Mere quibbles: Bagus and Howden’s critique of the theory of free banking


Despite its title, Philipp Bagus and David Howden’s critique of The Theory of Free Banking does more than merely “quibble” with that book’s arguments; their criticisms of those arguments are such as to suggest that the very foundation upon which my defense of free banking rests is deeply flawed. Here, I defend my work against Bagus and Howden’s criticisms, by showing that they rest upon careless or disingenuous readings of my arguments and a poor grasp of basic monetary economics.

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  1. 1.

    According to Norman et al. (2007), a survey of the historical development of interbank settlement systems, “Further innovations followed the development of more formalized clearing arrangements, i.e., with bankers clearing their claims in a coordinated manner and settling up according to a pre-agreed schedule, typically more frequently than before. This was desirable as the volume and value of interbank payments increased, since it reduced credit exposures” (ibid., p. 11, my emphasis).

  2. 2.

    See McGee (1958). My comparison is actually rather unfair to those who lodged the predatory pricing accusation, for they at least believed their complaint to be supported by empirical evidence.

  3. 3.

    In a footnote to their discussion of how free banks might cooperate to defy the usual limits to in-concert expansion Bagus and Howden (2010, p. 35n6) claim that in my article (Selgin 2001) on the subject, I argue the need for “a central bank to enforce a ‘stiff penalty-rate’ in the interbank overnight loan market to halt an in-concert credit expansion.” “It is ironic,” they remark, “that, as a free banker, Selgin must rely on the intervention of a central bank to show that the credit expansion of a free banking system would be restricted,” but this is a blatant misreading of my argument. In fact, the article in question claims, not that central banks are needed to keep overnight rates sufficiently high to preserve a demand for precautionary reserves, but that, if a central bank exists, it must not supply overnight credit at a subsidized (non-penalty) rate if the demand for precautionary reserves is to be well-defined. Of course, under free banking, where there is no central bank capable of manufacturing reserves out of thin air, overnight rates will necessarily be “punitive” in the relevant sense.

  4. 4.

    See, for example, Anna Schwartz’s (2008) New Palgrave article, “Banking School, Currency School, Free Banking School.”

  5. 5.

    In an open economy, the public may convert bank money into outside money for the purpose of making international payments.

  6. 6.

    Since my book’s appearance, I have addressed the topic of banking crises at greater length in several articles, including Selgin (1989b) and Selgin (1994).

  7. 7.

    Elsewhere in their article, Bagus and Howden themselves (Bagus and Howden 2010, p. 44) observe “It must first be remembered that the demand for money is the demand to hold real cash balances, i.e., it is a demand for real money services,” as if I and other free bankers had forgotten this, and as if they had not forgotten it a few pages before.

  8. 8.

    This, I hasten to say, is no criticism of Horwitz; as I have already said, no one reading him with any care would interpret him as Bagus and Howden do.

  9. 9.

    Observe that the reference here is not to a situation in which banks increase their lending independently of any prior increase in the demand for their liabilities. That would involve an illusion of sorts, because total spending must then increase, creating a bidding war for available factors that end by making them more expensive. Consult here my distinction between transfer and created credit.

  10. 10.

    For details concerning the development of Hayek’s views on optimal behavior of the money stock see Selgin (1999) and White (1999).

  11. 11.

    Concerning Mises’s view of the requirements for monetary stability, there is admittedly more room for disagreement. White (1992) argues that, despite some passages suggesting otherwise, Mises was in fact a proponent of free banking, who recognized the desirability of demand-accommodating growth in the supply of fiduciary media. Others, including Bagus and Howden and Salerno (2010), reach opposite conclusions in part by focusing on passages that White considers inconsistent with the thrust of Mises’s argument. In Theory of Free Banking (Selgin 1988, pp. 61–63), I myself took the latter approach and criticized Mises’s position accordingly. I have since come to see White’s interpretation as at least equally defensible.

  12. 12.

    I suppose that Bagus and Howden might claim that prices are flexible downwards, but inflexible upward, but that would just be jumping from one insupportable position to another.

  13. 13.

    Like many of the arguments offered by Bagus and Howden, this one appears to originate with Huerta de Soto (2006, pp. 647–9), who recognizes the resemblance of his theory to Goodhart’s. Huerta de Soto himself couches his version in terms of a prisoner’s dilemma game: in the absence of a central bank, he argues (ibid, p. 666–70), bankers find themselves in a non-cooperative equilibrium in which none is able to expand credit imprudently. Consequently, he argues, the banks will cooperate to “institutionalize joint credit expansion via a government agency designed to orchestrate and organize it.” By similar reasoning, of course, one could establish that competition does not generally work, because its very tendency to limit a firm’s profits must lead, ipso facto, to successful lobbying for an authority capable of setting and enforcing a monopoly price.

  14. 14.

    For general evidence, see Selgin and White (1999); Vera Smith (1936), and various entries in Dowd (1992). Dowd (1990), Selgin (1993), and White (1990) critically assess Goodhart’s (1990) alternative thesis.

  15. 15.

    Concerning the legality of fractional reserve banking at the time in question, see Selgin (2011).

  16. 16.

    Concerning this last tendency see Yeager (2010).


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I am grateful to Steve Baker, Toby Baxendale, Nicolas Cachanosky, Bill Lastrapes, Steve Horwitz, and Lawrence H. White for their comments. The usual disclaimer applies.

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Correspondence to George Selgin.

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Selgin, G. Mere quibbles: Bagus and Howden’s critique of the theory of free banking. Rev Austrian Econ 25, 131–148 (2012).

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  • Free banking
  • Fractional reserves
  • Austrian theory of the business cycle

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  • E32
  • E41
  • E42
  • G21