Chapter 9 FINAL THOUGHTS

This book has had two basic goals: (1) to summarize and critique some of the more important theoretical and empirical research on free banking, and (2) to present some of the author’s own thoughts on the theory and history of free banking. One hopes that the former has been accomplished in a manner that is both fair to those other researchers at the same time that it offers a clear and insightful exposition to the reader. As for the latter, all writers aim for a presentation that is persuasive. This writer is no exception. If this book builds a persuasive case for free banking, he will be delighted. If it is merely thought-provoking, he will still be more than pleased. Only a few last comments are needed to complete the task.

A METAPHOR

In order to illustrate the point to be made here, a brief digression is first necessary. Assume that an architect has designed a new office building. Assume further that the design is considered completely satisfactory—indeed, excellent—by those who commissioned its execution. Then the structure is built, subject to the local laws and regulations. Those legal constraints require that the builder use only local materials and local labor in the construction. Imagine that those local sources involve inferior materials and laborers of questionable skill. The result is predictable. The elevators do not fit flush with the floors, electrical appliances experience short circuits, doors do not close properly, the roof leaks when it rains, and so forth. In short, the office building is something of a failure; it pleases neither the owners nor the tenants. Would anyone blame the architect under such circumstances? Clearly not. The design was sound; it was the transformation of the design into three-dimensional physical form that proved inadequate, and the critical fact is that such inadequacy stemmed from violations of the design.

Now think of the free-banking theory of Chapters 2, 3, and 4 as constituting the “design.” Alleged applications of that model (the “building”) were the subject of Chapters 5 and 6, namely the free-banking experiments in Scotland and the United States. As was made clear, neither of those experiments was entirely successful—although at the macrolevel, the American system seems to have worked surprisingly well considering the institutional restrictions imposed. The essential parallel to the architectural metaphor is simply that, since the assumptions of the model were violated in practice, the resulting product was of course flawed. Furthermore, just as with the example of the building, the misapplication of a sound design should lead one to condemn the structure rather than its design; that is, the deficiencies of either Scottish or American free banking cannot with fairness be used as grounds for condemning true laissez-faire banking.

POSSIBLE FUTURE RESEARCH

Free banking is a subject that lies on the frontiers of monetary economics, and as such, it holds out the promise of potentially great rewards to those willing to explore its boundaries. To approach the issue of a future research agenda, one might think in terms of theoretical work, historical investigations, and practical implementations. The theoretical dimensions of free banking that need further attention include (1) the relationship between free banking and business cycles (does free banking constitute the final vindication of Say’s Law, as was suggested in Chapter 3?), (2) the possibility of private deposit insurance (is it necessary, and if so, is it practicable?), (3) the issue of informational asymmetries (why are they likely to pose a smaller problem under free banking than under central banking?), and (4) the effects of option clauses and adequate capital (can they eliminate bank runs completely?).

As to historical research, much more can be done if only the relevant data series can be found or constructed. It would be of obvious benefit, for example, to possess information on national income, unemployment, the money supply, interest rates, and the price level for Scotland (1765–1845) separate from Great Britain as a whole. At the microlevel, information on redemption rates on Scottish banknotes as well as the gold price of such banknotes could prove invaluable. An attractive replication project might be to scrutinize several of the free-banking states in the American South along the lines of Arthur Rolnick and Warren Weber’s examinations of New York, Indiana, Wisconsin, and Minnesota. There are several candidates: Georgia adopted free banking in 1838, Tennessee in 1852, Louisiana and Florida in 1853, and Alabama in 1849. Finally, detailed investigations should be undertaken into the nature and performance of free banking in such other countries as France, Canada, Sweden, Switzerland, China, Australia, New Zealand, South Africa, Spain, and Italy (Selgin 1988a, 7–12). This work has already begun (see, for example, Selgin 1987; Jonung 1989; and Dowd 1992).

A crucial question remains: How is the transition to free banking to be accomplished? Only a few works have specifically addressed this issue, and those treatments are all too brief. Donald Wells and Leslie Scruggs propose the following steps: (1) termination of the Fed’s monetary powers, that is, the end of both open market operations and discounting; (2) movement of the Treasury’s accounts to commercial banks; (3) phasing out over time the Fed’s check clearing system so as to encourage the reestablishment of private clearinghouses; (4) repeal of all legal tender laws; (5) establishment of freedom of entry and exit in banking; (6) removal of all reserve requirements, capital requirements, and restrictions on branching; and (7) granting to private institutions the right to issue their own notes (1986b, 264–65).

George Selgin adopts a more cautious approach. He suggests that, after banks have been freed from reserve requirements and limitations on branching, the stock of Federal Reserve notes be frozen. Subsequently, banks could redeem their liabilities in either those Federal Reserve notes or in some commodity, such as gold, depending on consumers’ preferences (1988a, 168–71).

Selgin goes on to claim that “there are no great logistic or material barriers standing in the way of the adoption of free banking; the transaction costs of a well-framed free banking reform are negligible” (1988a, 171). This seems a bit naive. Surely there are those—the employees of the Federal Reserve System and the FDIC, for example—who see the complete deregulation of the American financial system as a direct threat to their status and standard of living. Such persons may perceive the transition to a laissez-faire financial environment as extremely costly.

Richard Wagner is closer to the mark when he argues that “those who are interested in monetary reform should recognize that the circumstances they are concerned about reflect the outcome of people’s pursuit of their interests within our existing constitutional order. Monetary reform without political reform to redress the rent-seeking excesses of prevailing political institutions seems likely to be a short-lived aberration” (1986, 536).

Much more thought needs to be given to both the enabling conditions and the ramifications of a transition to free banking. Until the pervasive addiction to the welfare state has ended and a belief in laissez-faire capitalism has taken root, free banking may remain a political impossibility. The implementation of free banking could prove to be a task that is as much philosophical as it is technical.

A LAST WORD

Friedrich Hayek declares that “[w]hat we now need is a Free Money Movement comparable to the Free Trade Movement of the 19th century” (1978, 129). He is absolutely correct. Without free banking, inflation and periodic crises will remain the order of the day. Moreover, as long as money remains a tool of the state, that tool will continue to serve the state as a well-spring of income redistribution, social engineering, and military adventurism. A laissez-faire approach to money and banking is more than merely conducive to efficiency and stability. It is likely to prove to be the necessary precondition for prosperity, justice, and peace.