Banking on What We Know That Ain’t So

by Don Boudreaux on January 11, 2012

in History, Monetary Policy, Myths and Fallacies

Here’s a letter to USA Today:

Dismissing Ron Paul’s case against the Fed, you write “the Fed was created a century ago after the fifth banking crisis in just 34 years made clear that a rapidly industrializing nation couldn’t get by with the kind of loosely knit banking system that it had when the economy was mostly agrarian” (“Ron Paul’s 19th century economic ideas,” Jan. 11).

That’s the potted history.  The actual history is far more favorable to Mr. Paul’s case.

Nineteenth-century banks were hardly laissez-faire institutions.  Government saddled them with restrictions and requirements that kept the U.S. banking system artificially “loosely knit” and subject to unnecessary risks – for example, restrictions on branch banking, and requirements that banks hold poor-quality state and local bonds as collateral for their note-issues.

Nevertheless, even with this government meddling, the U.S. banking system performed better before the Fed’s creation than it has since.  Economists George Selgin and William Lastrapes, along with my colleague Lawrence H. White, recently examined U.S. banking history and concluded that “The Fed’s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed‘s establishment.  (2) While the Fed‘s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I.”*

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030

* “Has the Fed Been a Failure?

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