Free banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency (banknotes). In a free banking system, market forces control the supply of 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 either is 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 agency capable of serving as a "lender of last resort" in the usually understood sense of the term. Nor is there any government insurance of banknotes or bank deposit accounts.
Supporters include Fred Foldvary, David D. Friedman, Friedrich Hayek, George Selgin, Lawrence H. White. Steven Horwitz, and Richard Timberlake.
History
The free banking movement got its modern start in 1977 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 Charles Timberlake increasingly centering their writing and research around the concept, either regarding modern theory and application, or researching the history of spontaneously free banking.
Banking has been more regulated in some times and places than others, and some times and places it has hardly been regulated at all, giving some experiences of more or less free banking. Dowd, Kevin, ed. (1992), The Experience of Free Banking, London: Routledge explores several of them, including Canada, Colombia, Foochow, France, and Ireland.
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 other more regulated countries such as the UK and USA. 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 didn't really need to.
Switzerland
In the 19th Century several Swiss cantons deregulated banking, allowing free entry and issue of notes. 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."
Scotland
Scottish free banking lasted between 1716 and 1845, and is arguably the most researched and developed instance of free banking. 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.
United States
Although the period from 1837 to 1864 in the U.S. is often referred to as the Free Banking Era, the term is something of a misnomer, for it refers not to a general system of "free" banking in the literal sense described previously, but rather to various state banking systems based on so-called "free banking" laws, which, though they made it unnecessary for new entrants to secure charters (each of which was subject to a vote by the state legislature), nonetheless restricted their undertakings in important ways. Most importantly, U.S. "free" banks were denied the right to establish branch networks, and had to "secure" their notes by purchasing and surrendering to state banking authorities certain securities those authorities deemed eligible for the purpose. The securities in many cases included bonds of the authorizing state governments themselves; and it has been determined that the depreciation of these very securities was the chief cause of "free bank" failures, and indeed of bank failures generally, during the period in question. 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. Depreciation of assets over this period is also used to explain failures. In fact, the high-rate of bank failures during the so-called "free banking era" in the U.S. are attributed by several authors to bank regulation. Then, from 1863 to 1913, known as the National Banks Era, state-chartered banks were operating under a free banking system. Some scholars have found that the system was mostly stable compared to National Banks of that era.
Sweden
Sweden had two periods of free banking, 1830-60 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 suggest stability, and a single bank failure related to fraud in 70 years.
Modern relevancy
In the early twenty-first century, the advent of electronic currencies such as the Bitcoin have renewed the question of private money.
See also
- Henry Meulen, author of Free Banking: An Outline of a Policy on Individualism, 1934
- Richard Salsman, author of Breaking the Banks: Central Banking Problems and Free Banking Solutions, 1990
Bibliography
- George Selgin. The Theory of Free Banking. Rowman & Littlefield Publishers, Inc., 1988. Print.
- Lawrence H. White. Competition and Currency: Essays on Free Banking and Money. New York University Press, 1992. Print.
References
External links
- Automatic Stabilizing Mechanisms Under Free Banking (pdf) by Kevin Dowd
- Mutual Banking (1974 reprint of 1946 Modern Publishing edition), Mutual Banking (1850 edition) by William Batchelder Greene
- Reinventing Money
- Walter Bagehot: Lombard Street: A Description of the Money Market (1873) Library of Economics and Liberty
- Friedrich A. Hayek: "The Use of Knowledge in Society" (1945) Library of Economics and Liberty
- George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue (1988) Library of Economics and Liberty
- William Batchelder Greene: Mutual Banking, 1974 reprint of 1946 Modern Publishing edition, 1850 edition
- Vera Smith: The Rationale of Central Banking (1936) Library of Economics and Liberty
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