Free Banking - History

History

The free banking movement got its modern start in 1977 with The Denationalization of Money, by 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 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. 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 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 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 didn't really need to.
2. Switzerland. In the 19th Century several Swiss cantons deregulated 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 Free Banking. This period lasted between 1716 and 1845. The Bank of Scotland, the original Scottish bank charter and The Royal Bank of Scotland, chartered by England, issued competitive currencies. This resulted in a "currency war" 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 in his book Free Banking in Britain: Theory, Experience and Debate 1800-1845 This example has been contested by Murray Rothbard, resulting in a reply by White.
4. United States. 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 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, 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. Work on the Swedish free banking era has been done by Per Hortlund and Erik Lakomaa. Erik Lakomaa 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.