A political party in my country (Norway) writes in its program that it wants to "continue its work towards making the central bank independent and autonomous". At an internet debate a person remarked that that this could be interpreted to mean that they wish to privatize the central bank, and that this is a bad idea (because then private interests could control the money supply).
My question is, what would be the consequences of privatizing a nations "reserve bank"?
I understand that independent is not the same as privately owned. However, what I'm looking for is theoretical consequences of a privately owned central bank. Ie. would such an institution make any sense at all? I mean, if it was privatized then it would be just like any other private bank, so other banks would have no incentive to place their reserves at that specific bank (because the government would not have to bail them out if flopped). Wouldn't the owners steer away from the goal of "controlling inflation and providing stability" and rather work toward profit as a goal, and wouldn't that in effect provide a correct (as in provided by the market) interest rate? Even if the goal of the owners was to "control inflation and provide stability" through controlling the interest rate, how could they be competetive at a "market-incorrect" interest rate, unless they had an unlimited supply of money provided by the government or a legally protected monopoly on issuing money?
To me, it seems that the problem is not who owns the central bank, but rather that they have special privileges. What I'm wondering is if this is a correct assumption, and what would the reasoning behind it be?
Zlatko:I understand that independent is not the same as privately owned. However, what I'm looking for is theoretical consequences of a privately owned central bank. Ie. would such an institution make any sense at all? I mean, if it was privatized then it would be just like any other private bank, so other banks would have no incentive to place their reserves at that specific bank (because the government would not have to bail them out if flopped). Wouldn't the owners steer away from the goal of "controlling inflation and providing stability" and rather work toward profit as a goal, and wouldn't that in effect provide a correct (as in provided by the market) interest rate? Even if the goal of the owners was to "control inflation and provide stability" through controlling the interest rate, how could they be competetive at a "market-incorrect" interest rate, unless they had an unlimited supply of money provided by the government or a legally protected monopoly on issuing money?
Well, you have to define what a private central bank would be. It could be a privately owned corporation which is still granted all the special privileges given to a central bank, and thus granted a monopoly and protected from competition. Or it could mean just a "banker's bank," which is naturally open to competition.
The difficulty does come with the privileges, not with who owns it. Those privileges allow it to inflate the money supply, whereas with a banker's bank, the banks could hold their reserves in other privately issued currency if they tried to inflate beyond a certain point (I'm not a 100% reserves guy, I'm a free banking guy.)
The central bank, at least as the term is commonly understood, is a creature of the State, not of the market. A private central bank would merely be a 'private' arm of the State, and would not differ essentially from the US Fed. I think you're interested in how a market could function without a central bank (correct me if I'm wrong.) I agree with your assumption BTW - the central bank is essentially a privileged institution, regardless of who controls it. Here are two contrasting views on how the market might handle money:
In Defence of Fiduciary Media
These articles explain monetary theory briefly, and respectively argue for free banking and commodity banking. If you're considering staying here, I suggest you read up on Austrian monetary theory more generally when you get the time to:
The Theory of Money and Credit
It'll give you a better understanding of the workings of things like interest, and so on. The other readings on the reading list on Praxeology I put together will also help.
Zlatko:However, what I'm looking for is theoretical consequences of a privately owned central bank. Ie. would such an institution make any sense at all?
There was a free market central bank in New England in the 19th century. See A History of Money and Banking pages 115 thru 123.
Inquisitor:I think you're interested in how a market could function without a central bank (correct me if I'm wrong.)
I think you're interested in how a market could function without a central bank (correct me if I'm wrong.)
I am very interested in that. But I think I've muddled up my original question with my previous posts. If I had to concretize my original question, I would rephrase it as: "Is there more rent-seeking when the central bank is owned by the government or privately owned? (given it retains it privileges)"
Inquisitor: If you're considering staying here, I suggest you read up on Austrian monetary theory more generally when you get the time to.It'll give you a better understanding of the workings of things like interest, and so on. The other readings on the reading list on Praxeology I put together will also help.
If you're considering staying here, I suggest you read up on Austrian monetary theory more generally when you get the time to.
Thanks for the links, I will. I've only read "Econ for real people" so far, but I have some understanding of economics already (I'm an MBA undergrad) and am especially interested in macroeconomics, although what I have learned in class seems to belong mostly to the Keynesian tradition.
edit: Thank you also, Dbratton, for the link.
Zlatko:I am very interested in that. But I think I've muddled up my original question with my previous posts. If I had to concretize my original question, I would rephrase it as: "Is there more rent-seeking when the central bank is owned by the government or privately owned? (given it retains it privileges)"
It's the special privileges that lead to the rent-seeking behavior not the ownership. If they have monopoly status then it really doesn't matter, the government isn't going to just give them a free hand either but will expect something in return for their special status.
Now if they privatize the central bank and repeal the legal tender laws then it will get interesting...
The point is not whether the central bank is public or private, but the fact that it exists at all. A central bank has only one purpose, that being to coordinate inflation. In a libertarian minarchist society, central banking would be prohibited, being that it is inherently fraudulent. In addition, all regular banks would be required to maintain 100% reserves against bank notes and demand deposits, fractional reserve being inherently fraudulent. Legal tender laws would not be required, nor would they even be necessary.
In an anarchist society, clearly central banking and fraudulent fractional reserve banking would exist. However, people would be free to ignore them and do business with 100% reserve banks and accept only banknotes backed 100% by specie. In such a society, only those stupid enough to accept the funny money are going to be hurt when the system inflates, and ultimately collapses.
Mark B.: The point is not whether the central bank is public or private, but the fact that it exists at all. A central bank has only one purpose, that being to coordinate inflation. In a libertarian minarchist society, central banking would be prohibited, being that it is inherently fraudulent. In addition, all regular banks would be required to maintain 100% reserves against bank notes and demand deposits, fractional reserve being inherently fraudulent. Legal tender laws would not be required, nor would they even be necessary.
Everyone loves to toss around that fractional reserves are fraud, but they are only fraudulent if the depositor is led to believe that 100% reserves are held. Suppose I open a bank with a sign on the wall reading:
"You are free to deposit money here. You may write checks against your balance, and you may withdraw your money on demand. However, we do not maintain 100% reserves. Therefore, there is a possibility, however slim, that when you wish to withdraw your money, we may not have specie on hand. In that event, we will provide the payment to you within 5 business days, together with a 10% compensation. On the other hand, because of these fractional reserves, we are able to pay interest on your demand deposit account. We think it is an attractive bargain for you. If you do not agree, please take your business elsewhere."
Then I proceed to do so. Fraud? Who am I defrauding? If by central banking you mean a monopoly banker's bank, then of course a miniarchist libertarian ought to think it should be illegal - not because it's fraud, but because it's a forcible monopoly. However, I see no reason that a banker's bank would be illegal. It is legal, and would be legal in a miniarchy, for me to use a bank - why not for a bank to patronize a bank?
JAlanKatz:Everyone loves to toss around that fractional reserves are fraud, but they are only fraudulent if the depositor is led to believe that 100% reserves are held. Suppose I open a bank with a sign on the wall reading: "You are free to deposit money here. You may write checks against your balance, and you may withdraw your money on demand. However, we do not maintain 100% reserves. Therefore, there is a possibility, however slim, that when you wish to withdraw your money, we may not have specie on hand. In that event, we will provide the payment to you within 5 business days, together with a 10% compensation. On the other hand, because of these fractional reserves, we are able to pay interest on your demand deposit account. We think it is an attractive bargain for you. If you do not agree, please take your business elsewhere."
That's all fine and good but as the owner of a 100% reserve bank I'm not going to appreciate you lowering interest rates through your fractional reserve practices.
So I'm going to go around buying up your notes and cause a depletion of reserves on every third payday. People aren't going to like having to wait for their money so they are either going to become customers competing banks or you are going to have to change your practices and quit driving down interest rates for all the other banks. If you keep up these practices and become a 'wild cat' bank then your notes are going to start trading at a discount in relation to the amount of inflation you induce which would counteract any benefit your customers receive from the artificially low interest rates you provide.
There is historic precedent for all this -- fractional reserve banking is only viable if its propped up by the force of government or through collusion between the banks to prevent the actions I described above and even then it's kept pretty conservative because any group of banks can bankrupt any other group at will if it starts to get out of hand. The whole cartels aren't stable argument...
The fraud comes from not being able to pay the issued notes 'on demand' no matter who comes through the door demanding payment. Customers, general public or competing banks, it doesn't matter.
Anonymous Coward: So I'm going to go around buying up your notes and cause a depletion of reserves on every third payday. People aren't going to like having to wait for their money so they are either going to become customers competing banks or you are going to have to change your practices and quit driving down interest rates for all the other banks. If you keep up these practices and become a 'wild cat' bank then your notes are going to start trading at a discount in relation to the amount of inflation you induce which would counteract any benefit your customers receive from the artificially low interest rates you provide.
Well, that's certainly what you're going to try to do. I can try to prevent that from happening by competing with you for deposits, since you need deposits in order to buy my notes. But, regardless, none of this touches on the fraud question. To say that you'll outcompete me when I do something doesn't establish that what I'm doing is fraudulent and ought to be outlawed.
Anonymous Coward:The fraud comes from not being able to pay the issued notes 'on demand' no matter who comes through the door demanding payment. Customers, general public or competing banks, it doesn't matter.
Then there's no separate argument for central banking being fraudulent, but you agreed above:
Anonymous Coward: That's all fine and good but as the owner of a 100% reserve bank I'm not going to appreciate you lowering interest rates through your fractional reserve practices.
that I can have a bank with less than 100% reserves on demand deposit accounts without committing fraud.
JAlanKatz: Everyone loves to toss around that fractional reserves are fraud, but they are only fraudulent if the depositor is led to believe that 100% reserves are held. Suppose I open a bank with a sign on the wall reading: "You are free to deposit money here. You may write checks against your balance, and you may withdraw your money on demand. However, we do not maintain 100% reserves. Therefore, there is a possibility, however slim, that when you wish to withdraw your money, we may not have specie on hand. In that event, we will provide the payment to you within 5 business days, together with a 10% compensation. On the other hand, because of these fractional reserves, we are able to pay interest on your demand deposit account. We think it is an attractive bargain for you. If you do not agree, please take your business elsewhere." Then I proceed to do so. Fraud? Who am I defrauding? If by central banking you mean a monopoly banker's bank, then of course a miniarchist libertarian ought to think it should be illegal - not because it's fraud, but because it's a forcible monopoly. However, I see no reason that a banker's bank would be illegal. It is legal, and would be legal in a miniarchy, for me to use a bank - why not for a bank to patronize a bank?
Two(or more) people claim ownership to the same item, that is called fraud. You should read Rothbard's The Case Against the Fed.
However, if we lived in a voluntary society these private fractional reserve banks would not exist. No one would trust them(for good reason!) so no one would deposit in them. The only way they would exist is if your "minarchist" government gave them legal protection, creating a cartel just like we have today.
Peace
JAlanKatz:Then there's no separate argument for central banking being fraudulent, but you agreed above: Anonymous Coward: That's all fine and good but as the owner of a 100% reserve bank I'm not going to appreciate you lowering interest rates through your fractional reserve practices. that I can have a bank with less than 100% reserves on demand deposit accounts without committing fraud.
You can't redeem your notes on every third payday due to my theoretical actions so you would be in violation of your contractual 'demand deposit' obligation which *could* be considered fraud since this possibility is built into the system. It wouldn't be fraud against the depositors of your bank but to everyone who didn't agree to your policies who took your notes in good faith in exchange for goods and services.
If you were to print up 1oz silver notes and you really didn't have 1oz available to back them all then it could be argued that fraud was being commited. When the ineviatable bank run occurs I think all your debtors who lost money would agree with this assessment.
Now if you were to print the statement about funds not being available 'on demand' but subject to a waiting period on the notes themselves then it would be a different story, people who accepted the notes would be able to make their own decision about your fractional reserve policies where they may or may not be able to receive payment for services rendered.
Kinds of defeats the whole purpose of a money substitute though wouldn't it? The whole universally accepted part.
But, yeah, it would be possible to engage in legal counterfeiting operations if you really wanted to. The real question is would people accept your money at face value with all the terms and conditions applied while there were more sound competitors to chose from.
I might accept it at a discount which reflected both the risk and the amount of backing commodities in relation to printed notes in circulation if I were just Joe Businessman or a little over market rate if I were trying to bankrupt you as a competing banker.
Setting aside concerns of fraud.
I would concur with the other posters that fractional reserve banking would not long survive in a free society, whether anarchy or a true minarchy <wherein the government has not granted priviledges to the fractional reserve banks>. Fractional reserve notes would circulate at a distinct discount, depending on the reserve ratio of the bank in question. Many businesses would decline to accept them at all. Market preference would likely drive out fractional reserve banks, leaving 100% banks as the sole banks in the economy. My personal preference would be to avoid experimenting with fractional reserve at all. Stability and 0% inflation is much preferred.