Reviewing free banking in different US States and lessons for cryptocurrencies

Nice article by Helen Fessenden of Richmond Fed.

The idea of an “unregulated” currency, however, isn’t new. Before the Civil War, the United States ran a vast natural experiment by leaving “free banking” to the states, even while other major economies were adopting central banking. From the demise of the Second Bank of the United StatesOffsite in 1836 until the passage of National Banking ActsOffsite of 1863 and 1864, the United States lacked a federal authority to issue and redeem banknotes, act as a fiscal agent for the federal government, or keep banknote issuance in check. Instead, banking was run by the states, and “free banks” could issue their own banknotes. But just how much did this amount to the kind of free-entry, highly decentralized currency competition that some cryptocurrency backers advocate today?

Helen says free banking experiences differed across States. It was successful in New York and New England. This was largely due to the fact that their private notes were backed by safer assets. However, in Michigan, Wisconsin and Illinios free banks suffered as they invested in all kinds of assets. Read the piece for details.

What lessons for cryptos?

What are the lessons from this era? Some banknotes in New York and New England did indeed come closest to fulfilling the functions of money under a regulatory regime, enforced by the government or the private sector. Given that the attraction of cryptocurrencies today lies in the fact that their issuance is not determined by government fiat and that they are not publicly regulated, then, this historical record might give pause to those who see them as a potential substitute for money. The free-banking era also illustrates numerous examples of failures, especially in the Midwest, due to idiosyncratic regulation. This history suggests that effective regulation should involve a way to ensure that a new currency enjoys stable liquidity. This was a clear challenge for some states before the Civil War and for cryptocurrencies today.

Policymakers have recently pointed to some of these fea­tures as constraints on cryptocurrencies’ utility in the long run. Fed Vice Chairman for Supervision Randal Quarles noted in a speech last NovemberOffsite that among the dan­gers posed by cryptocurrencies is that during crises, “the demand for liquidity can increase significantly, including the demand for the central asset used in settling payments.”

“Even private-sector banks and certainly nonbanks can have a hard time meeting large-scale demands for extra liquidity,” he added. “Without the backing of a central bank asset and institutional support, it is not clear how a private digital currency at the center of a large-scale pay­ment system would behave … in times of stress.”

In a speech last MarchOffsite, Bank of England Gov. Mark Carney also underscored this point in a broader critique of cryptocurrencies, charging that they are “failing” as money for now. He warned that the inherently “fixed supply rules” of these currencies would run the risk of repeating another, less successful, historical experiment. “[R]ecreating a virtual global gold standard,” he said, “would be a criminal act of monetary amnesia.”



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