No central bank + fixed money supply == banking crisis? (US between 1834 - 1913)

[hazek]

Hello everyone,

As I ponder the heated discussion I had after the Tuesday presentation of Bitcoin here in Slovenia presented by Nejc Kodrič (bitstamp.net), his programer and developer Damian Merlak, another enthusiast programer they met in London Matija Mazi and me, where one audience member just couldn't be convinced that a fixed supply of money is a good thing and actually the best form a money can have..

..I'd just like to call attention to this most often grossly misunderstood issue surrounded with myths that a fixed supply of money with a banking system without a central bank and no regulation will lead to devastating banking problems and economic crisis. Myths that are most often spread without really doing any research on the matter. And when one actually does look at history and look at what the circumstances really were that did undoubtedly lead to pretty bad problems one finds that yet again it wasn't a market regulated strictly by it's consumers i.e. a free market coupled with no government regulations/no central bank the cause of these problems but that the truth is that there were regulations and that it was precisely those (big surprise, not) that lead to all those problems. Meanwhile in that same period of time a not perfectly free but much much better system in Canada worked problems free that barely gets mentioned or remembered.

How I know all of this? Well I don't know, but I do trust Dr. George Selgin, Professor of Economics at the Terry School of Business at the University of Georgia and author of a number of books on money and banking ("Bank Deregulation and Monetary Order" and "Good Money."), does and I'd invite you to lend him an hour of your time and listen to a lecture on this specific and for understanding the facts of history very important issue.

http://www.youtube.com/watch?v=JeIljifA8Ls

And please, if at all possible, stop spreading these ugly myths. Thank you!

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Rules for this thread:
1) the subject of this thread is the false accusation of no regulations + a fixed supply of money as the cause of banking crisis and panics - all posts must stay on this topic
2) any opinion not substantiated with a verifiable fact(s) of history is not allowed
3) sophistry and logical fallacies not allowed

Any post violating my rules for this thread will get deleted as an off topic post. If you want to spread BS you can do so in your own thread.

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[waspoza]

Very interesting video, thanks.

[Roger_Murdock]

Money is a market phenomenon (or at least it would be if the government got out of the way).  If you don't think 21 million coins (really  2.1 quadrillion units) is "enough," create a fork. "Problem" solved.

[Adrian-x]

Thanks, I am glad to have watched. 

[johnyj]

The problem with a fixed money supply:

When economy grows and generated more goods and services, the money are not enough to trade all the new goods, so the value of money increased, and that value increasing caused higher interest rate and hoarding, which further decrease the available money for transaction

And this will hit those with a debt very hard, they could not afford higher and higher interest due to the continuously rising value in money. And those who have a lot of saving are not willing to invest, since the return of just hoarding the money is much higher than investing those money and take business risk

As a result, the economy growth will be stopped and turn to negative, the number of tradable goods and services will reduce, until they become so scarce that their value against money rise again


This possibly is the reason that BTC economy can not grow fast, since holding BTC is much more profitable than invest BTC to generate new business, everyone will just hold BTC

Of course if BTC is not mainly used as a currency but as an investment target, then that is a totally different logic

[nobbynobbynoob]

This possibly is the reason that BTC economy can not grow fast, since holding BTC is much more profitable than invest BTC to generate new business, everyone will just hold BTC

Assuming that Gresham's Law applies to BTC in this manner. If everyone acts in their "self-interest" to hoard all their coin, this leads to the Nash equilibrium where their coin possesses no intrinsic value. But this has not happened in Bitcoinworld.

[notme]

Darn you!  You're 1 hour is quickly becoming 3.  Good series though.

[johnyj]

This possibly is the reason that BTC economy can not grow fast, since holding BTC is much more profitable than invest BTC to generate new business, everyone will just hold BTC

Assuming that Gresham's Law applies to BTC in this manner. If everyone acts in their "self-interest" to hoard all their coin, this leads to the Nash equilibrium where their coin possesses no intrinsic value. But this has not happened in Bitcoinworld.

The coin will never possesses 0 intrinsic value, because of it's usage, popularity and scarcity. It's the same as people using silver as transaction medium while they hoard gold, people will still use USD for transactions and hoard BTC for investment

As an investment target, BTC is much better than gold and house, it is easy to move across globe, it has stable and limited supply (gold supply can increase a lot if it is profitable enough for mining  companies), and it is backed by mathematics and network

[Etlase2]

Interesting theory. The only problem with it is that it doesn't match reality.

Nice try though.

Except that if we go by market cap (lol) it most certainly has. What reality do you live in?

[cunicula]

The comparison between countries with a central bank (lender of last resort) and countries without a central bank during this period is revealing.

http://www.rich.frb.org/publications/research/economic_review/1990/pdf/er760103.pdf

That is all.

[hazek]

The comparison between countries with a central bank (lender of last resort) and countries without a central bank during this period is revealing.

http://www.rich.frb.org/publications/research/economic_review/1990/pdf/er760103.pdf

That is all.

Of course, when government's regulation causes banking crisis and panics then there's no doubt banks do better with a lender of last resort.

That is all.

[Etlase2]

Except that even if we went by the terrible and almost worthless statistic of market cap it most certainly hasn't. I live in this reality: http://blockchain.info/charts/market-cap?timespan=all&showDataPoints=false&daysAverageString=1&show_header=true&scale=0&address=

Wait, so 122 > 188? That's an interesting and unsurprising reality you've created for yourself.

[Etlase2]

The reasons why Canada had fewer problems are very clear, and IIRC Selgin tends to gloss over these subjects (but I watched this video some time ago when it was posted here).

https://en.wikipedia.org/wiki/Early_Canadian_banking_system

The British administration under Isaac Brock introduced what became known as army bills in 1812, in order to finance the War of 1812. The total value of these bills was 250 000 pounds. These were promissory notes issued directly by the government. They came into wide usage during the war (1812-1815) to make up for the lack of bullion in Upper and Lower Canada. Unlike the card money used in the late 17th century, army bills could be and were in fact exchanged for gold coin once the war had ended. The army bills had thus proven themselves reliable, eradicating any real stigma against paper currency.

The government was issuing fiat at least until 1817 when...

In 1817, Montreal bankers were granted a charter by the British government to open the first formal bank in Canada. This was the Bank of Montreal. Under its charter, the Bank of Montreal was given a monopoly on the right to issue promissory notes on the model of the army bills. Because of its monopoly rights, the Bank of Montreal essentially acted as a central bank for both Upper and Lower Canada.

Voila, an effective central bank exists.

However, banking remained in private hands, which meant that the issue of currency was at the discretion of private bankers. This frequently led to high inflation when the infant Canadian economy was in recession.

That also caused inflation.

After Confederation, Canada developed a banking system very different from that of the United States. Whereas the United States was served a large number of small banks serving just one town or, at most state, Canada's banking sector came to be dominated by a few banks with transcontinental branch networks. The Canadian system promoted stability and produced far fewer bank failures than either the contemporary United States or Australian banking systems. The downside of the Canadian banking system was that it was much less competitive that the United States and Australian systems, which meant that consumers paid more for banking services. The legal foundation of the Canadian banking system consisted of a series of laws passed in 1870 and 1871.

It had to do with the fact that banks were national whereas US banks were very regional. Yes, this was due to some piss-poor regulation on the US's part, but the central bank "fixed" the problem. It most certainly was not that "canada was unregulated and free" though as you conclude in your post.

[hazek]

Btw I'm not trying to hold the Canadian model before 1935 as some hallmark of how free banking is done, it's just an example of a system that didn't have the same futile regulation as the US but also had no central bank that performed better, although far from the best.

In 1817, Montreal bankers were granted a charter by the British government to open the first formal bank in Canada. This was the Bank of Montreal. Under its charter, the Bank of Montreal was given a monopoly on the right to issue promissory notes on the model of the army bills. Because of its monopoly rights, the Bank of Montreal essentially acted as a central bank for both Upper and Lower Canada.

Voila, an effective central bank exists.

You also failed to mention:

In the years after 1817, Britain granted several new bank charters, including a charter to the now-defunct Bank of Kingston, which was to act as a competitor to the Bank of Montreal in Upper Canada. The new chartered banks were required under the terms of their charters to recognise one another's currency, a practice that allowed for the development of long-distance trade within British North America. However, banking remained in private hands, which meant that the issue of currency was at the discretion of private bankers. This frequently led to high inflation when the infant Canadian economy was in recession.

Meaning this "effective central bank" instantly got competition and in no way resembled a central bank of the European model.

[Etlase2]

Btw I'm not trying to hold the Canadian model before 1935 as some hallmark of how free banking is done,

I understand that, but you are trying to make the argument that the free market had something to do with it, which it did not.

it's just an example of a system that didn't have the same futile regulation as the US but also had no central bank that performed better, although far from the best.

Quite debatable.

http://faculty.marianopolis.edu/c.belanger/quebechistory/encyclopedia/BankinginCanada-CanadianBanks-CanadianHistory.htm

All the charters were alike and, therefore, the Bank of Montreal charter may be taken as typical. A study of this charter shows clearly that it was taken directly from that of the first Bank of the United States , which had been planned by Alexander Hamilton, the first secretary of the Treasury of the United States . Thus the Canadian banking system is a direct descendant - the only surviving one of the first Bank of the United States.

You also failed to mention:

Meaning this "effective central bank" instantly got competition and in no way resembled a central bank of the European model.

I didn't fail to mention it, the Bank of Kingston quickly failed and was irrelevant. There were others, though:

Through the collapse of the private Bank of Upper Canada at Kingston and the inability of the Bank of Kingston to get going within the period of its charter, the Bank of Upper Canada obtained a monopoly of banking within the province and hoped to keep it. With its control of the Legislative Council it could have thwarted all efforts to obtain new charters, but a financial crisis in 1821-2 made it necessary for the bank to apply to the legislature for a reduction in its capital and for other considerations. This gave the Assembly an opportunity to protest the monopoly, but it was not until 1832, however, that another charter - that of the Commercial Bank of the Midland District - was granted to the financial interests of Kingston whose first charter had lapsed. The Bank of Upper Canada had its charter extended in the same year.

The point is that there were very, very few of them and they all had central bank-like charters. No, they were not central banks per se, but it is much more difficult for a national bank to fail than a regional one. Reserves can be re-allocated to areas that need it whereas regional banks have no choice but to fail under pressure. And once some regional banks start failing, panic generally ensues.

And the supply of money was hardly fixed under this system, but that is another topic, I suppose.

[hazek]

Btw I'm not trying to hold the Canadian model before 1935 as some hallmark of how free banking is done,

I understand that, but you are trying to make the argument that the free market had something to do with it, which it did not.

Not so at all. I'm trying to show that a system can perform ok when there isn't a specific kind of government intervention that would cause otherwise.

it's just an example of a system that didn't have the same futile regulation as the US but also had no central bank that performed better, although far from the best.

Quite debatable.

http://faculty.marianopolis.edu/c.belanger/quebechistory/encyclopedia/BankinginCanada-CanadianBanks-CanadianHistory.htm

All the charters were alike and, therefore, the Bank of Montreal charter may be taken as typical. A study of this charter shows clearly that it was taken directly from that of the first Bank of the United States , which had been planned by Alexander Hamilton, the first secretary of the Treasury of the United States . Thus the Canadian banking system is a direct descendant - the only surviving one of the first Bank of the United States.

You also failed to mention:

Meaning this "effective central bank" instantly got competition and in no way resembled a central bank of the European model.

I didn't fail to mention it, the Bank of Kingston quickly failed and was irrelevant. There were others, though:

Through the collapse of the private Bank of Upper Canada at Kingston and the inability of the Bank of Kingston to get going within the period of its charter, the Bank of Upper Canada obtained a monopoly of banking within the province and hoped to keep it. With its control of the Legislative Council it could have thwarted all efforts to obtain new charters, but a financial crisis in 1821-2 made it necessary for the bank to apply to the legislature for a reduction in its capital and for other considerations. This gave the Assembly an opportunity to protest the monopoly, but it was not until 1832, however, that another charter - that of the Commercial Bank of the Midland District - was granted to the financial interests of Kingston whose first charter had lapsed. The Bank of Upper Canada had its charter extended in the same year.

The point is that there were very, very few of them and they all had central bank-like charters. No, they were not central banks per se, but it is much more difficult for a national bank to fail than a regional one. Reserves can be re-allocated to areas that need it whereas regional banks have no choice but to fail under pressure. And once some regional banks start failing, panic generally ensues.

And the supply of money was hardly fixed under this system, but that is another topic, I suppose.

Yes it's quite important that we are exact. They didn't have a central bank, this is non debatable. Because what they really had was a private competitive banking system comprised of a just a few by the state allowed banks, a system that in no way was the result of a free market. Again neither I nor Dr. Salgin are raising the Canadian model as some kind of ideal or a role model that a market regulated strictly by it's consumers i.e. a free market would come up with, just that a banking system without a central bank can work reasonable well when there are no regulations that would fatally flaw such a system.

[Etlase2]

Again neither I nor Dr. Salgin are raising the Canadian model as some kind of ideal or a role model that a market regulated strictly by it's consumers i.e. a free market would come up with, just that a banking system without a central bank can work reasonable well when there are no regulations that would fatally flaw such a system.

But there was nothing remotely close to a fixed supply of money, either. Nor will there realistically be with Bitcoin, either. Banking competition may end up with who has more reserves, or who holds a higher percentage of reserves, or who has a higher capital asset to liability ratio, etc. There is no such thing as a fixed supply of money. If people don't want to accept bitcoin-backed notes, then perhaps they have moved on to other cryptocurrencies. If they accept bitcoin-backed notes, that means we are in the same situation all over again where banks have the power to control money. If they move on to other cryptocurrencies (or include them), then bitcoin has failed to supplant fiat currency, at least on its own. The scarcity of bitcoins will ensure that banks will devise ways to get people to accept substitutes. Or people simply won't acquire them or any claim on them.

[odolvlobo]

I haven't watched the video, so I hope I'm not just repeating ...

My understanding is that the numerous crises during that period were a direct result of the invention of fractional reserve banking. Fractional reserve banking is a way to get around a fixed money supply, and those crises were actually caused by the resulting variable money supply and the associated risks that were introduced.

The Federal Reserve was an attempt to maintain the benefits of fractional reserve banking (liquidity, etc.) and create a common note (as opposed to different ones for every bank), while reducing the pitfalls (bank runs, default risk, and out-of-control money supply). Thus far, its performance has been poor at best.

I'm wondering what will happen when fractional reserve banking is implemented with Bitcoin.

[johnyj]

The dates hazek picked in https://bitcointalk.org/index.php?topic=118063.0;topicseen are interesting, they correspond with the rise of socialism in Europe (and, I'm assuming, the US too) due largely to widespread poverty and unemployment and a large part of that was caused by the situation Etlase2 warns of, the hoarding of a fixed amount of currency.

However, the reason for that has to be considered too. At that time industrialisation was booming, in many areas 1 man could do the work of 100 of a previous generation which goes a long way to explaining the mass unemployment and the mass poverty that came with it.

Move forward to the present day and in many areas 1 man can do the work of 10000. We need to work to earn money to survive so new areas of employment have evolved for us to find work in and welfare systems have been put in place to provide protection for those that would otherwise starve.

The obvious next step is to build on that system, to create new industries providing further employment and dismiss past systems as obsolete, never questioning the foundations of the system.

We need to work to earn money to survive. Is this really true any more? We've maintained that fundamental principle continually and built a huge and complex system to support it including a welfare system that has grown bigger and bigger as that system became harder to maintain.

The welfare state was discussed at length in another thread recently and the impression I got from that discussion was the concept is simply too alien to our way of life to clearly see how it would function and I think the concept of an economic system that isn't based on creating growth (and with it employment) is also too alien to see clearly. Money is the central component of our lives, this hasn't always been the case but I think it has been true for too long for us to see anything else as possible.

+++, lot's of good points in your post

Technology advance will always create unemployment, especially it happened on all the existing industries, IT's usage on existing industries created mass unemployment throughout the globe

In an ideal world, new consumption should increase steady and continuously, so that growth is predictable and there will always be new jobs.  But in reality, new consumption jumped up exponentially, from cloth to food to car to house, in each jump the value of consumption increased by at least 4 times. During the jumping process, everyone makes money, but what is going to be the next consumption for each household, which is 4x higher value than housing? None, and the most important: income do not increase exponentially, so it collapsed

In many welfare countries, people do not need to work to earn money to survive, the high tax of those nations established good bottom line for everyone. But those companies who is paying the tax will try to move the operation to other countries, unless all the countries create same welfare system

Robot will replace most of the human workers sooner or later, but in a future society when only robot are working and producing, who is going to buy the products that robot produced? Everyone becomes a robot owner, or government owns all the robot and dispatch the work results of robots to each household?

[hazek]

I haven't watched the video, so I hope I'm not just repeating ...

You should definitely watch the video because you don't have the full picture of what was going on.