d63edbdf_brary_of_Economics_and_Liberty__ast_Highlights_HIDE_HIGHLIGHTS
[Time] 6:09
Branch banking and currency issuance. Under free banking, would banks be the only suppliers of currency or merely the holders of deposits of government money? Today banks issue a lot of people's money holdings in the form of various kinds of deposits. Until recent times, banks were the only suppliers of any kinds of money. Pre-Fed times, pretty much banks and mints supplying money. Banks could issue their own circulating notes. The brands issued by different banks weren't truly distinct underlying monies. Different banks issued $1 notes, $5 notes, etc., but they were all claims to some underlying amount of gold. Uniform monetary standard, but no monopoly on the issuance of the paper. Stopped in two stages. During the Civil War, the state-chartered banks, which were the only kinds of banks that had existed at the time of the outbreak were deprived of the right by subjecting them to a stiff tax. Before that took effect another kind of bank was established--National Banks under Federal charter--and those continued to issue their own notes, but had to back them more than fully with government securities, to help finance the Civil War. Didn't have anything to do with improving the performance of the monetary system. As the government retired its debt, it became exceedingly costly for them to supply currency, so currency supply shrank; set stage for financial crises into the early 20th century. Argument for establishing the Fed: Let's set up 12 banks that can issue currency when the laws prevent the national banks and state banks from doing it. New set of banks not subject to the same rules. Problem was these banks could issue too much currency, and did so. If private sector created the roads, we'd have roads going everywhere--like we have now? If all currency were issued privately, would currency issuers have an incentive to inflate the currency? Just like the government does. If all currency were privately issued, what would be the protection for holders from inflationary pressure? Today if the bank makes too many loans (holding available stock of Fed-supplied reserved constant), no bank can go too far in making loans because checks are drawn on those loans, get redeposited and cleared, so a bank that is being too generous is running out of reserves. Puts strict limit on money creation in the form of deposits. Same discipline historically. Rival banks sent notes back for redemption. Doesn't work if you give one bank a monopoly because its notes are treated as reserves. Restraint in the private system. Suppose a bank makes too many loans, putting out too many bank notes. They circulate and get turned in naturally to my rivals. Rivals come to me looking for gold. If I've issued too many, I run out of gold. What protects the holders of my notes? They will continue to accept your notes as long as they believe you are behaving responsibly. What will usually happen if a bank gets a reputation for lending too aggressively, the clearing house will probably catch on before anyone else and throw that bank out; and then other banks won't accept its notes. Historical incident: Ayre Bank, Scottish bank pursued an easy money policy and was issuing too many notes; quickly discredited and Ayre Bank collapsed in fairly short order. Depositors suffered, but most of the losses were suffered by the bank owners, of which Adam Smith was one. Clearing system disciplines banks and keeps them from going overboard because they know what they can expect.
Selgin on Free Banking | EconTalk | Library of Economics and Liberty