Free banking

Free banking

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Encyclopedia
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
David D. Friedman
David Director Friedman is an American economist, author, and Right-libertarian theorist. He is known as a leader in anarcho-capitalist political theory, which is the subject of his most popular book, The Machinery of Freedom...

, Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...

, George Selgin
George Selgin
George A. Selgin is a professor of economics in the Terry College of Business at the University of Georgia, a senior fellow at the Cato Institute in Washington DC, and an associate editor of Econ Journal Watch...

, Lawrence H. White
Lawrence H. White
Lawrence H. White is an 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...

. Steven Horwitz
Steven Horwitz
Steven Horwitz is an American economist of the Austrian School.-Early life and education:Horwitz was born in Detroit, Michigan to Ronald and Carol Horwitz. He was raised in Oak Park, Michigan and graduated from Berkley High School in Berkley, Michigan in 1981. He graduated cum laude with an A.B...

 

Institutions



Free banking includes:
  1. Free entry of banking and fiduciary producers
  2. Freedom to issue banknotes (promissory notes issued by a bank payable to bearer on demand).
  3. Freedom to accept money on deposit to current account, and to pay and collect cheques for customers
  4. Freedom to borrow money on term deposit and other forms of secured and unsecured borrowing
  5. Freedom to lend money and otherwise invest the bank's assets
  6. Freedom to provide guarantees, documentary letters of credit, performance bonds and to incur other off balance sheet exposures.

History


The free banking movement got its modern start with The Denationalization of Money
The Denationalization of Money
The Denationalization of Money is a paper written by Friedrich Hayek, and published in 1977, in which he advocated the establishment of a free market in money.-Message:...

, by Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...

, 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
George Selgin
George A. Selgin is a professor of economics in the Terry College of Business at the University of Georgia, a senior fellow at the Cato Institute in Washington DC, and an associate editor of Econ Journal Watch...

, 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.
  1. Australia
    Australia
    Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

    . 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
    Branch (banking)
    A branch, banking center or financial center is a retail location where a bank, credit union, or other financial institution offers a wide array of face-to-face and automated services to its customers....

     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
    Real estate bubble
    A real estate bubble or property bubble is a type of economic bubble that occurs periodically in local or global real estate markets...

     caused the failure of many smaller banks and building societies
    Building society
    A building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially mortgage lending. These institutions are found in the United Kingdom and several other countries.The term "building society"...

    . Bankruptcy
    Bankruptcy
    Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....

     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.
  2. Switzerland
    Switzerland
    Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....

    . In the 19th Century several Swiss cantons
    Cantons of Switzerland
    The 26 cantons of Switzerland are the member states of the federal state of Switzerland. Each canton was a fully sovereign state with its own borders, army and currency from the Treaty of Westphalia until the establishment of the Swiss federal state in 1848...

     deregulated
    Deregulation
    Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...

     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."
  3. Scottish
    Scotland
    Scotland is a country that is part of the United Kingdom. Occupying the northern third of the island of Great Britain, it shares a border with England to the south and is bounded by the North Sea to the east, the Atlantic Ocean to the north and west, and the North Channel and Irish Sea to the...

     Free Banking. This period lasted between 1716 and 1845. The Bank of Scotland
    Bank of Scotland
    The Bank of Scotland plc is a commercial and clearing bank based in Edinburgh, Scotland. With a history dating to the 17th century, it is the second oldest surviving bank in what is now the United Kingdom, and is the only commercial institution created by the Parliament of Scotland to...

    , the original Scottish bank charter and The Royal Bank of Scotland
    Royal Bank of Scotland
    The Royal Bank of Scotland Group is a British banking and insurance holding company in which the UK Government holds an 84% stake. This stake is held and managed through UK Financial Investments Limited, whose voting rights are limited to 75% in order for the bank to retain its listing on the...

    , chartered by England
    England
    England is a country that is part of the United Kingdom. It shares land borders with Scotland to the north and Wales to the west; the Irish Sea is to the north west, the Celtic Sea to the south west, with the North Sea to the east and the English Channel to the south separating it from continental...

    , issued competitive currencies. This resulted in a "currency war
    Currency war
    Currency war, also known as competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a particular currency falls, so to does the real price of exports from the...

    " in 1727. The result was a cooperative equilibrium, where both banks agreed to accept rival banks' notes in the ordinary course of business. This area of study has been developed further by Lawrence H. White
    Lawrence H. White
    Lawrence H. White is an 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...

     in his book Free Banking in Britain: Theory, Experience and Debate 1800-1845 This example has been contested by Murray Rothbard
    Murray Rothbard
    Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...

    , resulting in a reply by White.
  4. United States
    United States
    The United States of America is a federal constitutional republic comprising fifty states and a federal district...

    . 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. In short, the shortcomings of banks and bank-supplied paper currency during the so-called "free banking era" in the U.S., far from establishing the need for special regulation of banks, testifies to the dangers of unwarranted or unwise regulation. Then, from 1863 to 1913, known as the National Banks Era, state-chartered banks were still operating under a free banking system. Some scholars have found that the system was mostly stable.
  5. Sweden
    Sweden
    Sweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund....

    . 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
    Stockholms Enskilda Bank
    Stockholms Enskilda Bank, sometimes called Enskilda banken or SEB, was a Swedish bank, founded in 1856 by André Oscar Wallenberg as Stockholm's first private bank...

    , founded in 1856). A new bank law was adopted by parliament in 1864, deregulating the interest rate
    Interest rate
    An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...

    . 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. Work on the Swedish free banking era has been done by Per Hortlund and Erik Lakomaa
    Erik Lakomaa
    Erik Martin Lakomaa is a Swedish political consultant known for his role as strategist for the no-campaign in the 2003 Swedish referendum on the euro. He has also advised a number of centre-right politicians, most notably Lars Wohlin and Nils Lundgren...

    . Erik Lakomaa (The Quarterly Journal of Austrian Economics, Summer 2007), has demonstrated that the Swedish experiment in free banking was successful. It reduced booms and busts. Only one bank went bankrupt for 70 years, an event related to fraud and not to excessive lending as has happened wherever central banking has been practiced.


There is speculation that with electronic currencies
Electronic money
Electronic money is money or scrip that is only exchanged electronically. Typically, this involves the use of computer networks, the internet and digital stored value systems...

 free banking can evolve into anonymous internet banking
Online banking
Online banking allows customers to conduct financial transactions on a secure website operated by their retail or virtual bank, credit union or building society.-Features:...

. The implications of this for the monetary system are unknown, and much of the rigorous theory in this area has been abandoned for a "wait and see" attitude.

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