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What we still need to know

Here are what I consider the most important gaps in our current knowledge of free banking.

Free banking and monetary equilibrium. George Selgin has provided the base on which future inquiry will be built. More remains to be said about the way that bank clearings signal banks to expand, hold constant, or contract credit.

Free banking in comparison to other monetary systems. More work is needed using balance sheets, models, or other tools of systematic description for comparing in depth the operational details of various monetary systems, especially in terms of how well they discover and respond to changes in the supply of and demand for savings.

The history of free banking. Much has been done, but much remains to do. As far as I know, nobody has published a book describing in detail a single episode of free banking. (Lawrence H. White’s Free Banking in Britain was a combination of theory, economic history, and history of thought, appropriate to the time because of its pioneering nature, but it was not simply a study of how the Scottish free banking system worked and how it evolved.) Ignacio Briones, a Chilean economist, wrote a good dissertation on Chile’s free banking period of the late 1800s, but he has not published it because he is busy in his current job as coordinator of international financial affairs in the Chilean Ministry of Economy. Moreover, he wrote it while studying in France and it is in French, a language that far fewer economists today read than read English or Spanish. Anders Ögren, a Swedish economist, has written a dissertation, published as a book, on the Swedish monetary system of the 1800s, but if he is to be believed, it was not a free banking system.

Returning to free banking. What are the steps, particularly with respect to financial regulation, that would re-establish free banking with the smoothest transition? Once re-established, are there any measures that would make free banking more politically durable than it proved to be the last time around? I understand that a student at George Mason University is working on issues such as these, advised by Larry White.

Rival monetary standards and free banking. Historically, free banking has been associated with the gold or silver standard. Other standards are conceivable, and have been proposed, such as Milton Friedman’s idea to freeze the existing monetary base or the late Earl Thompson’s idea for a labor standard of value. How do different possible standards compare with respect to their theoretical properties? In the end, consumer choice would determine which was superior. People might choose gold again, in which case we would have to investigate what it is about gold that people find to be so appealing. Or competing standards might coexist without one ever gaining a decisive advantage.


  1. Kurt, I agree much more work is need on the Free Banking Theory. In particular I think there is a significant need for a formalisation of the Free Banking model. Larry Sechrest has done some interesting work on this, but in my view more clearly need to be done. In particular I think there is a need to develop models that takes into account different “imperfections” such as asymmetrical information, sticky prices, barriers to entry and imperfect competition. Under what circumstances will Free Banking work and under what circumstances will central banking be preferable? More advanced formal models will shed more light on these issues. Testing the Free Banking model under different assumptions about asymmetrical information, stick prices, imperfect competition etc. will show how “robust” the model is to “competition” from central banking.

    Unlike some of the view expressed by George Selgin I believe formalisation is important as a tool to not only understand Free Banking, but equally important to market the ideas of Free Banking. Formalisation will also illustrates some of the weakness (if there are any?) in the standard Free Banking models of Selgin and White.

    Furthermore, Free Banking theories clearly also have a lot to contribute to terms of reform of monetary policy targets. Hence, the connection between Scott Sumner’s NGDP level targeting and George Selgin’s model of Free Banking is pretty clear. Furthermore, in the absent of total deregulation of banking and money – how should regulation look like? Free Banking theorist have a very good understanding of financial crisis erupts. Such insides could (should!) play a important rule in the debate of banking reform around the world.

  2. I'm new to this and looking for guidance, so please forgive my intrusion. I teach economics at a small university in Missouri. I've been reading Classical Liberal thought lately, and this is my first foray into Free Banking. I first ran across Larry White as an undergrad, my professor for Monetary Economics used his textbook.

    I have read White's paper on how Hayek was not in favor of "laissez-faire banking." I get a mixed sense from Adam Smith about it– in some places he advocates caps on interest rates out of concern for speculative lending. He outlines a financial crisis in Scotland that seems to display skepticism about banking in general, so I'm not sure how White can say he's a proponent of free banking.

    My question in regards to this post is "how do information asymmetries in banking work out in a free banking system?" there seems to be a belief, characteristic of Austrians, that prices are right and markets equilibrate. I don't see that actually happen many places in the financial world, monopolistic competition reigns.

    My second question is "what about monopolies?" Inevitably, some bank will gain an advantage over others and consolidation will happen as it seems to have had with every commercial banking system in the world. Some banks will simply be better geographically located to gain advantages. Removing regulations in the last 30 years has led to more monopolies than brought us closer to perfect competition.

    I share Hayek's skepticism about competitive commercial banks– that the competitive drive to expand credit when demand was high would lead to monetary disruption and a boom/bust cycle. I'm reminded of Greenspan's recantation to Congress about his belief in self-regulating financial enterprises.

    Any recommendations for reading material for me? Any literature that expressly addresses my concern? Thanks.

    1. On Adam Smith, see my earlier post with his name in the title, which contains the key quote on the matter. On information asymmetries, the Austrians see them as a feature, not a bug. The division of labor and the division of knowledge go together. Both enable groups of people to be far more productive than they would otherwise be. Asymmetrical information contains the seeds of its own disappearance, though, because if there is a profit opportunity from exploiting it, people will have an incentive to arbitrage away the profit. Start with Friedrich Hayek's 1945 essay "The Use of Knowledge in Society." For more, you should then contact Steve Horwitz (who blogs here), since he is an academic and will probably be more nearly on your wavelength than I am. Finally, in the only comprehensive survey that has so far been done on the history of free banking, a chapter I wrote in the 1992 book The Experience of Free Banking (edited by Kevin Dowd), I found no tendency toward monopoly in any historical free banking system. There was a tendency towards consolidation, but never a winnowing down from many banks to just one.

  3. Thank you for the response. "Tendency towards consolidation" is what we've seen historically in the U.S. and has led us to the oligopoly we have today of 9 "too big to fail" commercial/investment bank/insurance conglomerates.

  4. It is obvious that precious metals are going to play much more important role that in previous decades. Whether this is going to lead to some sort of gold standard or even free-banking-gold standard is questionable. I would argue that something has to change subtentially, but the question is if governments are going to let it happen. There is strong demand for an unregulated currency in market. We can see this in the quest of digital currencies. Recently the e-gold failure after targeted by US government discouradge a lot of private efforts in this field. Private companies cannot compete with stregth of governments, only market as whole can achive this. I would like to bring an attention to a new form of digital currency, which might be able to succeed in spite of governments efforts to surpress it, because there is no private institution to be taken down. The currency is decentralized and its strenght is equal the community (or the market) behind it, which actually growing in an expontial way. The name of currency is bitcoin. Suprisingly, we might well end with bitcoin standard: there is lot of development going now in this field, the first bitcoin bank was announced several months ago issuing flexcoin backed by bitcoin. For basic information about nature, positives and negatives of bitcoin see

  5. What if there has never actually been a Free Banking situation? What if Free Market money doesn't actually work and government involvement is necessary? Perhaps the best case scenario is to follow Hong Kong's example and license banks to issue their own notes so long as they provide the government with assets of equal value?

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