Free banking

Last updated

Free banking is a monetary arrangement where banks are free to issue their own paper currency (banknotes) while also being subject to no special regulations beyond those applicable to most enterprises.

Contents

In a free banking system, market forces control the total quantity of banknotes and deposits that can be supported by any given stock of cash reserves, where such reserves consist either of a scarce commodity (such as gold) or of an artificially limited stock of fiat money issued by a central bank.

In the strictest versions of free banking, however, there is either no role at all for a central bank, or the supply of central bank money is supposed to be permanently "frozen". There is, therefore, no government agency acting as a monopoly "lender of last resort", leaving that to the private sector as happened in the US in the panic of 1907. Nor is there any government insurance for banknotes or bank deposit accounts. [1]

Notable supporters include Milton Friedman, [2] Fred Foldvary, [3] David D. Friedman, [4] Friedrich Hayek, [5] George Selgin, [6] Steven Horwitz, [7] and Richard Timberlake. [8]

History

Banking has been more regulated in some times and places than others, and in some times and places it has hardly been regulated at all, giving some experiences of more or less free banking. Free banking systems have existed in more than 60 countries. The first system of competitive issuance of notes began more than 1,000 years ago in China (see below). Free banking was widespread in the 19th and early 20th centuries. Dowd, Kevin, ed. (1992), The Experience of Free Banking, London: Routledge lists the most currently known episodes of free banking and discusses in some depth a number of them, including Canada, Colombia, Fuzhou, France, and Ireland. Monetary arrangements with monopoly issues of notes, including government treasury issues, currency boards, and central banking, replaced all episodes of free banking by the mid-20th century. There were several reasons for the demise of free banking:

Some prominent 18th and 19th century economists, most notably Adam Smith, [9] defended free banking as opposed to the real bills doctrine. [10] After the mid 19th century, though, economists interested in monetary issues focused their attention elsewhere, and free banking received little attention. Free banking as a subject of renewed debate among economists got its modern start in 1976 with The Denationalization of Money , by economist Friedrich Hayek, who advocated that national governments stop claiming a monopoly on the issuing of currency, and allow private issuers like banks to voluntarily compete to do so.

In the 1980s, this expanded into an increasingly elaborate theory of free market money and banking, with proponents Lawrence White, George Selgin, and Richard Timberlake increasingly centering their writing and research around the concept, either regarding modern theory and application, or researching the history of spontaneously free banking.

Australia

In the late 19th century, banking in Australia was subject to little regulation. There were four large banks with over 100 branches each, that together had about half of the banking business, and branch banking and deposit banking were much more advanced than in other more regulated countries such as the UK and US. Banks accepted each other's notes at par. Interest margins were about 4% p.a. In the 1890s a land price crash caused the failure of many smaller banks and building societies. Bankruptcy legislation put in place at the time gave bank debtors generous terms they could restructure under, and most of the banks used this as a means to restructure their debts in their favor, even though they did not really need to.[ citation needed ]

Switzerland

In the 19th century, several Swiss cantons deregulated banking, allowing free entry and the issue of notes. [11] Cantons retained jurisdiction over banking until the enactment of the Federal Banking Law of 1881. The centralisation of note issue reduced the problem of the existence of "a bewildering variety of notes of varying qualities ... at fluctuating exchange rates." [12]

Scotland

Scottish free banking lasted between 1716 and 1845, and is arguably the most researched and developed instance of free banking. [13] The system was organized around three chartered banks – the Bank of Scotland, the Royal Bank of Scotland, and the British Linen Company – and numerous unchartered banks. It resulted in a highly stable and competitive banking system. [14] [15]

United States

Although the period from 1837 to 1864 in the US is often referred to as the Free Banking Era, the term is a misnomer in terms of the definition of "free banking" above. Free Banking in the United States before the Civil War refers to various state banking systems based on what were called "free banking" laws at the time. These laws made it necessary for new entrants to secure charters, each of which was subject to a vote by the state legislature with obvious opportunities for corruption. These general banking laws also restricted banks' activities in important ways. [16] [17] [18] [19] Most importantly, US free banks could have only one office and had to provide security for their notes not only through gold reserves but also by purchasing and surrendering to state banking authorities certain securities the state law deemed acceptable for the purpose. The securities generally included bonds of state governments. The depreciation of these bonds was the chief cause of bank failures in various episodes when many banks in a state failed. The lack of branch banking, in turn, caused state-issued banknotes to be discounted at varying rates once they had traveled any considerable distance from their sources, which was an inconvenience. Depreciation of assets more generally is also used to explain failures. [20] Several authors attribute the high-rate of bank failures during the Free Banking era in the US ultimately to restrictions on banks' portfolios of assets. [21] [22] Then, from 1863 to 1913, known as the National Banks Era, state-chartered banks operated under a free banking system. Some scholars have found that the system was mostly stable compared to the National Banks of that era. [23]

Sweden

Sweden had two periods of free banking, 1830–1860 and 1860–1902. Following a bank crisis in 1857, there was a rise in popular support for private banks and private money issuers (especially Stockholms Enskilda Bank, founded in 1856). A new bank law was adopted by parliament in 1864, deregulating the interest rate. The following decades marked the height of the Swedish free banking era. After 1874, no new private banks were founded. In 1901, issuing of private money was prohibited. Research on the Swedish free banking era suggests stability, and a single bank failure related to fraud in 70 years. [24] [25]

China

Jiaozi was a form of banknote that appeared around the 10th century in the Sichuan capital of Chengdu, China. Between 960 and 1004, the bank notes were totally run by private merchants. Until the government decided to regulate the business due to alleged increasing fraud cases and disputes, it granted 16 licenses to the biggest merchants of all. [26]

See also

Related Research Articles

A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a system of money in common use within a specific environment over time, especially for people in a nation state. Under this definition, the British Pound sterling (£), euros (€), Japanese yen (¥), and U.S. dollars (US$) are examples of (government-issued) fiat currencies. Currencies may act as stores of value and be traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are either chosen by users or decreed by governments, and each type has limited boundaries of acceptance; i.e., legal tender laws may require a particular unit of account for payments to government agencies.

<span class="mw-page-title-main">Gold standard</span> Monetary system based on the value of gold

A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the late 1920s to 1932 as well as from 1944 until 1971 when the United States unilaterally terminated convertibility of the US dollar to gold, effectively ending the Bretton Woods system. Many states nonetheless hold substantial gold reserves.

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but sudden deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e., when inflation declines to a lower rate but is still positive.

<span class="mw-page-title-main">Money supply</span> Total value of money available in an economy at a specific point in time

In macroeconomics, the money supply refers to the total volume of money held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. Money supply data is recorded and published, usually by the national statistical agency or the central bank of the country. Empirical money supply measures are usually named M1, M2, M3, etc., according to how wide a definition of money they embrace. The precise definitions vary from country to country, in part depending on national financial institutional traditions.

<span class="mw-page-title-main">Monetary reform</span> Movements to amend the financial systeem

Monetary reform is any movement or theory that proposes a system of supplying money and financing the economy that is different from the current system.

<span class="mw-page-title-main">Fractional-reserve banking</span> System of banking

Fractional-reserve banking is the system of banking operating in almost all countries worldwide, under which banks that take deposits from the public are required to hold a proportion of their deposit liabilities in liquid assets as a reserve, and are at liberty to lend the remainder to borrowers. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. The country's central bank may determine a minimum amount that banks must hold in liquid assets, called the "reserve requirement" or "reserve ratio". Most commercial banks hold more than this minimum amount as excess reserves.

<span class="mw-page-title-main">Causes of the Great Depression</span> Overview of the causes of the Great Depression

The causes of the Great Depression in the early 20th century in the United States have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises and recessions. The specific economic events that took place during the Great Depression are well established.

This history of central banking in the United States encompasses various bank regulations, from early wildcat banking practices through the present Federal Reserve System.

<span class="mw-page-title-main">Criticism of the Federal Reserve</span>

The Federal Reserve System has faced various criticisms since it was authorized in 1913. Nobel laureate economist Milton Friedman and his fellow monetarist Anna Schwartz criticized the Fed's response to the Wall Street Crash of 1929 arguing that it greatly exacerbated the Great Depression. More recent prominent critics include former Congressman Ron Paul.

The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics about how business cycles occur. The theory views business cycles as the consequence of excessive growth in bank credit due to artificially low interest rates set by a central bank or fractional reserve banks. The Austrian business cycle theory originated in the work of Austrian School economists Ludwig von Mises and Friedrich Hayek. Hayek won the Nobel Prize in Economics in 1974 in part for his work on this theory.

The Independent Treasury was the system for managing the money supply of the United States federal government through the U.S. Treasury and its sub-treasuries, independently of the national banking and financial systems. It was created on August 6, 1846 by the 29th Congress, with the enactment of the Independent Treasury Act of 1846. It was expanded with the creation of the national banking system in 1863. It functioned until the early 20th century, when the Federal Reserve System replaced it. During this time, the Treasury took over an ever-larger number of functions of a central bank and the U.S. Treasury Department came to be the major force in the U.S. money market.

<span class="mw-page-title-main">Lawrence H. White</span> American economist

Lawrence Henry White is an American economics professor at George Mason University who teaches graduate level monetary theory and policy. He is considered an authority on the history and theory of free banking. His writings support the abolition of the Federal Reserve System and the promotion of private and competitive banking.

<span class="mw-page-title-main">George Selgin</span> American economist (born 1957)

George Selgin is an American economist. He is Senior Fellow and Director Emeritus of the Cato Institute's Center for Monetary and Financial Alternatives, where he is editor-in-chief of the center's blog, Alt-M, Professor Emeritus of economics at the Terry College of Business at the University of Georgia, and an associate editor of Econ Journal Watch. Selgin formerly taught at George Mason University, the University of Hong Kong, and West Virginia University.

Modern monetary theory or modern money theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. According to MMT, governments do not need to worry about accumulating debt since they can create new money by using fiscal policy in order to pay interest. MMT argues that the primary risk once the economy reaches full employment is inflation, which acts as the only constraint on spending. MMT also argues that inflation can be addressed by increasing taxes on everyone to reduce the spending capacity of the private sector.

<span class="mw-page-title-main">Money</span> Object or record accepted as payment

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment.

Monetary inflation is a sustained increase in the money supply of a country. Depending on many factors, especially public expectations, the fundamental state and development of the economy, and the transmission mechanism, it is likely to result in price inflation, which is usually just called "inflation", which is a rise in the general level of prices of goods and services.

<span class="mw-page-title-main">Fiat money</span> Currency not backed by any commodity

Fiat money is a type of currency that is not backed by a commodity, such as gold or silver. It is typically designated by the issuing government to be legal tender, and is authorized by government regulation. Since the end of the Bretton Woods system in 1971, the major currencies in the world are fiat money.

Richard Henry Timberlake Jr. was an American economist who was Professor of Economics at the University of Georgia for much of his career. He became a leading advocate of free banking, the belief that money should be issued by private companies, not by a government monopoly. He wrote about the Legal Tender Cases of the U.S. Supreme Court in his book Constitutional Money: A Review of the Supreme Court's Monetary Decisions.

The Denationalisation of Money is a 1976 book by Friedrich Hayek, in which the author advocated the establishment of competitively issued private moneys. In 1978 Hayek published a revised and enlarged edition entitled Denationalisation of Money: The Argument Refined, where he speculated that rather than entertaining an unmanageable number of currencies, markets would converge on one or only a limited number of monetary standards, on which institutions would base the issue of their notes.

The real bills doctrine says that as long as bankers lend to businessmen only against the security (collateral) of short-term 30-, 60-, or 90-day commercial paper representing claims to real goods in the process of production, the loans will be just sufficient to finance the production of goods. The doctrine seeks to have real output determine its own means of purchase without affecting prices. Under the real bills doctrine, there is only one policy role for the central bank: lending commercial banks the necessary reserves against real customer bills, which the banks offer as collateral. The term "real bills doctrine" was coined by Lloyd Mints in his 1945 book, A History of Banking Theory. The doctrine was previously known as "the commercial loan theory of banking".

References

  1. ↑ Selgin, George A.; White, Lawrence H. (1994). "How Would the Invisible Hand Handle Money?". Journal of Economic Literature. 32 (4): 1718–1749. JSTOR   2728792.
  2. ↑ Friedman, Milton (1987). "Has Government Any Role In Money?" (PDF).
  3. ↑ Foldvary, Fred E. (November 2008). "Free Banking Explained". The Progress Report. Archived from the original on 2009-08-11. Retrieved 2010-01-24.
  4. ↑ Friedman, David D. (1982-09-23). "Gold, Paper, Or...Is There a Better Money?". Policy Analysis No. 17. Cato Institute . Retrieved 2012-03-08.
  5. ↑ Hayek, Friedrich (1976). The Denationalisation of Money . Coronet Books. ISBN   978-0-255-36239-9.
  6. ↑ "Interview: George Selgin". Region Focus. Federal Reserve Bank of Richmond. Winter 2009. Archived from the original on 2012-02-22. Retrieved 2012-03-08.
  7. ↑ Horwitz, Steven (1992). Monetary Evolution, Free Banking, and Economic Order . Westview Press. ISBN   978-0-8133-8514-3.
  8. ↑ Timberlake, Richard; Dowd, Kevin (1998). Money and the Nation State. Transaction Publishers. ISBN   9781412828956.
  9. ↑ An Inquiry into the Nature and Causes of the Wealth of Nations (1776), Book II, chapter 2, final paragraph, p. 286.
  10. ↑ White, Lawrence H. (2015-09-16). "Free Banking Theory versus the Real Bills Doctrine". Cato Institute. Retrieved 2019-08-06.
  11. ↑ Briones, Ignacio; Rockoff, Hugh (August 2005). "Do Economists Reach a Conclusion on Free-Banking Episodes?". Econ Journal Watch. 2 (2): 279–324.
  12. ↑ Goodhart, Charles Albert Eric (1995). The Central Bank and the Financial System . MIT Press. p.  211. ISBN   9780262071673.
  13. ↑ White, Lawrence H. (1995). Free Banking in Britain: Theory, Experience and Debate 1800–1845. London: Institute of Economic Affairs. ISBN   978-0-255-36375-4.
  14. ↑ Kroszner, Randy (1995). "Free Banking: The Scottish Experience as a Model for Emerging Economies" (PDF). Policy Research Working Papers (1536). World Bank. doi:10.1596/1813-9450-1536.{{cite journal}}: Cite journal requires |journal= (help)
  15. ↑ White, Lawrence H. (1992), "Free Banking in Scotland before 1844", in Dowd, Kevin (ed.), The Experience of Free Banking, London: Routledge, pp. 157–186
  16. ↑ Ng, Kenneth (1988). "Free Banking Laws and Barriers to Entry in Banking, 1838-1860". The Journal of Economic History. 48 (4): 877–889. doi:10.1017/s0022050700006653. JSTOR   2121621. S2CID   155043151.
  17. ↑ Bodenhorn, Howard (1990). "Entry, Rivalry and Free Banking in Antebellum America". Review of Economics and Statistics. 72 (4): 682–686. doi:10.2307/2109610. JSTOR   2109610.
  18. ↑ Economopoulous, Andrew; O'Neill, Heather (1995). "Bank Entry during the Antebellum Period". Journal of Money, Credit and Banking. 27 (4): 1071–1085. doi:10.2307/2077790. JSTOR   2077790.
  19. ↑ Rockoff, Hugh (1991). "Lessons from the American Experience with Free Banking". In Capie, Forrest; Wood, Geoffrey Edward; Pepper, Gordon (eds.). Unregulated banking : Chaos or Order?. London: Macmillan. doi:10.3386/h0009. ISBN   978-0-333-52049-9.
  20. ↑ Rolnick, Arthur J.; Weber, Warren E. (1984). "The causes of free bank failures: A detailed examination". Journal of Monetary Economics. 14 (3): 267–291. doi:10.1016/0304-3932(84)90044-8.
  21. ↑ Dwyer, Gerald P. (1996). "Wildcat Banking, Banking Panics and Free Banking in the United States" (PDF). Federal Reserve Bank of Atlanta Economic Review. 81 (3–6): 1–20. Archived from the original (PDF) on 2015-09-07. Retrieved 2018-06-01.
  22. ↑ Calomiris, Charles W. (2010). "The Great Depression and Other 'Contagious' Events". In Berger, Allen N.; Molyneux, Philip; Wilson, John O. S. (eds.). The Oxford Handbook of Banking. Oxford University Press. pp. 693–710.
  23. ↑ Freixas, Xavier; Rochet, Jean-Charles (1997). Microeconomics of Banking. MIT Press. p. 261. ISBN   9780262061933.
  24. ↑ Hortlund, Per (2007). "The Provision of Liquidity in the Swedish Note Banking System, 1878–1901" (PDF). Scandinavian Economic History Review. 5 (1): 20–40. doi:10.1080/03585520701234258. S2CID   152530914.
  25. ↑ Lakomaa, Erik (2007). "Free Banking in Sweden 1830–1903: Experience and Debate" (PDF). The Quarterly Journal of Austrian Economics . 10 (2): 25–44. doi:10.1007/s12113-007-9012-4. S2CID   154076201.
  26. ↑ "JiaoZi and Iron Standard – Examining world's first documented paper money system from China with lenses of Austrian economics". Rothbardian Gold Price.

Bibliography

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.