This article was published in the Spring 1995 issue of Formulations
by the Free Nation Foundation
Banking for Free:
Banking in a Free Society
by Bobby Yates Emory

  (to table of contents of FNF archives)   (to start of essay)

How will free people bank?
Where will bank examiners come from?
What will prevent inflation?
Bank panics

(to outline)   (to top of page)

If the economy in a libertarian society is to exist at a level more advanced than barter, people will need banking services. We need to understand how the banking system will be different from today. How will we insure that the banks are sound? Will we be able to have a sound currency? Since the Federal Reserve is a special privilege granted to some businessmen by the government, libertarians probably will not want to continue it. How will currency be issued? Before the Federal Reserve system was established, there were bank panics. Will we have them again? (For a more thorough discussion of free banking see Steven Horwitz's Monetary Evolution, Free Banking, & Economic Order (Westview Press, Boulder, CO; available from Laissez-Faire Books), reviewed by Eric-Charles Banfield in Nomos No. 45 and Formulations, Vol. II, No. 2 (Winter 1994-95).)

(to outline)   (to top of page) 

How will free people bank?

Free people will use banks similar to those we have today, but with several improvements. Banks will offer services that are not available today (because the government agencies controlling banks do not now allow the services). There will be a lot more variety in the banks available. Some banks will be larger because banks will be able to operate in more than one state. Some banks will be smaller than today because without government regulators to deal with, the minimum economic size will decline.

Banks will be more readily available in well-to-do neighborhoods because competition will not be prevented. Banks will be more readily available in poor neighborhoods because they will not be prevented from adopting policies more suited to their environment. Some banks will be safer than today. Others will be more flexible in their policies than what we have today.

Let a thousand flowers bloom

By not preventing innovation, we will allow bankers to adapt their services to the needs of their customers. Just as our needs for personal transportation can be met by a range of options from a simple one-speed bicycle to a flashy sports car or a family sedan or a stretch limousine or a pickup truck, so we will be able to choose a small personable bank or a computer-accessed bank or a large international bank. If we do not regulate them, banks will innovate much faster and in many directions. They will provide us with a wider array of services and develop many different styles of offering those services. Since most changes are the result of the accumulation of many small innovations, by removing impediments to small changes we will allow major changes to evolve faster.

Adapting to their niche

If we do not thwart them, banks will devise ways of adapting to the needs of potential clients. In wealthy neighborhoods, more branches will be opened, giving the residents added convenience and better prices (more competition will drive savings rates up and loan rates down). In poor neighborhoods, banks will be able to charge fees so they can compete with check-cashing services and rent-to-own stores. Without regulations standing in their way, banks will be able to differentiate their services and will find many other market opportunities to customize their services to the needs of potential customers.

(to outline)   (to top of page)

Where will bank examiners come from?

One of the "services" provided by government is to attempt to force banks to run soundly. If the government is not providing this "service," how will we know the banks are safe? Who will check that the banks are being honest with us? Our primary protection will be the free market. No one will continue to do business with a bank (or any other business) that cheats its customers, so any bank wishing to stay in business has a powerful incentive to make sure its customers know it is treating them fairly.

Private inspectors

Just as we can have safe electrical appliances without government intervention (Underwriters Laboratory is a private institution) so we can have a private bank examiner. If the government does not preempt the field, a Good Housekeeping seal for banks will be developed to reassure depositors of the soundness of their bank. Banks probably will form alliances for mutual aid when runs occur. These alliances also will set and enforce standards for safe operation.

More than one standard

With the flexibility of private institutions, there probably will develop a variety of standards, so that customers will be able to select from a range of types of banks, from very safe but very rigid to more flexible but not as safe.

(to outline)   (to top of page)

What will prevent inflation?

One of the primary concerns in designing a monetary and banking system is to eliminate inflation. Unfortunately, inflation has been a part of almost every monetary system yet tried. The history of money brings along with it the history of inflations. Modern coins have milled edges because the Roman Emperors used to shave the edges of coins. Today, almost every money is being deliberately inflated to the extent that it is no longer news. Only sudden disruptions, such as the recent devaluation of the Mexican Peso, are news. In recent years, only the German Mark and Swiss Franc have been relatively stable, so if we achieve an inflation-free money we will have accomplished a near miracle.

Current U.S.A. system a failure

Because of the size of the market and the volume of discretionary spending it represents, the U.S. dollar is almost an international standard. We should not be blinded by this apparent success. One of the most important functions of a monetary unit is as a store of value. In the eighty-odd years since the founding of the Federal Reserve in 1913, the dollar has lost roughly ninety percent of its value. That is hardly acting as a store of value especially in contrast to the previous 150 years, in which the value of the dollar fluctuated, but underwent no long-term trends. Notice the contrast between the two eras. The first included the turbulence and difficulty of the early years of the country, the rapid westward expansion and growth, and a disastrous civil war. The second era included the period in which the nation became the most powerful on earth with rapid technological advancement. Yet, in the first era, the money was stable and in the second it underwent a drastic decline.

Sound as a dollar or not worth a continental: Stability determined by design

What course do we choose for our currency? The 150-year stability of the dollar led to the phrase (now obsolete) "sound as a dollar." Unfortunately, we also have the archaic expression "not worth a continental" that expressed people's dissatisfaction with the currency issued by the Continental Congress.

Some monetary standards

Many standards have been tried. Most have been found wanting. The best results have been achieved with a commodity-based system. Gold (and to a lesser degree, silver) has worked best. Central banks' issuing fiat currency has almost always led to significant inflation. There has been recent favorable mention of currency boards but these entail more governmental structure than weare envisioning. They may be a preferable alternative to central banks for nations with a large government.

Best regulator a free market

Like most things, currency can best be provided by the free market. It will be self-regulating no one will want to hold a currency that is not sound. It will eliminate the temptation for politicians to steal from us in a way that most people will not recognize.

Likely solution

If a new nation is starting small, it probably will use existing currencies at first and then begin to develop its own currency after it has grown. It could use U.S. dollars to facilitate international trade and for settling current accounts. It could use Swiss Francs for longer-term contracts and annuities. As the nation develops, the most likely solution is to allow banks to issue their own currency, backed by whatever they choose. Probably a variety of currencies backed in a variety of ways will be available. Market forces will select the solution that provides the best combination of safety and efficiency.

(to outline)   (to top of page)

Bank panics

Throughout history there have been runs on banks. If the bank is practicing fractional-reserve banking, it can quickly turn into a problem as the reserves of the bank are depleted.

Some history

During the early history of the United States there were numerous bank panics. Because the banks were operating on fractional reserves, the usual cause was the depositors' losing confidence that the banks could redeem their deposits. These had a long and interesting history culminating in the Great Depression (which was a euphemism to avoid using the word panic). The panics were part of the excuse for establishing the Federal Reserve. But note that the last one occurred despite the Federal Reserve. One would hope that the bank examiners are well acquainted with this history.

Out of many, one: Multiple policies produce a stable whole

One of the reasons bank panics caused increasing problems in the U.S. was the increasing centralization of banking policy. Creation of the Federal Reserve with its centralized control of U.S. banks caused the Depression to be longer and worse than any previous panic. If we allow banks to set their own policy, the problems that arise will be restricted to the customers of that bank, rather than spread across the entire nation.

By allowing a variety of policies, we will have a more stable total economy. There may be occasional panics as the public questions the integrity of individual banks. Since all banks will not be forced to follow the same policies, the public is not likely to question most of the banks at the same time.  D

Bobby Yates Emory, of Raleigh, NC, has retired from a career as a programmer and systems analyst at IBM. A longtime libertarian activist, he has run for offices from County Commissioner to U.S. Senator, and held political party offices from Precinct Chairman to Regional Representative to the National Committee.

  (to table of contents of FNF archives)   (to outline)   (to top of page)