Free Banking - Promises to Pay

Look at the above note. It is fairly ornate but it is simply a promise. It reads as follows:

The President, Directors and Company of Hagerstown Bank will pay 5 dollars on demand to bearer.

It is a fascinating document incomprehensible to average spender of money today. Today, when one has a five dollar bill in one's pocket, one would say that they already have $5 dollars. And in fact today, that is true. If you have a five dollar bill, you have $5. But that wasn't true in the days this note was issued. This note was issued in what is now known as the Free Banking era in the United States.

I first came across the notion of Free Banking in the book Greenback, The Almighty Dollar and the Invention of America bu Jason Goodwin which tells the history of the dollar in the United States. I was fascinated to read about the Free Banking era of the United States which was in its heyday in the first half of the 1800s. I have read about it in other books since then but only recently that I came across an article advocating for the return to Free Banking as a monetary system.

Free Banking is a banking concept that is quite different from how banks are run today. If the subject of banking theory seems dry, it has a tremendous impact on the nature of the money we spend and on how our economy operates, how it promotes the creation of wealth and jobs, or not. I dare say the banking crisis and the financial crisis of the past few years would look very different if our financial world was allowed to function according to free banking principals.

In its essence, a free bank is a bank that is subject to no more, no less than the same rules that apply to corporations in general. We don’t often realize to what extent banks are regulated by rules formulated just for banks.

Probably the most noticeable thing a free bank can do is issue its own notes. Now, when you go to a bank to get cash what you get are Federal Reserves Notes (in the United States), notes on the Bank of Canada (in Canada), notes on the Bank of England (in England and in Wales), notes on the European Central Bank (in Eurozone countries) and so on and so forth.

But there was a time in the history of the United States when paper money was not just Federal Reserve Notes. In fact, before 1913, there was no such thing as a Federal Reserve Note. Yet there was lots of paper money. It is a fallacy that before the creation of the Federal Reserve in 1913, that all people spent was gold and silver coins.

By contrast, if you are in Scotland, and you go to say an ATM for the Royal Bank of Scotland take out say a 20 pound note, what you get is a note by the Royal Bank of Scotland that promises to pay the bearer on demand the amount of 20 pounds. What does that mean? It means that you can go to the counter with that note and demand 20 pounds, and if you do that you will receive a 20 pound note on the Bank of England. If you were to then go to the counter of the Bank of England with that 20 pound note on the Bank of England, what you’ll get a nice clean fresh one. Back when Britain was on the gold standard, you would have ultimately received gold sovereigns, gold coin weighing each a little less than a quarter ounce reflecting the legal definition of the British pound.

In actuality, Scotland is one of the few places in the world where a non-central bank has the right to issue notes. In the free banking era in the United States, before the existence of the Federal Reserve, a bank note generally promised redemption of so many dollars in gold rather than in Federal Reserve Notes.