White's free-banking thesis: A case of mistaken identity

Abstract

L awrence H. White's fascinating work entitled Free Banking in Britain: Theory, Experience, and Debate, 1800—1845 has had a not inconsiderable impact upon monetary economists. Everyone seems now to be, at the very least, aware of the issues relevant to the free banking versus central banking controversy. (Of course, White is not alone in his endeavors. See also the recent work of Rolnick and Weber,'' Rockoff, and Rothbard.) Furthermore, White's depiction of the Scottish system between the years 1695 and 1845 appears to have gone unchallenged as to its historical accuracy. This article examines several of White's key assertions, as well as several tangential ones, in light of the available historical documentation. Wherever possible, sources are quoted rather than paraphrased so as to reduce to a minimum any interpretive bias. What emerges from the process is the realization that—rather than White's model of a laissez-faire system devoid of a central bank, solidly based upon the unquestioned convertibility of notes into specie, with each bank bearing its full liquidity costs by holding its own specie reserves—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. In short, White's thesis that the Scots enjoyed free banking fails to be supported by the evidence. Parenthetically, I would like to point out that I draw these conclusions despite the fact that I am myself an advocate of free banking. White's theoretical model is elegantly stated and, furthermore, workable in the real world.