Many people blame the recent financial crisis on a lack of regulation and fraud in the financial system. However, the Federal Reserve appears to have been a significant contributor to the crisis in terms of both its poor monetary policy and faulty regulation of the financial system.
In contrast to the current approach of regulators attempting to outsmart the bankers, increasing competition by reducing the restrictions on banking activities and ending the special protections granted to privileged financial institutions will help increase financial intermediation and improve monetary stability. The best path to financial stability is to free the banking system from the current burden of inefficient and costly regulations.
Free and unregulated banking systems provide the financial intermediation consumers want while simultaneously reducing banks’ incentives to take risk. These benefits can be captured in spite of – indeed, because of – a lack of government intervention in the financial system. In a free banking system, banks are allowed to issue their own banknotes. These notes act as liabilities against each bank’s assets. Anyone who holds the banknote can redeem it or “cash it in” for a particular asset specified in advance, such as a regular U.S. dollar or possibly for a commodity such as gold.