George Selgin (Cato Institute) on Stablecoins, Bitcoin, and Free Banking [TRANSCRIPT]

 

Episode Transcript

Nic Carter 0:19
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 and free banking.

George has done so much work that I’ve learned from in my Bitcoin career, it’s hard to list it 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 was this paper by Gordon Zang, 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 stablecoins 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 gonna like it too. Let’s dive in.

It’s my enormous pleasure to have George Selgin here. George is the director of the Cato center for monetary and financial alternatives. And honestly, I don’t think it’s an exaggeration to say, you know, seminal figure in the world of Bitcoin. How Finney infamously famously referenced George’s work, some people think he did so infamous, in that in that great, great early post about bitcoins development, and you know, how he 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, it’s been enormously influential to me in my own understanding. And so I’m so so happy to have you here today. So thank you for joining us.

George Selgin 2:45
Not at all. Nick, I’m very glad to be on your show last and to have you saying nice things about me to your many fans. That’s, that’s a pretty good deal.

Nic Carter 2:59
Well, I feel 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 you know, the immediate concern is this interesting debate over stable coins and free banking, of course, catalyzed by this Gorton and Zhang 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. And 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. Synthetic commodity money.

And you talk about, you’re trying to basically situate Bitcoin in the 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?

George Selgin 4:21
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 hung around for a while, and it took a couple years before it actually made it into print. It was on ssrn. But no, I think the classification and the place I put that coin in that is still valid, and it’s basically a quadrant. You have no monies that have some non-speculative non-monetary use value, as economists say, an obvious example being gold, which has got an industrial demand demand is ornamental, etc, independent of its use as money or as a hedge and that sort of thing, then you have ones that don’t have any 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 is part of a built in scarcity. inescapable scarcity is part of the regulatory mechanism. And, and the other is where there is no natural scarcity. So there has to be a scarcity contrived, through deliberate management and couldn’t limitation of the quantity. And, and the interesting thing about Bitcoin is it belongs in quadrant that previously was empty, before its introduction, and it’s the quadrant where the thing has no natural no non monetary use value or value is a hedge based on some non monetary use, and yet, it’s scarce. It’s inherently scarce and the algorithm makes it so and I should say, all algorithmic cryptocurrencies, are synthetic commodity monies, whereas some non algorithmic stable coins, for example, are more like fiat money, they have actual central managers, as it were, and others are now they’re still looking a lot more like convertible monies.

Nic Carter 6:49
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 diner? Am I getting that right?

George Selgin 7:02
The Iraqi Swiss dinar. Those were ordinary, ordinary fiat currency, printed in Switzerland, that’s where the Swiss part comes in. But they were an Iraqi currency. And they were monetized that were basically replaced with something else and the old notes, the expectation was they become worthless, 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 did remain not only a parallel currency with the newer officially rocket currency, but one has retained its value a lot better because it had a unlike the new official currency, which was a plain old fiat currency.

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 drive this stuff, the 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 extensively monetary assets that have a slight 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, is, is built into the algorithm, as opposed to the natural scarcity of a precious metal where there’s only so much in the ground, right, it actually has a positive cost to 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 they made it up in a laboratory to be scarce. And, and that scarcity is not something that you can change, right? another analogy, you can multiply these four Whatever it is, it’s like having a system a supply formula that’s cranking out a certain amount of these things, of course, every every every day, but the the once the thing is turned on, was this, this program is turned on, you throw away the key. 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 have a manipulable fiat money that where there is no real built in, in an on unconditional scarcity.

Nic Carter 10:44
So the challenge is to develop a monetary institution which is non discretionary and follow some sort of preordained kind of rule.

George Selgin 10:54
That’s right. That’s what 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 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 and fashions whatever, that could really affect their value in bullet, 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 and 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 maintain stable nominal income, because I’m of that what’s now called the monetarist 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 are perhaps a little more in the spirit of what I was looking forward to when I wrote that paper. But of course, if something’s just tied to the US dollar, obviously, it’s not going to give us a better monetary standard than the dollar. But if it stabilizing the general price level as some stable coins tried to do, maybe you could see that as an improvement, you can certainly see how such such a coin if it worked the way it was supposed to could implement Federal Reserve inflation target, right? If it works, 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 Ampleforth, you know, where you 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, 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 money. Bitcoin was the first and here we’re getting into the brass tacks, 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 gonna see a lot more and we are seeing more. And in this rivalrous market competition between alternative synthetic commodity monies. It may be some time before we really hit that jackpot. And I don’t you know, I don’t like the talk that suggests that Bitcoin is the last word and will always be because it, it kind of goes against the notion that this is an ongoing process, dynamic innovation process. And we’re only in the early stages. Right? I hope, of course, the government will allow us to continue into later stages. That’s another question.

Nic Carter 15:26
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 as a generally accepted medium of exchange. Am I getting that right?

George Selgin 15:36
Yeah, that’s kind of the standard economist’s definition.

Nic Carter 15:40
Okay. Yeah. Obviously, there’s so many definitions for money. And so many debates over that. What, 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?

George Selgin 15:59
Well, first of all, no hard and fast answer to that question will do. And we know that because if it did, we could answer it for ordinary dollar denominated assets. And we can’t, that’s why you’ve got m one, m two, you had m three, it’s still there. And I have m four and m z, and you got a million different measures, all of which draw that try to draw the line in a different place when it comes to deciding when something is only of limited acceptability, right? So there is no absolutely correct criterion for that. But 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 ends when it comes to accept liability? 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, in remittances, it’s used more in certain countries where things are going Blotto with government, it’s certainly used more among people who need some pseudonymity and value. So it has its market. And 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 been as successful as it has been as an asset. For more specialized purposes, or as a savings and investment medium.

Nic Carter 18:23
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, of, you know, payments for stable coins as opposed to Bitcoin.

George Selgin 18:37
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 you don’t have as many state you don’t have the stable coin hodlers The funny thing is a lot of Bitcoin we have plenty of Bitcoin hodlers or enthusiastic hodlers. Well, you either hodl or you spend. And if you don’t spend, you’re not using the the asset as a medium of exchange, you can’t have it both ways. So the irony is that some hodlers being Bitcoin, Maxis are the ones who have jumped 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 this stuff and hold on to it because it’s going to go up in value, its velocity would would would approach zero, and it would be even less like it would qualify even less 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.

Nic Carter 19:49
But you pointed out and this gets us to this the centerpiece of our discussion that you know, given the the gnashing of teeth we’ve seen in Washington over stable coins. It’s a little disproportionate or slightly exaggerates the influence of stable coins on the economy today, because you point out that stable coins or themselves is still a niche, medium of exchange.

George Selgin 20:12
Oh very much so, however, you’ll find that when, when critics of stable coins go at them, usually they admit that they’re doing so on a has it were a speculative basis, their concern not so much about their importance today, are they systemic risks they pose today, which are trivial. I think they’ll all admit that the better ones. But they haven’t witnessed a 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 posed, 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 diem.

Nic Carter 21:22
Diem doesn’t even exist yet!

George Selgin 21:24
Doesn’t exist. But they’re still worried about it. They’re, they have a vision of it being a great success, which, of course, begs the question, but they, the point is that they really have these, these potentially global, large scale stable coins in mind, and they don’t, they don’t care about the others and swear they sometimes write as if all stable coins operated on the same principles as a tether with the same potential for problems. And they tend to treat dm that way too. Of course, diem is is still a little bit, 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 and manage it that 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.

Nic Carter 22:22
Right. Right there. So one interesting comparison, we’re gonna we’ve seen comparisons between stable coins and free banks, which we’ll talk about before that Izabella kaminska, at 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.

George Selgin 22:46
Well, it’s very apt when it comes to tether particularly. Right, 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 is not describing tether as euro dollars or close substitutes for your euro dollars is is about right.

Nic Carter 23:13
Should that assuage policymakers the fact that your 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 the euro dollar. So why worry about it?

George Selgin 23:31
Well I don’t think that they are saying when about how first of all about whether stable coins will generally remain offshore media. And I’m not sure they’re they’re all sanguine about whether such offshore media don’t have spillover effects into domestic markets of different kinds, including the US market, of course. And finally, the there’s a 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 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, assets it has been holding. This causes trouble in any of the markets where those assets are held by other financial intermediaries and so on. This is a kind of scenario that we’re worried about. And in that scenario, scale is everything. Well, scale is a big thing. The bigger the scale, the bigger a 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 other markets because of the potential knock off effects of falling prices of the assets in question.

Nic Carter 25:50
I looked at it historically, I think, tethers max redemptions was something in the 30 to 40% range. And I want to say, late 2018. And then most recently, they’ve had redemptions of, you know, single digit percentage, but, you know, a billion dollars or so because the whole thing’s worth $60 billion.

George Selgin 26:14
Yeah. 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 on Twitter, more provocatively than anything else that, 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 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, doesn’t set off all of the alarms, for know your customer and AML and all that, but it sets some off. And, 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 tethered to runs. But it’s not 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 that what 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 in what’s that going to do to people who aren’t necessarily directly involved?

Nic Carter 27:56
So you know, one thing I see a lot of the time is like, Well, why isn’t tether holding 100% cash or, you know, very, very liquid, short term instruments, curious for your views on that, you know, whether it’s legitimate to hold longer term, longer dated, maturity instruments or things that are, you know, not quite cash but near cash.

George Selgin 28:17
Well, legitimate is a tough word, of course, it requires unpacking, and it requires that we’ll 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 master account. So in that case, of course, cash ends up in practice meaning for an outfit like tether, meaning cash equivalents, as they’re sometimes called, in tethers reports, and that’s short term Treasury securities, right? Short term, or repos, repos are another. They could also keep accounts at banks as some stable coins do that 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 their insurance, they can use brokers and spread that money out.

So there are a lot of ways for tether or any other claim based stable coin issuer, by which I mean the ones that aren’t algorithm based to, to have very liquid backing up their, their claims against them short of holding fit in some form that does that make them perfectly safe? Well, it’s a matter of degree, when you start getting into banking that consists of riskier assets, though, like commercial paper, that the regulator’s start to draw a bead on you and you need to be subject to some stricter regulation. So I 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 be talking about imposing stricter, imposing regulations upon and they might still do so.

And, but what really bothers them is the possibility that stable coins could look like stable coins could look like some of them money market funds, prime money market funds, that’s the kind that hold non treasuries and could possess 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 are worried about is that they look, it looks, yes, it looks like a prime my money market fund circa 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.

Nic Carter 32:28
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 with one of these funds, instruments, if it’s meant to trade at par, trading at a discount?

George Selgin 32:47
Well, 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 stable 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 second point, 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 no five, right? Anyway, as long as they don’t go below that, they can post they can value, the money market fund claims at par, you know, and so even though their actual assets may fall a little bit below par their 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 consumers point of view, they could treat these money fund balances to the extent that they didn’t break the buck 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 asset value that creates all kinds of complications. So that became money back. And 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 it’s breaking the bond, right, 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? But what this caused was a general run on other funds, 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 will be other funds breaking the buck. And that and and, on top of it all, all the commercial paper issuers that were relying on these funds to finance firms issuing basically IOUs that were being bought by money market funds, the demand has dried up, though the government stepped in first to guarantee the money market funds themselves. They said essentially applying insurance giving them full insurance coverage, and intervene 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. And obviously, nobody wants to repeat that. In nobody wants to see it repeated 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?

Nic Carter 37:03
That’s fascinating. That’s I didn’t know a lot of that. I guess maybe it’s just a feature of the economy that shadow banking always emerges.

George Selgin 37:12
Right? This was a big part of the shadow banking story 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 money market funds were certainly among the most important failure points in the 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. And they know what to do with because of distrust to the money Fund, which those 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, they weren’t able to earn much. And you’re subject to capital requirements and things. So you know, they were very much inclined to turn depositors away if they could. Not your 1930s style run.

Nic Carter 38:34
So we have to touch on Gordon and Zhang that was the main thing I wanted to talk about. It’s taken us a while to get there. And, you know, frankly, yourself and Larry white, and, you know, I would say many of your colleagues have done a 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, 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, laissez faire banking, typical instance of it. But unfortunately, in the in the policy debate, it seems that our policymakers only ever refer to the 1830s 1860s in the US when they’re talking about free banking. First of all, let’s just define free banking. It’s not everyone knows what it is. So maybe we’ll just start with the definition.

George Selgin 39:37
Well, the term is used in different ways. So in fairness to Gordon and Zhang and other commentators, among us 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 in all. Ultimately, some one of them tried twice. And what, 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 call 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 have to actually have the state legislature, there 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. Right? Instead, with free banking, something like ordinary incorporation laws were established for banks. And so you met certain conditions. And 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 are 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 were 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 the States. So that was us style free banking. Confusion is that ever the reason why the 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 them 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 word. And what does that mean? Well, in the European sense, it meant banking systems that were relatively free from all kinds of regulation. So not only was the entry relatively open, but there were no heavy regulatory requirements. And, and banks, were free to issue notes, they were free to branch etc, etc. They’re free to do a lot of things that the US “free banks” couldn’t do. And you had discussions of that type of genuine – Larry and I call it genuine free banking – though, was never perfectly so you had lots of debates all over Europe about it, of course, the name varied with the place.

And, and so what they meant was we’re getting 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 US. So this has been a big source of confusion. But I blame the American economists like Gorton and Zang, 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 in this particular paper, which is all too common, is to look back at that American episode, which as you noted, lasted less than 25 years. That’s all it 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, is if the rest of the world didn’t offer any evidence that was worth considering, which is ridiculous, because there’s a huge amount of evidence for other plural note issue 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, then anything that occurred in that antebellum us experience.

So by 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 US free banking systems were bad, some of them are 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 suffolk system, which operated during that whole period and earlier, was a great system with a perfectly uniform currency. It had been so since 1824. So anyway, what what they done by treating the Wildcat banks or small, 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 so well, let’s see how they did in the past with paper notes. Oh, here’s the Reichsbank 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, of cherry picking. But what’s sad about it, and tragic about it is too many people know too little history outside of us 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 i one reason why I’m so annoyed by that paper is that Gorton certainly knows. And I think Jeff Zhang knows that there were these other systems that they are cherry picking they know better, they certainly should know better. But Gorton 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 Gorton, 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 mayor culpa. But with a free market culpa.

Nic Carter
Right.

George Selgin
Yeah, his own research. earlier than that, simply doesn’t justify some of the generalizations he’s been making since

Nic Carter
And to specifically drill into why and I know, it’s heterogeneous based on the state, why the 1830s 1360s why banks did fail at a relatively high rate, I think I saw you write somewhere that it was in the 200 range, maybe bank failures, if I’m not misremembering-

George Selgin
I couldn’t tell you the number. There were certainly more bank failures than that, if you add up all the failures, 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 an early 30s, you get the big, big numbers of bank failure. We never solved that problem. And, and to some extent, the underlying causes, were ones that have 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 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 that couldn’t diversify. They had no branches, so that all their assets and liabilities were confined to one relatively small geographic area that couldn’t diversify their balance sheets that made them very, very exposed made them tiny. First of all, how much capital can you put into a bank that can only lend in a small area, and it made them highly vulnerable to local shocks.

Unit banking was a massive cause of bank failures. If you if you looked at branch bank countries with branch banking like Canada to the north, where they could branch out across the country, even though they were having 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 us free banking laws that can’t be emphasized too much, is that all free banking laws, prohibited branching. So every so called us free bank was a unit bank. And by virtue of that fact alone, was weak. Bottom athletically, legislatively, not free market, but legislatively weak, it’s like the law says you have to be weak by Gosh.

Nic Carter
So just to click on that for a second. The intuition there is if you’re confined to a specific geographic region, you’re giving loans to a homogenous set of depositors.

George Selgin
Maybe you’re 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.

Nic Carter
Right. So the restriction on branching just prevents you from engaging in effectively diversification. And yeah, and makes you fragile.

George Selgin
It would be like telling a stable coin issuer that wants to back its money with commercial paper, okay, but only do it, you know, you can only have commercial paper issued by firms headquartered in this, you know, space with a 50 mile radius

Nic Carter
So that was one, restriction on branching very material. And then the other thing is, the states forced the banks to hold their their bonds.

George Selgin
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, 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, 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 legislature’s 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, wasn’t Wildcat banking. It wasn’t even the inherent lack of diversity of the balance sheets that that did the banks, and it was the fact that they were holding required collateral bonds, that turned out to fall a lot in value. And by the way, that this story is a little bit misleading in the 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 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 impose that restriction on on banks and free banking states, those banks would have done better as well.

Nic Carter
And I know we’re, running up on time here. But I mean, just to contrast, the the US experience with you know, what you call genuine free banking in places like Scotland or there’s other European instances in Canada,

George Selgin
Canada, which in ways is a nicer comparison, because it has a lot in common with the US. It’s again, the same specie, gold base dollar.

Nic Carter
So it’s a good kind of counterfactual example, I suppose like what what are the what were the practical Consequences of those systems and what did they look like?

George Selgin
Well, first of all, the confidence in in banknotes 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 1000s of them like they were in the US. 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 1000s. 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 Gorton and Zhang’s assertion that that can’t possibly be if all the banks have different assets. And par circulation was obviously achieved as well and much earlier in smaller countries because it was less geographically drat challenging to keep notes at par. And notes traded at par based on arbitrage basically getting them back to their sources and demanding payment.

That’s what kept them at par and nothing for the most part, it had nothing to do with where what the weather the assets were heterogeneous or not, if the assets were no good, the bank failed that was all there was to it. If not, then those tended to be current, it minus whatever costs 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 discount. Anyway.

The highly reliable banknote currency very little demand for gold or specie in ordinary circulation. Scottish banks in the 1830s typically held only 1% or less than 2% specie reserves, they’d never people never wanted specie, they wanted a good Scottish banknote, which was much more convenient. And they didn’t have crises. Scotland, the comparison between Scotland and England dumb English banking legislation got imposed on Scotland as well in the 1840s. It was notorious that was notorious of 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 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 in England, its total 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 that unit banking made banks artificially weak in the US people need to study the regulatory sources of banking instability and failures, those are always under played by the constructed a status to 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.

The other things besides up so that comparison of England and Scotland, Scotland one hands down similarly, in the United States comparison of the US 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 are 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 bank notes 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 are tiny. And some of them were failing because they were run by shysters. But, 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 other creditors would take any losses at all. So the record is very clear on crises, very clear on confidence in the currency. He’s very clear on failure rates and loss rates. And, and and well, what else do you want? Right? So when people like Gorton 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 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, right, relevant to the discussion of whether we should regulate stable coins are 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 the state banknotes, that was the debate then. And there were arguments for having a national par currency the but 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 stepped 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 Fed fiat currency, we have insured bank currency that meets the same requirements. So nobody’s talking about having stable coins become our national currency that their most definitions, most of them aren’t money in at all. That’s not what they’re trying to be. They’re certainly not trying to replace the US 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 Gorton and Zhang do is 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 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, the Freedom of Information Act request in 2010, which is a document that was almost entirely blacked up. 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 Zang 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, and why and deciding how to fix it and not treating them all alike, or are trying to regulate by analogy, which is a bad way to regulate stuff.

Nic Carter
I get a kick out of a renowned monetary historian telling us to forget history, but I’ll allow it.

George Selgin
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 that 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 corn spit into wild cat bank or antebellum free bank. Banking as a analog, or money market funds or anything for that matter is trying to jam a round peg into 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 make their good money or a good national money.

Nic Carter
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 what 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.

George Selgin
No, no, your article on this was very helpful. It was very good article. And, of course, Nic, you introduced to 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 I thought it was a very highly welcome and valuable contribution.

Nic Carter
Well, I appreciate that. Most of what I do is tell people to go read your work.

George Selgin
Well that’s more work.

Nic Carter
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 what would your your chief recommendations be there in terms of getting a good, good primer on free banking?

George Selgin
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 Alt m, that’s alt-M. And that stands for alternative money, of course. And there, they’ll find all kinds of essays. This is all time isn’t a blog, it’s essays, some of which are pretty long, especially those by yours truly. But they’re 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 us, banking and monetary history. I am going to toot my own horn in a different way, because alternate 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 us experience that be that and some of the essays on all 10 would be my recommendation.

Nic Carter
I probably, I have that back right here. I think it’s on my table right now.

George Selgin
For Scotland. Of course, the 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 as that are readily available online. Of course, if you have jstor, and that sort of thing, you can find a lot more. Kevin Dowd book, the experience of free banking is a good one on episodes beyond Scotland and the US. 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 in the you know, I want to kind of bring this back to health any and all that because originally, I think, in that free banking is not it’s not Bitcoin, it’s certainly not but Bitcoin is a, like we said as 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 of technology. It was the lightning of that day where that the banks would issue a 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 that’s right, it didn’t quite correct to say that that he was looking at my work or Larry’s as an inspiration for Bitcoin itself, but rather as an inspiration or as a as something that a Bitcoin could plug into, that would make Bitcoin more efficient. So how was already anticipating 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 and I think he’s right about that. Ultimately, I think Bitcoin would be a better money any any synthetic commodity monies that would be better money if it had a good free banking system that bundled with

Nic Carter
Well, George I I’d love to have the full exploration of that topic someday. We’ve 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.

George Selgin
That’s right.  I think anybody who 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 whether 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 their real consequence, you need that background of the theory of free banking, to understand regulation. And then the other thing is to consider in studying history, what whether it’s possible that problems are a result of regulation rather than a regulatory interference of 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 big problems caused by preceeding regulation. And it never ends. It never ends.

Nic Carter
Well, on that sunny note, we’re gonna wrap up George, thank you so so much, it’s really been a delight.

George Selgin
Oh, you’re very welcome, Nic and good luck with all your efforts, your good efforts on behalf of Bitcoin and and all that.