What is free banking?

[Matt Collins]

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[Zippyjuan]

What about the Free Banking era of the 1800's? The Second National Bank (central bank) was shut down and power over money given to states and state banks. They could issue thier own specie which was to be backed by metal. At one point there was over 3,000 different banknotes to choose from. Banks swelled from a handful of national banks to over 700. But the banks also had lots of problems. 16% closed after only one year- the average lifespan of a bank was only five years.

http://www.let.rug.nl/usa/essays/ge...ing/depository-safety-and-economic-safety.php

Kidwell and some other economists blame the state banking system for contributing to the volatility in the economy, even if it did not directly cause it. In the initial expansionary phase of the business cycle, overly optimistic banks would issue too many banknotes which would accelerate the growth of the economy. However, this would eventually lead to inflation and an over-extension of credit. A random downturn in key commodity markets would then sharply reduce the market value of many bonds and loans, and banks would be forced to call in loans and contract the money supply. Sometimes this led to cases of depositor panic and further reductions in the money supply, which brought the next contraction of economic activity (Kidwell, 56).

Most economists regard the free banking era as on balance being a de-stabilizing influence on the developing U.S. economy. Edward Symons writes "In some states, particularly Michigan where more than forty banks failed before the system was declared unconstitutional, the system is better characterized as a fiasco than a failure" (Symons, 22). However, free-banking advocates claim that this period is not a true test of their theory (Rolnick and Weber, 19-20). In particular, the legal requirement in most free banking states that note issues be tied to the market value of bonds limited the management to sub-optimal choices in terms of their note issues. In current free banking theory banks would have the incentive to issue a profit- maximizing volume of notes which would be based on economic factors, not exogenous regulations, and that this quantity of notes would not, in theory, cause monetary instability (Sechrest, 16-17).

Regardless of its merits or its problems, the free banking era ended in 1863 with the passage of the first of the National Banking Acts. These laws reasserted federal influence in the functioning of the nation's financial system.

 

[gwax23]

What about the Free Banking era of the 1800's? The Second National Bank (central bank) was shut down and power over money given to states and state banks. They could issue thier own specie which was to be backed by metal. At one point there was over 3,000 different banknotes to choose from. Banks swelled from a handful of national banks to over 700. But the banks also had lots of problems. 16% closed after only one year- the average lifespan of a bank was only five years.

http://www.let.rug.nl/usa/essays/ge...ing/depository-safety-and-economic-safety.php

Thats because of fractional reserve banking which lead to bank runs and the boom and bust cycle. But even the flawed system of the 1800 and early 1900's is better than what we have today.

A system of free banking where the legal system views fractional reserve as fraud, would be ideal.

 

[Dr. Dog]

Thats because of fractional reserve bending which lead to bank runs and the boom and bust cycle. But even the flawed system of the 1800 and early 1900's is better than what we have today.

A system of free banking where the legal system views fractional reserve as fraud, would be ideal.

Except it isn't fraud.

 

[gwax23]

Except it isn't fraud.

Yes it is. A bank claiming to be able to pay back all its depositors on demand but cannot cause it only keeps a 10% reserve, is committing an act of fraud to its depositors.

Go read some Rothbard before your next post on these forums please.

 

[TaftFan]

Yes it is. A bank claiming to be able to pay back all its depositors on demand but cannot cause it only keeps a 10% reserve, is committing an act of fraud to its depositors.

Go read some Rothbard before your next post on these forums please.

Fractional reserves isn't fraud in itself. Like you said, if the bank claims to be able to pay all of its money back at any time, then it would be fraud.

 

[ClydeCoulter]

Fractional reserves isn't fraud in itself. Like you said, if the bank claims to be able to pay all of its money back at any time, then it would be fraud.

Do banks usually make it clear to the depositor that there is no guarantee that the bank will be able to pay it back? Oh, FDIC? Is that what makes it "not fraud"?

 

[TaftFan]

Do banks usually make it clear to the depositor that there is no guarantee that the bank will be able to pay it back? Oh, FDIC? Is that what makes it "not fraud"?

No, because in the current system it doesn't really matter. We have the FDIC and the Fed is the lender of last resort.

 

[Dr. Dog]

Yes it is. A bank claiming to be able to pay back all its depositors on demand but cannot cause it only keeps a 10% reserve, is committing an act of fraud to its depositors.

Go read some Rothbard before your next post on these forums please.

You might find this hard to believe, but Rothbard was wrong.

If you can find me a bank that says they can pay back all of their depositors on demand, I will never post here again and cancel my account. In other words, I will continue to post here.

 

[dannno]

As far as fractional reserve lending I believe in the early days a lot of bankers who involved themselves in the practice were committing fraud and often times ended up dead when their depositers ended up getting short changed.

The most successful bankers were lucky and didn't get caught right away so they bought really hot prostitutes for the person(s) who made the laws and they legalized it for them.

Tada.

 

[dannno]

all [/B]of their depositors on demand, I will never post here again and cancel my account.

No, but my bank says that they can pay back 100% of my deposit on demand and if they can't, they will pay up to X amount as insured by the Federal Govt. Hey, wait a minute, that's me!! Who agreed to all this I sure didn't.

Sounds like legalized fraud.

 

[robert68]

What about the Free Banking era of the 1800's? The Second National Bank (central bank) was shut down and power over money given to states and state banks. They could issue thier own specie which was to be backed by metal. At one point there was over 3,000 different banknotes to choose from. Banks swelled from a handful of national banks to over 700. But the banks also had lots of problems. 16% closed after only one year- the average lifespan of a bank was only five years.

http://www.let.rug.nl/usa/essays/ge...ing/depository-safety-and-economic-safety.php

From interview of George Selgin:

RF: Tell me a bit more about that. The pre-Civil War period in the United States is commonly referred to as the “free banking” era. Is that a misnomer?

Selgin: Banks were free in the late antebellum United States in one sense only. Originally, you could only start a bank with a special charter passed by a state legislature, so entry was restricted. In some cases, it was very severely restricted. There were some states and territories, especially in the West, that banned banking altogether and others that chartered only a single, privileged bank.

Starting in the late 1830s, in reaction to the corruption of the previous system, states – beginning with Michigan and New York – created so-called “free banking” laws that allowed banks to be established through something like a general act of incorporation. So, banking under these laws was free in the sense that there was greater freedom of entry.

But the banks weren’t free in the sense that they were free from special regulations. In every case, their notes had to be backed by specified bond collateral, and this requirement often had very bad consequences. In many states, banks were forced to buy assets that turned out to be junk, and this was a major cause of failure in these supposedly “free banking” systems. None of the banks could have branches, either. As is evident to everybody today, the lack of branch banking was a very important source of U.S. banking system weakness and fragility.

 

[PRB]

Yes it is. A bank claiming to be able to pay back all its depositors on demand but cannot cause it only keeps a 10% reserve, is committing an act of fraud to its depositors.

Go read some Rothbard before your next post on these forums please.

I've never heard my bank promising me to pay back all my deposits immediately on demand, if I wanted that, I wouldn't be using a bank.

 

[Libertomics]

Yes it is. A bank claiming to be able to pay back all its depositors on demand but cannot cause it only keeps a 10% reserve, is committing an act of fraud to its depositors.

Go read some Rothbard before your next post on these forums please.

But banks can pay back all its depositors on demand, if a run on the bank happens they borrow from other banks if not a federal reserve bank. Depending on the federal funds rate and discount rate of course.

 

[Zippyjuan]

During the "free banking era" there were record numbers of bank runs and failures. Most only lasted five years.

The only way you can avoid all possible bank runs is to have a 100% reserve requirement- not allow banks to make any loans or investments with depositor money.

Depositing money at the bank is making a loan to the bank. If you loan money to a friend, do you expect him to be able to pay you back anytime you want the money? He can pay you- but he will have to borrow from somebody else. Is he committing fraud?

 

[gwax23]

Banks do not, as too many textbooks still suggest, take deposits of existing money from savers and lend it out to borrowers instead they create credit and money ex nihilo – extending a loan to the borrower and simultaneously crediting the borrower’s money account. This artificially inflates the money supply.