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Dizzy Miss Izzy

I'm so dizzy my head is spinning
Like a whirlpool it never ends
And its you, girl, making it spin
You're making me dizzy*

Tell me I'm not with it, if you must, but the fact is that until a couple of days ago I'd never heard of Izabella Kaminska, who bills herself as a "finance blogger" and believer in something called the "collaborative economy," in which sharing things takes the place of buying and selling them, the result being, she claims, a reduced carbon footprint.

Although I rather doubt that we're likely to witness an end to our "propensity to truck and barter" anytime soon, I don't doubt that such an event would in fact reduce carbon emissions: there would, for one thing, be a lot less less breathing going on. But what concerns me isn't Ms. Kaminska's general economic philosophy, to call it that. It's her vertiginous spin on free banking, which she saw fit to air this past week, first on FT Alphaville, and then on a blog of her own called, appropriately enough, Dizzynomics.

All this might have gone happily unremarked had the Econ Blogosphere's Grand Pooh Bah not seen fit to deem the last of these disorienting missives worthy of his readers' attention. And so it happens that, Despicable Free Banking Nobody though I am, I find myself submitting, for The Rt. Hon. GPB's consideration, my own humble post, the gist of which is that Ms. Kaminska hasn't the foggiest idea what she's talking about.

Because I addressed some errors in Ms. Kaminska's FT post in comments to that post itself, I'll embellish a bit here rather than repeat myself.

In discussing the founding of the Bank of England, Kaminska refers to the risk that "a private syndicate" took in "lending money to" the "UK" government. Let the anachronism pass. What matters is that the arrangement in question involved, not a loan directly made by the parties in question, but one made from the proceeds of a public stock offering, the lure for which consisted of monopoly powers the new Bank was expected to command. The stock sold in 12 days, and though the investors (again, not the scheme's principals) could hardly avoid taking some risk, their gamble had every appearance of being a darn safe one. According to Sir John Clapham (History of the Bank of England i, p. 20), among the various projects being floated in those times, "the Bank with its Parliamentary backing, its high sounding name, and its guaranteed income from the taxes was a very attractive proposition. The speed of the subscription need not surprise those more familiar than any pamphleteer of 1695 could be with how and why men invest."

I comment in the FT post itself on Kaminska's suggestion that the Bank of England was particularly effective at enhancing England's prosperity, so let me add here some brief excerpts from the source I referred to in that comment: Rondo Cameron's chapters on "England" and "Scotland" from his edited volume, Banking in the Early Stages of Industrialization (Oxford University Press, 1967). "The English banking system from 1750 to 1844, " Cameron observes, "was far from ideal in its contributions to either stability or growth of the economy as a whole." Topping Cameron's list of that system's infirmities is the Bank of England itself, whose "contributions to industrial finance were negligible, if not negative." Regarding Scotland Cameron says, in contrast, first, that despite having been "a poor country by any standard" in 1750, it "stood with England in the forefront of the world's industrial nations" a century later, and, second, that "the superiority of its banking system stands out as one of the major determining factors" of this relatively rapid growth.

Ms. Kaminska's estimate of the contribution of the Bank of England's monopoly privileges toward British economic stability is just as unfounded as her opinion regarding its contribution toward British prosperity. "Before the Bank knew it," she writes, "its notes had become the most liquid and trusted in the land." Actually, because the Bank didn't even bother to have branches beyond London before 1826, its notes were until that time seldom seen beyond the metropolis. (Nor, prior to the French wars, did the Bank issue notes for less than the princely sum of 10 quid.)

If the Old Lady's notes were nonetheless judged safer than those of country banks, that was because those banks were severely under-capitalized and under-diversified. And why was that? Because they were not only denied Joint-Stock status, but subject to a rule limiting their ownership to six partners or fewer. In short the country banks–the only sort, remember, allowed to operate wherever the Bank of England chose not to–were by law prevented from achieving any reasonable degree of financial diversification and strength.

Here we see how, like most apologists for central banks, Ms. Kaminska fails to understand that the advantages commanded by such banks have as their precise counterpart limitations imposed upon all others. Little wonder so many English country banks fell victim to the Panic of 1825! Contrast, again, the situation in Scotland at the time, with three chartered banks and twenty-nine provincial ones, all commanding nationwide branch networks, and not one bank failure since a private bank failed in 1816–and even that one paying 19s on the pound! "Certainly Scotland," Sir John observes, "appeared to have secrets of sound banking that England might inquire into."

Ms. Kaminska is sanguine enough to allow that the Bank of England's powers tempted it to engage in "imprudent money-printing." But she spoils this lapse from her otherwise unalloyed confidence in the benevolence of state-sponsored monopolies by adding, gratuitously, that the bank was "not helped by the fact that [it] still had to compete with a whole bunch of private banks who were just as keen to issue money to an equally imprudent degree." But, as I've noted, "compete" with "private" (meaning, presumably, country) banks is just what the Bank did not do, at least not until after 1826. Instead, by the terms of its charter it subjected them to inhibiting constraints, and then, having led them on by means of its own generous discounts, reversed course and…let them fend for themselves. (For evidence, see the relevant section of my article, "Bank Lending 'Manias' in Theory and History.")

Kaminska can at least take credit for originality in reporting that, during the 1840s, "a terrible inflation" took hold in England, and that it was to combat that outbreak that Peel's 1844 Act was passed. Alas, the claim owes its originality to the fact that there's not an ounce of truth to it. The same may be said for her claim that the Scottish system was stable only because Scottish bankers "were so good at forging oligopolistic cartels that happily restricted competition." As I noted in my FT comments, there's no evidence that limited entry was a source of any significant monopoly power in Scottish banking. (On the contrary: the system was notoriously efficient.) Nor is there any evidence that Scottish banks policed one another other than by engaging in regular note exchanges, as they would have been no less compelled to do had entry into the industry been open. But let us assume, for the sake of argument, that Ms. Kaminska is correct in holding that oligopoly was the cause of the Scottish system's superior stability. Then why, one wonders, does she not grant that a similar oligopoly might also have made England better off than it managed to be with its patently unstable blend of monopoly and hamstrung polypoly?

In 1833, thanks to a the efforts of the great Thomas Joplin, the terrible Six Partner Rule was partially circumvented by way of the discovery that its language encompassed note-issuing banks only, and not mere banks of deposit. The Bank of England thus faced for the first time competition from other joint-stock banks. Such are the facts. And what does Ms. Kaminska's make of this development? First, that it came, not in 1833–that is, well ahead of Peel's Act–but "in the latter half of the 19th century"; and, second, that it occurred, not because a clever banker discovered a loophole in the law aimed at severely restraining the Bank of England's rivals, but supposedly because restrictions imposed by Peel's Act on the Bank of England itself created "conditions" favoring the rise of "a new type of unregulated" bank. "Some history" indeed.

Ms. Kaminska concludes her remarks on English versus Scottish banking with a long excerpt from the Bank of England's web pages, telling of how it "established the concept of lender of last resort" in the wake of the crises of 1866 and 1890. Had the "concept" thrust down its throat, by Walter Bagehot, is closer to the truth. What that great man had to say concerning the respective merits of the English ("one reserve") and Scottish ("natural") systems is, or ought to be, too well known to warrant repeating.

In her Dizzynomics follow up Ms. Kaminska adds little to the substance of her FT argument against free banking, such as it is, preferring instead to heap anathemas upon free bankers, who according to her reckoning are thick on the ground (were it only so!), and whom she regards as "reason and logic deniers" incapable of grasping the fact "that whenever we've had free-banking systems they've resulted in chaos or alternatively co-beneficial collusion to the point were the system is not free by the standard definition of free."

No one, so far as I know, has ever claimed that the systems generally held out as examples of "free" banking–Scotland, of course, and Canada before 1914, among others–were perfectly so. Not me. Nor Kevin Dowd. Nor Larry White. Nor any other free banker I know. Of course those systems weren't perfectly free. No banking system ever was. Nor has Hong Kong ever witnessed free trade in all its unsullied glory. So what? The question is always whether the examples come close enough to serve as evidence of the likely consequences of the fully-realized alternative. Was Scottish banking, to return to that case, "close enough" to shed light on the consequences of truly free banking? The debate on that question was joined some years back, with Larry White weighing in in the affirmative against the counterarguments of Murry Rothbard, Larry Sechrest, and Tyler Cowen and Randy Kroszner, among others. Ms. Kaminska, having found the opposition's case neatly summarized in a blog post, simply overlooks White's rejoinders. She overlooks as well the not-insignificant body of theoretical work using induction aided by deduction rather than deduction alone to draw inferences about the likely consequences of unalloyed freedom in banking.

Kaminska herself needs no theory, on the other hand, to reach the conclusion that genuinely free banking, unlike the Scottish mongrel, must lead to "chaos." How can she know? As she offers neither evidence nor argument, one must hazard a guess. Mine is that she is referring to the U.S. banking system between the demise of the second Bank of the United States, in 1836, and the outbreak of the Civil War, and that she imagines, as many people do, that because a half-dozen states passed so-called "free banking" laws during that interval, it qualifies as one of perfect freedom from any sort of bank regulation. Excuse me for having had to suppress a yawn just now–it is a long post, after all, and fatigue is setting in, quite possibly for us both. Suffice to say, then, that old banking myths die hard, and that this especially hoary one about U.S. "free banking" seems harder to kill than Rasputin himself. That it is mostly hokum is nonetheless easily established: just have a look at any post-1975 work by an economic historian on the subject, including the locus classicus, Hugh Rockoff's The Free Banking Era: A Re-Examination (Arno, 1975). (A later survey piece is here.)

A misreading of the same U.S. experience seems also to inform several of the obiter dicta that follow Kaminska's opening thrust, including her claim that free bankers fail to "appreciate that it was standardizing certain subjective [?] values like weights, distances, time [sic] itself that has allowed society to cooperate, grow and thrive." (Because antebellum state banking laws generally prohibited branching, state banknotes tended to be subjected to discounts when encountered any distance from their source; in contrast, in the Scottish and Canadian systems, where banks were free to establish branch networks, banknote discounts, if they ever existed, eventually disappeared. Ditto her belief that free bankers "advocate a Wild West model where no one can trust anyone and everyone has to do due diligence themselves." (Though it's true that the antebellum [old] west was inundated by all sorts of phony bank paper, that result came about, not because banking was unregulated there, but because territorial authorities, by having outlawed it, made their citizens perfect targets for phony notes purporting to come from legitimate banks down east. Where banking was more, though not perfectly, free, as in 19th century Canada or Scotland, in contrast, it sufficed to trust one bank, and to accept only those notes regarded as current at that bank, to avoid trouble.)

I hope I've said enough to suggest why I find it remarkable than anyone should take Ms. Kaminska's ramblings on free banking (or, I now feel justified in saying, on any subject whatsoever) seriously. Perhaps no one does. Still I wish Tyler hadn't given those ramblings more currency by advertising them, without the benefit of critical comment, on Marginal Revolution: here, surely, is a case where sharing adds to rather than subtracts from the world's burden of hot air.
*Tommy Roe, "Dizzy."