Thursday, July 12, 2012

George Selgin's Balls-Out, Over-the-Top Ferocious Attack on Rothbardian Banking Theory

By Joesph Salerno
Over the years George Selgin has dished out quite a bit of abuse in various and sundry blog posts to Murray Rothbard and those who hold that fractional reserve banking is inherently unstable and cycle-generating.  I must concede Selgin is enormously entertaining in his balls-out, over-the-top ferocity in defense of something that he lately has been calling “monetary freedom.”    Danny Sanchez notedSelgin’s most recent rant in his blog yesterday. Delivered in George’s trademark serioso, ill-humored style, I must admit it made me smile over my morning coffee.  Here is a sample:
Although the first priority of every believer in monetary freedom must be to combat bogus arguments for monetary central planning, we cannot do this effectively unless we are just as relentless in exposing the 100-percent reserve movement for the moronic cult that it is, to keep its clownish convictions from giving the entire movement for monetary freedom, if not free market economics more generally, a bad name.
Moronic cult?  Clownish?  Now these are great polemics and I love George’s style; if he did not exist, I would invent him.  But he is notoriously prickly when confronted with criticisms of his own position.  He regularly trolls the Mises Community blogs sniffing out and trouncing one or another twenty-something Rothbardian “loony” (a favorite Selginian term of derision) who has worked up the temerity to utter even the mildest criticism of his idiosyncratic brand of “free banking.”  But, entertainment value aside, this is unseemly behavior for a senior scholar of Selgin’s status.  And it has caused Selgin to be seen as a parody of the aging and addled pedant running to and fro frantically trying to stamp out heresy but whose hilarious antics only invite further attempts to rattle and provoke him.  Indeed, he has become something of a standing joke among many younger students of Austrian economics who proudly boast of being “flamed” by Selgin.  Some already are joking about fashioning a T-shirt proudly displaying: “I Am a Member of a Moronic Cult.”
Given his hypersensitivity to criticism, I should hope George would be somewhat empathetic that a Rothbardian like myself responds to some of his abuse in a sharp and less than polite manner.  Somehow, I doubt this though.  George takes himself VERY SERIOUSLY and never seems to be in good temper, or to show the slightest shred of good will toward his opponents.
So let me briefly tell the Selgin story in less than flattering terms.
To cut to the chase Selgin’s conception of the nature and aim of “monetary freedom” can be summed up as follows:
1.  He adopts the New Keynesian position that nominal price rigidities cause any change in the reservation demand for money relative to the supply of money to generate a (positive or negative) excess demand for money that requires a prolonged adjustment process involving either deflationary depression or inflation.
2.  Following the New Keynesians, he uses the loaded term “demand shocks” to describe the voluntary  decisions of individuals to alter the amount of money they desire to hold.   For Selgin, any change in what he and the Keynesians call “aggregate demand,” i.e., total spending, even if it is the result of the voluntary actions of businesses and households, destabilizes the economy.
3.  Like any  garden-variety Keynesian, Selgin sees these fluctuations in aggregate demand as a market failure that must be offset by Fed policy.  He thus advocates that the Fed  implement a “productivity norm” that boils down to a nominal income target, a policy first proposed by Keynesian economist Benjamin Friedman in the 1970s.   In Selgin’s case he would  have the Fed target zero growth in aggregate demand, thereby maintaining the circular flow of money spending and income constant.   Most Keynesians would target a higher rate of growth in nominal income to allow for real output growth plus a small inflationary cushion against deflation.  But this is a minor difference.    The outcome is that in Selgin’s world prices would trend downward by a few percent per year rigidly mirroring the productivity-driven growth in real income; in the New Keynesian world prices would trend up by a few percent a year.  In both cases this would be achieved by Fed manipulation of the money supply (and interest rates)
4.  In other words, Selgin wants the Fed to continually expand or contract the supply of money in order to exactly offset any change in the social demand for money.  This is why Selgin, right along with Mankiw and other New Keynesians,  was a proponent of QE1 and (maybe) QE2.
5.  But binding a central bank to a “productivity norm” is a second best solution to economic instability for Selgin.  His preferred policy is something called “free banking” or “monetary freedom.”  Under the Selginian regime of monetary freedom, banks would be permitted to operate without any central bank or legislative interference, while subject to general contract law under which they would be obligated to convert their note and deposit liabilities into gold (or other market chosen commodity) on demand.  In particular, banks would  be able to determine their own cash reserves necessary to meet these obligations.   The result would be that the supply of money is automatically adjusted to the demand for money by market forces. Furthermore, foretells Selgin,  this system may evolve to the point where gold is completely expelled from monetary circulation into nonmonetary uses while a small amount is retained in quasi-monetary use as  an interbank clearing asset.  This evolutionary process would thus involve a massive expansion of the money supply.  Moreover at the end of this process, bank money will in effect become a fiat money.  But rest assured, at every step of the way seemingly infallible bankers will ensure a constant aggregate stream of money spending.
Given these views, it appears to me that what Selgin means by ”monetary freedom” is attaining Keynesian ends via market means.  But I do not think Selgin’s story is plausible in the least.  In fact, in my recent Congressional testimony, I gave another account of the likely outcome of a Selginian free banking system, which I advocated as the most practical means of getting rid of fractional reserve banking and suppressing the further issue of fiduciary media, that is, unbacked bank notes and deposits.  Both Mises and Rothbard advocated free banking for the same reasons.  In his last major publication on the subject, Rothbard proposed free banking under a genuine gold standard as an “excellent [albeit second-best] solution” to the problems of inflation and the business cycle.

Both Mises and Rothbard were therefore “currency school” free bankers–as I consider myself to be–who believed that the money supply should behave like a purely metallic currency and who rejected the “stabilization” of aggregate statistical constructs like the price level or total spending.  For currency school free bankers, free banking is a means for suppressing all political influence on the supply, value and distribution of the money commodity and allowing these variables to be determined exclusively by market forces.  Period.   Selgin on the other hand reveals himself as a Keynesian free banker who wants to stabilize a meaningless aggregate by employing a peculiar scheme.  In Selgin’s scheme, a certain narrow class of banker-entrepreneurs are uniquely privileged as error-free automatons and the particular market in which they operate, in contrast to all other markets, is “efficient”  in the neoclassical sense of almost instantaneously adapting supply to demand.

N.B. In this response to George I never once alluded to the issue of whether fractional reserve banking is fraudulent or not, a question that he seems to be fixated on.

The above originally appeared at and is reprinted with permission.


  1. I'll post here rather than on Mises because here I can post anonymously.

    (Maybe we should all rebel against the government's calls for attribution of all comments on websites by EXCLUSIVELY posting anonymously... it forces the evaluation of comment on the basis of comment rather than allowing people to indulge in the 'appeal to authority' fallacy. After all, regardless of the authority of the speaker, it is the content that is important.)

    As I was saying.

    So, Selgin calls fractional reserving deposits 'Monetary Freedom'. This is a very interesting position.

    So, I have $50,000 in a savings account. The bank can lend $45,000 out of my money and still maintain a 10% reserve.

    It could also arguably loan out $450K while holding the entirety of my $50K as the 10% reserve. It would simply expand the balance sheet for $450K in liabilities for the loan, $50K liability to me and $450K receivable as an asset from the loan plus the $50K cash asset from me. The result is a 10% cash reserve either way... but for brevity I will stick to $50K.

    So the bank doesn't tell me that $45,000 of my saving's money is loaned out and cannot be withdrawn. It tells me that I can have all $50K. It tells the recipient of the loan he can (and whomever he transfers that money to) that they can have the whole sum.

    Selgin says this is Monetary Freedom?

    So...if the recipient of the loan buys a Lexus, who owns the Lexus?

    The debtor used money for the purchase that belonged to me and was exclusively promised to me.

    If I withdraw my money, the bank will fold...because they will have defaulted on their reserve ratio requirements. So, who owns the Lexus?

    If I lose the money to the benefit of the debtor, then I was robbed.

    If I get the Lexus then the debtor and the Lexus dealership was robbed.

    Shall we call this scenario 'Automotive Freedom'?

    Does Selgin posit that both I and the debtor can own 100% of the same Lexus at the same time?

    The debtor may be on the other side of the planet. Can we really both have exclusive physical title simultaneously?

    Of course not.

    Selgin says he believes in 'Monetary Freedom'.

    In reality he believes in 'Monetary Magic'. Selgin believes that bankers, like Jesus with a multitude in the wilderness, can multiply loaves of bread and fish...and cars, and all the things that fractional reserve loans can buy.

    Poor Selgin.

    He's out of his gourd.


      Ouch. I don't blame you for wanting to post Anonymously.

    2. "Ouch. I don't blame you for wanting to post Anonymously."

      Unless the conditions of the deposit are stipulated, there is too little information in the hypothetical to draw conclusions. If the bank is not contractually entitled to withdraw a penny from your savings account, then yes it is fraudulently lending the money out. If it does so on the understanding that you save in it for money to be lent out, then no. It all depends on what it advertises.

      Whether or not this model will be sustainable in the market is a matter for the future to determine. It all depends on how well banks manage risk. Selgin can get bitchy and irritated by "rothbardian cultists" all he likes, but to the extent that a bank lies about what it does with money deposited in it, it will certainly be prosecuted for fraud. No need to bother with silly little academic arguments over this, anyone interested in keeping their money safe will ensure that the bank is upfront about how it intends to utilise said money.

  2. Georgie Boy is about as condescending as Krugman with how he speaks and writes. He was completely taken to the cleaners here last year when attempting to defend his statements about Rothbard fans being cultish and Friedman being a better monetary economist than Rothbard.

  3. Selgin was a proponent of QE1? Wow. He pretty much loses any ounce of credibility as a free market guy by that alone. Keynesian is his name, no matter what he calls. Salerno destroyed Selgin with this article!

  4. I'm afraid I don't see Salerno's point. Selgin advocates monetary freedom in that he doesn't think that the government should prohibit fractional reserve lending. Isn't this Rothbard's position? Didn't Rothbard argue that in a truly competitive setting where the government stayed out of it altogether, that fractional reserve lending would die out? The only difference I can see between Selgin and Rothbard is in what they predict, not what they advocate.

    I think it is perfectly proper for Salerno to respond to Selgin, but I also think that it is perfectly normal and proper for a discipline like Austrian economics to produce people like Selgin. We shouldn't be too quick to want to rule out contrary views. Rothbard, Hayek, and Mises all differed with each other on some points. There's no reason why we should expect lesser lights to come to the same conclusion or try to move in lockstep with some particular dogma even if it is put forward by an Austrian.

    1. Rothbard was against fractional reserve banking because he believed it was fraud. He did make an argument it would die out if government got out of the way (other than its allow of fractional reserve banking to continue), but in his view it was not a part of a free market.

    2. yes, in all frankness I think Selgin is acting in a rather histrionic fashion about what is really a matter of prediction and consumer preference.

    3. Selgin has emotional temper tantrums like a stereotypical ex-wife whenever someone disagrees with him. His insults and tirades that have nothing to do with the issues are also just like a bitter ex wife. I do admit to enjoying seeing people winding him up and his meltdowns though.

  5. Salermo implying that Selgin is keynesian is ridiculous and it makes him look bad. I think Selgin is not taking an intelligent approach here (using too many disrespectful words) but sometimes with this responses I kind of understand why.

    Just to clear a couple misunderstanding a couple of comments above me have made:


    >So the bank doesn't tell me that $45,000 of my saving's money is loaned out and cannot be withdrawn.

    No, that would be fraud. Fractional reserve banks tell you want they are doing with the money and you decided if you want to participate or not. Btw this is different than the system we have now. People tend to confuse free market fractional reserve banking and central bank fractional reserve banking and they are two different systems (and this is true whether you support one, the other or none).


    >Selgin was a proponent of QE1? Wow.

    Selgin argues that as long as we have a central bank QE1 was the response the central bank should have to the crisis. In his opinion QE1 was a bit too much though (or at least this was his position around 2010).

    But Selgin argues that the best solution to the crisis is to abolish the central bank (not QE1).

    1. I see that problem with "free banking" fractional reserve notes being finding informed payees who will accept the notes. A payee would have to fully understand that such a note is not at all the same as a 100% reserve note.

      In Detroit which is right on the Canadian border, most stores will not accept Canadian money even though the exchange rate today is over 98%. Unless there is some additional tax and/or regulatory issue, I would think it would make sense to accept the Canadian money at 80 cents on the dollar and get a big profit on the subsequent exchange.

      It seems to me that fractional reserve notes would be heavily discounted if accepted at all. But I'm not going to lose any sleep over such speculation regarding the far far future.

    2. Hugo,

      "Fractional reserve banks tell you want they are doing with the money and you decided if you want to participate or not."


      Do you have money in the bank?

      Did you receive any notice that you could not withdraw your money because it is currently loaned out?

      Really? Outside of a CD or other time deposit, you might be the first.

      In Britain hypothecation is the law of the land, fraudulent or not. When you make a deposit, whether demand deposit or not, in Britain that money is legally the property of the bank, and you have legally loaned it to the bank for whatever purpose the bank may choose.

      Hypothecation is NOT legal in the US.

      The problem with Fractional Reserves, in my view, is simultaneous exclusive claim.

      The only way general deflation, as opposed to deflation in one sector, can happen is when one or more of the purported exclusive owners of some quantity of currency discover that they are NOT the exclusive owners of the currency. Subsequently some portion of the 'owners', recognizing they cannot collect, write-off their supposed exclusive ownership.

      The 'write-off' IS the monetary deflation, because that currency actually ceases to exist with the claim.

      Contrast this with a commodity currency at 100% reserve ratio... It is physically impossible for the money to cease to exist. Its value relative to other goods and services can and will fluctuate, yes. But the actual money, then, can only change hands. It cannot cease to exist.

      This is one of the few areas, I think, where economics actually intersects the physical sciences in the form of the First Law of Thermodynamics.

      Your 100% reserve commodity money cannot cease to exist, it can only change form, and requires energy input to do so.

      Alternatively, your fractional reserve currency can be printed or booked indefinitely, but can never create prosperity...because physical raw goods and services require input - energy - to reach finished form. The energy required to add fractional reserve currency does not in any way relate to the energy required to produce finished goods or services. With no relationship between the creation of fractionally reserved fiat-currency and increased prosperity (defined as the relative availability of finished products), there can by definition be no causative relationship.

    3. I think the desirability and eventual fate of fractional reserve banks is settled by the physical issues of discounted exclusive title.

      There is no way for a fractional reserve bank to fail to impair the title to the money they fractionally reserve.

      While the fractional reserve bank will likely outperform on earnings for a time, just as would the above hypothetical 'Fractional Reserve Car Dealer', at some point the impaired title will be disclosed - resulting in the bank's book collapsing back to its reserve money - now ownership impaired - and so collapsing the bank's business.

      NO LAWS regarding the practice of fractional reserve banking is precisely what is required to cause this result. And if the above were NOT the natural result of fractional reserve banks, there would be no purpose for Central Banking, Legal Tender Laws, Deposit Insurance, or any of the numerous laws designed to support fractional reserve banking (and STILL visibly failing).

      So, the issue is not whether fractional reserve banking 'ought to be allowed' because no one here is proposing to stick a gun in anyone's belly.

      The issue is whether fractional reserve banking is effective.

      The answer to that question is very well recorded, not only in history, but in the design of the laws supporting fractional reserves. The answer is that fractional reserves are profitable in terms of interest accrual at the expense of principal loss (impaired title) and that they almost always fail when the loss of principal is discovered (bank run & deflation).

      If this were not so, there would be no need for governments to dictate legal tender, they could fractionally reserve tax receipts into new currency indefinitely without invoking Gresham's Law.

      If this were not so there would be no need for FDIC, because people would not panic to get their principal back.

      If this were not so, there would be no need for Regional Banks for bank-to-bank clearance or Central banks for the same purpose across borders, because all would understand they need only express unlimited confidence in the competence of the fractional reserve bankster for his notes to remain par redeemable.

      If the bank notes were not suspect there would be no need to clear the transaction at all. Other banks and individuals could simply use fractional reserve bank notes to cancel debts.

      But bank notes are as suspect as the competence of the bankers who write them.

      It is impossible to accept Rothbard's evaluation of fractional reserve banking - that it rests on fraudulent title to deposits - without accepting his judgement of its stability. The one is implicit in the other.

    4. Bob Rodis, thats indeed the opinion of the free market 100% reserve supporters. The problem is history shows all the examples where there has been a monetary free market people have supported fractional reserve banking. So the situation develops completely opposite of what you are suggesting.

      In fact, as far as I know, there has not been even one example of 100% reserve bank in a monetary free market system (there have been examples of 100% reserve banks but they did not opperate in a free market). So given the historical evidence I find hard to believe that now people would chose in a different way.

      The problem I see (for example in the anonymous response to my comment) is that people tend to mix free banking fractional reserve with central banking fractional reserve. They are completely different and have different effects. So extrapolating the problems we have now to a free banking fractional reserve system or even opposing free banking fractional reserve because you dont like the pressent system makes absolutely no sense. In fact, free bankers dont like the present system.

    5. I do not think most people historically gave much thought to the significant difference between 100% reserve notes and fractional reserve notes. I was dealing the ubiquitous alleged fraud issue. I was saying that there would be no fraud if all the parties understood the true nature of those notes, but ONLY IF they so understood. I tend to think that payees with a full understanding of what they are will tend to not want to accept them. But what do I know? Life's too short to spend more that 45 seconds worrying about whether people in the far distant future are going to accept or reject these notes.

      I spend my time more fruitfully worrying about whether I will still be able to buy a cheap working Betamax machine in the year 2035.

    6. "Selgin argues that as long as we have a central bank QE1 was the response the central bank should have to the crisis. In his opinion QE1 was a bit too much though (or at least this was his position around 2010)."

      So as long as massive intervention is taking place, the answer to any problem is far more intervention? Does that concept also apply with the welfare state, the drug war, and the warfare state abroad? Do we need to spend billions more on the drug war since it is going so poorly? Do we need to occupy Pakistan since Afghanistan is a failure? What horrible logic from Selgin - even as a "second best" solution.

    7. >>>>Salermo implying that Selgin is keynesian is ridiculous and it makes him look bad.<<<<

      Good thing Selgin disagreed with the Keynesians on things like QE1 or else there might be some truth to what Salerno says, eh?

  6. I saw Selgin at an Institute for Humane Studies summer program in 1992 and he acted the same way then. At that point, I think he was working with Larry White and was championing "free banking." When asked about the problems raised by Salerno - albeit in a more rudimentary form - Selgin got angry and dismissive, unbuttoned another button on his shirt and hit on a young twentysomething co-ed in the third row. I thought he was an arrogant ass then and I think that estimation has proved true over time.

    1. An interesting recollection, and especially so in light of the fact that I quit lecturing for IHS, in protest, when Walter Grinder and Leonard Liggio were forced out, that is, several years before the seminar of which you speak, and did not take part in its seminars again until quite recently. But of course that's not to suggest that readers of this forum should hesitate to believe the other (curiously self-contradictory) details you pretend to recall so well.

    2. I must correct myself. Grinder was forced out sometime in '92, so I may have done my last IHS seminar that summer. Whether the image of me responding to a question about fractional reserves as anonymous suggests is a plausible one I leave to others to determine. (For what its worth, I recall always getting very nice student evaluations, which were also anonymous. Perhaps there was one nasty one that I've mercifully forgotten about! Perhaps this is really all about a certain girl in the third row, though I'm afraid I don't remember that bit either!)

    3. Selgin, so you supported QE1?!?!?!? Really? I don't see how anyone can call themselves a free market economist and hold that view. I expect Krugman and Bernake and the other Keynesians to do that, but not someone who laughs at claims that he has keynesian views.

    4. Not exactly tough to believe that Selgin acted defenisively and arrogantly with the way he conducts himself online over and over again.

      Where is Major Freedom, anyway? He really let Selgin have it a few months ago when Selgin was a topic here.

  7. Dr. Salerno-
    I watched the Congressional Hearing to which you link, and came away from it uncertain whether, in a market-based banking system, full reserve banking is an empirical prediction or a normative goal. You seemed at points to be saying "this is what would happen" and other times to be saying "this is what would happen and it is a good thing, too!"

    So, presume for a moment that Selgin and White are correct, and fractional reserve would prevail absent government restrictions aimed at preventing it. Would you still consider this regime to be an improvement over the Federal Reserve system or the previous National Banking System? If, empirically, fractional reserve prevailed, would you then favor government intervention to create full reserve?

    If so, what do you conceive of as the problems with fractional reserve in a market system? Your statement talks about inflation, but since such testimony must necessarily be simplified, it was unclear when you meant this would occur. During transition? (pro-)Cyclically? Continuously?

    Btw: a link to any previous posts on this topic (offered by anyone) is more that sufficient as a reply.

    1. The biggest problem FRB banks with low reserve ratios face is that they have competing claims to the same stored commodity. Now this can be alleviated if the depositors accept that their savings can only be withdrawn after a period of time, during which the bank may pay a satisfactory rate of interest. On the other hand, if no such arrangement prevails and the bank messes up maturity matching and assessing risk, it may very well see its own assets withering away. I don't think any Rothbardian has an issue with upfront FRB, they just don't think that banks will be able to get away with low ratios of commodity money to lent out assets.

      THe issue arises when FRB banks utilise demand deposits to finance their lending and fraudulently issue claims to stored commodities in excess of what they possess. Not only will this make them unstable due to the very mechanism Selgin describes of other banks redeeming these money substitutes, perhaps to gain competitive advantage, but it will also open them up to prosecutions for defrauding their clientele.

      Can a bank ever issue two competing claims to the same stored commodity? I don't see why. Any holder will have to accept the risk of the fact that the note may only be redeemable for a fraction of its supposed value. They're not alchemists and pretending that this somehow increases the real resources in the economy is fiction, and this will cause inflation. Luckily, it'll be shortlived due to a lack of any protections by the gov't.

    2. In a free market, no one would be issued a special privilege to issue notes referring to non-existing commodities. Everyone (you, me, a firm, a "bank") would be free to issue whatever notes/claims they want. The market would price each note accordingly. If said notes are issued (exchanged) under false pretenses, that would amount to fraud.

      Savers of capital can easily meet with entrepreneurs and investors ready to employ it without issuing notes under false pretenses (fractional reserve banking).

      Both theoretically (logically) and empirically FRB can only end in two possible outcomes: (1) collapse of the Ponzi scheme as the amounts of capital claimed overshoot the amounts in store, or (2) a central bank.

      There is absolutely no need to "outlaw" FRB in a free market. If it's fully disclosed, then it will die off on its own. If it's performed under false pretenses, then it will die off as fraud.

  8. Does Selgin come across as incredibly bitter and angry at how certain Austrians are far more influential among the public and famous than him, despite decades of his trying? Wenzel would be one with this blog, so would Tom Woods, Salerno, Block, Dilorenzo, etc? That might explain how bitter and hyper-sensitive he is over the mildest form of criticism.

    Of course, what would a cult member such as myself know?

    1. I doubt Selgin has anything to be jealous about any of those guys. Wenzel interview Johnson a while back and made it a point to show Johnson's lack of knowledge of the ABCT, when Johnson asked Wenzel about the pre-fed booms and bust Wenzel said he was barley going to start to read about those and quickly went back to grilling him. Now how can someone who post aboutthe fed so much not have been informed about this, yet expecting more from Johnson when he was busy running a business being a governor. Woods is a historian, and not a good one, look at his dishonesty about the 1920-21 recession. Salerno is not as famous, and Selgin was alot more friendlier than i would have been in his him response to Salerno. Block is just an extension of Rothbard, though not as conservative(paleo-conservative like Woods, Rockwell, Paul, Hoppe, etc.. Dilorenzo? Is he really an economist? Most of what he is known for is for having a fetish for Lincoln bashing. Again why would Selgin have to be jealous of any these individuals. They all probably think that a bank is warehouse, FRB is fraud(not Salerno,Wenzel?). Selgin strikes me more as an academic who has shoot down these dumb objections while these celebrity like figures keep bring them up.