Free Banking Is the Necessary Precondition for Discovering Whether or Not Banking Is a NATURAL MONOPOLY

A standard proposition of modern microeconomic theory is that if there exist significant economies of scale, that is, if long-run average costs decline over the range of output demanded in the market, then only one firm will survive. Such a firm would be a “natural monopoly.” It has often been argued that banking may be a natural monopoly, and if so, the most efficient approach is to restrict competition and allow only a single issuer of banknotes, the central bank. In short, if there are large cost economies in banking, then free banking may not be an optimal solution. 

The most basic rebuttal to the natural monopoly argument is to point out that costs cannot be known to the producer (much less to the economist) prior to the process of production and a firm’s costs are likely to change when the market structure changes. From this it follows that

a governmental producer of money is not an efficient natural monopolist unless he can prevail in conditions of free entry. . . . The only operational proof that a common money is more efficient than currency competition and that the government is the most efficient provider of the common money would be to permit free currency competition. (Vaubel 1986, 933, 935)

That is, free banking is the necessary precondition for discovering whether or not banking is a natural monopoly. In the absence of such competition, those who claim that banking is a natural monopoly are guilty of making an unsupportable assertion. 

—Larry J. Sechrest, Free Banking: Theory, History, and a Laissez-Faire Model (Auburn, AL: Ludwig von Mises Institute, 2008), 162-163.