Money and Banking in a Free Society

by Jerry O’Driscoll   

At the Coordination Problem, Pete Boettke drew our attention to James M. Buchanan’s paper, “Economists Have No Clothes”. It’s a short piece, chock full of insights.  I want to draw on some not raised by Pete.  

Buchanan observes that protagonists are prone to claim “that ‘the market’ (or ‘capitalism’) either works or does not work without constraints, a claim that is demonstrably unsupportable…”  He reminds us that Adam Smith’s “whole effort” was aimed at identifying the right laws and institutions, so that self-interested behavior would lead to outcomes that were generally beneficial.  

The Wealth of Nations is filled with examples of malfunctioning markets due to bad laws and institutions.  Smith never defended business or businessmen per se, indeed had nothing good to say about them.  He defended the simple system of natural liberty, whose meaning he specified over hundreds of pages.   

The modern heirs to Smith are the property rights and Public Choice theorists, who examine the rules, laws and institutions necessary to make markets work.  And they analyze what happens when those institutions are absent.  

Buchanan then turns his attention to money and finance and asks what I think is the essential question. “Why have political economists, in particular, been apparently so willing to accept as sacrosanct the monetary framework in being?  Why has not more attention been paid to alternative structures, to differing rules and institutions?”  

Buchanan makes clear that the financial crisis was not just a crisis of the monetary and financial system, but of the prevailing economic theory that takes the existing system as “sacrosanct.” He describes the crisis as “a Pareto-inferior shift in which all persons in the nexus were made worse off by their own utility calculation.”  

He offers up some ideas on what needs to be done to reform the monetary and financial system. I don’t necessarily share his exact prescription, though I think each part of it deserves consideration and debate.  I do endorse his call for an institutional or constitutional approach to reform. 


3 thoughts on “Money and Banking in a Free Society

  1. Those of us who have worked for the Fed think there is a great deal of wisdom in what Jerry writes above. The corruption of the monetary system unanchored to gold or silver or anything else of real value (we are reliant on the good will of the authorities to avoid overissue, and we see where that has gotten us), combined with an avoidance of swift and certain market punishment of those who issue bad paper (or bad securities)(Bill Black keeps asking, “Why did 2000 people go to jail in the aftermath of the S&L scandal but no one has gone to jail yet in the aftermath of fall 2008, especially near the top of the pyramid?”), all lead to a colossally unsustainable system.

    Smith’s great insight was seeing the interconnectedness of all things economic. It is a mistake today to think, for example, that if we only could get the bank regulation right, the monetary question would take care of itself (the conceit of the 1960s). Similarly, it is a mistake to think that if we only could get the monetary equations right, bank regulation would take care of itself, the conceit of the Greenspan era (not if only the spineless and the feckless are your regulators).

    Pat Parkinson is the new chief of bank supervision at the Fed’s Board of Governors. What do you think is likely to happen next on the quality of bank supervision (regardless of its quantity, which is likely to be bad)? And with the reappointment of Bernanke, what is likely to happen to the quality of money itself (again, without regard to its quantity)?–Walker Todd

    It would be better to

  2. Did you notice that Buchanan described the current monetary regime as a “money anarchy” and called for more government control and regulation in the financial area to alleviate this (eg re-instituting Glas-Steegal)? Or you simply must praise everything Buchanan says anytime?

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