On The Brink with Castle Island - George Selgin (Cato Institute) on Stablecoins, Bitcoin, and Free Banking (EP.234)

Episode Date: August 2, 2021

George Selgin, director of the Center of Monetary Alternatives at the Cato Institute joins the show to discuss Bitcoin, Free Banking, and stablecoins. In this episode:  Why George refers to Bitcoin as a synthetic commodity money Why George was excited by the possibility for synthetic commodity money What conditions would have to hold for Bitcoin to be considered money Why money is a spectrum rather than binary Are stablecoins prone to bank runs? Is Tether's melange of underlying collateral sufficient? How should stablecoins be regulated? Why are regulators looking into stablecoins today? Comparing stablecoins to Money Market Mutual Funds Why money market funds broke the buck in 08 Are stablecoins as systemic as money market funds? George's objections to Gorton and Zhang's paper on free banking and stablecoins George's definition of free banking Was the 1830s-60s period in the U.S. a period of genuine free banking? The actual causes of bank failures in the pre-Civil War period Why 'unit banking' was so fragile What lessons can be taken from Canada's experience with free banking in that era Why the history of Free Banking is a red herring in the stablecoin debate George's recommendations for a primer on free banking George's reflections on Hal Finney's reference to his work Why bank failures are often the consequence of regulation Content mentioned in this episode:  Selgin, Synthetic Commodity Money  The Alt-M Blog Selgin, Money Free and Unfree White, Free Banking in Britain Selgin, The Theory of Free Banking Dowd, The Experience of Free Banking Gorton and Zhang, Taming Wildcat Stablecoins Sponsor notes:  This episode is brought to you by Withum, a top 25 accounting firm with a cutting-edge Digital Currency and Blockchain Technology practice. To learn more, visit  withum.com/crypto.

This episode is brought to you by Witham, a top 25 accounting firm with a cutting edge digital currency and blockchain practice. Wherever your company is at, from pre-seed to IPO, Witham has tailored solutions for you. To learn what their advisory tax and audit services can do, visit Witham.com slash crypto. Hello and welcome back to On the Brink. Today, we have one of my absolute favorite academics and writers on the show, George Selgin. many of you will know who he is. Hal Finney referred to his work and a very famous post that he made on the Bitcoin talk, forums about the intersection of Bitcoin in free banking. George has done so much work that I've learned from in my Bitcoin career. It's hard to list at all. We actually do get into some of his references for introductory topics later in the episode. But the immediate motivation to bring George on to the show, finally I've wanted to you for a long, long time, was his page. by Gorton and Zhang about stable coins and free banking and their relationship. And I wanted to

get George's thoughts on this because he's a very keen understanding of stable coins and of course is one of the foremost world authorities on free banking. And so I'm just so happy to get George on. Really love this conversation. And I think you're going to like it too. Let's dive in. Brought down by bad mortgage investments, Lehman, which has 25,000 employees will be liquidated. The federal government loans American International Group AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac,

the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more to Britain's ailing economy with a new round of concentrated easy. You print a couple trillion dollars, and all of a sudden, people start to worry. So out of this worry, we have something called a Bitcoin. Bitcoin. It's my enormous pleasure to have George Saldron here. George is the director of the Cato Center for Monetarian Financial Alternatives.

And honestly, I don't think it's an exaggeration to say, you know, a seminal figure in the world of Bitcoin. Hal Finney infamously or famously referenced George's work. Some people think he did so infamously. In that in that great, great early post about Bitcoin's development and, you know, Hal talked about free banking. And I think free banking and Bitcoin, those ideas are deeply. intertwined, although not all Bitcoiners agree with me, of course. But I've certainly benefited a

huge amount from your work, George, and that of your colleagues. It's been enormously influential to me and my own understanding. And so I'm so happy to have you here today. So thank you for joining us. Not at all, Nick. I'm very glad to be on your show at last and to have you saying nice things about me to your many fans. That's a pretty good. good deal. Well, I believe you've done a few Bitcoin podcasts in the past. I think I listened to you on Crypto Voices back in the day, which was a really great one. So I think we certainly benefit from your continued sort of engagement with the industry. That's definitely a net gain for us as Bitcoiners. There's so many places to start. And the real reason I wanted to talk, the immediate

concern is this interesting debate over stable coins and free banking, of course, catalyzed by this Gordon and Zang paper. But maybe before we do that, I just, I mean, I feel like I could interrogate you for three or four hours on the topic of Bitcoin, probably, but we'll keep it, we'll keep it to a minimum. So maybe we can start with your great paper. I think it was 2013 paper, synthetic commodity money. I don't remember. That might have been the actual title. Yes, it was the title. It was the title. And you talk about, you're trying to basically situate Bitcoin in the monetary taxonomy, Bitcoin, among other things.

So that's kind of how I refer. I describe Bitcoin if I'm trying to be really precise thanks to that paper. But also, it's been a while since you wrote it. So I'm curious as to whether that's still your current view, whether you still describe it that way, or if there's anything sort of new that's changed your mind on that. No, no. I still think synthetic commodity money is a good way to think of Bitcoin. And as you said, the paper actually wrote it originally in 2012, so it was pretty early. It was late 2012. And then it, you know, as papers do, it hung around for a while. And it took a couple years before it actually made it into print. It was on SSRF.

But no, I think the classification and the place I put Bitcoin in that, is still valid and it's basically a quadrant. You have monies that have some non-speculative, non-monetary use value as economists say. Obvious example, an obvious example being gold, which has got an industrial demand, demand as an ornament, et cetera, independent of its use as money or as a hedge,

and that sort of thing. Then you have ones that don't have obvious use value. And so that's one on one of the axes of the quadrant. Those are the two options. And then the other is where scarcity is is part of a built-in scarcity, inescapable scarcity is part of the regulatory mechanism, right? And the other is where there is no natural scarcity, so there has to be a scarcity contrived through deliberate management and limitation of the quantity. And the interesting thing about Bitcoin is it belongs in a quadrant that previously was empty before its introduction, and it's the quadrant where the thing has no non-monetary

use value or value as a hedge based on some non-monetary use. And yet, it's scarce. It's inherently scarce. The algorithm makes it so. And I should say all algorithmic cryptocurrencies are synthetic commodity monies. Whereas some non-alorithmic stable coins, for example, are more like fiat money.

They have actual central managers, as it were. And others still look a lot more like convertible monies. And in the paper you make some really interesting analogies, apply this taxonomy to some other monies that through some contingency happened to be scarce, right? So was it the Swiss dinar? Am I getting that right? Iraqi Swiss dinar. Yes. So what happened, those were ordinary fiat currency printed in Switzerland. That's where the Swiss part comes in. but they were an Iraqi currency, and they were demonetized. They were basically replaced with something else, and the old notes the expectation was they'd become worth us, but they instead were adopted as a parallel currency that was now a scarce commodity,

though it was a scarce commodity that didn't have any non-monetary use, but it remained not only a parallel currency with the new official Iraqi currency, but one that retained its value a lot better because it had a, unlike the new official currency, which was a plain old fiat currency, it had a definite scarcity. There were only so many of the things around. The old plates had been destroyed, et cetera. And that ended up making it more valuable and making it retain its value against, say, the dollar a lot better than the official replacement. So that's an example of a kind of synthetic commodity money.

The non-monetary counterpart of this notion of synthetic commodity money would be an artist's print where you have the plates for the print, but you destroy them. So that only after making a certain number and then that's it, they can't be replicated. And of course, in Bitcoin's case, the difference is the plates are only. only going to get destroyed once there's about 21 million, but they will be destroyed. We know that. In contrast, fiat money is like lithographs where the plates are still there and the authorities can, you know, for all you know, could make a zillion of them until they draw the stuff, the prints down to their paper value. And sometimes that actually happens. So there's, that's, it's analogous

to that. But of course, it's for monetary or at least, ostensibly monetary assets that have a client distinction. And the reason you call it synthetic is because it's just simply not material, or is it because the scarcity is contrived? What makes it synthetic is the fact that the scarcity is synthetic. It's the scarcity is built into the algorithm, as opposed to the natural scarcity of a precious metal where there's only so much in the ground eventually.

has a positive cost of production, but it's rising at the margin and so on. So it's the scarcity that's synthetic. It's as if they made it up in a laboratory to be scarce, and that scarcity is not something that you can change. Another analogy, you can multiply these forever, is like having a system, a supply formula that's cranking out a certain amount of these things, of course, every, every day. But once the thing is turned on, once this program is turned on, you throw away the key. And now you've got real scarcity. If someone has the key and can change the program,

then you're back to the world of just of a manipulable fiat money. where there is no real built-in in unconditional scarcity. So the challenge is to develop a monetary institution, which is non-discretionary, and follows some sort of preordained kind of rule. That's right. What excited me about synthetic commodity money, meaning all the things that could be designed using those criteria is what's the possibility is the possibility. You can design one that turned out to have very good monetary properties. So the best way to think about that is we know about precious metal monies and other commodities that in the past have been used as monies.

And we know they all have their problems. You know, you have new discoveries or you have a change in the non-monetary demand. in fashions, whatever, that could really affect their value and the volatility of their value. And for those reasons and others make them not the best general medium of exchange or monetary standard from a macroeconomic point of view. But what if you could make up a commodity that didn't suffer from non-monetary demand shocks because nobody has any non-monetary use for it? And the supply, there's not going to be any surprise discoveries.

We're going to rule those out. We've already solved some of the problems with ordinary commodity monies. And Bitcoin, by the way, does both of those things. What we lack, what we still would like to do is have the algorithm be such that the adjustments in supply are so smart that they give us macroeconomic stability. Which I think means you'd have to somehow get the supply to adjust to me. maintain a stable nominal income because I'm of the what's now called the market monitorist school on that as a desideratum of macro stability. Now, we don't have any kind of stable coin that can do that, and Bitcoin can't do that. But that's the sort of thing I was looking forward

to. And you might say more generally stable coins, or perhaps a little more in the spirit of what I was looking forward to when I wrote that paper. But of course, not really to the, if something's just tied to the U.S. dollar, obviously, it's not going to give us a better monetary standard than the dollar. But if it's stabilizing the general price level, as some stable coins try to do, maybe you could see that as an improvement. You can certainly see how such a coin, if it worked the way it was supposed to, could implement a Federal Reserve inflation target, right? If it worked ideally. Now we know there's many a problem trying to get stable coins of that sort, algorithmic ones, to behave the way you want them to. They're subject to speculative attacks

and all that. So the challenge is out there. It's cool to think about it. I'm glad people are coming up with very interesting attempts to address it. And they certainly are interesting. And many of the coins have little features that seem to be part of a puzzle, like Ample Forest, you know, where you could have a neutral increase in everybody's balances, it's like neutral money adjustment of supply in response to some feedback from an Oracle or otherwise about what's going on in the economy. So I think this is very early, a very early stage of the development of synthetic commodity monies. Bitcoin was the first, and here we're getting into the brass tax, right?

If I'm not totally enthusiastic about Bitcoin, it's because, although I am thrilled by it, and it's the great prototype, and it's accomplished a whole lot, it's only the first. I think we're going to see a lot more, and we are seeing more, in this rivalry market competition between alternative synthetic commodity monies, it may be some time before we really hit the jackpot. And I don't like the talk that suggests that Bitcoin is the last word and will always be because it kind of goes against the notion that this is an ongoing and process, dynamic innovation process, and we're only in the early stages. I hope, of course, the government it will allow us to continue into later stages. That's another question.

So one thing I've seen you say many times I think is defining, I want to be careful with my words here, defining money is a generally accepted medium of exchange. Is that, am I getting that right? Yeah, yeah, that's a kind of standard economist. Okay, yeah, obviously there's so many definitions for money and so many debates over that. what would you say would be, you know, a set of criteria or, you know, thresholds that would have to be reached for you to say that, for instance, Bitcoin met that standard in your book? Yeah.

Well, first of all, no hard and fast answer to that question will do. We know that because if it did, we could answer it for ordinary dollar-denimated assets and we can't. That's why you've got M1, M2, you had M3, it's still there. And you have M4 and MZ. And you've got a million different measures, all of which try to draw the line in a different place when it comes to deciding when something starts, ceases to be generally accepted and is only of limited acceptability. Right. So there is no absolutely, absolutely, correct criterion for that. When we turn to Bitcoin, I guess the best way to think about it is to think how close is it to any of the M's when it comes to acceptability and how broadly accepted it is.

And I think, I'm afraid, I think the answer is it would be a pretty big M that would encompass Bitcoin because it is not used much in ordinary retail payments. Certainly it is used for some. It's used more in remittances. It's used more in certain countries where things are going plateau with government. It's certainly used more among people who need some pseudonymity and value. So it has its market. It's not a trivial market by any. means. But we need to distinguish the extent of that market and how much it's grown since Bitcoin was introduced from the extent of the market for Bitcoin as a speculative asset. And that's the one that's really exploded. And they're not the same thing. So not all demand for Bitcoin is demand

for a medium of exchange, let alone one for ordinary purposes. And their Bitcoin has not have been as successful as it has been as an asset for more specialized purposes or as a savings and investment medium. One of the things I've noticed is much higher, like I'm going to be misusing this term a little bit, would be a higher velocity of payments for stable coins as opposed to Bitcoin. That's right. Stable coins much more often demanded to be used as means of exchange, and that translates into high velocity. In other words, you don't have as many, you don't have the stable coin hodlers. The funny thing is a lot of Bitcoin, we have plenty of Bitcoin hoddlers or enthusiastic hodlers. Well, you either hoddle or you spend.

And if you don't spend, you're not using the asset as a medium of exchange. You can't have it both ways. So the irony is that some huddlers being Bitcoin maxis are the ones who will jump on me and try to beat me up for saying it's not money. Yet, if everyone did exactly what they say we should be doing, which is to load up on the stuff and hold on to it because it's going to go up in value, its velocity would approach zero and it would be even less like it would qualify even less as money than then it actually does in practice it qualifies as money because some people aren't hodlers and some people are happy to

go buy stuff with it but you pointed out and this gets us to the centerpiece of our discussion that you know given the the gnashing of teeth we've seen in Washington over stable coins it's maybe a little disproportionate or it slightly exaggerates the influence of stable on the economy today because you point out that stable coins are themselves is still a niche medium of exchange. Very much so. However, you'll find that when critics of stable coins go at them, usually they are, they admit that they're doing so on, as it were, a speculative basis. They're concerned not so much about their importance today or their systemic risks they pose

today, which are trivial. I think they'll all admit that, the better one. But having witnessed the massive growth in the stable coin market of late, propelled in part by COVID, of course, they are now fearing that some of these coins will become sufficiently important as to present some systemic risks. And of course, then the question is whether they're right about that and whether they're right about the risks pose and whether they're right about the solutions that they propose. Mostly, let's face it, mostly these people really are just talking about Tether and DM. Right, right. DM doesn't even exist yet. Doesn't exist, but they're still worried about it. They have a vision of it being a great success,

which of course begs the question. But the point is that they really have these potentially global large scale stable coins in mind. And they don't care about the others. And it's why they sometimes write as if all stable coins operated on the same principles as tether with the same potential for. problems and they tend to treat DM that way too. Of course, Diam is still a little bit of the black box so we know what they're saying they're going to do with it. We don't, how they're going to manage it, but we don't, we know even less about what they really are going to do than we've

known about tether. And of course, we'd have, we've had to beat it out of tether. Right. Right. Right. So one interesting comparison, we're going to, we've seen comparisons between stable coins and free banks, which we'll talk about. Before that, Isabella Kaminska, the Financial Times, has compared stable coins to euro dollars. She calls them crypto euro dollars. I think this is a pretty apt comparison. I'm curious what you make of it, though. Well, it's very apt of what comes to tether, particularly. Because most of that is in the offshore. It's offshore. It's not subject to any regulation. So in that, respect I think tether is not describing tether as euro dollars or close substitutes for euro

dollars is about right yeah should that as swage policymakers the fact that euro dollars is such a critical and large feature of the dollar system and then saying look just within that taxonomy stable coins are just a crypto transmitted version of a euro dollar so why worry about it? Should that? Well, I don't think that they are sanguine about how, first of all, about whether stable coins will generally remain offshore media. And I'm not sure they're all sanguine about whether such offshore media don't have spillover effects into domestic markets of different kinds, including the U.S. market, of course. And finally, there's a question about whether there are technical questions about whether being offshore makes any difference as far as possible fire sales of underlying assets. So what these people are worried about, one of the main things is that suddenly everybody wants to redeem their tether. And tether, has finds it has to unload its portfolio, has to sell a lot of stuff.

So you have a big, people are worried about there being a major sell-off and Tether, which is, of course, a claim-based stable coin, not an algorithmic one, and has to sell off stuff from its portfolio. That puts downward pressure on the prices of the various, financial assets it has been holding. This causes trouble beyond tether in any of the markets where those assets are held by other financial intermediaries and so on. This is the kind of scenario they're worried about. And in that scenario, scale is everything. Well, scale is a big thing. The bigger, the scale, the bigger component of demand for particular assets that the

stable coin represents, the greater a run on that stable coin issuer, the greater the threat such a run poses on other markets because of the potential knockoff effects of the falling prices of the assets in question. I looked at it historically. I think Tether's Max Redemptions was something in the 30 to 40 percent range in I want to say late 2018. And then most recently they've had redemptions of a single digit percentage, but a billion dollars or so because the whole thing's worth $60 billion.

Well, you know, this gets into the details of how various stable coins operate and just how run prone they really are. I did remark on Twitter more provocatively than anything else that there's a sense in which the market for tethers is one where people are not all that keen on redeeming if they can possibly avoid it. They don't want to have to divulge their transactions when these are all large volume transactions when we're talking. about tether redemptions, we are, of course, talking about redemptions of $100,000 or more. It doesn't set off all of the alarms for your customer and AML and all that, but it sets some off. And, of course, the transactions are not ultimately anonymous. So there's a stickiness to tether demand that limits the extent of redemptions, and to that extent,

and therefore limits the vulnerability of tether to runs, but it's not absolute. And of course, what really matters is not how many redemptions are going on in ordinary times, but what happens when you really have a crisis. That's what regulators want to know, which is why they do stress tests and all that, is what happens in a crisis? Are you going to get a massive redemption run? and what's that going to do to people who aren't necessarily directly involved? So, you know, one thing I see a lot of the time is like, well, why isn't they're holding 100% cash or, you know, very, very liquid short-term instruments?

I'm curious for your views on that, you know, whether it's legitimate to hold longer-dated maturity instruments or things that are, you know, not quite cash, but near-cash. Well, legitimate is a tough word, of course. it requires unpacking and it requires that one have some ultimate objectives. First of all, we have to be very careful with the word cash, which is very ambiguous. One thing that Tether cannot do conveniently is hold actual fiat money, which it could only do in one of two ways. One is by actually stocking up on federal reserve notes and redeeming with those. And the problems with that should be fairly obvious.

And it doesn't, those notes don't yield any interest income, which is going to make the operation a little bit harder to keep profitable. Right. The alternative in theory is that it has reserve balances at the Fed, but you can't have those unless you're some kind of a bank, you have some kind of charter. And even then the Fed could deny. you a master account. So in that case, of course, cash ends up in practice, meaning for an outfit like Tether, meaning cash equivalence, as they're sometimes called, and as they're called in Tethers

reports. And that's short-term treasury securities. Right. Or repos, repos or another. they could also keep accounts at banks as some stable coins do they keep balances at banks which are insured they're not fiat money they are backed of course by some fiat money and some bank loans etc but if they're small enough below 250,000 now they're they're insured so they can use brokers and spread that money up so there are a lot of ways for a tether or any other claim-based a stable coin issuer by which I mean the ones that aren't algorithm-based to have very liquid backing of their claims against them short of holding fiat in some form does that make them perfectly safe well it's a matter of degree so when you start getting into

backing that consists of risk your assets though like commercial paper that the regulators start to draw a bead on you and think you need to be subject to some stricter regulation. So my guess is that if all we were talking about were stable coins 100% backed by treasuries or bank deposits, the regulators would be less inclined to worry about them and to be talking about imposing regulation. upon them. They might still do so. But what really bothers them is the possibility

that stable coins could look like stable coins could look like some of the money market funds, prime money market funds, that's the kind that hold non-treasuries, and could present the same problems that such prime funds

presented back in 2008. when we had the big meltdown. That's really what's on their mind. And of course, some like Gorton and Zhang, some observers are inclined to look at Tether and say, that looks like one of those money market funds to me. And the problem is that those money market funds themselves

looked a lot like banks but weren't regulated like banks. So what people who are worried about Tether, worried about is that they look it looks yes it looks like a prime money market fund circuit 2008 but it also looks like an unregulated bank because that's what such funds looked like back then and still do to some extent so just to you know a lot of people my age probably won't have much recollection of breaking the buck with those funds back in the day what is the practical issue there you know with uh with one of these funds, instruments it's meant to trade at par, you know, trading it a discount? Yeah, it's a long story, but basically the creators of these money market funds, which are

mutual funds, but that hold highly liquid assets, either treasuries or commercial paper and that sort of thing, decided that they could make them safe enough so that they could post a table net asset value. And the SEC went along with it and said, okay, but if you move more than a certain amount, you can round up from, you know, a very small amount. It's actually, it's called penny rounding that it's actually more like nickel rounding because it's point something something 05. Right. Anyway, as long as they don't go below that, they can post, they can value. the money market fund claims at par. So even though their actual assets may fall a little bit below par, the actual worth of their assets calculated on a mark-to-market basis, they could ignore that. Well, that had a big advantage, of course,

from the consumer's point of view, they could treat these money fund balances to the extent that they didn't break the buck or didn't look like they would, just like bank accounts and even write checks. from them and that sort of thing, which you can't do with fluctuating acid value. That creates all kinds of complications. So they became money-like. And that looked like it was working just fine.

In fact, until there had been one instance of a fund that broke the buck before 2008. But primary reserve, which broke it then, was only the second. And ultimately, you know, it redeemed. and very little was actually ultimately lost by the shareholders. But, but as a consequence of the run that was based on anticipation of its breaking the buck, because it's like a bank. And if you get your money, if it's acting like a bank, that means you get your money out first. If you think they're going to break the buck, you get your money out first.

And then, of course, the costs are going to be borne by the suckers behind you in line. And that's exactly what happened. But that's not all. So far, that would just be about one fund, right? It's big. But what this caused was a general run on other funds where there was, particularly those that were suspected of holding Lehman Brothers paper, which is what got primary reserve in trouble. And so it became a more widespread run and a more widespread sell-off of assets. And there was a great fear that there would be other.

other funds breaking the buck in that, and on top of it all, all the commercial paper issuers that were relying on these funds to finance them, firms issuing basically IOUs that were being bought by money market funds, the demand has dried up. So the government stepped in first to guarantee, well, both to guarantee the money market funds themselves essentially applying insurance giving them full insurance coverage and it intervened to buy up the commercial paper that the funds were no longer buying to help firms stay financed and liquid so it was a massive intervention and it was it was one of the you know key elements of the financial crisis obviously nobody wants to repeat that and nobody wants to see it repeat

despite reforms that have been made to money market funds since 2008, because these new crypto assets that aren't money market funds officially and therefore aren't subject to modified regulations or money regulations of any sort and are ending up doing exactly the same thing with the exact same consequences. And what's the point of that? So this is the way people are thinking. That's fascinating. I didn't know a lot of that. I guess maybe it's just a feature of the economy that shadow banking always emerges in one way or another. This was a big part of the shadow banking story. It wasn't the whole story, but it was a big part. The repo market was part of the story and there were other aspects of it. But the money market funds were certainly among the most

important failure points in the crisis. And I mean the prime money market funds. There were plenty of funds that only held Treasury securities. For the most part, they didn't face similar troubles and some of them had net inflows. In banks, of course, people forget, but many of the banks were getting more deposits than they know what to do with because of distrust of the money fund, which both substitutes. And so this was far from your ordinary banking crisis in that not all banks, some of them got in trouble because of involvement with subprime mortgages. But many banks were just being flooded with deposits and they didn't know what to do with them. It was a pain in the behind because they weren't able to earn much and they were subject to capital requirements

and things. So they were very much inclined to turn deposit. away if they could, not your 1930-style run in that case. So we have to touch on Gordon and saying that was the main thing I want to talk. It's taking us a while to get there. Yes, exactly. And frankly, yourself and Larry White and I would say many of your colleagues have done an excellent job kind of preemptively engaging with this. I mean, you've made your whole career, at least one of the big aspects of your study, has been free banking.

And, you know, I'd read, you know, much of your work, and I was very familiar with the issues involved in, you know, calling the antebellum period kind of orthodox, let's say fair banking or, you know, typical instance of it. But unfortunately, in the policy debate, it seems that our policymakers only ever refer to the, you know, the 1830s, 1860s in the U.S. when they're talking about free banking. So maybe just summarize for us. First of all, let's just

define free banking. Not everyone knows what it is. So maybe we'll just start with the definition. Well, the term is used in different ways. So in fairness to Gordon and Zhang and other commentators, among U.S. economists, it tends to be used only to refer to banking systems set up between 1837, and the Civil War in various states, I think 18 and all ultimately. One of them tried twice. And what was free about these banking systems, and that free banking was in the names of the laws, so it's legitimate to refer to them as free banking laws

because that's what people called them back then. But the name was in that context, it was misleading. They introduced an element of greater, freedom and not an insignificant one in some cases, to the extent that unlike the previous situation, if you wanted to start a bank under a free banking law, you didn't have to actually have the state legislature. There were only states chartering banks during this period. You didn't actually have the state legislature vote you specifically permission for your bank to go into business. Instead, with free banking something like ordinary incorporation laws,

were established for banks. And so you met certain conditions in you could be a bank. The law had already, you know, set up a banking commission or whatever, a banking authority to make sure you, you know, checked all the boxes, and now you could be a bank. And there was no question of the legislature showing preference to you or putting the kibosh to your bank just because you hadn't bribed enough of them or because they didn't like you or because you wear pals with them, all of the corruption of the previous charter-based system, as it was called, sometimes called the spoil system, were done away with by what were more uniform procedures for establishing banks that replace them in these states. So that was U.S. style free banking. The confusion is that

there were the reason why those laws were called free banking because free banking had a broader connotation and you know how legislatures are they like to give names to laws that make him sound better than they are in this case they made it sound like these were systems that were going to be free in the European sense of the world and what did that mean well in the European sense it meant banking systems that were relatively free from all kinds of regulation So not only was an entry relatively open, but there were no heavy regulatory requirements. And banks were free to issue notes. They were free to branch, et cetera, et cetera.

They were free to do a lot of things that the U.S. free banks, quote unquote, couldn't do. And you had discussions of that type of genuine, Larry and I call it genuine free banking, though it was never perfectly so. You had lots of debates all over Europe about it. Of course, the name varied with the place. So in France, it was Le Bank Libre. In Germany, it was, what was it, Berk-Fri-Hai? I'm not sorry, it was, oh, goodness.

My German just popped out of my brain, Bankfri-Hai, and so on. And so what they meant was, We're not going to give monopoly privileges to one bank, but we're going to have a relatively open competition, not necessarily laissez-faire, but close, and closer than the U.S. So this has been a big source of confusion. But I blame the American economists, like Gordon and Zhang, for, not so much for using free banking the American way, but for writing sometimes as if there was no other version of it. What they do, what Gordon and Zhang do in this particular paper, which is all too common, is to look back at that American episode, which as you noted, lasted less than, it was about 25 years. That's all that lasted, right?

And say, this is what happens when you let competing banks issue currency, as if it were the only example or set of examples. And if basically, as if the rest of the world didn't offer any other. that was worth considering, which is ridiculous because there's a huge amount of evidence for other Plural notice-you systems in other parts of the world some of which were much freer much more representative of what happens in an unregulated market, if you will, than anything that occurred in that Antebellum US experience. So they ignoring all of that as I put it on Twitter treating those limited instances, and by the way, they also focus on the worst of them, because not all the U.S. free banking systems were bad. Some of them were quite good. And there were non-free banking arrangements in the antebellum system, side-by-side-free banking ones,

some of which also worked very well. The New England suffix system, which operated during that whole period and earlier, was a great system with a perfectly uniform currency. It had been so since 1824 or so. Anyway, what they've done by treating the wildcat banks or a small set of antebellum banking experiences as representative of what they call how private money works and then comparing those to stable coins is as if I were to write about whether central banks should issue digital currency and say, well, let's see how they did in the past with paper notes. Oh, here's the Rice Bank in 1923. Look how awful it was.

Well, that's what happens when you let central banks issue Fiat money. So I'm sure don't want to repeat that again. It's the worst kind of cherry picking, but what's sad about it and tragic about it is too many people, know too little history outside of U.S. experience, assuming they know that, history of money and banking. so they don't realize how much, how, what kind of grotesque cherry picking is taking place in this paper. And I, one reason why I'm so annoyed by the paper is that Gordon certainly knows, and I think Jeff Zhang knows, that there were these other systems and that they are cherry picking. They know better. They certainly should know better.

But Gordon particularly has talked about in other papers. the Scottish banking system. He wrote a review essay on Larry's book. And by the way, Gary Gordon had long been one of my favorite monetary economists. I have very high opinion of him, but not since 2008 when he seems to be trying somehow to make up for that crisis, which some people say his own work contributed to. I don't really like that sort of criticism, but trying to make up for it, not with a Maya culpa, but with a free market culpa. Right. And his own research earlier than that simply doesn't justify some of the generalizations he's been making since.

And to specifically drill into why, and I know it's heterogeneous based on the state, but why the 1830s through 1860s, why banks did fail. at a relatively high rate. I think I saw you right somewhere that it was in the 200 range, maybe bank failures, if I'm not misremembering. I couldn't tell you the number, but I suspect it's higher than that, all of the bank failures.

There were certainly more bank failures than that. If you add up all the failures, the United States had lots of bank failures not only before the Civil War, but after the Civil War. And of course, as most people know, the peak number of bank failures occurred after the Federal Reserve was established in the 1920s and 30s. That's where you get in the early 30s.

You get your big, big numbers of bank failures. So we never solved that problem. And to some extent, the underlying causes were ones that had persisted all through that period right up to the establishment of federal deposit insurance in 1934. It wasn't the free market. It was the lack of a free market. that manifested itself in two very important ways generally. And then I'll get to the specifics of the free banking laws and how they contributed.

But the two general ways up to 1934 were first and foremost unit banking. Most banks were unit banks. They couldn't diversify. They had no branches. So all their assets and liabilities were confined to one relatively small geographic area. They couldn't diversify their balance sheets. That made them very, very, very. exposed, made them tiny, first of all. How much capital can you put into a bank that can only lend in this small area?

And it made them highly vulnerable to local shocks. Unit banking was a massive cause of bank failures. If you looked at branch banks, countries with branch banking like Canada to the north, where they could branch across the country, even though they were half, the Canadian economy was less diverse by far than the US economy for any given year. but its banking system was far more diverse because the banks could do business and the big ones all did everywhere. They had branches all over the country, west coast to east coast. So that's huge. And one of the facts about U.S. free banking laws that can't be emphasized too much is that all free banking laws prohibited branching. So every so-called U.S. free bank was a unit bank. And by virtue of that fact alone was weak. Automatically, legislatively, not free market, but legislatively weak. It's

like the law says you have to be weak, by gosh. So that's one thing. And just to click on that for a second, so the intuition there is if you're confined to a specific geographic region, you're giving loans to a homogenous set of depositors. Is that exactly good idea? a rural country where there's nothing but wheat, right? Every loan is to a wheat farmer. There's a wheat blight. You're finished. Right.

So the restriction on branching just prevents you from engaging in effectively diversification and makes you fragile. They'd like telling a stable coin issuer that wants to back its money with commercial paper. Okay, but only do it. You can only have commercial paper issued by firms headquartered in this. you know space with a 50 mile radius how diverse so that was one the restriction on branch should very material and then the other thing is the states force the banks to hold their debt

this is a particular problem yeah so now once you get away from the unit banking problem which persisted throughout both the antebellum and the postbellum period up to up to recent times but without insurance making up for it until 1934. Then if we focus on, then we have to look at different periods for different problems. And as you just said, in the antebellum free bank, so-called free banking period, another one was free banks were all required to back their notes at least 100% often more by particular securities that the state government bank authorities made them hold. And it turns out that in some free banking states, not all, in some of these systems, the choices the legislatures made of what kinds of securities to consider eligible were poor choices.

And the most common cause of free bank, quote unquote, failures before the Civil War wasn't fraud, it wasn't wildcat banking. it wasn't even the inherent lack of diversity of the balance sheets that did the banks in. It was the fact that they were holding required collateral bonds that turned out to fall a lot in value. And by the way, this story is a little bit misleading in that the reason the falling price of legally required collateral shows up as a major cause of bank failures is partly because a lot of the antebellum free bank failures were clustered in the years just after the beginning of the Civil War or just after it looked like the Civil War was going to break out. And they, some of them in border states particularly and in southern states, of course, were holding the bonds of what became Confederate state

governments and those bonds absolutely collapsed in value and brought down a lot of the banks with them. So that's part of the story. And that, again, we don't know what assets these banks would have been investing in if they hadn't been required to buy bonds that turned out to be junk. But we do know that banks that weren't required to buy such bonds in most cases did better. So probably if we had not imposed that restriction on banks and free banking states, those banks would have done better as well. And I know we're running up on time here, but I mean, just to contrast the U.S. experience with, you know, what you call genuine free banking in places like Scotland or there's other European instances and Canada. And also Canada, which in ways is a nicer comparison because it held a lot in common with the U.S. including the same piece gold-based dollar.

So it's a good kind of counterfactual example, I suppose. Like what were the practical consequences of those systems? And what did they look like? Well, first of all, the confidence in bank notes in those systems was very high. In Canada, people had no problem accepting the notes of the major banks. By the way, there weren't thousands. of them like they were in the U.S. This was another fact that space that's a result of unit versus branch banking. There were many fewer banks to begin with. There were dozens rather than thousands.

So there were that many fewer brands of bank notes and they were all in Canada by the 1890s, any bank note from any bank was passed at par everywhere in the country, quite contrary to Gordon and Zhang's assertion that that can't possibly be if all the banks have different. assets and and par circulation was all obviously achieved as well and much earlier in smaller countries because it was less geographically challenging to keep notes at par notes notes notes traded at par based on arbitrage basically getting them back to their sources and demanding payment that's what kept them at par had nothing for the most part it had nothing to do with whether the whether the assets were heterogeneous or not if the assets were

no good the bank failed. That was all there was to it. If not, the notes tended to be current, it minus whatever cost it took to get them back to for redemption. That was the main thing. And unit banking, of course, was the real reason why we had persistent note discounts in the United States. And countries with branching did not have any such discounts. Anyway, the, so a high demand, highly reliable bank note currency, very little demand for gold, species in ordinary circulation. Scottish banks in the 1830s typically held only 1% or a little less than 2% species reserves. People never wanted specie. They wanted a good Scottish bank note, which was much more convenient. And they didn't have crises. The comparison between Scotland

and England before English, dumb English banking legislation gone. imposed on Scotland as well in the 1840s, it was notorious. That is, it was notorious that the English system was less stable than the Scottish system. On my Twitter profile, the background picture is a cartoon drawn during the 1825 panic. One side shows what's happening in the English banking system, and the other side shows what's happening in the Scottish system. And in Scotland, everything's calm, everything's fine. In England, it's total panic. And by the way, they also had laws that restricted the size of all their banks except the Bank of England. The so-called six-partner rule was in effect for that period. And that made them weak in the same way the unit banking made banks artificially

weak in the U.S. People need to study the regulatory sources of banking instability and failures. Those are always underplayed by the constructed estates who will assume that anything good that happens in money must be because the government has fixed things and anything bad must be because the government hasn't intervened, which is nonsense historically. Anyway, the other things besides, so that comparison of England and Scotland, Scotland one, hands down, similarly in the United States, comparison of the U.S. and Canada, and this is mostly after 1870, because Canada didn't have a uniform banking law until then, but we had national banks backed by government bonds, which caused all kinds of problems, our uniform currency, was uniform, but it sucked. Canada had a relatively uniform currency, some discounting of currency until the early 1890s, but had no crisis. Did banks fail? Yes, they did. Failure is pretty much part of any successful banking system, but the failure rates and the freer systems were low. The losses to the holders of banknotes and deposits tended to be low. If you look at Canadian bank failures, it's almost always the small banks that fail.

Some of them were tiny. And some of them were failing because they were run by shysters. But they're the exceptions. Most of the banks were very solid. And if any of those failed or even if smaller banks failed, often the remaining banks would gobble them up and nobody would, none of the creditors would take any losses at all. So the record's very clear on crises, very clear on confidence in the currencies, very clear on failure rates and loss rates.

And, well, what else do you want? So when people like Gordon and Zhang do their own little selective history, to be polite about it, they give a very, very, very wrong impression of what private money issuers are. are capable of. Now, I should add to all this, that most of their discussion of this is absolutely irrelevant, not just whether it's right or wrong, irrelevant to the discussion of whether we should regulate stable coins or not. And here I just want to make a point what a large part of that paper is written, as if the debate today were a debate similar to or reprising the debate in 1863, when it was, should we have a national park currency or should we stick with these state banknotes? That was the debate then. And there were arguments for having a national park currency.

I've argued that, you know, fine, introduce a national park currency, if that's the only way you can do it by having the federal government step in. But that's not an argument for wiping out the state banknotes. In fact, I've written an article about that. Today, we have a national currency. We have the fiat currency. We have insured bank currency that meets the same requirements. So nobody's talking about having stable coins become our national currency. By most definitions, most of them aren't money at all. That's not what they're trying to be.

And they're certainly not trying to replace the U.S. dollar. They're not trying to replace banks. They would be a supplementary currency, a set of currency. options for special uses, which is what they are now. So treating this all, as Gordon and Zhang do, as if we're re-debating the question of whether we want to have a uniform national currency or not, is ridiculous. It is absolutely irrelevant. All those parts of that paper should be tossed out, and the bad history should be tossed out. And as I also pointed out on Twitter, if you do that, if you were to redact all those parts of that paper covered with black ink, it would look like,

the Federal Reserve's own response to Bloomberg's Freedom of Information Act request in 2010, which is a document that was almost entirely blackened out. That's what it would look like. They wouldn't be very much left. So the way we have to decide what to do with stable coins is, I think, by not getting off on the wrong foot, as Gordon and Zhang and many others have done by talking about Wildcat banks, but by treating them as what they are. forgetting history, asking which ones are dangerous and why and deciding how to fix it and not

treating them all alike or trying to regulate by analogy, which is a bad way to regulate stuff. I find I get a kick out of, you know, a renowned monetary historian telling us to forget history, but I'll allow it. In this case, the history is a red herring because the issues are different, the assets are different. The analogies that we have been offered are unreliable, both because the old stuff has been misrepresented. At least it's been presented as typical when it isn't and so on, and because the new stuff is much more heterogeneous than it's been presented to be. So trying to make all stable coins fit into Wildcat Bank or antebellum-free bank banking as an analog,

or money market funds or anything, for that matter, is trying to jam up around Pagan to a square hole or vice versa. It's just not a good way to proceed. These things should be examined based on their current merits based on the current issues. And that's all about whether they're dangerous or not. It's got nothing to do with whether they're good money or not, let alone a good national money. You know, the reading this, I certainly didn't regret having a bit of a grounding in free banking history because it allowed me to immediately pick out the same thing you're identifying, that they're being extremely selective in their description. So I'm glad that I had looked into it.

No, no, your article on this was very helpful. It was very good article. And, of course, Nick, you introduced probably more people at once to this general topic area than any single article. might have done because you have a big audience of people who probably haven't been exposed to it. So I thought it was a very highly welcome and valuable contribution. Well, I appreciate that. I mean, mostly what I do is tell people to go read your work. So that's really hard. Yeah, well, that's more work. That's harder.

I'm a conduit. And speaking of that, I mean, as we wrap up on the free banking topic, I find it absolutely fascinating, even if the historical analogies are perhaps not as apt as some would make them or try to make them out to be. What would you, where would you recommend people go? You've written so much. Larry White's written so much. What would your chief recommendations be there in terms of getting a good, good primer on free banking?

Well, you know, I think the best thing they could do for a primer is to go to our, that is the center's online publication, which is called Altm, that's Alt-Dat. M, and that stands for alternative money, of course. And there they'll find all kinds of essays. The Altam isn't a blog, it's essays, some of which are pretty long, especially those by years truly. But there's substantive essays that fall short of being stuffy and technical like academic publications, but they're substantive, they're solid.

And you'll find an index there for different topics, one of which is free banking. and loads of stuff. So that's not a bad place to start at all. On U.S. banking and monetary history, I'm going to toot my own horn in a different way, because Alt-M is in some ways my baby as well. But I put together a bunch of my essays relevant to that history in a book that Cato published called money free and unfree. So for U.S. experience, that would be that and some of the essays on all of them would be my recommendation. I have that book right here. I think it's on my table right now. Good stuff in that. For Scotland, of course, the classic work, the seminal work is Larry White's free banking in Britain. The second edition of which is now already some years ago that it came out

in the 90s, but it's available online from the Institute of Economic Affairs. My theoretical work on free banking, the theory of free banking, which was the first book I published way back in 88, based on my dissertation, is also available online from Liberty Fund. And so there's a bunch of things that are readily available online. Of course, if you have J-Store and that sort of thing. You can find a lot more. Kevin Dowd's book The Experience of Free Banking is a good one on episodes beyond Scotland and the U.S. And we are preparing a second edition of it, at least Knock Wood, I think we are.

There's a separate podcast on that end up. But if all goes well, we should have that out sometime in the spring. So those are some of the main sources I would recommend. And, you know, I want to kind of bring this back to Hal Finney and all that because originally, I think in that, you know, free banking is not, it's not Bitcoin. It's certainly not bit. Bitcoin is a, like we said, a synthetic commodity money. It's a, it's a standard money. If it were money, it would be a standard money. It wouldn't be a bank issued IOU that's a claim to standard money. And what Finney was talking about back then and referring kindly to my work was the second layer. He saw free banking. as the second layer technology. It was the lightning of that day where that the banks would issue peer-to-peer substitutes for Bitcoin

that would be, as it were, off-chain. I think that was the context in which he was interested in my work. And so it isn't quite correct to say that he was looking at my work, or Larry's, as an inspiration, for Bitcoin itself, but rather as an inspiration or as something that a Bitcoin could plug into that would make Bitcoin more efficient. So Hal was already anticipating the the costliness of relying on Bitcoin alone as a medium of exchange in a Bitcoin standard world. He was anticipating the fact that you needed bank what banks or some kind of second layer. And he was thinking that

you know, a good old free banking system on a Bitcoin standard might, might do the trick. And I think he's right about that. Ultimately, I think Bitcoin would be a better money. Any synthetic commodity money would be a better money if it had a good free banking system that bundles with. Well, George, I'd love to have the full exploration of that topic someday. We're out of time now, but this has been absolutely, absolutely fantastic. I'm so grateful for you joining me, as I said before, you know, enormous fan of your work. I think it's very relevant to Bitcoin, but it's also just, it's been so eye-opening for me in terms of understanding how the causes of bank failures are often the presence of regulation rather than the lack thereof. That's right.

There are two things I think anybody wants to understand banking. economics needs to do and not because of the only things, but because of the most neglected things. First, understand the potential self-ordering processes at work in a system that isn't regulated heavily where the competition is the main source of regulation. Try to understand how things work. You don't have to come at it assuming that they work well, but you should try to get a grip on how things work. Only then can you understand just what regulatory interferences of different kinds are doing to the system? What is the real consequence? You need that background of a theory of free banking to understand regulation. And then the other thing is to consider in studying history

whether it's possible that problems are a result of regulation rather than of regulatory interference or intervention rather than of the inherent or tendencies of unregulated banking arrangements. Try to sort these things out. Otherwise, you end up doing what we've actually done. You heap bad regulation on top of bad regulation, on top of bad regulation, and you've just ended up with myriad regulations, most of which are unwitting attempts to fix the problems caused by preceding regulation. And it never ends. It never ends. well on that sunny note we're going to wrap up george thank you so so much it's really been a delight oh you're very welcome nick and good luck with all your efforts your good efforts on behalf of

bitcoin and uh and all that