Rothbard’s historical and polemical article challenges the rehabilitation of free banking through Chile’s monetary experience from the early nineteenth century to the aftermath of the 1925 reforms. Drawing principally on Frank W. Fetter and Albert O. Hirschman, he argues that abolishing central banking does not secure monetary stability if banks retain the power to issue fractional-reserve liabilities. His chronological account culminates in a defense of banking freedom constrained by full specie backing.
The reason was not simply that the country had no central bank; more importantly, Chile had no paper money or fractional reserve banking at all!
This distinction organizes Rothbard’s interpretation. He presents early nineteenth-century Chile as a hard-money order sustained by political resistance to banks of issue. Rejected proposals for governmental banking, restrictions on paper currency, and the closure of the Banco de Chile in 1850 establish his baseline: stability preceded free banking and rested, in his account, on commodity money rather than merely the absence of a central bank.
The turning point is the influence of the French economist Jean Gustave Courcelle-Seneuil, appointed professor and government adviser in 1853. Rothbard links the authority of imported European expertise to the adoption of the banking law Courcelle-Seneuil drafted in 1860. That law permitted broad entry and note issuance without reserve requirements or government inspection, retaining gold redemption and limited restrictions on note volume and denominations. Rothbard portrays this arrangement as an unusually favorable test of free banking, then traces its vulnerability during the war with Spain in 1865.
War-induced withdrawals exposed banks whose prior credit expansion had left them unable to withstand a crisis. Government intervention authorized inconvertible notes, accepted them in taxes, and progressively extended privileges in exchange for bank financing. For Rothbard, the decisive consequence was the expectation of future rescue:
But the signal had been given to the banks that the government would bail them out in times of real financial trouble, and so an inflationary boom soon began, fueled by bank credit expansion and ensuing speculation.
The mechanism therefore joins fractional-reserve expansion to fiscal dependence and government protection. Restored convertibility did not restore discipline: mining speculation and rising commodity prices gave way to depression after 1874, agricultural indebtedness, and public deficits. In 1878, renewed government borrowing from already overextended banks accompanied further note issuance, specie exports, and suspension of redemption. What was announced as temporary inconvertibility became a prolonged fiat regime.
Rothbard rejects an unfavorable balance of payments as an independent explanation for the suspension, treating it instead as an effect of domestic bank-credit inflation. He supports this interpretation with the banks’ June 1878 figures: 46.8 million pesos in demand liabilities against only 3.45 million in specie, alongside extensive insider lending at the Banco Nacional. The article’s force lies in this proposed sequence from thin reserves through crisis to political rescue, although its own narrative makes government privileges integral to the system’s deterioration.
The concluding historical sections follow the unsuccessful return to gold in 1895 at an appreciated peso parity, renewed inconvertibility in 1898, and Edwin W. Kemmerer’s 1925 introduction of a central bank and dollar-linked gold-exchange standard. Neither the later reform nor centralization supplies Rothbard’s solution. He also distinguishes Courcelle-Seneuil’s banking legacy from his trade liberalization and privatization measures: the discredit attached to banking reform, Rothbard argues, damaged the reputation of policies he otherwise endorses.
The Chilean experience highlights an important point: that central banking and free-banking are not the only possible monetary alternatives.
This final conceptual move turns a historical counterexample into a challenge to the terms of monetary debate. Rothbard separates freedom of entry from freedom to create fractional-reserve claims, proposing banking under mandatory 100 percent specie reserves and treating fractional-reserve issuance as fraud or theft. Chile matters to his argument because it allegedly demonstrates that inflationary fiat money can emerge without a central bank; the relevant dividing line is ultimately reserve discipline, not simply centralized versus competitive note issuance.
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