THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Thursday, August 27, 2009

Some Thoughts on Money, Part II: The Different Schools of Thought

Beginning approximately in the late 18th century, three broad schools of thought developed on money, banking, and credit. These have largely disappeared as discrete, identifiable schools in the general confusion that seems to have flooded into all areas of thought with the rise in positivism in all its forms. Many of the elements from these three schools, however — more accurately, two schools and a "sub-school" — have been incorporated (although not in any rational or meaningful way) into the confused mess known today as "monetary and fiscal policy." These three schools were:

• The (British) Currency School,

• The (British) Banking School, and

• The Free Banking School.

Very briefly, the tenets of these schools (and what follows contains some extreme oversimplifications to allow for space and time constraints) were:

The Currency School

As we have seen in previous postings, the Currency School believed that issues of banknotes backed by government debt should be strictly limited to a pre-determined amount, and the rest of the currency should either be gold coin or banknotes backed by gold. The definition of "money" was restricted to gold and banknotes backed either by gold or a limited amount of government debt. The role of the central bank was primarily to finance government operations without recourse to the tax system.

The Banking School

The Banking School believed that real bills, the needs of trade, and the "law of reflux" (that money created for productive purposes — not speculation, derivatives, or government spending, i.e., "fictitious bills" — was self regulating in that the money would return to the issuer when used to repay the loan) should govern bank operations. The definition of money included anything that could be used in settlement of a debt. The role of the central bank was to create money to provide adequate liquidity for industry, commerce, and agriculture and ensure that all currency throughout the region served by the central bank passed at par. The government should raise what money it needed through taxation or borrowing existing accumulations of savings.

The Free Banking School

The Free Banking School believed that competitive private banks would not over-issue banknotes or create too much money in the form of demand deposits or other negotiable instruments through the application of the real bills doctrine, whereas a monopoly issuer — such as a State-controlled central bank or government treasury would do so as a matter of course. Money was defined as anything that could be used in settlement of a debt. There was no recognized legitimate role for a central bank.

If we reflect on the basic tenets of each of these schools, we can see where many of the ideas they embody can be found in the monetary and fiscal policy followed by a number of today's governments. Unfortunately, due to the problem of trying to make incompatible elements work together as a system to achieve political rather than economic ends, especially when critical factors are omitted or ignored, or there is no fundamental agreement on principle, is a recipe for disaster. This is true regardless of the goodwill (or lack thereof) on the part of policymakers or the academics advising them.

In subsequent postings we will examine each of these schools briefly. We might then be able to see if there is a way to take the obvious good from each of them, and synthesize them into a rational whole. In this way we might be able to see if it is possible to discern any underlying principle that joins all of them at some level. We can then, perhaps, develop some principles of a coherent system that works for the betterment of our social institutions in a manner consistent with the demands of individual human dignity and personal sovereignty.

To do this we will look at how each system 1) defines money, 2) understands the role of banks of issue, and 3) assigns what role to a central bank.