Krugman’s Mythology of U.S. Banking History
By Carl Close • Tuesday May 15, 2012 10:32 AM PDT • 5 Comments
Do the banking panics of the late 19th century prove that a safe and sound financial system requires government oversight of banks? Paul Krugman (and most every pundit) seems to think so. In his New York Times column of May 13, he writes: “Current right-wing mythology has it that bad banking is always the result of government intervention, whether from the Federal Reserve or meddling liberals in Congress. In fact, however, Gilded Age America—a land with minimal government and no Fed—was subject to panics roughly once every six years.”
That volatility would seem like a slam dunk for Team Krugman—except for one thing: the banks of that era did, in fact, face onerous government regulations that weakened the safety and soundness of the financial system. Krugman has picked an example that undermines his case; the Nobel laureate in economics and celebrated commentator has misread U.S. banking history.
As Steven Horwitz notes at Coordination Problem, banks were not allowed to operate branches across state lines, and this prohibition of interstate banking hindered their ability to diversify their portfolios and made them prone to panics. Moreover, federally chartered banks were required to back their currency with government bonds; this regulation made it too costly for them to respond to increases in the demand for money by issuing more bank notes, which in turn led to currency shortages and financial crises, such as the disastrous Panic of 1907.
Horwitz continues:
But Krugman has a much bigger puzzle to explain away: if free markets in banking are the problem, why did Canada, which, during this period, had a far less regulated banking system than the US, not experience the panics we did, and why did no Canadian banks fail during the Great Depression while around 9000 US banks did? If Krugman’s criticism of the “mythology” is correct, the Canadian banking system of that era should have been a basket case, but instead it was a model for the world precisely because it lacked the two most damaging government regulations present in the US. Canadian banks have always been free to operate nationwide and were, before 1934, able to issue their own currency free of bond collateral requirements. The very free market in Canadian banking dramatically out-performed the much more regulated US system.
So Professor Krugman, what say you? If the reason banks fail is because free markets in banking don’t work, how do you explain the lack of the problems you claim plague free markets in the much less regulated pre-1934 Canadian banking industry? The mythology, Professor, is your history, not mine.
Well said.
Tags: American History, Federal Reserve, Free Market, Money and Banking, Regulation 
It should also be pointed out that Chistina Romer has published research that shows the pre-Depression era economic swings were a factor of more primative statistical methods instead of structural factors, and that the post-WWII economy has been just as chaotic when using the old methods with the new data.
j.d. | May 15, 2012 | Reply
When do you think Paul will be making his response? Really looking forward to it.
WikiProtest | May 15, 2012 | Reply
Re j.d.’s comment:
In his March 21, 2012, post at Freebanking.org, George Selgin critiques the first installment of Fed Chairman Ben Bernanke’s recent lectures at George Washington University. Selgin writes: “Bernanke’s claim that output was more volatile under the gold standard than it has been in recent decades is equally unsound. True: some old statistics support it; but those have been overturned by Christina Romer’s more recent estimates, which show the standard deviation of real GNP since World War II to be only slightly lower than that for the pre-Fed period. (For a detailed and up-to-date comparison of pre-1914 and post-1945 U.S. economic volatility see my, Bill Lastrapes, and Larry White’s forthcoming Journal of Macroeconomics paper, ‘Has the Fed Been a Failure?’).”
The links to those articles didn’t survive my pasting, but you can find the articles here:
“Has the Fed Been a Failure?” by George A. Selgin, William D. Lastrapes and Lawrence H. White, CATO WORKING PAPER NO. 2 (Nov. 9, 2010)
http://www.cato.org/publications/working-paper/has-fed-been-failure
“The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869-1908,” by Christina D. Romer, JOURNAL OF POLITICAL ECONOMY 97:11 (1989)
http://www.jstor.org/discover/10.2307/1831054?uid=3739560&uid=2&uid=4&uid=3739256&sid=56176676813
Carl Close | May 15, 2012 | Reply
Those who wish to know weather or not the fed has been a failure or not should read both Ron Paul’s END THE FED and G.Edward Griffin’s The Creature from Jekyll Island.Each chapter has a great summary at the end.apparently neither Obama nor Mitt Romney thought so because Obama reappointed Ben Bernanke to head the Federal Reserve while in a Republican debate when asked what would he do about the Federal Reserve? Mitt Romney said,”I am not going to take my effort and focus on the fed.” as for his opinion of Ben Bernanke,he said that Bernanke helped advert a major crisis in America.A first time audit of the federal reserve revealed 16 trillion in secret loans to bailout American and foreign banks and businesses.in 1918, Woodrow Wilson said,i have betrayed my country with the Federal Reserve Act of 1913.The same year of the Federal Income Tax became law and in 1933 the Internal Revenue Service was established. history has showed that on Dec. 23, 1913 the U.S. Constitution ceased to be the governing covenant of the American people and our liberties were handed over to a small group of international bankers.Alan Greenspan was responsible for the stock market crash of Oct. 1987, Black Monday.maybe more people need to read about Colonel Edward Mandell House and the book called Philip Dru,Administrator which described a detailed plan for the future government of the United States.This was in 1911.
Bob Marshall | May 21, 2012 | Reply
Hi Bob – do you know the original source for the oft mentioned quote attributed to President Woodrow Wilson : “I have betrayed my country”.
Joan Collins | May 2, 2013 | Reply