Skip to main content

Free Banking and Gold

The type of free banking espoused by Ron Paul and Larry White has bank money convertible into gold.  In other words, gold is the base money.   Chris Colvin (a future colleague and reader of this blog) emailed me to ask whether a gold standard is essential for free banking.  Chris, like many other economic historians, has problems with the costs of the classical gold standard, particularly in the inter-war period.  The classical gold standard is often criticised for driving the business cycle and generating real income instability.  The economic decline suffered by economies after they came back unto gold after periods of conflict was particularly severe.

How would a free banker reply to this criticism?  Larry White argues that banking systems were "regulated in ways that almost surely contributed to monetary instability.  It would be necessary to disentangle these regulatory effects from any instability due to the gold standard itself" (Theory of Monetary Institutions, pp.49-50).
Other advocates of free banking, such as Hayek and Benjamin Klein  have suggested that banks in free banking systems could issue fiat-type money i.e., money which has no commodity backing it.  Others, such as Greenfield and Yeager (1983) suggest that a free banking system should have a multi-commodity standard (keeps price level more stable than gold) and a separation of the medium of exchange from the medium of redemption (i.e., bank money is denominated in the medium of account bundle, but redeemable for an indexed quantity of convenient and available commodities).

Larry White discusses these alternatives in his Theory of Monetary Institutions.  His main objection is that these alternatives are all untried entrepreneurial ideas, whereras a gold-standard free banking system has existed in the past.  As such, he is very much wed to the Mengerian view of the organic evolution of money.  



Popular posts from this blog

The Failure of Herstatt Bank

As an undergraduate, I was taught about the failure of Herstatt Bank in 1974 and Herstatt risk. This bank was only the 35th largest bank in Germany at the time so why would anyone be interested in studying its failure? Herstatt failed because of its involvement in risky foreign exchange business. When it closed its doors on 26 June 1974, counterparty banks (mainly in New York) had not received dollars due to them because of time-zone differences - this is known as settlement risk. The cross-jurisdictional implications of its failure resulted in the Bank for International Settlements setting up the Basel Committee on Banking Supervision and Herstatt's failure was a key reason for the establishment of real-time gross settlements systems, which ensures that payments between two banks are executed in real time. The Bank of England's Ben Norman has an interesting post on Herstatt over at the Bank's new blog ( Bank Underground ). As well as giving an excellent overview of

Boom and Bust: A Global History of Financial Bubbles

Boom and Bust: A Global History of Financial Bubbles, co-authored with my colleague Will Quinn , is forthcoming in August. It is published by Cambridge University Press and is available for pre-order at Amazon , Barnes and Noble , Waterstones and Cambridge University Press . 

The Great Depression

Marginal Revolution University has a great video on the Great Depression.