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Is Government Regulation Necessary for a Stable Financial Industry? : A Possibility of Self Regulated Financial Industry. J.D. Han King’s College, UWO. 1. Free Banking: Free Entry and Self Regulated Note Issues. Historical Instances of Self-Regulated, or Free-Market Financial Industry

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Is Government Regulation Necessary for a Stable Financial Industry? : A Possibility of Self Regulated Financial Industry

J.D. Han

King’s College, UWO

1 free banking free entry and self regulated note issues
1. Free Banking: Free Entry and Self Regulated Note Issues

Historical Instances of Self-Regulated, or Free-Market Financial Industry

  • Scotland, 1720-1840
  • U. S. A., 1836/7-1863
  • Canada, prior to Bank of Canada 1935
  • Sweden, 19C
  • Hong Kong, Contemporary
2 were they stable
2. Were They Stable?
  • Conventional Wisdom

-> Yes, Scotland, Canada, Sweden and HK

-> “No”, U. S. A.

 We would like to challenge the second part of Conventional Wisdom

3 scottish free banking
3. Scottish Free Banking:
  • Period: 1720-1840
  • How did it work?:

-Banks could print out paper monies, or notes as long as they do not default on redemption request of the notes for species

-No government charter needed;

Self regulated, competitive (free market driven) supply of money and banking practices

evaluation of the scottish free banking era
* Evaluation of the Scottish Free Banking Era

Compared with the Contemporary British Banking Experience

  • Stability: no major bankruptcy

-exception: Ayr Bank

  • Availability: more banking services per capita
  • Competition: small banks along with large ones
  • Efficiency:
  • spontaneous evolution of a clearing house (payment association)
  • Rapid propagation of information
4 american experiences
4. American Experiences

1) Conventional Wisdom:”Bad”

-> Free Banks were called “Wildcat Banks”

2) Revisionist View:

by A. Rolnick and W. Weber

“Not So Bad in many states except for Minnesota, etc.”

1 first paper by rolnick and weber new evidence on the free banking era
(1) First Paper by Rolnick and Weber: “New Evidence on the Free Banking Era”

In Three Categories (failure rate; years in business; loss for note holders):

New York: Fairly Good (8%; 8 years; 26 cents per dollar)

Wisconsin and Indiana: O. K.(26-31%; 4-3-2 years; 11-24 cents for dollar)

Minnesota: Bad (58%; NA; 70 cents per dollar)

2 second paper by rolnick and weber explaining the demand for free bank notes
(2) Second Paper by Rolnick and Weber:“Explaining the Demand for Free Bank Notes”

Did the note holder really suffer such a great loss (70-75% of the face value of the note or paper money) due to Bankruptcy of Free Banks in Minnesota?

Their studies found that it was “Not Really” that bad at all. Why?

three point arguments
*Three Point Arguments

i) “The note holders had been well informed of the true value of the assets/notes from Minnesotan Free Banks.”

: Free Market is more efficient in propagating information than we expect

(Evidence: Well conversed the New York/Chicago Market Value of Government/Railway Bonds as Major Assets and Reserves of the Banks)

ii mutual funds interpretation
ii) Mutual Funds Interpretation:

“The notes were issued with railroad bonds, which were traded below par. The bank notes were priced to reflect the value of their backing assets”

The value of the notes depends on the total value of the assets divided by the number of notes/shares”

*Evidence: Payment for the grading of a mile of railway was a lot larger in Minnesota than elsewhere in the U.S.

iii therefore the note holders did not have much loss even in minnesota
iii) “Therefore, the note holders did not have much loss even in Minnesota”

- Minnesotian Experiences with Free Banks were not too bad (given the time and the location)

5 lessons to be learned
5. Lessons to be Learned



Financial Industry may be Viable

and even be superior.

6 stretching the argument further
6. Stretching the argument further:
  • Is government’s monopoly of a currency necessary for the stability of price level?
1 conventional wisdom
1) Conventional Wisdom:

“ unregulated competitive production of money will lead to over-issue of money and thus an infinite price level”

2) Revisionist Model by Benjamin Klein“Do Private Monies Lead to Infinite Inflation?”: No for the following 2 reasons

(1) Informed Consumers’ Screening

No,as long as they are Distinguishable monies, and

“Brand Name Identification” is possible.

Financial Market is information efficient

(2) Incentive Compatibility of Private Money and Honesty

-Money demand is unique

-Consumer Confidence is built over a very long time in a ‘smart’ way.

-The present value of the bank’s non-deceiving “profit” stream will be larger than the benefits from deceiving scheme of printing bad monies and running away.

* The cost of counterfeit was more serious than the cost of private over-issue fraud and bank failures.

3 extension
3) Extension
  • In the age of Globalization, currencies will compete internationally freely in the domestic economy as well as in the financial market;
  • “High-confidence monies” will win over “low-confidence monies”;

- Market confers Trust and Confidence, not Government

  • Euro, and an increasing ‘(U.S.) Dollarization”;

“Is Euro going to succeed?”

“Is Canada going to use U.S. dollars?”