Capitalism Under Attack: Adam Smith and Free Banking

Capitalism is under attack from many directions today.  In this context,  Financial Times just published a fictional “Letter to Capitalists from Adam Smith,” praising what capitalism has achieved over the past 200 years.

Despite its imperfections, the letter argues, it is much better than the alternatives.  The fictional voice of Smith writes,

“I am pleased to see that capitalism has triumphed over communism and socialism in virtually every part of the world…This triumph has occurred because capitalism’s greatest strength – productive economic activity – has succeeded in creating more opportunities for more people than anyone – including me – ever imagined. And with more wealth, billions of people now in the middle class can secure education for their progeny, purchase necessities and luxuries at once-unimagined levels, pursue leisure activities for a greater part of their lives and retire with higher levels of economic security.”

The letter goes on to suggest what Smith might have advised today, among other things, about saving the Euro from self-destruction and reducing the US government’s ominous debt.

The question of money and banking is especially important today, since so many of the attacks on capitalism are based on the recent failures of the financial sector.  The irony is, however, that banking is one of the most centrally controlled and regulated sectors of modern economies and in no way represents a free market ideal.  Adam Smith himself advocated a system very different from the one we have currently.

In The Wealth of Nations he argued for the core of what today is called Free Banking.  He writes:

“If bankers are restrained from issuing any circulating bank notes, or notes payable to the bearer, for less than a certain sum, and if they are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented, their trade may, with safety to the public, be rendered in all other respects perfectly free.”

In other words, according to Smith, banks should be free to operate, issue bank notes, diversify, compete, so long as they are legally bound to redeem their banknotes in whichever asset or base-currency they have promised to pay to the bearer of those notes.  Under these conditions, accountability and competition among banks would regulate the issue of currency.  We can infer from this that Smith actually might have advocated for a break up of the Euro (not the common market) and for competition in currencies issued by independent banks.

This may sound crazy to some, but there is much scholarship to suggest that this form of free banking would outperform our current system of central banking.  Consequently, Free Banking may offer the alternative to the recessions and bailouts that have called capitalism itself into question.

For those interested in the theory and history of Free Banking, Lawrence White, a Professor of Economics at George Mason University and leading scholar in the field, will be giving a talk at Centre for Civil Society this Thursday, January 12th at 3:30pm.  The title of the talk is “Free Banking in Scotland and Canada: Lessons for Today.”  Everyone is welcome to attend.  The venue will be at the CCS office, A-69 Hauz Khas, New Delhi, 110016.  Check out the announcement here: http://ccs.in/ccsindia/lhwhite-talk.html