrencies of this type is extremely desirable, because it could eventually provide us with better alternatives. Of course, whether such an alternative, should it arise, will actually get adopted as money is a big question; in practice making that happen is quite difficult. I’m speaking now of the ideal possibilities.

Stablecoins are the second sort of cryptocurrencies. The better, more stable examples of these are redeemable claims, or IOUs, that in some respects resemble old-fashioned banknotes like those issued in past free banking systems. They could be a very important component of some future monetary arrangements, and new alternatives to central bank money, and paper fiat currencies especially, that are more efficient but, if done right, just as stable. So these could also make an important contribution to the overall efficiency and stability of future monetary systems.

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