Free Banking Lawrence H. White SREK 2014. oll.libertyfund.org
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Transcript of Free Banking Lawrence H. White SREK 2014. oll.libertyfund.org
Free Banking
Lawrence H. WhiteSREK 2014
http://www.iea.org.uk/http://www.econlib.org/
oll.libertyfund.org/
Two views of money
Coins can be privately produced
• Why then have governments monopolized coinage? • To improve quality?
Silver content of European govt. coins, c1300-c1500
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
c1300 c1400 c1500
per
flo
rin
Castile Maravedi
Cologne Schilling
Flanders Groot
Austria Schilling
France Sou
Lubeck Schilling
Rome Soldo
Florence Soldo
Prague Groschen
Venice Soldo
Aragon Sueldo
England Shilling
Bank‑account money
• more portable• greater uniformity than
debased coins
1.
2.
Why did bank account balances become transferable?
1.
2.
Account of
1. Antonio -$1002. Bartolemo +$100
Account balance transfer
Account of
1. Antonio -$1002. Bartolemo +$100
Money Warehouse
Assets Liabilities
coins in vault $200 owed to Alice $10owed to Bob
$10 owed to others $180
Economical means of safe storage.
Is there a more economical alternative for payments?
Fractional-reserve Bank
Assets Liabilities
coins in vault $40 owed to Alice$10
owed to Bob $10
loans, bills $160 owed to others $180
Advantages to the bank?
Advantages to the customer?
BANCO di MEDICI
Bank‑issued currency
Warehouse receipts do notresemble banknotes
When is a fractional reserve feasible?
Is a fractional reserve banknote like a lottery ticket?
BANK
Is it inherently fraudulent to hold a fractional reserve ?
Why might a fully informed customer agree to fractional reserves?
1. A money warehouse contract is legitimate.
2. A time deposit contract is legitimate.
3. A demand deposit contract is neither a money warehouse contract nor a time deposit.
4. Therefore, a demand deposit contract is not legitimate.
1. A dog has four legs.
2. A cat has four legs.
3. A goat is neither a dognor a cat.
4. Therefore, a goat does not have four legs.
Banks will accept one another’s liabilities at par (face value)
• Non-par means customer inconvenience
• Profitable for banks to eliminate these inconveniences
Suffolk Bank (Boston), 1830s
Bank of Scotland Royal Bank of Scotland,est. 1727
Freely evolved banking systems
• Definitive money: specie (gold or silver coin)• Unit of account: specie unit• Retail CAMOEs: bank-issued currency and
transferable account balances– Bank-issued money denominated in the specie unit– widely accepted at par – All banks are linked into a unified clearing network
• Seen historically in banking systems that were free of significant legal restrictions
Scotland Canada Sweden New England
Historical free banking systems
… and 50+ more
Why did we switch to fiat money?
IOU NOTHING
Over the years, all the governments in the world, having discovered that gold is, like, rare, decided that it would be more convenient to back their money with something that is easier to come by, namely: nothing.
Simplified free bank balance sheet
Assets Liabilities + Equity
______________________________________
R reserves N notes in circulation
L loans and securities D deposits
K equity capital
A profit-seeking bank equates at the margin MR from loans = MR from reserve holding MR from loans = MC of liabilities to fund them MC of notes = MC of deposits
balance sheet constraint: R + L = N + D + K
Managing a free bank of issue
• Bank optimization determines N, D, R• Desired N and D are finite, because
redeemable notes (or deposits) cannot simply be circulated ad lib
• One thing to print up the notes; another to keep them in circulation
– Undemanded (excess) notes will return to be redeemed
– To cultivate a demand to hold its notes, the bank must incur provide costly services
– Thus rising MC limits profit-max size of public’s desired N
Assets Liabilities + Equity
R
L
N
D
K
What corrects a bank’s over-issue?
• Reserve losses as notes return for redemption• “overissue”: the quantity of a bank’s currency in
circulation exceeds the quantity demanded – given its optimizing expenditures on non-price competition– cause: either bank expands N, or Nd falls
• What corrects over-issue? – Not: Fullarton's (1845) flawed “law of the reflux” – Not: repayment of loans or “real bills”– Correct theory: actual N converges on desired Nd as the public
adjusts toward its desired portfolio of assets
• Adjustment of system-wide N as Nd falls or rises
Mises on market correction of N under free banking
“A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy. If regard to the behavior of its competitors prevents it from further reducing the rate of interest in bank-credit transactions, then -- apart from an extension of its clientele -- it will be able to circulate more fiduciary media only if there is a demand for them even when the rate of interest charged is not lower than that charged by the banks competing with it. Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow an independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause.”
--Theory of Money and Credit, p. 347 (1980 ed.)
Competition vs. monopoly in note-issue
• Competition (many issuers) limits the danger of a large-scale overissue – Random money-supply errors will tend to
offset one another in the aggregate – Danger of large-scale overissue is greatest
when a single issuer has a 100% share of the circulation
• Free banking’s adjustment of N to Nd helps to stabilize aggregate spending– Hayek’s “money stream”
• Policy implication: don’t restrict note-issue to a single institution. Allow free entry.
James Wm. Gilbart, leader of British Free Banking School
The problem of runs
Run-prone bank account
• Greater expected payoff to redeeming sooner rather than later
1) debt claim
2) unconditionally redeemable on demand (first come, first served)
3) default likely on last claim served
Non-run-prone bank account
• Modify any one of these conditions:
1’) equity claim, like MMMF
2’) conditional redeemability, like a notice-of-withdrawal clause
3’) solvency assurances• adequate capital• diversified portfolio of safe assets • extended liability for shareholders• clearinghouse certification