Myth 10: Fiat Money is Necessary to Have a Lender of Last Resort

Barry Eichengreen (2011) writes:

Under a true gold standard, moreover, the Fed would have little ability to act as a lender of last resort to the banking and financial system. The kind of liquidity injections it made to prevent the financial system from collapsing in the autumn of 2008 would become impossible because it could provide additional credit only if it somehow came into possession of additional gold. Given the fragility of banks and financial markets, this would seem a recipe for disaster. Its proponents paint the gold standard as a guarantee of financial stability; in practice, it would be precisely the opposite.

Briefly, the classical conception of the “lender of last resort,” spelled out by the English journalist and banking historian Walter Bagehot (1871) during the classical international gold standard era, is an institution that lends reserves to illiquid (but solvent) commercial banks in a period of peak demand for currency or bank reserves, in the extreme during a period of bank runs.  Its aims are to prevent regrettable bank insolvencies due to hasty asset liquidations, and to satisfy the public’s demand for currency or reserve money so that the runs cease and the market calms.  This seems to be the notion that Eichengreen has in mind.

Assuming that the Federal Reserve exists and is the agency to which the role is assigned, Professor Eichengreen takes a true gold standard to imply that “it could provide additional credit only if it somehow came into possession of additional gold.”  That is, the gold standard is not “true” unless it imposes a 100 percent gold marginal reserve requirement on central bank liabilities.  This is a highly idiosyncratic understanding of a true gold standard.  Peel’s Act of 1844 did impose a 100 percent marginal gold reserve requirement on expansion on the Bank of England’s note-issues, but the Bank could still provide additional credit by expanding its deposit liabilities.  Indeed the Bank is generally understood to have acted as a lender of last resort during the Baring Crisis in 1890, while Peel’s Act was still in place.

A 100 percent gold marginal reserve requirement on all central bank liabilities would constrain last-resort lending.  But imposing such a rule on the central bank is not required to have a true gold standard, and indeed having a central bank is not even required.  A gold standard, again, is generically defined by gold serving as the medium of redemption and medium of account, not by any reserve requirement imposed on a central bank. The United States was on the classical gold standard without a central bank from 1879 to 1914.  During that period, private clearinghouse associations acted as lenders of last resort to their member banks (Timberlake 1984).  So a central bank is not even necessary to have a lender of last resort.

Eichengreen (2011) argues that “confidence problems are intrinsic to fractional-reserve banking and why an economy with a modern banking system needs a lender of last resort.”  But as noted in Section 6 above, confidence problems are minimal if no legal restrictions prevent banks from adequately capitalizing and diversifying themselves.

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The Most Important Thing Holding Up the US Dollar

by Ron Paul

Today’s economic conditions reflect a fiat monetary system held together by many tricks and luck over the past 40 years. The world has been awash in paper money since removal of the last vestige of the gold standard by Richard Nixon when he buried the Bretton Woods agreement — the gold exchange standard — on August 15, 1971.

Since then we’ve been on a worldwide paper dollar standard. Quite possibly we are seeing the beginning of the end of that system. If so, tough times are ahead for the United States and the world economy.

Yellen’s Missing Jobs

March 31, 2014

The new Federal Reserve chairman, Janet Yellen, gave a policy speech today at Chicago, where, in a startling gesture, she mentioned three working individuals by name — Jermaine Brownlee, Vicki Lira, and Doreen Poole. They lost their jobs the Great Recession and have been struggling ever since. It was a refreshing, even affecting demarche by Mrs. Yellen, who has made a return to full employment a public priority. She underscored her sincerity by telephoning Mr. Brownlee and Ms. Lira and Ms. Poole before delivering her speech.

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The Rueffian SynthesisJohn D. Mueller

Publisher's Note: Originally released in June/July of 1991, this detailed report discusses Jacques Rueff's economic theories and applies them to modern economic events.

By John D. Mueller

Who Was Jacques Rueff?

... Trained in science and mathematics at the Ecole Polytechnique, Rueff devoted his first theoretical work to showing that the same scientific method applies to “moral” or “social” sciences like economics as to the physical sciences (Des Sciences Physiques aux Sciences Morales, 1922). In both cases, he pointed out, individual acts can be “indeterminate,” but the pattern of large numbers of individual acts can be predicted as a matter of probability. And so in economics no less than physics, as he later wrote, “A scientific theory is considered correct only if it makes forecasting possible.”

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Excerpts From:


by Lewis E. Lehrman

"Forerunners of man lived upon the planet several million years ago. But the unique, modern, social order of man – civilization – emerged only four to five thousand years ago. Historical and archaeological evidence suggests that the institution of money evolved coterminously with civilization. From the standpoint of the 100,000-year history of Homo sapiens, civilization and money are but young and fragile reeds. Today their very existence is threatened by financial disorder."

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Turkey’s Cut-rate Expectations

Kathleen Packard  |  Apr 18, 2014
There is a lot of bad behavior in the global political and monetary world. Much of it comes in countries that should know better. Recep Tayyip Erdogan’s Justice and Development Party (AKP) easily won municipal electons in Turkey but the party’s candidates won far short of the nation’s votes. The Wall...
Hostility toward gold has a long pedigree.  19th century depiction of Pliny the Elder courtesy of the Library of Congress Gaius Plinius Secundus, commonly known as Pliny the Elder, in his The Natural History, Book 33, section 3, writes: Would that gold could have been banished for ever from the earth, accursed by...
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Jacques Rueff, a key figure in European economic circles from the 1930s until the 1970s, was, first and foremost, an...
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Jun 17, 2008
Key Monetary Writings
John D. Mueller

Elements of Economic Theory and American Political Economy

Economic theory began in the natural law philosophy with elements from Aristotle and Augustine, first integrated by Thomas...
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Prosperity Through Gold
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