Adam Smith Institute

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Free banking in 19th century Switzerland

RePEc is a wonderful service, provided like the fantastically useful FRED by the Federal Reserve Bank of St. Louis. It has feeds on twitter and via RSS, which are one of the best ways of keeping up with new research papers on economics, provided as full pdf files—all for free. Occasionally, their feeds deliver older papers, which have presumably been scanned and indexed online in the database for the first time. A recent example was "The Competitive Issue of Paper Money in Switzerland After the Liberal Revolutions in the 19th Century" by Ernst Juerg Weber, an economist who was then, in 1990, and is still now, working at the University of Western Australia. I had never heard of him but his papers all look extremely interesting. This one is no exception, and it tells of how banking was completely deregulated during the early 19th century in Switzerland, and how it worked extremely successfully:

The main finding of this paper is that competition provided a stable monetary system in Switzerland in which the purchasing power of bank notes equaled that of specie and only one bank failed. The Swiss banks did not over issue bank notes because there was no demand for depreciating notes in the competitive Swiss monetary system. Each bank faced a real demand for bank notes that depended on the usefulness of those notes in commer­cial transactions. And the marginal revenue of inflating was negative for each bank because depreciating notes impose information costs on their users and people could easily substitute notes. In contrast, modern central banks can inflate at a profit because (i) they have the exclusive right to issue currency and (ii) currency substitution is limited by legal tender laws and -if necessary -by exchange controls. The Swiss monetary system was also stable in the sense that rising costs prevented a central-bank-like monopoly by a single issuer.

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Liberals won a short civil war in 1848 then, in control of the federal government, removed restrictions on the free movement of goods, capital and people between cantons. This included allowing private banks to issue the newly-unified currency, the Swiss Franc.

There were no legal tender laws or exchange controls, and by 1880 there was one note issuing bank per 80,000 people, or 36 in total. Even though cantonal banks had regulatory and tax advantages, commercial note-issuing banks were able to outcompete them

Banks worked like any other business, with free entry into the note issuing business determined by whether they could offer notes that people found useful in transactions. Savings banks stayed out of the note business because they could not profit from issuing them.

However during the 1860s and 1870s more the democratic factions were in the ascendancy and started rolling bank liberal provisions, for example setting up subsidised and guaranteed cantonal note-issuing banks and heavily regulating note issue. By 1881 the Swiss free banking era was over despite its success.

In general free banking is a strange issue, because it seems like advocates have done a huge amount of work showing its successes and highlighting the failures of alternative systems. But opponents have mostly ignored all of this and seemingly work on entirely unchallenged views of one free banking system (the USA 1837-1862), acquired apparently by osmosis. If free banking wouldn't work in the modern era, then opponents need to do a lot more to explain why.