Front Page Titles (by Subject) 11: Free Banking and Monetary Reform - The Theory of Free Banking: Money Supply under Competitive Note Issue
11: Free Banking and Monetary Reform - George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue 
The Theory of Free Banking: Money Supply under Competitive Note Issue (Lanham, MD.: Rowman & Littlefield, 1988).
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Free Banking and Monetary Reform
Rules, Authority, or Freedom?
So long as the money supply is centrally controlled, the central authority must either actively manipulate the money supply or it must adhere to a predetermined monetary rule.1 That these are the only options for monetary policy is the view that has been handed down by several generations of economists. Implicitly or explicitly theorists have rejected the alternative of free banking. This is also true of many Chicago-School economists—the best-known proponents of monetary rules and opponents of monetary discretion—who otherwise argue for a free society based upon free markets.2 For the cause of free banking the last fact is especially significant, because it means that a large and highly respected body of theorists, who might most readily have concurred with the arguments for free banking, have instead aligned themselves with advocates of monetary centralization.
Why have Chicago economists denied the efficacy of the free market in the realm of money and banking? To begin, they have doubted the very desirability of commercial banks issuing fiduciary media. Lloyd Mints (1950, 5 and 7) saw no benefits at all in such institutions; and although Simons (1951) and Friedman (1959, 8; 1953, 216-20) may not have shared this extreme position, they at least considered fractional-reserve banking to be “inherently unstable.” Such a perspective does not incline its holders toward the view that banking should be entirely unregulated, except in peculiar cases (such as Mises’s) where it is believed that free banking will somehow lead to the suppression of fractionally-based inside monies.
It has already been argued (in chapter 2) that fractional reserve banking is beneficial, contrary to Mints’s position. It was also argued, in chapters 8 and 9, that there is no “inherent instability” in free banking. In fact, the particular sort of instability emphasized by Mints and Friedman—changes in the volume of money due to changes in the form in which the public wishes to hold its money—arises only in systems lacking freedom of note issue.3 The problem is indeed inherent in systems with central banking and monopolized currency supply, but it is not inherent to all fractional-reserve banking.
Elsewhere various Chicago economists—especially Milton Friedman (1959, 4-9)—have criticized free banking on the grounds that it leads to unlimited inflation, involves excessive commodity-money resource costs, and encourages fraud. For these and other reasons they have claimed that the issue of currency is a technical monopoly which must be subject to government control. Each of these arguments has been critically examined and found wanting. The Chicago School’s dismissal of free banking was, in short, premature.
We are today in a much better position than the Chicago economists once were to consider free banking as an alternative monetary policy, distinct from reliance upon either rules or authorities. The best way to appreciate the advantages of this alternative is to view it in light of arguments on both sides of the rules-versus-authorities debate. Jacob Viner (1962, 244-74) provides an excellent summary of these arguments. According to him, the Chicago pro-rules position is that rules provide “protection . . . against arbitrary, malicious, capricious, stupid, clumsy, or other manipulation . . . by an ‘authority’ ” and that they guarantee a monetary policy that is “certain” and “predictable” (ibid., 246).4
The principal argument for discretion is, on the other hand, the ipso facto deficiency of regulatory policies that “attempt to deal by simple rules with complex phenomena” (ibid.). A monetary rule necessarily precludes “the possibility of adaptation of regulation by well-intentioned, wise and skillful exercise of discretionary authority to the relevant differences in circumstances” (ibid.). Viner lists four considerations that stand in the way of the successful use of any monetary rule. They are (a) the existence of a multiplicity of policy ends, which no simple rule can fulfill; (b) the presence of more than one monetary authority or regulatory agency (which makes it difficult to assign responsibility for enforcement of a rule); (c) the existence of several instruments of monetary control (which complicates execution and enforcement of a rule even when there is a single monetary authority); and (d) the possibility that a satisfactory rule may not exist even if policy is aimed at a single end and is implemented by a single authority using a single instrument of control.
Although all these considerations are relevant, let us abstract from (a), (b), and (c) by assuming, first, that the sole end of monetary policy is to maintain monetary equilibrium (i.e., to adjust the nominal quantity of money in response to changes in demand); second, that responsibility for control of the money supply is vested with a single authority, namely, the “well-intentioned” directors of a central bank; and third, that open-market operations are the sole means for centrally administered changes in the money supply. This limits the problem to one of finding a satisfactory monetary rule. The difficulty here is that even a clearly defined policy end may involve “a quantity of some kind which is a function of several variables, all of which are important and are in unstable relation to each other” (ibid.). When this is true “there will be no fixed rule available which will be both practicable and appropriate to its objective” (ibid.).
Suppose the desired end is the accommodation of the demand for money, which is indeed “a quantity . . . of several variables . . . in unstable relation to each other.” No simple monetary rule such as stabilization of a price index or a fixed percent money growth rate can fully satisfy this end. In fact the constant growth rate rule, which is now most popular, abandons any effort to accommodate seasonal and cyclical changes: it regards only secular changes in demand as predictable enough to be the basis for a steadfast formula.
And yet, as far as the desires of some advocates of monetary rules are concerned, the fixed money growth-rate proposal—especially when it is defined in terms of some monetary aggregate—is not strict enough. It still permits the monetary authority actively to conduct open-market operations to meet the prescribed growth rate. A pre-set schedule of open-market bond purchases cannot always be carried out, because the relevant money multipliers (which determine the effect of a given change in the supply of base money upon the supply of broader money aggregates) are not constant or fully predictable.5 There will, therefore, always be occasions under such a rule when some discretion will have to be tolerated so that open-market purchases do not miss their target. On the other hand, if such discretion is permitted, it can be abused, and so, to state once more the warning of Henry Simons, it would make the supposed rule “a folly.”
It is apparent, then, that if we must have a central monetary authority we must choose between the dangers of an imperfect and perhaps ill-maintained rule and the dangers of discretion and its possible abuse. This choice has been made somewhat less difficult in recent years, because the authorities’ abuse of their discretionary powers has been such as to overshadow the potential damage that might result from blind adherence to some pre-set formula. In the United States the loss of faith in authority has given rise to a new proposal that is the ultimate expression of Simons’s anti-discretion position. The proposal is that the supply of base money should be permanently frozen—that is, that the Federal Reserve System should cease open-market operations entirely.6 Here at last is a rule calculated to prevent mischief: all that needs to be done to guarantee its strict observation is to close the Fed! Milton Friedman, who for years advocated a constant M-1 growth-rate rule, is now the most prominent champion of this frozen monetary base proposal.
Thus monetary policy has reached an impasse. Under a strict monetary rule, and especially in the case of the base-freeze proposal, the really desirable end of monetary policy—achieving monetary equilibrium—has to be sacrificed to the much lower, cruder end of merely preventing the authorities from introducing more instability into the system than might exist in the absence of any intervention, capricious or otherwise. Is such an inflexible arrangement the best that can be hoped for? So long as one clings to the assumption of centralized control and centralized currency supply, there is reason to believe that it is. We have seen, in chapter 7, why discretion, even in its best guise, is likely to hurt more than it helps.
But centralized control need not be taken for granted. The supply of currency could instead be placed on a competitive basis. This solution, unlike solutions based on centralized control, can achieve monetary stability while simultaneously eliminating government interference. Free note issue combines all the virtues of Friedman’s proposal—which completely eliminates the danger of capricious manipulation of the money supply—with those of a system capable of meeting changing demands for money. Freedom of note issue resolves the “inherent instability” that afflicts centralized systems of fractional-reserve banking. By supplying an alternative form of pocket and till money—competitively issued bank notes—to accommodate changing public demands, free banking reduces the public’s reliance upon base money as currency for use in everyday payments. In this way base money is allowed to remain in bank reserves to settle clearing balances. Fiat base money can thus be made to play a role similar to the one played by commodity money in the “typical” free banking system which has been given prominence through most of this study. Base money never has to move from bank reserves to circulation or vice-versa, so that, in such a system, there is no question of any need for reserve compensation to offset the ebb and flow of currency demand.
Free banking on a fiat standard may seem far from the sort of free banking discussed in previous chapters, but the difference is not really so great. True, the preceding pages discussed mainly a commodity standard, because this is the type that would most probably have evolved had banking been free all along; but events have been otherwise. For better or worse our monetary system is at present based on a fiat-dollar standard, and the momentum behind any existing standard is an argument for its retention. Existence of a fiat standard is, however, no barrier to the adoption of free banking. As far as banks today are concerned, fiat dollars are base money, which it is their business to receive and to lend and to issue claims upon. For most of the 20th century the only claims allowed (we are as usual considering ones redeemable on demand only) have been checkable deposits. What is proposed, therefore, is that commercial banks be given the right to issue their own notes, redeemable on demand for Federal Reserve Dollars, on the same assets that presently support checkable deposit liabilities.7 Once the public becomes accustomed to using bank notes as currency, the stock of high-powered money can be permanently frozen according to a plan such as Friedman’s without negative repercussions due to changes in the relative demand for currency.
This simple proposal does not involve any interference whatsoever with the dollar as the national monetary unit. Yet, it would make it possible for Federal Reserve high-powered money to be used exclusively as bank reserves, for settling interbank clearings, while allowing bank notes to take the place of Federal Reserve Dollars in fulfilling the currency needs of the public.8
A Practical Proposal for Reform
How can this proposal be implemented, and how can it be combined with a plan for freezing the monetary base? A reasonable starting point would be to remove archaic and obviously unnecessary regulations such as statutory reserve requirements and restrictions on regional and nationwide branch banking. The majority of nations with developed banking industries have not suffered from their lack of such regulations, evidence that their elimination in the United States would not have grave consequences. In fact, branch banking has significant micro- and macroeconomic advantages over unit banking, and its absence is probably the most important single cause of the relatively frequent failure of U. S. banks.9 As for statutory reserve requirements, it has already been shown (in chapter 8) that they are impractical as instruments for reserve compensation. Apart from this, they serve no purpose other than to act as a kind of tax on bank liabilities. Furthermore, their existence interferes with banks’ ability to accommodate changes in the demand for inside money. If the monetary base is frozen this restrictive effect is absolute. On the other hand, elimination of statutory reserve requirements, unless it proceeds in very small steps, could open the door to a serious bout of inflation. A solution would be to sterilize existing required reserves the moment the requirements are removed. This could be done as follows: suppose the statutory reserve requirement is 20 percent. Presumably banks operate with reserves of, say, 25 percent—only the excess 5 percent are an actual source of liquidity to the banks. It could then be announced that after a certain date there will be no further rediscounts by the Federal Reserve Banks (thus encouraging banks to acquire adequate excess reserves). Then when the deadline arrives reserves held for statutory purposes could be converted to Treasury bills—a non-high-powered money obligation—and the statutory reserve requirements could at the same moment be eliminated.10
In addition to reserve requirements and restrictions on branch banking, restrictions on bank diversification such as the Glass-Steagall Act should also be repealed. This would allow banks to set up equity accounts, reducing their exposure to runs by depositors, and opening the way to the replacement of government deposit insurance by private alternatives.
While these deregulations are in progress, Congress can proceed to restore to every commercial bank (whether national or state chartered) the right to issue its own redeemable demand notes (which might also bear an option-clause) unrestricted by bond-deposit requirements or by any tax not applicable to demand deposits. This reform would not in any way complicate the task facing the still operating Federal Reserve Board; indeed, it would reduce the Fed’s need to take account of fluctuations in the public’s currency needs when adjusting the money supply. The multiplier would become more stable and predictable to the extent that bank notes were employed to satisfy temporary changes in currency demand.11 Over time banks would establish the reliability of their issues, which need not be considered any less trustworthy by the public than traveler’s checks.
For competitively issued notes to displace base money from circulation entirely the public must feel comfortable using them as currency. This might be a problem: the situation differs from the case of a metallic base money, which is obviously a less convenient currency medium for most purposes than bank notes redeemable in it. There is no obvious advantage in using paper bank notes instead of equally handy paper base dollars. Nevertheless, imaginative innovations could probably induce the public to prefer bank notes. The existing base-money medium could as a deliberate policy be replaced by paper instruments of somewhat larger physical size, fitting less easily into wallets and tills. Bank notes, on the other hand, could be made the size of present Federal Reserve notes. The appearance of base dollars could also be altered in other ways, for instance, by having them engraved in red ink. In this form they might seem even less familiar to currency users than the newly available bank notes. Finally, base dollars could be made available only in less convenient denominations. Two-dollar bills would work, since they already have an established reputation for not being wanted by the public, but larger bills would be most convenient for settling interbank clearings. Banks, of course, should be allowed to issue whatever note denominations they discovered to be most desired by their customers.12
Other innovations need not be a matter of public policy but can be left to the private incentive of banks. Banks could stock their automatic teller machines with their own notes, and bank tellers could be instructed to give notes to depositors who desire currency, unless base dollars were specifically requested. Banks might also conduct weekly lottery drawings and offer prize money to persons possessing notes with winning serial numbers.13 The drawings would be like similar lotteries now held by several daily newspapers. They would make notes more appealing to the public, as they would constitute an indirect way of paying interest to note holders, just as interest is now paid on some checkable deposits.
A combination of measures such as these would almost certainly lead to near-complete displacement of base dollars from circulation. Once this stage was reached—say, once 5 percent or less of the total of checkable deposits and currency in circulation consists of base dollars14 —a date could be chosen upon which the supply of base money would be permanently frozen. When this date arrived, outstanding Federal Reserve deposit credits would be converted into paper base dollars, and banks that held deposits with the Fed would receive their balances in cash. Banks could then exercise their option to convert some of this cash into specially created Treasury obligations (see note 12). At this point the Federal Reserve Board and Federal Open-Market Committee could be disbanded. This would end the Fed’s money creating activities. The System’s clearing operations could be privatized by having the twelve Federal Reserve Banks and their branches placed into the hands of their member-bank stockholders.15 The frozen stock of base dollars could then be warehoused by the newly privatized clearinghouse associations. Dollar “certificates” or clearinghouse account entries could be used to settle interbank clearings, thereby saving the dollar supply from wear and tear. Only a small amount of base dollars would actually have to be kept on hand by individual banks to satisfy rare requests for them by customers. In the unlikely event of a redemption run, a single bank in distress could be assisted by some of its more liquid branches or by other banks acting unilaterally or through the clearinghouse associations; some banks might also have recourse to option clauses written on their notes. Finally, bank liabilities might continue to be insured (by private firms), although there might not be any demand for such insurance under the more stable and less failure-prone circumstances that free banking would foster.
The above discussion assumes that base money dollars will continue to command a saleability premium and that they will therefore continue to be used to settle clearing balances among banks absent any legal restrictions compelling their use. Such need not be the case, however. Indeed, it should be emphasized that, although the above reform is designed so that a continuation of the present paper-dollar standard is possible under it, the reform is not meant to guarantee the permanence of that standard. Some other asset might replace paper dollars as the most saleable asset in the economic system and hence as the ultimate means of settling debts. This would drive the value of paper dollars to zero (since there is no nonmonetary demand for them), rendering the dollar useless as a unit of account. In this event a new unit of account, linked to the most saleable asset in the system, would evolve, thus bringing the dollar standard to an end. As Vaubel (1986) emphasizes, one aim of a complete free-banking reform should be the elimination of any barriers standing in the way of the adoption of a new monetary standard. Fiat currencies issued by other governments or even by private firms (including composite currencies like the ECU), if they were judged more advantageous by the public, could then replace the present dollar standard. Also, the way would be opened for the restoration of some kind of commodity standard, such as a gold standard. This does not mean that a change of standard would be likely; however, if many people desired it, it could occur. A well-working free banking system can grow on the foundation of any sort of base money that the public is likely to select, and competition in the supply of base money is no less desirable than competition in the supply of bank liabilities, including bank notes, redeemable in base money.
Of course this reform is radical, and it is not likely to be adopted in the near future. Nevertheless, there are no great logistic or material barriers standing in the way of the adoption of free banking; the transition costs of a well-framed free banking reform are negligible—with benefits as great as the potential for undesirable fluctuations in the dollar supply if it is not undertaken. Therefore, although political reality renders such reform unlikely in the near future, it would be unfortunate if this were made the excuse for avoiding the vigorous discussion that might minimize the waiting time for its implementation. The present banking system is likely to generate a need for drastic change sooner or later, and if reform is delayed until a time of crisis, there can be no question of any smooth, costless transition to a well-working, deregulated system. On the contrary, an occasion of panic is likely to breed the sort of “temporary” makeshift measures that end in more regulation and centralization, leaving the banking system in an even less satisfactory state, and still further removed from the practical and theoretical ideal of perfect freedom.
Free banking in a near-perfect form has not existed anywhere since 1845, when the Scottish free banking era was ended by Peel’s Bank Act. Its closest approximations since that time, including the plural note issue systems of Sweden, China, and Canada, which survived into the 20th century, have also been replaced by more monopolistic and restrictive systems based upon central banking. How significant is this? How serious have the actual consequences of governments’ failure to allow free banking been?
The consequences have been very serious, for reasons that should be evident by now. When banking is regulated and centralized, the supply of money fails to respond automatically to changes in demand. Excessive money creation leads to forced savings and to inflation, and these are eventually followed by a liquidation crisis. Insufficient money creation leads to immediate depression and deflation. History is littered with such monetary disturbances. Besides these there have been numerous instances, in the 19th century especially, of currency shortages, which might have been avoided had banks been completely free to issue notes. Currency shortages rarely occur today, but the price for avoiding them has been central banks’ all too generous expansion of supplies of high-powered money—expansion well in excess of what has been needed to meet demands for currency. As a result inflation has become a chronic, worldwide disorder.
That inflation has been the overall tendency of centralized banking should not surprise anyone, because an agency able to expand its assets gratuitously finds it difficult to resist using this power to its uppermost limits. With free banking no longer an issue, it was merely necessary that convertibility requirements be dismantled for these limits to be greatly expanded. The only thing that stands between fiat money creation by central banks and limitless inflation is political pressure from those who know and fear the consequences.
But these are only the direct effects of the rejection of free banking. The indirect effects have been even more unfortunate. These stem from the interventionism dynamic, in which one ill-conceived regulation justifies a myriad of others. Bond-deposit requirements, restrictions against branch banking, and other regulations plagued the National Banking System and led to crises that provoked even more regulations and centralization, giving rise to the Federal Reserve System. When the new arrangement became involved in even greater disturbances, yet another batch of restrictions on freedom of choice was imposed. The gold standard became a scapegoat, and was gradually dismantled. There was at work a kind of regulatory ratchet-effect, and the banking system we have today is the result. There have been other consequences as well. One of them is the view that the monetary authority ought to control, not just commercial banks, but all kinds of financial institutions. Another is the idea that a world central bank will be the ultimate cure for monetary disorder. But most significant has been a body of opinion convinced that the free market is inherently unstable, and that only far-reaching government involvement will make it work. Failure to allow the market to function in money and banking has thus encouraged the view that the market system as a whole is unreliable and in need of further state regulation and centralization.
All this should not be taken as suggesting that problems would not arise under free banking. A free banking system is not perfect. Bankers will sometimes err in their entrepreneurial decisions; they will make bad loans and investments, and some banks will fail. Exogenous fluctuations in the output of commodity money will occur due to technological innovations which are not mere responses to changes in demand, and such fluctuations will be a cause of monetary disequilibrium.1 The nonmonetary demand for the money commodity may be unstable. Finally, changes in the total supply of inside money will also not occur in perfect correspondence with changes in demand: there may be minor episodes of aggregate excess supply or excess demand, as bankers grope to discover their maximum, sustainable issues in an environment where consumer note preferences are not perfectly stable or predictable.
Nevertheless, the equilibrating tendencies of free banking, which this study has attempted to analyze, are in keeping with monetary stability. Under free banking economic forces reward bankers who make decisions consistent with the maintenance of monetary equilibrium (and minimization of costs) and punish bankers who make decisions inconsistent with these goals. Although tendencies are not equivalent to perfection, this is not a special disadvantage of free banking: there is no such thing as a perfect monetary and banking system in a world without perfect human beings capable of making perfect decisions.
It also has to be admitted that free banking is not an arrangement the consequences of which are entirely predictable. There are gaps in our knowledge of how a free banking system functions, gaps that future research (aided, perhaps, by actual practice) will hopefully fill. Some of these concern the implications of free banking for the distribution of loanable funds, the effects of competitive note issue on the relative economies of unit and branch banking, the implications of free banking for government finance, the possible international uses of base money in an open free banking system and their implications for domestic stability, and the possibilities for 100 percent fiduciary substitution (elimination of outside money from bank reserve holdings) by way of advanced clearinghouse arrangements and their implications for theory and policy. Going beyond such issues it must be realized that no actual free banking system is likely to stand still. On the contrary, any such system is likely to continue to evolve new practices and techniques which theory cannot possibly anticipate. We see this happening even at present, despite the existence of prohibitions and regulations that thwart change. Innovations in electronic banking especially are progressing far more rapidly than any theory that might account for their consequences. It is evident, however, that these consequences are generally favorable ones. The same is also likely to be true of the even more numerous innovations that would be possible if banking were entirely unregulated.
In another sense, though—that which concerns the course of the money supply—the consequences of free banking are predictable. The environment it produces is favorable to entrepreneurial decision-making and to the undertaking of ventures expected to yield their fruits through long periods. Nothing of the sort can be said of regulated, centralized systems of money supply. This is true, not only because those in charge of a centralized system cannot have the information necessary for stability—a fact given due attention throughout this study—but also because stability is simply not in the interest of those in charge. I have for the most part refrained from emphasizing the second point; but it would be foolish to ignore it entirely and to pretend that politicians are not self-interested persons whose interests often conflict with the goal of maximum consumer welfare.2 Admitting this, the fact remains that a centralized banking system would work badly even if angels (but not omniscient angels) were placed in charge of it.
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[1.] Some material in this chapter has appeared previously, in somewhat altered form, in G. A. Selgin, “The Case for Free Banking: Then and Now,” Cato Institute Policy Analysis (October 21, 1985).
[2.] See in particular Henry C. Simons (1951); Lloyd W. Mints (1950); and Milton Friedman, (1959). Again we must note Friedman’s recent reconsideration of his former views, in “Has Government Any Role in Money?” Friedman’s current policy recommendations place him in fundamental agreement with reform suggestions made in this chapter. Whether other monetarists will follow him (and Anna J. Schwartz, who co-authored the above mentioned article) in this change of heart remains to be seen.
[3.] See above, chapter 8. It should be noted however, that Mints regarded prohibition of competitive note issue as an “unnecessary legal restriction.” “I can see no reason,” he wrote (1950, 187-88), “why, if fractional reserves against deposits are desirable, they are not equally desirable for notes. . . . In fact, the prevailing arrangement . . . operates to prevent a complete interconvertibility of notes and deposits” the consequence being “the preverse behavior of the volume of bank loans.” As I mentioned in chapter 8, Friedman also, in his earlier writings, recognized free note issue as a possible solution to what he nevertheless insisted on calling the “inherent instability of fractional reserve banking.” Yet Friedman originally rejected this solution, in one place because it “has little support among economists, bankers, or the public” (1953, 220), and elsewhere for reasons summarized in the text above.
[4.] Ibid. Some rational-expectations theorists also defend a monetary rule as providing greater predictability. However, in their models rules are often only “weakly superior to” (i.e., no worse than) all possible discretionary policies.
[5.] An example of a variable causing changes in the money multiplier is the relative demand for currency, which was discussed at length in chapter 8.
[6.] See for example Milton Friedman (1984a, 1984b) and Richard H. Timberlake, Jr. (1986, 760-62).
[7.] Strictly speaking, issue of bank notes by commercial banks is not presently illegal; however, such issue must still meet the bond-deposit requirements established under the National Banking System or the 10 percent tax on state bank notes. Since all bonds eligible as security for circulating notes were retired before 1935 (or had the circulation privilege conferred upon them withdrawn), note issue, while not illegal, is nevertheless impossible under existing law. Restoration of commercial bank note-issuing privileges merely requires repeal of the bond deposit provisions in the original National Banking statutes and of the prohibitive tax on state bank notes.
[8.] Thus, in contradiction to Friedman (1984a, 47), competition in note issue need not represent an effort to replace the “national currency unit.”
[9.] On unit banking as a source of financial instability in the United States and its role in turn-of-the-century monetary reform see Eugene Nelson White (1983).
[10.] Since Treasury bills bear interest, this reform would eliminate an important source of interest-free funds to the government. Since approximately $48 billion are held today to meet statutory requirements, their conversion into Treasury bills would involve a maximum gross loss to the Treasury of $2.88 billion, assuming that Treasury bills pay 6 percent interest. The net loss would be less, however, since increased bank earnings would also generate additional tax revenue.
[11.] Contrary to this view is the view, cited by Friedman (1984a, 49) of the “new monetary economists,” who argue that prohibiting bank-note issues actually stabilizes the demand for high-powered money.
[12.] Some of these suggestions would automatically be realized if Friedman’s recommendation—that the frozen stock of base dollars be converted into Treasury notes—were adopted. It would be safest, however, to have base dollars in a form capable of circulating, later allowing banks the option of converting some or all of them into special interest-earning Treasury obligations created for the purpose. The new Treasury obligations could be offset by cancelling an equivalent value of Treasury obligations held by the Federal Reserve banks.
[13.] This idea is suggested in J. Huston McCulloch (1986).
[14.] The figure is now (1985) approximately 35 percent. (Source: Federal Reserve Bank of St. Louis, U. S. Financial Data, March 28, 1985, 3-4.)
[15.] As is recommended by Richard H. Timberlake, Jr. (1986, 760). See also Joanna H. Frodin (1983). As Timberlake notes, privatization of the clearing system would probably result in an arrangement similar to what existed in the pre-Federal Reserve era.
[1.] This problem would, however, not arise in a system such as that outlined in chapter 11, in which the stock of base money consists of a permanently fixed supply of paper money.
[2.] The assumption that monetary authorities are self-interested (rather than altruistic) persons has fortunately been incorporated into modern monetary theory by writers in the “public-choice” tradition. See for example Richard E. Wagner (1977, 1980); W. Mark Crain and Robert B. Ekelund, Jr. (1978); Robert J. Gordon (1975); Keith Acheson and John F. Chant (1973); Mark Toma (1982); and William P. Yohe (1974).