During times of panic, how did the free market deal with the problems of bank suspensions and hoarding? Did the market just collapse and wait for the government to rescue the economy? Or did it deal effectively with these problems? FULL ARTICLE by Clifford F. Thies
Source link: http://archive.mises.org/13132/the-economics-of-depression-scrip/
The Economics of Depression Scrip
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This was a fascinating article. Scips are hardly ever mentioned in most history books, especially those distributed in public schools. When alternative currencies threaten the status quo, government steps in.
Interesting article! Another example of trying to regulate natural human nature which almost always backfires.
Here’s another amazing instance of Scrip, and with the typical State Socialist response and tragic consequences:
http://en.wikipedia.org/wiki/Local_currency
The Wörgl Experiment
The Wörgl experiment that was conducted from July 1932 to November 1933 is a classic example of the potential efficacy of local currencies. Wörgl, a small town in Austria with 4000 inhabitants, introduced a local scrip during the Great Depression. By 1932 unemployment in Wörgl had risen to 30%. The local government had amassed debts of 1.3 million Austrian schillings (AS) against cash reserves of 40,000 AS. Local construction and civic maintenance had come to a standstill. On the initiative of the town’s mayor, Michael Unterguggenberger, the local government printed 32,000 in labor certificates which carried a negative 1% monthly interest rate and could be converted into schillings at 98% of face value. An equivalent amount in schillings was deposited in the local bank as cover for the certificates in case of mass redemption and earned interest for the government. The certificates circulated so rapidly that only 12,000 were ever actually put into circulation. According to reports by the mayor and economists of the day who studied the experiment, the scrip was readily accepted by local merchants and the local population. It utilized the scrip to carry out 100,000 AS in public works projects involving construction and repair of roads, bridges, tanks, drainage systems, factories, and buildings. The scrip was also accepted as legal tender for payment of local taxes. In the one year that the currency was in circulation, it circulated 13 times faster than the official shilling [citation needed] and served as a catalyst to the local economy. The heavy arrears in local tax collection declined dramatically. Local government revenue rose from 2,400 AS in 1931 to 20,400 in 1932. Unemployment was eliminated, while it remained very high throughout the rest of the country. No increase in prices was observed. Based on the dramatic success of the Wörgl experiment, several other communities introduced similar scrips.
In spite of the tangible benefits of the program, it met with stiff opposition from the regional socialist party and from the Austrian central bank, which opposed the local currency as an infringement on its powers over the currency. As a result the program was suspended, unemployment rose, and the local economy soon degenerated to the level of other communities in the country.[1][2]
Absent government caused panics I’d think scrip would only likely ever be used in the case of huge supply shocks to the economy that cause a loss of confidence. Does Mises speak on the matter of scrip use during these periods?
This article was very interesting.
For more on the fear of deflation and the Krugman’s babysitter co-op see here:
http://mises.org/journals/qjae/pdf/qjae6_4_2.pdf
I continue to read about local scrip schemes (à la The Wörgl Experiment) and am fascinated by them. They “work”, of course, by forcing users of the scrip to spend locally which, in the short run, would certainly tend to increase a town’s business. The drawback, which is never mentioned by promoters, is that there can be no saving of the scrip as it decreases in value by design. Without saving, there can be no capital accumulation and, alas, the local economy is destined to stagnation.
Something Paul Krugman, with his damnable baby-sitting certificates, obviously never worried about. In fact, I’m sure he considered it a feature and not a bug.
Exactly, something that is apparent within about 3/4 of a second of reading the quoted paragraph from that Wikipedia entry. Amazing that people continue to believe that working inside the system designed to deprive them of their wealth either speedily or less speedily (in a Hegelian dialectic!) somehow allows them to do win.
Gernot,
The Wogle experiment is NOT working within the system. The system was a centrally controlled, Socliast run central bank. This was a LOCAL revolt. No, they didn’t set up a Rothbardian paradise Forgive them for their lack of imagination in 1932 Austria. The system of 1932 Austria was NOT local govenrmnet rule, but a highly centralized rule that repeatedly rejected the rights of local communities to govern themselves.
Craig,
I agree that there is no long run savings with the scrip. Where does it say that this local community saw Scrip as a long term solution? They were just trying to deal with a problem the Socialist central bank created. Had the Austrian central bank NOT intervened, what would have been the outcome? Mises has the answer, of course. The community would have moved away from unbacked scrip and moved towards a sound money as soon as they desired to increase their savings. Unfortunately, the bank intervened.
Great examples! I wonder if these scrip experiments would be condemned by the Austrian anti-fractional reserve and “Money out of thin air” crowd.
Indeed. What is the instrinic value of the scrip? Chances are it’s made of paper and ought to return to its native value.
Again, I think this article perfectly illustrates how some quantities of money are better than others, in other words that there is an optimal money supply.
Seems to me the babysitter coop could have had stumbled on a common treatment for a depression: price reduction. If I were a member, I could offer babysitting services for half a chit. I would sit twice for one full chit. If I dropped my price by 75%, I could babysit for one quarter of a chit, or a chuarter. If the price was forced down like this, there would be no need for the creation of new chit. In fact, the creation of new chit did reduce prices, but it was invisible due to the inflation. Had the real price dropped, it would have had the same effect and would have occurred naturally. In other words, the fear of deflation is translated to the fear of falling prices, which is not the same. In a depression, as prices fall, reserve cash is now worth more in a trade, and the desire for hoarding is satisfied. I can buy the same sitting services and maintain a 75% reserve.
The problem therefore with the chits is that they failed one of the basic tests of money: they were not easily divisible. Had they produced the proper currency and let markets work, the coop would have been just fine.
To draw the lesson that Krugman does is particularly dangerous. In his baby sitter coop there was only one price: the price of sitting for one night. But modern economies are vastly more complex, and prices are relative to one another. If you increase the amount of chit in a real economy, you distort relative prices. This creates bubbles. I you want to see a fun illustration of this, stick a straw in a glass of soapy water and blow your new money into the liquid economy. If you added air evenly to the surface, no bubbles. But if you inject it into one spot, bubbles galore (by the way, a great way to explain this to kids). The Fed adds money through a straw. If the babysitter coop had given all the new chits to one person, the effect would have been price inflation. Unfortunately, the one with the new chits first would benefit most.
If Krugman’s babysitter coop had actually been a market, it would have been fine. But it was designed by a “central planner” who developed the chit. This badly conceived policy caused the problem, not hoarding. It is actually a great illustration for ending the Fed!
I like this bubble experiment, but I don’t understand what you mean by adding air evenly to the surface. I would like to do this for one of my classes.
If it were possible fro the Fed to distribute new money evenly, it would be like the blowing on the surface. Friedman’s helicopter.
Another point: the coop engaged in price fixing. Each night of baby sitting cost one chit. It is not a surprise that there where shortages.
Another problem with his babysitting coop analogy is that there is no structure of production. The only thing people spend their ‘chits’ on is babysitting hours, and its simply assumed that everybody has the necessary equipment for babysitting(dipers, toys, baby food, etc).
A ‘better’ analogy would be that everybody in the coop buys one good, and everybody buys any other goods from within the coop with their ‘chits.’
But of course Krugman would never use this analogy, because it wouldnt resemble his understanding of the economy, but rather would be closer to Murphy’s ‘Sushi economy’
Although it’s already been partially addressed above, I think the real problem with the babysitting “chits” is that they were value-inelastic. If the willingness to offer goods for money in a free market is increased, relative to the supply of money, the price of goods will go down (ie, money becomes more valuable). The opposite will occur if people are selling less goods. This allows any quantity of money to serve sufficiently to accomodate exchanges in an economy of any size. By contrast, the value of the “chits” was fixed in terms of services, so if people were more willing to offer babysitting services, the value of the chits (in terms of babysitting services) would not rise, and there would be a shortage of “money” (chits). Similarly, if they had found that everyone wanted to spend chits on babysitting services and no one wanted to accumulate them, then there would be a surplus of “money”.
Agreed. I have never had a problem securing babysitting on the free market. I just pay cash. It was a failure of planning and price controls. I have even gotten babysitting through barter with neighbors.
Although the issuance of scrip by private banks is certainly an interesting example of how free markets cope with monetary panics, it seems like people would only accept scrip if they were denied the alternative of redeeming their banknotes in gold or silver-in other words, if the banks suspended payments in specie, in violation of their contracts. This seems, therefore, to be at best a second-rate solution to simply removing the ability of banks to suspend payment without a pre-existing contractual agreement allowing them to do so (which most people probably wouldn’t agree to except with the provisos that the suspension would be temporary and that the bank would pay some penalty to compensate their note and deposit holders for the inconvenience). Such a requirement would, at the very least, encourage higher reserve ratios (and hence less monetary expansion and contraction), or lead to outright full-reserve banking.
Aren’t that clearinghouse-issued “chits” some kind of privately produced money, hence something very similar to Fractional Reserve Banking?
Come on, Robert Murphy et al., start whining about this article!
It occurs to me that, in my recounting of the history of bank clearinghouse certificates and other forms of depression scrip, I did not intend to endorse any particular kind of scrip. While almost the entire mass of the scrip to which I referred was redeemable in what was passing as dollars at the time, I did mention one form that was redeemable in commodieis. Certificates redeemable in actual goods and serices would seem the best; e.g., redeemable for 1 dollar or 1 bushel of corn or 1 hour of yard work (something like this was stated on a local currency issued by Josiah Warren’s “anarchist” expierment of Modern Times, on Long Island. I realize that some Austrians believe that gold is money, but, speaking for myself, while I respect Sir Isaac Newton as a physicist, I don’t think his mistake is advising the Queen to fix the exchange rate of gold into silver, at a price that turned out to overvalue gold and so drove out silver via Gresham’s Law, should hold much sway any longer. Mises said gold became money because government screwed things up when trying to make bimetallism work. He supported gold, through the 1960s, because it was a symbol of 19th century economic liberalism. It is a factual matter as to whether this symbolism is still current or whether a different commodity or set of commodies would come to be money if the market were, nowadays, to decide the matter.
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The Long Depression was a worldwide economic crisis experienced in the latter half of the Victorian era. The Long Depression was felt most heavily in Europe and the United States, which had been experiencing strong economic growth fueled by the Second Industrial Revolution and the conclusion of the American Civil War. At the time, the episode was labeled the Great Depression, and held that title until the Great Depression of the 1930s. Though a period of general deflation and low growth began in 1873, it did not have the severe “economic retrogression [and] spectacular breakdown” of the latter Great Depression
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