ignore the fact that a 71-year-old economist who won the
Nobel Prize can still change his views every week on bank
regulation. One would think he would have found a stable
theoretical framework to think this through by this time?
Monetarism has obviously not been very helpful. Note instead
the interesting reason he gives for his new scepticism: when
they put their money in a bank, depositors cannot know if
their money is in a secure account or in a risky investment.
Isn't this one of the
fundamental problems with the current banking system, that
is, fractional reserves? You think your money is there and
you can retrieve it at any time, but the bank only keeps a
fraction of it in its vaults and has lent most of it to
someone else. Austrians and others before them have been
saying for centuries that this was a sort of fraud that led
to unsustainable leveraging and to booms and busts. Mr.
Lucas is right to see that there is something wrong here. He
just hasn't found a good explanation of why and what should
be done about it, and so he adopts the default position of
confused free-marketeers, which is that more regulation must
be the answer.
The article tells us
about another left-wing Chicagoite, Douglas Diamond, who
refused to sign the petition against Paulson's bailout
because he believes governments have no choice but to
provide safety nets for banks and tougher oversight. Again,
the explanation given by the finance professor for parting
with his colleagues is quite interesting:
Diamond began studying bank failures when he was a
doctoral student at Yale in the 1970s. The 1963 book
that Friedman wrote with Anna Schwartz, "A Monetary
History of the United States, 1867- 1960," provided
the foundation. A copy, held together by Scotch
tape, sits on Diamond's desk, even though he
concluded at Yale that a main premise was wrong.
Friedman's view that banks failed in the 1930s
because the U.S. money supply contracted as panicky
Americans started hoarding cash and the Fed reacted
too slowly. Diamond sees the money supply as less
significant than Friedman did.
Banks failed, he says,
because their assets weren't readily converted into
the cash that depositors were demanding.
Is it just me or do I see a pattern here? There is no
explicit mention of it, but just like Mr. Lucas, Mr. Diamond
seems to have realized that the fractional reserve system (that's
what the last sentence is referring to) is a crucial part of
the problem. His solution however (if his views are
correctly reported in the article) is to have governments
impose even more regulation on the banking system and to
intervene to save it when it is on the verge of collapse.
When it's precisely because governments control the monetary
system, condone banking fraud and constantly save banks from
the consequences of their fraudulent practices that we have
Chicago school economics
is in such a mess that it's hard to decide who we, as
Austrians, should sympathize with: the inflationists who are
still claiming to defend free-market principles, or those
going over all the way to the interventionist side but who
may be doing it on the basis of a legitimate preoccupation
with the fractional reserve system.
One can't help but agree
with arch-Keynesian James Galbraith, who is quoted in this
article as saying that "The inability of Friedman's
successors to say anything useful about what's happening in
financial markets today means their influence is finished."