The Prime Minister of Iceland recently commissioned a report by Frosti
Sigurjonsson (henceforth referred to as "Mr. S") to recommend a
better money and banking system for Iceland. (I'm sorry, but isn't Frosti a
great first name for someone from Iceland!) The
recently
released report recaps Iceland's sorry history of money and banking
disasters and lays the majority of the blame for the 2008 collapse on the
institution of fractional reserve banking, which caused an out of control
increase in the money supply. Mr. S recommends its abolition. For this I
applaud Mr. S and hope that the prime minister accepts the report and urges the
Icelandic legislature to act upon it.
My endorsement of the report's primary recommendation does not mean
that I believe that Mr. S fully understands money and banking from an Austrian
perspective. Nevertheless, his recommendation, limited as it is, is a huge step
in the right direction. To this extent it is compatible with my recommendations,
delivered at the recent Mises Canada's "Prices and Markets"
conference, that called for the abolition of fractional reserve banking, the
separation of deposit and loan services, and an end to deposit insurance. Mr. S
recommends the same for Iceland.
Mr. S is correct that the central bank lost control of the money supply
in the years leading up to 2008 as the banks leveraged their excess reserves
into new loans, which created new deposit money out of thin air. Sounding very
much like Weimar Republic and Zimbabwean central bankers, he states that it was
the duty of the Central Bank of Iceland (CBI) to "provide banks with
reserves as needed in order to not lose control of interest rates or even
trigger a liquidity crisis between banks." He accuses the banks of lending
for speculative rather than worthwhile purposes, whereas he has no such concern
over government control over this powerful economic lever. He is confident that
the central bank would expand and contract the money supply in a fashion that
would be beneficial to all society and that government would spend new monies
only for purposes that would benefit the nation. Whew!
The resultant monetary regime in Iceland would be very similar to that
of America during our Civil War (1861-65), when the North introduced fiat paper
money. The Greenbacks--so named due to their color on one side--were pure irredeemable
fiat monies issued by the Treasury Department. At that time America had no
central bank, thanks to the foresight and courage of President Andrew Jackson,
who was able to block the renewal of the charter of the Second Bank of the
United States in 1837. When the North won the war, it did eventually buy back
the Greenbacks for gold. The lesson here is clear--one of the main reasons that
governments debase money is to fight wars. The North found it impossible to
finance the war with taxes and honest debt, so it resorted to confiscation via
the monetary printing press. Are Iceland's leaders any different? They may not
want to fight a war, although they did get into a naval shoving match with
Great Britain in the 1950s through 1970s
over fishing rights, the so-called "
Cod Wars". So one
never knows.
Mr. S believes that government needs the power to introduce new money
to meet the needs of an expanding economy and that the central bank and
government will do so for the good of the nation as a whole and not for private
purposes. At a minimum he believes that the money supply must expand in order
for the economy to expand. In this regard he is a full-fledged Friedmanite, who
little understands the adverse impact of even a low level of money growth on
the structure of production. On the contrary, he sees money growth as necessary
for economic growth and has full confidence that government will spend any
newly created money only for good. It is obvious that either he's never heard
of public choice theory or does not subscribe to its conclusions. Really, who
today believes that government, which after all is manned by some of the most fallible
humans in society, can (1) be completely altruistic in its spending decisions and
(2) would know what is best anyway? I refer Mr. S. to F. A. Hayek's wonderful
Nobel
speech in which he clearly articulates his theory of the pretence of
knowledge.
Mr. S concludes his proposal with a call for what he terms the "sovereign
money system". Right away we know that he is not an Austrian when he
states "The CBI will create enough money to promote the non-inflationary
growth of the economy." He would separate money creation from money
allocation. A money creation committee would decide how much money to create
and then the parliament would decide how to spend it. New money would serve five
purposes--fund new government spending, reduce taxes, pay off the public debt,
provide a citizen bonus, and increase lending to business. Money would not be
backed by debt, but would be a sovereign asset created at will. The proposal
does remove the ability of banks to increase the money supply through the
lending process. All to the good so far. But it transfers this power to
government. It allows government to spend what it wishes, as long as the money
creation committee goes along, by counterfeiting whatever amount is desired. Government
would not be required to increase taxes or issue new debt. Halleluja! A
counterfeiter's dream! Also a government dream. Somehow I have little
confidence that the money creation committee will not go along with whatever
spending plans the parliament desires, a sure path to hyperinflation.
Be that as it may, I hope that Iceland implements that aspect of Mr.
S's proposal that requires banks to maintain one hundred percent fiat reserves
on checking accounts. Then separating deposit banking from loan banking would
negate the need for deposit insurance. Perhaps Iceland's central bank and
government will exercise their money printing power with discretion long enough
for the rest of the world to see the benefits of abolishing fractional reserve
banking and moving to a one hundred percent fiat reserve system. After that we
can fight the next battle--prohibiting central banks from expanding the fiat money
supply and then finally tying money to specie at a legally enforceable ratio.
At that point money production can be turned over completely to private hands
and the central bank abolished.
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