ABSTRACT
This chapter attempts to compare the framework provided by free banking to the institutions of the United States National Banking System. It offers an explanation for the financial panics that struck the system in 1893 and 1907 and make some observations concerning the succeeding reform debate and the origins of the Federal Reserve System. To understand why currency shortages and financial panics were recurring problems in the National Banking System, it is necessary to review the relevant legal restrictions it imposed and examine some of their unintended consequences. The legislation that formed the National Banking System included three broad categories of restrictions: bond-collateral requirements, reserve requirements, and limits on branching. The bond-collateral requirements created a difficulty regarding the profit incentives facing national banks. Under the National Banking System, the bond-collateral requirements raised the cost of accommodating changes in the public’s currency-to-deposit ratio, leading to currency shortages.
