All Commentary
Monday, October 1, 1984

Book Review: Free Banking in Britain: Theory, Experience, And Debate, 1800-1845 by Lawrence H. White

(Cambridge University Press, 510 North Avenue, New Rochelle, N.Y. 10801) 1984 • 171 pages • $29.95 cloth

For decades two closely-related ideas have been taken for granted. The first holds that business cycles stem naturally from within the capitalist market economy; and the second, that free banking is a most unstable system, as evidenced by pre-Civil War America. Significantly, near unanimity on these questions has not always existed; during the 18th and 19th centuries prestigious economists thought otherwise—frequently the exact opposite. One counts Americans, British and French among them, including the Physiocrat DuPont de Nemours, Adam Smith, J. B. Say, Mushet, Parnell, Gilbart, S. Bailey, H. C. Carey, Hildreth, Courcelle-Seneuil and the unjustly forgotten friend of Bastiat, the encyclopedic Charles Coquelin, with his numerous disci ples.

The great merit of Professor White’s book lies in the challenge it presents to today’s views about money and banking. To this end, Professor White has chosen to examine the British theoretical debates and the Scottish free banking history before 1845. Going beyond the controversy of the Currency School versus the Banking School, Professor White focuses on the previously overlooked Free Banking School, which questioned the basic premises of the other two. In so doing, it addressed a more basic issue: under which condition—competition or regulation—is a banking system more efficient? It concluded in favor of competition. The Free Banking School identified the root cause of recurring economic disturbances in the legal monopoly of the Bank of England over bank note issue. Consequently, it favored subjecting the Bank of England to competition in bank note issue as the best means of checking credit fluctuations. White’s exposition of this controversy provides a most valuable refutation of interventionist reasoning.

Furthermore, the book challenges the validity of the classic argument against Free Banking, which cites the American experience before the Civil War. The term “free banking,” as used in this instance, is misleading, given the close regulation of banks by the state legislatures. Thus, one cannot fault “free banking” for the failure of systems that were not, in fact, free (except for competitive and stable New England, one might add). In contrast, White presents the truly free banking system of Scotland before 1845 as a paradigm, showing that this competitive system generated no erratic fluctuations. Scotland’s system was prosperous and depression-proof, while the regulated English banks suffered severe monetary disturbances.

The reader should note White’s use of a simplified bank balance sheet model showing, with twelve equations, the self-regulating nature of a free banking system. That is, the system spontaneously adjusts the supply to the demand for currency. White points out that under free market conditions the bank reserve ratio may be well below 100 per cent. “Fractional reserves” exist naturally and may fall to surprisingly low ratios. After citing a Scottish bank in the 1830′s that “held specie reserves averaging only 0.5 per cent of total demand liabilities,” White accurately concludes that “a bank note-issuing firm is presumably competent to choose a level of reserves prudent enough for its own private purposes.”

So convincing are the conclusions of Professor White’s research that even before the publication of his book and while travelling in Scotland, England and Continental Europe, he had already influenced academic thinkers significantly. Combined with a growing interest in the monetary contributions ofLudwig von Mises and F. A. Hayek, Professor White’s theoretical and historical work will undoubtedly foster a better understanding of free competitive processes in money and banking.