Rothbard, The myth of Free banking in Scotland, and Sechrest, White’s Free-Banking Thesis: A Case of Mistaken Identity, claimed that the so-called “scottish free banking” (1716-1845) were not really free.
Both of them were convinced that the Bank of England (the central bank at that time) act as a lender of last resort - both for Scotland and England.
According to Sechrest, “the scottish system was de facto a central bank system in which individual private banks pyramided their note issues upon the reserves of the three chartered banks, which, in turn, pyramided their issues upon the reserves of the ultimate source of liquidity for the entire British Isles : the Bank of England”.
Much (or part) of the reserves of the private banks were held in the form of public (ie chartered) bank notes, and the three chartered banks kept their reserves largely in deposits with the Bank of England. Furthermore, he notes :
I have already noted that the nonpublic banks often redeemed their notes and deposits in the notes of the public banks, rather than in specie (i.e., much of the reserves of the nonpublic banks were held in the form of public bank notes).
And White responded by citing Charles Munn, page 55 in Free Banking in Britain, (see page 69/194 in “navigation page”). It seems that scottish banks did not hold theses notes as reserves.
The mixed notes which often figure in the balance sheets were the notes of other banks and banking companies which had been taken in the course of business. These were unimportant as a reserve asset because they were exchanged at least once per week after the formation of the note exchange in 1771. The amount which appeared in the balance sheet would largely depend on whether the exchange took place before or after the balance was struck. Nevertheless, in times of pressure the amount of mixed notes taken between exchanges might prove to be a useful temporary relief from a liquidity crisis.
On note exchange, Selgin explains its benefits in “The Theory of Free Banking” (1988) (see chapter 2, Regular Note-Exchange). The acceptance of the rival’s notes increases the ‘acceptability’ of the two notes so that these notes remain in circulation much longer, reducing clearing debits and notes redemption (ie, increasing bank’s liquidity).
But it’s not clear to me. Why don’t private banks just borrow as much as they can get from the three chartered banks, which in turn borrow from the Bank of England ? They lend their surplus reserves and generate inflation. Where am I wrong ?
Then, I have a little doubt about the british suspensions. White states, page 42, (see 56/194 in “navigation page”) :
The suspension of convertibility by Scottish banks was illegal under the Act of 1765, but curiously enough no one seems to have challenged them seriously in court . . . One explanation is that, London being Britain’s financial centre, suspensions by the London banks made the Scottish banks unable to get extra gold from their correspondent banks or from sale of securities in the London market.
I have never heard about these british suspensions. I always believe that the british suspensions only concern the “Restriction period”, 1797-1821, because of French Revolutionary Wars. Maybe the british banks can legally suspend payments, I don’t know. I’m searching for facts.
(I have already sent a mail to White - still awaiting a response - I hope to get some response here.)