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In the second half of the nineteenth century, the Chilean free banking system worked similarly to how Adam Smith describes the eighteenth-century free banking system in Scotland. The characteristics of free banking that Smith identifies as conductive of successful outcomes—free entry, unlimited liability, and convertibility on demand—are present in both Scotland and Chile. And the Chilean system failed for similar reasons to the worries Smith had about the Scottish system: inconvertibility, legal tender, involvement with government borrowing, and lobbying. The Chilean experience of free banking appears to follow Smith's account of free banking. [ABSTRACT FROM AUTHOR]

The article focuses on monetary economics, the views of Henry Meulen, and banking history in Scotland and Great Britain. The free banking system in Scotland promoted competition and innovation, bank stability when bank failures were common in England, abolition of the fixed price of gold, and the use of discount bills. Legal restrictions, including the suppression of Scottish free banking, Meulen's theory of credit, a paper exchange medium issued by private bankers, credit tokens, and option-clause notes--which protected banks from undue demand on gold because they could not be redeemed immediately--are mentioned. The 1844 Bank Charter Act gave the Bank of England a monopoly on note issues, banned gold-reserve substitutes, and required total coverage of notes.

The article comments on the use of Scottish banking experience as counter-evidence to the legal restrictions theory of money. The article analyzes the work of Tyler Cown and Randall Kroszner, who are critical of some of the interpretations of Scottish banking. It is explained that Scottish banking is viewed as a regulatory regime approximated laissez-faire closely enough that its institutions, practices, and performance were basically those of an unregulated free-market monetary system. Crown and Kroszner argue that the Scottish regime did not closely enough approximate laissez-faire to provide evidence damaging to the legal restrictions theory.

The option clause is a contractual device from free banking experiences meant to prevent banknote redemption duels. It has been used within the Diamond and Dybvig (J Pol Econ 91: 401-419, 1983) framework to suggest that very simple contractual solutions can act as an alternative to deposit insurance. This literature has, however, been ambiguous on whether the option clause can replace deposit insurance outside of those two contexts. It will be argued that the theoretical clause does not generally affect the likelihood that a solvent bank goes bankrupt because of a bank run, as empirical evidence suggests it is already near null, and that the exercise of the clause will have the effect of diminishing the size of creditor claims on bank assets because it exacerbates the agency problem of bank debt. It will therefore be argued that the clause is only desirable in (a) free banking systems that are historically devoid of bank runs in the first place and have other means of managing debt-related agency problems and (b) under the unrealistic assumption that bank runs are self-fulfilling prophecies. It will be argued that the agency problem of bank debt makes the option clause undesirable outside of free banking systems. [ABSTRACT FROM AUTHOR]

Comments on Larry Sechrest's perspective on Scottish free banking. Relative failure rate between English and Scottish banks; Convertibility issue; Scottish banking system's departure from the theoretical ideal of a laissez-faire banking system.

Discusses some of the reasons for the skepticism on Lawrence H. White's work on Scottish free banking of the period 1765 to 1845. High bank failure rates; Note invertibility; Restrictions on small-denomination notes; Usury Law as a constraint on competition; Privileges of the chartered banks.

Examines the practice of free banking in Scotland from 1695-1845. Competitiveness of the Scottish banking system; Concentration of banks' note issue in 1845; Pseudo central banking functions of the Bank of Scotland and the Royal Bank of Scotland.