Can you have a fiat currency without a central bank?

Question

Currently the United States dollar, and (as far as I know) the rest of the world's currencies are fiat, that is there are no commodities (gold) supporting the value of the money system. This system is enforced by the Federal Reserve System in the United States, as well as by the other central banks in other countries, who are charged with maintaining monitary stability. They, however, do not seem very well equiped to do so, as can be attested to by all the problems created in the economy by their bad policies (for instance the current "housing crisis" that was caused by the Fed keeping interest rates too low for too long post 9/11). I believe a market based solution would be a better way of insuring monitary stability, however, I can see no way to do this with our current fiat currency. I believe it would be possible to do so with a commodity based currency, however, to do so would require deflating the dollar enough to a point that the USA would be destitute.

So, does anybody know if it is possible to eliminate the Federal Reserve, and let market forces determine interest rates, without returing to the gold standard, which would impoverish us?

OPM -

What do you mean the Fed dosen't control interest rates? Perhaps control isn't the correct word, as they don't send out a memo to all consumer banks saying "effective immediately, all mortgage interest rates are now at 6 a half percent"... or something like that... but isn't that exactly what they are trying to do indirectly via setting the Fed funds rate, through their open market activities, and by setting the reserve requirement?

And as for the current housing market issue, do you not think the sub-prime market wasn't expanded by the fact that money was avaliable on the cheap due to the Fed increasing liquidity in the post 9/11 recession? I remember all the ads at the time "...interest rates are at an all time low, come in and see how we can get you into an ARM and save you hundreds on your mortgage" or "...refinance your credit card debts". These low interest rated did encourage people who otherwise could not afford to buy homes and other big ticket items to purchase sed items... typically on adjustable rate loans, which was quite unwise (as adjustable rate loans are designed for high interest rate situations)...

I'm just thinking that if the commercial lenders weren't flush with cash from the federal reserve they may have been a little more cautious about their lending policies, and wouldn't have pushed these bad loans on so many people...

Answer 1

You absolutely can have a fiat currency without a central bank. Just put the Treasury (or Ministry of Finance, or whatever else you call it) in charge of monetary policy. The problem with that approach is that the Treasury, headed by a political appointee, will use monetary policy for short-term political gains. An independent central bank, where governors are appointed for longer terms and on a staggered basis is usually more capable of resisting those pressures.

As to gold supposedly supporting the value of money, you are sorely mistaken. Gold, as J.M. Keynes explained back in 1930s, does NOT support the value of money; it it money (and goods and services it buys) that supports the value of gold. When you break the artificial link between gold and money, gold becomes what it really is, a technical metal traded in a highly volatile market. Just look at the history of gold prices; over the last 30 years, gold was traded for anywhere between below $300 and above $600.

As to monetary stability, it is not as desirable as you would think. In many cases, monetary flexibility is more important. A moderate devaluation of national currency and a monetary easing can help a country to end a recession faster or not get into one in the first place. Also, read up on Robert Mundell's "unholy trinity"; out of three major policy objectives (inflation, unemployment, and exchange rate) you can with, some degree of confidence, control any two. When you choose the exchange rate as your policy target, you automatically lose your ability to impact either inflation or unemployment.

To summarize, as bad as fiat currencies may be, the alternative (a commodity-based currency) is substantially worse.

Answer 2

As to the first question, the answer is yes. The United States was on fiat money during several periods prior to the permanent suspension of the gold standard. The classic example is the greenback period beginning during the civil war.

Commodity based systems should be avoided at all costs. They only work if markets are Pareto efficient. We are off the gold standard because the gold standard created the Great Depression.

You are giving too much credit to the Fed regarding the housing crisis. I am an economist and I cannot see where the Fed really had anything to do with it or 9/11.

Contrary to popular opinion, the Fed does not control rates. In most circumstances the Fed is reacting to market conditions making itself neutral. In practice, this is its actual goal, to make money neutral. We do know from empirical research that Fed actions do impact the markets, but the impact is very brief and usually small, some specific rare exceptions being also important. The goal of the Fed should be to make money a non-factor in economic decisions in the sense that price levels move with money supply and so price stability should govern all other choices (except in a monetary crisis as in the past few weeks).

Commodity money of all types is problematic for two reasons, it is hard to transport to rebalance global prices and there is a tendency to hoard it to prevent inflation triggering economic collapses in other parts of the world that end up with commodity shortfalls.

The current housing crisis began innocuously. Banks have made subprime loans for all of American history, but only to a very select crowd. So it isn't a surpise the rating agencies found the deliquency rate on subprime loans was below that of the prime loans five years ago. Very few people qualified for subprime lending, such as newly graduated physicians.

When the banks were able to get a fee to make a loan and get the loan off its books, it no longer cared about the risk, just the volume. Other lenders popped up to make even more loans.

At the same time, international banking regulators altered capital requirement rules. A bank making loans entirely in Florida, for example, would be at a higher risk that a bank lending nationally. So collateralized mortgage obligations that were national were considered safer than direct lending. So banks were permitted to reduce their required capital if they owned a diverse portfolio than a local one, at about a four to one ratio. This caused all banks to strip loans off their books and sell them in the open market. This meant banks could no longer judge the quality of these loans directly since they were packaged into a large offering.

These two facts combined created a large market failure.

The banking system is fine right now, it is all the non-banks such as Countrywide Lending which are in trouble. Since they do not have a deposit base, they depend upon credit from others. As this collapses, so does their business model.

Answer 3

Yes, i just read some new ideas about it.
The problem begins on the monetary policy, its a monopoly!. The cental banks do what ever the want to and that affect negatively to the poblation.

A solution could be letting the market forces do all. But how? With competition. A new idea is that all banks could have they own currency. The good currency will perdure in time because people demand that and the only for this is beacuse is very stable. BAd currencies will go out and by demand-supply theory all could reach a general equilibrium.
With this, the federal bank would dont have to exist at all. Even inflation would equal to 0 and interst rate and money quantity will be at equilibrium.

Answer 4

The answer to your question is 'obviously'.

In many states, we had such a system with private banks producing private money until - whenever - maybe 1900? At anyrate, you could set yourself up as bank, issue currency, and people could trade it and use it. If I remember right, in Minnesota in 1820's, there were 300 such currencies.

It was chaos. That is why business wants to keep uniting and creating single currencies. It is much easier to do business that way. The Fed is doing a fine job and can be measured by the amount of inflation or deflation in the economy. Since the late 80's we really have been doing relatively OK. Probably better than a system of thousands of banks.

Answer 5

Our Constitution requires Congress to control the value of our money, so in essence all that happened was power and authority was transfered from the Treasury to the Federal Reserve. A quick fix is to transfer it right back to the Treasury.

The reason why they wanted Congress to control monetary value is multifold. They didn't want states competing with eachother through monetary systems leading to economic instability. Second, while they were free-market liberals, they hated and despised bankers (Bank of England being their target of hatred) and didn't want bankers to control the money because they understood how dangerous that was.

So, how to fix it? First, you order the Federal Reserve to buy all US public and private debt. Second, you could pull the US and its assets out of the IMF and WBO. That would bring back huge amounts of wealth back to the US Treasury. Follow that up with a bank holiday so that you have time to do the next phase. Next, you pull the Government and it's assets out of the Federal Reserve. This would laden all debt to the Federal Reserve Corperate entities alone. Then you require that all banks hold at least a 50% reserve. Then you allow the banks to open up again but freeze all credit issuance.

Now, with the Federal Reserve so laden with debt and no way to make money, it'll go bankrupt. That's when you can seize everything else it holds to pay off part of the debt. Next, you use parts of the newly reaquired wealth to pay the rest off. Now that we're balanced, you ratchet the reserve requirements again to absorb half of the Treasury's final holdings. This will give the government a padding in case of emergency, and hold credit expansion (the biggest cause of our current inflation crisis) at bay, all without going to a commodity backed currency, getting rid of the Fed Reserve totally, and solidifing the dollar.

From there all you have to do is maintain.

Answer 6

Stop confusing republicans with liberal democrats. I do not support the federal reserve or fiat currency. I think we should abolish the fed reserve and get back to the gold and silver standard

Answer 7

The only way to do it is to drastically lower the standard of living and have massive unemployment......which is fine with me...