Free banking

{{Short description|Economic system}} {{Hatnote|This article is about an economic system. "Free banking" also refers to the provision of indirectly-funded transactional accounts, which often rely on bank charges.}} {{Public finance}} '''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.

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.<ref>{{cite journal |last1=Selgin |first1=George A. |author-link1=George Selgin |last2=White |first2=Lawrence H. |author-link2=Lawrence H. White |title=How Would the Invisible Hand Handle Money? |journal=Journal of Economic Literature |volume=32 |number=4 |date=1994 |pages=1718–1749 |jstor=2728792}}</ref>

Notable supporters include Fred Foldvary,<ref>{{cite web |last=Foldvary |first=Fred E. |author-link=Fred Foldvary |title=Free Banking Explained |work=The Progress Report |date=November 2008 |url=http://www.progress.org/2008/fold586.htm |access-date=2010-01-24 |archive-url=https://web.archive.org/web/20090811031126/http://www.progress.org/2008/fold586.htm |archive-date=2009-08-11 |url-status=dead }}</ref> David D. Friedman,<ref>{{cite web |last=Friedman |first=David D. |author-link=David D. Friedman |url=http://www.cato.org/pubs/pas/pa017.html |title=Gold, Paper, Or...Is There a Better Money? |work=Policy Analysis No. 17 |publisher=Cato Institute |date=1982-09-23 |access-date=2012-03-08}}</ref> Friedrich Hayek,<ref name=":0">{{cite book |title=The Denationalisation of Money |first=Friedrich |last=Hayek |author-link=Friedrich Hayek |year=1976 |publisher=Coronet Books |isbn=978-0-255-36239-9 |url=https://archive.org/details/denationalisatio0000haye |url-access=registration }}</ref> George Selgin,<ref>{{cite web |url=http://www.richmondfed.org/publications/research/region_focus/2009/winter/full_interview.cfm |title=Interview: George Selgin |work=Region Focus |date=Winter 2009 |publisher=Federal Reserve Bank of Richmond |access-date=2012-03-08 |archive-url=https://web.archive.org/web/20120222090122/http://www.richmondfed.org/publications/research/region_focus/2009/winter/full_interview.cfm |archive-date=2012-02-22 |url-status=dead }}</ref> Steven Horwitz,<ref>{{cite book |first=Steven |last=Horwitz |author-link=Steven Horwitz |title=Monetary Evolution, Free Banking, and Economic Order |publisher=Westview Press |year=1992 |isbn=978-0-8133-8514-3 |url=https://archive.org/details/monetaryevolutio0000horw|url-access=registration }}</ref> and Richard Timberlake.<ref>{{cite book |first1=Richard |last1=Timberlake |author-link1=Richard Timberlake |first2=Kevin |last2=Dowd |author-link2=Kevin Dowd |title=Money and the Nation State |publisher=Transaction Publishers |year=1998 |url=https://books.google.com/books?id=owmgZi8Gp5IC|isbn=9781412828956 }}</ref>

While Hayek is generally considered to be the pioneering proponent of free banking in the post war era with his 1976 tract, ''The Denationalization of Money'',<ref name=":0" /> prior to him economist Benjamin Klein in his article ''The Competitive Supply of Money (1974)''<ref>Klein, Benjamin, 1974. ''[https://www.jstor.org/stable/1991457 "The Competitive Supply of Money,"]'' Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(4), pages 423-453, November.</ref> had argued in its favour.

==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. {{harvtxt|Dowd|1992}} 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.<ref>{{cite book|title=The Experience of Free Banking|editor1-last=Dowd|editor1-first=Kevin| place =London | publisher =Routledge | year =1992}}</ref> 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: * Economic theories claim the superiority of central banking. * Desire to imitate the institutions of more advanced economies, especially Great Britain. The Bank of England was the model for many later central banks, even outside the British Empire. * Desire of national governments to collect seigniorage (revenue from issue) from note issues. * Financial crises in some free banking systems that created demands to replace free banking with another system that advocates hoped would have fewer problems.

Some prominent 18th and 19th century economists, most notably Adam Smith,<ref>''An Inquiry into the Nature and Causes of the Wealth of Nations'' (1776), Book II, chapter 2, final paragraph, p. 286.</ref> defended free banking as opposed to the real bills doctrine.<ref>{{Cite web|url=https://www.cato.org/blog/free-banking-theory-versus-real-bills-doctrine|title=Free Banking Theory versus the Real Bills Doctrine|last=White|first=Lawrence H.|date=2015-09-16|website=Cato Institute|language=en|access-date=2019-08-06}}</ref> 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 Denationalisation 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|date=October 2015}}

===Switzerland=== In the 19th century, several Swiss cantons deregulated banking, allowing free entry and the issue of notes.<ref name="Briones">{{cite journal |last1=Briones |first1=Ignacio |first2=Hugh |last2=Rockoff |title=Do Economists Reach a Conclusion on Free-Banking Episodes? |journal=Econ Journal Watch |volume=2 |number=2 |date=August 2005 |pages=279–324 |url=http://econjwatch.org/issues/volume-2-issue-2-august-2005}}</ref> 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."<ref>{{cite book |last=Goodhart |first=Charles Albert Eric |url=https://archive.org/details/centralbankfinan0618good |url-access=registration |title=The Central Bank and the Financial System |publisher=MIT Press |year=1995 |page=[https://archive.org/details/centralbankfinan0618good/page/211 211]|isbn=9780262071673 }}</ref>

===Scotland=== Scottish free banking lasted between 1716 and 1845, and is arguably the most researched and developed instance of free banking.<ref name="White">{{cite book |first=Lawrence H. |last=White |author-link=Lawrence H. White |title=Free Banking in Britain: Theory, Experience and Debate 1800–1845 |location=London |publisher=Institute of Economic Affairs |year=1995 |isbn=978-0-255-36375-4}}</ref> 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.<ref>{{cite report |last=Kroszner |first=Randy |title=Free banking: The Scottish experience as a model for emerging economies |language=en |type=Working paper |series=Policy Research Working Papers |volume=1536 |id=WPS1536 |publication-place=Washington, DC |publisher=World Bank |date=November 1995 |doi=10.1596/1813-9450-1536  |doi-broken-date=21 November 2025 |url=https://documents1.worldbank.org/curated/en/719951468760530224/pdf/multi-page.pdf }}</ref><ref>{{cite book |last=White |first=Lawrence H. |author-link=Lawrence H. White |chapter=Free Banking in Scotland before 1844 |title=The Experience of Free Banking |editor1-last=Dowd |editor1-first=Kevin |place=London |publisher=Routledge |year=1992 |pages=157–186}}</ref>

===United States=== {{Main|History of central banking in the United States#1837–1862: "Free Banking" Era}} {{See also|Wildcat banking}}

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.<ref>{{cite journal |last1=Ng |first1=Kenneth |title=Free Banking Laws and Barriers to Entry in Banking, 1838-1860 |journal=The Journal of Economic History |volume=48 |number=4 |date=1988 |pages=877–889 |jstor=2121621 |doi=10.1017/s0022050700006653|s2cid=155043151 }}</ref><ref>{{cite journal |last1=Bodenhorn |first1=Howard |title=Entry, Rivalry and Free Banking in Antebellum America |journal=Review of Economics and Statistics |volume=72 |number=4 |date=1990 |pages=682–686 |jstor=2109610 |doi=10.2307/2109610}}</ref><ref>{{cite journal |last1=Economopoulous |first1=Andrew |last2=O'Neill |first2=Heather |title=Bank Entry during the Antebellum Period |journal=Journal of Money, Credit and Banking |volume=27 |number=4 |date=1995 |pages=1071–1085 |jstor=2077790 |doi=10.2307/2077790|url=https://digitalcommons.ursinus.edu/cgi/viewcontent.cgi?article=1017&context=bus_econ_fac |url-access=subscription }}</ref><ref>{{cite book |last1=Rockoff |first1=Hugh |chapter=Lessons from the American Experience with Free Banking |title=Unregulated banking : Chaos or Order? |editor1-first=Forrest |editor1-last=Capie |editor2-first=Geoffrey Edward |editor2-last=Wood |editor3-first=Gordon |editor3-last=Pepper |location=London |publisher=Macmillan |year=1991 |isbn=978-0-333-52049-9 |doi=10.3386/h0009 }}</ref> 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.<ref>{{cite journal|last1=Rolnick|first1=Arthur J.|last2=Weber|first2=Warren E.|title=The causes of free bank failures: A detailed examination|journal=Journal of Monetary Economics|volume=14|number=3|date=1984|pages=267–291 |doi=10.1016/0304-3932(84)90044-8}}</ref> 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.<ref>{{cite journal |last1=Dwyer |first1=Gerald P. |title=Wildcat Banking, Banking Panics and Free Banking in the United States |journal=Federal Reserve Bank of Atlanta Economic Review |volume=81 |number=3–6 |date=1996 |pages=1–20 |url=https://www.frbatlanta.org/-/media/Documents/filelegacydocs/ACFCE.pdf |access-date=2018-06-01 |archive-url=https://web.archive.org/web/20150907080558/https://www.frbatlanta.org/-/media/Documents/filelegacydocs/ACFCE.pdf |archive-date=2015-09-07 |url-status=dead }}</ref><ref>{{cite book |last=Calomiris |first=Charles W. |editor1-first=Allen N. |editor1-last=Berger |editor2-first=Philip |editor2-last=Molyneux |editor3-first=John O. S. |editor3-last=Wilson |title=The Oxford Handbook of Banking |publisher=Oxford University Press |date=2010 |pages=693–710 |chapter=The Great Depression and Other 'Contagious' Events}}</ref> 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.<ref>{{cite book |title=Microeconomics of Banking |first1=Xavier |last1=Freixas |first2=Jean-Charles |last2=Rochet |page=261 |publisher=MIT Press |year=1997 |url=https://books.google.com/books?id=0uhyai9jSGgC|isbn=9780262061933 }}</ref>

===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.<ref>{{cite journal |last1=Hortlund |first1=Per |title=The Provision of Liquidity in the Swedish Note Banking System, 1878–1901 |journal=Scandinavian Economic History Review |volume=5 |number=1 |date=2007 |pages=20–40 |doi=10.1080/03585520701234258|s2cid=152530914 |url=https://swopec.hhs.se/hastef/papers/hastef0613.pdf }}</ref><ref>{{cite journal |author-link=Erik Lakomaa |last=Lakomaa |first=Erik |url=https://mises.org/journals/qjae/pdf/qjae10_2_3.pdf |title=Free Banking in Sweden 1830–1903: Experience and Debate |journal=The Quarterly Journal of Austrian Economics |volume=10 |number=2 |year=2007 |pages=25–44|doi=10.1007/s12113-007-9012-4 |s2cid=154076201 }}</ref>

===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.<ref>{{cite web|title=JiaoZi and Iron Standard – Examining world's first documented paper money system from China with lenses of Austrian economics|url=http://rothbardiangoldprice.com/2015/08/jiaozi-and-iron-standrad-examining-worlds-first-documented-paper-money-system-from-china-with-lenses-of-austrian-economics/|website=Rothbardian Gold Price|access-date=2015-08-22|archive-date=2015-08-29|archive-url=https://web.archive.org/web/20150829010308/http://rothbardiangoldprice.com/2015/08/jiaozi-and-iron-standrad-examining-worlds-first-documented-paper-money-system-from-china-with-lenses-of-austrian-economics/|url-status=dead}}</ref>

=== India === Free Banking prevailed in India in the first half of the 19th century. There are about fifteen recorded cases of such banks and possibly many more existed. The earliest one was the Bank of Hindustan. The Paper Currency Act of 1861 marked the start of a monopoly in currency note issue by the Government of (British) India, four years after it ascended to power after 1857 taking over from the East India Company.<ref>{{Cite book |last=Moorthy |first=Vivek |title=Applied Macroeconomics: Employment, Growth and Inflation |publisher=I.K. International Publishing House Pvt. Ltd. |year=2017 |isbn=978-93-85909-39-9 |location=New Delhi |pages=207}}</ref>

== See also == {{Portal|Banks|Money}} * Bank Charter Act 1844, a U.K. law ending permission for banks to issue bank notes that acted as currency * ''Money as Debt'', 2006 animated documentary film * Henry Meulen, author of ''Free Banking: An Outline of a Policy on Individualism'', 1934 * Wildcat banking

== References == {{Reflist}}

== Bibliography == {{refbegin}} * {{cite book |last=Selgin |first=George |title=The Theory of Free Banking |publisher=Rowman & Littlefield Publishers; Cato Institute|year=1988 |location= |isbn= 9780847675784|oclc=16405124}} * {{cite book |last=White |first=Lawrence H |title=Competition and Currency: Essays on Free Banking and Money |publisher=New York University Press |year=1992 |location= |isbn= 9780814792247|oclc=19392491}} {{refend}}

Category:Banking Category:Banking terms Category:Anarchist theory Category:Libertarian theory Category:Monetary reform