Do We Need Central Banks?

[malco]

I got the idea for this discussion from Frugalist's thread about whether we need inflation at all.

Do we need central banks at all? Why don't we use private currencies that compete on the real utility factors of a currency: wide acceptability; preservation of value over time; low transaction costs, etc.

There are already quite a number of Internet based currencies, mostly based on gold. Do you think these will gain power over time as hidden inflation in the dollar and Sterling cause businesses and individuals to look at other ways of holding value?

Surely there was a time when private banks issued notes based on the gold standard? I am not pushing the gold standard here, just making the observation. It has to be said that inflation between 1717 and 1914 did not cause an overall decline in the value of real money (ie; periods of inflation were corrected by deflation back to the norm of about £4 Sterling per Troy ounce of gold. A gold sovereign was worth £1 Sterling up until the First World War - now it is worth £100!

Do you think one outcome of the coming financial storm will be a rejection of central banks subject to political influence, and their replacement by global currencies that know no border or sovereign allegiance?

Will this be a better world?

[Dr Doom]

I got the idea for this discussion from Frugalist's thread about whether we need inflation at all.

Do we need central banks at all? Why don't we use private currencies that compete on the real utility factors of a currency: wide acceptability; preservation of value over time; low transaction costs, etc.

There are already quite a number of Internet based currencies, mostly based on gold. Do you think these will gain power over time as hidden inflation in the dollar and Sterling cause businesses and individuals to look at other ways of holding value?

Surely there was a time when private banks issued notes based on the gold standard? I am not pushing the gold standard here, just making the observation. It has to be said that inflation between 1717 and 1914 did not cause an overall decline in the value of real money (ie; periods of inflation were corrected by deflation back to the norm of about £4 Sterling per Troy ounce of gold. A gold sovereign was worth £1 Sterling up until the First World War - now it is worth £100!

Do you think one outcome of the coming financial storm will be a rejection of central banks subject to political influence, and their replacement by global currencies that know no border or sovereign allegiance?

Will this be a better world?

If you look at historical situations where countries have suffered economic collapses of one type or another in the past they generally revert to using 'local currencies', whether that be packs of cigarettes or whatever.

What the central banks of the world want is a global currency, from which there is no escaping for anyone.

I think this is the purpose of the imbalances that have been allowed to build up and the sharp correction that will be needed to correct them. When people are suddenly starving on the streets in the western world, the question will be asked "how was this allowed to happen", at that point the finger can be pointed at "competing currencies". The question is whether the people will accept it or not, it will be make or break time for world government.

As a more long-term solution either a silver or gold backed currency, providing the basis for a sound money system would be desirable in my view.

[MarkG]

Do we need central banks at all?

We don't. The communists wanted them because they knew that control of the money supply was essential if you wanted to control the people... that's what they really exist for.

[Magpie]

We don't. The communists wanted them because they knew that control of the money supply was essential if you wanted to control the people... that's what they really exist for.

Nothing to do with stability, protecting the currency, avoiding economic collapse or anything like that then... Just the reds under the beds.

[BandWagon]

Why have paper as our currency?

It only has value inasmuch as there is confidence in that value, that to me seems rather precarious.

And let's not forget that paper currencies have this nasty habit of failing, largely due to goverments using inflation as an easy way to get themselves out of the doo-doo.

As an alternative a return to the gold standard would be welcome, but gold has limited real uses, and it's value is largely determined by it's limited supply.

There is also the problem that the biggest producers, Russia and South Africa, are not the most politically stable regions, and why be held hostage to either country?

The best solution would be if the currency could be determined by the market, whether it be Dollars, Rubles, Gold, Pig Bellies, Lumber or Marlboros.

Sadly goverments aren't likely to allow this anytime soon, after all we know how much they hate competition.

Hence they will continue to tax capital gains, and we'll be stuck with the fallible paper stuff.

[MarkG]

Nothing to do with stability, protecting the currency, avoiding economic collapse or anything like that then...

You'd better hope not, because if it was then it's been an absolute disaster. The pound and dollar have lost about 99% of their purchasing power since central banks were imposed.

Or are now going to claim that destroying 99% of your purchasing power is 'stability' and 'protecting the currency'?

Central banks have done little but harm in their entire existence. Quite how anyone but a control freak can support them is beyond me.

Fortunately they're becoming increasingly irrelevant, as anyone can set up a private currency on the Internet.

Edited May 24, 2006 by MarkG

[Magpie]

You'd better hope not, because if it was then it's been an absolute disaster. The pound and dollar have lost about 99% of their purchasing power since central banks were imposed....

Fortunately they're becoming increasingly irrelevant, as anyone can set up a private currency on the Internet.

Yes, all the goldbugs can swap their goldtokens on the internet, excellent. That'll sort everything out.

I don't think the communists had such a massive influence on creating the BOE in 1694. It's had some ups and downs to be sure, but central banking has been a cornerstone of trying to create a modern economy. But it probably would be best to go back to medieval times where the rich can gloat over their gold, and the rest of us peasants can just scrabble around in the mud hoping for a few crumbs...

Do you think one outcome of the coming financial storm will be a rejection of central banks subject to political influence, and their replacement by global currencies that know no border or sovereign allegiance?

Will this be a better world?

On a more balanced note, there are problems with all systems, with or without central banks. Here is an extract from the Wikipedia entry on why the Federal Reserve was set up in the US after a period when they had tried to get by without a single central bank:

"The Panic of 1907 was a relatively serious economic downturn in the United States caused by a New York credit crunch that spread across the nation and led to the closings of banks and businesses. The severity of the downturn was such that it prompted the United States Congress to form the Federal Reserve System. It was the fourth Panic in 34 years."

Edited May 24, 2006 by Magpie

[MarkG]

Yes, all the goldbugs can swap their goldtokens on the internet, excellent. That'll sort everything out.

Indeed it will. You sound like a retail store owner laughing at the first online retail stores in the 1990s... don't think many are laughing today.

I don't think the communists had such a massive influence on creating the BOE in 1694. It's had some ups and downs to be sure, but central banking has been a cornerstone of trying to create a modern economy.

Again, by 'modern economy' you mean 'bloated, centralised bureaucratic state'... exactly what the communists wanted to create, and exactly why they supported central banking.

You, of course, think that a bloated, centralised bureaucratic state is a good thing: but it won't be long before they collapse under their own weight just as the USSR finally did.

[Magpie]

Again, by 'modern economy' you mean 'bloated, centralised bureaucratic state'...

No, I mean a non-medieval state where investment in capital projects is feasible. And one where bank runs and "Panics" are not as prevalent as they were when the US (for instance) tried to deal with a modern economy without a central bank.

I'm not sure which exact part of our economic history you are so rosy-eyed about but on closer examination there seem to have been some real problems under most systems.

[MarkG]

No, I mean a non-medieval state where investment in capital projects is feasible.

So you're claiming that capital investment didn't occur before central banks?

You're seriously claiming that? I guess we all lived in caves until the central bankers saved us.

And one where bank runs and "Panics" are not as prevalent as they were when the US (for instance) tried to deal with a modern economy without a central bank.

LOL. You mean like the great depression? Central banks issuing fiat currency _guarantee_ boom and bust by their very nature.

Or is it just that you prefer a guaranteed constant wearing down of your wealth through inflation to a possibility of losing wealth if you stick money in a corrupt bank? Yes, I guess that's truly 'modern' thinking.

Either way, it doesn't matter. Central banks are just so 20th century, and will die with the bureaucratic state.

Edited May 24, 2006 by MarkG

[Magpie]

So you're claiming that capital investment didn't occur before central banks?

You're seriously claiming that? I guess we all lived in caves until the central bankers saved us.Either way, it doesn't matter. Central banks are just so 20th century, and will die with the bureaucratic state.

No I'm claiming that central banks came about in the early stages of the industrial revolution for a reason - the development of national debts, the increasing complexity of financing involved in major capital projects led most economists to see the need for central banks.

Central banks are not "just so 20th century". They have been around for centuries, and specifically came about in the era of maximum industrial expansion. The US tried doing without one for a while in the late 19th centruy and it was a disaster.

LOL. You mean like the great depression? Central banks issuing fiat currency _guarantee_ boom and bust by their very nature.

I know there are arguments to be made either way here, but it's pretty widely accepted that the severity of the Great Depression, especially in the US was partly because in the early 1930s, rather than abandoning the obviously flawed gold standard, the government stuck to it, raised interest rates and went with the usual belief of gold-standard adherents that the suffering of the nation would eventually right itself.

The flawed economic system of the 1920s, involving an attempt to force stability through the gold standard contributed directly to those events. Central banks didn't manage to avoid the depression, perhaps they couldn't have no matter what, but the reliance on the gold standard certainly didn't help...

The pit of the depression came in 1933, and the slow recovery started once the gold standard was abandoned.

Edited May 24, 2006 by Magpie

[Harry Sacks]

I don't go along with the argument that central banking has somehow improved the standard of living.

Mankind has always tried to improve living standards regardless of the monetary system.

Sure, more people have access to clean water, health care and education than before, the reason is because we've all worked for it, produced something of value.

Look back to 1694 and see how many wars have been fought, all of which have served the interests of bankers. Regimes are funded, wars started, fought, and wealth destroyed. This creates more demand for debt, secured against the population for future generations. Someone somewhere will always be paying more to meet the interest.

[watchinandwaiting]

No I'm claiming that central banks came about in the early stages of the industrial revolution for a reason - the development of national debts, the increasing complexity of financing involved in major capital projects led most economists to see the need for central banks.

Central banks are not "just so 20th century". They have been around for centuries, and specifically came about in the era of maximum industrial expansion. The US tried doing without one for a while in the late 19th centruy and it was a disaster.

I know there are arguments to be made either way here, but it's pretty widely accepted that the severity of the Great Depression, especially in the US was partly because in the early 1930s, rather than abandoning the obviously flawed gold standard, the government stuck to it, raised interest rates and went with the usual belief of gold-standard adherents that the suffering of the nation would eventually right itself.

The flawed economic system of the 1920s, involving an attempt to force stability through the gold standard contributed directly to those events. Central banks didn't manage to avoid the depression, perhaps they couldn't have no matter what, but the reliance on the gold standard certainly didn't help...

The pit of the depression came in 1933, and the slow recovery started once the gold standard was abandoned.

USA went of the gold standard 15th August 1971.

[malco]

I did not really intend this thread to be a bickering session.

The Bank of England was a largely "medieval" institution when it was set up, if we take medieval to mean a sovereignty largely hung around a hereditory ruler, with state finances being the Privy Purse and the discretion of the sovereign, influenced by a narrow range of favoured courtiers. This pretty much describes the Bank of England of 1694, since at that time Britain was an aristocracy ruled through a hereditory Upper House and a Lower House composed of merchants and landowners elected from just a few percent of the male population. The BofE was to provide financing for war - and until 1946 it was a private institution of the City of London, not a public body.

Niall Ferguson's The Cash Nexus describes the development of "central" banks. He notes that as wars became more expensive, governments had to borrow from a greater and greater percentage of the population, so the pressure for representation grew, or was forced by revolutions. Even the Napoleonic Wars did not have much affect on the ordinary peasantry, except when an army awept over their lands, other than that they had little involvement. Their job was to grow food. The American Civil War was probably the first modern war as we understand it, in drawing in a large proportion of the male population to fight.

However, this is not the place to delve into the history of international banking. I am inclined to think that no currency can retain its value over many decades unless it is disciplined to something real. That reality may be precious metals, or coal production or whatever. Perhaps company shares will be used more widely as currency in the future. I do not see that the gold standard precludes activity like making loans for large scale capital investment. It just means that the currency is tied to something immutable. Likewise I don't see why banks can't issue their own currencies, competing on stable value across time, based on tangible assets (say a mix of commodities).

I'm no financial whizz-kid. I don't think inflation is necessary - it reveals a flaw in our system. I think it is a problem that could be solved, but only after the current system has been disgraced.

Edited May 24, 2006 by malco

[Magpie]

USA went of the gold standard 15th August 1971.

No that's when Nixon closed the gold window, meaning that the dollar's convertibility to gold, agreed under the Bretton Woods agreement, was ended.

Roosevelt took the US off the gold standard in 1933 (following the UK in 1931 and various other Eueopean nations). He also made it illegal for private citizens to own gold (to protect the currency). He has never been forgiven by right-wing libertarians in the US for the gold confiscation act (which admittedly was a bit dictatorial...) or for saving the US economy by using socialistic measures.

After the war Bretton Woods was agreed, whereby some of the elements of the gold standard ere restored - fixed currencies in particular, but the dollar became the de facto world currency and was convertible to gold. That's what was ended in 1971.

[watchinandwaiting]

No that's when Nixon closed the gold window, meaning that the dollar's convertibility to gold, agreed under the Bretton Woods agreement, was ended.

Roosevelt took the US off the gold standard in 1933 (following the UK in 1931 and various other Eueopean nations). He also made it illegal for private citizens to own gold (to protect the currency). He has never been forgiven by right-wing libertarians in the US for the gold confiscation act (which admittedly was a bit dictatorial...) or for saving the US economy by using socialistic measures.

After the war Bretton Woods was agreed, whereby some of the elements of the gold standard ere restored - fixed currencies in particular, but the dollar became the de facto world currency and was convertible to gold. That's what was ended in 1971.

Exactly USA external debts were backed by gold until 1971. That was still gold standard as far as the rest of the world was concerned.

[Magpie]

I did not really intend this thread to be a bickering session....

Thanks for your thoughtful reply and apologies for bickering, it's one of my worse habits.

You're right that central banks changed significantly as National Debt and modern warfare developed. I'm simplifying a complicated argument, largely to point out that central banks as such are not a 20th Century aberration, whatever their future might be.

I do not see that the gold standard precludes activity like making loans for large scale capital investment. It just means that the currency is tied to something immutable. ....

Well, a fully backed gold standard does create problems with large scale investment if the gold isn't in the bank to back such a loan. And once you get fractional reserve banking you are already moving away from a "pure gold standard", and this creates the possibility of inflation. The gold standard as it existed in the 19th century tended to counter this with bursts of deflation. There are problems either way, but even a currency tied to gold will fluctuate in value, depending on the value of goods and services.

Honestly I don't think central banks are completely inevitable - it may be that a less bloated way can be found to regulate currency. But I get wound up by inflated claims about gold, and I find the idea of central banks as a socialist conspiracy a bit irrelevant to understanding what their actual role has been.

Exactly USA external debts were backed by gold until 1971. That was still gold standard as far as the rest of the world was concerned.

Yes but not from 1933-45 which was my key point.

Edited May 24, 2006 by Magpie

[Harry Sacks]

The Bank of England was a largely "medieval" institution when it was set up, if we take medieval to mean a sovereignty largely hung around a hereditary ruler, with state finances being the Privy Purse and the discretion of the sovereign, influenced by a narrow range of favoured courtiers. This pretty much describes the Bank of England of 1694, since at that time Britain was an aristocracy ruled through a hereditary Upper House and a Lower House composed of merchants and landowners elected from just a few percent of the male population. The BofE was to provide financing for war - and until 1946 it was a private institution of the City of London, not a public body.

By the time the BoE was formed the vested interest were well established. Cromwell was financed by these individuals to transfer power from the monarchy to the 'money changers' who later took possession of the square mile. The aristocracy became their puppets.

[Biriani]

I do not see that the gold standard precludes activity like making loans for large scale capital investment. It just means that the currency is tied to something immutable. Likewise I don't see why banks can't issue their own currencies, competing on stable value across time, based on tangible assets (say a mix of commodities).

The problem of a stable currency isn't one which is necessarily solved by requiring that it is tied to real commodities rather than being wholly fiat.

In many ways, it potentially makes things worse. In such a case, you will find that the value of your currency fluctuates according to mining output, seasonal harvests or changes in demand.

For the vast majority of people who have no need to see their purchasing power fluctuate according to such things, a currency which depreciates in value at, say, a reliable 2% per year is actually much more preferable. It also prevents overly privileging one or two commodity classes (eg gold/silver) and distorting their price relative to the world's actual need for them.

Of course, if you're going to have a fiat currency, you do need central banks. Private firms simply couldn't be trusted to issue notes, which is why the right to do so became concentrated in central banks following banking crises thoughout the 18th and 19th centuries.

A central bank's mere presence is no guarantee of stability either. Central banks that were controlled by governments naturally found their position being abused to manipulate the economy for political purposes.

Since governments realised that manipulating them was ultimately harmful, and central banks started to gain independence, they have proved much more able to deliver a stable currency. Of course, this is a very difficult job, and mistakes are made, but if price stability is what you're after, you'd be hard pressed to find a group of people more devoted to that task than central bankers.

I sometimes worry that this site is at risk of losing its credibility when arguments like these are seized on so enthusiastically.

You can make a good case for the housing market being overvalued and ready for a crash without having to resort to government conspiracies, the need for a return to the gold standard and the evils of central banking. Associating ourselves with this kind of arguments just makes it easier for the mainstream to dismiss our views.

[Harry Sacks]

But I get wound up by inflated claims about gold, and I find the idea of central banks as a socialist conspiracy a bit irrelevant to understanding what their actual role has been.

Yes but not from 1933-45 which was my key point.

The gold standard is irrelevant, it could just as well be the uranium238 standard. In the past gold was valued for reason different to today. It is a far more useful commodity now, but there is not enough gold in the world to match the 'value' of national debt. What is important, the confidence other nations have in your currency. Globalisation creates co-dependence between economies and relative currency stability for nations whose central banks have printed them into bankruptcy.

[Dr Doom]

Likewise I don't see why banks can't issue their own currencies, competing on stable value across time, based on tangible assets (say a mix of commodities).

Pegging a currency to a mix of commodities would almost certainly be a bad idea.

For example, the value of silver relative to gold over time tends to fluctuate.

You would potentially reach a point where value of silver currency was worth melting down, or vice versa.

[non-FTBer]

You can make a good case for the housing market being overvalued and ready for a crash without having to resort to government conspiracies, the need for a return to the gold standard and the evils of central banking. Associating ourselves with this kind of arguments just makes it easier for the mainstream to dismiss our views.

I have to agree with most of what you said.

Even with a gold standard there would be inflation and deflation of the value (or purchasing power) of gold.

Like you said, very much dependant on gold production (mining) and scarcity of goods.

It would also have a profound effect on countries without significant gold reserves.

There were plenty of countries through history starting wars over gold... all thats changed is that we now have wars over oil (as that becomes more scarce).

On the flipside, I don't agree that the inflation rate is currently 2% or that CPI adequately measures inflation. I also do not accept that the BoE is completely independant of government meddling.

The most blatant example of this is that the BoE MPC has 5 of 9 members appointed by the treasury which is under political control (GB). And just to top it off they have to control Interest Rates to target a fictional inflation measure cooked up by another government department - the ONS.

Then just to make the public think that the figures aren't cooked they plan to make the ONS independant... all spin though, I cannot believe for one second that a bunch of power hungry thugs like Nu Liebour would ever give up control of anything voluntarily.

Gold standard is not the answer we're looking for. But the current fiasco gets right on my t1ts.

I think what is required is a political change, not neccessarily a banking system change.

If the banking sector was truly independant of government meddling, and had proper strict regulation then would we have the mess we have now?

How many problems in this country would be solved by honest politicians?

Labour won't even sack disgraced politicians when they've lied or abused their positions... no honesty in politics.

Edited May 24, 2006 by non-FTBer

[Dr Doom]

The problem of a stable currency isn't one which is necessarily solved by requiring that it is tied to real commodities rather than being wholly fiat.

In many ways, it potentially makes things worse. In such a case, you will find that the value of your currency fluctuates according to mining output, seasonal harvests or changes in demand.

It is highly unlikely to make things worse. If you fix it to gold, the fluctuation in the amount of gold in the world changes very slowly. Much more slowly than a purely fiat currency that can be inflated at the flick of a switch or pen.

If you fix to some type of consumable, for example packets of cigarettes. As was done in germany after the 2nd world war. When there was an oversupply of cigarettes (currency) people would just smoke the cigarettes. A funny example sure, but it shows how at least with a commodity backed currency there isn't this huge hidden wealth transfer to fight wars, which the population wouldn't support if they had to pay for them through direct taxation.

For the vast majority of people who have no need to see their purchasing power fluctuate according to such things, a currency which depreciates in value at, say, a reliable 2% per year is actually much more preferable. It also prevents overly privileging one or two commodity classes (eg gold/silver) and distorting their price relative to the world's actual need for them.

Of course, if you're going to have a fiat currency, you do need central banks. Private firms simply couldn't be trusted to issue notes, which is why the right to do so became concentrated in central banks following banking crises thoughout the 18th and 19th centuries.

A central bank's mere presence is no guarantee of stability either. Central banks that were controlled by governments naturally found their position being abused to manipulate the economy for political purposes.

Since governments realised that manipulating them was ultimately harmful, and central banks started to gain independence, they have proved much more able to deliver a stable currency. Of course, this is a very difficult job, and mistakes are made, but if price stability is what you're after, you'd be hard pressed to find a group of people more devoted to that task than central bankers.

I sometimes worry that this site is at risk of losing its credibility when arguments like these are seized on so enthusiastically.

You can make a good case for the housing market being overvalued and ready for a crash without having to resort to government conspiracies, the need for a return to the gold standard and the evils of central banking. Associating ourselves with this kind of arguments just makes it easier for the mainstream to dismiss our views.

More people are about to lose more of their wealth than ever before in history,

an undebatable fact if you believe a *** is imminent or happening.

Where does this wealth go. Does it just disappear in a puff of smoke?

I haven't always believed in banking conspiracies, but they do explain an awful lot.

And it's not like there is a shortage of evidence.