A few thoughts on free banking

Shouldn’t you have mentioned David Glasner? He wrote a whole book on free banking (I own it):

http://www.amazon.com/Banking-Monetary-Reform-David-Glasner/dp/0521022517/ref=tmm_pap_title_0?_encoding=UTF8&sr=&qid=

Also Kurt Schuler…..

If you disagree with me, you are a “reason and logic denier”. Love that bit. Let’s just savour it in all its glory for a while.

Although those innovations you describe are interesting, don’t confuse “free banking” as you use the phrase with free banking as the free banking school uses it. One has little to do with the other.

Scott, I wish you would not dismiss the possibilities for good “monetary policy” arising as a spontaneous order from a free-banking system. Whether one or another theorist predicts a system you recognize as beneficial, the actual performance of a live market will always surprise all of us.

The concerns about cyclical aspects of a living money supply were addressed by the free-er systems in place prior to WWI. As Jim Grant (and Antal Fekete for that matter) point out, the original Federal Reserve Act envisioned the reserve assets having a high proportion of short term commercial paper. Both those authors refer to this as “self-liquidating debt” and 91 days was a typical term. Having the money base consist of assets that come AND go with the ebb and flow of seasonal economic activity would seem to cover the dominant cycle and just about any other that might manifest itself in a changing NGDP. The very existence of such bills (and the due diligence necessary for their “Acceptance”) constitutes a direct measurement of core GDP and is not subject to central agency policy whims or data skews. So long as the fractional circulation credits riding atop those assets also expand and contract proportionate to their backing reserves, I don’t see where the resulting “policy” will differ much from what you believe would be a wise and flexible centrally planned supply.

“standardizing certain subjective values” Holy cow. I’m sorry not to be rude but I don’t think she understands what economists mean when they use the word value. “Subjective value” doesn’t refer to value in sense 4, it refers to value in sense 3. Value in sense 3 can’t be standardized, nor would it helpful in any way to try to do so. Cooperation doesn’t require that anyone agree that something has the same value in sense 3-if it did, cooperation would be impossible.

Nor does she understand she could call whatever time she likes 3 pm, as long as she knew the formula to convert her clock’s time to someone else’s. One wonders at the chaos that must result from those places that don’t observe daylight savings time, or people who insist on using military time. Why, it must be absolute bedlam for all of society because those people have to take an extra few seconds to calculate what time everyone else would say it is.

Clearly she doesn’t understand, that it was merchants who standardized measures of gold in equivalent weights of grain, and common law only codified these measures, as part of enforcement of contracts and adjudication of disputes. It was only later that Kings and Governments created their own measures, which in turn had to be based on the pre-existing ones.

And clearly she does not understand that it is not “collusion” for a bank that says “My unit note is a promise to pay the bearer on demand 32 ounces of gold” to exchange notes from another bank who says “My unit note is a promise to pay the bearer on demand 16 ounces of gold” at a ratio of 1:2. It’s just mathematics. Nor is it “collusion” if the second bank measures gold in grams, for the first bank to figure out the conversion factor between grams and ounces!

One sort of wonders though, what to make of such a glib new agey statement as “systems are cyclical.”

Scott: “when I say “free banking” I mean unregulated banking”

This to me seems as too broad a definition. There are numerous regulations, from anti-money laundering regulations, anti-fraud regulations (such as banks knowing their customers), there are deposit insurance regulations and many more. As with most things I think free banking can be measured on a scale, not in some binary manner like “any regulation = slave banking” and the moment when there is no regulation whatsoever then it suddenly becomes “free banking”

Free banking people should say which regulations are problematic for their ideas and why. I always thought that the key thing for free banking is that banks should be able to issue their own currency, not that they should not be subject to anti-terrorist laws. As for former thanks to revolution in payment systems during last 20 or so years it is all but a reality.

And I mean it in a good way because otherwise “free banking” is just a label for wide variety of people from those who really want to abolish anti-money-laundering regulations to those who disagree with deposit insurance to those who want gold standard or those who want banks to have physical paper currency. In other words it is a mess.

@J.V. Dubois-If you define “free banking” in such a way that a system in which there are reserve requirements, deposit insurance, etc. as “free” because banks can issue debit cards, it is you who has the idiosyncratic definition of free banking.

As far as I could tell reading “Free Banking in Britain“, the Scottish system’s only “regulation” of any kind, was the fact that, at least initially, banks were, with some exceptions, required to be unlimited in their liability (which is even stronger than it sounds, because Scottish bankruptcy law was stronger than English law). Anti-money laundering laws were not present in the historical examples of reasonable approximations to true Free Banking. Neither was deposit insurance. Apologies if it strikes you as a “mess” to point out that banking without regulation means banking without regulation.

JV,

Few would argue that there has been worldwide growth and innovation in the financial sector, as there has in other industries. And within that sector, there are highly competitive elements.

But,

1. Banking regulations are not like regulations in other industries, by a long shot.

2. With few exceptions in the world, commercial banks do not issue their own notes (either digital or physical)–they issue the “notes” of central banks which aren’t even notes in the historical sense, but rather basic money.

3. The management of that basic money under political geographic monopolies is different with different incentives than when managed under competing commercial institutions.

These differences have significant effects on the macro economy. Or so say the free bankers.

Vikingvista:

1. There are industries like healthcare, food processing, energy and utilities, telecomunication, weapon manufacture and many others are arguably even more regulated than banking sector.

Plus again banking is heavily globalized so even if US banks are heavily regulated maybe banks on Cayman Islands or Luxembourg are not. And as opposed to trying to purchase health services (when sick), electricity, pay your phone bill or buying a gun – with banking services you have an opportunity to actually use services of these foreign banks. It is not comparable, by long shot.

2. By the same logic no banks ever issued their own notes – they issue notes of units of account (be it gold or central bank money)

I claim that if you deposit your money on bank account all you own is promise of your bank to pay you back that ammount – a bank liability, an electronic bank note.

However, more importantly you can have this promise in your pocket in form of bank card and use it to purchase stuff. Bank money is regularly used as medium of exchange. Your counterpart in transaction (or his bank) can decide if he accepts this electronic bank note from your bank. Most of the time all bank monies deliver on promise to hold the exchange rate 1:1 to whatever currency they are tied to – exactly as banks from freebanking era promised to keep some parity to gold or some other precious metal.

However if you are unlucky – such as recently some people on Cyprus – the promise of your bank to purchase back their bank note for central bank money may not be fulfilled. In that case no other bank would accept transfer from your account nor would you be able to withdraw central bank money from ATM .Your “money” would evaporate. How can this happen? Because it is just bank money, not central bank currency.

I claim that when you use credit card issued by commercial bank you are using that bank private money.

3. It is not only about “geographic monopolies”. Again you also have bitcoin credit card in the same way you have dollar credit card. As far as I know bitcoin is not related to any “geographic monopoly”. This is how it can work: https://www.youtube.com/watch?v=di88knQveQY

Vikingvista:

1. There are industries like healthcare, food processing, energy and utilities, telecomunication, weapon manufacture and many others that are arguably even more regulated than banking sector. I am not saying this because I support this regulation but just to show that banking sector is hardly unique in this way.

Plus again banking is heavily globalized so even if US banks are heavily regulated maybe banks on Cayman Islands or Luxembourg are not. And as opposed to trying to purchase health services (when sick), purchasing electricity plan, your phone service or when buying a gun – with banking services you have an opportunity to actually use services of these foreign banks. In this way banking is not comparable, it is much freer than aforementioned industries by long shot.

2. By the same logic no banks ever issued their own notes – they issue notes of units of account (be it gold or central bank money)

I claim that if you deposit your money on bank account all you own is promise of your bank to pay you back that ammount – a bank liability, an electronic bank note.

However, more importantly you can have this promise in your pocket in form of bank card and use it to purchase stuff. Bank money is regularly used as medium of exchange. Your counterpart in transaction (or his bank) can decide if he accepts this electronic bank note from your bank. Most of the time all bank monies deliver on promise to hold the exchange rate 1:1 to whatever currency they are tied to – exactly as banks from freebanking era promised to keep some parity to gold or some other precious metal.

However if you are unlucky – such as recently some people on Cyprus – the promise of your bank to purchase back their bank note for central bank money may not be fulfilled. In that case no other bank would accept transfer from your account nor would you be able to withdraw central bank money from ATM .Your “money” would evaporate. How can this happen? Because it is just bank money, not central bank currency.

I claim that when you use credit card issued by commercial bank you are using that bank private money.

3. It is not only about “geographic monopolies”. Again you also have bitcoin credit card in the same way you have dollar credit card. As far as I know bitcoin is not related to any “geographic monopoly”. Go an watch “Xapo Debit Card” on youtube to see how it can work (I cannot post links here for some reasone it causes comment not to get through)

[Ten minutes was an awfully long wait,eh, for me to get your comment versions out of spam? Actually, the word ‘credit’ cost you more points than the link. See our comment policies for more info. –Econlib Ed.]

“Plus again banking is heavily globalized so even if US banks are heavily regulated maybe banks on Cayman Islands or Luxembourg are not…In this way banking is not comparable, it is much freer than aforementioned industries by long shot.”

In free banking, individual commercial banks predominantly used natural competitive market regulatory signals to determine reserve ratios, capital requirements, solutions to liquidity problems, and essentially every other feature that defines “banking” aside from the usual legislated generic regulations protecting life and property that apply essentially equally to all endeavors. It is about the theory and history of a regulatory regime exists today mostly only in vestigial form.

You do sound like you’ve done little more than hear the phrase “free banking” and from that attempt to surmise what decades of scholarship in what has come to be called the free banking school is all about. But you are in luck. Some really fantastic scholars over at freebanking.org have spent the last few years posting and answering questions. I think you’d find it interesting spending some time perusing their posts. Not that you’d agree with their history or soundness of their theory, but you would at least correct your misunderstanding about what they are.

“By the same logic no banks ever issued their own notes – they issue notes of units of account (be it gold or central bank money)…I claim that if you deposit your money on bank account all you own is promise of your bank to pay you back that ammount – a bank liability, an electronic bank note.”

You confuse even contemporary notions of banknote and deposit. Historically banks *typically* issued their own notes–paper they created for circulation, with their names on them, not specific to any bearer, promising redemption by that bank in some stated amount of basic money (like a weight of gold). That essentially has ceased to exist (with minor exceptions). Euros and Federal Reserve Notes are not only not liabilities of the commercial bank handing them out, they aren’t liabilities at all, since the issuers–the central banks–don’t redeem them for anything. They are basic money.

Deposits are an accounting of a bank’s debt to *specific* depositors. You can transfer those liabilities with checks, but checks are not banknotes (whether digital or not).

“I claim that when you use credit card issued by commercial bank you are using that bank private money.”

You are using the basic money created by the prevailing central bank (that is what is being promised). You are using the creditworthiness of the issuing commercial bank. But unlike historical banknotes, the debt the merchant accepts on the credit card is not being circulated as a common medium of exchange–as a basic money substitute. It is straightforward debt, settled up between the merchant and the bank. It isn’t private money, because it isn’t money at all.

“Again you also have bitcoin credit card”

If bitcoin ever becomes money, and I hope it does, then you will have a point. But as of today, its acceptance is not nearly common enough for it to be properly called “money”.

Scott observes, “free banking is a great idea for banking but a horrible idea for monetary policy.”

For the record, I’ve always insisted that free banking is, as the name suggests, a banking regime, not a monetary one. The Scottish system was free banking and a metallic monetary standard, so its behavior reflected the workings of these combined banking and monetary regimes. But to treat “free banking” as implying some particular monetary regime, or as being a sort of monetary regime in itself, is a mistake.

I’m sure that Larry White, David Glasner, and Kevin Dowd all share my prospective. It’s only those who confuse free banking with Hayek’s competing currencies idea, or who are simply not well-versed on the subject, who treat it as a substitute for some sort of monetary rule, standard, or policy.

I have always assumed, reading selgin and co that free banking basesed on stable base should produce good montary policy.

Lets assume a fiat based fixed currency stock. In my understanding this, combined with free banking, should produce pretty good montary policy. The banks profit seeking will cause them to lower there reverse ratio as far as possile or increase it depending on velocity.

So free banking should achive a fairly good approximation of stable MV and thats what market monetarism is mostly all about.

Im not, btw, douting that one also could have free banking and any other monetary regime.

George and Vikingvista: I am really at loss here. All you talk about is some vague “binding regulations” without really addressing any substance of my arguments:

1. Banking is international. If you want to have a bank account in a bank in a country that does not require deposit insurance then you are free to do so. For instance as far as I know there is no obligatory deposit insurance scheme for banks on Cayman Islands. Mitt Romney has an account there. You can do the same from your home using courier to deliver documents.

2. Additionally you can get virtually all banking services you may want using international [shadow] banking sector. And you can use these services comfortably from your home – from almost anywhere in the world.

This is incredibly important point, because if you call for getting rid of regulation you should take into account what is the relevant market here. With banking services and thanks to internet and communication revolution the market is truly global.

PS: vikingvista: While I disagree with how you define money or your view on free banking era it is insubstantial for my argument. So let’s modify my example and let’s assume that shop owner immediately recognized your bank note for “money” that it is.

At the end of the day he would bring this banknote to his own local bank and he would deposit it on his own account (since he does not want to have all that cash at home for safety purposes). His commercial bank would then take that bank note and trade it on interbank market for their own banknotes/gold. So exactly the same thing that now happens in few milliseconds when you pay for something via debit card – only instead of gold commercial banks settle their debts using government (central bank) money.

JV,

“All you talk about is some vague “binding regulations” without really addressing any substance of my arguments”

Perhaps I have been misunderstanding you. Your argument seems to me to repeatedly be that innovations in the speed of clearing technology between banks means that free banking effectively exists today. I then repeatedly explain how that is irrelevant to whether free banking exists or not. And of course a 10 minutes perusal of freebanking.org gets you plenty of explanation of how clearinghouses worked, so you must know that modern innovations in that technology have no bearing on your argument. Neither of us, apparently, thinks his points are getting addressed.

“For instance as far as I know there is no obligatory deposit insurance scheme for banks on Cayman Islands. Mitt Romney has an account there. You can do the same from your home using courier to deliver documents.”

Again, a mystery to me why you would think this means that free banking exists. You are of the opinion that the Cayman Islands have a free banking regime? For the sake of argument, let us say that it is true. You then are claiming that FDIC, capital requirements, Federal Reserve lending policies, and other US banking regulations therefore have no significant effect on the US banking industry? Is that because you think that almost no Americans use these American banks, but instead do almost all of their banking through the Cayman Islands or “shadow” banks? Do you personally avoid using the conventional commercial banking system in your country? When you talk to people around you, do you find it harder to find someone who uses or does not use conventional commercial banking?

I just can’t see how you can seriously claim that, e.g. in the US, conventional US commercial banks with all their associated regulations are not a substantial part of the banking industry in the US, or that their effect on US banking is so slight as to have no appreciable macro effect.

“While I disagree with how you define money or your view on free banking era it is insubstantial for my argument”

You don’t think it substantial to an existing state of an economy what people predominantly do? I think that is one of your mistakes, which is why I keep mentioning it. People predominantly use money. People do not predominantly use bitcoin. People predominantly use conventional commercial banks. People do not predominantly use banks in the Cayman Islands or shadow banks.