J.D. Han King’s College, UWO Is Government Regulation Necessary for a Stable Financial Industry? : A Possibility of Self Regulated Financial Industry J.D. Han King’s College, UWO

1. Free Banking: Free Entry and Self Regulated Note Issues Historical Instances of Self-Regulated, or Free-Market Financial Industry Scotland, 1720-1840 U. S. A., 1836/7-1863 Canada, prior to Bank of Canada 1935 Sweden, 19C Hong Kong, Contemporary

2. Were They Stable? Conventional Wisdom -> Yes, Scotland, Canada, Sweden and HK -> “No”, U. S. A.  We would like to challenge the second part of Conventional Wisdom

3. Scottish Free Banking: Period: 1720-1840 How did it work?: -Banks could print out paper monies, or notes as long as they do not default on redemption request of the notes for species -No government charter needed; Self regulated, competitive (free market driven) supply of money and banking practices

* Evaluation of the Scottish Free Banking Era Compared with the Contemporary British Banking Experience Stability: no major bankruptcy -exception: Ayr Bank Availability: more banking services per capita Competition: small banks along with large ones Efficiency: spontaneous evolution of a clearing house (payment association) Rapid propagation of information

4. American Experiences 1) Conventional Wisdom:”Bad” -> Free Banks were called “Wildcat Banks” 2) Revisionist View: by A. Rolnick and W. Weber “Not So Bad in many states except for Minnesota, etc.”

(1) First Paper by Rolnick and Weber: “New Evidence on the Free Banking Era” In Three Categories (failure rate; years in business; loss for note holders): New York: Fairly Good (8%; 8 years; 26 cents per dollar) Wisconsin and Indiana: O. K.(26-31%; 4-3-2 years; 11-24 cents for dollar) Minnesota: Bad (58%; NA; 70 cents per dollar)

Their studies found that it was “Not Really” that bad at all. Why? (2) Second Paper by Rolnick and Weber: “Explaining the Demand for Free Bank Notes” Did the note holder really suffer such a great loss (70-75% of the face value of the note or paper money) due to Bankruptcy of Free Banks in Minnesota? Their studies found that it was “Not Really” that bad at all. Why?

*Three Point Arguments i) “The note holders had been well informed of the true value of the assets/notes from Minnesotan Free Banks.” : Free Market is more efficient in propagating information than we expect (Evidence: Well conversed the New York/Chicago Market Value of Government/Railway Bonds as Major Assets and Reserves of the Banks)

ii) Mutual Funds Interpretation: “The notes were issued with railroad bonds, which were traded below par. The bank notes were priced to reflect the value of their backing assets” The value of the notes depends on the total value of the assets divided by the number of notes/shares” *Evidence: Payment for the grading of a mile of railway was a lot larger in Minnesota than elsewhere in the U.S.

iii) “Therefore, the note holders did not have much loss even in Minnesota” - Minnesotan Experiences with Free Banks were not too bad (given the time and the location)

5. Lessons to be Learned Self-Regulated, Regulation-Free, Banking/Financial Industry may be Viable and even be superior.

Just a second! There are 3 segments to consider in the financial sector: - Banks - Securities Market - Money

-We can also stretch this point to the Money (next). -We have so far reviewed the strength of Self-regulated Banking Sector (Free Banking). -We have an emerging historical evidence of the Superiority of Self-regulated Securities Market. Read Neil Reynolds’s inspiring article on the Dutch Securities market of the 16th Century, entitled, “Self-regulation: The Dutch had it right,” The Globe and Mail, Aug.12, 2006. -We can also stretch this point to the Money (next).

6. Stretching the argument further: Is government’s monopoly of a currency necessary for the stability of price level?

1) Conventional Wisdom: “ unregulated competitive production of money will lead to over-issue of money and thus an infinite price level”

2) Revisionist Model by Benjamin Klein “Do Private Monies Lead to Infinite Inflation?”: No for the following 2 reasons (1) Informed Consumers’ Screening No,as long as they are Distinguishable monies, and “Brand Name Identification” is possible. Financial Market is information efficient (2) Incentive Compatibility of Private Money and Honesty -Money demand is unique -Consumer Confidence is built over a very long time in a ‘smart’ way. -The present value of the bank’s non-deceiving “profit” stream will be larger than the benefits from deceiving scheme of printing bad monies and running away. * The cost of counterfeit was more serious than the cost of private over-issue fraud and bank failures.

3) Extension In the age of Globalization, currencies will compete internationally freely in the domestic economy as well as in the financial market; “High-confidence monies” will win over “low-confidence monies”; - Market confers Trust and Confidence, not Government Euro, and an increasing ‘(U.S.) Dollarization”; “Is Euro going to succeed?” “Is Canada going to use U.S. dollars?”