Scotland’s free banking era

Banking practices in 18th century Britain are as captivating and romantic to me as a moor-set novel. The stories of Edinburgh’s competing bank houses in 1765 offer as much drama and intrigue as any feuding Georgian manor houses and, looking at the history, I can just imagine chemise-clad Regency women, fainting behind their kerchiefs, just as fearful of unregulated banks as they were of their own muscular servant gardeners.

What gives me a case of the vapors, myself, is that people rarely read these stories, even though these stories have absolute relevance to their own bank accounts. If more soccer moms, frightened by the idea of unregulated banking, understood how Scottish banking worked in the 1700s, they wouldn’t be at the mercy of predatory banks today, nor would they fall for (or, worse, support) all the banking regulations being pushed through Congress by the big banks, themselves.

The time period from 1716 to 1844 in Scotland was an era of “free banking” (or about as free as the planet has yet known): back then the Scottish government imposed very few regulations on banks and all the banks existing in and around Edinburgh and Glasgow were free to issue private currencies. (Today, we have corrupt laws against private currencies here in the U.S.) These competing Scottish currencies were also sound or “hard,” meaning that every currency note was backed by gold or silver. Anyone holding a bank’s note could redeem it at the teller window for an equivalent amount of gold or silver bullion, usually in the form of coins. Paper currency back then was simply used to conveniently replace the handling of heavy coinage. (In fact, paper currencies emerged from the practice of the public’s trading their bank receipts for stored gold and silver nuggets.)

The benefits of competing currencies have been mostly lost to history, though crypto has revived their study somewhat. But here in the U.S., with the Federal Reserve holding a monopoly on the issuance of money since 1913, and the removal of that money’s hard backing by gold in 1971, most of our citizens have lost any understanding of the ways competing hard currencies can benefit the consumer. We’re also quite shielded from understanding the ways a money printing monopoly can benefit a few high-ranking central bankers enjoying life in the 1%. Which is why books like Free Banking in Britain are so important.

The primary argument against competing hard currencies has always been that private banks would print too much of their own money. This can be a problem because the more units of a currency that get circulated, the less valuable each unit becomes. A similar plot twist happened in The Hitchhiker’s Guide to the Galaxy when the Golgafrinchans decided to adopt the leaf as legal tender. “[W]e have run into a small inflation problem,” explained the Golgafrinchan management consultant, “on account of the high level of leaf availability, which means that… the current going rate has something like three deciduous forests buying one ship’s peanut.” Let’s call the idea of printing too much money, then, a Leaf Problem.

But wait a minute, isn’t overissuance of money exactly the problem we’ve had with the Federal Reserve for over a century now? Why are we not making the Leaf Problem argument every time the Federal Reserve prints a $2 trillion stimulus package? The Federal Reserve has over-printed dollars to such a degree that the value of a dollar has fallen over this time to a measly four cents. Of course, the “value” is still one dollar by law, but we see the true loss in its value as prices continually rise. What was worth a dollar in 1913 is today worth about four pennies, a loss of 96 percent of our purchasing power.

So we, the people, have been denied the freedom to enjoy competing hard currencies (and the preservation of our purchasing power and wealth) because the government is worried we’ll print too much of our own money. But that’s exactly what the government has turned around and done. Now you see why I no longer vote.

Anyway, White’s research in Free Banking in Britain shows that, oddly enough, private banks in 18th century Scotland tended not to over-issue their currency notes. Why was that?

Well, first we need to define what it means to over-issue. How much is “too much” when it comes to printing hard money? “Too much” is simply more money than a bank could back with its gold reserves. If a bank did over-issue its currency, its customers might decide to redeem that currency for gold and if the bank didn’t have enough gold on-hand, that could spell doom for a bank. This is precisely why many banks have failed throughout history. (Today, the Federal Reserve is shielded from any consequence arising from over-issuing the dollar because the Fed is no longer is obligated to redeem dollars for gold, which might be one reason it so happily over-prints them.)

Another key feature of free banking in 18th century Scotland was that banks operated under unlimited liability. If a bank failed as a result of over-issuing its currency (or any other bad business decision) the shareholders were obligated to cover their customers’ losses. This was such an important feature in the free banking market that when the Scottish government made limited liability available to private banks in 1862, most of them refused it, worrying that it would cause their customers to lose confidence in them. Honest bankers were proud to operate under unlimited liability as they had no intention of over-issuing their currencies or driving their profitable banks into the ground.

That’s not to say bad decisions weren’t sometimes made. A spectacular crash involving the Ayr Bank, for example, occurred in 1772. But because of the free-market force of unlimited liability, Ayr’s 241 shareholders covered the entirety of the bank’s losses. Today, of course, we have limited liability and shareholders are shielded from their bank’s poor business decisions, forcing the government (us, the taxpayers) to cover any losses through the FDIC.

White covers other reasons why these free, private Scottish banks tended to operate so well in the 18th century (including the note exchange systems and joint stock structure), and he also compares and contrasts them with the heavily regulated English banks, large and small, of the same time period. It’s certainly an eye-opening subject of research and White has covered it exhaustively (including a refutation of a few counter-arguments made by Rothbard).

Of course, as with all economic non-fiction, the writing can be dense and filled with jargon. I do wish economists could learn to write in more engaging ways; their failure to do so keeps most people ignorant about basic economic truths and it’s a complete shame. But White’s book contains information that is worth our time and effort to slog through. Banks like the Federal Reserve literally ciphon money from the public by regulating competing currencies out of the industry and the public will continue to experience the theft of inflation until it begins to learn what inflation is and which regulations allow it to proliferate.

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