Quarterly Journal of Austrian Economics

Volume 13, Number 4 (Winter 2010)

We explore several unaddressed issues in George Selgin’s (1988) claim that the best monetary system to maintain monetary equilibrium is a fractional reserve free banking one. The claim that adverse clearing balances would limit credit expansion in a fractional reserve free banking system is more troublesome than previously reckoned. Both lengthened clearing periods and interbank agreements render credit expansion unrestrained. “The theory of free banking” confuses increases in money held with increases in real savings, resulting in exacerbated economic cycles when fiduciary media is issued equally under both scenarios. Most troubling, these economic cycles generated by the free banking system breed an incentive to create a  coordinating agent serving as a lender of last resort. The central bank is demonstrated to be a natural, if not unavoidable outgrowth of the fractional reserve free banking system.