If you pay attention to central bank agitprop, you may have noticed an interesting trend: Central bankers are increasingly fond of making references to monetary history, specifically the pre-Civil War period in the U.S. That was when the U.S. entered a monetary era known as “free banking.”
As it’s characterized today, this was a rollicking time, rife with bank failures and monetary instability, in which banknotes traded at a discount to par reflecting the creditworthiness of the bank. As the central bankers tell it, if you were to take a Tennessee banknote to New York, for instance, your money might not have been accepted at par. From the 1830s to the 1860s, the vast majority of banknotes were issued privately, by banks mostly regulated by individual states.
Our monetary elite has become fixated on this period recently. In May, Federal Reserve Governor Lael Brainard denounced antebellum banking in a speech exploring the creation of central bank digital currencies (CBDC): "Indeed, the period in the nineteenth century when there was active competition among issuers of private paper banknotes in the United States is now notorious for inefficiency, fraud, and instability in the payments system. It led to the need for a uniform form of money backed by the national government."
Back in 2018, the president of the St. Louis Fed, James Bullard, also issued his own history-inspired critique of cryptocurrency, saying “cryptocurrencies are creating drift toward a non-uniform currency in the U.S., a state of affairs that has existed historically but was disliked and eventually replaced.”
In a hearing on digital currency last month, U.S. Sen. Elizabeth Warren repeated similar talking points, comparing stablecoins to “wildcat notes from the 19th century.”
And just last weekend, Jeffery Zhang, an attorney at the Federal Reserve, and Gary Gorton, a professor at Yale, published a paper entitled “Taming Wildcat Stablecoins” in which they pejoratively compare stablecoins today to the banking context in the 19th century, which they refer to as “free banking.” The paper concludes that privately issued money (whether free banking or stablecoin-based) cannot work, and that only a sovereign can supply good money. The paper was commended by none other than the high prince of fiat, Paul Krugman, who used it as an opportunity to condemn stablecoins.
In all these cases, attacks on free banking – the notion of permitting banks to operate largely outside the confines of state regulation – are rhetorically employed to undermine stablecoins.
Stablecoins come in many forms but primarily exist as tokenized IOUs for commercial bank dollars that circulate on public blockchains, allowing settlement in dollars (or other sovereign currency terms). They trade at par because they are convertible for underlying dollars in commercial banks – or sold to someone who is willing to undertake that conversion. Because stablecoins trade on public blockchains and facilitate the global exchange of value across a network of exchanges and wallets, and issuers for the most part aren’t regulated as banks, these comparisons to laissez-faire banking naturally emerge.
So do stablecoins constitute a reprisal of free banking, and if so, is this a problem? On the first question, I would answer in the affirmative. Free banks relied on gold as reserves, whereas stablecoins are mostly issued against commercial bank dollars. Larry White points out other things where there are no analogies in terms of the liabilities between notes issued by free banks and the stablecoins of today. But by and large, the comparisons are quite apt.
So much so that we wrote a white paper in summer 2020 pointing out that stablecoins and their issuers (oftentimes exchanges) represent a potential technologically enabled return to a free banking era. As we say in the piece, “lessons can be taken from the history of prior banking epochs when private entities took responsibility for issuing money, effectively outside of state control.” So on this point, we very much agree with the comparison between free banks and stablecoins proffered by Brainard, Zhang and Gorton.
However, their emphasis solely on the U.S. instance of free banking is wrongheaded. As economists George Selgin and Larry White have spent virtually their entire careers pointing out, and we echo in our crypto-dollar piece, the American antebellum episode did not constitute genuine laissez-faire banking. Banks during that period were forced to hold risky state government bonds and were restricted from engaging in “branching” – meaning they couldn’t establish branches nationwide. This inhibited them from geographically diversifying their depositor base and from having free choice in their asset portfolio. It’s no wonder that bank failures were common.
Neither of these peculiarly U.S.-based restrictions was present in genuine free banking episodes such as Canada. There’s also Scotland’s successful case study, chronicled by the aforementioned Selgin and White, alongside Kroszner and Dowd. The repeated omission of successful historical instances of free banking – Scotland, Canada, Sweden, and Switzerland – in which bank failures were uncommon, notes were mutually accepted by rival banks and traded at par, appears strategic. For analyses that do consider the fuller historical record, see Selgin and White’s comparisons of free banking and contemporary stablecoins.
So why are the central bankers so keen to characterize the private issuance of money as inherently unstable?
Because they are deeply conflicted: They rely on these myths to sell us their proposed solution in the form of CBDCs. It’s no coincidence the anti-stablecoin contingent is generally fond of CBDCs and believes the state should not only control the issuance of money but also have the power to determine which transactions are valid.
We do not have to speculate on this front: If you listen to central bankers, they invariably de-emphasize privacy in transactions and mention the necessary imposition of controls inhibiting activities that the government claims are illicit. This is sometimes euphemized as “balanc[ing] an individual’s right to privacy with the public’s interest in the enforcement of AML/CFT regulations” – despite the fact that physical cash has no inbuilt anti-money laundering/combating the financing of terrorism controls. I have yet to come across a central banker proposing a CBDC project with the precise and same qualities of privacy and transactional freedom as physical cash.
The debate is fundamentally about the state’s role in society. CBDCs promise to strip some of the issuing power of money away from the commercial bank sector (which exists as a public-private partnership) and restore it to the central government. This would naturally grant governments extremely powerful tools for surveillance, societal control and would empower central bankers with granular tools to affect the money supply. In a country where the politicization of banking is an established doctrine, CBDCs would represent a colossal victory for those trying to concentrate power in state hands.
Thus, the reason historical episodes with private monetary issuance and administration are so frequently a target is because they stand in the way of attacks on stablecoins. The success of stablecoins, and the attendant stagnation of CBDC projects, is embarrassing to central bankers and policymakers. Stablecoins offer everything that CBDCs hope to achieve, but in a completely bottom-up, free-market way.
If economists can prove that episodes of free and unrestricted banking were failures and led to massive consumer losses, they might prove that similar, latter-day systems are a bad idea, too. Unfortunately for them, not only is their historical account flawed, but so is their present-day assessment of stablecoins.
Far from being inherently flawed or unstable, stablecoins are an overwhelming success today. The free market has allocated over $110 billion in deposits to these projects, even though they have only really existed in production for seven years or so. Stablecoins collectively today settle anywhere between $10 and $20 billion on a given day – trading with extremely tight spreads.
Gorton and Zhang object that stablecoin recipients will not accept these tokens at par, because the “no questions asked” (NQA) principle is violated due to a lack of confidence in the issuer and no government backing. “Without NQA,” they insist, “the community had no money. Stablecoins that do not satisfy this principle also will not be able to serve as money in transactions.” But their analysis is off base both historically and in the present day. Private banknotes worked just fine – in Scotland, between 1716 and 1844. Today, stablecoins have been embraced and indeed accepted at par by millions of individuals and firms, thanks to the presence of convertibility.
Indeed, our venture fund – alongside many of our industry colleagues – today prefers to settle investments in stablecoin format because they operate 24/7, offer strong finality and do not face the massive headaches involved with sending wires abroad. Startups we invest in increasingly ask for them – and in some cases process payroll in stablecoin format. For globally distributed teams, stablecoins make far more sense than trying to tackle transfers to dozens of different countries via extractive intermediaries and the byzantine correspondent banking system.
On this topic the free market has already outmatched central banks. Encouragingly, some central bankers, like Fed Vice Chair Randal Quarles, have understood the merits of stablecoins and have not dismissed them out of hand. Nevertheless, it is clear now that nothing in money or finance is deemed outside the purview of Washington and the New York Fed. The key question is, once they get ahold of them and regulate them “appropriately,” how will they do?
As for the consumer benefit of private versus public money, one only has to consider what happened after the free banking episode in the U.S. Monetary issuance was centralized in the hands of the state, which promptly inflated away everyone’s savings during the Civil War. Curiously, the central bankers touting the benefits of public money omit that part of the story.
Thanks to Matthew Mežinskis for his feedback on this article.