Where is private note issue legal?

• Author: McBride, William
• Position: Essay

During the 18th and 19th centuries and for part of the 20th century, more than 60 countries had free banking. The major characteristics of free banking are competitive issue of notes (paper money) and deposits by commercial banks, low legal barriers to entry, little regulation unique to the industry, and no central control of reserves (the monetary base) within the national monetary system (Dowd 1992, White 1995). Among the countries that had a form of free banking was the United States. Even after the freest period of free banking ended, with the Civil War, banks continued to issue notes until the federal government effectively monopolized note issue in 1935.

How Note Issue Became a Government Monopoly

Despite extensive historical experience with free banking, it has long since become commonly accepted among economists, jurists, and the public at large that issuing notes and coins is properly a government monopoly. (1) This attitude is at variance with attitudes about most other goods and even about other forms of credit. Over the last 30 years or so, people around the world have seen the benefits of moving from government monopoly to competition in many industries, including airlines, railroads, electricity generation, mail, and telephones. All former centrally planned economies now have competition in banking. Whether in Washington or Warsaw, no consumer would be happy with a monopoly government bank from which there would be no appeal if it refused him a mortgage, a car loan, or a credit card.

Why, then, is note issue different? The answer seems to be the analogy between notes and coins as hand-to-hand currency. From ancient times, coinage has been considered a government prerogative. The first Chinese coins, issued during the "Spring and Autumn period" (771-403 B.C.) may well have been government-issued; the first Western coins, issued about 600 B.C. in Lydia, a Greek kingdom in what is now western Turkey, certainly were. When the Pharisees asked Jesus whether it was lawful for the Hebrews to pay taxes to their Roman occupiers, his reply was to ask them whose image was on the coins they used to pay taxes. The coins were Roman, so the image was Caesar's. Jesus then famously replied, "Render therefore unto Caesar the things which are Caesar's; and unto God the things that are God's" (Matthew 22: 21).

The Gospel account illustrates the close connection between coinage and taxation. Caesar, and the little Caesars of a thousand principalities who were his eventual successors, issued coins because a monopoly of coinage offered a way of raising revenue that was within the administrative capabilities of ancient and medieval governments. Coinage revenue was significant back then, while today revenue from notes and coins is normally but a small part of government revenue--2 to 3 percent in the United States. Advances in record keeping have given modern governments the ability to tax rich streams of income that tax collectors before the 20th century would have had difficulty even discovering.

From a purely economic perspective, taxation is the only substantial rationale for a forcible government monopoly of coinage. Claims that coinage is a natural monopoly do not withstand examination. If government is a natural monopolist, it is unnecessary to forbid potential competitors, because they are doomed to fail. Moreover, the natural monopoly argument neglects that until the 19th century, governments generally did a poor job of supplying coinage in amounts appropriate for the public's demand. Official coins were often in shortage, occasionally in glut, and rarely in appropriate supply. This was true both in the East and the West (Peng 1994, v. 1: 197, 358, 393, 545, 547, 585-94; Sargent and Velde 2002: 52-53, 131-38). Private mints, sometimes legal, sometimes illegal, sometimes operating in a gray area of the law, operated in some Western countries in the 18th and 19th centuries and during numerous episodes over centuries in China when the supply of government coinage was inadequate. The British government led the way in supplying a fairly adequate coinage in the 19th century after adopting some, though not all, of the consumer-friendly practices pioneered by private British mints. It lacked sufficient confidence in the Royal Mint's ability to compete with the private mints, thus it prohibited them from continuing to issue coins for circulation in Britain (Selgin 2008: 235-66, 295-305).

The first true circulating notes were issued in China, apparently around the year 995, and were issued by private bankers in the city of Chengdu. The government monopolized note issue in 1024 (Peng 1994, v. 1: 369). So began the first instance of a cycle repeated often in Chinese history: government debasement of the currency as its finances became increasingly precarious; de facto abandonment of notes by the public; then a new ruler or dynasty that eschewed government note issue, allowing free banking, until it too encountered financial problems. Over these cycles, China never seems to have had a vigorous debate about competition versus monopoly in note issue.

In Europe, the first true circulating notes were issued in 1661 by Stockholms Banco, a private bank chartered by the crown in return for half of the profits. Later, after the bank encountered financial problems, the Swedish parliament took it over; much later still, it became what is now Sweden's central bank. Europe's multiplicity of political jurisdictions allowed a variety of policies toward note issue, from competition to monopolization, to develop side by side. Likewise, there was no consensus of views among economists. Adam Smith ([1776] 1981: Book II, chapter 2, final paragraph) contended: "If bankers are restrained from issuing any circulating bank notes, or notes payable to the bearer, for less than a certain sum, and if they are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented, their trade may, with safety to the public, be rendered in all other respects perfectly free." The next economist who exercised an influence anywhere near as great as Smith, David Ricardo ([1817] 1953: 354, 362-63), took the contrary position because of his belief that "after the establishment of Banks, the State has not the sole power of coining or issuing money." He proposed a government monopoly of note issue, an idea he reiterated several years later in a posthumously published pamphlet (Ricardo [1824] 1962: 285-87). At the time, the Bank of England was privately owned (as it would remain until 1945) and it had a de facto monopoly of note issue in and around London, while "country banks" issued notes competitively outside London under onerous restrictions. Ricardo proposed to replace the note issues of the Bank of England and those of the country banks with a government issue. He did not address conditions in Ireland, which had a situation like that of England, with the Bank of Ireland as a privileged bank, or Scotland, where banks operated much more on a footing of equality without onerous restrictions.

Monetary events in Britain during the Napoleonic Wars and financial crises in 1825 and 1836-37 provided fodder for debate about banking regulation. One of the key questions was whether existing arrangements about note issue had contributed to the crises, and whether to change the arrangements. The Currency School, which took many of its ideas from Ricardo, triumphed with the Bank Charter Act of 1844 (7 & 8 Vict. c. 32), the Bankers (Ireland) Act 1845 (8 & 9 Vict. c. 37), and the Bank Notes (Scotland) Act 1845 (8 & 9 Vict. c. 38). The Bank Charter Act subjected the Bank of England to a 100 percent reserve requirement in gold for notes issued above 14 million [pounds sterling]. It forbade new issuers of notes in England and Wales, froze the existing...