Friday, October 31, 2008

Let Them Fail

My editorial is now up on the ARI/ARC site.

Update: The editorial was picked up by:
Austin Business Journal
The Daily Citizen (Georgia)
Enter Stage Right
News-Democrat & Leader (Kentucky)
Northwest Arkansas Times
Babylon Beacon, Massapequa Post, Amityville Record, Long Island
Journal Gazette (Fort Wayne Indiana)
Press of Atlantic City
The Journal (college newspaper of Webster University in St. Louis)
American Chronicle
Colorado Springs Business Journal


Blogger Paul Blair said...

I don't know much about U.S. banks between 1870 and 1913, but I do know something about the era of so-called "wildcat banking" from 1816-1863. As Wikipedia mentions, "This era, commonly referred to as free banking, was not a period of true free banking as banks were only free of Federal regulation. Banking was left to the states to regulate. The actual regulation of banking during this period was quite varied state to state."

The banks of New England at that time were some of the freest banks that ever existed in history. They were also the most stable, even to the extent of absorbing business cycles from regulated banks in neighboring states. On this, see the article "Free Banking," in Business Cycles and Depressions: An Encyclopedia. I plan on posting on the web a more extensive study of these banks, made by the 19th century French economist Charles Coquelin. I'm hoping to have the translation complete within the next few weeks; it will be available here.

The big injustice is that the banks of that era are all tarred with the same brush; the free banks are blamed for the instability of the banks under state regulation.

What happened after 1863? The passage of the National Bank Act of 1863, according to Wikipedia, "established a system of national charters for banks. It encouraged development of a national currency based on bank holdings of U.S. Treasury securities. It also established the Office of the Comptroller of the Currency (OCC) as part of the Department of the Treasury. This was to establish a national security holding body for the existence of the monetary policy of the state. The Act, together with Abraham Lincoln's issuance of 'greenbacks,' raised money for the federal government in the American Civil War by enticing banks to buy federal bonds and taxed state bonds out of existence. The law proved defective and was replaced by the National Bank Act of 1864."

"A later act, passed on March 3, 1865, imposed a tax of 10% on the notes of State banks to take effect on July 1, 1866. The tax effectively forced all non-federal currency from circulation and increased the number of national banks to 1,644 by October 1866."

Let it not be said that that period was one in which banks were free and unregulated.

5:41 AM  
Blogger Burgess Laughlin said...

The article is very well written. Its structure funnels the reader along to the end, where the point is made that radical deregulation is needed. It sweeps through more than a hundred years of history and stops in the present. It provides an easy to understand and easy to remember analogy to "managing" forests. The alternatives are: Laissez-faire leading to progress vs. "management" leading to conflagrations.

Thank you for an inspiring example of intellectual activism.

11:45 AM  
Blogger Paul Hsieh said...

Thanks again for another outstanding OpEd. Like Burgess, I thought the forest fire analogy was a great way to concretize the abstract economic issue for folks without much formal education in economics.

I hope your piece gets a wide circulation!

3:02 PM  
Blogger Galileo Blogs said...

Nice piece, Amit. "Let them fail," is the capitalist version of the monarchical "Let them eat cake." The difference is that the capitalist version is the moral one.

Paul Blair,
You should read "Breaking the Banks" by Richard Salsman. He provides a great history of the free banking era, with lots of supporting data. He demonstrates that free banking nationally (not just New England) had pretty good results, better than the post-1913 Federal Reserve era. He also makes clear how free banking was not truly free. Various limits did exist, the most egregious being state limits on branch banking. Such limits contributed to the severity of bank failures later on during the Great Depression.

Despite the limits on free banking, the results were generally good, according to Salsman.

5:47 PM  
Blogger Amit Ghate said...

First off, thanks for the support everyone!

To Paul Blair, I think that translation would be very valuable as there doesn't seem to be much readily available data on that period. Please feel free to post here when it's up.

However, the argument I always hear (both in the stock discussion rooms/boards that I frequent, and in the financial media) is from the time immediately prior to the Fed 1865-1913 or 1870-1913, which is why I chose to address that period. There's of course much more that could and should be said, but 750 words is a surprisingly small number to get a substantive point across.

Burgess and Paul, thanks for the comments on the article -- after looking at it so many times while editing, I lost all perspective on it. It's nice to see that people actually got out of it what I was intending (basically to argue that (a) business failures are a normal and necessary part of capitalism and (b) there's nothing special about banks that excludes them from this principle). It's only one small point in the whole battle, but I figure if we all just keep chipping away, we may have some impact.

5:52 PM  
Blogger Burgess Laughlin said...

Amit et al,

I would like to make a minor suggestion that might be useful to clever intellectual activists who are speakers or writers--if it pans out.

Doesn't "Laissez faire!" mean "Let them act!"? And isn't "Let them act!" the general case that subsumes "Let them fail!"?

Would "Let them fail!" be "Laissez faillir!" in French?

If so, possibly, at some point in a speech or essay, "Laissez faillir!" might be an amusing segue into "Laissez faire!".

4:01 AM  
Blogger Paul Blair said...


I'll post here when the translation is up. I wasn't intending to be critical of your piece, which I liked; however, since I know a bit about pre-Fed banking I thought you might like some details. The existence and nature of banking regulations in the 19th century are often misrepresented so as to blame freedom for what is actually the result of regulations--which are often simply assumed not to exist.

With regard to galileo_blogs' comment that the "free banking" of the period was not truly free, that depends on which state one is talking about. My research on this topic is not extensive, but I believe that only New York and Rhode Island adopted specific legislation against branch banking; Massachussetts had none. (However, Massachussetts did impose a 1% tax on bank capital, so its banks were not free in that regard.)

You can see here my translation of Coquelin's article on the New York system of so-called "free banking," which was actually an early experiment in deposit insurance. And, not surprisingly, a failure. Here again, the term "free banking" got applied to this regulated system, while the much freer banks in other states got ignored.

I purchased Richard Salsman's book long ago; time to get it out again.

7:31 AM  
Blogger Michael Labeit said...

The crucial idea, I think, pushed in the editorial is that the phenomenon of risk encourages rationality, innovation, and efficiency. The free-market creates an environment where survival is linked with economic performance. The problem occurs when the government severs the link between one's performance and one's survival, encouraging the perversion of incentives and the incursion of irrational risk. People for some reason believe government involvement reduces risk, unfortunately.

1:12 PM  
Blogger Michael Neibel said...

Congrats on having your essay picked up by those other publications!

3:42 PM  
Blogger Amit Ghate said...

Thanks Mike!

1:44 PM  
Blogger Paul Blair said...

I mentioned that I would post here when the translation of Coquelin's article on free banking in New England was complete. It's now up on the web; see the article "The Banks of the United States" linked to here.

2:13 PM  

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