Haud Yer Wheesht! Important Lessons From Scotland's Banking History

Iceland’s Kitchenware Revolution of 2008-2009 was in response to their 2008 financial crisis, leading to constitutional reform efforts in 2010-2013 (which ultimately failed)¹. An important lesson was learned by one of the random citizens selected to write the Constitutional Council’s proposal, the basis of the new draft constitution. Citizens exerted a tremendous effort positioning themselves to make changes to their government, but she wished they had spent much more time thinking about what to do once they got in the position. In that spirit, we entertain the following: can gold and silver, reinstated as circulating money, work, again? Would the answer differ if currency is or is not issued by private entities or central banks? Can economic booms and busts be avoided? What about financial or banking crises? Got the answer? As the Scottish say, “Haud yer wheesht!” (Meaning: to hold your tongue or shush.) History may beg to differ.

Scotland’s Free Banking Success

Theoretically, market forces should be sufficient to self-regulate the banking industry in a sound monetary system. In this scenario, credit was issued only by private banks. Credit was a promise to pay some “Thing” of value, gold, unlike today where credit is a promise for credit itself (i.e., Federal Reserve Notes). The market had confidence to use said credit (currency) as a money if the banks keep adequate gold reserves.

Thomas Sowell, a well-known economist, professor of economics, and author, was originally a Marxist whose studies under Milton Friedman did not convert him into a capitalist. Sowell’s eventual conversion to capitalism resulted from his use of critical thinking². He recognized that economic theories abound and the best way to verify which are consistent with reality is simply to examine history. His observations ended up converting him into a free market capitalist. So, we turn to the research of George Selgin, who looked for examples in history where financial stability existed without central banks.^3,4

Scotland had a stable financial system (free of financial panics), coincidentally starting shortly before the birth of the United States of America and lasting nearly 50 years beyond the end of the American Civil War. Unfortunately, England, the several States, and the United States of America did not learn from Scotland’s success. During a similar period, the several States and the United States of America had panics in 1792, 1812, 1819, 1837, 1839, 1857, 1861, 1873, 1893, and 1907.

In Scotland, private banks issued private notes that circulated as money; the banks were self-regulating and competed against one another. The most effective incentive against excessive risk taking was that each bank exerted pressure on the other by receiving each others’ notes while transacting their daily business in conjunction with actively presenting the notes for collection, i.e., redemption for gold. To honor its obligations, this required each bank to manage its credit to preserve its gold reserves, or be insolvent.

Another reason Scotland’s system worked was the lack of a bailout to save the Ayr Bank. Ayr Bank had attempted and achieved becoming the largest bank in Scotland; but in reaching that goal it was overly aggressive, overextending credit. It ultimately could not honor its notes when presented for collection by other competing banks, and failed. There was no “too big to fail” bailout. The experience was a powerful deterrent against other banks taking excessive risk; it enabled Scotland to enjoy over a century of successful free banking.

Selgin notes that a benefit to the self-regulation of privately issued bank notes was that it tended to stabilize the amount of spending in the economy. If spending declined, banks could issue more notes as fewer notes were being presented for collection; in contrast, if spending increased, banks would remove notes from circulation to maintain an appropriate level of reserves. The overall effect was lending policies among the independent private banks that affected each other, causing corrections in the extent of credit issued and leading to well-maintained levels of reserves. In short, Scotland’s self-regulation led to diminished boom-and-bust economic cycles and a panic-free financial system.

Lessons from History: Unfree Banking

Many people hold the belief that a uniform currency and a central bank would be a better system. Thomas Sowell might disagree after reviewing history. “[W]ith the government you have surrogate decision makers and they cannot possibly know as much as the individuals whose personal decisions have been preempted.” What outcomes occurred after surrogates provided assistance in England, the several States of the Union, and then the United States of America?

History and Selgin remind us that England’s and other early central banks’ monopoly on currency was destabilizing. England’s central bank notes became reserves; the total reserves effectively became the amount of gold plus the central bank’s notes. As the central bank increasingly issued notes, excessive credit resulted. Overextended, redemption of central bank notes led to significant reduction of its gold reserves, causing it to contract credit to stay solvent, placing stress on the reserves of other English banks, leading to financial instability and economic crisis.³

Scotland’s free-banking system, in place at the time of the crisis caused by England’s central bank, escaped this turmoil, despite being on the same British pound unit. Monopoly in currency supply was not a cure but a cause for financial instability. Canada, Sweden, Switzerland, and Scotland enjoyed success without monopoly currencies in the 1800s, despite all being fractional reserve banking systems.⁴

American Banking

American banking devolved; it was not a free banking system. Approximately 1,500 state-chartered banks issued private notes, circulating as currency – some exchanging at par (one silver dollar for a one-dollar note) if issuing banks were in close proximity, some discounted to varying degrees (less than one silver dollar for a one-dollar note), or outright refused due to concerns of insolvency of the issuing bank.

Various legislations in the several States influenced the banking system; the freedom to discount notes provided some deterrent to excessive credit. Nineteen of the twenty-six states and two of three territories issued bonds and incurred state debt. States’ laws often required their bonds to be used as state bank reserves instead of gold or silver. States often collected taxes in private bank notes, increasing note demand and consequently demand for State Treasury securities. Excessive state borrowing for massive improvement projects (e.g., canals, railroads, etc.) followed. Ultimately the effect of England’s central bank was replicated within many States. Eight States and the Florida territory defaulted on debt in the early 1840s, shortly after the Panic of 1837. The primary issue, again, being expansion of reserves (state bonds).

Ultimately, state bank note issuance ended with Congress’ 10-percent tax on them. Congress replicated to a large extent the States’ legislations – chartering National Banks, authorizing currency to be issued by each with reserves being United States debt, and created demand for the non-uniform national banks’ currency by accepting them for payment of dues and taxes. Massive credit expansion occurred. Post Civil War surpluses led to Congress to paying-off more than 50 percent of its debt, reducing the National Banks’ reserves. Credit contraction followed, leading to financial crisis and panics.

The state banking systems had established a quasi-central banking effect in each of most States and federal territories. Why expect a different outcome after replacing them with a single larger quasi-central bank in the disguise of a national banking system? Monetization of debt and expansion of “base money” beyond gold and silver with reserve requirements of government debt were the primary cause of financial instability. Congress completed the currency monopoly with the creation of the Federal Reserve in 1913, and two decades later eliminated commodity money altogether from circulation. Bank reserves in the United States are now FRNs, i.e., reserves are not money but credit for nothing of intrinsic value. “A nod's as guid as a wink tae a blind horse.” (meaning, a small hint is enough to convey what I want). Like granddaughter, like daughter, like mother (Congress, the several States, England).

Risk-Taking Is a Right

A sound monetary system does not prevent private actors from taking risk, nor should it. Risk-taking by private people is a right; this is an essential part of liberty and property rights – the right to make your own decisions and to do what you wish with your property (provided that you do not infringe on others’ rights).

Fractional reserve banking, while a complicating factor, is not the root cause of financial crises; as history has shown, risk taking is involved, but improper, ineffective, and destructive government regulations are primarily to blame. Taking risk and having a poor understanding of risk is not illegal. Consuming alcohol is legal; when consumed in excess and for long periods of time, it is destructive. What we need are “friends who don’t let friends drink and drive” (self-regulation), not police arresting us for a DUI and courts mandating counseling after getting in an accident (bailouts) – at that point, the damage is already done.

Choice of Money or Currency Is a Constitutionally Protected Right

In transactions between private parties, choosing to use actual money (gold and silver) or currency (paper money, whether fiat or bills of credit redeemable for money, or cryptocurrency) is also a right. When parties chose to receive currency (credit), whether a private bank note or a United States Note (greenback), they took a risk that the note denominated in “dollars” might not be redeemed for gold and silver coin “dollars.”

In contrast, in America, State and federal governments are constitutionally constrained to pay debt in what is known as legal tender. Legal tender for State governments constitutionally is gold and silver per Article I, Section 10, Clause 1 (A1S10C1), “No State shall … make any Thing but gold and silver Coin a Tender in Payment of Debts”⁵. In contrast, the next Clause states that “No State shall, without the Consent of Congress, …”. A1S10C1 is clearly an absolute prohibition and a duty to make gold and silver legal tender. The Supreme Court has held numerous times that private parties may waive the right to government debt payments to them in gold and silver, accepting some other “Thing” such as private bank notes⁵.

Do you waive your right to constitutional money and accept FRNs? Will you wait for government to reinstate constitutional money on your behalf or will you exercise your right and demand the several States to uphold A1S10C1? Will you heed Iceland and emulate Thomas Sowell, or will you “wing it” when the time arrives?⁶ “Fools look to tomorrow. Wise men use tonight.” Make the best of your time now; do not procrastinate. Only by taking action will you succeed.

Visit TheStateRemedy.com to read more about protecting our wealth, restoring comity to all, and saving our republic for future generations.

Footnotes:

1 Pots, Pans and Other Solutions, documentary movie, 20 June 2012, Miguel Marques, Yolanda Rienderhoff, Pedro Bruno Carreira and LIGHTS ON(E); YouTube.com/watch?v=JGwMIlpgR2A, full movie is under two hours, YouTube.com/watch?v=gTKre-ez1-w (trailer: YouTube.com/watch?v=YlKP5zMXPEE)

2 Thomas Sowell on the Myths of Economic Inequality, Hoover Institution, interview, 15 Nov 2018, YouTube.com/watch?v=mS5WYp5xmvI

3 Financial Stability Without Central Banks, Institute of Economic Affairs, Mathieu Bédard, Kevin Dowd and George Selgin, February 16, 2018. Available (free) at SSRN.com/abstract=3853687

4 Money Free and Unfree, George Seglin, Cato Institute, 2017.

5 Gwin v. Breedlove, 43 U.S. 29 (1844)

6 The Dynamics of Revolution and Civil War, Michael Vlahos, RPI Conference 2023; SoundCloud.com/ron-paul-liberty-report; released 28 Oct 2023 on the Ron Paul Liberty Report podcast.