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What’s new in the last 15 years

In a previous post I listed what I consider to be 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. During the 20 years from Friedrich Hayek’s revival of interest in free banking in 1976, researchers on free banking made great progress rediscovering the past and melding old ideas with newer ones. They succeeded in bringing the theory of free banking up to date from the mid 19th century, the last time it had enjoyed development by a group of keen minds rather than just by scattered individual thinkers.

In the last 15 years the earlier pace of progress has not continued. Partly it is the nature of scholarship: creative ideas come in bursts, and every discipline has its slow periods after the ideas have been digested. Partly it is because the core group of researchers, including some of the other bloggers on this site, is nearly the same as it was 20 years ago; new ideas usually require fresh blood. Here are what I consider the most important ideas that have been developed since those I mentioned in the earlier post.

  1. George Selgin explored how the ideal of neutral money fit with the fashion for inflation targeting among central banks. His monograph Less Than Zero argued that compared to the ideal of neutral money, inflation targeting would tend to produce inflation that was too high during booms and too low during busts. Selgin also argued that free banking approached the ideal of neutral money more closely than central banking.
  2. The ideal of neutral money provided a basis for researchers on free banking and fellow travelers among the Austrian economists to criticize the monetary policy of the Federal Reserve and some other central banks over the last five or six years. Before the global recession they were among the few to worry that monetary policy was too expansionary. After the recession began, they were among the first to be persuaded by Scott Sumner, or to conclude on their own, that the policies of the Federal Reserve and the European Central Bank in particular were too contractionary. Many researchers on free banking consider that nominal GDP targeting or something similar would more nearly approach the ideal of neutral money for central banking policy than inflation targeting does, though not as closely as free banking would. And now, a step down in importance from the top two ideas, two others:
  3. Note issue by federally chartered banks is legal in the United States.
  4. There has been more research on and argument about historical cases of free banking, such as Anders Ögren’s research on Sweden and Ignacio Briones’s research on Chile (links are to only to bits of their larger bodies of research).

This list is not an exhaustive catalog of "new" ideas; it simply includes what I consider to be the top ones. There has been other very good work, such as Selgin's research on free-market coinage, that has expanded our knowledge of free banking but that does not seem to me to be as central to the development of the subject. I invite reactions from my fellow bloggers and from readers.


  1. How about Larry Sechrest's mathematical model of free banking? I find Appendix A of his Free Banking book to be the best explanation of free banking dynamics, but I'm a mathematician. But, isn't it an important development in free banking theory in the last 15 years?

    1. I've never commented publicly on Larry Sechrest's book, and regret not having done so while Larry was still around. But as the book is often made that his was a more rigorous formulation of my own theory, I hope I'll be pardoned for saying that I don't believe his presentation was actually consistent with my theory; as I recall there was one place in particular in which his argument seemed quite opposite mine. Perhaps I will make a blog comment about this once I can get my hands on my copy of Larry's book.

      1. Hi Professor Selgin, if you would write a blog post or comment about Larry Sechrest's book and especially about the details of his mathematical model, I would be so happy. I'm very curious how it is inconsistent with your model; is it because his doesn't separate the variables of checking account money and banknotes? I'm sure you can get your hands on a copy; it's available online for free!

  2. Kurt, what do you see as the direction future research should take? I'm kind of stumped on where to go from here.

  3. Kurt, I enjoyed your article: "Note Issue by Banks: A Step Toward Free Banking in the United States?" (But it may not be clear to your readers that they need to click on the word “legal” in item #3 to get it.)

    If I had read your article yesterday, I may not have started a new Facebook page called "National Free Banking," which attempts to improve on Salmon P. Chase's 1863 Civil War effort. I describe the site as follows:

    "National Free Banking advocates a form of free banking that, in addition to offering easily obtained federal charters (so free banks can issue their own competing legal tender notes and engage in Congress-supervised fractional reserve practices), also guarantees depositors unfettered access to full reserve TreasuryDirect general and coin-only accounts under McCulloch v. Maryland (1819). National Free Banking also seeks to maintain FDIC protection for depositors."

    But, back to your article, I was encouraged to learn that there are presently laws on the books that make entry into free banking easy, but I think you at least implied that federally-chartered banks would be more feasible than state-chartered.

    On the other hand, the article was discouraging because of the likelihood that free banking will encounter "a hostile reception from a U.S. government jealous to protect the seigniorage (revenue) it earns …". I know you weren’t talking about what I’m going to discuss below, but I certainly agree that taxation (especially how the federal income tax regulates fiat legal tender under the Commerce Clause) needs to be fully explored before free banking has any chance of surviving in the United States.

    Milton Friedman is often associated with Depression Era income tax issues, but I haven’t found any direct evidence that he recommended the employee “special income tax” authorized by the Supreme Court in Helvering v. Davis (1937), one of three Social Security cases decided in that year.

    Wikipedia states: “… Friedman spent 1941–43 working on wartime tax policy for the Federal Government, as an advisor to senior officials of the United States Department of the Treasury. As a Treasury spokesman during 1942 he advocated a Keynesian policy of taxation, and during this time he helped to invent the payroll withholding tax system. He later said in an interview, ‘I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now.”

    As you may know, when Congress or its central bank issues fiat money, taxation is not directly required for raising revenue because Congress can just create whatever money it needs. On the other hand, the fiat power needs a corresponding power or “negative incentive” to regulate how the money gets distributed, and to create minimum income thresholds or poverty levels (Friedman’s negative income tax?).

    No need to answer that question. I’m just trying to be more certain about what the depositor is doing, or failing to do, that causes the need for government currency intervention.

    All my research to date shows that the heart of the problem lies with the depositor’s failure to take title to his/her deposits, whether this failure is caused by depositor neglect, or, by government or bank failure to provide a convenient legal mechanism for taking title.

    Stated differently, ever since our first Treasury-Direct experiment with irredeemable greenbacks in 1862, along with our first income tax law, also in 1862, circumstantial evidence points to an almost automatic need for government to regulate, through taxation, non-coin “fiduciary media,” i.e., money to which the depositor has not claimed title, whether that substitute money comes from the sovereign (Congress), its central bank, prospective federally-chartered free banks, or other sources.

    Of course, this is not to mention the incentive that bankers’ have to obstruct. Bankers naturally abhor the idea that a property right (title) has been claimed on its some of its deposits, and therefore that some of their funds are subject to full reserve restrictions. Talking to bankers about providing full reserve options for their depositors is like talking to commercial fishermen about how to ban fishing in their most lucrative fishing grounds. But, hopefully, one day Congress and the judiciary can do something to protect the lone natural person, and to level the playing field.

  4. I'm stunned that it's legal for banks to issue currency. If banks were to start issuing their own money would they even print notes? Wouldn't cash cards or debit cards be cheaper? I'm not saying that's what I would want them to do as I like banknotes but I'm probably part of a small enough minority on this issue that the banks wouldn't lose much if anything by not catering to us.

    Don't get me wrong, using a debit card has a lot of advantages but I like folding money and would hate to not see these hypothetical new examples.

    1. Warren, Kurt Schuler's article above (click on "legal," item #3) speaks to this a little bit on page 462: "Banks seeking to issue notes today could promote acceptance of the notes by making them look and feel much like Federal Reserve notes, at least initially. …"

      Personally, I'd like to see uniformity also, and Congress has the right to require this as a condition of granting the corporate charter. For example, I think all federally-chartered free bank notes should look the same, but just have the issuing banks serial number or charter number conspicuously printed on the note somewhere.

      1. Of course with companies like Square and their card reader and this Google Wallet and whatever else that is percolating out there that will be coming out we could get to an almost note-less economy even in the absence of free-banking.

        I understand the practical matter of having similar looking and sized notes to what we have now but the romantic in me wants to go back to the large format notes with beautiful engraving and multiple colors. That's why I like the historical notes (and coins), it's like having little pieces of art in your wallet.

        And no dead politicians, please. Not that I'm opposed to the concept of dead politicians I just don't want their faces on my money.

        I know this is a tertiary part of free-banking but as a potential end user and not a theorist it's closer to the center of what free-banking would mean in my life and therefore it's important to me that the currency is not only useful but beautiful.

        In addition to having to change all the ATM and vending machine inputs all those money trays sitting in cash registers all over the country would have to change. And those are 30+ to 50+ dollars depending on the brand. Plus personal wallets would have to get a little bigger to accommodate the new sized money.

        So the odds of breaking out of that path to go where I want things to go is nil.

        However there may be a way to keep the current size bills but make them more attractive just by having a certain set of base features which would be what the note-readers scan but that leaves open the rest of the note for different designs.

        1. My preference would be to have four Congress-supervised circulating notes, two issued by private banks and two issued directly by the Treasury Department, but all notes would look similar on the front face (and would have their functional electronic equivalent):

          (1) FEDERAL RESERVE NOTE: stays the same, legal tender FOR all debts public and private.

          (2) NATIONAL BANK NOTE: looks the same on front, but with “NATIONAL BANK NOTE” across the top and “legal tender FOR all debts public and private” on the front, with back portion used to provide various information about (potentially thousands) of privately-owned note-issuing free banks, such as date of charter, charter number, supervising federal authority, bank contact and branch information, where to check for bank solvency and rating, etc.

          (3) UNITED STATES NOTE: looks the same on front, but with “UNITED STATES NOTE” across the top, legal tender FOR all debts public and private, with back portion staying the same as the Federal Reserve note. (This currency is for those who object to how the fractional reserve practices of private banks take economic discretionary power away from their representatives in Congress.)

          (4) UNITED STATES DEMAND (or BEARER) NOTE: front states “UNITED STATES NOTE” at the top, but adds “WILL PAY TO THE BEARER ON DEMAND” above the dollar amount at the bottom. This note is “legal tender IN PAYMENT OF all debts public and private,” and is redeemable on demand in current U.S. coin. The back portion would stay similar to the existing Federal Reserve Note. (This currency is for people who want to claim title to their money and who object to the regulatory income tax on the receipt or “incoming transfer” of non-coin money, assuming we eventually establish that an income tax is indeed used to regulate fiat legal tender under the Commerce Clause.)

          Issuers of currencies #1 and #2 should be allowed to engage in reasonably regulated fractional reserve practices, but all banks are subject to full reserve restrictions on currencies #3 and #4, and Congress itself is subject to a kind of full reserve requirement when currency #4 is used by depositors.

          In my view, the above scheme is a realistic way to keep the U.S. monetary system Constitutionally-sound and to allow for a relatively smooth transition away from central banking, assuming the people and the judiciary can keep “currency competition” fair and recognize that, in the event of future conflict, Treasury-Direct currencies (#3 & #4) are ultimately “sovereign” under the U.S. legal framework, and that even Congress has no right to withhold currency #4 from its constituents.

  5. In your 2001 Cato article you remark: "Restrictions on branch banking also made banks (and before the Civil War, their notes) more vulnerable to failure than they would otherwise have been, by depriving them of the portfolio diversification that can come from having borrowers dispersed across regions." Were there also restrictions on the syndication of loans across state lines? Could not (for example) a New York bank have bought a partial interest in a loan made by a California bank, thereby achieving some geographical diversification? If this was legal, it should have been fairly common; was it?

    Banknotes would not work in vending machines. More important, banknotes would be uninsured by the Federal government; many people have a (superstitious?) veneration for a Federal guarantee. Furthermore, with Federal deposit insurance, banks have lost the habit of promoting their financial soundness to the public, and few people have any clear idea of which banks are sound and which are more likely to fail. The recent financial crisis damaged confidence in the banks, as some of the largest and best known among them were "bailed out" by the Federal government. My guess is that few people would be willing to accept a banknote from Citicorp–not to mention Fifth Third–not to mention Slippery Rock State Bank–at par with a Federal Reserve note, absent some rather expensive incentives offered by the banks. (On the other hand, Apple and ExxonMobil look like pretty safe potential issuers.)

    Commentator Warren hints that banks' issuance of debit cards is nearly equivalent to issuing banknotes. Perhaps it will soon be routine for many depositors to take withdrawals in the form of "pre-paid" cards rather than currency–an up-to-date substitute for banknotes.

  6. It seems to me that there is also a lot of time wasting during the back and forth criticism between full reservists and free bankers. The full reservists tend to attack a misrepresentation of the free banking argument, or tend to misinterpret what they are criticizing, and then the full bankers have to defend themselves by restating their position. I wonder if less time was spent debating back and forth more time would be spent on advancing theory.

    Anyways, in what directions do you think free banking theory can be taken? Are you talking about a more in depth synthesis with other "Austrian" theory (e.g. capital theory, monetary theory, et cetera)? What holes do you perceive there to be in free banking theory?

  7. I haven't time to read the entire paper about legal note issue, but I do have a question.

    Even if U.S. banks are legally permitted to issue banknotes, is the government really going to let that situation remain if banks actually started exercising their right to issue?

    I just don't see it. It seems to me that any move by banks to issue notes would quickly countered by new legislation (with possible exceptions for the politically influential, of course).

    1. Lee, the federal government will allow independent free banks to issue their own notes, just like it presently allows the Federal Reserve to do so, but only after Congress understands that free banking will open up vast new sources of tax revenue.

      To explain how this is possible, I need to briefly explain something that very few U.S. lawyers understand, which is the difference between taxes on “income derived from property sources” (IDPS) vs. taxes on “income derived from non-property sources” (IDNPS).

      Most people, including most lawyers, think that the 16th Amendment authorizes the existing income tax and Social Security taxes on our wages and salaries, but it does not. Congress always had the power to tax IDNPS, and if the 16th were abolished today, Congress would still have the power to tax this form of income. And I believe Milton Friedman and others understood this during the New Deal era and the “revolution of 1937,” which is when the “gateway” employee portion of the Social Security “special income tax” came into being in Helvering v. Davis.

      A closer look at the history behind the 16th will reveal that its sole purpose was to clarify that taxes on IDPS (rental income, interest & dividend income, profits from employing labor of others, etc.) were not direct taxes on the property sources of those income items, which would mean that without the 16th they’d be subject to the Constitutional restrictions of the two Direct Tax Clauses.

      In short, when Congress understands that taxes on IDNPS were always Constitutional and will allow for new sources of income tax revenue from users of the new “fiduciary media” created by thousands of new federally-chartered free banks, it will embrace free banking whole-heartedly.

      The only currency-users from which Congress will not be able to exact an income tax would be users of the coin-based currency I mentioned above at post 4.a.1.a (currency #4, United States Demand Notes). But even here, Congress will gain a power to indirectly "tax" new users of current U.S. coin through its power under the Coining Clause “to regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.”

      Don’t worry if you don’t understand this. I haven’t met another lawyer or law student who understands it either. I try to better explain the difference between taxes on IDPS vs. IDNPS on my website in this short essay:

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