I used the price system to determine which problems were collectively the most valued and therefore tried to solve the problems that paid the most money.
TLDR: Banks regularly collapsed and not just because of fraud, but started to collapse less as they got regulated more. The system functioned (for certain values of "functioned"), but shockingly enough the man on the street did not turn out to be better at evaluating a bank's solvency than central banks. They were of course also less able to bail themselves out if they misjudged a bank's solvency.
A major problem with the comparison is that many of the regulations on free banking, particularly that against banks operating in multiple regions, greatly limited the ability of banks to absorb regional and concentrated shocks in the economy. If you can only have bank branches in Kansas by law, and Kansas crops have a really awful year, your bank is screwed in a free banking system. Without that artificial limit, free banking is much more robust.
If you consider fractional reserve banking as fraud (banks should only be allowed to lend out funds that you have lent to the bank for a period of time, not funds that you are merely storing in your checking account; a bank run in this context is when account holders want to withdraw their money and it is not there), the system should be fairly stable without a "lender of last resort".
I don't really see why fractional reserve banking is necessary.
If you want full-reserve banking then (i) that's a different thing from free banking in practice and (ii) full reserve banking would result in interest rates wildly fluctuating because currency reserves are fixed in the short term, and the business sector's need to borrow for cashflow reasons varies. Wildly fluctuating short term interest rates deters longer term investments => slower growth
Also, since most full reserve proposals don't ban credit creation altogether (i.e. you can still issue and exchange IOU notes), but simply restrict credit creation and acceptance by institutions calling themselves banks, you end up with the economy relying on an unregulated shadow banking system even more prone to booms and busts to fulfil credit needs.
It is if you want passive interest rates above negative. Storing money without touching it at all costs money. Worst of all to society the value is nill or negative compared to investing it in something and collecting dividends. There was even an ancient parable about that involving a lord giving money to peasants for safekeeping for a few years. He scolded the one who buried it and praised the one who used it for investments and started collecting the profits.
Theoretically if it is that much of an anathema one could have a 1:1 reserve and explicit money market style transactions for everything but the question is what would be gained? The liquid cash would be "safe" from bank runs at the cost of guaranteed losses to depreciation and storage fees. Keeping it insured and interest generating is a winner as an option.
You are right - this will be a strong incentive to keep as little as possible in a checking account, and either lend or invest the rest. There are two main differences from the current system:
1. Depositors will have to explicitly give up/lock their funds for a set period of time if the funds are to be lent out and they are to earn interest. Early withdrawals come with a significant fee. This makes bank runs very unlikely, eliminating the need for a central bank. The longer you want to lend the money for, the higher the interest. But you can also lend money overnight.
2. No money creation, leading to proper alignment of time preferences of investors/consumers and businesses. Interest rates correctly reflect this time preference. If money represents a claim on real resources, then a business can only use as many of these resources for investment as consumers are willing to forego consuming. Interest rates reflect the actual supply and demand of resources/consumption at different time horizons and do not get artificially "set" or otherwise manipulated.
Because of these two properties, the boom-bust leverage cycle is greatly dampened, if not completely eliminated.
(1) Because maturity transformation is no longer permitted, every time somebody wishes to take out, say, a mortgage, the bank has to find somebody who has >$200k they're not even going to consider spending for quarter of a century. As a result, costs of borrowing go massively up, which is bad for everybody except for a small proportion of rentiers sufficiently wealthy to be entirely unworried by liquidity. Joe Sixpack proves to be even less adept at managing an overnight lending portfolio than full time professional bankers, and loses money as a result.
(2) The money supply is artificially "set" at a particular level on the basis of the unambiguously false assumption that real resources do not change over time rather than being allowed to fluctuate and grow to properly align itself with creditworthy borrowers' growth projections in a way commensurate with price stability. The boom bust cycle is replaced by permanent bust.
1. Could maturity transformation not be done by the markets? E.g. if you want a mortgage, you essentially issue a bond; lenders may then decide to hold the bond for a short period of time and then sell it on the secondary market. With regards to consumer products, I am sure the market would come up with something user-friendly. But I see your point.
2. The money supply could grow predictably, e.g. like Friedman's proposal of replacing the Fed with a computer that expands the money supply in a predictable manner.
1. Banks are a market solution to maturity transformation (it's just that doing maturity transformation without frequent liquidity crises needs access to more short term borrowing facilities than private capital markets can offer). Treating mortgages as tradable financial products instead of obligations the issuer should be happy to keep on their balance sheet was the cause of the bad underwriting that led to the financial crisis, not the solution to it.
2. Friedman's k% rule is better than a fixed money supply, but it's still every bit as arbitrary and further removed from the relevant market indicators of resource constraints (creditworthy borrower demand and price inflation) than the current system.
I'd love to see a browser extension that allows this community to mark up existing news websites with other resources/arguments against. Similar to Rap Genius Web Annotator https://genius.com/web-annotator
A general understanding might help, but IMO knowing specifics is not necessary. I've known plenty of entrepreneurs that have little to no understanding of economics.
In addition, economics can get quite political. Again, a general understanding of why it's political can help here, but specifics are not necessary.
