Free Banking Era Note Issue

Forums: Economics
Email this Topic • Print this Page

During the free banking era banks could issue notes that were redeemable on demand for specie. When a bank made a loan they would do so by issuing notes. My question is, why wouldn't the person who was issued these notes not immediately turn around and redeem them for specie. This would eliminate their exposure to discounting. I understand why they would be accepted once in circulation, but not how they would ever make it past the original holder. It seems like it would make no sense to take notes over specie as the initial receiver of the loan.

Same goes for deposits. If I deposited specie and wanted to make a withdrawal, why would I ever keep notes? It would make sense to immediately redeem the notes. Notes offer no additional protection against robbery and are less durable. Also, notes always run a risk of devaluation or complete failure.

Topic Stats
Top Replies
Link to this Topic

Type: Question • Score: 0 • Views: 441 • Replies: 5

No top replies

@blitz459,

Specie (typically gold or silver coins) are heavy, and issued in denominations whose size is limited because it is proportional to the amount of metal physically present.

Banknotes are lightweight, can be issued in arbitrarily large denominations by private commercial banks, and are easily secreted on one's person or among one's effects, which makes them less subject to robbery.

1 Reply

@puzzledperson,

True, but a simplification of Gresham's Law does say that "bad money drives good money out". Those banks want to hang onto all the 'good' money they can get.

1 Reply

@roger,

Your original question asked why someone to whom a banknote was issued would hang on to it instead of instantly redeeming it for specie.

If you want to know what banks got out of it, the answer is the ability to make more loans, hence more profits from interest payments by borrowers.

Banks issued loans in the form of banknotes, not specie. Because they assumed that not everyone who held their banknotes would attempt to redeem them for specie simultaneously, they could issue more loans (banknotes) than they possessed in gold or silver coins (specie) or other reserves.

1 Reply

@puzzledperson,

Yes. At this point, I would like to point out that I didn't have a question, whether original or follow on. The citation of Gresham's Law was an interesting side note, or so I thought.

1 Reply

@roger,

My apologies Roger, I somehow gained the erroneous impression that you were the originator.

I think Gresham's law properly applies to specie debasement (e.g. mixing with base metals) by governments.

But if you're suggesting that banks of the period hoarded gold you are probably right. In any case I suggest you make your point more explicitly so that it can be discussed and elaborated.

0 Replies

Free Banking Era Note Issue

Related Topics

Quick Links

My Account

able2know