# Free Banking ## Metadata * Author: [Larry Sechrest and Kevin Dowd](https://www.amazon.comundefined) * ASIN: B005GQNHL2 * Reference: https://www.amazon.com/dp/B005GQNHL2 * [Kindle link](kindle://book?action=open&asin=B005GQNHL2) ## Highlights The position taken by advocates of free banking is that no amount of tinkering with the present system will suffice. They insist that only a fundamental change in the banking structure can solve the monetary problems faced by the United States or any nation. — location: [460](kindle://book?action=open&asin=B005GQNHL2&location=460) ^ref-62709 --- central banking and legal tender laws go hand-in-hand. Moreover, “a central bank is not a natural product of banking development. It is imposed from outside or comes into being as the result of Government favours” — location: [473](kindle://book?action=open&asin=B005GQNHL2&location=473) ^ref-48794 --- money. For a “money producer” (a free bank), however, the firm’s product trades against goods and services, not money. Thus, for such firms, marginal cost and marginal revenue must be measured in terms of goods and services rather than in money terms. If the price of money is its purchasing power, it cannot be otherwise. — location: [976](kindle://book?action=open&asin=B005GQNHL2&location=976) ^ref-3595 Interesting perspective but I don't buy it because their revenue is not in goods. --- it is relative prices that guide actors in their allocative decisions in the market. What prices do is allow actors to coordinate their actions . . . prices reflect and convey knowledge . . . competition allows this knowledge to be passed in the market through acts of buying and selling. . . . What economies “do” is coordinate actions through prices. With this view, it is easy to see why macroeconomic problems are really microeconomic problems. (1988, 32) — location: [1423](kindle://book?action=open&asin=B005GQNHL2&location=1423) ^ref-3948 --- Keynes’s essential complaint is actually against not an oversupply of goods but an undersupply of money. . . . Keynes’s complaints should not have been directed against Say’s Law and the market per se, but against central banks. . . . Keynesian concerns are, at best, valid only in the absence of monetary competition. — location: [1571](kindle://book?action=open&asin=B005GQNHL2&location=1571) ^ref-18571 --- Business cycles begin with an increase in the money supply such that the money supply exceeds money demand at the existing level of prices. As moneyholders spend their excess cash balances, prices rise. If the resulting actual rate of inflation exceeds the expected rate of inflation forecast by workers, then real wage rates fall, the demand for labor rises, and unemployment declines below the natural rate — location: [1585](kindle://book?action=open&asin=B005GQNHL2&location=1585) ^ref-43580 --- What is being overlooked in the celebration of the retreat from state socialism is the fact that the thirst for planning continues to afflict many politicians, bureaucrats, and economists. The species socialism may be dead, or at least gravely ill, but the genus collectivism is alive and well. — location: [1738](kindle://book?action=open&asin=B005GQNHL2&location=1738) ^ref-43389 --- In short, the advocates of a centrally dictated monetary policy are in one sense too modest. To advocate such nominally noncomprehensive planning is, in fact, tantamount to proposing that there be bureaucratic influence upon the great majority of economic events. In another sense, they are, perhaps, too boastful. They seem always to assume that the relevant economic knowledge is (or will be) available to the monetary authorities. The intent of this chapter is to argue that central banks are not only unwilling, but also—and this is the more radical proposition—unable to follow a rational monetary policy. — location: [1750](kindle://book?action=open&asin=B005GQNHL2&location=1750) ^ref-21398 --- It will be shown that, no matter what its incentives may be, no monetary authority can possess the economic knowledge it would have to have in order to maintain monetary equilibrium. — location: [1758](kindle://book?action=open&asin=B005GQNHL2&location=1758) ^ref-30639 --- Electoral impatience, of course, is incompatible with meaningful economic reform, and in particular with a consistent anti-inflation policy. Political leaders who seek to apply policy in a consistent manner invariably lose out to “reflationists” and price controllers. Thus, anti-inflationary efforts are undermined at every turn over the long haul . . . once employment and productivity figures begin to appear. — location: [2066](kindle://book?action=open&asin=B005GQNHL2&location=2066) ^ref-51725 --- It would seem obvious that every intervention by a monetary authority distorts not only current conditions, but also individuals’ expectations of future conditions, and the more extensive the intervention, the more one finds that resources are diverted to learning about the interventionists rather than about market participants. — location: [2132](kindle://book?action=open&asin=B005GQNHL2&location=2132) ^ref-43395 --- If true economic knowledge is widely dispersed, at least partly tacit in nature, discovered by trial and error in a free market context, and both goal- and agent-specific, then central monetary authorities are confronted by an insurmountable obstacle. They attempt to aggregate data that cannot, when aggregated, represent meaningful economic knowledge, and, on the basis of that data, they undertake macroeconomic actions designed to achieve goals that (even when desirable) can only be attained at a microeconomic level. — location: [2136](kindle://book?action=open&asin=B005GQNHL2&location=2136) ^ref-59756 --- To compare the decentralized adjustment mechanisms of free banking to the tools of central bank policy is something akin to placing a scalpel rather than a blunt instrument in the hands of a surgeon. The typical central bank tools—changes in legal minimum reserve ratios, changes in the discount rate, and open market purchases or sales of government securities—are creatures of aggregation. As such, they attempt to correct at the national level what may only be an imbalance at the local level. — location: [2150](kindle://book?action=open&asin=B005GQNHL2&location=2150) ^ref-13750 --- Public-choice theory seems to present an irrefutable argument that central banks are either rent-seekers or the agents of those who seek political rents. To aim for monetary equilibrium at all times would be to forgo such rents. — location: [2170](kindle://book?action=open&asin=B005GQNHL2&location=2170) ^ref-11996 --- There appear to have been at least sixty episodes of approximate free banking, that is, cases where banks were allowed to issue their own notes (Dowd 1992, 2). — location: [2273](kindle://book?action=open&asin=B005GQNHL2&location=2273) ^ref-9358 --- White declares that “Scotland’s per capita income was no more than half that of England’s in 1750 but nearly equal it by 1845” — location: [2294](kindle://book?action=open&asin=B005GQNHL2&location=2294) ^ref-51977 --- First of all, one needs to realize that the one-pound note of 1765 had roughly the purchasing power of $180–$200 in the United States today. — location: [2703](kindle://book?action=open&asin=B005GQNHL2&location=2703) ^ref-31027 No notes under 100 dollars, doesn't make for a useful money. --- Scottish banks were systematically excluded from competition by means of notes for the business of those whose currency needs were relatively small in scale. — location: [2708](kindle://book?action=open&asin=B005GQNHL2&location=2708) ^ref-27526 --- However, on closer inspection, one finds some serious flaws in the Scottish system. The failure rate (1772–1830) for Scottish banks was not lower than that for English banks. Banknotes were not consistently convertible into specie on demand. The prohibition of small-denomination notes not only curtailed mutually beneficial transactions between banks and their customers, but also may have diluted the constraints on overissue. The Usury Law limited competition in credit markets. The three chartered banks held privileged positions within the system, and Scotland seems to have avoided neither the inflation nor the numerous crises that plagued the English.24 Doubts about White’s interpretation of the Scottish experiment with free banking seem justified. — location: [2793](kindle://book?action=open&asin=B005GQNHL2&location=2793) ^ref-25913 --- In summary then, the conventional critique of American free banking is that (1) the multiplicity of notes led to fraud, with consumers often accepting at face value notes that were redeemable—if at all—at a fraction of that face value; (2) short-lived “wildcat”4 banks established by unscrupulous persons were commonly encountered; (3) there were high rates of bank failure with concomitantly large losses to noteholders; (4) the system more likely hindered than fostered economic development via the allocation of financial capital; and (5) free banking was both highly inflationary and highly unstable, for example, conducive to indiscriminate bank panics that had negative spill-over effects on real variables. As will be seen, each of these charges has been subjected to criticism by recent researchers. What emerges is a very different image. Free banking in the United States—though certainly blemished—was far less chaotic than has been believed. Moreover, the imperfections that did exist were largely the result of regulatory restrictions. — location: [2885](kindle://book?action=open&asin=B005GQNHL2&location=2885) ^ref-15353 --- they uncover substantial evidence that supports their theory regarding the source of free-bank failures. Plotting bond prices and bank failures, they observe that by “examining the data on below par failures during 1852–1863 for New York, Indiana, and Wisconsin, it can be seen that all but two of the 59 below par failures occur in” periods of substantial declines in the prices of bonds — location: [3051](kindle://book?action=open&asin=B005GQNHL2&location=3051) ^ref-15130 --- they conclude that free-bank failures were due not to fraud, but to the legal requirements that notes be backed by state bonds and notes be redeemed on demand in specie. The first imposed an unnecessarily risky portfolio on free banks; the second prevented free banks from — location: [3055](kindle://book?action=open&asin=B005GQNHL2&location=3055) ^ref-11042 --- The lesson from Minnesota’s free-banking period is potentially very important. Here was a newly formed, frontier state with a largely rural populace. Despite this, it proved impossible to circulate free-bank notes at par value when they were backed by risky assets. This suggests that laissez-faire banking is not necessarily plagued by an informational asymmetry that encourages fraud. The significance of such evidence lies in the fact that many apologists for central banking base part of their case on the assumption that such asymmetries are universal and ineradicable. — location: [3094](kindle://book?action=open&asin=B005GQNHL2&location=3094) ^ref-23532 --- in the West (everything from Ohio to the Pacific Ocean), the source of the people’s enthusiasm for free banking was “that they perceived serious difficulties with allocations of bank capital achieved under state owned or state chartered banking systems” (Rockoff 1975, 50). The states in which such difficulties had manifested themselves included Indiana, Tennessee, Ohio, and Missouri — location: [3131](kindle://book?action=open&asin=B005GQNHL2&location=3131) ^ref-21833 --- Kentucky and Indiana, he finds “high” bank profit rates prior to the introduction of free banking. More telling are the data for Ohio. There profit rates fall significantly as soon as free banking is adopted, suggesting a more competitive market. — location: [3139](kindle://book?action=open&asin=B005GQNHL2&location=3139) ^ref-55502 --- the total losses to noteholders in the state of New York from 1838 to 1861 as $398,336 (1903, 137–38). Conant helpfully adds that the total note circulation in New York during that time period was approximately $314 million (1927, 375). This represents an average loss per dollar held of a minuscule 0.127 percent. New York did indeed have one of the best free-banking systems—of that there is no doubt. Nevertheless, such small losses seem utterly incongruous in the context of the usual image of free banking. Moreover, this just deals with nominal balances. Over the 1838–1860 period, the purchasing power of each dollar in the United States rose, on average, by 15.6 percent.13 In other words, in New York noteholders on average experienced a net gain in terms of real balances, despite the losses resulting from free-bank failures. For a modern comparison, one may look at the 1968–1990 period. Federal Reserve noteholders suffered losses in purchasing power of almost 75 percent over that span,14 and that does not take into account the enormous cost to taxpayers of closing insolvent financial institutions. — location: [3152](kindle://book?action=open&asin=B005GQNHL2&location=3152) ^ref-65247 --- one should not overlook the fact that the prime financial center of the United States—New York30—was in a state that had an excellent free-banking system that had been in operation since 1838. It would seem plausible that free banking did come to dominate the American monetary system between 1850 and 1860. — location: [3412](kindle://book?action=open&asin=B005GQNHL2&location=3412) ^ref-59814 --- Overall, one might say that according to the Friedman and Schwartz series, free banking exhibited relatively less short-run stability and relatively more long-run stability than with the Hepburn and Temin series. — location: [3806](kindle://book?action=open&asin=B005GQNHL2&location=3806) ^ref-23681 --- The most likely form of free banking in the future—and the only form that has existed in the past33—is that which issues inside money redeemable in some commodity, usually gold. In such a context, the stability of the commodity base is an attribute of free banking itself. — location: [4215](kindle://book?action=open&asin=B005GQNHL2&location=4215) ^ref-26093 --- the American experiment with free banking was not a pure test of the application of laissez-faire principles to banking. Be that as it may, and assuming the data are reasonably accurate, it appears that American free banking was indeed consistent with a significant degree of (particularly long-run) macroeconomic stability, contrary to popular belief. — location: [5634](kindle://book?action=open&asin=B005GQNHL2&location=5634) ^ref-40513 --- Neither the Scottish nor the American episode of free banking was a case of true laissez-faire banking. They were only approximations to the model. — location: [5725](kindle://book?action=open&asin=B005GQNHL2&location=5725) ^ref-61285 --- White explains that restrictions on branching not only prevent banks from holding properly diversified asset portfolios, but they also affect banks’ liabilities. This follows from the fact that “a branched bank is less susceptible to random withdrawals or even runs by depositors in any area because it has a broad source of deposits (it can rely on the law of large numbers) and can transfer reserves from surplus to deficit branches. — location: [5858](kindle://book?action=open&asin=B005GQNHL2&location=5858) ^ref-22785 --- to limit banks’ ability to branch is to encourage the formation of banks that are small, inefficient, poorly diversified, undercapitalized, and unstable — location: [5871](kindle://book?action=open&asin=B005GQNHL2&location=5871) ^ref-57651 --- It is obvious from the above that American free banks were burdened with important restrictions and, thus, did not constitute a pure laissez-faire banking system. — location: [5926](kindle://book?action=open&asin=B005GQNHL2&location=5926) ^ref-18811 --- The RM model is clearly inferior. The best that can be said for the RM model is that in the long run, it is noninflationary. It does not, for example, allow for any ready response to consumer demand. — location: [6137](kindle://book?action=open&asin=B005GQNHL2&location=6137) ^ref-29874 A 100% gold backed currency has many drawbacks. At a fundamental it is anti debt & anti promises. --- The only way in which an inflated currency can remain in circulation is to have its use mandated by law—to pass legal tender laws. Inflation is far more likely under central banking than under free banking for that reason. — location: [6588](kindle://book?action=open&asin=B005GQNHL2&location=6588) ^ref-59191 --- “the Federal Reserve was designed to act as a government-sponsored and -enforced cartel promoting the income of banks by preventing free competition from doing its constructive work on behalf of the consumer” — location: [6714](kindle://book?action=open&asin=B005GQNHL2&location=6714) ^ref-34615 --- It is no accident that the twentieth century—the “century of collectivism”—is also the century in which central banking became the norm. Richard Wagner sums these points up neatly when he argues that “the support for central banking seems more likely to be explained by the economic theory of rent-seeking than by the theories of market failure and public goods” — location: [6724](kindle://book?action=open&asin=B005GQNHL2&location=6724) ^ref-63396 --- Finally, detailed investigations should be undertaken into the nature and performance of free banking in such other countries as France, Canada, Sweden, Switzerland, China, Australia, New Zealand, South Africa, Spain, and Italy (Selgin 1988a, 7–12). This work has already begun (see, for example, Selgin 1987; Jonung 1989; and Dowd 1992). — location: [6861](kindle://book?action=open&asin=B005GQNHL2&location=6861) ^ref-47311 --- Richard Wagner is closer to the mark when he argues that “those who are interested in monetary reform should recognize that the circumstances they are concerned about reflect the outcome of people’s pursuit of their interests within our existing constitutional order. Monetary reform without political reform to redress the rent-seeking excesses of prevailing political institutions seems likely to be a short-lived aberration” — location: [6879](kindle://book?action=open&asin=B005GQNHL2&location=6879) ^ref-29218 --- Until the pervasive addiction to the welfare state has ended and a belief in laissez-faire capitalism has taken root, free banking may remain a political impossibility. The implementation of free banking could prove to be a task that is as much philosophical as it is technical. — location: [6884](kindle://book?action=open&asin=B005GQNHL2&location=6884) ^ref-17473 --- as long as money remains a tool of the state, that tool will continue to serve the state as a well-spring of income redistribution, social engineering, and military adventurism. A laissez-faire approach to money and banking is more than merely conducive to efficiency and stability. It is likely to prove to be the necessary precondition for prosperity, justice, and peace. — location: [6890](kindle://book?action=open&asin=B005GQNHL2&location=6890) ^ref-20918 ---