Over at the Mises blog, it is claimed that there is "no cost of production" associated with expanding the supply of money under free banking. Specifically:
The bundle of bad economics and misunderstanding of free banking in that quote is quite a sight to behold.
"the bankers can *unilaterlly* affect the demand for their products by simply raising or lowering the interest on loans they offer; they effectively face *no* costs of production. These market “signals” aren’t really market-based at all because their origin in based not on private property but entirely on the will of the bankers. This is what distinguishes them (banks under free banking) from other businesses in the economy as a whole, who face costs of production they cannot unilaterally control."
Let's start with the "no costs of production" argument. It's amazing that this argument even gets raised given that White and Selgin's theoretical models of the profit-maximizing decision facing free banks were all about demonstrating the rising marginal costs facing free banks when they expand. You can't make their claim that the money supply is determinate without it.
The key cost is the increased risk of illiquidity as excess supplies of bank liabilities are returned to the overissuing banking for redemption in one form or another. As free banks expand, more of their notes and deposits will get returned for outside money directly over the counter or indirectly through the bank clearing mechanism. For a given quantity of outside money (e.g. gold), expanding their liaibilities means a rising risk of being caught with insufficient outside money to pay off those redemptions. This increased risk is not a "physical" cost of production, but it is a cost of production nonetheless.
Critics need only get as far as p. 4 of White's Free Banking in Britain to see the variable "L (expected liquidity costs)" in his model, along with claim that "expected liquidity costs increase with an increase in [notes] or [deposits]" for a given quanity of specie on the next page. The bottom of p. 5 and the top of p. 6 catalog the various rising marginal costs facing banks expanding their note issuance and deposit creation.
So to claim that free banks face "no costs of production" requires either that one is ignorant of the core claim of the free banking literature and/or that one is adopting a notion of "costs of production" that is deeply at odds with the subjectivism and marginalism of Austrian economics. In either case, this anti-FB argument fails and fails miserably.
The liquidity cost point provides the response to the second point, which is that somehow free bankers don't face costs of production they cannot unilaterally control. When one understands that the relevant cost of production is the risk of illiquidity, which itself depends on the preferences of liability holders, then there's absolutely nothing different about free banks from any other firm on the market facing an upward sloping marginal cost of production curve. They are indeed "based on private property" - namely, the private property of the owners of bank notes and deposits who will decide whether or not to exchange that private property for outside money or a deposit credit at another bank.
It's worth noting that free banks face rising costs of underproduction as well. To the degree that free banks produce too few notes and deposits, they will face rising opportunity costs in terms of the foregone interest on the loans they could make to bring those notes and deposits into existence. Finding the joint minimum of the costs of over- and under-issuance is one way to look at the entrepreneurial task facing free banks.
The process by which free banks face rising costs of production and are thereby constrained to produce the quantity of their liabilities their customers wish to hold (and no more or no less) is thus absolutely no different from the process facing every firm in all competitive markets. That, in fact, is the core of the argument for free banking, which is to apply the (Austrian) theory of the market process to the production of money. The claim that free banks are somehow different is without merit.