The Breakdown - The History, Present, and Future of Central Banks, Feat. George Selgin

Episode Date: August 7, 2020

Today on the Brief: Better news in the jobless claims this week A new bitcoin adoption cycle? A check in on Lebanon Our main conversation is with Dr. George Selgin.  Dr. Selgin is a Senior Fellow and Director of the Cato Institute's Center for Monetary and Financial Alternatives as well as Professor Emeritus of Economics at the University of Georgia.  In this eye-opening conversation, he and NLW go deep on the history, present and future of central banks, including: Why the Scottish and Canadian banking systems in the 19th century that central banks aren’t a prerequisite for stability Why the USA’s “free banking” system wasn’t free at all Why the instability in the late 19th century US banking system was caused by regulation, not the lack of a Fed Why the Fed’s first decades were a disaster Why the Fed gets more power when it underperforms  The problems with the Fed’s response to 2008 What lessons the Fed could have but didn’t learn between the Great Financial Crisis and COVID-19  Find our guest online Website: Alt-M.org Twitter: @GeorgeSelgin

Sure, let's think about ending the Fed. Let's consider it. But consider how you could possibly do that in a way that will succeed, both in the sense that you really do end up with a lot less Federal Reserve than you have today, if not zero Federal Reserve, whatever that might mean. But you also end up with a U.S. dollar that preserves its value and is a good medium of exchange in other ways. Now, if you can figure out how to do it, that, then please do it. I've been thinking about it a lot. But I'm not going around with a t-shirt that says end the Fed until I really figured it out. And I'm certainly not going to pretend that that's a policy solution when it's just a slogan so far. Welcome back to the breakdown with me NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, bitstamp, and nexo.io, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, August 6th, and today our main conversation is another amazing interview. This time with George Selgin, the director of the Center for Monetary and Financial Alternatives at the Cato Institute.

It's an amazing historical look at central banks that I know you're going to love. But first, let's do the brief. First up on the brief today, the FBI has rated social media influencer Jake Paul's house in... I'm just kidding. Let's talk about jobless claims. So what happened? The jobless claims, the new initial jobless claims, fell 249,000 to 1.19 million. The forecast had been 1.4 million, so obviously an improvement. Continuing claims decreased as well. They decreased 844,000 to... to 16.1 million. Both of these numbers are really, really good in context of a reversing trend

that we'd seen over the last couple weeks where things had actually been getting worse. Now, of course, the overall magnitude of these numbers is still really, really not good, right? Still more than a million new claims per week. However, if we're viewing it in the trend, the worst potential was that we were going to continue to see a rise. We'll get more information tomorrow with the July report from the Bureau of Labor Statistics, but this is hopefully a sign that maybe some of the losses that we'd seen as the coronavirus ramped up again in the end of June and early July have been, if not turned around, at least starting to level off a little bit. Next on the brief, a quick check-in on Lebanon.

I'm sure that you've seen that there was a huge blast earlier this week. There were videos of it all over social media. I mean, it's totally devastating from a human perspective, more than 100 people dead. And it seems now that although people were very skeptical at first, it was in fact just an accident. There were apparently 2,700 tons of ammonium nitrate that had been stored near the docks for six years. And when a ship carrying fireworks caught on fire setting off those fireworks, it just became a powder keg that released that massive explosion that you saw. This is, of course, just the latest challenge for an already beleaguered society and an already beleaguered economy. Inflation has been way above 50%, and the lira to USD, which had been held around

1,500, since 1997, broke last year and has just been rising steadily throughout this year. A few months ago, I did a podcast on the background of this whole situation, but the unofficial exchange rate got as high as 9,800 Lebanese pounds to the U.S. dollar. And before the blast, that had been around 7,800 pounds, according to lira rate.com, after the blast, it got as high as 8600 this week before coming back down to 8300. So just another challenging situation. And I think it's worth keeping track of these places because ultimately they're not so disconnected as we think. They are subject to the forces of the global economy. They are dealing with issues that have regional implications from a political perspective. So obviously, this blast was the last thing they needed

here and certainly my heart goes out to them there. And I'm hoping but not optimistic that Lebanon doesn't just enter the story as one of the absolute casualties of 2020. Last on the brief today, are we entering a new Bitcoin adoption cycle? The number of Bitcoin addresses holding at least $10 of crypto rose to a record high of $16.6 million, according to Glassnote. This is up 14% from the previous peak of $14.5 million, which was in January 2018, which, as you'll know, is right after that 20K peak was hit in the Bitcoin price. This suggests that there is a new user-based growing of smaller holders, and I think that you can expect this to explode if and when folks like Dave Portnoy come in.

This also matches what we saw from Square yesterday with them reporting that they had had 875 million in Bitcoin revenue in quarter two, which was up 186% from the quarter before and 600% year on year. All of this together suggests that it's not just old people recycling more money into Bitcoin, but in fact, a new group of people as well. With that, let's move to our main conversation with George Selgin. As I mentioned before, George Selgin is a senior fellow and director of the Center for Monetary and Financial Alternatives at the Cato Institute. He is also a professor emeritus of economics at the University of Georgia. He has written a huge number of books, including the theory of free banking, less than

zero, the case for a falling price level in a growing economy, and most recently floored, how a misguided Fed experiment deepened and prolonged the Great Recession. George is not only an economist but an economic historian, and I wanted to take advantage of that to discuss something which is a constant mainstay in our conversations, not just on the breakdown, but in macro in general, which is the role of central banks. Everyone listening to this podcast has spent their entire life in the central bank era, where these institutions exerted an outsized impact on the modern economy. However, this didn't come from nowhere. It wasn't just something that naturally happened out of the blue. There were a specific set of realities that got us to where we are,

and on this conversation, I wanted to go back with George to actually explore how that happened and even more what the previous era looked like and is there anything we can learn from it. If you have ever wanted a compact but powerful overview of the history of central banks, this podcast is for you. As with all our long podcast, this is edited only very briefly, but let's waste no more time and dive right in. All right, Dr. Seljan, thank you so much for hanging out today. Oh, not at all. Glad to be with you. So I want to start. You had a great tweet a couple days ago, maybe a couple of weeks ago, where you said basically that it's hard to be someone who isn't a gold bug and on the other hand isn't an MMT, or at least when it comes to being on Twitter. But that's where

you are. You find yourself in this interesting kind of middle space in a lot of ways. And that's why I'm excited to have you on the show. And I think that part of what I want to bring to this is, is your deep and kind of rich historical background and so many of the issues that are contemporary now. But for people who aren't familiar with your work, I'd love to just have you give a little bit of background and kind of your life in economics, I guess. Okay. In one minute, right? Yeah, exactly, exactly. Reduce it all to a very short little overview.

Well, the big story, I guess, the most important story is that concerning how I became interested in monetary. economics. And it was in 1980. At that time, I was actually studying marine resource economics, a completely different area that was an attempt to pursue an interest in marine biology that I'd had for many years. Anyway, it was during the inflation, which was double digit then, which was, of course, exceptionally high. And I found myself really, really. feeling inadequate because I didn't understand the inflation and I was supposed to be an economist. So I found myself spending a lot of time in the library reading about monetary economics to try to get a handle on what was happening, at least to my satisfaction.

To make a long story short, I really got hooked on the works I was reading. A lot of them seemed horrible. but then I ran into some that struck me as particularly compelling and convincing, one of which was Ludwig Vanniz's theory of money and credit, which was an awesome book, and I still consider it by far the greatest thing written on monetary economics up to the time when it came out, originally 1912. That in turn got me interested in pursuing some of the other readings by the Austrian economists, and one of those was Hayek's denationalization of money.

Well, if Meese's work impressed me for its scholarship and for being very, very systematic, and incidentally for helping me understand inflation, Hayek's impressed me in a very different way by absolutely shaking up my prejudices, or I should say my priors about monetary stability and banking and all that, by making me consider whether central banks were actually necessary, and more than that, whether government regulation of money and banking was more harmful than helpful. So with that hypothesis in mind, I got a little grant from the Institute. for Humane Studies, which I used to spend a summer studying what role regulation had played

in United States, economic, and especially monetary instability over the decades. And that study, that research absolutely convinced me that regulation was indeed more often a cause of instability than a cure. And ultimately, I learned about free banking. I read Larry White's what was then his dissertation on the Scottish banking system and what later became his book on the subject. And I wrote

to Larry and I said Larry he was still a grad student. This is Lawrence White to some of you, Larry White to me. But anyway, I wrote to Larry and he was at UCLA finishing and I said Larry or Professor White or whatever I called him

then, when you get a job at a graduate school, I assume it's going to be a research institution, let me know so I can come and be your first student. And Larry went to NYU and then I went to NYU. For incidentally, I'd already applied. And so it worked out very well because I got a fellowship and Larry ended up teaching there and I became his first student. And that set me on the path that ultimately led me to become an academic and to teach for 25 years after which, Five years ago, almost now, I ditched the academy and came to Cato to be their main monetary wonk.

And that's the short story. That was a little more than a minute, but still. No, that's wonderful. I'm going to come back to some of the current parts. One of the things that I think is so fascinating about what you do now and what you spend your time on is kind of inhabiting the world of the theoretical and the practical. and trying to navigate that in terms of having a voice in actual policy decisions as they happen. But before that, I'm going to actually ask you to keep the academic hat on a little bit because, you know, I have a history background.

And I think it's such an important piece of understanding where we are to understand where we came from. And we all kind of live in this paradigm and have grown up and never really experience anything different in the paradigm of central banks, right? And the central bank era. But there was, in fact, periods that counter to the narrative were not kind of just the crazy wild west of money, but actually saw stability. So, I mean, I guess in the modern era, right, in the 19th century, what did the non-central bank system actually look like? Well, first of all, you're quite correct that central banks, certainly as we know them today, we're not prevalent, certainly not at the beginning of the 19th century. really most of the world central banks were set up much later. They really started to sprout like mushrooms in the early 20th century. So before that, you had quite a few countries that did not

have central banks or any kind of monopoly suppliers of currency. So instead, what did you have? Well, the business of issuing paper money was, in most cases, left to commercial banks, to several. commercial banks. The number depended on the place. But the point is that you had at least some competition in that business, and it was a private business. Bank notes, paper money, as they were at the time, where just another version, in fact, the more popular version of bank created, private bank created money. Deposits subject to check, they didn't have debit cards back then, deposits were around, but they were of more limited importance. For the most part, banks, they funded themselves by getting people to hold their paper IOUs, denominated in some

basic coin unit like the U.S. dollar, which was a gold unit for most of the last half of the 19th century. And then those notes circulated as paper money does today. So the U.S. case was very special and not typical of the results of competition, and we could talk a lot more about it if you like. But if you wanted to see, I think, better examples of what competition in the supply of all kinds of money, except coin itself, looked like, the better case studies would have been Scotland, especially in the first half of the 19th century, and Canada in the last half. in the 19th century until World War I. There were, though, many other countries that had competitive or plural currency issuing institutions instead of central banks in that era. And there were, finally, there were serious debates in many of these countries that preceded the establishment of central banks with good people arguing on both sides, and I would say,

frankly, in many cases, the better arguments were those of the critics of central banks. However, the government put its thumb on the scales, as it were, and swayed the outcome in its favor. I say its favor, because whatever their other merits, central banks have certainly been useful to their sponsoring governments as sources of fiscal support. So that's a rough outline of what went on. Of course, I haven't tried to describe to you in any detail how these systems worked, and I'll only say that they worked very well, and there were good reasons why they, in some cases, there were good reasons why they worked well. It wasn't just a good luck. I guess that's a worthy detour for at least a minute. For the systems that

did work, what was it about them that worked, especially because I think we might next come into the comparison and what the genesis of the central bank era was? Well, the main thing about these systems was that they weren't unregulated, except in the conventional sense that the governments didn't do a lot of regulation. Instead, the regulation was there, and it was important, but it consisted of the competitive rivalry among the different banks of issue. That's the name for banks that issue paper currency. What was happening, And what tended to happen was these banks would very jealously guard their share of the currency market.

Of course, they tried to build that share as much as possible. But they also tried to minimize their rival's share. And the way they did that in practice was by first of all agreeing to accept the notes of rival banks that they judged to be sound in the daily course of business, the way banks today accept checks that are drawn on other banks. But then they would see to it on a daily basis or perhaps somewhat less frequently, depending on how far back you go. They would make sure those notes were actively returned to their source for payment. And this discipline the banks because they were constantly being pressed to

fork up, either fork up species, gold or silver, to redeem their notes by these requests from rival banks, or they had to have notes of the rivals to present to offset what was coming back to them. And this discipline of adverse clearings, which is what I call it in my first book, that was the main thing that kept a lid on excess credit creation and helped to dampen the business cycle in countries that practiced it. It did not, however, prevent the money supply from growing when there was a legitimate need for more exchange media. Because in that case, the people would be holding on to larger balances of money. And as long as that was so, the banks could issue more because it wasn't all coming back to them. So there was a tendency.

It wasn't perfect. But there was a tendency for the supply of bank created money to adapt itself to demand, not grow too excessively relative to demand, and therefore not spark cycles of boom and bust. You could see this in some cases very clearly. I'll just mention one of the most obvious ones. Back then, especially, the demand for currency, as opposed to bank deposit money, the demand for circulating currency had a very distinct seasonal pattern. And it was obvious why. There would be a big peak in the demand during the harvest season when the crops were being moved and workers had to be paid. And they were mostly itinerant workers, so they didn't want checks, even if the farm owners could have paid a check. And then there was a little peak at Christmas time, which still

exists today. There was also a July, a little July spike. Now, if you look at these systems, Canada was a good example. If you look at the pattern of the supply or quantity of currency, by gosh, it shows exactly the pattern that you would expect demand to show because it was following demand. It peaks every autumn. Then it comes down. Then it comes back up a little for Christmas, comes back down, comes up in July. Perfect, perfect, perfect, perfect. tooth pattern. And if you looked at the United States instead, let's say around 1880 or, you know, the last decades of the 19th century, and I actually have charts showing this, you'll see a currency supply. It's not at all responsive. Now, we didn't have a central bank either, but we had a very

screwed up non-central banking system, and I write about that. But the point is not so much to comment on the U.S. arrangement, but to show that. that the Canadian one, for example, automatically adjusted the supply of money in a way that a central planner would be proud to have adjusted it if he knew how. And so you didn't need a central planner to do it. It was happening spontaneously as a result of market forces. If I could just get every monetary economist, you know, grab them and make them look at what was happening. Canada then, and I've tried, I bet a lot of them would be just flabbergasted to see that this system without any central management did what a good currency and banking system is supposed

to do. And they had very few crises, remarkably few. So what more can you want? Well, so this is, I think it's actually, again, let's go into the difference in the U.S. system because what I'd love to do now is kind of bring us up to the shift into the central bank era, the arguments for the Federal Reserve. So it's probably good for us to understand a little bit about what was making the U.S. work not quite as well. Absolutely. Yes, it's very important. Well, the U.S. proves an important point that while a system can work very well without a central bank, not having a central bank is not a sufficient condition for having a well-working monetary system. We really proved that because we had all kinds of problems. It's probably

fair to say that among developed countries at the time, the United States had the worst banking and monetary system, a terrible banking and monetary system. And this was true both before and after the Civil War, but importantly, it was true for different reasons because things changed a lot during the Civil War. One thing that was common to both errors was the fact that we had way too many banks, and they were small, for the most part, very small and very under-diversified. And that's because, unlike other countries, unlike Canada, for example, we didn't allow most of our banks to branch. There were a few states that did. But for the most part, the banks we had were so-called unit banks. That meant that they had one place of business,

and they did all their lending in that area and got all their funding from customers in that area. Their assets and their liabilities were highly under-diversified. And anyone in your audience who knows something about finance, and I assume most of them do, will understand that that's a bad start for a business like banking where diversity is the key to safety to limiting risk from loan lending and investment and risk from depositors occasionally for whatever reason wanting to take their money out if they're all coming from the same place maybe they'll all want to take their money out at once that small that lack of branch banking that unit banking restriction to call it that, because it was a result of laws that prohibited branching,

was probably the most, no, I won't say probably, it was definitely the most important reason for banking instability in this country until the advent of deposit insurance. Most banks that failed were small, and they failed because they were small and undiversified. So there's restriction number one that was pretty much unique to the United States. It by itself explains a whole lot. But for some others, we have to distinguish what was true before the Civil War and what was true after. Before the Civil War, currency was issued exclusively by state chartered banks, at least after the demise of the second bank of the United States. That was one of two early experiments with a federally chartered bank, but after 1836, we had no federally chartered bank until the Civil War. So states alone were chartering banks, and those banks were the sole source of paper currency. I've already mentioned the problem that these banks tended to be very small and under-diversified

because they didn't branch. But there were other problems that were very serious as well. One of these was that because the banks couldn't branch, when they issued currency, if that currency, if their notes tended to wander any distance from the banks that they came from, it would cease to command its full species, that is gold or silver value, its face value. And the main reason for that was if you wanted gold or silver for the node, if you wanted to redeem it, to convert it, you had to incur the cost of getting back to that one place where you could get the gold. So if a bank in Maine issued a note and somehow somebody was foolish enough to go to California with that main banknote, why they could sell it to a broker in California, but they

might lose three, four percent of the note's value. And that's all it would be worth out there. And that wasn't necessarily because the bank in Maine was broke. That could be so just because of the costs, given the way transportation was, of the broker. that he had to incur to get the gold from Maine, right? So if there were branch banking like there was in Canada, you wouldn't have had these discounts on banknotes, and they would have all commanded their full value anywhere in the country. If a bank, if someone with a note from the Bank of Halifax,

from its office in Halifax, Canada, went to Vancouver in 1893, That note would be worth the same value in Vancouver as in Halifax because there'd be a branch of the Halifax Bank right there in Vancouver where the note could be redeemed. So branch banking made banks safer. It also made the privately issued currency more uniform and automatically uniform. You didn't need the government to make it uniform. Third problem, before the Civil War. many banks passed so-called free banking laws so-called and this has been a big source of confusion to people the name sounds like oh they're not regulated but it isn't so it wasn't so in every state that did this and there were i can't remember how many but something like 14 states that did it the banks first of all none of them could branch so the unit banking was it for every so-called free banking state right there, right there, you have something that's not very free about this kind of free banking.

Second, though, they all required their banks, the states that passed these laws, all required their banks to back their notes with specific securities, 100%, sometimes more. And guess what? When they decided what securities were eligible as backing for the notes, they typically chose their own state government securities, no matter how junky they were. Well, lo and behold, a lot of these free banks ended up failing. And guess what? Economic historians have looked to see why. It wasn't because they were wildcats or fly-by-nights or fraudulent, as a lot of people have assumed. It was because the securities, the bonds, that their own governments made them by as a condition for being banks

and for issuing notes, which you had to do to be a bank back then, those bonds depreciated and the banks went under. That's what really happened in most cases. So here you have the whole first half century of American banking I've just summarized, and almost all the biggest problems are because the government imposed restrictions that made banks and their currency a lot worse than it might have been in a truly free system. If we go to the Civil War, we get a whole different story. And I've got to keep it short, though it's rather complicated.

So for those of your listeners who really want to know the details, I recommend a paper that's online called New York's Bank, and it's about the origins of the Federal Reserve, but it talks about the sources of instability before the Fed, which I'm about to try to summarize. During the Civil War, the government was desperate, the union government, was desperate for funds to pay for the war. And as governments often do when they're hungry for funding, they tamper with their monetary systems. They're not tampering with those systems because they want to improve them and make them more stable.

They're squeezing them for money for funding for their war efforts. This is a constant fact in monetary history that economists too often ignore in their tendency to assume that governments only regulate for the sake of the general welfare. Anyway, as a result of this desire for funding, the government decided, first of all, to issue its own paper money called greenbacks. I won't talk a lot about that, but the supply of this stuff was fixed, an absolute amount. amount of several hundred million dollars, which was a lot of money back then. The second thing they did was to create a new system of federally chartered banks called national banks. It wasn't just one, like the bank of the United States, anyone could apply for and get a charter for a new national bank and state banks could convert. Now, when they did that, they also stipulated, as some state

governments had in the past that these national banks had to back their notes with specific bonds from a specific source. Can you guess whose bonds they had to buy if they wanted to issue currency? I'm guessing that you're guessing that it was bonds of the union government. And if so, you're right. They were trying to fund the war. That was the whole point. So the banks could issue currency as national banks, but they had to buy government bonds. The idea was to create a captive market for those bonds. Unfortunately, it didn't work well at first because although some people applied for new national bank charters, none of the state banks converted, very few. They didn't want to. And that's because despite everything, those that had survived that long, actually had pretty good reputations,

things had gotten a lot better over the years. And so they had no incentive. They had no incentive. to convert. Well, in 1866, the government solved that problem, even though the war was over, by taxing all state banknotes out of existence, prohibitive tax. At that point, of course, you had a lot of banks convert if they could. And now the currency supply consisted only of those national banknotes backed by specific U.S. government bonds. It's U.S. now, because the war is over in the Union won, plus the greenbacks, which were fixed in supply. Okay. If you've kept with me up to this point, I want you to remember what I said about the seasonality of currency demand. I gave the example with a peak in the autumn and the smaller peaks

at other times. Well, the problem with the new currency system, the antebellum, post-bellum currency system was that it wasn't at all flexible. It didn't do anything. It wasn't capable of what the private Canadian system, for example, was fully capable of. And that's because the banks had to buy these government bonds to secure their currency. And over the years after the Civil War, the bonds got rarer and rarer and more and more expensive. So it was prohibitively costly for banks to secure notes unless they were confident they'd stay out in circulation for the whole year. when it came to that portion of demand that was temporary in the autumn, they just said, chuck it. We're not going to do that.

Anyway, that and a number of other factors that were part of the way the national banking system set up, including the system of reserve requirements it involved, resulted in tremendous instability, particularly in the harvest season when there was a peak demand for currency, you would get banks reserves being run down and a tendency for the money markets to tighten up, especially in New York. And sometimes this would degenerate into full-blown financial panics, currency panics, they were called. That happened in 1884, in 1893, in 1897. These panics were what led to the movement that ultimately the reform movement,

that ultimately ended with the Fed's establishment in 1914. Now, here's what you've got to know, among other things. There were no panics in Canada. They had a perfectly smoothly operating system up there, and the people were very pleased with it. Newspapers were reporting at the time that Canada had no problems, unlike the United States. Now, if you're thinking about,

this, you're probably asking or you should be asking why the heck we didn't look to Canada and say, why don't we do what they're doing? Why don't we free up our banks? Let them branch. Let them issue notes on general assets, no special bond requirements. Let them compete and achieve stability that way. Well, a lot of people did. There were between 1907 or sorry, 1893 and 1907 or eight, there were dozens of bills presented to Congress all attempts to try to reform the U.S. system by deregulating it, more or less, along Canadian lines. Of course, there were variations, but all of these attempts involved freeing up the bank's ability to issue notes and allowing them to branch, which was extremely controversial, unfortunately, because it met resistance from a lot

of vested interests. What was interesting about those vested interests is that the small unit banks in the countryside, they opposed branch banking because they thought Wall Street was going to take over. But Wall Street was opposed to branch banking also because they knew, Wall Street knew that if banks from the Midwest, especially Chicago and other Midwestern cities, if they could branch, New York would lose all the correspondent accounts that they got from banks that couldn't access the New York market unless they opened accounts with New York banks. Anyway, those reform efforts all failed. It wasn't just because of the opposition I mentioned, but it was also because of a powerful Rhode Island senator named Nelson Aldrich, who the Wall Street bankers had in their pocket, as it were. But if you want to know the whole horrible story, you'll read that paper I mentioned.

But the basic bottom line is, our problems before 1914 weren't due to the tendencies of free markets in money and banking. They were due to the consequences of misguided regulations. Had we been able to repeal all those misguided regulations, we would have had a smoothly working system more or less like Canada only probably better because we would have had we had a more diverse economy than theirs we were 10 times bigger if anything our banks should have been more not less stable than Canadian banks were what's going on guys I'm excited to share that one of this month's breakdown sponsors is crypto.com crypto.com offers one of the most cost-efficient ways to purchase crypto out there as they've just waived the 3.5% credit card fee for all crypto purchases

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NXO also lets you earn up to 10% annually on your Fiat and digital assets. What's more, interest is paid out daily, and you can add or withdraw funds at any time. Get started at nexo.io. This gets us to the modern era, and we are, by the way, I appreciate this incredible survey that we're doing now, and I'm just going to lean into it because I think it's great. So we're now in the modern era, the Federal Reserve is created. What is the early period like? You know, any time that there's a new system, a new orthodoxy implemented, there's usually a period at which point, you know, it may turn back or, you know, how did the Federal Reserve,

what was the Federal Reserve's initial mandate and how did it become cemented as the default system? And I guess on top of that, how did it correspond to the rise of central banks elsewhere? Was the Federal Reserve kind of inspiration or, you know, how did it become the system that we've come to experience or expect now of just being the standard? Well, first of all, the Fed, I would characterize it as a middle period central bank. By then there were several others already. The Bank of England and the Bank of Sweden were the two oldest. The Bank of England, probably the more important of the two, and certainly in its influence and prestige.

But there were already several others, but there would be many more created after the Fed. They would be more created. There would be the majority of central banks we know today, including those for countries that were around back then. They were created in the 20s. That was the big push. But as for the Fed's mandate and performance, the first thing to be said about the mandate was it was not a mandate to manage money, as it's understood today. The Federal Reserve was

bound by a gold standard. Nobody expected it to do anything but maintain the gold standard that had already been in place. That itself is significant because it means that people at the time didn't think the gold standard per se was the problem. They didn't believe those crises that had been taking place were a result of the gold standard, which so many economists today assume. But the people who didn't think the gold standard was to blame back then, they were right. If the gold standard had been the problem, Canada would have had panics. Other countries would have had panics because they were all on the gold standard. But that didn't happen.

The problems of the U.S. were problems of its peculiar regulations. Anyway, the Fed's mandate was to provide an elastic currency. That was it. It was supposed to supply currency when it was needed. at times when the national banks couldn't do so or weren't willing to do so. It was supposed to create the sawtooth pattern of currency supply that the Canadian system automatically generated, but do so as a result of its deliberate arrangements.

Actually, when you get right down to it, the system was almost, it was very basic. Think about a bunch of banks where, they've got assets, and if they were free to do so on their own, they could just substitute deposits for banknotes anytime their customers wanted them. It's just changing the IOU. It's a different form. It's not having more IOUs. And that's what Canadian banks did. So in the fall, people's farmers wanted to swap deposit balances for IOUs in the form of paper notes, and they did. The notes would go up, the deposits would go down, no problem. In the U.S., because of the regulation, on national banks, they couldn't do that. So they created 12 special banks, the Fed. And they said to them,

okay, you can issue notes on assets, the same assets that national banks have, but they can't issue notes on those assets. Instead, they have to bring the assets to you in a procedure called discounting, and you give them your notes for those assets. It's like breaking somebody's leg. You know, the movie, Misery. You know, you break somebody's leg. Then you break somebody's leg, then you bring them, they can't move, and they're in bed. You bring them food and say, see, thanks to me, you can have food. Well, yeah, because I broke your leg. You need me to bring it to you.

But if your leg wasn't broken, you'd get it yourself. Anyway, that's how the Fed worked. It was a set of banks that were exempt from the restrictions that screwed up the other banks and therefore could do what they couldn't. But it worked terribly to answer your, Third question, the first decades of the Fed were an absolute disgrace. Let's consider. The Fed gets started in 1914.

That year, there's a panic because of World War I, but the Fed isn't quite ready to operate, and another emergency law is invoked that actually works really well because it involves basically freeing up the banks temporarily. Now the Fed gets involved, and the first thing that happens is it helps, especially once the U.S. enters the war and places an embargo on gold exports, the Fed engages in, helps the government engage in inflationary finance. And we have the first double-digit inflation.

Well, the worst inflation since the Civil War, and the worst in the 20th century, by the way, the inflation rate, the peak inflation rate during World War I was higher than the peak in the late 1970s, early 1980s. So that's just within the first four year. Then you have one of the worst depressions in the U.S. history. I think it's now the third or fourth worst depression. It keeps going down the list as we keep having new ones. But it was a severe depression in the early 1920s that was basically a result of the fact that prices had risen so high during the war, but the Fed was determined to reestablish the gold standard, and that meant they had to come down

one way or the other, and they came down quickly, but not painlessly. That's up to 1921. Then in the 20s you have a period of relative calm, though one in which many argue that at the end of that decade the Fed was keeping interest rates too low and therefore contributing to an artificial unsustainable bull market, especially in the last. couple years and doing so partly because it was in cahoots with the Bank of England for reasons I don't need to go into. Then, of course, you have the Great Depression, the first part of it, 1929, 1933, the worst financial downturn. Finally, to give one more case in 1937, there's another crash in the middle of the Great Depression, if you consider that Depression to have lasted the whole

decade. There's a depression within the Depression in 1937, 1938, and some believe the Fed was complicit in that as well. Well, that's some record, isn't it? Because those crises were all worse. Oh, and banking panics. Before 1914, there were actually, the frequency of banking panics was actually less than it was in the Fed's first 20 years. There were many. There were five banking. panics just during the early years of the Great Depression alone. And the number of bank failures in the country was much higher after the Fed than before. But to be fair to the Fed, that was a result more of agricultural overinvestment during the war than anything else. So I wouldn't pin that on the Fed. Still, I don't think anyone can look at the Fed's performance through the Great Depression

and conclude that it was a great success. On the contrary, I think an honest, an honest assessment has to be that the Fed failed to achieve the goal that was designed to achieve, which was stabilizing markets by assuring an adequate supply of currency. It was a dismal failure. However, with central banks and the Fed maybe in particular, nothing's, succeeds like failure. When other enterprises perform badly, they go out of business. When central banks perform badly, they get their powers enhanced so they can do more. And that's exactly what happened to the Fed in the 1935 Banking Act. There was more concentration of power in

Washington, et cetera, et cetera. And of course, the gold convertibility of the dollar domestically at least was eliminated, and the dollar was devalued in 1934. So the Fed, in both of those respects, was put on a much looser leash than it had been on, as if everything, as if the Fed's failure had been entirely a result of the gold standard constraints. But as Milton Friedman and Anna Schwartz, among others, have shown, it wasn't actually the gold standard that, that, uh, is a lot of the gold standard. led to the great monetary contraction of the early 1930s. When the Federal Reserve stopped paying gold, when the national bank holiday was declared on March 4th by FDR,

it was done at the behest of the Federal Reserve banks, not commercial banks, who had already shut down the New York banking system and some other. But it was done because the Federal Reserve, was afraid it might run out of gold. It was sitting on $1 billion of excess gold reserves. It went into the Great Depression with vast amounts of gold reserves. We had too much gold in the 20s. And so the gold standard really wasn't constraining the U.S. monetary system very much. The errors of the Federal Reserve were a result of other factors.

other rules and regulations it imposed on itself, which caused it to manage things very, very badly. And that's what Friedman and Schwartz say. They don't say anything about, Friedman's not a gold standard guy. Neither was Anna. But their book clearly states that what happened in the 30s was not the fault of the gold standard. And that's important to, that's something that's people should keep in mind. It was the incompetence, as they put it, of the Federal Reserve authorities. It can't fail much more than that, fellas. I mean, that's about as bad as it gets. But here we are, 2020, and we still rely on the Fed to avoid serious business cycles. And lo and behold, we still have serious business cycles. Now, I'm not saying that this current crisis is all the Fed's fault.

Of course, that's not true. I am saying, though, that alternatives to central banking, even today, deserve to be taken more seriously than they have been, and that economists are particularly to blame for not knowing enough about them, not being aware of how they operated in the past, and not thinking out of the box today when it comes to better ways, coming up with better ways to avoid cycles and crises. So this has been a critique that some have levied over the last, you know, decade of crises that we've experienced over the last couple decades. And I guess I want to kind of connect the dots between some of these historical antecedents with the modern era of the Fed. So I guess let's start in 2008.

You know, one, how had the mandate of the Fed changed? broadly speaking, obviously, there's been a lot of intervening time at that point from what we were just talking about. But two, the Fed has been both lauded and blamed for its role. In fact, in some ways, there's not a narrative consensus, or at least there's highly competing narratives for the end of 2008 or the response to 2008. What do you make of that story? And then we'll get to maybe more contemporary as we're kind of running back the same playbook now. Well, to start with the mandate, after the Great Depression, although the Fed wasn't obliged to convert its dollars into gold for U.S. citizens, there still was a kind of a remnant of the gold standard in place internationally among central banks. And so the mandate then was for the Fed to maintain relatively stable exchange rates and maintain that gold value for the dollar. going forwards, and especially under the Bretton Woods system that was put together at the end of

World War II. So the overarching mandate was to operate monetary policy in a way consistent with a preservation of that fixed exchange rate arrangement. Well, the Fed didn't do that. The Fed didn't do that, mainly because of fiscal pressure, pressure to help finance both the Vietnam, war and the great society spending efforts of the government. The Fed overissued dollars. This caused the dollar dollars to accumulate, first of all, in foreign central banks, but ultimately it caused them to start cashing them in for gold. We couldn't maintain our obligations. We couldn't continue to fulfill the obligations to redeem the notes. And so Nixon finally took us off the gold standard altogether in 71. After that, the Fed's mandate, of course, has varied, but in essence,

it's been, for the most part, the so-called dual mandate, where the Fed is supposed to look after both inflation and unemployment, supposed to keep the one from being either too high or too low, and the other from being too high. And this mandate, of course, has been practiced in very different ways with different degrees of success over time. More recently, the inflation part of the mandate has been understood to mean that the Fed should keep the inflation rate around 2%. And now it's been toying with that. It's trying to not be quite as rigidly committed to 2% as it had been in the past.

So that's the basic story about the mandate. As for 2008, I'll say, first of all, all that I think 2008 is a good illustration of how a 2% inflation target to the extent that the Fed attempts to stick with it can be very dangerous. Because the Fed actually did a pretty good job sticking to 2% inflation. If you looked at its performance in terms of that target up to 2008, you'd say everything was just fine. But in fact, other criteria suggest that the Fed.

policy was excessively easy in those years from roughly 2005 to 2008. The situation, by the way, here resembles very much those last years of the 1920s. One measure of excess was the fact that nominal spending was growing at a faster than usual rate, about 7, 8 percent instead of 4 percent or so. And of course, interest rates were very, very low, and the excess money growth was part of a deliberate commitment by the Fed that it shouldn't have made to keep interest rates low for a long period. And all of this, I believe, did contribute to the housing or real estate boom, the mortgage boom, how much it's hard to say. But I think that Fed is to some extent culpable for that boom. And to that extent, it's also somewhat responsible for the bust that followed. And by the way, this isn't

inconsistent with the fact that the mortgage lending boom was a worldwide boom. Anything the Fed does tends to be communicated to other central banks. If it's pursuing an easier policy, other central banks tend to do the same, partly because or mainly because stability of their dollar exchange rates, is very important to them. So we tend to be the dog that wags the rest of the world's monetary tails. Anyway, as for the Fed's response to the crisis itself, I've written about this at length, and it is very hard to summarize.

But I do think the Fed did a number of things that did not help. I think it failed in many respects to respond to the crisis as it unfolded the way it ought to have. In particular, the Fed devoted a lot of effort to rescuing particular monetary institutions, to bailing out particular firms and markets. And at first, while it was doing this, it was also tightening credit in other markets. It was sterilizing its emergency lending programs. What that means is that it didn't let total systems,

liquidity grow by lending, making these emergency loans and not trying to tighten up in any other respect. Instead, it made more funds available to the targets of its emergency lending program and compensated by selling securities from its portfolio government bonds to soak up as much lending from the market as it was providing to its emergency lending targets. What that meant was was it was starving the sounder part of the market in some cases to help some firms that were perhaps not worthy of it. And that's exactly the wrong thing for a central bank to do. The classical lender of last resort policy, as it's come down to us from Walter Badgett, and which is routinely endorsed by Fed officials, says you provide liquidity to all the solvent

firms and you let the insolvent ones go bust. I think we, to a considerable extent, we're doing the opposite in the early stages of the 2007 and eight crisis. After that, we started paying interest on reserves. And the Fed did, I mean, not we. And that policy also, I think, was the wrong policy at the wrong time. It, too, was desired. It was designed to make sure that new reserves that the Fed was creating, and it was creating large quantities of new reserves through this emergency lending, would not contribute to general liquidity by being lent in the federal funds market, by being made available in that market. They paid interest on reserves or started paying it expressly to prevent banks from lending reserves out to other banks.

There again, what's that got to do with keeping the market generally liquid? It was exactly the wrong policy. I could go on and on about this, but I know you don't have a lot of time. But there were many respects in which I believe the Fed's policies, especially in the early stages of, the 2008 crisis where we're misguided. It should never have paid interest on reserves. There is a good case for paying interest on reserves in good times. Perfectly sound case. But in a crisis like that, when you need to have interest rates as low as possible and liquidity being available as cheaply as possible, interest on reserves is precisely the wrong policy.

I might give that list that as the number one mistake of the Fed at that time. So I've heard you say that the Fed could have spent the intervening decade between then and now learning the lessons of 2008, but it didn't. And so found itself doing or running back a similar playbook. What do you mean by that? And what sort of similarities are we seeing that? maybe ill-suited to the new crisis that we've faced this year? What I mean by that is that in 2008, the Fed found it had to really scramble to put together all kinds of ad hoc new lending facilities to deal with that crisis.

And I'm not saying they were all necessary, but the point is the Fed felt they were necessary. And so before you knew it, you had half a dozen more new lending facilities. Some engaged in so-called 13-3 lending, others with different forms established under different Fed authorities. So it had to do a lot of that. And that should have gotten the Fed thinking, in my opinion. Should have gotten the Fed thinking. if our established standing facilities were inadequate to deal with this crisis, and we had to create all this new stuff, which was temporary, by the way,

maybe that means that we should re-examine those standing facilities and see if we can't come up with more robust ones that can handle the next crisis, so we don't have to cobble together a bunch of emergency facilities. And of course, during those 10 years, the Fed was engaged in a strategic review, et cetera, et cetera. But it never, ever even began to modify its standing facilities in any way. It made no changes at all, which to me, in retrospect, especially, but even before, was shocking, because many of us were writing about some things the Fed ought to consider doing by way of new facilities or modified standing facilities, including allowing them to deal with more broad

sets of collateral or with a broader set of counterparties and that sort of thing, which is what most of those emergency facilities were allowed to do. They were set up so the Fed could lend money in places or to counter parties it normally didn't deal with, or let them. on collateral that normally didn't take. That's what they were for. So why not consider broadening the collateral for the standing facilities or creating new standing facilities which means permanent ones that can handle it? But nothing was done. Nothing at all so. When this new crisis came, allowing that it's a very different crisis, right? It never had one like this. They were all different. It started from scratch. The only advantage it had as compared

to 2008 was it could go back and dust off some of the temporary facilities it had before. That is, instead of having to come up with them again, it knew how to do it and just had to reestablish them, that saved some time. But still, it had to establish another half dozen new facilities from scratch. In the meantime, some of the Fed's operating standing facilities hardly do anything. The discount window has been more abundant for years now and so on. So if a major crisis won't get the Fed to think about tinkering with its standing facilities and trying to improve them and make them more capable of handling crises, I don't know what will.

It seems like the Fed is married to the idea that the standing facilities it had, circa 2000 are the ones it should have until the end of time. And that's not what's been happening at other central banks. If you look at the Bank of Canada or if you look at the Bank of England or if you look at the ECB, you'll see that in all those cases, they've had major changes in their facilities. In the U.S., in contrast, that one real big change we've had is this change to the floor operating system, which is the one where you always pay banks' interest on reserves no matter what. And as I've said, that particular change, I think, has not been for the better.

And it certainly isn't proving particularly helpful today. And it wasn't helpful back in 2008. There's all this going on, obviously now, especially with the rise of Fin Twit and these other sort of social media spheres where this type of economic policy is being debated out in the open in different ways. the introduction of new heterodox communities, whether it's the gold community who's, you know, been around for a while getting louder or the Bitcoin community or what have you. A lot of critiques are being leveled at the Fed and at our current system at any given time. And one of the things that I've noticed a lot in your, in your content, in your tweets and your writing is a desire to kind of

focus on the right critiques versus the wrong critiques to figure out what's practical and what's not. So, you know, if you just looked at memes on Twitter right now, you would think, okay, I guess guess, you know, because of money printer go bur, we should end the Fed. Because of Judy Shelton, we're going to return to a gold standard. Because the dollar has declined a little bit over the last couple weeks, that means the dollar's role as a reserve currency is over and we're headed towards hyperinflation. When you look at this set of issues, what do you think are the actual important, you know, challenges that we should be focused on? I mean, maybe one of these is actually a thing to hone in on, but, you know, how do you kind of make sense of which areas to prioritize

as you examine what change can actually happen in the short and medium term? Yeah, well, that is a broad question, but it's an important one. And I think you've hinted at what's actually an important part of my answers. We have to, we have to focus on particular issues, first of all, means not wasting time envisioning solutions that are not likely to be solutions for all kinds of reasons. I think the amount of intellectual energy to call it that, because quite frankly, in some cases, how much intellect goes into it, that is spent on talking about getting back to a gold standard would be much better directed at other possibilities. things for all kinds of reasons. I've already, I think, I hope made it clear to your listeners.

I'm not a critic of the old gold standard. On the contrary, I think it was a pretty good system while it lasted. Unfortunately, the road we took to get away from it is not a road you can head back along very easily. You can't in particular, the biggest thing that has happened, and not to just forget about all the little technical issues involved. Forget even about whether it's possible to imagine getting a whole bunch of countries to cooperate, which you have to if you're going to have an international gold standard. Forget all that. Just think about the credibility of government commitments to honor promises to pay gold.

Just think about that. Just think about that. Think about fixed exchange rates in other currencies and their credibility. if you like. What's happened over the course of the 20th century mainly, but it's more true today, as true as ever today, is that government's promises to maintain fixed convertibility commitments for the currencies. No one trusts them anymore. No one, that's gone. No one trust them. If the Fed today promised a fixed exchange rate in euros, eventually would become the object of a speculative attack at some point where people said, we don't think you're going to be able to maintain this.

And if the pass is any guide, those speculators will eventually be right. And the Fed will toss up its hands, and that'll be the end of that. They did it to Britain. They did it to the Thai bot. They did in all kinds of places to Russia. Well, what about gold? Same thing. That's exactly the same kind of commitment that the Fed would be making. It would be subject to the same speculative pressures that would eventually succeed in breaking it down. And the very fact that that's likely, it means it's more likely because we all know it's not going to last. So unless you can stuff the credibility or confidence genie back into the bottle that flew out of in 1934 or three, you can't have a gold standard today like we had in the past. The only way you could have it is if somehow private

enterprise were to start it up again. But there's no tendency for that to happen because of network effects. We don't have time to go into it, but I've made this point with gold people, but also with Bitcoin people who don't like hearing it. But it's very hard to unseat a well-entrenched currency, especially one that's internationally entrenched like the dollar is, notwithstanding all this talk about how the dollar's not going to be a reserve currency much long. etc., etc. That's just a bunch of hot air. The fact is that the dollar has no serious rivals. The Chinese Iran is not a rival. Gold is not a rival, and they're all not rivals for different reasons, but for very strong reasons. But the most important of all is the simple fact of the dollar's

prevalence is a medium of international exchange, invoicing, and reserves for central banks. There's nothing close to it. It has no close rivals. It'll take dramatic events to change that, none of which are in the offing right now. This crisis is not one of them. So partly because it's not just our crisis. So people should forget about gold. They should forget about Bitcoin for the same reason.

I don't mean they should forget about it as an investment. that's fine. And then they've all power to those who do well with that. And I don't mean that Bitcoin isn't important as a currency for certain purposes. It has unique privacy advantages, which unfortunately are advantages to a lot of people trying to do nefarious things, but they can also be and are occasionally advantages to people who just want to escape persecution from the government. And I think that that's a very desirable, it's very desirable to have a medium for that purpose.

But as for going shopping, forget about it. It's just not very good for that. And the set of people who worry so much about their privacy that they'd rather go shopping with Bitcoin than with dollars today in the United States is minuscule. most people don't, their values just aren't like that, and I don't think that's going to change. So we should be talking, most of all, we should be talking here in the United States about the dollar, the good old or bad old U.S. dollar and the Fed and how to make them better. And I don't mean that we shouldn't consider ending the Fed, but ending it, if we're going to consider it, That means more than just saying it, right?

Unfortunately, most people who say in the Fed haven't considered it much in the sense of thinking about how that could be done and how it could be done so that the outcome is not one that consigns the U.S. dollar to the dust bin. because a whole lot of us are holding a whole lot of those dollars, and I don't think anybody wants the dollar to become worthless. So the question is, how can we limit the feds of powers in a way that preserves the U.S. dollar and not just preserves it, but makes it a more reliable and stable currency and makes the U.S. economy more stable, because one thing we know for sure, any reform that destabilizes the U.S. economy, anything we do to the Fed that creates another big crisis or makes it more likely is not going to result in ending the Fed. It's going to go the other way where the Fed gets more power. That happens every time. So if you're going to chip away at the Fed's power,

you've got to do it in a way that improves things. Otherwise, you'll never succeed in making it smaller and less powerful than achieving a Fed-less or even minimal-fed system. So that's what I mean by saying, sure, let's think about ending the Fed. Let's consider it, but consider how you could possibly do that in a way that will succeed, both in the sense that you really do end up with a lot less federal reserve than you have today, if not zero federal reserve, whatever that might mean. But you also end up with a U.S. dollar that preserves its value and is a good medium of exchange in other ways. Now, if you can figure out how to do that, you know, then please do it. I've been thinking about it a lot. But I'm not going around with a T-shirt that says end the Fed.

until I've really figured it out. And I'm certainly not going to pretend that that's a policy solution when it's just a slogan so far. I think we need to get you a T-shirt that says, End the Fed with an asterisk and then has a giant essay on the back in very, very small print. Dr. Snellj, I really appreciate the time. Yeah, I suppose.

Maybe we'll just have it come with a little book. Yeah, exactly. One of my dogs. Yeah, there you go. Maybe the whole collection, I think, at this point. Listen, I really appreciate you spending so much time with us today. You could easily ask questions for another two or three of these. So we'll have to have you back.

But for now, where can people find or follow you for more of these insights? Oh, well, what I'd like people to do is follow me on read my essays and my colleagues essays on Alt M, that's Alt-M as in money. And that's our online publication and the publication of the Cato, Center for Monetary and Financial Alternatives. I have essays there routinely. These days, I'm writing about the New Deal and its effects on the, in achieving its success in achieving recovery from the Great Depression, or lack thereof. And also, I'm on Twitter and my handle, what is my handle? I think it's just my full name, George Selgin.

Let me see. I have to look up my profile and see what it says. Yes, it's just George Selgin with capital G and S in case that matters. And so you can follow me there. I'd love that. And then, of course, I have books, and you can find all of them on Amazon by looking up my name. And if you buy any of them, I'd just be a... absolutely tickled. Well, we'll make sure to include all these links in the show notes, but for now,

thank you again for spending so much time with us today. Two reflections coming off of that conversation with Dr. Selgin. The first has to do with how much more likely it is once a thing it exists to give that thing more power rather than to remove power and to take it away. The way that Dr. Seljan put this was obviously having to do with the Fed doing things that didn't work but getting more and more power on the other side of it, but I think it's a larger phenomenon that has to do with any type of institution. It's what makes institutional and political change so hard. There's a certain inertia in these institutions that makes it very difficult to peel back what they can do. And to me, this gets at the important second point, which is that for anyone who's invested actively in

making the world look more like what you would like it to look like, understanding where your levels of power are and where the opportunity for change lies feels very, very critical. It is, as Dr. Seljan put, appealing to use slogans that are good for Twitter when talking about these major institutions and bodies of power. However, those slogans, those memes, don't on their own actually make change. In fact, in many cases, their main function is to make people feel like they have done something when actually they have done nothing. One of the most optimistic things about the time that we live in is that there are no gatekeepers or there are certainly less powerful gatekeepers than ever when it comes to the types of things

that we get to discuss, the Overton window on the issues we care about. Even with questions of neutrality of platforms, the ability for people to build a voice, to build a content stream, to build an audience have never been better. And so I hope that we have more of the right conversations, whatever those may be, rather than being content to simply reduce things to snappy Twitter pippy insights. Anyways, guys, most of all, I hope that you enjoyed this historical look at Central Banks. If you like this type of episode, this type of historical episode, let me know, leave me a review that says so. Hit me on Twitter at NLW and tell me so. I would like nothing more than the excuse to do more historical episodes because I think they're

fascinating and essential. So hit me up, tell me what you thought, and until tomorrow, guys, be safe and take care of each other. Peace.