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The Rationale of Central Banking: And the Free Banking Alternative
The Rationale of Central Banking was first published in England in 1936. Vera Smith spent her professional career in a variety of research positions. She wrote articles and books on money, banking, economic development, and the labor market and translated into English books by Wilhelm Röpke, Oskar Morgenstern, and Fritz Machlup. This book provides a scholarly review and judicious assessments of the experience and theory that bear on the issues of free banking and central banking. Its wide-ranging discussion identifies both the fallacies in the arguments for central banks and the influential fallacies in the arguments against free banking. Vera Smith’s work should play a prominent role in any reappraisal of our monetary institutions.
216 pages, Paperback
First published January 1, 1936
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Displaying 1 - 4 of 4 reviews
January 19, 2025
Gran libro de revisión histórica sobre la estafa de la banca central. No llega a exponer una conclusión o alternativa sólida (como si hizo su profesor Hayek después), pero sirvió como punto de partida para tener una base de datos sobre la que trabajar. Fue la gran referencia para mi tesis de grado en economía.
March 21, 2016
It's impressive that this 1935 book remains one of the best histories of central banking in the West. While other economists have continued to study every aspect of banking regulation and formation, almost none have made similar comprehensive studies of just why central banks emerged, or what writers of the time thought that meant. Vera Smith's work provides both a comprehensive history of central banking in England, France, America, and Germany, and also a history of the debate over central versus "free" banking.
As Smith notes, the reason for the lack of academic interest is that most economists take central banking as almost natural or inevitable. Her history shows how contested these early central banks were. Most gradually evolved beginning with some minor government privileges. The Bank of England in 1697 got the first grant of limited liability for a corporation, as well as a monopoly on government deposits and payments. After 1709 the government expanded its privileges by forbidding any other banks of more than six owners from issuing notes. Napoleon in 1802 forced a few banks to merge into a new Bank of France, and gave it a monopoly of notes issues in Paris. In 1848 the bank's notes were made "legal tender" all over France, while other "departmental" banks were given only legal tender in their localities. In Prussia, the central Prussian Bank was allowed the most total issues of notes by the government, and after 1875, its notes were the only ones allowed to be paid out over other banks counters.
Each of these privileges may seem minor on their own, with little rhyme or reason to their enactment, but they each provided a single bank with new powers to control the money of the nation. They were all also given in exchange for more loans to the government that granted them. Thus the central banks and the government set up a symbiotic relationship which gradually pushed out other banks from the note-issuing business and began, often after several financial panics, to control the monetary systems of the country.
Smith describes the debates among central banking advocates and the "bankfreiheit," or "free banking school." The latter often pointed to the dangerous connection between central banking privileges and central bank loans to the state. They also pointed to the dangers of special "suspensions" of bankruptcy by the state when they needed more funds from these banks, which also lead to inflations. Free bankers tended to be members of the "real bills" school of banking, which believed that as long as independent banks issued notes on short terms loans, these notes would come back to the bank soon and would not lead to inflations. Both sides agreed, by contrast, that checks and deposits were not inflationary and did not need to be centralized because checks always returned promptly to the banks that issued them and did not circulate generally among an unknowning populace.
Smith's book can ramble a bit and it can lack some crucial background, but it is still an important reminder of the both the origins and dangers of central banking, and the continuing possibility of alternatives.
As Smith notes, the reason for the lack of academic interest is that most economists take central banking as almost natural or inevitable. Her history shows how contested these early central banks were. Most gradually evolved beginning with some minor government privileges. The Bank of England in 1697 got the first grant of limited liability for a corporation, as well as a monopoly on government deposits and payments. After 1709 the government expanded its privileges by forbidding any other banks of more than six owners from issuing notes. Napoleon in 1802 forced a few banks to merge into a new Bank of France, and gave it a monopoly of notes issues in Paris. In 1848 the bank's notes were made "legal tender" all over France, while other "departmental" banks were given only legal tender in their localities. In Prussia, the central Prussian Bank was allowed the most total issues of notes by the government, and after 1875, its notes were the only ones allowed to be paid out over other banks counters.
Each of these privileges may seem minor on their own, with little rhyme or reason to their enactment, but they each provided a single bank with new powers to control the money of the nation. They were all also given in exchange for more loans to the government that granted them. Thus the central banks and the government set up a symbiotic relationship which gradually pushed out other banks from the note-issuing business and began, often after several financial panics, to control the monetary systems of the country.
Smith describes the debates among central banking advocates and the "bankfreiheit," or "free banking school." The latter often pointed to the dangerous connection between central banking privileges and central bank loans to the state. They also pointed to the dangers of special "suspensions" of bankruptcy by the state when they needed more funds from these banks, which also lead to inflations. Free bankers tended to be members of the "real bills" school of banking, which believed that as long as independent banks issued notes on short terms loans, these notes would come back to the bank soon and would not lead to inflations. Both sides agreed, by contrast, that checks and deposits were not inflationary and did not need to be centralized because checks always returned promptly to the banks that issued them and did not circulate generally among an unknowning populace.
Smith's book can ramble a bit and it can lack some crucial background, but it is still an important reminder of the both the origins and dangers of central banking, and the continuing possibility of alternatives.
June 27, 2023
This book is old and started as a PhD thesis. It describes the discussion around free banking, central banking and the gold standard taking place in 19th century Germany, France, UK and the US.
This is a fascinating book. It paints a clear picture for how politicians, economists and bankers thought about banks, and their role in society, at the time.
The most important point of the book is that banking was excluded from the free-market ideology made famous by Adam Smith. There were a number of misunderstandings and logical fallacies about how banks would operate in a free market. There was also often a pressing need for the government to finance itself, and this led to state intervention. The author has a great anecdote on Napolean.
She holds up the Canadian, Suffolk and Scottish systems as the most free banking systems. She considers the US system somewhat free until the central bank was created in 1913 albeit with heavy restrictions. I would also put the National Currency Act from 1683 as a turning point for a less free american banking system.
She discusses other interesting topics such as the impact of regulations in the US on the (in)stability of the banking system: Banks usually had more liquidity than required by minimum reserve requirements, but during bank runs when liquidity dropped below this arbitrary number they were forced to suspend withdrawals to maintain the level rather than use the reserves. The restrictions against branches also created liquidity problems. Country banks could not open branches elsewhere to use their capital effectively. It was parked in the cities. During harvest season these country banks had to pull their deposits creating financial crises in the cities!
This research is a great compliment to the other books on banking I've read so far. It provides historical context that I have not read elsewhere (particularly on the continental european banking systems).
This is a fascinating book. It paints a clear picture for how politicians, economists and bankers thought about banks, and their role in society, at the time.
The most important point of the book is that banking was excluded from the free-market ideology made famous by Adam Smith. There were a number of misunderstandings and logical fallacies about how banks would operate in a free market. There was also often a pressing need for the government to finance itself, and this led to state intervention. The author has a great anecdote on Napolean.
She holds up the Canadian, Suffolk and Scottish systems as the most free banking systems. She considers the US system somewhat free until the central bank was created in 1913 albeit with heavy restrictions. I would also put the National Currency Act from 1683 as a turning point for a less free american banking system.
She discusses other interesting topics such as the impact of regulations in the US on the (in)stability of the banking system: Banks usually had more liquidity than required by minimum reserve requirements, but during bank runs when liquidity dropped below this arbitrary number they were forced to suspend withdrawals to maintain the level rather than use the reserves. The restrictions against branches also created liquidity problems. Country banks could not open branches elsewhere to use their capital effectively. It was parked in the cities. During harvest season these country banks had to pull their deposits creating financial crises in the cities!
This research is a great compliment to the other books on banking I've read so far. It provides historical context that I have not read elsewhere (particularly on the continental european banking systems).
April 25, 2016
Very dense, but very informative. This is one of the 'go to' books for anyone who has an interest in money and banking as topics, especially those interested in central banking as an idea and economic-political force. Smith's writing can be cumbersome at times, but she is never obscure nor difficult to understand after 2-3 rereadings of a particularly dense or clunky passage.
Displaying 1 - 4 of 4 reviews