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OK, my first thread on misconceptions about the history of bank-issued paper currency, motivated by claims that history shows that the private market can't be entrusted with supplying currency of any sort, including digital currency. Here I deal w/ antebellum U.S. experience.
The claim has been made recently by several legal scholars, including my friend @DanAwrey and more recent acquaintance @steelewheelz https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3532681
But it is also popular with central banking authorities, who sometimes use it to justify extending their monopolies of paper currency to include monopolization of digital P2P monies.
But the basic historical claim--that private currency systems are inherently unreliable and prone to fail, simply isn't true. If this strikes you as a ridiculous claim, please bear with me! I know it goes against widespread opinion. Nevertheless that opinion is mistaken.
To confront it, I must explain, (1) that the popular view relies almost entirely on accounts of what supposedly happened in the U.S., to the neglect of experience elsewhere; and (2) that those accounts are themselves badly misinformed.
To begin with the second point, the first thing that must be made clear is that the U.S. has NEVER had a (mostly) unregulated private currency system, either nationally or at the state level.
As Bray Hammond put it in his monumental history of antebellum banking, until 1837 “The issue was between prohibition and state control, with no thought of free enterprise.”
(Elsewhere Hammond described the prevailing American opinion as holding that, because banks are dangerous monopolies, it was best to have as few of them as possible!)
Starting in 1837, states began passing so-called "free banking" laws, introducing what came to be known as the "free banking era." Alas, too many scholars have taken this literally, as referring to an era in which banks were free to do whatever they wished.
Nothing could be further from the truth. Despite the term, "free banking laws" subjected all banks set up under them to more-or-less strict regulations--including some absent from some "unfree" state banking systems. https://www.alt-m.org/2015/07/23/real-pseudo-free-banking/
Two regulations to which all free banks were subject were: (1) unit banking (free banks could not have branches); (2) specific "bond backing" requirements for any notes they issued. The first limitation hampered portfolio diversification in all FB systems.
The damage done by the second requirement depended on what securities banks were compelled to purchase. In some cases, the required securities weren't safe. Not surprisingly, they often consisted of securities of the sponsoring state and local governments.
Several "free banking" systems were dismal failures. But far from having failed because they took advantage of lax regulations, most of the banks that succumbed did so because the securities they were forced to buy were junk. Economic historians have known this for years now.
See, for instance, Rolnick and Weber's widely-cited work: https://www.alt-m.org/2015/07/23/real-pseudo-free-banking/. Another claim is that "wildcat banks" were common during this period. Hugh Rockoff first exploded this myth as long ago as 1974: https://www.jstor.org/stable/1991023?seq=1
Much research since offers further insights; but none contradicts the basic findings of this research. (For a nice summing-up see this Jerry Dwyer piece: https://www.frbatlanta.org/-/media/documents/research/publications/economic-review/1996/vol81nos3-6_dwyer.pdf
Some point to discounts on antebellum U.S. banknotes--their valuation at < face value, as proof of the inherent shortcomings of competitively-supplied currency. This is another serious error. Those discounts were chiefly, indeed overwhelmingly, a by-product of unit banking.
That is, they reflected the fact that most antebellum banks had only one place of business to which their notes could be presented for payment in specie. Note discounts mostly reflected the transportation and other costs of returning notes to their sources from far-off markets.
On this see Gary Gorton: https://www.jstor.org/stable/2138929?seq=1 Default risk was another factor, but one of lesser importance: https://www.jstor.org/stable/41353851?seq=1
What very few seem to realize is that note discounts were well on they way to vanishing when state bank notes were forced out of existence during the Civil http://War.In one of my own articles, I ask and answer the following question: how much would someone had lost...
...in October 1863 by buying EVERY outstanding non-Confederate banknote in the country for its current face value (in greenbacks) and then selling them to a broker either in NYC or in Chicago for their discounted values? Try and guess the answer. (No peaking!)
Answer: < 1% of his or her investment! Why so little? Trains and telegraphs, mainly. And this despite unit banking laws! For details see https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1465-7295.2000.tb00039.x
In the article I just cited, I also show that there was in fact no good reason for putting state banks out of the currency business. In fact, doing so would contribute to the currency shortages and crisis that were to plague the new National Currency system.
But that's the subject of my next string.
Attn: @DavidBeckworth @dandolfa @Aarondklein @PeterContiBrown @BobMurphyEcon @Frances_Coppola @TimDuy @tymoignee @NathanTankus @LevMenand @robertewright @sghorwitz @jp_koning @ProfKateJudge @lawrencehwhite1 @WilliamJLuther @1954swilliamson @MacRoweNick @mattwridley @yaronbrook
(Thread #2 is here: https://twitter.com/GeorgeSelgin/status/1274403232606011398?s=20.)
