Saturday, 2 October 2010

A Tactical Step Forward?

I was looking over Toby Baxendale's proposal for banking reform in the UK in conjunction with this recent discussion involving some of the heavyweights at Peter Boettke's blog. Baxendale's proposal, if I understand it rightly, argues for the introduction of enough new money by the Bank of England to instantiate a 100% reserve system among the commercial banks (RBS and the like). What I like about the proposal is that, by eliminating the need for a lender of last resort (the Bank of England), it does seem to represent an intermediary step forward between our current predicament and the ideal of a free banking system; if a lender of last resort is not required because banks are keeping 100% reserves, then the only remaining arguments for the continuing existence of the Bank of England are about government spending.

Baxendale's proposal is a bold tactical step. The chief problem with it seems to be that, in effectively advocating the outlawing of fractional reserve (after Baxendale's reform, "fractional reserve accounts" will actually be no more than closed mutual funds), Baxendale's proposal might create new problems whilst the Bank of England, although its original function will have been abolished, yet remains in place issuing loans to government departments and large insurance firms and the like. As George Selgin argues in the Boettke discussion thread and at rather more length here (pdf), the fractional reserve system is not of its own inflationary and involves only temporary redistributions of purchasing power rather than regressive currency debasement, so outlawing fractional reserve, rather than being a good in its own right, is merely an instrumental means of reaching a slightly better but still precarious position from which to further advance the cause of free banking.

Are there any better tactical ways of thinking about the problem of going from the current situation in which commercial banks are like mere branches of the Central Bank to the ideal situation of free banking and competing currencies?

Disclaimer: Although I can recite the basics of Austrian Economics (the origins of money and credit, the subjective theory of value, capital structure and the business cycle, inflation vs deflation, Gresham's law and competition among private currencies), I'm way in over my head here at this level of detail, so in writing this my aim is to clarify my own grasp of the proposal and the discussion surrounding it. For beginners, Brian Micklethwait has a good podcast interview with Mr Baxendale here.

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