The Case for Monetary Freedom and Free Banking

First Published: 2014-12-19

There has been no greater threat to life, liberty, and property throughout the ages than government. Even the most violent and brutal private individuals have been able to inflict only a mere fraction of the harm and destruction that have been caused by the use of power by political authorities.

There has been no greater threat to life, liberty, and property throughout the ages than government. Even the most violent and brutal private individuals have been able to inflict only a mere fraction of the harm and destruction that have been caused by the use of power by political authorities.

The pursuit of legal plunder, to use Frédéric Bastiat’s well-chosen phrase, has been behind all the major economic and political disasters that have befallen mankind throughout history.

Government Spending Equals Plundering People

We often forget the fundamental 
truth that governments have nothing 
to spend or redistribute that they do not first take from society’s producers. The fiscal history of mankind is nothing but a long, uninterrupted account 
of the methods governments have devised for seizing the income and wealth of their citizens and subjects.

Parallel to that same sad history must be an account of all the attempts by the victims of government’s legal plunder to devise counter-methods to prevent or at least limit the looting of their income and wealth by those in political power.

Every student who takes an economics course learns that governments have basically three methods for obtaining control over a portion of the people’s wealth: taxation, borrowing, and inflation––the printing of money.

It was John Maynard Keynes who pointed out in his 1919 book, The Economic Consequences of the Peace:

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they also confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some . . .

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Limiting Government with the Gold Standard

To prevent the use of inflation by governments to attain their fiscal ends, various attempts have been made over the last 200 years to limit the power of the State to print money to cover its expenditures. In the nineteenth and early twentieth centuries the method used was the gold standard. The idea was to place the creation of money outside the control of government.

As a commodity, the amount of gold available for both monetary and non-monetary uses is determined and limited by the same market forces that determine the supply of any other freely traded good or service: the demand and price for gold for various uses relative to the cost and profitability of mining and minting it into coins or bullion, or into some other commercial form.

Any paper money in circulation under the gold standard was meant to be money substitutes––that is, notes or claims to quantities of gold that had been deposited in banks and that were used as a convenient alternative to the constant withdrawing and depositing of gold coins or bullion to facilitate everyday market exchanges.

Under the gold standard, the supply of money substitutes in circulation was meant to increase and decrease to reflect any changes in the quantity of gold in a nation’s banking system. The gold standard that existed in the late nineteenth and early twentieth centuries never worked as precisely or as rigidly as it is portrayed in some economics textbooks. But, nonetheless, the power of government to resort to the money printing press to cover its expenditures was significantly limited.

Governments, therefore, had to use one of the two other methods for acquiring their citizens’ and subjects’ income and wealth. Governments had to either tax the population or borrow money from financial institutions.

But as a number of economists have pointed out, before World
War I many of the countries of North
America and western and central Europe operated under an “unwritten
fiscal constitution.” Governments, except during times of national emergency, were expected to more or less 
balance their budgets on an annual 
basis.

If a national emergency
 (such as a war) compelled a government to borrow money to cover its
 unexpected expenditures, it was expected to run budget surpluses to
pay off any accumulated debt when the emergency had passed.

This unwritten balanced-budget rule was never rigidly practiced either, of course. But the idea that needless government debt was a waste and a drag on the economic welfare of a nation served as an important check on the growth of government spending.

When governments planned to do things, the people were more or less explicitly presented with the bill. It was more difficult for governments to promise a wide variety of benefits without also showing what the taxpayer’s burden would be.

World War I Destroyed the Gold Standard

This all changed during and after World War I. The gold standard was set aside to fund the war expenditures for all the belligerents in the conflict. And John Maynard Keynes, who in 1919 had warned about the dangers of inflation, soon was arguing that gold was a “barbarous relic” that needed to be replaced with government-managed paper money to facilitate monetary and fiscal fine-tuning.

In addition, that unwritten fiscal constitution which required annual balanced budgets was replaced with the Keynesian conception of a balanced budget over the phases of the business cycle.

In practice, of course, this set loose the fiscal demons. Restrained by neither gold nor the limits of taxation, governments around the world went into an orgy of deficit spending and money creation that led some to refer to a good part of the twentieth century as the “age of inflation.”

Politicians and bureaucrats could now far more easily offer short-run benefits to special-interest groups through growth in government power and spending, while avoiding any mention of the longer-run costs to society as a whole, in their roles as taxpayers and consumers.

The Counter-Revolution Against Keynesianism

Beginning in the late 1960s and 1970s a counter-revolution against Keynesian economics emerged, especially in the United States, which came to be identified with Milton Friedman and monetarism.

To restrain government’s ability to create inflation, Friedman proposed a “monetary rule”: the annual increase in the money supply should be limited to the average annual increase in real output in the economy. Put the creation of paper money on “automatic pilot,” and governments would once more be prevented from using the printing press to capriciously cover their expenditures.

But in the years after receiving the Nobel Prize in economics in 1984, Friedman had second thoughts about the effectiveness of his monetary rule. He stated that Public Choice theory – the use of economic theory to analyze the logic and incentives in political decision-making – persuaded him that trying to get central banks to pursue a monetary policy that would serve the long-run interest of society was a waste of time.

Just like the rest of us, politicians, bureaucrats, and central bankers have their own self-interested goals, and they will use the political power placed at their disposal to advance their interests.

Said Friedman: “We must try to set up institutions under which individuals who intend only their own gain are led by an invisible hand to serve the public interest,” He also concluded that after looking over the monetary history of the twentieth century, “Leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.”

Separating Money from Government Control

Though Milton Friedman was unwilling to take his own argument that far, the logical conclusion of his admission that the control of money can never be trusted in the hands of the government is the need to separate money creation from the State. What is required is the denationalization of money, or in other words, the establishment of monetary freedom in society.

Under a regime of monetary freedom the government would no longer have any role in monetary and banking affairs. The people would have, to use a phrase popularized by the Austrian economist F. A. Hayek, a “choice in currency.” The law would respect and enforce all market-based, consensual contracts regardless of the currency or commodity chosen by the market participants as money. And the government would not give a special status to any particular currency through legal-tender laws as the only “lawful money.”

Monetary freedom encompasses what is known as “free banking.” That is, private banks are at liberty to accept deposits in any commodity money or currency left in their trust by depositors and to issue their own private banknotes or claims against these deposits.

To the extent these banknotes and claims are recognized and trusted by a growing number of people in the wider economic community, they may circulate as convenient money substitutes. Such private banks would settle their mutual claims against each other on behalf of their respective depositors through private clearinghouses that would have international connections as well.

Few advocates of the free market have included the privatization of the monetary system among their proposed economic policy reforms. The most notable advocate of monetary freedom and free banking in the twentieth century was the Austrian economist Ludwig von Mises, who demonstrated that as long as governments and their central banks have monopoly control over the monetary system inflations and the business cycle are virtually inevitable, with all of their distorting and devastating effects.

But the last 30 years have seen the emergence of a body of serious and detailed literature on the desirability and workability of a fully private and competitive free-banking system as an alternative to government central banking.

Self-Interest and Monetary Freedom

Its political advantage is that it completely removes all monetary matters from the hands of government. However effective the old gold standard may have been before the First World War, it nonetheless remained a government-managed monetary system that opened the door to eventual abuse.

Furthermore, a free-banking system fulfills Milton Friedman’s recommendation that the monetary order should be one that harnesses private interest for the advancement of the public interest through the “invisible hand” of the market process.

The interests of depositors in a reliable banking system would coincide with the self-interest of profit-seeking financial intermediaries. A likely unintended consequence would be a more stable and adaptable monetary system than the systems of monetary central planning the world labors under now.

Of course, a system of monetary freedom does not do away with the continuing motives for government to grow and spend. Even limits on the government’s ability to create money to finance its expenditures does not preclude fiscal irresponsibility, with damaging economic consequences for a large segment of the population through deficit spending and growing national debt.

Monetary Freedom and a Philosophy of Liberty

In the long run, the only way to limit the growth of government spending and power over society is to change political and ideological thinking. As long as many people want government to use its power to tax and regulate to benefit them at the expense of others, it will retain its power and continue to grow.

Monetary and fiscal reform is ultimately inseparable from the rebirth and implementation of a philosophy of freedom that sees government limited to the protection of each individual’s right to his life, liberty, and honestly acquired property.

As Ludwig von Mises expressed it ninety years ago in the aftermath of the First World War and during the Great German Inflation of the early 1920s:

“What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last, however, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.”

If the belief in and desire for personal and economic liberty can gain hold and grow once more in people’s hearts and minds, monetary freedom and fiscal restraint will eventually come by logical necessity.

First published at EPICTiMes, December 8, 2014.


Dr. Richard M. Ebeling is the BB & T Professor of Ethics and Free Enterprise Leadership at The Citadel in Charleston, South Carolina, He was formerly professor of Economics at Northwood University. Was formerly president of The Foundation for Economic Education (FEE), was the Ludwig von Mises Professor of Economics at Hillsdale College in Hillsdale, Michigan, and served as president of academic affairs for The Future of Freedom Foundation.

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