Academic journal article Independent Review

Central Banking in a Free Society

Academic journal article Independent Review

Central Banking in a Free Society

Article excerpt

Tim Congdon is a thoughtful and experienced British financial-market economist and policy advisor. In this new monograph Central Banking in a Free Society (London: Institute of Economic Affairs, 2009), he ponders how central-banking institutions might be reformed to prevent a replay of the recent financial fiascoes that have affected the United Kingdom as much as the United States. On the one hand, as he notes, the Bank of England as presently constituted has made a mess of things. On the other hand, he argues, we should retain a central bank able and ready to act as a lender of last resort because it benefits the public by lowering the commercial banks' costs of intermediation. In pursuit of a less reluctant lender of last resort than the Bank of England has recently been, he proposes provocatively that the bank be privatized - turned into a clearinghouse association owned by the commercial banks it supervises.

Free-market monetary economists will find the reprivatization of centralbanking roles entirely reasonable with respect to clearing and settling interbank payments, administering mutually agreed solvency and liquidity requirements for member banks, and organizing interbank loans of reserve money. ("Member" and "mutually agreed" here mean that any bank's joining would be optional.) Such a reform would more or less re-create U.S. arrangements before the Federal Reserve Act. But Congdon also wants the Bank of England to continue its current roles of issuing fiat money at its own discretion and enforcing the legal restrictions on commercial banks mandated by Parliament. If the proposal to privatize such nonmarket roles seems like trying to square the circle, its seeming character may derive from Congdon's paradoxical view that living under discretionary monetary policy and regulatory rule making by men called central bankers is consistent with living under the rule of law.

Congdon suggests that the Bank of England's status as a central bank is not only beneficial, but natural. He reviews the debate between what he calls the "imposed order" and "spontaneous order" views of central banking. The Bank of England's history, as he indicates, is complex. Its evolution from a commercial bank into a central bank was not planned from the outset, and hence it was spontaneous in the sense that it was an unintended result. But it would not have happened without its parliamentary grants of privilege, and hence it was imposed. Congdon grudgingly acknowledges that "[Vera] Smith was right" in taking the imposed-order view in her book The Rationale of Central Banking (1936), in that "the privileges given to the Bank of England" meant that the institution "could be construed" as having been imposed "from above" (p. 38). Later he nonetheless asserts: "We have shown how a central bank . . . arises, perhaps not surprisingly given its important functions, as a spontaneous product of market forces in banking" (p. 84). In fact, showing that a central bank can arise as the unintended result of legislated privileges is a far cry from showing it to be a product of market forces. As Congdon writes on the very next page, not the market but "the state has granted the central bank the exclusive right to issue legal-tender notes."

The Bank of England's key privileges were its legal monopoly of the London note issue (which dates from the Act of 1708, not from the Act of 1826 that Congdon cites on p. 38), its role as banker to the state, and its government guarantee against being liquidated in the event of failure. To retain its privileges, the bank toed Parliament's line, and in so doing it gradually became a state -directed policymaking institution rather than a firm maximizing profits for shareholders. The Victorian banking writer Walter Bagehot in his classic Lombard Street, which Congdon cites repeatedly on other matters, was quite clear that legal privileges were the source of the Bank of England's central-banking status. Bagehot wrote:

the Bank of England had among companies not only the exclusive privilege of note issue, but that of deposit banking too. …

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