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Can the monetary system regulate itself, or does it require oversight by government regulators? According to Lawrence H. White, who gave a lecture entitled "Can the Monetary System Regulate Itself?" at Rhodes College this past March the answer to the first question is "yes" and the answer to the second question is "no."[1]

According to Professor White, who was until recently the F.A. Hayek Professor of Economic History at the University of Missouri-Saint Louis and who will join the faculty at George Mason University this fall, theory and history provide a strong case for a free market in money and banking.

The idea that a monetary system can regulate itself has a long tradition in economics and appears in the work of Adam Smith and David Hume. Both believed that the price mechanism would prevent money shortages. This stands in contrast to the ideas of 17th- and 18th-century European mercantilism. According to the mercantilists, the wealth of nations consisted of its stock of gold and silver reserves. In the minds of the mercantilists, the way to for a country to get rich was to encourage exports (which earn gold and silver) and to discourage imports. However, according to the "price-specie flow mechanism" identified by Hume prices adjust to ensure a balance of imports and exports.

In his March 9 lecture at Rhodes, Professor White pointed out that today's crisis is an artifact of the highly regulated monetary system. He proposed that banking deregulation would reduce exposure to external shocks and increase rather than decrease stability. White cited his research on the history of banking in Scotland to provide evidence that the banking system can correct itself without government intervention. Specifically, he argued that a market with private note-issuing banks has built-in mechanisms to constrain monetary over-expansion.

According to White, vigilant internal monitoring would be vital to a bank's ability to weather external storms, and the prospect of failure would provide banks with the incentive they need to be prudent stewards of their depositors' funds. Therefore, government intervention in the monetary system is superfluous when it is not destructive. The self-correcting tendency of an unregulated market for money suggests that it is time to reconsider whether we need the Federal Reserve.

The unregulated system's alleged susceptibility to bank runs is also over-stated. One of the most important reasons for bank failure is not bank runs but bad loan decisions: Professor White demonstrated that government loan guarantees and government willingness to bail out failing banks have in fact encouraged risky loaning behavior. Though the Federal Reserve aims to promote monetary and economic stability, they distort interest rates, worsen inflation, and cause business cycles by printing money.

In Scotland, as Professor White pointed out, people still use private bank notes issued by independent banks. These banks succeed in the market not through government regulation but by promoting the use of their notes (in order to promote their business, for example, they set up many ATM machines and charge no fee for withdrawal of their notes).

Canada's experience during the Great Depression also gives us reason to doubt the wisdom of monetary intervention. Canada has historically had low levels of government intervention and an unregulated banking system. Professor White noted that people did not run on Canadian banks in the same way that they ran on American banks during the Great Depression. In part, this was due to the absence of branch banking restrictions that prevented American banks from diversifying their risks. The Canadian banking system adjusted to new market conditions and did not undergo the protracted crisis that occurred in the United States.

Professor White's lecture showed that, historically, a free-market approach to the banking industry is less prone to crises and operates efficiently through the invisible hand of the market. From the ideas of David Hume and Adam Smith, through the experience of banking systems in Scotland and Canada, we can see that the case for government intervention in the monetary system has been overstated.

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