Monday, May 14, 2012

Jonathan Finegold Catalán on Free Banking and ABCT

I direct readers to this interesting post by Jonathan Finegold Catalán, which I welcome, where he attempts to answer my charge that free banking would, under the logic of the Austrian business cycle theory (ABCT), lead to perpetual Austrian business cycles:
Jonathan Finegold Catalán, “Fiduciary Cycles,” Economic Thought, 14 May, 2012..
I will post a proper response to this tomorrow, but some quick thoughts. I welcome the idea that the number of anti-fractional reserve banking Austrians is “dwindling ... [sc. and] more and more ... [sc. Austrians] are simply switching to supporting free banking.”

However, I am taken to task with the accusation that my question is “an illustration of just how poorly LK understands both the Austrian theory of industrial fluctuations and the theory of free banking.” That is surprising. Catalán seems to imply he will dispute my assertion that “Mises’ and Hayek’s work in the area was to show how fiduciary expansion leads to business cycles.”

Yet only a few paragraphs we read:
“In Hayek’s early writing (I have in mind his 1933 [1929] article “Monetary Theory and the Trade Cycle;” specifically, chapter four), he does actually believe that fractional reserve banking leads to recurrent business cycles.”
It is like watching someone proclaim that they are going to walk down a flight of stairs with elegance and grace - only to trip over and fall head over heels to the bottom.

Nor do I find the White/Selgin model of fractional reserve banking, and how it will supposedly stop cycles, very convincing. Many nations had approximations of free banking in the 19th century, e.g., Australia. In this case, a system of banks under a gold standard, no central bank and very light regulation (that was mostly ignored anyway) produced a credit boom that blew a huge asset bubble in property. The familiar debt deflationary depression followed.

Anyway, more on this tomorrow.


  1. Two comments that will hopefully help shape your response tomorrow,

    1. Strangely, you quote me out of context. Literally two paragraphs before that I explain the general concept of the theory -- an over-expansion of the supply of fiduciary media in circulation. Then I explain why early Hayek made the mistake of considering these cycles as part of the nature of a modern banking system (something I think I forgot to add, as a n.b., is that Hayek thought that it was just a price to be paid for the greater efficiency of fractional reserves) -- he didn't consider the institutional nature of a banking system characterized by certain key qualities: (a) a monopolized currency [this is the emphasis in Selgin's critique of current institutions in A Theory of Free Banking] and (b) a cartelized industry (through the Federal Reserve System), amongst other traits (ex. [c] regulations which homogenize action). In short, when I explained Hayek's early mistake, I didn't intend to support your thesis (in fact, everything else does the exact opposite and provides contrasting context to this part of Hayek's thought);

    2. I'd be interested in your thoughts on W/S. But, I think it's fair to admit that those approximations were just that ... approximations. I don't know the empirical evidence well enough, especially given even internal divisions over what it implies (e.g. White v. Rothbard v. Sechrest over Scotland). But, there were aspects of these banking systems which could lead them to instability: possible factors depending on what example we're talking about include constraints to bank branching, government-orchestrated fiduciary expansion (e.g. the greenbacks period), quasi-cartelizations (e.g. national banking systems), and constraints on the isolated issuance of money (which is a big one for avoiding bank runs).

  2. LK,

    "It is like watching someone proclaim that they are going to walk down a flight of stairs with elegance and grace - only to trip over and fall head over heals to the bottom."

    I dont see how you say this off of the passage that Catalan wrote about Hayek. He was just simply stating that early in Hayek's career he did believe that FRB was the cause to business cycles. Catalan makes the case that Hayek did not believe in this later on, especially by the time he wrote 'The Denationalisation of Money'. Catalan says further that what is influential in Hayek's early work on the business cycle is that the Austrian theory cycle was an endogenous one

  3. Is this an accurate quoting of this source and, if so, is this source reliable?

    The 1840 Colonial Bank Regulations issued by British Treasury governed colonial banking. The requirements included that: capital should be a determinant amount and must be fully subscribed; total debts must not exceed three times the paid up capital and that all notes were to be payable on demand in specie at the place of issue. Failure to pay on demand for a total of 60 days in any year entailed forfeiture of incorporation. Personal liability for bank shareholders was capped at an amount equal to twice capital and loans against real estate, shops or merchandise were to be prohibited. Amendments to the regulations in 1846 limited the note issue to the amount of paid up capital.

    Banking was not substantially affected by the regulations, however. For example, the restrictions on total debt and note issue were largely ignored (Butlin 1986). Likewise, banks found loopholes around the prohibition on lending for land (Pope 1989). In practice, Australian colonial banks were allowed to raise the limits on note issue by including coin and bullion in paid-up capital. Over time, even this stricture was relaxed; by 1856 the Bank of Australasia secured a licence to print private notes up to the value of three times its specie and bullion holdings. Reserve requirements were easily met as “double counting” was permitted: reserves used to back the note issue were simultaneously used to provide liquidity in the event of a deposit withdrawal. Rules limiting total indebtedness were also no threat because deposits were excluded.
    This freedom of note issue was, however, accompanied by strong liability provisions. In most colonies by the late 1860s, shareholders had unlimited liability for their note issue (Pope 1989).


    Economic Papers: A journal of applied economics and policy

    Sounds like a disaster in the making to me.

    1. You're saying the absence and failure to enforce regulation was a disaster??


    2. I'm not saying anything yet. I asked if that was an accurate quote from and accurate source. Thus, I'm asking if that is an accurate description of that period in Australia so we are at least on the same page as a starting point regarding those historical facts.

    3. LK, many Austrians, myself included, actually consider the banking system to be one giant governmental department. The Fed is the government headquarters, and the member commercial banks are the governmental branch offices.

      When banks have the government granted, and protected, privilege of expanding loans out of thin air, and have the "lender of last resort" backstop from the Fed headquarters, which itself creates reserves out of thin air to bail out fractional reserve banks, calling for the curbing of lending practices in the banking system is really just a call for the government to be more tightly regulated.

      I won't speak for Bob, but the reason why Austrians would consider 19th century banking in Australia to be a disaster in the making, is because of the de facto growth in state intervention into the economy via the banking system. That's what "free reign banking" really is. It is an expansion of activity derived from state intervention.

      When people talk about "deregulating" the banks, what that means to most Austrians is a deregulating of state intervention, which is another way of saying MORE regulation in the free market.

      ABCT does not distinguish between "legal" fractional reserve credit expansion and inflation, and "illegal" fractional reserve credit expansion and inflation, such that Austrians all of a sudden turn into statists who want more regulations on "private" banks. ABCT is value free. It just speaks of what will likely happen when it takes place.

    4. "ABCT does not distinguish between "legal" fractional reserve credit expansion and inflation, and "illegal" fractional reserve credit expansion and inflation, "

      This, then, raises the issue of why, under the model of the ABCT, free banking systems aren't subject to perpetual ABCs.

      But anyway, this post is directed against the theories of free bankers, not the anti-FRB Rothbardian cult.

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