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Free Market Banking

Clifton B. Lutrell

• Economist, Federal Reserve Bank of St. Louis

“Thomas Jefferson on Money and Banking: Disciple of David Hume and Forerunner of Some Modern Monetary Views.” History of Political Economy 7 (1975): 156–173.

While Jefferson's monetary views have been criticized on the basis of inconsistency and of his presumed failure to understand banking, they were generally consistent with the views of David Hume. And after allowance for the general substitution of demand deposits for bank notes, they are not greatly different from the views of some leading economists today.

Jefferson's proposals for monetary reform were grounded in the libertarian views of Spinoza, Locke, Montesquieu, Hume, Smith and other seventeenth and eighteenth century writers who espoused the natural rights of the individual within a stable framework of rules for competition and enterprise.

Jefferson studied those writers who had already described a system in which most day-to-day restrictions, such as wage and price fixing, trade barriers, occupational restrictions, and other economic controls handed down from the Middle Ages, could be dispensed with. He shared their view that a community is most thriving when left free to individual enterprise. His opposition to chartering the First Bank of the United States reflected his view that the power of the federal government should be limited.

Jefferson's experience with excessive paper money issues encompassed three periods: (1) the colonial period, (2) the Revolutionary War, and (3) the state-bank emission from 1811 to 1816. The emissions in each period were followed by widely fluctuating prices and sharp changes in debtor-creditor relationships. In consequence, he proposed a banking system that would eliminate the economic instability caused by such issues.

Hume outlined a 100 percent commodity reserve banking system that would rigidly limit the quantity of money to the quantity of specie. Like Hume, Jefferson held that an increase in circulation of paper money did not induce an increase in commerce, manufactures, or capital. Adam Smith missed a point shared by Hume and Jefferson: “that paper money has an impact on the total quantity of money and on prices.” Jefferson, on the basis of his experience with American banking, criticized Smith: “The only advantage which Smith proposes by substituting paper in the room of gold and silver ... is to replace an expensive instrument with one less costly.... But this makes no addition to the stock of capital of the nation.”

Jeffersonian economists, such as Charles Holt Carroll, hold that no gains were added to a nation's wealth by an increase in paper money, and continued Jefferson's criticism of Smith.

Among U.S. writers whose monetary proposals are similar to Hume's and Jefferson's are Irving Fisher, Henry Simons, Lloyd Mints, and Milton Friedman.

Although separated by more than a century, Jefferson and the typical recent proponent of more rigid monetary control share many basic political and economic views. Each supports an institutional framework that would provide for compatibility of individual and social interest. Both believe the function of the state should be limited to the production of public goods and services—the maintenance of law and property rights to prevent coercion of one individual by another, common defense, fire protection, roads, a stable monetary system—and that control of resources and production in the private sector should be determined exclusively by enterprise and competition.

In sum, Jefferson proposed a money and banking system that was consistent with his strong libertarian views. His experience with monetary instability and his studies of leading economists convinced him that only a purely specie currency would meet his criteria for a stable monetary unit.

He saw unstable money producing major price changes, altering debtor-creditor relationship, causing windfall gains and losses in private wealth, disrupting foreign trade, and reducing the efficiency of domestic resource use. He believed that no real gain in wealth or production would result from a rising volume of paper money. Consequently, he proposed that banks should be prohibited from issuing monetary liabilities and should operate in much the same way that savings and loan associations and mutual savings banks operate today.