Uneasy Money

Recently I have been working on a review of a recently published (2011) volume, The Empire of Credit: The Financial Revolution in Britain, Ireland, and America, 1688-1815 for The Journal of the History of Economic Thought. I found the volume interesting in a number of ways, but especially because it seemed to lend support to some of my ideas on why the state has historically played such a large role in the supply of money. When I first started to study economics, I was taught that money is a natural monopoly, the value of money being inevitably forced down by free competition to the value of the paper on which it was written. I believe that Milton Friedman used to make this argument (though, if I am not mistaken, he eventually stopped), and I think the argument can be found in writing in his Program for Monetary Stability, but my memory may be playing a trick on me.

Eventually I learned, first from Ben Klein and later from Earl Thompson, that the naïve natural-monopoly argument is a fallacy, because it presumes that all moneys are indistinguishable. However, Earl Thompson had a very different argument, explaining that the government monopoly over money is an efficient form of emergency taxation when a country is under military threat, so that raising funds through taxation would be too cumbersome and time-consuming to rely on when that state is faced with an existential threat. Taking this idea, I wrote a paper “An Evolutionary Theory of the State Monopoly over Money,” eventually published (1998) in a volume Money and the Nation State. The second chapter of my book Free Banking and Monetary Reform was largely based on this paper. Earl Thompson worked out the analytics of the defense argument for a government monopoly over money in a number of places. (Here’s one.)

And here are the first two paragraphs from my review (which I have posted on SSRN):

The diverse studies collected in The Empire of Credit , ranging over both monetary and financial history and the history of monetary theory, share a common theme: the interaction between the fiscal requirements of national defense and the rapid evolution of monetary and financial institutions from the late seventeenth century to the early nineteenth century, the period in which Great Britain unexpectedly displaced France as the chief European military power, while gaining a far-flung intercontinental empire, only modestly diminished by the loss of thirteen American colonies in 1783. What enabled that interaction to produce such startling results were the economies achieved by substituting bank-supplied money (banknotes and increasingly bank deposits) for gold and silver. The world leader in the creation of these new instruments, Britain reaped the benefits of efficiencies in market transactions while simultaneously creating a revenue source (through the establishment of the Bank of England) that could be tapped by the Crown and Parliament to fund the British military, thereby enabling conquests against rivals (especially France) that lagged behind Britain in the development of flexible monetary institutions.

Though flexible, British monetary arrangements were based on a commitment to a fixed value of sterling in terms of gold, a commitment which avoided both the disastrous consequences of John Law’s brilliant, but ill-fated, monetary schemes in France, and the resulting reaction against banking that may account for the subsequent slow development of French banking and finance. However, at a crucial moment, the British were willing and able to cut the pound lose from its link to gold, providing themselves with the wherewithal to prevail in the struggle against Napoleon, thereby ensuring British supremacy for another century. (Read more.) [Update 2:37 PM EST: the paper is now available to be downloaded.]

In writing this review, I recalled a review that I wrote in 2000 for EH.net of a volume of essays (Essays in History: Financial, Economic, and Personal) by the eminent economic historian Charles Kindleberger, author of the classic Manias, Panics and Crashes. Although I greatly admired Kindleberger for his scholarship and wit, I disagreed with a lot of his specific arguments and policy recommendations, and I tried to give expression to both my admiration of Kindleberger and my disagreement with him in my review (also just posted on SSRN). Here are the first two paragraphs of that essay.

Charles P. Kindleberger, perhaps the leading financial historian of our time, has also been a prolific, entertaining, and insightful commentator and essayist on economics and economists. If one were to use Isaiah Berlin’s celebrated dichotomy between hedgehogs that know one big thing and foxes that know many little things, Kindleberger would certainly appear at or near the top of the list of economist foxes. Although Kindleberger himself never invokes Berlin’s distinction between hedgehogs and foxes, many of Kindleberger’s observations on the differences between economic theory and economic history, the difficulty of training good economic historians, and his critical assessment of grand theories of economic history such as Kondratieff long cycles, are in perfect harmony with Berlin.

So it is hard to imagine a collection of essays by Kindleberger that did not contain much that those interested in economics, finance, history, and policy — all considered from a humane and cosmopolitan perspective — would find worth reading. For those with a pronounced analytical bent (who are perhaps more inclined to prefer the output of a hedgehog than of a fox), this collection may seem a somewhat thin gruel. And some of the historical material in the first section will appear rather dry to all but the most dedicated numismatists. Nevertheless, there are enough flashes of insight, wit (my favorite is his aside that during talks on financial crises he elicits a nervous laugh by saying that nothing disturbs a person’s judgment so much as to see a friend get rich), and wisdom as well as personal reminiscences from a long and varied career (including an especially moving memoir of his relationship with his student and colleague Carlos F. Diaz-Alejandro) to repay readers of this volume. Unfortunately the volume is marred somewhat by an inordinate number of editorial lapses and mistaken attributions or misidentifications such as attributing a cutting remark about Paganini’s virtuosity to Samuel Johnson (who died when the maestro was all of two years old). (Read more) [Update 2:37 PM EST: the paper is now available to be downloaded.]