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I have a question: In a theoretical free market economy, yet where there is still a large element of human irrationality and speculative interests, would there be a need for a central bank? If so, what would its role be? If not, do we simply let matters like exchange rate, interest rate, and money supply run its own course? Would there be a need to instate a buffer for market wide panics?

As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED? Do you think it would make a difference to the current crisis? Or would it lead to further problems down the road? If so, what are the potential problems?

*** Mod's note: See split topic for the question about sub-prime govt. interference - sN ***

Edited by softwareNerd
Added "split topic" annotation

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I have a question: In a theoretical free market economy, yet where there is still a large element of human irrationality and speculative interests, would there be a need for a central bank? If so, what would its role be? If not, do we simply let matters like exchange rate, interest rate, and money supply run its own course? Would there be a need to instate a buffer for market wide panics?

I do not see why a central bank is necessary. My guess is that in a free market there will be banking giants, such as J.P. Morgan, who are capable of obviating real disasters through rational and moral action. J.P. Morgan is credited for mitigating the Banking Panic of 1907.

In addition, most likely there will also be risk-reducing mechanisms such as deposit insurance available through private means. This should accomplish some of the intended purposes of a central bank. Of course, this still will not prevent all acts of large-scale irrationality, such as another tulip bulb craze, but it will be moral and also practical.

As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED? Do you think it would make a difference to the current crisis? Or would it lead to further problems down the road? If so, what are the potential problems?

Free market economists such as George Reisman (see here) and Thomas Sowell (see here) have argued that the measures undertaken by the Federal Reserve to prevent another dot com crash helped contribute to the subprime mortgage "crisis". Most likely, the freezing of these loan rates will contribute to the next crisis. The authors of Freakonomics have also argued that there is a palpable degree of fraud involving cash-back mortgages that has also contributed to the bursting of the subprime housing bubble.

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As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED?

I have a one-minute-case which presents the Austrian Business Cycle Theory, a theory that explains how monetary manipulations cause business cycles.

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I have a question: In a theoretical free market economy, yet where there is still a large element of human irrationality and speculative interests, would there be a need for a central bank? If so, what would its role be? If not, do we simply let matters like exchange rate, interest rate, and money supply run its own course?...

Of course there's no need for a government central bank. In fact, the unit of money should be left completely to the free market; government has no business doing anything to manage or manipulate the supply of money.

Recall also, that the United States had no central bank from about 1837 to 1913. That was a period of rapid economic growth; it was also a period during which money had a stable value.

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Or would each bank offer their own legal tender?
You ought to be able to answer this. What does money represent? What is the significance of a government printing money, as opposed to a private institution?

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Good links DarkWaters. I have been studying this topic, reading various books and such, trying to gain more knowledge of it. I'll throw my two cents in but you guys let me know if I am wrong on anything.

I have a question: In a theoretical free market economy, yet where there is still a large element of human irrationality and speculative interests, would there be a need for a central bank? If so, what would its role be? If not, do we simply let matters like exchange rate, interest rate, and money supply run its own course? Would there be a need to instate a buffer for market wide panics?

There would be no need for a central bank and these things would all be determined by markets. Currencies would ideally be traded, much as they are now, but each currency would be backed by gold reserves. Interest rates represent the cost of money, and they would be determined by the market as well. Right now with the credit crunch occuring there is a large demand for money, so interest rates should be relatively high. However, the Fed has kept rates artifically low, and will probably lower them again during their next meeting on Dec. 11. This artificially low cost of money only serves to increase malinvestment, which will likely need to the next bubble in a different asset class.

As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED? Do you think it would make a difference to the current crisis? Or would it lead to further problems down the road? If so, what are the potential problems?

I think it is a short-term patch on a larger problem. The Fed lowering the rates is especially damaging. To lower the Fed Funds rate the Fed has to create more money, causing each dollar to be worth less. The problem down the road is that this will lead to a devaluation of the dollar as investors flee for currencies which pay higher rates. A devalued dollar will raise our cost of imported goods. It's tough to find a product that does not rely on importing. Also, oil is priced in dollars and many foreign countries have state-run oil companies that produce oil. In exchange for their product they receive dollars, which they must find a use for. Usually they buy up US Treasury debt, helping us finance our deficit spending, but sometimes they buy other assets denominated in dollars, such as US stocks, real estate, commodities, and bonds. I think it was last week when sovereign wealth fund Abu Dhabi in the Mideast invested $7.5 billion in Citigroup. And the deal I heard of before that was another mideast fund purchasing 20% of the NASDAQ exchange. Security concerns are obviously a factor here.

Funny how you hear politicians in an uproar about "predatory lending" and Wall Street creating exotic securitized mortgage products. These people say that the banks should take a hit by freezing ARMs, lowering rates, etc. But I haven't heard any politician advocate government take a hit by freezing or lowering property tax payments and rates.

Edited by adrock3215

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You ought to be able to answer this. What does money represent? What is the significance of a government printing money, as opposed to a private institution?

Money is basically an I-Owe-You from the government. So yes, a private institution like a bank could just as well print them.

But indeed, what would be the significance?

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Money is basically an I-Owe-You from the government. So yes, a private institution like a bank could just as well print them.

But indeed, what would be the significance?

Some people think that government controlled banks can be trusted more than private institutions.

This is of course not true, on the contrary, it is often government that starts printing money and in the same time keeps any competition out by using force.

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The important thing is that the market allow the best currency to win. When the state has a monopoly on fiat money, it inflates the currency to expand its power whenever it wants. That's why the dollars has lost 95% of it's value since the Fed went off the gold standard.

Surely, however, banks could agree to print one kind of tender, or some such, otherwise fraud would be immensely easy, right?

Not with commodity money. A 10 Gold Gram Visa certificate is 100% compatible with a 10 Gold Gram Citibank certificate.

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I have a question: In a theoretical free market economy, yet where there is still a large element of human irrationality and speculative interests, would there be a need for a central bank? If so, what would its role be? If not, do we simply let matters like exchange rate, interest rate, and money supply run its own course? Would there be a need to instate a buffer for market wide panics?

No, there is no need for a central bank. Abolishing the practice of fractional reserve banking would do much to improve system stability but that's still not enough. There are a host of other issues (moral, political, technical) that must also be taken care of. Then, if all financial laws were the way they ought be, and the system had adjusted itself to this accordingly, the irrationality of individuals would not be a threat to system stability. There would be no risk of 'contagion,' no spreading panic as runs on banks draws down deposits, triggering fire sales and crashing out the money supply through the credit multiplier acting in reverse, etc.

There would also be no need for governments to have a role in exchange rates or interest rates. As to the money supply...

Money is basically an I-Owe-You from the government. So yes, a private institution like a bank could just as well print them.

Real money is commodity money rather than debt money. The premiere commodity for this purpose is gold, though silver can work just as well. What banks would do then is offer printed or electronic certificates entitling the holder to receive gold or silver on demand, which certificates are easier to carry and trade with. All has nothing to do with governments - they should not even make the coins never mind print notes - other than that it is their job to make sure people abide by contracts etc.

At this point it would be easy to go into a big spiel about the evils of fractional reserve banking, but I instead I refer you to "Human Action" by von Mises and "Capitalism" by Reisma, and then once you've done that you should sink your teeth into Mises' Theory of Money and Credit.

(Aside: a gold bug is someone who says gold just HAS to be the money, as a near-religious dogma, and who then casts about for reasons to support that dogma only for the purpose of bashing unbelievers' heads with them. Rational people, on the other hand, have definite and objective criteria for the commodity that should be money, and will find that gold is presently the best, that silver is also acceptable for lesser valued coins, that the two metal currency systems could run side by side quite easily, and that the merits of silver and gold as money could change if the situation changes. As David said, the thing to do is let the market decide, with me only adding that there could be two winners rather than just the one.)

But indeed, what would be the significance?

It isn't that private institutions could also produce monetary instruments but that money-production should strictly be only in the hands of private for-profit financial institutions. Governments shouldn't be in the money-production business at all. The only things governments should be doing is upholding proper laws so that financial institutions don't steal credit from their customers (and their customers' customers) through issuing more certificates than they have actual money on hand for.

JJM

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