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What's old (and some classics)

Brad asked about the free banking book classics. What I had already planned to write, below, partly answers his question.

Current thinking about free banking began with Friedrich Hayek’s 1976 pamphlet Denationalisation of Money (link is to an expanded version first issued in 1978 and reprinted in 1990). Until then, the idea of free banking had received no sustained attention from economists since the 1800s. Hayek’s timing was good: he wrote at a time of accelerating inflation in many Western countries, and his 1974 Nobel Memorial Prize in economics gave him a certain celebrity. Denationalisation of Money brought belated attention to a 1936 book by one of Hayek's students, Vera Smith (after marriage, known as Vera Lutz). Smith's book, The Rationale of Central Banking, remains essential reading on free banking.

The next big step forward in developing the idea of free banking was Lawrence H. White’s 1984 book Free Banking in Britain (link is to the 1995/2008 second edition). Whereas Hayek’s approach was mainly theoretical, White explained how the Scottish system of free banking had enjoyed practical success for more than a century, until ended by law in 1845. White’s book was a mixture of economic theory, economic history, and history of thought.

Most subsequent writing on free banking has been a development of themes that were in Hayek or White. Here are what I consider the most important ideas on free banking that have been well known for at least 15 years among those of us interested in the subject — the "what's old" that I mentioned in my previous post.

  1. There is a sophisticated theoretical case to be made for free banking as the monetary system that best promotes monetary equilibrium. (George Selgin is the key thinker here with his 1988 Theory of Free Banking; Steve Horwitz has also done work on the topic.)
  2. Central banking is subject to the criticisms of centralized economic planning that Ludwig von Mises and Hayek made in the 1920s and 1930s, which other economists acknowledged as valid when communism collapsed in the late 20th century. Mainstream monetary theory indirectly addresses the criticism by claiming that money is a natural monopoly, but to my knowledge it has not tried to rebut the Mises-Hayek arguments head on.
  3. Free banking systems existed in dozens of countries until the early 1900s, and most seem to have worked successfully – much better in some ways than the central banking systems that replaced them. (An essay of mine in a book edited by Kevin Dowd, The Experience of Free Banking, is no classic, but it remains the best short overview of the subject. Unlike the other works I have linked to, it is unfortunately quite expensive.)
  4. Historical cases of free banking were typically associated with a gold or silver standard. A contemporary free banking system might operate on a different kind of monetary standard. Theorizing on this topic necessarily involves some leaps of imagination.


  1. Thanks for the list, Kurt, really helpful …. looking forward to reading the recommended books over the coming weeks.

    But, before we start discussing free banking in depth, I wonder if anyone would disagree with my view that the U.S. Constitution creates an entirely new kind of monetary system, one that may not be compatible with the many different European models mentioned in the books.

    Winston Churchill once said, "The best argument against democracy is a five minute conversation with the average voter." … but, regardless of what we may think of a "people owned" government that can issue its own fully-public currency directly through its Congress and Treasury Department without using its central bank, does anyone know of any other country's monetary system that is similarly constructed?

    I'm asking because I don't believe so, but on the other hand, I haven't really analyzed the constitution's of other countries, whose central banks seem to be chartered by decree of a monarchy, not by representatives (Congress) of its "people."

    1. I see mostly similarity between the United States and other countries on the matters you mention. As concerns the legal aspect, even in monarchies, issuance of currency was typically subject to parliamentary approval by the 1800s because monarchs no longer had absolute power. If you want to exclude monarchies from consideration, remember that after achieving independence from Spain, many Latin American countries tried to model their systems of government on the United States, including their constitutional and legislative treatment of money. As concerns the economic aspect, since independence the United States at various times has had issue of notes (paper money) by privately owned banks with widely varying degrees of regulation; by a government department (the U.S. Treasury); and by a central bank (the Federal Reserve). Many other countries, including Canada and Mexico, have had the same arrangements.

  2. No, I'm not necessarily excluding monarchies, but perhaps trying to call into question the entire "view from the top" or "top to bottom" approach to banking and monetary policy, which doesn't seem to be working well at all. And this is the problem I have with our secretive, unaccountable, "independent" central bank, which seems to control Congress, rather than the other way around. My hope is that some form of free banking will eventually put monetary power back down at the bottom, locally, with "the people" (as unsophisticated as they may appear from the top).

    Some day I'd like to research the constitutions of the Latin American countries you mentioned, to try to understand why they couldn't duplicate our system, which as you may know, was constructed under some very unique socio-economic (including anti-slavery) circumstances. The U.S. system is essentially built on the corporate model where "the people" are actual "shareholders," who elect a board (both houses of Congress), then both the shareholders and board elect various officers, departments, committees, etc. So, perhaps you can see why I believe we have a real "bottom to top" system that may not be compatible with other more centralized, traditionally "top heavy" systems (that the U.S. seems to be following).

    Not that I agree with everything he says, but "monetary realist" Merrill Jenkins, Jr. once described my view very well: "The secret to good government, peace and prosperity lies in the ownership of the medium of exchange. When the people own the coin and currency they use, then the government depends on the people for its support, and the people direct the policies of government. If any other entity controls the medium of exchange that the people [believe they] are forced to use, then that entity controls the policies of government, and through government, controls the people."

    Perhaps this is another way of looking at the monetary "competition" free banking is trying to achieve.

  3. Hello all,

    Over the weekend I skimmed the recommended books by F.A. Hayak, Vera Smith & George Selgin, and I’d like to propose an informal, unofficial legal solution, without of course knowing the specifics of running or regulating banks.

    After reading overviews by Smith and Selgin, it became apparent to me that the National Banks Era (1863-1913) in the U.S. never got a chance to properly develop, and that we’ve been trapped in a central banking mindset ever since that era ended, not to mention that we may also still be undergoing post-Civil War reconstruction.

    In short, my opinion is that only federally chartered banks with full branch banking rights should be allowed to develop the free banking principles expounded by the experts. I hold this view mainly because: (1) central banking simply doesn’t work (and may also be unconstitutional when issuing irredeemable notes), and (2) under Article 1, Section 10 the Supreme Court will ultimately not allow state-chartered bank notes to compete with federal monetary powers.

    Incidentally, George Selgin and I exchanged some views about state chartered banks (and potential conflict with Article 1, Section 10) on Steve Horwitz’ Facebook wall, which began on May17. So, rather than re-explain here, the series of posts there should explain why I believe state-charter-based free banking would not work. Also see Veazie Bank v. Fenno (1869), an old monetary case that still represents how the Supreme Court is likely to feel about sharing federal money-creation powers with the states.

    In Vera Smith’s “The Rationale of Central Banking and the Free Banking Alternative,” she writes, on page 26 in Chapter 5, The Organisation of Banking in America: Decentralisation without Freedom:

    “The really substantial improvement that might have been effected through the National Banking Law was one that the authorities failed to realize, namely, the provision of facilities for a branch banking system. On the contrary the National banks were forbidden, except under special circumstances, to establish branches.”

    And on page 2 of Chapter 11, Discussions in American Prior to the Foundation of the Federal Reserve System, she writes:

    “There were in 1913 over 20,000 banks, of which about 7,000 were National Banks issuing notes and the rest non-note-issuing banks operating, not under the National Bank Law, but under the banking law of the States in which they lay. This was frequently cited as an example of the practical application of the principles of free banking. But while it was true that any person or group of persons complying with certain requirements could open a bank of issue, and that the business was open to all on the same terms, there were at least two important points of divergence between the American ‘free banking’ so called and free banking in the more general sense in which the terms was used by the writers on the continent of Europe. Firstly, the banks were excluded from practically all possibilities of developing branch organization, and most banks outside the big cities approached more or less to local monopolies. Secondly, the National Banking Law, under which the ‘free’ banks operated, specified a peculiar system of note issue. It is at least a supportable view the American bank organization lacked the advantages of both central banking and of free banking proper.”

    Regarding George Selgin’s “The Theory of Free Banking,” in Chapter 1, Overview, he writes:

    “More than other nation the United States has bolstered the myth of free banking as an historic failure. … As Bray Hammond notes, legislators in the early years of the republic never applied the principle of laissez faire to the banking business. ‘The issue was between prohibition and state control, with no thought of free enterprise.’ Banks were outlawed except when specifically authorized by state legislatures, and permission to set up a bank was usually accompanied by numerous restrictions, including especially required loans to the state.”

    Selgin then explains how mismanagement occurred at the national level during the Civil War that “precluded secular growth of the currency supply,” which in turn led to “the great money panics of 1873, 1874, 1893, and 1907,” which “provided the principal motive for creating the Federal Reserve System, which ended the era of plural note issue. Yet the crises would never have occurred (or would have been less severe) had it not been for government regulations that restricted banks’ powers of note issue in the first place.”

  4. George Selgin's Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage, 1775-1821 ought to rate as a classic. It's not an academic work, nor does it rehash his excellent theory of free banking. The book more a historical portrait of state capture of the monetary system through coin, culminating in a brief but remarkable break from history during a critical phase of the Industrial Revolution. Plus it's full of neato pictures of coins.

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