Front Page Titles (by Subject) 1: Overview - The Theory of Free Banking: Money Supply under Competitive Note Issue
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1: Overview - George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue 
The Theory of Free Banking: Money Supply under Competitive Note Issue (Lanham, MD.: Rowman & Littlefield, 1988).
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That competition in production serves the interests of consumers, and that monopoly in production is opposed to those interests, is a maxim which has guided mainstream economic thought and policy since the days of Adam Smith. Most enterprises have been influenced by it. One exception, though, is the issue of currency. Only a handful of theorists objected to governments setting up privileged banks, with monopolies or quasi-monopolies in note issue, during the 17th, 18th, and 19th centuries, and fewer still took exception later on, as central banking—a supposedly conscientious version of monopolized currency supply—came to be viewed as an indispensable part of national monetary policy.
As a consequence of these developments, the theory and implications of unregulated and decentralized currency supply have been largely ignored. Indeed, central banking has been taken so much for granted that for many years no effort was made to examine alternative systems, even to show why they must fail. Lately, though, a new interest in unregulated or “free” banking with decentralized currency supply has surfaced, spurred on by the poor performance of central banks. F. A. Hayek’s pioneering work on Choice in Currency (1976) and his later monograph on Denationalisation of Money (1978) challenged the view that governments are more fit to provide media of exchange than private firms. This opened the gate to an entire new field of inquiry, to which there have already been numerous contributions. Most have been studies of the history of decentralized banking systems. The studies show that, of past systems involving decentralized currency issue, those that were least regulated actually worked rather well, whereas those that worked poorly were also not free from inhibiting regulations.1 By questioning the claim that free banking has failed in the past these studies justify renewed theoretical inquiry into its operational characteristics compared to those of central banking.
Purpose and Plan of This Study
The purpose of this study is threefold. Its principal aim is to advance the theoretical understanding of free banking. Despite recent and excellent empirical work, the theory of free banking is still more or less where it was when Vera Smith (1936) reviewed the literature on it. Second, it seeks to employ the theory of free banking in a critique of banking systems with monopolized currency supply, including all central banking systems. Finally, the study will suggest practical means for improving existing monetary and banking arrangements.
The sequence of chapters reflects this tripartite purpose. Chapters 2 through 6 offer a positive theory of free banking. The purpose of chapter 2, “The Evolution of a Free Banking System,” is to motivate and justify assumptions concerning the institutional make-up of free banking. These assumptions provide the framework for the rest of the study. Chapter 3 considers the limits to the expansion of free bank liabilities (inside money) when the demand to hold them is unchanging; it also discusses the special status of monopoly suppliers of currency that places them beyond the pale of the usual forces of control. Chapter 4 defends a particular view of monetary equilibrium, which serves as a criterion for evaluating the response (discussed in chapters 5 and 6) of a free banking system to changes in the demand for inside money. Chapters 7 and 8 contrast free banking to central banking, with a focus on their abilities to keep the quantity of money and currency at their equilibrium levels. Chapters 9 and 10 complete this comparison by examining some alleged shortcomings of free banking that central banking is supposed to avoid. Finally, chapter 11 looks at free banking as a practical alternative to other means of monetary reform; the chapter ends with a sketch of a plan for deregulating and decentralizing the existing mechanism of currency supply.
Throughout the study emphasis is placed on the distinctive, macroeconomic implications of free banking. Its microeconomic consequences, though not unimportant, are less controversial. In fact, the emphasis is even more narrow: as the subtitle indicates, the study concentrates on the macroeconomic implications of competitive note issue, free banking’s most distinct and unconventional feature. Other features, such as deregulated deposit banking (with payment of interest on checkable accounts), branch banking, use of special electronic means for transfer of funds, etc., have not only been extensively dealt with elsewhere but are currently being put to practice in existing banking systems around the world. Moreover, scholarly opinion decidedly favors deregulation in these areas.2 The competitive issue of currency—and of redeemable bank notes in particular—is, on the other hand, a relatively unfamiliar and unexplored possibility, and one that most economists dismiss. The reason for this is not far to seek: monopolization of the supply of currency is essential to modern central banking operations. Therefore, to consider this form of deregulation is to consider a radical restructuring or abandonment of conventional views on the conduct and necessity of centralized monetary policy. Such revisionism is far removed from the everyday concerns of money and banking theorists, who need to study arrangements as they find them. But it is precisely what the present investigation undertakes.
The argument is straightforward: nothing about free banking requires it to be approached with technical sophistication beyond what might be found in a graduate money and banking textbook. Money and banking professors might even assign this book to their students as a complement to standard theory. In fact, many of the theoretical arguments that appear in these pages should be familiar: what is new is the effort to put old concepts to work in examining a banking system with different institutional features. The reader needs to realize this. If he pays attention only to particular arguments (the trees), he might think little of what is being said is new or controversial. If, instead, he only pays attention to the conclusions (the forest), he might think that what is being said is not merely new but also the product of some new and bizarre reasoning.
The reader should also note that this book does not attempt to discuss the relative political merits of free versus central banking. There is much to be said in favor of deregulation and choice in currency as means for freeing the monetary system from political manipulation. Nevertheless this study seeks to explore the theoretical merits and demerits of free banking quite apart from any political considerations. Therefore, in discussing the operations of central banks, it generally assumes that they are governed solely in the interest of consumers. As a result, the argument must be somewhat biased in favor of centralized control, since it is assumed that free banks operate only for the sake of private profit.
The Historical Background
Although this study will look at free banking from a theoretical point of view, it will help to sketch briefly the history of central banking in various leading nations. Conventional wisdom holds that central banks were established, at least in large part, in response to defects of unregulated banking. Recent works that contradict this view have already been mentioned. The following survey highlights historical evidence from these and other sources.3
The Bank of England was established by King William III in 1694. It was designed to secure “certain recompenses and advantages . . . to such persons as shall voluntarily advance the sum of fifteen hundred thousand pounds towards carrying on the war with France.” In the age of mercantilism the granting of special privileges to business firms in exchange for financial assistance to the state, especially during wartime, was common. Yet in banking this pattern continued even into the twentieth century. The Bank of England followed it faithfully until 1826, routinely securing for itself additional monopoly privileges in addition to extensions of its charter. In 1697, in exchange for a loan of £ 1,001,071, it was given a monopoly of chartered banking, limiting competition to private bankers. In 1708, in return for a loan of £ 2,500,000, the Bank’s owners were rewarded by an act prohibiting joint-stock banks (private banks of six partners or more) from issuing notes. To extend its privileges through the remainder of the century the Bank made further, large loans to the government in 1742, 1781, and 1799. In 1826 it suffered its first setback: a campaign led by Thomas Joplin gained for joint-stock banks the right to engage in note issue and redemption outside a circle with its radius extending 65 miles from the center of London, where the Bank of England was headquartered. But this threat of competition was made up for in 1833 by a law officially sanctioning the use of Bank of England notes by “country” banks as part of their legal reserves and for use instead of specie for redeeming their own notes. This encouraged country banks to use Bank of England notes as high-powered money (a role the notes were already playing to a limited extent as a result of the Bank’s monopoly of London circulation), expanding the Bank’s power to manipulate the English money supply.
In the meantime the reputation of all note-issuing banks suffered as a result of the suspension of 1797-1821. It was further eroded by a crisis in 1826. The authorities clamoured for restrictions upon note issue, making no effort to distinguish the powers of the Bank of England from those of other less privileged note-issuing banks. The country banks thus shared the blame for overissues that originated in the policies of the Bank of England. The consequence was Peel’s Bank Act of 1844, which prohibited further extension of country-bank note issues while placing a 100 percent marginal specie-reserve requirement on the note issues of the Bank of England. The Bank Act eventually gave the Bank of England a monopoly of note issue, as the Bank assumed the authorized circulation of country banks when they closed. It also added to the rigidity of the system by increasing the dependence of country banks on the Bank of England for meeting their depositors’ increased demands for currency. Since the Bank of England was itself restricted in its ability to issue notes, the system was incapable of meeting any substantial increase in demand for currency relative to the demand for checkable deposits. For this reason the Bank Act had to be repeatedly suspended until the desirability of having the Bank of England free to function as a “lender of last resort” during “internal drains” of currency was made conspicuous in Bagehot’s Lombard Street (1874). When it formally acknowledged its special responsibilities the Bank of England became the first true central bank, the prototype for other central banks that would be established in nearly every nation on the globe.
If England’s was a model central banking system, then Scotland’s was its antithesis. From 1792 to 1845, Scotland had no central bank, allowed unrestricted competition in the business of note issue, and imposed almost no regulations on its banking firms. Yet the Scottish system was thought to be superior by nearly everyone who was aware of it. Its decline after 1845 was caused, not by any shortcoming, but in consequence of the unprovoked extension of Peel’s Act, which ended new entry into the note issue business in Scotland as well as England.4
From 1831 to 1902 Sweden also had a nearly unregulated free banking system (Jonung 1985). At the end of this period there were 26 note issuing private banks with a total of 157 branches. The note issues of these private banks competed successfully with those of the Riksbank (the bank of the Swedish Parliament) despite taxes and other restrictions imposed upon private notes and despite the fact that Riksbank notes alone were legal tender. One measure of the success of the Swedish private note-issuing banks is that, throughout their existence, none failed even though the government had an explicit policy of not assisting private banks in financial trouble. The system was also orderly in that there was an organized system of note exchange, with all notes accepted at par by the various banks. Finally, the absence of banking regulations in Sweden was crucial to its exceptionally rapid economic growth during the second half of the 19th century.5 In this private note issue played a major role, both as an instrument for marshalling loanable funds and as a means for promoting overall development and sophistication of the Swedish financial system. Still, despite its success, Swedish free banking was dismantled in stages beginning in 1901 when the government, resenting the loss of state revenue from reduced circulation of Riksbank notes, sought by means of regulations and offers of subsidies to restore to the Riksbank a monopoly of note issue. The private banks’ right to issue notes was formally abrogated in 1904.
Still another free-banking episode took place in Foochow, the capital of Fukien province, in mainland China.6 China went through numerous, disastrous experiences with reckless issues of government paper money, starting as early as the 9th century. At last the Ch’ing dynasty (1644-1911) decided to let note issue be an exclusively private undertaking, except for two brief, unsuccessful government issues during the 1650s and 1850s. In Foochow (and also in some other cities) local banks prospered under the Manchus, issuing paper notes redeemable (usually on demand) in copper cash and free from all government regulation.
Unlike government issues this private paper currency, which grew greatly in importance during the 19th century, was highly successful. Typically it did not depreciate, and it was widely preferred to bulky and non-uniform copper cash. Notes of larger banks circulated throughout Foochow at par, thanks to an efficient note-clearing system. Though smaller banks often failed, only one large local bank did so in the entire history of the industry. The large banks (of which there were 45 in the system’s last decades) commanded a high level of public confidence and respect.
The downfall of free banking in Foochow following the Republican revolution of 1911 was caused by the new central government’s restrictive regulations. These favored several very large, non-local or “modern style” banks which had given financial support to the revolutionaries. The Nationalists, when they gained power in 1927, were especially beholden to the modern banks (which issued silver-based monies) and favored them by prohibiting the issue of copper notes. At last, in 1935, the Nationalist government made notes of the three largest modern banks legal tender. The government eventually intended to give its greatest financial benefactor, the Central Bank of China, a monopoly of note issue. But its program was interrupted by the Japanese invasion of 1937, which caused it to concentrate on maximizing revenues from increased issues of legal tender. The consequence was yet another instance of paper money issued by the Chinese government becoming absolutely worthless.
Centralization of note issue in China was finally accomplished during the 1950s by the Communists, whose People’s Bank took over the branches of the Central Bank of China as well as offices of many remaining local banks. Though little information exists concerning the performance of the People’s Bank, what there is suggests that China continued long after the war to suffer from hidden inflation, disguised by an extensive system of official prices. Despite the general superabundance of money that this inflation implied, local communities also suffered from a shortage of convenient, small-denomination exchange media,7 such as had been well provided in Foochow during the non-inflationary, free-banking era.
In France merchants’ attempts to establish banking on a sound, competitive basis were repeatedly frustrated by the government’s desire to borrow money that it could not, or would not, repay. The spectacular failure of John Law’s Banque Royale in 1721, which had become a government bank three years before, prevented for half a century the establishment of any new bank of issue. In 1776 a new bank, the Caisse d’Escompte, was established to engage in commercial lending, but soon became involved in large loans to the state that caused it to suffer a liquidity crisis. The bank appealed to the Treasury to repay its most recent loan, but instead the government authorized a suspension of specie payments. The bank remained solvent, however, and when the government loan was repaid it resumed specie payments. After this, repeated forced loans to the state so entwined the bank with the government that it became, in effect, a branch of the Treasury. Its notes were made redeemable in Treasury assignats, which were made legal tender in 1790. The government soon sank into bankruptcy under a torrent of assignats, dragging the Caisse d’Escompte down with it.
Renewed attempts to establish banks of issue in the 1790s were defeated by Napoleon, who reacted to private banks’ refusal to discount government paper by establishing a rival institution, the Bank of France, in which he was also a shareholder. Support for the new bank, at first unimpressive, improved when one of the private banks decided to consolidate with it. Nonetheless Napoleon remained dissatisfied, and in 1803 he passed a law giving the Bank of France the exclusive privilege of issuing bank notes at Paris and forbidding the establishment of banks in other regions without official approval. This forced the Bank of France’s principal rival, the second Caisse d’Escompte, into merger with it. Finally, in 1806, the Bank of France was placed under formal government control, and in 1808 it was given an exclusive right of note issue in every town in which it established branches.
The fall of Napoleon led to the establishment, throughout the country, of local banks of issue. These defied the monopoly of the Bank of France, although the latter remained the sole nationwide supplier of currency.8 After 1840 the government refused to grant any more charters for new note-issuing banks, and in 1848 those already in existence were absorbed by the Bank of France. Thus the period of limited competition was short lived. But its end gave rise to a prolonged debate between the champions of free banking and defenders of the Bank of France, with the majority of French economists on the former side.9 The French free banking theorists were again active in 1857, when the charter of the Bank of France came up for renewal. The 1860 annexation of Savoy, which had its own note-issuing bank, generated the most intense discussion of all, but soon their repeated failure to win any practical victory for their beliefs caused the free bankers to abandon their cause. The close of the decade marked the end of significant anti-monopoly agitation.
Unlike France, Spain had a relatively liberal banking policy in the years just prior to 1873. It had many note-issuing banks, most of which were monopolies solely in their province of establishment. The exception was the Bank of Spain which, although begun as a financially conservative enterprise, became involved in large-scale loans to the government that eventually made it fiscal agent to the state. In return for this it was eventually given exclusive rights to interprovincial branching. Then, in 1874, six years after the overthrow of the Bourbon monarchy, in return for a loan of 125 million pesetas the new republican government gave the Bank a monopoly of note issue.10 The government also offered generous concessions to other banks in return for their becoming branches of the Bank of Spain. Most of the smaller banks accepted.
During the first decades of its independence, Italy, too, had a plurality of note-issuing banks. But the risorgimento left the new state with an immense debt, in which several of the banks, and the National Bank of the Kingdom in particular, were involved. As an alternative to retrenchment the Italian government sought further help from the note-issuing banks.11 It secured this help by allowing the notes of the Bank of the Kingdom issued in connection with loans to the state to pass as inconvertible (forced) currency, while at the same time awarding limited legal tender status to the notes of other issuing banks. This arrangement continued until 1874, when all Italian banks were placed on an equal footing, in that all were allowed to participate in the issue of irredeemable paper for the purpose of monetizing the national debt. This reform also prohibited further entry into the business of note issue. In consequence of these reforms the Italian money supply became extremely unstable. Its growth followed the growth of government expenditures. In 1883 gold convertibility was officially restored, but lack of strict enforcement, including severe limitations placed on the exchange of bank notes and settlement of clearings between competing banks, caused the system to remain in a state of de facto inconvertibility. Ten years later, a scandal erupted when several banks made unauthorized issues of legal tender notes.12 This gave rise to reforms leading to the establishment of the Bank of Italy, which had a monopoly of note issue conferred upon it in 1926.
Francesco Ferrara, the leading Italian economist of the era of the risorgimento, argued vehemently against the forced currency laws and other legislation that limited banks’ obligations to redeem their notes (Ferrara 1866). Ferrara also objected to the limitation of entry into the note-issue business, arguing that free competition among issuers of convertible currency was the best means for ensuring monetary stability (Ferrara 1933). These opinions were seconded by Guiseppe Di Nardi in his definitive study of this era in Italian banking (Di Nardi 1953).13 The findings of these writers suggest strongly that interference by the Italian government ruined what might otherwise have been a successful example of free banking.
Canadian experience also contradicts the view that free banking is inferior to central banking. During the 19th century Canada had a much more liberal banking policy than the U.S., and its banking system performed much better than the U.S. banking system of the same era. Canadian laws allowed plural note issue, permitted branch banking, and encouraged the growth of an elaborate clearing system.14 After 1841 the only serious restrictions on banking freedom had to do with capital and note issue. To receive a charter and limited-liability status a bank had to have $500,000 (Canadian) or more of paid-in capital soon after opening. Note issue was limited to the amount of this paid-in capital, but this restriction had no effect until the severe currency drain of 1907.15 In 1908 the law was changed to allow an emergency circulation exceeding capital by 15 percent during crop moving season. The government also monopolized the issue of notes under five dollars, but government note issues were restricted by a 100 percent marginal reserve requirement modeled after Peel’s Act. For this reason government note issue did not become a source of inflation until World War I, when Canada joined Britain and the other Dominion nations in going off the gold standard. It was then that the government allowed, even pressured, the chartered banks to suspend payment, which they did. Meanwhile government (Dominion) notes were made legal tender and issued in large denominations to encourage their use for the settlement of clearings among the chartered banks. Since neither the government nor the banks were paying out gold, this was in effect a fiat-money central banking system, with the Treasury acting as the issuer of high-powered money. Though the war ended, the government did not retire the large Dominion notes, nor did it abolish the legal tender laws which made them high-powered money, and so the Treasury retained its power to manipulate the money supply.
Although Canada returned to the gold standard in the 1920s, it went off it again (once more in sympathy with Britain) in 1931. Canadian monetary experts soon became disenchanted with the “half-way house” measures affecting note issue, in which the Treasury was able to manipulate the money supply like a central bank but was not guided by any set policy. This fact, together with the desire of the government to escape permanently from the confines of private finance, led to demands for the creation of a true central bank.16 To satisfy these demands the Bank of Canada was established in 1935. It secured a monopoly in note issue shortly thereafter.
The Canadian banking system was an example of a well working free banking system which suffered few crises and included some of the world’s most prestigious banking firms. It was frequently referred to by American writers anxious to correct the defects of their own system but, unfortunately, equally anxious in most cases to find the answer in some piece of legislation. At the beginning of the Great Depression (several years before the Bank of Canada was established), when thousands of banks in the United States went out of business, the Canadian system proved its worth by not suffering a single bank failure.
Three other Dominion nations, South Africa, Australia, and New Zealand, also had plural note-issue systems and also adopted central banking in the wake of wartime financial measures. (The experience of Australia is discussed below in chapter 3.) In these cases also it is not clear that central banking was adopted because of any inherent defects of unregulated banking. The desire of these governments to borrow money on favorable terms, together with theorists’ recognition that wartime legislation had undermined natural checks against monetary expansion, were the most obvious reasons for the creation of central banks in these places.17 Other Dominion nations were urged by the Home Government to follow suit on the grounds that there was need for “intra-imperial co-operation.”18 By this time central banking had become a matter of national pride, and the opinion developed that “no country could be considered to have attained maturity until it had given birth to a central bank.”19
The U.S. Experience
More than any other nation the United States has bolstered the myth of free banking as an historic failure. It cannot be said that central banking emerged in the U.S. in direct response to the government’s quest for funds. The Federal Reserve System was the end result of a long monetary reform effort, aimed at correcting real problems of the previous system—a system that involved plural note issue. The new institution also commanded the approval of an overwhelming majority of economists.
Nevertheless, U.S. experience does not demonstrate the failure of unregulated banking, for the simple reason that banks have been heavily regulated throughout American history. As Bray Hammond notes (1957, 186), legislators in the early years of the republic never applied the principle of laissez faire to the banking business. “The issue was between prohibition and state control, with no thought of free enterprise.” Banks were outlawed except when specifically authorized by state legislatures, and permission to set up a bank was usually accompanied by numerous restrictions, including especially required loans to the state. The situation after 1837—when the charter of the Second Bank of the United States expired—has been aptly referred to as involving “decentralism without freedom”;20 many note-issuing banks were established, but all were subjected to inhibiting regulations by the State governments that chartered them, and entry into the business was tightly restricted. Many western states and territories, including Wisconsin, Iowa, Oregon, Arkansas, and Texas, for a time allowed no note-issuing banks whatsoever. Other states restricted the business to a single, privileged firm. In most places branching was also outlawed.
1837 was, however, also the year in which increased public dissatisfaction with the charter or spoils system of bank establishment led to the adoption of “free banking” laws in Michigan and New York. These laws, later adopted in other states as well, brought banking into the domain of general incorporation procedures, so that a special charter no longer had to be secured in order for a new bank to open. This was an important step toward truly free banking, but it stopped well short of it. State governments, having relied for years on financial assistance they had received from privileged banks, sought to retain such assistance while still allowing free entry into the banking business. To accomplish this they included “bond-deposit” provisions in their free-banking laws. These provisions required banks to secure their note issues with government bonds, including bonds of the state in which they were incorporated. Typically, a bank desiring to issue 90 dollars in notes would first have to purchase 100 dollars (face value) of specified state bonds, which could then be deposited with the state comptroller in exchange for certified currency.
Though bond-deposit requirements were ostensibly aimed at providing security to note holders, they only served this function if the required bond collateral was more liquid and secure in value than other assets that banks might profitably invest in. In reality, the opposite was often true, particularly in free banking states in the west and midwest. In these places, “banks” emerged whose sole business was to speculate in junk bonds—especially heavily discounted government bonds. Bond-collateral, purchased on credit, was duly deposited with state officials in exchange for bank notes equal to the better part of the face value of the bonds. The notes were then used to finance further rounds of bond speculation, with any increase in the market value of purchased bonds (which remained the property of their buyers) representing, along with interest earnings, a clear gain to the bankers. The infamous “wildcat” banks were mainly of this species, most of their issues being used to monetize state and local government debt.21
Even the more responsible examples of bond-deposit banking had a critical flaw: they linked the potential growth of the currency component of the money stock to the value of government debt. This flaw became evident when, with the onset of the Civil War and the tremendous financial burden brought by it, Treasury Secretary Chase decided to employ bond-deposit finance on a national scale. Thus arose the National Banking System, in which the supply of currency varied with conditions in the market for federal bonds. The new system first revealed its incompatibility with monetary stability in the years after 1865, when state bank notes were taxed out of existence. After 1882, when surpluses began to be used to contract the federal debt, the system’s shortcomings were magnified: as the supply of federal securities declined, their market values increased. The national banks found it increasingly difficult and costly to acquire the collateral needed for note issue. This precluded secular growth of the currency supply.22 It also meant that cyclical increases in the demand for currency relative to total money demand could not be met, except by paying out limited reserves of high-powered money which caused the money supply as a whole to contract by a multiple of the lost reserves.
These conditions set the stage for the great money panics of 1873, 1884, 1893, and 1907. Each of these crises came at the height of the harvest season, in October, when it was usual for large amounts of currency to be withdrawn from interior banks to finance the movement of crops. The crises provided the principal motive for creating the Federal Reserve System, which ended the era of plural note issue. Yet the crises would never have occurred (or would have been less severe) had it not been for government regulations that restricted banks’ powers of note issue in the first place.23
The United States did have one experience with more or less unregulated, plural note issue. This was the New England Suffolk system of the antebellum period. New England had been more generous than other regions in granting charters to note-issuing banks. But prohibition of branch banking slowed the evolution of an efficient system of note exchange and clearing, thwarting normal competitive checks against overissue. Eventually the Suffolk Bank of Boston, in an effort to improve its note circulation by reducing the Boston circulation of country bank notes, set up an innovative system of note exchange which eventually formed the heart of America’s most praised banking system.24 The Suffolk is sometimes said to have performed as a free-market central bank. This is misleading. Unlike central banks the Suffolk did not have even a local monopoly of note issue; rival banks did not reissue its notes, and they held only such minimum deposits with it as it required as a condition for par acceptance of their notes. Thus the liabilities of the Suffolk Bank were not high-powered money. It could restrict the issues of other banks by promptly redeeming their notes, but it could not cause a general expansion of bank money by increasing its own issues. The Suffolk’s position was, in this crucial sense, more like that of contemporary commercial banks competing among co-equal rivals than like that of a privileged bank of issue.
Obviously these brief remarks do not add up to an historical argument for free banking. Nor do they adequately describe the complex political and intellectual forces responsible for the universal adoption of central banking.25 The reason for mentioning them here is to show the reader that the historical record does not provide any clear evidence of the failure—except politically—of free banking. Since past experience provides no motive for the rejection of free banking, we are justified in examining its theoretical and practical implications.
[1.] See especially Jonung (1985); Rockoff (1974); Rolnick and Weber (1982, 1983, 1986); Vaubel (1984c); and L. White (1984d).
[2.] An example of contemporary, pro-deregulation opinion is Benston (1983).
[3.] For more complete historical surveys see Cameron (1972); Conant (1915); and V. Smith (1936).
[4.] Lawrence White’s excellent and comprehensive study of the Scottish system, Free Banking in Britain, makes it unnecessary for us to delve into the details of that episode here.
[5.] See Lars G. Sandberg (1978).
[6.] For a detailed discussion of this episode see my “Free Banking in China, 1800-1935.”
[7.] For evidence see “ ‘Circulation Notes’ in Rural China” (1957). Here it is reported that Agricultural People’s Cooperatives (APCs) were resorting to issues of illegal currency to compensate for the insufficient provision of small-denomination notes by branches of the People’s Bank.
[8.] The departmental banks were local monopolies the notes of which were current only in their department of issue. The government, in cooperation with the Bank of France, refused the department banks’ request for permission to accept and redeem each other’s notes and also rejected their 1840 petition to organize a note exchange. Despite the existence of such obstacles to competition the departmental banks retained a solid reputation. See Rondo Cameron, “France, 1800-1870,” in Cameron (1972).
[9.] The French free-banking school had among its members Charles Coquelin, J. G. Courcelle-Seneuil, Gustave de Molinari, J. E. Horn, and (after his conversion from Saint-Simonism), Michel Chevalier. Of their scholarly contributions the most impressive is Horn’s “La liberte des banques” (1866). On the history of this school see Nataf (1983).
[10.] At the time, this was approximately $25 million. “All the existing provincial banks, then numbering eighteen, were ordered to liquidate their circulation and transfer it to the Bank of Spain.” See Conant (1915, 313).
A railroad-bond mania during the 1860s ended in a wave of private bank failures, which ultimately contributed to the overthrow of the monarchy. It should be noted, however, that this speculative bubble was itself the result of a railway law passed in 1855. See Gabriel Tortella, “Spain 1829-1874” in Cameron (1972).
[11.] “During the period 1861-90 the government’s budget was in deficit every year, and the public debt grew from 2.4 billion lire in 1861 to 12.1 billion lire in 1890.” See Jon S. Cohen, “Italy 1861-1914,” in Cameron (1972). This article gives a good, concise account of the course of centralization of the Italian currency system.
[12.] According to Conant (1915, 21-22) the “unauthorized” issue involved “the guilty connivance of public officials” who were the initial recipients of most of it.
[13.] Two contemporary writers whose views generally correspond to those of Di Nardi are Michele Fratianni and Franco Spinelli (1984).
[14.] Although there are only five major Canadian banks today, there were about 40 in 1880, 20 in 1910, and 11 in 1930. Most of these had extensive branch networks.
[15.] Ontario and Quebec adopted New York style “free banking” laws during the 1850s and 1860s, so that their banks’ note-issues were for a time restricted by bond-deposit requirements. But banks already in existence in these provinces when the laws were passed did not have to conform to them. As a result, in the words of Horace White, the unregulated banks “crowded the free banks to the wall.” The free banking laws were finally repealed in 1866. See Horace White (1896, 360-61).
[16.] “The matter of securing an additional supply of funds was what was uppermost in the minds of most of the advocates of a central bank. Most . . . had no clear idea of what its functions should be” (Stokes 1939, 52). See also Plumptre (1938) and Bordo and Redish (1986, 18-22).
[17.] See Plumptre (1938).
[18.] Ibid., 199. Later, similar pressure was put on the British Commonwealth countries.
[20.] See V. Smith (1936, 36).
[21.] See Hammond (1957, 618-21) and Rockoff (1974, 145-46). Ironically, the wildcat banks are often used to illustrate unregulated banking and its consequences.
Wildcat banks were also less common than is frequently supposed. According to Rolnick and Weber (1982), only 7 percent of the bond-deposit banks incorporated in New York, Indiana, Wisconsin, and Minnesota closed within a year of their establishment with assets insufficient to redeem their notes.
[22.] According to Friedman and Schwartz (1963, 128), between 1882 and 1891 the supply of national bank notes fell from $350 million to $160 million.
[23.] For a more detailed discussion of events leading up to the adoption of the Federal Reserve Act see V. Smith (1936, 128-46).
[24.] On the Suffolk system see Whitney (1881) and Trivoli (1979).
[25.] This task has, however, been undertaken in Vera Smith’s admirable though neglected work. See also Schwartz (1984).