The Best Banking is Free Banking

1. The Best Banking is Free Banking

2. Outline of this Report In this report I will discuss and argue why I believe a Free Banking system is better for consumers, bankers and the overall economy. I will also discuss why government regulation interferes with a free market and why governments should not interfere in the regulation of the banking system. The main arguments of this report will be broken down into five areas. Throughout these areas I will be giving my own personal analysis on the topics and why a Free Banking system is better for all. You will see a common constant in my report that I believe the market should drive the banking sector and consumers are just as responsible for their decisions as banks. 1)Quick overview and ideas of Free Banking 2)Arguments against Free Banking system and rebuttal of arguments 3) Arguments for Free Banking system 4) Government Regulation 5) Historical Evidence

3. Introducing Free Banking The Free Banking system dates back centuries ago to areas allover the world. In a free banking system bank’s could offer services in which they saw fit to each individual consumer. This could be done without government regulation or monitoring. Banks could make decisions on loan contracts, repayment details or fee payments. -In the Free Banking system banks had control over all of their daily activities. - Banks could print their own monies - Extend loans to whom they wanted without regulation - Free Banking gives free entry into the market -Freedom of money lending -Free Banking was free of government regulation

4. Against free banking Many have argued that free banking is just not viable, responsible, practical or safe for the health of the economy. The focus of these arguments is usually on the safeness of a free banking system to the health of an economy. Many argue that issues of counterfeiting, wildcat banking and over issuing of bank notes can be detrimental in free banking, resulting in failures, destruction of consumers wealth and economic instability in the banking sector. All of theses apprehensions are legitimate concerns of those who worry about the free banking system, but all of those concerns have answers. The structure of a free banking system would actually create stability around these issues if conducted properly.

5. Counterfeiting The argument surrounding counterfeiting in the Free Banking system is more likely than in the current system is absurd. No matter how anyone argues, counterfeiting is evident in central banking as well as free banking. This is because no matter the rules and regulations, there will always be someone or some group looking to counterfeit in order to make a profit. The risks of counterfeiting are lower in a free banking system. The reasoning why risks are lower, is that in a free banking system the banks themselves would have more to lose if their monies are counterfeited. They would lose their reputation as a reputable bank and lose customers who in a free banking system drive banks to succeed. In fact monitoring in a free banking system would probably be greater than a central banking system, because bank owners and managers in free banking will want to monitor all the notes being retuned to the bank. These owners and managers would be able to find counterfeit money easier because of their expertise of their own monies. Historical evidence of free banking showed similar results of some counterfeiting but no widespread amount of counterfeiting took place.

6. Wildcat Banking People argue that Free Banking doesn’t have any control over the activities banks decide to partake in causing a great danger for consumers. This argument can be based on wildcat banking, which was claimed to happen in remote areas during the American free banking era. Wildcat banks were banks that operated recklessly in remote areas that failed within a year of operation. Most of the bank failures that were attributed to wildcat banks were actually not a result of wildcat banking, but changes in laws. An example of this is how Indiana banks were affect by the changes in Ohio laws restricting the use of notes from other states. With a lot of Indiana Bank notes being held in Ohio this caused a decrease in the demand for Indiana bank notes resulting in the return of notes for redemption. This caused a decrease in Indiana bonds which were two thirds of the banks securities. The decrease in securities because of new laws led to the bank failures. Some arguments that banks will play a part in risky and reckless activities if not governed is true. This is why market demand and smart consumer choices are so important. In a free banking system consumers are just as responsible for market failures as banks. Those consumers must do research and do due diligence to establish what bank is right for them. The market demand that is established in competition will force banks to act in a manner that they do not destroy their reputation of being a reputable bank. If the bank losses this reputation than smart consumers who drive market demand will not use these banks. Thus the closures are not directly related to recklessness of actions, but loss of reputation and consumer confidence.

7. Over issuing notes In the current banking system, banks do not have control over issuance of their own notes (paper monies). Many argue if banks were able to issue their own notes, many banks would be carless and issue more notes than their holdings can back. The carelessness of mass issuing notes would cause bank failures and hurt consumers who will lose deposits. In my opinion this argument is false for the reasoning that has been touched on in the pervious examples. It is not in the banks best interest to be careless with issuance of bank notes. Carelessness leads to a surplus of notes and a lost value in the notes use as a medium of exchange. This leads to rejection of those bank notes and the loss in demand for that bank’s notes and financial services. This would cause bank failure which is not a goal of the bank. So it is easy to see that excess issuing of notes will hurt the bank and not help the bank. This is yet another example on how the banking system is market driven. Basically the well informed consumers (holders of notes) will not wish to hold notes from a bank with a reputation of over issuing notes. Hence consumer will demand a different bank note. Banks know this and will make rational decisions not to over issue their notes causing demand and stability of their notes.

8. Pro Free Banking A Free Banking system in my view is superior to the current regulation system in place in the banking industry. Many will point out how free banking caused failures, but the same can be said about the current banking system. There are bank failures and an influx of bank bailouts in today's banking market. The difference is these banks are being rescued on the account of taxpayers/consumers money. A free Banking system would reduce this problem (its is impossible to eliminate failure no matter what systems are in place). The responsibility would be put on the bank and consumers in a free banking system. Smart proactive consumers would be safe from the bad decisions of banks that fail, because they would have done research to seek out the best bank in a free banking system. Free banking leads to consumers demanding better banking practice. This demand in the market creates 1) Stability 2) Increased Competition 3) Efficiency

9. Pro Free Banking Continued Stability Free Banking is very sensitive to consumer demand and market expectation. For this reason banks will monitor practices more carefully in a free banking system to ensure they have the trust of consumers. Banks will want to focus monitoring to reduce asymmetric information such as moral hazard and adverse selection. The closer monitoring of these will lead to a more stable bank and increased trust from consumers. This trust leads to stability and stability leads to a decrease in bank failures and bankruptcies of banks. Increased Competition The lack of restrictions on banks in free banking creates a entry free system, where banks can be created. This system will lead to many different sizes and types of banks being opened, increasing the competition for consumers business. The increased competition benefits the consumer and the overall banking economy. Efficiency The Free banking system will force bank mangers to create new ways to stay competitive and create new business and keep current customers satisfied. This will lead to increased efficiency of the banking system. Example: cleaning house

10. Government Regulation Government regulation and intervention in the banking system is unwarranted and unneeded. Government regulations imposed on banks, only hurt the taxpayers and consumers by government’s wasting time and money on regulation and monitoring costs. The issues that government regulation supporters bring forth are: 1)Production of Information to Reduce Information Asymmetry First the argument that governments need to produce information about information asymmetry is false. The government does not have to interfere and provide consumers with information about every major decision consumers make. For example the government does not create information for you about who you choose to marry. It is up you to find this information out through dating and relationship building that will form trust between you and your future spouse. So just like marriage it is up to the individual consumer to find information about banks and perform research to find a bank they can trust. The free rider problem will not exist because those who work hard and spend money to find trust worthy banks will not give out their secrets that they worked hard to produce.

11. Government Regulation Continued 2)Protecting and Backing Deposits Second I would argue that the protection the government gives consumers on bank deposits makes it more likely for banks to participate in risky and carless investing/banking activities, because they have a safety net from the government. This safety net hurts the consumers because it will be their tax dollars that will pay for this payment of lost deposits when a bank fails. Without the safety net, banks will be more careful creating a lesser chance of failure. Not costing the consumer anything. Regulation decreases profits and liberalization Lastly the regulation on assets of a bank constrains the resources banks can use to make profits, decreasing efficiency and risk reduction. This constraint on assets leads to money not being used to expand investments and it also restrains risk management. This causes banks to be more sensitive to external shocks and bank failures. Overall regulations just hamper the success of banks well being in the economy and causes banks to be more sensitive to economic conditions.

12. Historical Evidence During the period of 1720 – 1840 the Scottish and British formed and used very different banking systems. The British banking system was heavily regulated and monitored, where the Scottish system was not. The Scottish banks were also allowed to issue notes and conduct commercial banking. The difference in regulation is clearly a historical example of how free banking is better for economies. At the beginning of this time period Scotland's per capita income was half of England's. With a free banking system Scotland's economy was able to grow faster than England’s. This faster growth brought per capital incomes to almost equal in the free banking era. The growth can be attributed to the superiority on the Scottish banking system that was more innovative, more reliable and much more stable than its British counterpart. Oddly enough the British was experiencing many bankruptcy's in there heavy regulated system while only one major bankruptcy occurred in Scotland (Ayr Bank).

13. Historical Evidence Continued This stability was driven by consumer demands for a more completive market. At this time the Scottish banking system was morecompetitive than the regulated British banking. The increased competition cause the Scottish to innovate and make such innovations as clearing house procedures. As you can see free banking was and always will be driven by consumer demands for greater competition and free banking will meet these demands. The demand creates a competitive and stable environment for economies to grow without recourse of bank failures.

14. Conclusion Throughout this report I have brought forth information to showcase the superiorities of a free banking system. Many will argue that free banking is risky and irresponsible because of issues such as counterfeiting, wildcat banking and over issuance of notes all leading to increased bank failure. When in fact all of these problems can be answered and actually turn out to be free banking strengths. The free banking system gives more stability, increased competition and efficient bank markets. Where government regulated systems just increase the risky activities that banks partake in and hamper competition for consumer well being. Now to end I would like to state that free baking is superior because responsibility in thrust upon banks. In free banking a banks reputation is everything, so anything a bank does to hurt their reputation will not be beneficial. The increased responsibility creates a better market for both consumer and economies, decreasing bank failures.

15. References http://www.cato.org/pubs/journal/cj16n1-3.html Google Books: ‪Experience of Free Banking‬ By Kevin Dowd http://economics.about.com/cs/moffattentries/a/scot_banking.htm http://www.frbatlanta.org/filelegacydocs/acfce.pdf http://www.frbatlanta.org/filelegacydocs/acfce.pdf