Guest Article – Towards a Freer Future: Why Transitioning to Free Banking Isn’t So Daunting

By Carlos Martinez and Sid Gundapaneni

Since the Federal Reserve began operations in 1915, the United States has continued to experience cyclical periods of harsh economic downturns. In the present, we are now entering our second recession in two years, along with prices surging at rapid rates. The Federal Reserve has not provided macroeconomic stability through monetary equilibrium, nor through its mandate of stable prices & full employment.

Alternatives to central banking are being increasingly argued, yet many do not understand how exactly such a task would be carried out, as central banking cannot be abolished overnight. The authors of this piece are tasked not to argue the merits of a society without central banking, but rather to explain how a central bank could be phased out without a collapse of the American, or even global, economy.

Even some of the most famed self-described libertarian economists had to admit that the task of dismantling the “Fed” would face several obstacles regarding economic costs that we may not see as convenient. For instance, in a recent blog post at Econlib, Scott Sumner stated that it was not as easy as numerous free-market economists have said to “get rid of the fed.”

Although muddled, the conditions to determine how the market and investors would react to such a transition would be challenging. If the Fed were to be abolished, all its assets would need to be sold. Doing so instantaneously would have pernicious effects on investments resulting from a massive hike in the Federal Funds rate. That said, if the Fed were to pursue quantitative tightening more gradually, expectations may be able to stay anchored, and mitigate typically observed ill effects of tightening. Therefore, the Fed must proceed with caution when taking such sweeping changes in order to avoid a recessionary period that could trigger a global depression. 

This also means going forward, that all government debt would have to be purchased from private actors or foreign governments, since the Fed would no longer be purchasing such assets. Due to treasury bonds’ safety, it is likely that commercial banks would be eager to buy much of the Fed’s newly sold assets.  

The money from the large-scale asset sales will have a crucial role in transitioning away from central banking. Foremost, It is important to remember that all nationally chartered banks and some state banks in the United States hold stock in their respective regional Federal Reserve bank equal to 3% of its combined capital and surplus of stock. When moving away from the Fed’s regime, it’s critical that these banks be compensated as best they can. 

Although the number of outstanding Federal Reserve Bank stocks is not publicly available, the Fed can use the money received from selling assets towards buying out all member banks that are stakeholders of the institution. On the chance that there are still residual reserves, the Fed must destroy the money stock to prevent artificial inflation. 

The last crucial consequences of getting rid of the Federal Reserve are money and its fiscal impact on the economy. That is to say, would Americans still use the dollar as their primary currency, even though the Fed is vanishing? Moreover, would taxes be paid with private money if the government were to lift the restrictions on banks’ currency issuing?

When it comes to the fiscal modes of collecting revenue with a decentralized banking system, there are some considerations to be made. Among them is that the dollar would still exist as base money that could be used for government nature transactions involving taxes and specie money. Private banks could issue their private notes backed by base money, so long as their notes are equally if not far more saleable.

There could be instances where if the Government were to accept these private currencies and not impose a standard in paying governmental fees, individuals might use low-valued, worthless, and inflated currencies for tax purposes. For this reason, the federal government will restrict tax payments to be made in dollars. We recall that Gresham’s law will not fade away that easily.  

Aside from taxation, non-dollar denominated currencies would not be prohibited in any sense. The competition of currencies in the market should be encouraged, and is the central tenet of a free banking regime. All other voluntary transactions can be denominated in whatever currency is preferred by the agents involved in said transactions. 

It is not acceptable to criticize the Fed’s existence without having an idea of how a post-Fed economy would come into fruition, let alone function. There are numerous complications in this transition, but that should not be a deterrent for advocates of monetary reform. Through careful, pragmatic changes, only then can we envision a future without the Federal Reserve.