The Rationale Of Central Banking - Vera Smith (1936)

THE RATIONALE OF CENTRAL BANKING

A Liberty Press Edition

Vera

C. Smith THE

RATIONALE OF

CENTRAL

BANKING and the Free Banking Alternative

PREFACE BY LELAND

r

.

Liberty

,'7/

Fund

Indianapolis

B. YEAGER

LibertyPress is a publishing imprint of Liberty Fund, Inc., a foundation established to encourage study of the ideal of a society of free and responsible individuals.

The cuneiform inscription that serves as our logo and as the design motif for our endpapers is the earliest-known written appearance of the word °freedom" (amagiJ, or "liberty _It is taken from a clay document written about 2300 B (. in the Sumerian city-state of Lagash Reprinted by permission of A. Wilson-Smith. Prelate ©1990 by Leland B Yeager All rights reserved.All inquirms should be addressed to Liberty Fund, lnc, 8335 Allison Pointe Trail, Suite 300, Indianapolis, IN 46250-1687. This book was manufactured in the United States of America.

Library Smith,

of Congress

Cataloging-in-Publication

Data

Vera C., 1912-1976

[Rationale of central banking] The rationale of central banking and the free banking alternative Vera C. Smith; preface by Leland B. Yeager p. cm. Reprint. Originally published" The rationale of central banking. Westminster, England: P.S King & Son Ltd., 1936 Includes bibliographical references 1. Banks and banking, Central 2. Banks and banking, Central-Europe--History 3. Banks and banking, Central--United States-History. HG1811.$5 1990 332.1' 1'094--dc20 90-30937 CIP ISBN 0-86597-086-6 ISBN 0-86597-087-4 1098765432

(pbk)

Contents

Preface

by

Leland

Publisher's

xxvii

by Vera

C. Smith

xxx

Introduction Universal

in recent

banking" the

3 acceptance

cussion

II

xiii

Note

Foreword

I

B. Yeager

times

• Historical

responsibility

The

in

General

early

of banks

on the banking;

banking

discussions business

of issue

period

of freedom

which

the

tion more sults

origin the

of privileges nature

of

causation.

leading

• Second

tender"

issue_ note

and

of

organisation in the

period: was

the

period;

character

of early in

its accumula the

the central

of notes;

the

circumstances

founded;

modern

v

in

N

Government

of Government

War

in su-

evolution

• England:

for financing

of the

its relaissue

its partial

trend countries

consequences

Napoleonic

note of the

policy,

forms

in return

and

of the

and

of England

characteristics of "legal

"free

problem

8

priority

° General

in the

Bank

in the

and

general

cycle

of dis-

Central

• Alternative

banks

• The

of "central" • The

in trade

of

• Lack

England

remarks

note-issuing

tion

• Meaning

to deposit

persession

banking

examples

Development

Banking

tion

of central

interven-

Bank

acquired

bank; gold

the

began

reto

vi

THE RATIONALE OF CENTRAL BANKING

be concentrated the

Bank

The

looked

agitation

greater

for

for note to free

as in the

country reserves

serves

• Antagonism

and

banks;

the Bank's

consolidation

The

Scottish

of

banking

and

to

period

of the

centralised

the

adoption

{the

previous

of

the rigid

establishment

inertness

kinds

controversy

of 1848 pressure

• The

extreme

provinces

of a discount rate)

Bank

• The

in-

departmental

in the

discount

on the

on of

events

. Treasury

of France of

an attack

restitution

• Period of

suspension

of all

pe-

• Pressure

• The

adopted

of

• Short

• The

low

restrictions

Bank

• The

of France

Banque

•

policy new ° The

Enquire--

upheld.

The Organisation Decentralisation

• Developments

banks rates

the

experiences

regime

of France

discount

by the

Savoy

Misleading

by the

assignat

Bank

facilities

provoked

centralisation

in 1845. 28

retarded by the

prolonged

The

success

Central

centralisation

Bank

and

interference

of the

under

of banking

Bank

after

systems.

introduction

for note-issuing keep

lack

policy

• Fourth

25 . The

then

liberalism; but

• Complete on

its influence

of

monopoly

creased banks,

re-

note-issuing

banks

of banking

Bank

of banking

stock

France

of freedom

the

as well

to centralisation

to acknowledge

• Legmlative

in

notes

the

deposit

System

Development

riod

of

provinces;

to centralisation joint

•

period

of other

Development

Law's

resort"

in London

tendency

towards

beginnings

Banking

in the

as 1825

of last third

competition

reluctance

operations

1844;

The

issuing

then

as early

"lender

banking;

• Increasing

of gold

the

of England; as the

stock

opened

of free

V

joint

freedom

Monopolistic

IV

Bank

upon

banking

on

II1

in the

was

of Banking in without Freedom

interpretations in the

° The States;

Bank prevalence

America: of North

42 America

of restriction

CONTENTS

vii

and monopoly • Second experiment with a central bank (the First Bank of the U.S.) • The 1814 suspensions • Political influences • The lack of branches and of clearing facilities • The third attempt to maintain a central institution (the Second Bank of the U.S.); the suspensions of 1836 and 1839 • The extreme laxity with which insolvency was treated • Attempts to deal with over-expansions and suspensions {a)the more frequent return of notes secured by the Suffolk bank system and the Massachusetts taw: (b) penalties tbr suspension; (c) special security for note holders, prior liens on assets: double liability; the New York safety fund system • The "free banking" law of New York • The Civil War and the general application of the bond deposit system by the National Bank Act. VI

The Development of Central Banking in Germany The late development of modern banking business • The first semi-State bank in Prussia • Competition of private banks • 1833 onwards--Treasury monopoly of the note issue • The policy in Bavaria and Saxony • The growth of the Bankfreiheitspartei in the 'forties; the scarcity of capital and the idea that banks possess "magic power"; the crddit mobilier idea; the genuine scarcity of note currency • This and the issues of notes by the border States led to a reorganisation of the Royal Bank ° The continual agitation secured at last some concessions for private note-issuing banks • Joint stock banks in credit mobilier business • Slow development of note-issuing banks; the notes of the border States again the motive for slight modifications in the restrictions on private note-issuing banks • The reaction in favour of central banking beginning with the crisis of 1857; the 1866 crisis and emphasis on central bank aid; deposit banking given freedom by the reform of the law on joint stock companies: the realisation of the importance of discount policy • All these factors led up to the foundation of the Reichsbank.

57

viii

VII

THE RATIONALE OF CENTRAL BANKING

Discussions Subject Prior

on

Discussion

not

Liverpool

and

cussions

Theory

the

MacCulloch's

the

ones;

small

tages

of central

free

note

holders

• Gallatin

emphasised

quent

exchange

of notes

check

if all banks

banking

trade

is wholly an adherent • The

American

mended so

free

banking

is no

capitulation

of the

reserve of the

that

it;

in

of the

France

although

free

banking recom-

Raguet

Gallatin

argument

defence

competition

Hildreth,

Condy

that

to expansion;

fre-

provides

• Tooke,

and

towards

check

Discussions

the advan-

opposed

for America;

af-

• S. J. Loyd--the

rule

consumer

• Longfield's

mechanism

drain expanding

as regards

in step to the

Carey

disposed

reprehensive

gold

as the

effectiveness

school,

writers,

banking

favourably

The

expand

• to ex-

• G. W. Norman--this

to the

of the

the

and

the

is an exception

beneficial

• Parnell's mechanism

be protected;

in a crisis

• Dis-

• tendencies

as well

should

banks

Club

because

banks

and

banking

clearing

banking

cumulative

non-expanding

• Joplin

stock

Economy

on

71

England

• The

policy

no

in

Political

become

fects

the

for joint

banking

attack

of

America

prominent

of free

pansion

and

the campaign

at

defence

VIII

the

in England to 1848

not

was the

James

Scotch

was

also

clearing

Wilson's

re-

system.

and

92

Belgium Influence

of literature

America • The

° The

royal

rise of free banking

quelin,

Du Puynode

Politique;

the

low

rate

discount

that

for

of notes

of banking

in

argument--Cieszkowski

in the

• The exchanges

school--the raises

unity--Adolphe

the difficultj'es

development

agitation--Courcelle-Seneuil,

Pamphleteers interlocal

tiplicity

the

• Debates

necessitates

case

on

prerogative

Soci_te

case against (Victor

Pereires,

difficulties d'Eichtal;

of scrutinising

plurality;

Bonnet)

Aubry

which

Cod'Economie

• The

provide

Brasseur's notes

had been

it

• The the

mulreal

argument exagger-

CONTENTS

ated

• Competition

lier,

Mannequin

basis tants

proposed by Lavergne ° The • Wolowski versus Chevalier

the

Banque

• Limited

Enqu_te

Laveleye

attacked

Cernuschi

and

Summary

of the

mary

ment

for

system

The

Discussions

in the

• The

by

bank

•

in general

°

Coullet

° Later

• Sum-

publications

• Juglar's

within the

de

bankers

argu-

a competitive

free,

banking

and

should

dom

along from

and

unity lines

banking

the legal

framework

banking

° Michaelis'

again

represented

by

trade

cycle

merely

because

100

it would

argument

for the

lender

doctrines

of Geyer

and

Wagner's

change

Post-l$4$

better of last

resort

of

for checking doctrine of modern

of central for

control

Tellkampf

Kongress

on deposit

his anticipation support

bank-

formulation

currency

argument

free-

free

• The

mechanism

° Nasse's

bank-

or real

emphasis

percent

Geyer;

from

issue

supported

Michaelis;

automatic • The

theories

° Tellkampf:

of free banking;

expansion

of emphasis

of free

standpoint

Otto

lit-

support

in the note

school

of German

doctrine

• Wagner

and

credit

change

° Rise

currency

be either

Volkswirte

114

Gerstner Hi_bner's

percent

Scottish the

Germany

via von

'fifties

100

there

The

case

between

in

erature

Deutscher

X

connection

influences

ing

notes

case by Horn

° Emile

of free

bank

dispubefore

schools.

Foreign

ing

school

Courcelle-Seneuil

clearing

Coq, Cheva-

a departmental

group

banking

Chevalier,

° The

banking

anti-inflation

attacked

central

by

on

most prominent ° The evidence

inflationist

Modeste

a central

demanded plurality

° The the

of the flee banking

of Wolowski,

IX

in banking

ix

banking;

central the

banking

note

• Critique

° Wagner

and

issue

to

of the Knies

°

of attitude.

Discussions

in

132

England The

absence

Mills and

of discussion

Herbert

Spencer

in the ° French

'fifties

except

influences

for R. H. in the

'six-

x

THE RATIONALE OF CENTRAL BANKING

ties

• The

English

policy

by

the

chen;

support

Guthrie's

attack

the

analysis

Table

XI

and

French

of the

of the last

of cross

banking

to the

of effects

"lender

banking in

Foundation

the

evidence

and

. Bage-

to

and

banking versus

school

Prior

Federal

of J. S.

system

central

currency

America

of

attack

question

of central

between

versus

monopoly; general

reserve

theory

Gos-

Patterson;

Commission

single

resort"

groupings

Discussions

• The

and

bv

of England

• Bagehot's

memorandum

hot's

of a discount

Economist

doctrines

by Phillips

plurality

adoption

The

Pereire

on the Bank

issues

versus

Mill's

to the

of France;

of the

on fiduciary unity

reactions

Bank

• free

adherents.

the

146

Reserve

System The

American

century

system

at the

• Differences

free banking deposit

proper

system

get loans

out

the

issue

deposit

encouraged

difficulties

if the

public

deposits

° Long-run

trend

in the note issue

• Sluggishness

pensions

of

American

system

issue,

cash

clearing

• The

attributed

reserve

of reserves house

of redemption

payments were

to inelastic

the use

wanted

policy,

• Attempts

loan

Xll

Act to provide

a permanent

central

and

The

Arguments

Banking Tbe ences

in

of in-

with

sus-

of

by

the latter

the

of note

Tt'easury

in

by the relief

•

• The high cost of the Aldrich-Vree-

currency

° Swing

banking

instead

and to lack of economv

emergency

Commission

to

con-

• Short-run

inelasticity

to remedy

certificate,

the Monetary

notes

• Crises

The need for a Government fiscal agent check collection ° The 1907 crisis and land

banl¢_ with

deficiencies

to the

and

(b) bond

for preference,

sequent

flexibility

twentieth system

of branches;

which

credit

of the

American

• (a) prohibition

of note by

beginning

between

• The

of opinion

work

of

in favour

of

institution.

Favour

of

Central

167

Reconsidered

acceptance between

of central central

and

banking free

• The

banking

main systems

differ• Mo-

CONTENTS

nopoly

of note

banking

issue

defined

cludes

a general

central

bank

banking

can

with

the

free

banking

small cies

banking

note

banking thesis

affects

of the free

mechanism

of control

can

be sustained;

are

no

causes

all banks

lender

of last

the cases ern

the

and

banking:

(b) deposit

banking

and

la) pursuit co-operation

policy

to deposit

is an au-

how

fhr this

that

profit

there motive for a

arguments banking

tendencies

° Final systems

• Tendencies

to

• Modin the

of a rational

of the two

° Future

there

that

expand

• Argument

of these

tendencies

of control

Appendix: "Automatic

notes

they

bankers

because

(b) international

on comparative

tension

that

tendenbankers

whether

via clearings;

• Application

of the

comparative

of central

for central

of central

disturbances

bound

° Protection

to ioin in an expansion

of (a) small

policy;

contro-

necessarily

bankers

banks

resort

arguments

theory tary

argument

conservative

currency

is not

of the central

• Argument

on

tbr and against--

versus

all banks

or not

° Free

dependent

case

• The

tomatic

prebut a

bankruptcy

doctrines

° Arguments

drain

• Free

standard,

closely

• The

argument

to expansion

an external

policy

school

holder

gold

to legalised

reserves

connections

with

of the

banks'

versy up

of reserves of obligations

resort

the

in gold

• The

centralisation enforcement

abandonment

keeps

movements

and

• Strict

xi

moneremarks

in causing towards

ex-

banking.

On the Working Mechanism"

of

of the Credit

197 Control

Bibliography

201

Index

209

Preface

Vera

Smith's

The

Rationale

of Central

Banking

invites

us to

reassess our monetary institutions and give reform proposals due consideration. The decades since it first appeared in 1936 have restored its themes to relevance. Governmentdominated poorly.

monetary Other

systems

experience,

have

as well

continued

as the

to perform

work

of James

Bu-

chanan and the Public Choice School, has heightened skepticism about government generally. People are now willing to discuss what Vera Smith set out to examine: "the relative merits

of a centralized

system

of competitive

monopolistic banks

trade" (p. 3). After a biographical leading on

themes

them

money

and and

Vera

sketch

of her

how

banking

I then they

system

possessing

of Vera

book.

consider banking

Smith

all

equal

Smith,

offer bear

current

wrote

The

Rationale

of Central

Banking

She

Ph.D.

as

her an

Hayek, Lionel nis Robertson; assistant.

issues

degree

undergraduate

there in

1930.

in

1935, She

a group

of students

nowned

economists,

not

only who, Smith

to the like

school's

having

herself,

were the

xUi

en-

studied

faculty

experienced

as a

School of A. Hayek.

Robbins, T. E. Gregory, J. R. Hicks, in 1933-34 she was Hugh Dalton's

Thanks

of

reform. at the University of London the supervision of Friedrich

received

the

embroidery

doctoral dissertation Economics under rolled

a to

I survey

some

on

and rights

with

and Denresearch but

also

to become London

to re-

School

xiv

THE RATIONALE OF CENTRAL BANKING

in what were perhaps its golden years. In 1936-37 Smith served as economic assistant at the Imperial Economic Committee. In April 1937, Smith married the German Friedrich Lutz, who was an assistant to Walter

economist Eucken in

Freiburg and had held a fellowship of the Rockefeller Foundation in England in 1934-35. In the year of their marriage Friedrich Lutz received another Rockefeller fellowship, and the couple traveled to the United States. After a year and a half back in Europe, the Lutzes returned to the United States just before the outbreak of World War II. (Lutz's traditionalliberal orientation blocked him from an academic career in Nazi Germany.) During the war Vera Lutz served search staffs first of the International Finance

on the reSection of

Princeton University and then of the League of Nations, also in Princeton. In the latter post Vera Lutz worked with such noted economists as Alexander Loveday, Gottfried Haberler, and Ragnar Nurkse. From 1939 to 1953 Friedrich Lutz held positions from instructor to full professor at Princeton University. After a year in 1951-52 as visiting professor at Freiburg, in 1953 he moved to the University of Zurich, where he taught until retiring in 1972. He was a visiting protbssor at Yale in the winter of 1962-63. From 1950 to 1963 Mrs. Lutz spent frequent periods for research at the Bank of Italy, the development agency for southern Italy, and the Banca Nationale del Lavoro. From 1963 to 1969 she frequently visited Paris for research on French indicative planning. She never chose to accept a teaching position. Professor Lutz died in Zurich in 1975; Mrs. Lutz, born at Faversham, Kent, England, on 28 April 1912, died in Zurich on 20 August 1976.' Biographical and bibliographical facts come mainly from articles assembled by Ente per gli Studi Monetarl, Bancari e Finanzlari "Luigi Einaudi," 1984, especially those by Rosaria Giuhani Gusman and Gottfried Haberler; fi.om Verena Veit-Bachmann's article on Frledrich Lutz; and |rom a letter and enclosure dated 26 June 1989 v_rltlen by Mrs. Brenda K. Fowler, the sister of Vera Smith

PREFACE

Vera

and

Friedrich

Lutz

were

xv

both

prominent

members

the Mont Pelerin Society, and Friedrich was from 1964 to 1967. The Society's international consists ness

mainly

people

of scholars

but

It was

established

also.

F. A. Hayek

in 1947

with

and revitalizing classical The Lutzes collaborated etarv

and

Theory Mrs.

alone

(1962)

purpose

Central

Firm

works, (1951).

lated

planning,

books

by

Books

in Economic

Planning

for

the

Theory

and

Experience

and

the

Wilhelm

labor

Fritz Machlup from German into A central bank, as Smith notes, development.

It originates

bears

privileges

special

serves

as banker

banks

and

for

monopolizes

money. From this and characteristics of its country's

gold

form

a large

of the

portion

It is constrained than competing notes typically

redeemable. suspends

reserve,

and

payments

and

for

the

and

of natural

the

issue

its notes

and it

ordinary of paper

and

of ordinary though obligation

to meet goes

trans-

secondary functions bank: it guards the

reserves

unable

Be-

Typically,

and

dominates

cash

Lutz

favors

responsibilities.

under a gold standard, banks would be, by the When

(1969).

banking, pubdevelopment,

Morgenstern,

privilege derive the of a modern central

bulk

Develop-

government

government or

by

English. is not a product

through and

the

The

written Economy:

Mrs.

Oskar

Monand

Market

market,

Ropke,

socialism

(1950)

sides writing many articles on money, credit, lic finance, the theory of the firm, economic economic

of

including

in lta(v

Ita(v, a Study

of the French

and busi-

the leadership

of fighting

Policv

of the

include

and

Analysis

the

journalists

under

liberalism. on several

Exchange

of Investment Lutz

ment An

Foreign

includes

of

its president membership

this

off the

deposits banks.

less tightly to keep its obligation,

gold

it

standard,

while its notes acquire forced currency. (One excuse for such actions is that reserves held with it can be guaranteed Lutz. I am grateful valuable inibrmation.

to Mrs

Fowler

for

going

to the

trouble

of preparing

her

IVt

THE

safe

only

RATIONALE

if its notes

redemption

OF CENTRAL

remain

suspended.)

in circulation

Control

over

and deposit issue gives the central or scale of the country's money

and

over

the

general

touches

A central

credit

on

bank

the

may

even

the

note size

Smith

BANKING

with

volume

their

of its own

bank power and banking

over the system

situation.

aims

and

originate

origins

of central

banks.

owned

profit-

as a privately

seeking institution. Another motivation, not incompatible with the first, is to help in the financing of government. Smith reminds us of that reason for establishment of the Bank of England, and she in France and elsewhere. The bank profit

special

shows

privileges

and

similar

motivations

dominant

position

of a central

thrust responsibilities onto it that dilute orientation. This is true of fully evolved

like today's Bank of England and in the United States. As "lender bank

is supposed

banks

during

currency,

to come

shortages

lending

to the

rescue funds

its own

freshly

of the

and

public

objectives

such

as,

before

System central ordinary

scramblings

issued

Disregarding narrow profit considerations, use its influence over money, credit, and serve

or override its central banks

the Federal Reserve of last resort," the

of reserve

them

at work

bank

it is supposed interest rates 1914,

keeping

country's currency firmly on the gold standard and, adays, resisting inflation while promoting production employment and

those

for notes.

(to the

extent

that

objectives

are

as

Smith

defines

it, is a regime

to issue

bank

to to the

nowand feasible

compatible).

Free banks

banking, to operate

and

even

strictions beyond compliance (pp. 169-170). A bank may permission

if it can

capital,

and

has

same

the

terprises.

win Its

show

public

notes

with general enter the field profit

prospects,

confidence

rights

and

responsibilities

notes

are

"promises

in itself

no

re-

company law without special raise and

as other to pay,"

allowing

under

sufficient its notes.

business

redeemable

It enin

PREFACE whatever dard, this gold).

the basic money might be (under is gold or instruments redeemable

As Smith

gold

points

standard No bank

tion

having

pending liquidated,

Smith France,

could

"A general

reviews

legal

would be being applied would

the

Germany,

banking

and

controversies century, over

in these whether

sponsibilities

and

United

countries, a central

powers

all

or

part

of England, States.

She

is desirable

or,

on

by countries

She

menting

on

Smith on

page

each

cross-groups

The

first

two

monetary

debates

accepted

the

wanted behave banking trines

into

from

quantity

four

to their

currency of either

schools

their

surveys

contrary, of central of Italian rather

than

to group tolargely com-

writings.

according

trines of either the and their advocacy ing.

reviews

writers

144-145)

of

also

left free a review

finding it convenient of writers who were

other's

and of its

Scotland,

the

and

writings.)

sus-

mainly in the nineteenth bank with its distinctive rebe notes,

Spanish

bank

bankrupt the claims

private banks might advantageously domination. (She sets aside, as she by topics, presumably gether the arguments

in circula-

Any

declared to meet lose

of the

conditions"

notes

tender.

histories

the

these

irredeemable

declared

Stockholders

the gold stanat full value in

abandonment

under

keep

them

redemption its assets

creditors. investment.

out,

is inconceivable

(p. 170). by

xvii

are the

camps

(as in her

table

of the

doc-

acceptance

school central

or the banking school banking or free bank-

mainly

associated

1820s

theory

on. 2 The of

money

with

British

currency and

school generally

to make a mixed system of gold and paper currency much as pure gold money would have done. The school about

accepted

"real

bills,"

doctrines about

tinged

accommodating

with

fallacy, the

doc-

quantity

2see Anna J. Schwartz (1987), under the reference listing that follows, for a discussion of different schools. Subsequent in-text citations are to references in this listing.

xviii

THE

of money,

even

RATIONALE

over

OF CENTRAL

the

business

supposed needs of trade, and reflux of excessive bank notes. The

controversy

tinct,

says

ditional

to and

banking

and

(1984)

over

Smith

and

(pp.

176): of the

currency Schwartz

central

banking arguments

(1987)

is that

White

British

controversies,

and

man

the

Henri

Austrian

have

since

dealt

whereas

von

in that

Historically, connected and was

support with

the

for central currency

the currency school's claimed as a victory

free-banking France, ideas,

school

for even

quantity in excess

placing

provided

came

claims that

that

they

are

Smith

repeatedly

bankmassige Deckung, able. Literally, it means

evidently "bankwise

idea

that

assets.

a bank's

the

monetary

(p. 176),

more

bank

especially

in

banking-school

the

notes

denial

cannot

bv

way

ill-conceived uses

school,

controversy as well. The

on

issued

closely

banking

suspicion,

of the

be issued of loans

emphasis the

regarding cover"

liabilities

French-

says

was the

including

appropriate kinds (p. 172). The banking school placed bankable

with

emphasis

ideas,

exclu-

extended

position so far as they the volume of money

under

so much

and

and

As she

success in theoretical for central banking

inflationaiLv

theory

almost

seem to have adschools both, but Michaelis and Otto

banking

than

collapsed

Smith

Mises,

position.

theirs could be a perfectly consistent aimed at checking fluctuations in and credit.

the

White

free-banking school, school. Perhaps the

Schwartz

Ludwig

Cernuschi

adby

Lawrence

her study to the continent. Few writers hered to the currency and free-banking Smith did find at least the Germans Otto Huebner,

is dis-

disputed

Both

into three: the and the banking

sively

in the

automatic

it raises points

schools.

categories school,

to changes

a supposed

versus

explanation with

cycle,

about

171-172,

independent

Anna

Smith's four the currency

free

BANKING

should

German

of on

term

it as untranslatand refers to the be matched

by

PREFACE holdings "real-bills

of suitable doctrine,"

liquidating the

commercial

production

very

few

would

or

months.

and

school

loans,

the

on

money Besides

at preventing

school general

(pp.

not

applied

apply

competing

banks'

other

the

(p.

and 174

and

fiduciary centralized greatly

in chapter

in their

by

Bank hold

Walter

clearly

recognizing accept

reserves

adequate

concluding

they

difference

central

banking

which

never

would involves

of claims

adverse

on each

clearing

balances

a centralized

Britain's

and not

a dediffer

question

system

the

attendant

and

or comment

having

responsibilities

the and

them.

especially,

alternative up

anom-

have deliberately designed Britons had to make the best

for meeting

came

a compro-

banking

Smith

on central banking versus was necessary, for "the

over again

as adopting

its weaknesses its

chapter

the main arguments This reconsideration

without

business currency

and especially have a certain but

The

Bagehot

(p. 143). He found

of England

In her

assets might

XII). In practice,

alous-not what people would from scratch. But it existed, and of it by

of

the point of bank

results.

interprets

view

fallacy

the

note issue constrained by a fixed limit system with gold convertibility would

Smith mise

later

of

disturbing that the

for settlement

posed

supply

ignored overissue

system,

system.

demands

restraint

a

173-174).

to a free-banking

to a centralized

within a principle

to the

overlooking

the banking short-term

to finance

such

supply

The supposed principles of bankable of automatic reflux of excessive notes validity

loans goods

be quickly remedied without It was just such disturbances

aimed

to the notorious short-term, self-

of additional conducted

to market.

composition involved, that not even a merely notes can conditions.

industrial

marketing

match

coming

These, according quintessentially

Banking

properly

goods

assets. were

xlx

system

for discussion in all the

reconsiders free banking. superiority of

became and

later

was

a dogma accepted

foundations

of

xx

central ments,

THE

RATIONALE

OF CENTRAL

BANKING

banks" (p. 167). For answers to most of these the reader should see Smith's own discussion.

argu-

One argument against free banking is that the notes of a particular bank do not remain in the hands of the persons who dealt with it voluntarily, as by borrowing from it. Routine circulation thrusts them even onto persons scarcely in a position to discriminate between good and bad notes. The government should therefore impose some uniformity onto the note issue (p. 177). A second argument concerns monetary expansions and contractions, leading to inflations and depressions. "Any attempt to make a final evaluation of the relative merits of alternative systems of banking must look primarily to the tendencies they manifest towards instability, or more particularly to the amount of causal influence they exert in cyclical fluctuations" (p. 192). Opponents of free banking (such as Mountifort Longfield, discussed below) argued that aggressively expanding banks might impose the burden of restraint, or even the necessity of going out of business, onto more conservative banks (pp. 85-88, 177-178). A third argument holds a central bank better able than competing banks to command public confidence and to cope with crises, as by serving as lender of last resort (pp. 185ff). A fourth argument finds a central authority necessarv for a "rational" monetary policy (pp. 189-190); a fifth regards central banks _ essential to international monetary cooperation (p. 190). These last two arguments had become in Smith's time "the almost exclusively motivating reasons for the foundations of new central banks" (p. 192). Modern thinking tended to favor "intelligent planning" over automatic rules. A related argument presumably at work, as in the establishment of the Federal Reserve System in the United States, is one Smith does not state explicitly: other countries already have central banks. Why remain backward or out of step?

PREFACE

Nowadays, central fortable

furthermore, banks jobs.

Before ponder

are

Mountifort

calls

a system

ume

of business

bank

aggressively

who, of two

and

caused

banks

holding

that

and

com-

reform,

let us

important

contro-

reserve

its loans

doing

gold and

the

1840,

same

vol-

Now

one

Later

on,

reserves. note

85to

issue.

gold, let us say for export and resulting price inflation deficit,

the notes of the falls, rather, on of the

of February

initially equal

demanding expansion

present demand

gold

most

article

a balance-of-payments

selectively tion. This the

of monetary

far the

in an

expands

as the public starts after the monetary has

issues "by

to suppose

prestigious

in the theory of free banking" (p. 88; cf. pp. 197-199). She attributes the controversy Longfield,

imagined

reasonable

for providing

to specific

Smith

versial point 88, 177-185,

it seems

valued

turning what

ill

bank

that

the

public

guilty bank both banks. did

not

will

not

for redempAs a result,

increase

its note

circulation falls in greater proportion than its circulation. If this moderate bank wishes to restore its original reserve ratio, it must shrink its volume of business, which, however, enables

its

moderate

aggressive

bank

may

less it too expands To

banks and

gain

most

and

being

will suffer depression,

by

Smith One looks

flaw how

contraction

in Longfield's continuous by the

the

as the

un-

or

panic

in her

interpretation argument, expansion

moderate

period

many

note-

group

could

she

A system scarcely

concluding

may

says, group

will

cause

is that

be

chapter;

be in order

by one

exwill

of excitement

arrives.

prosperity

this argument and

several

during

to contract

examines

The

in self-defense. with

to a country's

restatement

further. altogether,

under alternations of business of high and low prices. A bank

expanding

quick

even

out of business

a country

more injurious devised. some

to expand

aggressively

generalize:

issuing citement

rival be driven

here. it over-

of banks

and

an increasing

xxii

THE

RATIONALE

proportion of the gold banks' reserves, which ate banks

have

on

and their val

the

during

granting

notes

at the

clearinghouse.

banks' rowers pay return one

bank

repaying

has

loans.

notes

them bank

to

to their

demand

to

the

repay the lag an inter-

expanding

for settlement

banks

issuers out

than

suffer

redemption

from

depositors

In a competitive

of rival

expands

stage

begin

of

be presented

them

the

through

the

with

the

drain

drain

of gold;

almost

bor-

no bank

clearing rest,

other

counter.

will

It will

process.

balances

it, and it will lose mechanism would

external

reserve

its own

of

the the

or from

system,

over

of step

clearinghouse will go against its rivals in settlement. This earlier

of loans,

amounts

his

of its own

customers neglected

repayment

nevertheless

as it receives

out the

the

was

bank

Longfield's argument considers only for redemption of notes. It overlooks

each notes

argument

expanding

as its borrowing of the argument

increasing

would

Furthermore, public's demand incentive

to an

and

which

on the expanding before the moder-

of business.

in Longfield's

flow

notes strand

bank's

out

flaw

return

other banks' loans. That

between

driven

minor

the

BANKING

outflow to impinge will be exhausted

been

A relatively stress

OF CENTRAL

If

at the

gold paid to work at an

the

bank

immediately

would (a point

stressed by Lawrence White and George Selgin, cited below). This effect comes in addition to the immediate arithmetical reduction _n the ratio of reserves to the bank's expanded

note

Smith's two

kinds

issue.

discussion

brings

of money,

bank

to mind notes

one

and

distinction

checking

between

accounts.

Pas-

sively and at least temporarily, the ordinary transactions member of the public will thrust onto him notes issued banks counts. ceived, banks

besides

his own.

He will which thev are

The

promptly will quickly drawn on.

same

is not true

deposit be

or

cash

routed

for

of checking any

ac-

checks

payment

of a by re-

to the

PREFACE If money gold

consisted

bullion,

exclusively

perhaps,

of checking

serving

as the

tion medium) and if all payments clearing process would operate way.

Unlike

checks any

some

portion

be

promptly

would bank

mand

expanding

for

xxili

were in the

of

bank

substantially

for

out be

dilutes

cess.

Not all notes

tion.

Surely,

or delays return

though,

In an economy

routinely lar banks, notes

free

relax

through

leading

the

issues

major

starting

of free

point

for the

slightly.

in other

re-

to concontinue

in their own an incentive

particuto send

clearing

process. assessment

and

re-

standard. This was clearly has in recent years been the

revival

of interest

in the

question

banking.

Many questions suggest themselves: money unit be defined? Should the dollar with

all other

able

in gold?

money,

with

kinds

of money

Should

the unit

the

money

bank

under

larly, kind

what should the of money in which

instructions

ultimately

redeemable?

the

States

United

money

only continue would

of monetary

lorm concerns the monetary implicit in Smith's work and

pro-

for redemp-

operating

cash receipts would have

then,

clearing

discipline

but

deand

accounts,

issuers

today, most money would accounts. Retail merchants

banks

of the

the

the

punished

of the

to their

and

with

promptly

discipline

banking

depositing their each of which

of other

One

notes

with

spects as it does sist of checking

the

quickly

all

settlement;

of step

restrained by adverse clearing balances. The coexistence of bank notes with bank somewhat

(with redemp-

made by check, the tightest conceivable

presented

in it would

and

notes,

its business

deposits

accounts

reserve

at all--and

supply to keep

or indirectly

dollar

the

(Federal central

by

price

Reserve

level

the

fiat central

stable?

Simi-

money be--the denominated and notes

Is it necessary bank

redeem-

of government

managed

base or dominant other kinds are

nowadays.) any

directly be the

How should the be defined in gold,

to issue

fill this role

to have and

any

manage

in

base it?

xxiv

THE

Nobel laureate authorizing the linked

with

ably

have

RATIONALE

F. A. Hayek (1976, issue of competing

his supervision influenced

and

George

Selgin

free

banking

and

well

as

deposits,

annual

entirely

Books

(1988)

survey

Lawrence

the

history

presumWhite

and

theory

to issue

probably

be

(1984) of

notes

as

denominated

in gold or in government base would have been frozen. The sev-

monetary

conference

D.C.,

in February

for

dissertation

by

of banks

would

either amount

to ideas

1978, 1984) has proposed private currencies. Ideas

freedom

which

in Washington,

BANKING

of Smith's

him.

propose

and redeemable money, whose enth

OF CENTRAL

radical

of the 1989,

monetary

Cato

Institute,

held

was

devoted

almost

reform

along

private-

enterprise lines; and a book of papers from earlier conferences (Dorn and Schwartz 1987) contains much discussion of similar themes. An idea (1983,

that

1989)

or exerting

seems

would any

special

system. But the count in which counts unit.

kept, which

its own quantity value, dle ble

control

to replace

dollar

operations. of gold. however,

this have would

be free new

unit.

to keep

defined

today's

banking

unsatisfactory fiat money.

unit

Each its notes take

by some

notes bank, and place

and faced

deposits not

by a specific instability in

a more services money

actual

bun-

nearly

sta-

in general. issue, banks

denominated

competition,

redeemable.

in the

it in

comprehensive

deposits with

The

by employing

possess

over goods and barred from

to issue

vices defining the amounts of some

and

define a new unit of accontracts written, ac-

new

would

me

money

The unit might be defined Because of gold's probable services

probably

the

and

issuing

money

bill of government

promote

a unit and

Greenfield from

the

so forth,

and

purchasing power With the government

would

over might quoted,

would

of goods

to Robert

government

government prices are

is the

government

promising bar the

in would

Redemption goods

and

ser-

unit but indirectly instead, in equal-valued convenient medium, possibly gold but

PREFACE

probably

designated

securities.

xxv

Routine

interbank

settle-

ments at the clearinghouse, as well as arbitrage, would quickly reverse incipient deviations of the price level from what corresponded to the unit's commodity-bundle definition. The ordinary member of the public would need to understand the system's details no more than he needs currently to understand Federal Reserve operations. Far from involving the textbook inconveniences of barter, the proposed system would feature a well-defined unit of account. Freed from the restraints that nowadays seem necessary to maintain, more or less, the value of the government fiat dollar, financial innovation would flourish, bringing a payments system more convenient than the one we know today. Market forces would make the quantity of money accommodate itself to the demand for money at the stable price level corresponding to the unit's definition. This self-regulation of the money supply would bring decisive advantages in macroeconomic performance. Here is not the place for a full analysis of these issues. My point is that academic discussion of radical, private enterprise-oriented monetary ideas has become respectable again. Public discussion and political feasibility may follow in time. Vera Smith's scholarly review and judicious assessments of the experience and theory that bear on the issues of free banking and central banking nent role in the ongoing discussions. Leland B. Yeager Ludwig von Mises Distinguished Auburn University

should

play a promi-

Professor

of Economics

xxvi

THE RATIONALE OF CENTRAL BANKING

References

Dorn,

James

Money,

A., and

University

Anna

J. Schwartz,

of Chicago

editors,

Press,

The

Chicago,

Search

fi)r

Stable

1987.

Ente per gli Studi Monetari, Bancari e Finanziari "Lulgi Einaudi," Moneta, Dualismo e Pianificazione nel Pensiero di Vera C. Lutz, Societa Editrice

il Mulino,

Bologna,

Greenfield, Robert L., and to Monetary Stability," 15:302-315,

August

1984.

Leland B. Yeager, "A Laissez-Faire Approach Journal Qf Money, Credit, and Banking,

1983.

Gusman, Ente...

Rosaria Giuliani, "Note Bio-bibliografiche Einaudi, 1984, pp. 89-110.

Haberler,

Gottfi'ied,

"Vera

e Friedrich

Lutz.

economisti dei nostri tempi," in Enle Hayek, Friedrich A., Choice in Currency, Occasional

Paper

48, London,

Friedrich

Siegel,

editor,

Research, Cambridge, Schwartz,

A., "The Money

Future

Anna

School,"

The

and

J., "Banking New

School,

Palgrave,

of _donev,

Pacific

graphie,

1987,

Verena, vol.

Ballinger

White, Lawrence H., Free Press, New York, 1984.

for

coppia

di

47-53. Affairs,

School,

Lutz,"

Neue

of

in Barry

N.

Policy

Company, Free

of Economics, Rowman

Institute

Public

Publishing

Currency

August

ed.,

Unit of Value,"

A Dictionary

"Friedrich

15. pp.

2d

Institute

Press, New York, 1987, vol. 1, pp 182-185. Selgin, George, The Theory of Free Banking, Totowa, N.J., 1988. Velt-Bachmann,

famosa

. . . Einaudi, 1984, pp. Institute of Economic

Monetary

in Crisis,

San Francisco, Mass., 1984.

Una

in

1976.

Hayek, Friedrich A.. Denationalisation Economic Affairs, London, 1978 Hayek,

(1912-1976),"

Banking Stockton

&. Littlefield, Deutsche

Bio-

565-567 Banking

m Britain,

Cambridge

University

Yeager, Leland B., and Robert L. Greenfield, "Can Monetary equilibrium Be Eliminated?" Cato Journal, 9, Fall 1989.

Dis-

Publisher's

The

publisher

and

Mr.

ter's book invaluable. The

would

like

A. _A'ilson-Smith back

Rationale

to thank for their

into

print.

of Central

by P. S. King

and

subtitle

and

Banking

reflect

the

For this

breadth

and

Their

Brenda

was

of the

their

assistance

has

originally

Alternative

edition,

K. Fowler

in bringing

Son in London. spirit

LibertyPress

Mrs. help

Banking

in 1936

the Free

Note

sisbeen

published

_*e have to more

added

the

adequately

work.

we have

newly

set the

type.

Obvious spelling errors have been silently corrected. Footnotes are now numbered consecutivelv within each chapter. Otherwise, the text and the footnotes have been retained and

styled

however,

as they has

original edition have provided

following

in the

original.

significantly

included only full bibliographic

tance in providing French, German, the

were

been

enhanced.

Professor

bibliography, Citations

on American, we would like

Lawrence

White

versity of Georgia, Professor Philippe Natal of the of Paris, and Dr. Reinhold Veit and Mrs. Wendula owstroem of the Walter Eucken Institut. A new, has

been

prepared

for this

edition.

xxvii

in the

last name, title, and year. We information. For their assis-

this information and Italian titles,

scholars:

The

English, to thank of the

Uni-

University v. Klinckfull index

Foreword [to the

This the

essay

is a study

development

note issue was of laissez-faire

It has

been

of the

Edition]

historical

of Central

and

Banking,

the

analytical

bases

reasons

of

why

the

made the exception to the general application principles, and why Central Banking was

adopted in preference in the note issue.

gree

Original

submitted

of Doctor

to "Free and

of Philosophy

Banking"

approved in the

with

competition

as a thesis University

for the

De-

of London.

My grateful thanks are due to Professor F. A. von Hayek, who first suggested the topic as a subject worthy of research and

gave

like also ish

me

Library

some

valuable

to acknowledge

of the

of Political less

easily

advice

on

occasions.

assistance

given

and

Economic

Science

accessible

London October

many

the

I should

me by the

material. Vera

1935

xxix

Brit-

in obtaining

C. Smith

THE RATIONALE OF CENTRAL BANKING

CHAPTER

I

Introduction

In the present centurv centralised banking systems have come to be regarded as the usual concomitant, if not one of the conditions of the attainment of an advanced stage of economic development. The belief in the desirability of central bank organisation is universal. Recently also there have been attempts to widen the unit of control in the movement towards international banking institutions and international co-operation between the already existing central banks of the separate countries. There is, however, a noticeable lack of any systematic examination of the bases of the alleged superiority of centralised banking over its alternative. Practically all the discussion on the relative merits of a centralised monopolistic banking system and a system of competitive banks all possessing equal rights to trade, took place in a period of some forty to fifty years in the nineteenth century, since when it has never been reopened. In that period, however, the subject was one of the most keenly debated of its time. This is especially true of France, and indeed the period of about twenty years during which French thinkers occupied themselves with this problem is perhaps the most productive of any in French economic literature, both from the point of view of output and from the standpoint of its quality in comparison with that of other countries in the same years. In the twentieth century most countries have finally decided in favour of a central banking system, but in the nine3

4

THE

teenth the

century

(at least

Continent

and

tem

as it stood

not

seriously

of dispute take. were

RATIONALE

the

as to what

banking

gory.

Even

sort

possible willing was

BANKING

again,

of form

date--it the

already

especially

England,

of the Bank that

sys-

Act of 1844

was

was

still a matter

system

theories industries

regarded

doctrinaire

on

the

banking

when laisser-faire so far as other

most

most

States--in

passage after

was

the

to 1875), United

challenged

It is notable that at their height

cerned,

up

in the

after

OF CENTRAL

should

and politics were con-

as in another free-traders,

cate-

with

the

exception of Courcelle-Seneuil in France, were unto apply their principles to the business of banking. It

widely

some

contended

special

regulations should eral decades. Very

that

regulations,

little

take

attention

erature

to the

system

of banking

banking

must

although remained

has

been

consideration that

what an open

paid

of the we

be the

have

subject

precise

form

question

in modern

of

these for sev-

economic

lit-

rationale

of the particular

succeeded

in evolving,

in

the light of the progress that has been made in economic science since the time when the problem was in the forefront of discussion.' The actual discussion which did take place

is, moreover,

fathers gland,

one

with which is surprisingly

authorities

of the

controversies

responsible

for

introducing

countries previously without them the benefits-to'be obtained therefrom. It is the that have

purpose in the

banks

to discover

ing

and such

motives.

of this past led An

the

our

decision

in favour

to a free

banking

system

recent challenge und Konjunkturpolitik,"

central have

any

theoretical

clear

of the

reveals

zs that made 1928.

by

of

in

for

the

as opposed

countries Mises

idea

underly-

reasons

banking

in most

into

the motives of central

foundations

of a central

fore-

in Enthat the

banks

essay to investigate to the establishment

examination

eventual

'The only stabilisierung

among

this generation, more especially unfamiliar. Neither do we find

a combihis

"Geldwert-

INTRODUCTION

nation of political motives and historical accident which played a much more important part than any well-considered economic principle. The exact significance to be attached to the terms "free banking" and "central banking" will become clear in the course of the argument, but for the present we shall summarise the problem in the following questions: Is it preferable that the note issue should be in the hands of one single bank, or at any rate a definitely limited number of banks specially authorised to undertake it, and among which one bank holds a position of sufficient predominance over the rest as to be able to exercise some control over them, or is it preferable that there should be as many banks of issue as find it profitable to enter the note-issuing business? Further, if this latter alternative is affirmed and plurality is allowed, is it necessary to impose special requirements, such as a prior lien on assets or the deposit of bonds, to protect note-holders from the consequences of bank failures? Secondly, even if the issue of notes is restricted to a single bank, should there not be freedom for the foundation of banks of deposit exercising no rights of issue? The question may be put still more generally: Is it necessary in the interests of sound banking and a stable currency to impose special restrictions, other than those imposed on all business corporations under the company law, firstly, on banks issuing notes, and, secondly, even providing the answer to this is in the affirmative, on banks of deposit which issue no notes? This was the historical approach to the question as it presented itself to the writers of last century. The place of primary importance was given to the first problem of the note issue, and it is to this that we shall devote most attention. Our plan will be first to sketch the decisive events, relevant to our main topic, in the history of banking and credit in the leading countries, and then to examine the arguments of both sides in the theoretical controversy.

6

THE RATIONALEOF CENTRAL BANKING

So far as English were quite clearly the

system,

once

threatened. Scotch the

banking is concerned, drawn at a comparatively established,

Scotland

system

never

is of particular

was

free-banking

markably

was

quoted

school

successful

broad outlines early date, and verv

interest,

by

practically

as the

conclusive

functioning

the

seriously

because

every example

of the

the

member

of

of the

system

they

re-

advo-

cated. The United States of America were likewise cited by the protagonists of the central banking school as the clearest disproof

of the practicability

rather

later

than

a centralised ries

England

banking

of moves

and

favour of the the discussion

of any

such

in finally

system.

and

went

before

same plan in 1875, but to consider Germany

appropriate

many

did not form

to consider

of the

subject

was

a unit

the

till 1871.

practically

In

our

study

years of the of

The

ous

on those stages

secondly,

facts,

which

States,

by 1875,

chronological

firstly,

to other

mark and

aspects

agement and interference in banking The chief interest of any theoretical of the part

banking

it may

nomena to consider evolved

system

in the

be assumed

of booms some

by the

and

Ger-

by which

time

to assume a far points of interest

choice

at variand,

of Government

man-

causation

We shall of trade

in the Free

of the the United be concen-

of the

place

lies

in the

economy

in the

depressions. theories

the

to

competition, in general. treatment

general

to play

of the

disputants

since

discussion

development

which

monopoly

refer

in

later in the debates preliminary Federal Reserve System.

the

between

a se-

deciding

theoretical

banking systems of England, Scotland, France, States and Germany, our main emphasis will trated

adopting

here it rather distorts as a whole, and it is

the question of the standard had come greater importance, but in America several were raised some the establishment

was

through

at last

separate

closed

France

irrevocably

Germanv

countermoves

more

system.

Banking

of the have

cycle versus

phe-

occasion causation Central

INTRODUCTION

7

Banking controversy. Both sides produced evidence to show that financial and industrial crises were not the fault of the particular system they advocated. The most satisfactory theory yet offered in explanation of booms and depressions, however, is one which at that time was undeveloped and which finds the perpetually disequilibrating force in monetary disturbances expressing themselves in a divergence between the "natural" and market rates of interest and between voluntary savings and real investment. This divergence is in some way connected with bank policy, and the question then arises: How can banks continuallv act as disequilibrating forces? It might be supposed that if banks made mistakes as a result of which they sooner or later found themselves in difficulties, they would in future act differently on the basis of their revised estimates of their opportunities. Such we should expect to be the consequences, provided the banks had to submit to the full effects of their acts. One of the questions which must be put is whether this responsibility condition is not too often shelved by certain features of the particular system of banking organisation which has been favoured bv the modern world. While recognising

that the maladjustments

mav be due, not to the

specific tbrm of the banking system, but rather to at present unresolved technical difficulties, common to any system, in maintaining equilibrium between savings and investment, or in stabilising the effective quantity of circulating media, it seems not improbable that the tendencies to misdirection are magnified by the form of the system, part of it which entrusts the determination

in particular that of the volume of

credit to a single authority, between which and the Government there exist reciprocal incentives to paternalism. It is not unlikely that the bolstering up of banking systems by their Governments is a factor which makes for instability.

CHAPTER

The

I!

Development

of Central

Banking

in England

It

must

posit

have

banking

been

so in England sterdam. with the

and

coin

in the

and

received

had

won

culating large

bullion

that,

chronologically,

of notes. banks

At least

at Hamburg

a banker

more

in exchange

such

form of a mere receipt, to hand. And it was only

the

public

over

notes

that

sums

early

with

their

Moreover,

issue

on deposit bankers

dethis

was

and

Am-

in general only became important of the issue of notes. People would

something

originally in the passed from hand

true

the

But banking development

deposit they

generally

preceded

to confidence the

public

on the could

lend

banks

by

persuaded

of a mere out

when

which could be ariel- the bankers

in the was

security

only

readily

as a bank-note,

any

cir-

to leave book-entry.

great

part

of

what was dei_osited with them if they could pay out notes in case depositors should suddenly want more cash. And so it was

that

to be

when

made by had been It was problems ened

the

generally

most

those most

advantages

of deposit

recognised, countries widespread.

in note arose, strongly

the where

the

then,

that

issuing, and

it was

here

to establish

banking

most

that

rapid use the

came were

of bank

currency

earliest

banking

Governments

monopolies 8

first strides

under

threatthe

sys-

THE DEVELOPMENT

OF CENTRAL BANKING IN ENGLAND

9

tem of concession by charter. When banking was in its infancy, doubtless many mistakes were made,' and there was some justification for a Government's interfering at least to prevent fraudulent operations. And it is very relevant here to point out that when banking was making its first experiments, industry and trade were only just being weaned from mediaeval protectionism, and it took at least a century for the new system to organise a commercial code for largescale enterprise. The practical non-existence of company law in general before the nineteenth century was especially serious in spheres touching the currency of a country: what damage could be done was likely to have particularly widespread effects, since the whole population dealt in money. But it must be admitted that it is almost certain that by far the most powerful reason leading to the maintenance of Government intervention in the banking sphere, at a time when it was on the decline in other industries, was that power over the issue of paper money, whether such power is direct or indirect, is an exceedingly welcome weapon in the armoury of State finance. As deposit banking became, from about the 'thirties of last century onwards, more important relatively to the issue of notes, the dispute that had arisen about monopolies in the note-issuing business tended correspondingly to diminish in importance, although it could not fall entirely out of the discussion because of the intimate connection between the two branches of the banking business. Deposits must always have at the back of them a sufficient reserve of currency, and therefore the total amount of currency must be a major factor in the determination of the total volume of deposits that can be created through the lending operations of the banks. Thus, if a central banking authority controls the issue 1 Under complete freedom good banking depends not only on the ability of the bankers, but also on the public's having sufficient knowledge and experi+ ence to detect the good from the bad, the genuine from the fraudulent.

!0

THE RATIONALEOF CENTRAL BANKING

of notes, credit.

it also

Assuming

controls,

that

countI\V'S alternative

though

a paper

currency

a) It may

be subject

to the

delegated

free

The

private

latter

of a single

It may mav

be

entirely

exercise

control

the

volume

control

control

to a three

of the

State;

of a single

private

of a large

number

competition

institution

may

take

independent

of the

over

by taking

it either

of

adjunct

we may conceive may be undertaken:

exclusive

to the

c) It may be left to the of banks of issue. system

rigidly,

is a desirable

commercial development, ways in which its issue

b) It may be institution;

forms.

less

various

State,

or

the

a share

in

its capital and thus entbrcing its will through its representatives on the directorate, or by subjecting it to the dictates, matters when

of general

policy,

system

is nominally

the

of a Minister free

ever, history shows that virtuallv difficult tor the bank to maintain. Also the framework vocates

plural system within which

of a free

regulations; a well-devised Again trolling

we

should

where

has

it is the centre

certainly

who

holds

the

swings 1875

can

roughly

of policy under

four

the

of a so-called major

power, bv the some

summarise in the

control,

a right

will

favoured

case

an absolute

phases.

State

howbe very

certain

assumed that the general law would be sufficient.

is to some extent qualified other institutions exercising side narrower limitations. We

such

have

distinguish

instittltion

from

in

Even

may varv in the nature of the legal it functions. There have been ad-

system

others have company

of Finance.

The

mixed but

first

clauses a single

from

system

in which

course of banks

was

of con-

the

case

in which

it

its monopoly

existence of a number of the same functions the

evolution

where

monopoly

special

of

events

of issue

a preliminai[v

of inand

before period

THE

when were

DEVELOPMENT

banks were theoretically

because

they

of the

legislative

either

absolute

OF CENTRAL

BANKING

IN ENGLAND

only just beginning to emerge, and at liberty to form freely even if it was

were

not yet obtrusive authority.

In the

or to some

enough second

extent

to catch period,

qualified,

the

return

solute or along tion of control. This

to restrictions

the

scheme

lines

and

of a mixed

was

is more

or

less

the

and increasThe tourth either

with

representative,

Let us now fhcts

topic.

turn

became

merchants lion with

with

differ-

tor

of banking the middle

on

rates,

the

on loans

many

are

which

other

second

since

receipts

on

to rely from

they they

period

the issue control.

in

foundation of the Bank by an event of a rather had

England,

of the

histor-

relevant

to our

produced

what

countries. sense are century,

could gave

began to circulate of small private

rights, and carrying free from Government

had

account

that

in the modern of the seventeenth

deposits,

and

of the deposits arose a number

The

detailed

France

to be when

took to depositing their balances of coin and bulthe goldsmiths. The goldsmiths then began offer-

interest

higher

with

a model

The origins found in about

more

development

We commence

later

ing

to the

of banking

ab-

centralisa-

ences as to dates, of the course of events in England, and Prussia. Scotland and America fall outside it. ical

eye

dominant.

monopoly,

system,

they only

monopoly,

The third phase was characterised by plurality ing liberty, but by no means complete freedom. witnesses

1l 1

London

large

of notes

extent

at

dating

and

from

heavily

the

ushered Charles

for his financial He ran

thus equal

unrestricted

banking,

bankers.

them

as money. There firms, all having

of England in 1694, was fortuitous political nature.

to a very the

English

re-lend

in acknowledgment

in II

needs into

debt

and in 1672 suspended Exchequer payments and therefore the repayment of bankers' advances. The King's credit was thereby

ruined

for several

decades

to come,

and

it was

to

12

THE

provide

a substitute

destroyed

that

the scheme foundation and

RATIONALE

OF CENTRAL

for the

William

sources

III and

BANKING

of accommodation

his

Government

Company

of the

Bank

of England.

"for the better raising sum of £1,200,000."

The

early

favours

history

between

In the

a capital

and

of the

Bank

a needy

ing corporation. with

Its establishment

paying was

amounting

issue

niments renewed

of so many

the

notes

and

accompa-

privileges

of the

Bank,

therefore

its note

issue,

paid

be

that

no

through

bank

the

should

allowing and

also

of the Government all sums due to the

to its prestige.

other

was

Government

the

must

provided

usual the

and

considerably

founded sum

extended

Government added

was same

its capital

of the possession that henceforth

of

in return the Bank amount. 2 This sud-

1697

giving it the monopoly balances by ordering that

Exchequer

an accommodat-

all the In

of as

of exchanges

This

and same

produced

inflation.

the

Bank

to £1,200,000.

of a currency

it to increase

into

and

instance,

was

many clauses minor event,

a series

Government first

immediately lent to the Government was authorised to issue notes to the den

in with

of a financier by the name of Patterson for the of an institution to be known as the Governor

described by the _nnage Act, among the which its incorporation looked an absurdly being of the

thus

fell

Bank,

a provision

Further, ever

it was

establish

also

itself

by

the the

method of acquiring a special Act of Parliament. Lastly, Act stated that no act of the Governor and Company of

the

Bank

ture

the

member

of England particular of the

was

to subject

private

and

corporation,

or make personal

a clause

which

the privilege of limited liability. This was to be denied to all other banking other one and a half centuries. It was See

just

2 In practice Feavearyear,

about

this

time

that

the

the liabilities on note issue were "The Pound Sterling," p. 118.

liable

to forfei-

property

of any

bestowed

was a favour associations new not

type

restricted

on it which for an-

of business to this

amount.

THE DEVELOPMENTOF CENTRAL BANKINGIN ENGLAND entity known as the joint stock and it was therefore an obvious the Bank's sort

of

which

already

privileged

monopoly was

business

in this

in so many

that

This

effectively

issuing

and,

than

joint

since

with

business altogether. More than the application of the prohibition than

the

issue

In 1713 for a loan loan

of notes

was

less

to be

obtained

banking

business,"

the now customary out interest. After ministration renewal £110,000. 1781

of the

the

beginning fited the from the

no

charter the

same

of the less

National

short-term course

the

note-

was

held

from

banking

Debt.

before other

question.

again resources

additional

in return for the

capital,

in 1800. seven Bank

In short, century

times

by the

of England,

accommodation of its daily

the

to an increase in its its privileges of"ex-

again

accompanied

this time entrusted In return

for

between the

by

a loan withwith the adthe

the Bank paid the Government another renewal and another

nineteenth

than of the

ordinary

was

loan transaction, 1751 the Bank was

of its charter There was

and

and

days

into

Bank gained at the same time the right note issue. The 1742 renewal reaffirmed clusive

from

issue,

issue

six months.

a century was to pass to banking business

raising

of

Bank's

might

in those note

to be called

by

the

than

firms

the charter was further renewed, to the Government, and as the

were

some

old forms

in 1709

six partners

banking

synonymous

it with

it to raise its capital the relevant Act

time

stock

hold, of

of organisation, to the

when

or at any

excluded

business,

superior

of more

at demand

to be practically

to endow

besides allowing to the Government,

no firms

payable

was taking reinforcement

type

Accordingly,

charter was renewed, in return for a loan notes

position particular

respects

association.

specified

company step in the

IS

1694

Treasury

and

had

successive

renewals

3 and

quite

given

this, by

the

1764

a fee of loan in the

beneof apart

Bank

in

transactions.

_See MacCulloch, "A Treatise on Metallic and Paper Money and Banks," p. 42.

14

THE RATIONALEOF CENTRALBANKING The

result

of the

accumulation

of an

was to give the Bank of England influence in the financial world vate

banks

pete

in

to experience

the

same

majority of private about 1780. A further gan

to adopt

the

The

period not

of the

torce

because

note issues effect was

had that

of keeping

ultimate

in

balances

it provides

to com-

London

with

beginning

the

the

from

pressure

on

the

of the

by beBank

to acquire our

point

an outstanding

consequences

and pri-

been abandoned the smaller banks

is interesting

because

of Government

the

and

was thus already of a Central Bank.

1797-1819

only

of privileges

in continuing

of business,

practice

of England, which the characteristics

view,

difficulties

lines

arrav

a position of prestige such as to cause small

of

example

Bank,

but

also

Government's

pol-

icy towards the Bank were to add to the latter's influential position in the country's banking system. Soon after the outbreak of the French War, Pitt had to ask for advances from the

Bank.

advances

Now

the

to the

Bank

Act of 1694 had

Government

without

tion of Parliament. For a long time theless been advanced on Treasury Bank.

The

doubtful;

legality

of

so in 1793

a Bill indemnifying made such

they

time

in getting

neglected came

tion, asking

should

be kept

Pitt

the

the

been

to the

liability

for

seriously Bank

to keep

authorisa-

clause,

neverat the

regarded

as

Government the

loans

but so that

to comply

for it had

to continue however,

figure.

Parliament,

compelled

Pitt lost no very the

usefully Bank

with

beGov-

to any amount. By 1795 these so excessive as to affect the foreign endanger

directors down

a certain

limiting

virtually

requirements had become and

and

had

applied

below

the Bill through

henceforth

exchanges

Bank

express

and giving it legal authority in the future, on the condition,

to insert

ernment borrowings

the

the

it to make

small amounts had Bills made payable

practice

it against

in the past transactions

that

this

forbidden

his

the

Bank's

reserve

posi-

appealed

to the

Government

demands

on

Bank,

the

and

at

THE

the

same

What

DEVELOPMENT

time

it contracted

Pitt did,

itate the of small sued

however,

BANKING

discounts

was

to take

IN ENGLAND

to private

15

customers.

all possible

steps

to facil-

Bank's lending to the Government. The old dislike notes was thrown to the winds: 4 £5 notes were is-

for the

issued

OF CENTRAL

first

in 1797

time

in

in order

junction

with

another

pension

of the

1795,

and

to provide measure

payment

small

of that

in cash

£1 and

£2

notes

were

currency

year,

of the

in con-

namely,

Bank's

the

sus-

notes.

This

suspension of cash payments was procured ment by Act of Parliament in order to meet

by the Governa critical situa-

tion

at a time

in which

it already

the

had

ernment's

Bank

was

faced

by a "run"

weak

reserve

an extremely

action

amounted

position.

to a legalisation

when

The

of

the

Govbank-

ruptcy of the Bank, and it created a precedent which led the public in future always to expect the Government to come to the aid of the Bank in difficult circumstances. We cannot

here

enter

upon

tion of causes other than Bank's difficulties before the expansion of credit take under Government itself deal with must

a cause, with

also

these

an outflow of be a contraction

Throughout pound after in bank

that the pressure

have

other

finance,

purposes

the

cepted

4 The issue issue of notes

Bank's

the

method

whatever

were

par.

Bank

of England of legal

not officiallv

of notes for less

Finally

contribu-

capacity

so declared

in

1812

for sums less than than £5 m 1777

the £1 had

prior

it arises, of the increases notes

been

forbidden

had

tender

cur-

to 1812,

payments, and they were usuallv Government

to

of dealing

cause

character

they were taken in all Government partly out of patriotic motives, at

the

the period of the rapid depreciation 1800, when there were phenomenal for war

They

since

specie, from of credit.

credits

since haps

of the

Bank was forced to undermust, besides having been

weakened

causes,

for all practical rency.

a discussion

the Government borrowings, to the 1797. Let it suffice to remark that

but perac-

declared In 1775

and

the

16

THE

RATIONALE

OF CENTRAL

BANKING

them to be legal tender for all payments. These events had important effects on the position of Bank of England notes in the country. The country banks began to look on them as backing for their own note issues, and in many parts of the country they took their place in the local circulation for the first time. Another effect of the war experiences was to give the impetus to the first detailed discussion of banking and currency, ushered in by the report of the Bullion Committee, and continued with unlagging vigour till well over the turn of the half century. There is no doubt that the release of the Bank from its obligation to pay in cash proved very profitable to it. The Bank's interest in the suspension was stressed by several later observers. Gallatin remarks _ that its declared dividends rose from 7 percent dinary profits,

to 10 percent, besides £13,000,000 of extraorand Horn writes 6 that on the morrow of its

resumption of cash payments its shares The return to more or less normal brought

with

it, already,

a tendency

fell 16 percent. conditions in 1819

to regard

the

Bank of

England as a regulating institution holding some special position of duty in the currency and credit system of the country, and, indeed, the Bank directors made a representation to Parliament protesting against what they regarded as an attempt to establish a system which would place upon them the responsibility "for supporting the whole National Currency.' '_ Despite the fact that the Bank of England note ceased to be legal tender, the country banks tried to keep their customers to the habit of taking Bank of England notes in lieu of gold, and there was by this time very little gold left in the provinces. The country banks still needed gold to cash their own 5 "Considerations 1831, p. 47. "La Liberte des : See "Parliamentary port No. 338.

on

the Currency

Banques," Papers,

and

Ranking

1866, p. 301. Reports from

System

Committees,

of the

1819/'

United

States,"

Vol. III.,

Re-

THE

small notes,

DEVELOPMENT

since

OF CENTRAL

BANKING

IN ENGLAND

the Bank did not issue notes

below

17

£5, but

in case of extra strain, the Bank's stock of gold in London had already become practically the sole source of supply. Furthermore, the country banks were coming to expect the Bank to lend to them in times of stress. At such times when the notes of country bankers lost their acceptability, the public showed no hesitation in taking the notes of the Bank of England, and meet an internal

these drain

served just as well as gold coin to of cash. In the 1825 crisis the Bank

was at first hesitant about assisting the country banks, but after a week or so turned round and lent freely to them. It assisted not only with gold but also with the re-issue of the £1 notes that had been in circulation in the restriction period, since £5 notes were unsuitable as everyday currency for small transactions. The blame for the 1825 crisis was laid on the country banks and their issues of small notes. There were at this time between seven and tence, and between

eight hundred of these banks in exis1810 and 1825 about one hundred and

fifty of them had become bankrupt. There emerged an agitation in favour of allowing joint stock banks, other than the Bank of England, to set up, on the grounds that the present private concerns of not more than six partners were too small to be solid and that joint stock companies would be much stronger and more stable. It was pointed out that not only were small groups of inexperienced traders allowed to go freely into the banking business, but that under the existing law it was only these who could do so, and that if concerns with greater financial backing could set up, they would drive out the bad firms. The prime mover in the campaign for joint stock banking was Thomas Joplin, whose pamphlet of 18223 called attention to the great success of the Scotch system, and who was later to take a leading part in "The Scotland."

General

Principles

and

Present

Practice

of Banking

in England

and

18

the

THE

foundation

RATIONALE

of the

OF CENTRAL

National

BANKING

Provincial.

The

Bank

of En-

gland opposed the proposals relentlessly and countered them by suggesting that it should set up branches itself in the provinces. Lord Liverpool and his colleagues replied that the proposal of the Bank for establishing branches would not be sufficient to provide for the needs of the country. Incidentally, Liverpool," in trying to persuade the Bank that an improvement in the country circulation would be to its own advantage, hinted at the growing tendency for the Bank of England to become the centre of a single gold reserve, the sole depository for gold in times of favourable exchanges and the sole resort for obtaining it in the opposite circumstances. The success of this campaign marks the beginning of a third period, a period of increased liberalism in English banking. By the 1826 Act joint stock banks were permitted to establish outside a sixty-five mile radius from London and the Bank of England was authorised to set up branches. The presumed evil of small notes was met by an Act of the same year prohibiting the issue of notes of lower denomination than £5. By this time it had become obvious that banking business did not consist solely in the issue of notes; nor was this necessarily the main department of banking. Another branch of banking had taken root and was awaiting further development: deposits subject to draft by check were already an important feature of the commercial world. The urgency of the demand for the free right to issue notes therefore subsided into the now more important need for greater freedom in the establishment of deposit banks. It was decided that the charter rights of the Bank did not include any monopoly of deposit banking, and in 1833 the Act for the renewal of the _' See his letler Io the Governor Horsley Pahner m his "Causes and Market," 1837

of the Bank Consequences

of England (1826), printed by J. of the Pressure on the Money

THE

Bank

DEVELOPMENT

Charter

OF CENTRAL

accorded

the

BANKING

permission

IN ENGLAND

for joint

19

stock

banks,

not issuing notes payable to bearer on demand, to set up in London. The first bank to set up under the new provisions was the London and Westminster, Joint Stock Bank, the Union Bank don

and

The der

County

1833

should

by

serve

made

the

maintain

to strengthen

Bank)

their the

a single

Bank

of England

notes

above

£5 so long

convertibility."

tendency

reserve

demands,

banks

paid

were

presented,

mate

demand

it was the

not

The

towards

system

especially

out Bank

of England

a very

of keeping

came

the

country,

holder but

Between of issue been that

1826 had

1836

during

the

and

then

1839. Governor

gold

1(,All these banks were at the beginning ited habihtv was nol allowed them before

ulti-

From

this

to adopt

reserves

whole

stock

banks

and

seventy it was

of

blamed

unlimited 1858

the

from

England, liability

Causes

and

Consequences

of the

Pressure

on

the

had

on these

companies;

Mone

cri-

Horsley

1_ and

11 It also secured the final abohtlon of the Usury Laws. The Bank exempted fi'om them so far as borrowing was concerned, in 1716, but until 1833 that it was free to charge what rates it thoughl fit for loans itself _2"The 1837.

in

of the

joint

especially

Bank

notes

the

looked to get the Bank be-

about

system

came

of the

of

reserve.

years,

banking

own

banks

reserve

of these

last three

Criticism

re-

country

and

they way

a hundred

and

of a freer

their

of their

(cash)

about

the

for the

part

of the

was

Bank

of England.

to which In this

banking

tounded,

opponents

ses of 1836 Palmer,

and

when

Bank

greater

only

of the

been

formed the

not

also

the

metallic

of the

withdrawn, step

at the Bank necessary.

the

of panic,

notes

tar or unnatural

the form of balances Bank notes whenever

of this

hands

ten-

as they

on hand at all ordinary £5, but in times of extra

deposits

fell on the

legal

result

making

in the

in times

or their for gold

practice

the London and the Lon-

for sums

England. Gold still had to be kept times for making payments below heavy

by

Bank.'"

Act also

(except

followed of London,

the lim-

had been _t was not it granted 3 Market,"

20

THE

question ments in England tee 1_had whether ments in that prior tendency circulation,

RATIONALE

OF CENTRAL

BANKING

was again raised of the relations between movethe country bank-note circulation and the Bank of note circulation. The 1832 Parliamentary Commitbeen unable to reach any definite conclusion as to or not the country issues usually followed movethe Bank of England issues. Palmer now contended to 1836 the Bank of England had followed up any to an outflow of specie with a contraction of its but that what should have been the influence of

this policy had been rendered nugatory by the imprudent credit facilities and low money rates occasioned by the issues of the joint stock banks. He claimed that between 1834 and 1836 the issues of the joint stock and private banks in the country had together increased by 25 percent, and that this had led to a continuous export of bullion until the Bank had finally been obliged to raise its discount rate, an event which had caused the stringency on the money market in 1836. It was also his opinion that banking provision had been adequate under the system of private banks existing prior to 1826, and that in face of this it was dangerous to encourage the formation of additional joint stock banks. He thought the merit of the private banks had been grossly understated. "Nearly eighty private banks suspended their payments in 1825," he says, "yet no stronger proof could be afforded of the really substantial state of the country banks at that time than that a very small proportion (it is believed not ten) proceeded to bankruptcy." Palmer's allegations evoked a somewhat ironic reply from Loyd, TM who failed, he said, to find in the Bank's accounts sufficient evidence of Palmer's contention that

the Bank

13 Report 1831-2.

of

the

the

had, during

Committee

of

the years

Secrecy

14 Reflections suggested by a perusal "Causes and Consequences of the

on

of Mr Pressure

the

Bank

under of

discussion,

England

Charter,"

J. Horsley Palmer's pamphlet on on the Money Market," 1837

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

21

kept its securities constant and contracted its circulation when specie diminished. He found rather that the reverse had been the case, and he very much doubted whether the joint stock banks had the power to extend their issues for any length of time should the Bank of England carry out a "regular, steady and undeviating course of contraction." Loyd was claiming that the central issuer, whose notes were now looked upon as reserve money by the joint stock banks, had both the power and the duty to control the action of those banks, while the Bank directors still refused to accept that responsibility. Loyd and his followers considered at the same time that the indirect power of control of the Bank of England was insufficient because the country note issuers were late in following up contractions by the Bank of England. '_ Most of the discussion after this time centred round these problems of central bank policy and the effectiveness of the control it had over the total circulation and the necessity or lack of necessity for limiting note issues to a predetermined figure. In England the currency and banking controversy tended to overshadow the wider issues of free banking. The two problems were, of course, not entirely independent, and their interconnections will be considered in a later chapter. All that concerns us here is that it is the final victory of the currency school in 1844 which brings us to our fourth period and the decision, at least in practice, in favour of a central banking single reserve system. It was the 1844 Act which ensured the ultimate monopoly of the note issue in the hands of the Bank of England. It provided in the first instance that the Bank of England's fiduciary issue should be limited to a figure of £14,000,000. The other banks of issue at that time in existence were to be allowed the continuance of

tion year

_5 See his "Remarks on the management and conduct of the Bank of England 1839 "

of the circulation and the Country

and on the condiIssuers during the

_2

THE RATIONALEOF CENTRAL BANKING

the

right

fixed

to issue,

in each

reached

but

case

in

the

rights

were

were

absorbed

limit

average

just

preceding if they

another

rights,

issues

was

their

issues

had

the

the

Act,

or Bank

rights

Bank

for opposing in a very

ket

in times

measure and

on the Bank

of England

as

only

paper Bank

1825,

occasions

when

provisions the

provision of England

in fact,

a tradition

Bank,

or

_public,

thing

other

the

to

than

full

Act,

quarters

issue

of the

the mar-

that

less

unfulfilled.

as, as

put

to the

hope

his

likely

The always

necessary,

no practical always rely

1847, ready,

to exempt and that

the the

Bank,

to

the

opinion clause

was

of

a mere

application, since on the Government

the to

time it got into a difficult posithe Bank and the Government

too

or

Peel's

Bank

in some

were,

aid

Government

it was

of it every between

he said,

much

to be the

fiduciary

having could

legalise a breach tion. The relations

1839.

of the

expressed

limiting

It would,

situations

proved, showed

of the Bank of last resort"

for rendering and

such

events

the

Act."

1836

crises

naturally Act,

was

of the authorbank could ac-

the position the "lender

position

render

1866

from

was the

like

was,

1857

Peel's

difficult

would

occur

or

voluntarily

of issue.

Horsley Palmer now invoked what Bagehot later christened, grounds

their

with,

if they

acquire such rights to the extent of two-thirds ised issues of the banks concerned. No new quire

and

amalgamated

bank,

and

of the

figure

altogether

by,

their

maximum

the

period

to lapse

renounced

the

at

the

long

established

Government,

Government

for either to envisage

support

to the

the any-

Bank

in

time of stress. It had always been a privileged and protected institution, and it was in the interests not only of the Bank but also of the Government that it should remain so. The delicacy

Bank

directors

of the

Bank's

were

extremely

position

loath

in a system

1_See l?eavearyear, "The Pound Sterhng." p 256.

to recognise which,

as the

the re-

THE

DEVELOPMENT

OF CENTRAL

sult of a long series of Government it the controlling element in the was the nature of this lysing in his "Lombard Looking

at

knowledge development, quarter the

the

1844

Act

of the

from

that our

23

had made structure. It

Bagehot

position

was

ana-

of superior

to be the features of later banking the amalgamations of the last

nineteenth of the

IN ENGLAND

manipulations, countrv's credit

responsibility Street."

of what were in particular

anomaly

BANKING

century,

situation

it is impossible

in which

this

to ignore

Act left

the

pro-

vincial note-issuing banks. Since they were prohibited from acquiring by purchase or absorption the circulation of other banks of issue, there was a tendency towards the preservation of the smaller banks, even when it would have been more economical happen that the the

note

issue

obtained banks

by which

cluded

for profits

were

estimated

joining

a larger

engaged

from

them to combine, because it might to be obtained from the retention of

the

to be greater concern.

in the

London

Bank

as a London

bank

Act, but under the notes. Thus, although from

which

the

was conducted, ing business

Secondly,

note-issuing

market

dents to pay out their notes point in this respect was the had been founded, not like

than

and

had

those

to be

joint

stock

business

were

to pay

correspon-

ex-

in London. A striking case in National Provincial Bank. This the London and Westminster

without

note

issue

under

the

1833

1825 Act as a joint stock bank issuing this bank had a head office in London

general

administration

of all

it was excluded from carrying whatsoever in the metropolis.

its branches on any It was

bankthese

anomalies that Gladstone sought to remove in the Country Note Issues Bill he introduced in 1865. In return for the removal

of the

choosing permissive authorised have

the

disadvantages

to take

advantage

Act only) circulation, right

mentioned

above,

of its provisions

those (it was

banks to be a

were to pay a tax of £1 percent on their and the Government was, besides, to

to terminate

their

issues

altogether

after

ape-

24

THE

RATIONALE

OF CENTRAL

BANKING

riod of fifteen years. Hankey and Goschen got this clause of the Bill amended so as not merely to empower the Government to terminate the issues of such banks after fifteen years but to compel it so to do. It was thus to become an instrument for getting rid of the country circulation altogether, but Gladstone so worded the preamble as not to preclude entirely negotiations for a renewal of the term. The Bill failed to pass, however, and in 1866 the National Provincial, probably the bank most concerned, started a banking business in London at the price of sacrificing its right to issue notes. From this time onwards the joint stock banks concentrated their efforts on deposit business. The theoretical discussion lingered on a few years largely as the reflection of developments abroad.

longer,

CHAPTER

111

The Scottish System

But for the fact that the Act of Union was just over a decade too late, the Bank of England might have been the Bank of England and Scotland. As it was, however, Scottish banking developed along independent lines. At the beginning, the practice of giving concessions by charter was followed. The Bank of Scotland, founded by a group of Scottish merchants in 1695, only a year after the establishment of the Bank of England, received under Charter from the Scottish Parliament a monopoly for twenty-one years. This Bank experimented almost immediately with a policy of setting up branches, and it also issued notes for denominations as low as £1. When in 1716 the Bank's monopoly expired, it protested strongly against threats of competition, but without success, and in 1727 a second charter was granted to the Royal Bank of Scotland. The primary object of forming under special charter was that the Bank obtained thereby the right to limited liability, but there was no restriction in Scotland on the liberty of joint stock companies to set up in the banking business so long as the shareholders were willing to accept unlimited liability for the debts of the association, and not much time elapsed before unchartered banks of this kind were starting up all over the country. 25

26

THE

RATIONALE

OF CENTRAL

BANKING

Only one further ish Linen Company

charter was granted: this was to the in 1746. All the other banks formed

der

law.

the

ordinary

number

of partners

experimental

stage,

ber

of substantial

and

financial

after

of the

went banks The

or private Scottish

which

early

tries.

kept

each

was very

other's

and

to the

compared

with

other

of deposit In 1826

banking and there were,

(with

twentv-four

(with

ninety-seven

permit

joint

of Englan time

stock

d had

there

banks

had

only

set

The

taken

by joint

capital certain

was

to establish, up

been

any

one

and

clearing

twice

a week

and

branch

or-

and

there

more

was,

rapid

as

growth

of loan technique. three chartered banks joint

eleven only and

not even Right

failure

disaster--and by the public

stock

banks

private

just being

branches.

serious

coun-

banks

adopted

twenty-two and

stock

in other the

of regularly made

banks

resources. characteristics

systems

They

development besides the

Scotch banking--the Ayr that the total loss sustained figure

to the

a much

legislation

yet

in 1772

of damage

beginning,

branches)

in England

Avr Bank

deal was

were

branches),

size

of the

between

countries,

of a num-

private

the

settled. the

hands

of considerable

practice

exchanges from

the

the

in th_

little

place

it from

on

of abuses

of the

competition

strictly

almost

whereas

their

immediately

ganisation

most

with larger deve]oped

keen

notes;

balances

collapse

banks;

banks system

into

did a great

distinguished

There

thev the

The

out of business

restriction

period

companies

of notes

smaller

no

a short came

stock

strength.

was

after

banking joint

an over-issue

credit

There

and,

Britun-

banks, passed the

up

in the

to

Bank to that

history

of

it was computed had not exceeded

a

of £36,000. Scottish

network

of solid

institutions,

tive interference, with an already business--its marked success and cesses which English eyes

free

from

highly developed its freedom ii_om

legisladeposit the ex-

lead to suspensions--could not help but impress at a time when large numbers of the small coun-

THESC03_FISH SYSTEM

27

try banks in England were foundering. Still more, perhaps, did it impress the protagonists of free banking on the Continent. The investigations by Committees of both Houses of Parliament in 1825 into the supposedly evil practice of the issue of £1 notes and the suggestion that it should be prohibited alike in Scotland as in England aroused bitter indignation in Scotland. The Scottish community had become, by long use, accustomed to handling £1 notes instead of gold in their daily transactions, and it was consequently not from the banking interests alone that the protests derived. Notable among the antagonists was Sir Walter Scott. It was, indeed, difficult for the promoters of the 1826 legislation to claim on the experiences of Scotch banking that the issue of £1 notes had had any catastrophic results. Scotland escaped the censure of its £1 notes, but had to submit to the Peel regulations of 1845. These conferred a monopoly of the note issue on the then existing Scotch banks. The fiduciary issue of each bank was limited to a maximum fixed on the basis of an average taken over the previous year, but, unlike the English banks, the Scotch ones could issue notes above this fixed limit so long as they backed the extra notes a 100 percent by gold, and also if two banks fused they might retain a fiduciary issue equal to the combined issues of both. The regulation imposed by the Act was regarded with dissatisfaction ibr many years afterwards. In 1864 complaints were coming from Scottish quarters that owing to bank extinctions Scottish note issues had diminished and Bank of England notes were not fitted to fill the gaps because they were not issued below the denomination of £5. And ibr the comfort of the opponents of Peel's legislation the next thirty years witnessed two of the worst failures the Scottish banking system had ever experienced, comparable onlv with that of the Ayr Bank a century before. These were the collapse of the Western Bank in 1857 and of the Glasgow Bank in 1878.

CHAPTER

The

IV

Development

of Central

Banking

in France

T

.he

unfortunate

retarded

banking

years.

The

Banque

G_n_rale bank

after

the

but

the

ity,

founded

Caisse

tions

with

very

financial

of

advance

an

caused the

notes in The first

of

1788, and assignats,

selves

legal

ment

bonds,

this

tender backed

to carry

French bank

became,

bank

and giving

exchange 1776. This

into

short-dated by

the

biens 28

limited of very

to the already

liabil-

Finance. close

practically

rela-

a branch The

promise

Treasury

in

1783

payments. heavily

of forced

after this followed the issued in 1789, which but

there-

and before

it suspended

finances,

in the

of paper,

branches

Government.

frs.

his

on other

with

came

many for

of note-issuing

Minister

in fact,

of the

State

resulted

formation

a partnership the

6,000,000

on the

of the

Caisse,

set up

department

a "run"

exigencies

on the

Turgot, and

1716

Government

The

chiefly discounting of issue was founded

beginning

in

over-issue

firms

Lhe State,

of the

Law

in France for

five years.

d'Escompte, by

to John

issues

country

in a disastrous

restrictions

business, no bank

was

the

after

although

of banking transactions,

From

resulted

of note in that

given

closed

raised

banks,

experiences

monopoly

and

the

first

development

in debt

currency

Governwere

to

to its

assignat r_gime. were not them-

interest-bearing nationaux,

The

usually

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN FRANCE

_9

discounted with the Caisse. But in 1790 the assignats became legal tender currency. France was flooded with them and the Caisse collapsed, leaving behind it a distrust of paper money which was to be widespread and longlived. A decree of 1792 had forbidden the establishment of banks of issue, but the abrogation of this decree and the restoration of the ordinary currency in 1796-97 encouraged some of the Paris discount banks to undertake the issue of notes. Chief among these were the Caisse des Comptes Courants and the Caisse d'Escompte du Commerce. A new development took place in 1798 when a bank of issue was set up in the provinces, namely, at Rouen. This bank took the step of issuing notes as small as 100 frs. The Paris banks had not been in the habit of issuing notes for less than 250 frs. The freedom prevailing at this time in banking in France seems to have proved very satisfactory, and no disasters occurred, but the march of political events destined this state of affairs for a short existence. Napoleon's mania for centralisation getting Government paper discounted, lack of confidence in that Government,

and his difficulty in chiefly owing to the turned his attention

to the potentialities of a bank founded under Government auspices. So in 1800 he persuaded the stockholders in the Caisse des Comptes Courants to dissolve the company and merge it into a new bank, called the Bank of France. The Bank was financed with an initial capital of 36,000,000 frs., obtained partly from the original capital of the Caisse des Comptes Courants, partly by new subscription by the public and partly from Government funds, obtained from the sinking fund of the national debt. Soon after the foundation of the Bank the Government sold out a large part of its shares, but the independence of the Bank was not thereby much increased. Further negotiations, and manipulations, largely quite unscrupulous, were undertaken in 1802, as a

30

THE

RATIONALE

OF CENTRAL

BANKING

final result of which the Caisse d'Escompte du Commerce was unwillingly induced to fuse with the Bank of France. The most severe blow to competition came a year later, however, when the Government, by the famous loi du 24 Germinal an XI, granted to the Bank of France the exclusive privilege of issuing notes in Paris, ordered those Paris banks already issuing notes to withdraw them by a certain date, and forbade the organisation of any bank of issue in the provinces except by the consent of the Government, which reserved the right not only to grant all privileges of issue but also to fix the maximum of such issue. The pretext for this piece of legislation was the slight financial crisis in 1802, but, in fact, nobody had brought any accusation against the competitive banks. From the outset the Bank of France was under continuous pressure from Napoleon. As early as 1804 a dispute arose between them because the Bank was not discounting Government paper cheaply enough. Under this pressure the Bank discounted too much and issued more notes than it had the specie to maintain. This over-issue, together with the spread of a rumour to the effect that Napoleon had sent away the metallic reserves of the Bank to Germany for military needs, saw the Bank in serious difficulties in the following year. It had partially to suspend payment and its notes depreciated 10 percent to 15 percent. Fbr this Napoleon laid the blame on the Bank and determined to bring its constitution more under the Government. So in 1806 he gave the State a larger share in the Bank's administration by replacing the Committee elected by the stockholders by a Governor and two deputy-Governors appointed by the head of the State. Further heavy loans to the Treasury in 1813 caused another partial suspension of cash payments in the next year. This gave impetus to a good deal of criticism and to a movement of opinion in favour of making the Bank independent of the Government, but nothing came of this proposal.

THE

It soon ward,

became

with

France

England

IN FRANCE

was

and

America,

particularly

slow

they

in

provinces

where,

grew

small

were

the

firms

specialising

practically

on

non-existent.

31

extremely

facilities;

from

they

that

BANKING

of banking

which

apart

OF CENTRAL

apparent

as compared

opment at

DEVELOPMENT

in the was

devel-

the

so

pace

far,

exchange

Special

back-

and

business,

authority

had

been given to the Bank of France in 1808 to set up branches, and in those towns where it established them it was to have exclusive

rights

of issue.

Lyons,

Rouen

a very in the

brief existence, difficult years

also

and

argued

mands serve

It set

Lille,

but

up

they

because in which

in favour

of

its first were

Almost

immediately of the

their

Paris,

there

during ernment

on

attempt was

the

all closed

suppression

banks

were

period

a nature

to

defeat

to severe any

great

They had the right to issue ters and one or two other utes;

thev

could

only

district; and their times the amount tions

of

of their

branches

the

"Departmental."

to such

banks

were

founded

re-

Bank

of

by

the Govof private Banks of But these

of their

were

of

business.

only for their headquarmentioned in their statbills

payable

narrow

or employ Their

de-

the

outside

which

in their

sphere

between

own

exceed three The restric-

districts agents

and

almost

of operations

infinitely smaller than the departement, and fact, merely small local banks. Nevertheless, departmental

after

liberalism,

were the in 1817-18.

expansion notes towns

the

sanctioned establishment

restrictions,

discount

operations

to set up

title

by

facilities

sight liabilities might not of their metallic reserves.

inability

in

their on

increasing

banks of issue. These and Bordeaux, formed

subjected

that

credit

which three projects were of the Restoration for the

departmental Rouen, Nantes

down

encroach

abandonment

to establish

a short

offices

they had proved unprofitable they had begun, and it was

might, in periods of tight credit, of the central bank in Paris.

France

branch

their belied was

they were, in six additional 1835

and

1838,

3_

THE

and

the

Bank

RATIONALE

of France,

OF CENTRAL

now

taking

BANKING

fright

at the

threat

of a

competing banking interest, began itself to organise branch offices, fifteen of which were started between 1841 and 1848. Each monopoly

branch of the

Comptoirs

of the

the note

Bank issue

Bank

of France

sation only an ordonnance on the recommendation Banque, tain

whereas

a special

which

the

conduct

they

rendered

cant.

They

and after charters greater

royale, of the

to the met

with

1840 the for their

removing some also unsuccessful.'

had

to ob-

area

over

system over

Government foundation. in the

of

note-issuing

the

the

could depart-

towards

business

statutes they

brought

complete conclusion

it practically

direction

of

contained,

were

centralisation

political disturbances, but the opposition of France to the renewal of the charter makes

any more towards

was

in the

1848 Bank

year

insignifiof France

to grant movement

issue

in that

from Bank

of the departmental banks on the occasion of the discuscharter of the Bank of France,

restrictions

its logical

far

of the

refused So the

of their

of policy reached

were

disapproval

note

Bordeaux

authori-

greater

advantage

community the

for modifications

trend

a

There never even developed among the debanks any system of exchange of notes: the success of these banks and the services

freedom

The

1840

the

of a branch

it a great

to an end. The representations to the Chamber of Deputies, sions of the renewal of the asking

for their

after

Also

as a member gave

of course given town. Moreover,

which would be granted Conseil G_n_rale de la

banks

of Parliament.

Comptoir

was own

required

departmental

Act

business

mental bank. partmental nevertheless,

opened in its

as a result

of the of the

voiced by the of the Bank of certain

that

the

1 Their chief claims were the following: (a) to be allowed to discount paper payable not only in their own town, but also m any town having a bank; (b) to be able to discount bills having two signatures only, the present requirement being three, (c) to be authorised to issue notes for 100 frs.

THE DEVELOPMENT

OF CENTRAL BANKING IN FRANCE

33

departmental banks would in any case not have survived after the expiration of their charter rights. The 1848 political crisis foreshadowed in many people's minds a repetition of the assignat regime, and their first instinct was to hoard specie, with the inevitable consequence of a run on the banks. The Government was naturally interested in preserving the capacity of the Bank of France to give it financial support in dealing with the insurgents. It therefore gave to the Bank's notes coursforce and allowed it to issue notes for 100 frs., 2at the same time imposing what it regarded as a safeguard against excessive issues by putting a maximum limit of 350,000,000 frs. on its note issue. The departmental nally the maximum

banks were, it is true, given what were nomisame facilities, and their notes subjected to a limit which amounted to 102,000,000 frs. for all

nine banks together, but since their notes were made legal tender only within their own respective localities, while the notes of the Bank of France were legal tender all over France, the circulation of the Bank of France gained an overwhelming ascendancy over that of the departmental banks. The 1848 decree was consequently their ruin rather than their salvation, and in the same year they agreed to submit to a fusion with the Bank of France, practically the only course that remained open to them short of liquidation. Thus by two Government decrees they became Comptoirs of the Bank of France, which acquired their authorised note issues as an addition to its legal maximum. The events of the period immediately following 1848 throw light also on the subordination of the Bank to the will of the Treasury. Up to the decree to which we referred above, the Government had never imposed any limitation on Up till 1847 the Bank had not been allowed to issue notes in Paris for less than 500 frs. At the Comptoirs in the provinces it could, like the departmental banks, issue them for as low as 250 frs. In 1847 the same mimmum denomination was made to apply to Paris, where any case been circulating previously.

provincial

notes for that amount

had in

a4

THE RATIONALEOF CENTRALBANKING

the

amount

of the

the

Bank's

obligation

prohibition gone,

note

of small

it did,

issue.

It had

been

content

to pay

specie

on

demand,

that

both

notes.

as we

Now

have

seen,

impose

The

difficulties

obligations

of the

in cash,

legalising

which

Bank

had

its bankruptcy,

had,

cial obligations were concerned, tion, and it showed itself ready cash

payments.

ings

at

June,

the 1848,

had

arrived

was

to make

ceeding By this (about

Bank and

scale

regular or three

years.

time,

however,

400,000,000

it had

frs.),

the Bank

and

end

a very

it had

for

commer-

borrowunstable.

during

of 1849

In

Government

by which the

the

latter

the

suc-

Bank

had

to 525,000,000

strong

already

ing the restrictive measures relating notes, and it would probably have

its

short durato revert to

the

sums

its issue

the

reason

its position

At the

to increase

avowed

Government

of fixed

this

in meeting

as its private

1849,

a

were

if it should to the Trea-

been of very at an early date

made with

but

on on

checks

to raise to lend

the

in November, advances

permission

been

at which

continued again

at agreements

two

received

But the

these

of France

so far

and

a limit,

Government showed itself ever ready form anv obstacle to the Bank's readiness sury.

to rely,

metal begun

frs.

reserve suppress-

to the redemption decided in favour

of its of a

complete resumption had not been for the

of cash payments much earlier if it Government borrowing factor. If Trea-

sury

demands

were

going

Bank

believed

its cash

to continue

reserve

would

at the

same

be inadequate.

other hand, its note issue very soon approached maximum, and the Bank was faced with the choice applying of

for a further

reverting

to its

increase old

statutes

of its legalised under

ume

of notes

it was

agreement had been duction of the Bank's

allowed

to issue.

On the

it would would on the

It was

only

the

the new either of

circulation

which

obliged to redeem its notes and cours force ished, but there would be no legal limitation

rate,

or be

be aboltotal volafter

an

reached with the Treasury for the reobligations to lend, that the Bank felt

THE

safe

DEVELOPMENT

in reverting

August, cal

to its old

crisis

seen

how

with round

about

1850

paucity but even

of a paper

corresponding

did

the

politi-

provincial

through

the

in

local

greater

withheld

England

in

prominence

especially facilities

banking,

in the for the

there

and

where

was

the

contrast

the

country

a

and knowledge, even if they had at least accustomed the

to banking

notaire.

the

iarmers

crops

and

stocks

and

been

monopoly

revolution

habits.

Courcelle-Seneuil,

the practical impossibility in the rural of either borrowing or lending, except

fact that

over

with

mind

stressed of France

year

had

1848

single,

into

of deposit

strong

from

facilities, most itself. Where

local connections no other service,

especially, districts

slowly

3_

it finally

industrial

brought

circulation

particularly

the

IN FRANCE

this

centralised, of the

of credit in Paris

absence

bankers with had rendered

their

and

emerged

a completely progress

spread

the

France

The

the extreme provinces,

timid

statutes,

of issue.

France

was

BANKING

1850.

We have bank

OF CENTRAL

had

Moreover, received

the proceeds

in lump

to make

a much

sums

their

longer

as he also

pointed of the

at a particular

disbursements

period

out, 3

meant

sales

of

time

in

much

that

they

more were

in

possession of balances of spare cash for the greater part of the year. These balances could have been deposited in the banks and used to make short-term loans if there had been local

banks

simply

We have for the

the

count

policy,

"La

hoards,

now less

business. and

next the

the

Libre,"

decades

occasional against 1867.

were

features

free-banking provided

two

As it was,

savings

commendable were

of criticism Banque

the

described of the

grounds

during torrent

with

into

opening

In addition, erful

to deal

went

which

but

nevertheless

by

the

of

the

Bank

set

gradual beginnings of which

of France.

balances

used.

controversy

stringency the

the

not

the

stage

in France. very

pow-

emergence of a disevoked This

partic-

a

36

THE RATIONALEOF CENTRALBANKING

ular

aspect

of the the

of the

nature

very

discussion

and

object

earliest

is explained

of banking

days

of

which

French

Government

by

a conception

had

its origins

banking.

flexibility d'Escompte cent. The

of discount rate. In the case of the Caisse it was forbidden to charge more than 4 perrate of discount of the Bank of France was fixed by

six years

1806

the

it was

must

be to discount at

rate again

enough,

until

1814,

possible

a stable

when

tract of

credit, doing

charged the short nally

so

other

than

its loans. of charging

almost that

In 1819

of

rationing,

it kept or

the

rate

to the

to strengthen

of interest purchase its reserve.

instance

for

not

that

the

changed It seems as far

in both

or to conmeans

4 the for

price

some

(4 percent)

as

directions,

conceivable

adjusting

rate

not

to extend

it adopted

a lower

in these

to maintain

any

in

of Napoof France

to 5 percent.

sticky

the

until

Bank

It was

it necessary

adopt

for

the

of reasonable

the

his

Bank

for it was found

at

raised

date (having less than thirty decided to reduce all rates

strain order

rate,

Bank

firms

in 1807.

of the

and figure,

claims Bank

criticised

it was

it was

policy

it would

for

policy

and

when

the

the

he

to 4 percent

been

and

and

on

policy

by the aim of the

for all commercial

reduced

to have

at that Discount

conditioned that the

4 percent,

liberal was

at 6 percent,

invariable

to 5 percent.

was primarily It was his idea

being

held

reduced

years leon.

standing

Government

it was

limitations

in the

the

first

imposed

from

beginning

provisionally

had

Right

on

it

months bills

of

days to run) to 4 percent.

before it fiIn times of

constant

resorted

of specie It was

and at

for

a premium, the

first

time

to in in

4In times ol strain it always meant that some form of rationing had to be resorted to M Rouland. Governor of"the Bank of France, remarked before the Commismon of Enquiry (1865) tbat vvhet_ the Bank kept its rate o_ discount fixed it often had to relect demands tor discounting at that rate in conslderahle proportions So he states that m 1812. 30 percent of the total demands were rejected, in 1832, 14 percent and m 1841 and 1842. 6 percent. See "Depomtions de 5,iN1 les delegues et les regents de la Banque de France." p 116

THE

DEVELOPMENT

1847 that it discovered

OF CENTRAL

BANKING

the effectiveness

IN FRANCE

37

of a rise in the rate

in stemming a drain of cash. It had already relowered its rate when the 1848 crisis brought another shock, and it was still too much afraid of using the weapon of discount rate to combat it. It continued throughout the year to discount at 4 percent, while the departmental banks, which were less able to bear the strain, were charging 6 percent. The reduction of the rate in 1852 to 3 percent brought to an end a period of just over thirty years, during which, with the sole exception of 1847, its rate of discount had remained unchanged at 4 percent. This is in striking contrast to the practice of the Bank of England, whose rate was changed no less than fifty times between September, 1844, and December, 1856. From the 'fifties onwards the French rate began, however, to fluctuate more frequently. The greater willingness to change the rate was probably strengthened bv the greater need to do so, arising with the increased mobility of specie due to improved transport facilities and communications, which made arbitrage operations much easier. Also, perhaps, some allowance should be made ibr the beginnings of the activities of the Credit Mobilier in the direction of capital export. Anyhow, a strong tendency to an outflow of specie set in between 1855 and 1857, culminating with the crisis of that year. The Bank was at first hesitant about raising bank rate, and in the autumn of 1856 the Governor asked the Eraperor to sanction a suspension of cash payments. This the Emperor refused and the Bank next reverted to the practice of imposing a limit (two months) on the echeance of bills it was prepared to discount. Finally in 1857 it gave definite recognition to the principle of raising bank rate when there is a drain on the specie reserve, and in that year the Usury Laws prohibiting a rate above 6 percent were abrogated so far as the Bank of France was concerned. But even so, the Bank

still relied

partly

on the method

of charging

higher

38

THE RATIONALEOF CENTRAL BANKING

rates

on the

longer-dated

some

weeks

at 7 percent,

tuated

much

oscillate rate.

more

more

the

But

in France

and

a corresponding

sion

to establish

of this

view

of France lishment nopoly was

to give by

the

Increased by

1864, the

the

first

of issue.

that

the

in fact

rights

practical

and

it was

the

question

on

that

gen-

the

Bank,

for permisadherents

which

the

institutions

founders of the Credit Mobilier.

was

of the Bank

came

perhaps

in the

the

out

around

and

participants

fairly

of the

by

to

of MacLeod.

attack

Many

and

significance

arising

general

disinterested

now

the

Bank

did not prevent the of issue, that it was

only,

to other

it flucbegan

of England

quarters

charter

for

estaba mo-

Government

in places

not

oc-

Bank.

incidents

more

writing,

but

Bank

was

big

held

and

writings

in some

banks out

rate

was

onwards

the

to the

was granted its privilege in France of other banks

free

sion

other

pointed

time

with

demand

not by law

cupied

that

heretofore,

owing

it provoked

rate

from

of bank

largely

the

than

in harmony

doctrine

accepted,

In 1861

and

violently

or less

In England erally

bills.

the

type was

marketing

to the

of Savoy

most

controversy

prominent

were

the

discus-

of Savoy

to be focussed.

discussion

new This

given

annexation

that

Not the

least

among

the

Pereire

brothers,

of credit institution known a bank which carried out

of bonds

and

equities,

in

and

as the undereven

di-

rect subscription to the newly issued capital of industrial companies, as well as to State loans. The founders had projects for setting they lier

failed was

up similar

to do imitated

institutions

directly,

independently

brothers had other financial

from the business

incidentally

a combination

chance of success, Investments which

in other

although

the

in Germany.

outset always the business

as was consist

French

that proved for the

hoped of note had

countries.

This

Credit

Mobi-

The

Pereire

to add to their issue; this was

exceedingly

little

by German experiences. most part of industrial se-

THE

DEVELOPMENT

curities

and

market

except

hold

which

against

OF CENTRAL

are

difficult

at heavy liabilities

BANKING

IN FRANCE

to sell in certain

loss

prove

of the

very

very

Bank

of

whole

Savoy

came

question

oly of the The

that

should they voy

of free

Bank

treaties

lished

up

for

shortest

notes

reopened

versus

the

the

monop-

of France. accompanying

individuals

be allowed had held concluded

viz.,

to

saw no possibilthe rights of the and

in banking

of the

assets

term,

discussion

trade

states

dangerous

payable on demand. The Pereires, however, ity of obtaining note-issuing rights until

a9

the

and to exercise

under from

annexation

institutions the

of Savoy

belonging

same

estab-

rights

to Savoy in France

the law of Savoy, and the this that it had the right

as

Bank of Sato establish

branches able on

over the whole of France and to issue notes paydemand. It was here that the Credit Mobilier saw its

chance.

It concluded

by

which

raise

the

a capital

and

gain

France Bank

an agreement

Pereires of the

were, bank

a controlling was

alarmed

at

Bank

rival. notes

The Bank of Savoy paid for as low a denomination two-named

no

interest

on

less

than

100

bills.

The

Bank

Government's lege,

and

fying

the

with

the

business

paper, deposits frs., 5 and

from

Government's Bank

5 At the renewal for 50 frs. It actually of Savoy affair

of Savoy,

had

the

Minister

opposition and

The

Bank

of having

of the

teatures

to make

then

of its charter m 1857 first took advantage

Bank

it a keen

of France

as yet

issued

discount

a protest

obligation the

to

amount

as certain

likely

not only

made

contractual obtained

were

of Savoy

interest to depositors, issued as 20 frs., and could dis-

could

of France

concern.

prospect

whereas and

Bank

subscription,

its present

especially

of the

count

times

the

the

own

in the

as a competitor,

of Savoy's

their

to ten

influence

much

of Savoy

with

by

on

the

plea

to maintain

entered

it had acquired of this in 1864,

for

three-named

of Finance to the

paid

notes

Pereire itself

of the

its

privi-

a letter

signi-

agreement into

negotia-

the right to issue notes at the time of the Bank

40

THE

tions

with

agreed

that

RATIONALE

Bank,

its claims together

money

into

the

Its

the

appointment

policy

pamphlet

of the

a petition

an investigation, count

rate

on

by the

300

the

Bank

the

raising

of the

The

that

effect

was

to produce

of France.

Isaac

an enquiry,

and

Paris

to

Pereire the

merchants

grounds

that

the

raising

had

led

to the

Conseil not

earlier

finish

wrote

from

system

on the subject. on both issues

tar

of the

more

academic it was

the bimetallic

time

The

problems

rate

of competing having

that these in face of it,

bank

might

be

bv

the et

1865, much

banks.

Evidence

any

competence

the

writers question.

for

Bank's was

invariable,

was

superior was

taken

to speak

The results showed a verdict of the in favour of the Bank of France.

superseded

of the

of strain

its rate of issue

majority

to mark the close of the discussion issue was concerned, but among it continued

for several

at the

beginning

It was

a strange

of the

de and

raised

whether in times

disre-

l'Agriculture

which

firstly,

re-

periodic

in February,

of maintaining a single

all those

This may be taken as the practical

until

two:

whether

practically

by

down.

a

demanding

undertaken

de

its discount

to its old policy

secondly

to a plural

1866, died

primarily

of raising

was

opened

June, had

were

policy

preferable and,

until

against

Commerce

discussions

enthusiasm

made

enquiry

du

The

discussion new

the

Superieur

l'lndustrie. did

of

being

a

enquire

Emperor

also

of France

were

direction

for an discount

turn of crises. Finally the Bank itself suggested demands should be satisfied, so that its position, the attacks elucidated.

latter

in return

of a Commission

such

from

the

immediate

Bank

demanding

ceived

notes

directed the attention of many peoneglected subject of the theory of

market. lor

of which

to issue

with

rate to 8 percent in 1864, ple to the hitherto rather demand

BANKING

as a consequence

to renounce

indemnity. This incident,

the

OF CENTRAL

years

longer,

'seventies

coincidence

so the

that

by the

THE DEVELOPMENT OF CENTRAL BANKINGIN FRANCE Credit the

Mobilier,

Bank

Bank's

acquittal

to lead

same

same

system,

find time the

direction.

of the

itself into

trend

of the

almost

at the

in serious

only

was

the monopoly issue of notes

retention

of the

of the

note

with

unification.

issue

a year

of the

which

were

later.

countries

debates

against

moment

consolidating

in neighbouring the

accusation very

difficulties,

liquidation

as France

centralisation political

engineer

In Holland

posal to replace free trade in the favour

chief should

to its going

At the ised

the

of France,

41

in 1863

her

central-

was on

in the

the

pro-

of the Netherlands Bank had resulted in a decision monopoly. was

In Italy

proceeding

by in

increased pari

passu

CHAPTER

The

V

Organisation

of Banking

in America:

Decentralisation Without

The

Scottish

experiences

support of the claims to American history tunate.

The

American

case

controversy, it cannot

ther.

decentralised

sential The

as a forceful

was

school, to have

evoked

in

but appeals been so for-

as evidence

by both

without both

freedom;

of central

it lacked

banking

the

and

es-

of

free

and

the

proper. distribution

of powers

State authorities left in the hands of both. dislike

State

between

institutions

rights.

and

Nevertheless,

of the

commercial

early

period

great

difficulty

Federal

Bank

of North

need in America's in getting

for

a jealous the

the War of Independence impelled ment to take the first initiative in the promotion

the

legislative control in banking The country started off with

of centralised

individual

uine

example

but so far as the system as a whole be described as an illustration for ei-

characteristics

banking

served

of the free-banking can hardly be said

sides in the is concerned, It was

Freedom

42

for

for funds

The

lack

facilities

industrial private

regard

need

in

the Federal Governbanking sphere in the

America.

banking

matters a natural

capital

at

development for such

of a genthis

very

caused an enter-

THE ORGANISATION

OF BANKING IN AMERICA

4a

prise, and the Government was obliged to become a substantial shareholder in the Bank. It shared the unpopularity of all central institutions, and after the war its charter was repealed. Not very long afterwards banks began to set up in the more progressive States under the separate legal systems of the various States concerned. The usual procedure at the beginning was to apply for a charter which gave the bank the privilege of limited liability. In most cases the charter contained clauses limiting the amount of liabilities the banks might legally incur to a certain multiple of their paid-up capital,' and in some instances it imposed also a lower limit on the denomination of notes. In very few States did unchartered banks set up with unlimited liability. 2 Almost as soon as any possibility arose of private individuals and unincorporated associations wanting to set up without charter, restrictions were placed on their entry into the banking business by the legislatures concerned. Most of the eastern States passed laws similar to the 1818 law of New York, which made both deposit banking and note issue conditional on special legal authorisation, and the majority of the Western States followed up the same policy. But the actual effect of this rule varied from State to State according to the ease with which charters were obtainable. There of course, the

was least stringency in the east, which was, district in which there was most call for

banking facilities. The most liberal policy was to be found in New England and more especially in Massachusetts and Rhode Island, where charters were granted to nearly all The most common rule was that note issues should not exceed double the amount of the bank's capital. Such provisions were, however, usually purely nominal; the limits they imposed were never likely to be reached. See Gallatm, "Considerations on the Currency and Banking System of the United States," 1831, p. 65. z Only in England and Scotland were joint stock companies generally subjected to unlimited liability. In America, as well as on the Continent, the principle of limited liability became the general rule right from the beginning.

44

THE RATIONALE OF' CENTRAL BANKING

who applied for them. ' In New York already established banks seem to have exercised a powerful influence in persuading the legislature to refuse to grant charters to new competitors; and there was an increasing tendency to restriction the further vou went south and west. Meanwhile, a second attempt had been made to run a central bank. This was the Federal institution, known as the First Bank of the United States: From its parent bank at Philadelphia the company had early begun to develop branches, and this caused much annoyance to the State banks and their legislatures. The opposition of the Republican Party was forceful enough to secure its suppression when its charter came up for renewal in 1811. The disappearance of this bank and its branches was followed by a rapid growth of State banks. In 1811 there had been about eighty-eight, and within the next three years a hundred and twenty new bank charters were granted. Most of these banks lent heavily to the Federal Government when war was declared in 1812, and their excessive issues caused about three-quarters of them _ to seek the sanction of their respective Governments to suspensions of cash payments in 1814. After this their issues expanded still further and their notes fell to discounts ranging from 10 to 30 percent," The _See Carey, "The Credit System of France, Great Britain and the Umted States," 1838, p 68, 4 Founded in 17f)1. The Federal Government had subscribed part of the capital and pledged "ttself not to grant a charter to any other bank for the next twenty years, The New England banks fulfilled their engagements. All the banks to the south and west failed. See Gallatin, "Considerations on the Currency and Banking System ol the United States," p 42, Most failures in these and the following years took place where entry into the banking trade was most restricted, Carey gives figures of failures from 1811 to 1830 In New England as a whole the number of banks between 1811 and 1830 averaged 97 and the total failures were 16, In New York the banks averaged 26 and there were 11 failures. In Pennsylvania there were 29 banks with 19 failures, and the proportion of Loss increases as you go further to the west and south " Gallatin estimated that within the first fifteen months of the suspension of specie payments, their note issues increased by 50 percent Op. clt., p 45.

THE

ORGANISATION

OF BANKING

IN AMERICA

45

resumption of specie payments nominally took place in 1817, but in 1819 there was a further suspension, which lasted two more years. The foundation of these early banks was much more often based on political influence than on real commercial necessity. It was attended by abuses in the paying in of capital which were often directly aided by the State. In the case of the First Bank of the United States itself, the United States Government subscription of $200,000,000 was a purely fictitious book entry. Some of the banks had scarcely any capital at all, and nearly all of them had much less than was nominally subscribed, and since the liability of shareholders was limited, there was very little protection for the creditors. The State legislatures, when they did at last set themselves the task of opposing these fraudulent practices, experienced incredible difficulties in framing legislation to deal with them. Another feature of these early banking tormations was their close connection with State Treasuries. It was a common practice fbr States to require banks to make loans when necessary to the State chartering them. Special provisions were often made for this in their charters, and in addition Acts were passed from time to time authorising specific loans. The result of this frequently was that the banks were so heavily "loaned up" to the Government as to have practically no substance left for supplying commercial demands, a factor which must have contributed considerably to their early excesses. The result of the autonomy of the rather small sparsely populated area of the State was that the banking system tended to assume a very fragmentary nature. A State bank had rights to carry on business only within the borders of the State from which it received its charter. This meant that America could not develop a branch system of banking, and it was perhaps in this circumstance that the chief justification lay for an institution such as the First Bank of the United

4,6

THE RATIONALE OF CENTRAL BANKING

States. Secretary of the Treasury, Gallatin, expressed the opinion some years later that if the Bank of the United States had been in existence in 1814, the chaotic banking disturbances of that year would not have occurred.; The most essential condition for the suppression of excess note issues is their presentation for payment at frequent intervals. A very serious trouble throughout the history of American banking was the lack of a regular system of clearing the notes of the various banks. Notes tended to travel considerable distances, and since a bank in one State had no branches in any other State and generally no correspondents either, there existed no ready-made agencies for collecting the notes of rival banks and presenting them for payment. This was a function that the First Bank had begun successfully to perform, and its consequences must undoubtedly have been to curb the tendencies of the local banks to excessive note issues. Another experiment in centralised was made in 1816 with the foundation

banking institutions of the Second Bank of

the United States. In common with the First Bank, part of its capital was subscribed by the Government, and it was to be the depository of the balances of the Federal Treasury without obligation to pay interest on them. It had, moreover, the right to establish branches without consulting the Governments of the States concerned. A new feature of its charter was a clause intended to minimise the likelihood of cash suspensions, by imposing a penalty, meet its obhgations on demand, tax on the amount in default. Gallatin

maintains

in the event of its failing to in the form of a 12 percent

that it was only as a result

of the organ-

isation of this bank that the State banks were prevailed upon to resume cash payments, since it was the Second Bank which proposed a convention to which the State banks finally agreed. It is interesting to note that one of the stipula: "Considerations p. 46.

on the Currency

and Banking

System

of the United

States,"

THE ORGANISATIONOF BANKINGIN AMERICA tions

made

by

the

State

banks

United States should, in any the credit of any of the said

was

that

the

emergency that banks, contribute

to any reasonable extent in their support. declaration of the view that it is the duty to act as lender of last resort. The Second branches soon rights, tion.

and

chief

was

sented on the dency

them Bank

The

for

toed. This put central bank.

except

banks

brought

first

the

from the Bank and Shortly afterwards

of new

blow

was

New

firms, with

to insolvent York.

the

latter

notes

struck

opposi-

against

the

then

pre-

and

was declared to the Presi-

in 1833

deposits

for many

decades

of cash

payments

England,

laxity

applied

early bank

when

to be

he

removed

deposited instead in selected State banks. the renewal of the Bank's charter was ve-

suspensions

extreme

up

the

their

where

the

water. Probably the worst feature and the one to which, combined entry

backed by

Government

an end

in New

of the

This is a very of the central

for redemption in coin." "War" by Jackson when he succeeded

orders

General

State

it "accumulated

in 1829.

gave

the

objection

that

Bank

might menace its resources

of the United States and its twenty-five into conflict with the defenders of State

of course

The

Bank

Bank came

47

much which

In charters

banks

granted

again

chaos

principles Take

occurred

was

for a in 1836,

kept

of the American with the exclusion

of the

banks.

to all projects

due,

above system of the was

of bankruptcy

as an example

before

1828

sions that if a bank suspended payment (usually three months) it should cease

were

the

there

the

State

were

of

provi-

for a certain period operations unless it

obtained permission to continue, after an examination of its affairs, from the Chancellor of the Circuit, and if at the end of a year

it still did

its rights

altogether.

the these

unconditional rules

were

not resume Charters period made

payment, created

allowed completely

it should after

to ten

days.

ineffectual

surrender

1828

shortened

But in 1837 because

all the

48

THE RATIONALE OF CENTRAL BANKING

State legislature passed a Suspension Act allowing suspending banks to continue for a year without applying to the Commissioner. Other States followed New York's example and passed nature. _

Suspension

Laws of an even

more pernicious

Further suspensions took place in 1839, but were confined this time to Pennsylvania and the States further to the south and west. Boston and the eastern States sustained payments. Pennsylvania passed laws legalising the suspension on condition that the banks should make certain loans of money to the State, and it was arranged that they should resume specie payments in January, 1841. The obligation to lend to the Government naturally had the effect of making it more difficult, if not impossible, for the banks to resume payments, and the date for resumption was postponed by another Act which, in return for further subscription to a Government loan, allowed the loan was vears.'

the banks to continue the suspensions until repaid, which might be any time up to five

The losses sustained by the Federal Treasury in the suspensions of 1836 and 1839 called forth proposals for making the Treasury independent of the banks. From the 'forties onwards State banking showed signs of improvement. Most of the States had by this time succeeded in framing provisions for securing the paying up of capital bv subscribing shareholders. The more difficult task was to remove the tendencies towards expansions and to secure note-holders against losses due to suspensions. A major deficiency over the whole of tile American banking structure had long been the infrequency of the return of notes to their issuers. One of the earliest and most successful attempts to secure that notes were redeemed more often was a volunSee Gallatin, "Suggesuons on the Banks and Currency States," p. 36 " See Gallatin, op. cit., p 49

of the Several

Umted

THE ORGANISATION

OF BANKING IN AMERICA

419

tary system put into force by the Suffolk Bank of Massachusetts. Bank-notes circulated at places distant from their issuing bank at discounts varying with the difficulty of sending them home for redemption. The smaller was the chance of its notes being presented for payment, the larger was the volume of notes that a bank could safely issue. The result of the lack of any machinery for ensuring the collection of notes was therefore that banks began purposely to place themselves at long distances from the most important centres of business. This was what happened in Massachusetts. The banks of Boston found themselves at a distinct disadvantage because the country banks were securing practically the entire circulation even in Boston. Large numbers of country bank-notes never returned to the banks that had issued them, but remained in Boston circulating without hindrance at the recognised rate of discount. The Boston banks made several attempts to systemise the sending back of notes for redemption. The most successful was the Sufiblk Bank system. `°This bank arranged fbr New England country banks to keep with it permanent deposits of $5,000 plus a further sum sufficient to redeem notes reaching Boston. The Suffolk undertook to receive at par the notes of banks who made such deposits, and the notes of country banks who refused to come into the scheme would be sent back for redemption. The Suffolk Bank, moreover, refused admittance to its clearing agency to banks whose integrity was not above suspicion. This had the intended effect of curtailing the circulations of the country banks. The Massachusetts legislature also passed a law, in 1843, to secure the more frequent return of notes by providing that no bank should pay over its counter any notes but its own. A similar law was passed in Louisiana. Other States placed penalties on the default to pay notes in specie on de"_Started

in 1819.

40

THE RATIONALEOF CENTRAL BANKING

mand,

either

by

the

imposition

of a percentage

tax

amount involved or by making the offending the forfeiture of its charter. This latter measure been

the

most

fications

effective

if it had

as to reserve

many

of the

Louisiana

States.

The

requiring

culation

plus

In other over-issues

most

reserve

some

protection

adopted

assets. which

Another measure adopted made bank shareholders

ing

out

ceeded

the

York

practice

contributions

of the their

scheme

to subsidise and

capital

of weakening

of the and

fact itself to risk of the safety-fund solvent _1Estabhshed

banks

many

on

actually scheme

inwas

a system

not had

the

banks

The

to the

at the

pay-

they

on the

further

basis

were

issues

tempted

of on

unhealthy

the

of

especially

as a percentage over

ex-

under

expense

ones,

assessed

scrutiny

of

liabilities. where

managed

of the

of

a tendency

computed

It also

lien

holdings

to be allocated

of course,

was

public

was

unmet

institutions

merely

bank. the

'1 This

prudently

but was

fect

banks,

weak

actual Several

a prior

of capital ambitious

against

was,

premium

risks,

the

the

notes

of insolvent

more

insurance

system.

There

in the

over-issue.

respective

to a fund

liabilities

assets.

stronger

actuarial

of cir-

was that of double liability, liable for the debts of the

of banks

the

ticular

an

to their

Safety-Fund

this

as the

in

that

against

note-holder

such of giving

equal

insurance

paid

was

not to preventing the of notes on demand,

over and above the amount by them in the bank. The most

New

banks

following

amount

compulsory

Speci-

to emerge

of one-third

to the

States

the

enforced.

began of these

were directed redeemability

of suspensions

shares vested

the

deposits.

event

to an

rigidly also

stringent

a specie

cases efforts and ensuring

but to giving

bank

been

requirements

on

bank liable to should have

efof par-

by

this

bigger issues. Between 1840 and 1842 eleven banks failed, the fund was exhausted, and

banks in 1829

had

to be called

upon

for increased

contri-

THE

ORGANISATION

OF BANKING

butions. Future contributions vance for charges in respect

IN AMERICA

51

were also mortgaged in adof an issue of State bonds made

to replenish the fund. After the bankruptcy of the fund in 1842, it was made security for notes only and no longer for deposits as well, but it still proved inadequateY We have already observed that the banking business in the United States, or at least over the greater part of it, was in the first half century of its growth by no means open to free entry. But from 1838 onwards there was a change of policy in several of the States which made it possible for banks to set up without having to obtain a charter. The new policy was inaugurated by New York in 1838 in a so-called Free-banking Law. Under this law it was made permissible for any person or association to issue notes, provided they had deposited with the Comptroller the equivalent amount in the form of certain securities. All stocks of the United States and those of States approved by the Comptroller were eligible, and, in addition, certain bonds and mortgages on real estate. Should a bank default on its notes, the Comptroller would sell the collateral securities in order to redeem them. The first effect wild dash to establish

of the newly banks.

granted

freedom

was a

Immediately on the passage of the bill arrangements were made for the formation of over a hundred and thirty new banks; about half of these had actually started business a year later and nearly half of them had gone out of business after another three years. The idea in the minds of many of the bank organisers seems to have been that if their notes were secured, nobody would ever demand their redemption. Many of them set up solely for the purpose of issuing notes, but in 1848 the State passed legislation requiring banks to undertake discount and deposit business as well as note circulation. 12 The

fund

was

finally

wound

up

in 1866

52

THE

The

bond

RATIONALE

deposit

investment

OF CENTRAL

system

in certain

had

lines,

the

rather

peculiar

culation meant

depend also that

could

effect

realise

deeming

their

their

circulation, doing

securities first

bond

deposit their

which

they their

were

chartered banks. perfect guarantee

Parallel other

States

bank bonds.

to get

the

amount

had

was

not

very

tied

free

funds

cir-

in

chance

of

little

up

for re-

of notes

in Government

to sell until

circulation,

note

State bonds. It on other lines,

a feature

they

had

which

in comparison

put

with

the

Moreover, the system was by no means a of note redemption, because when a bank stocks

the

could

beginnings

measure

be

century

disposed

of this

of competition,

foundations

nineteenth

up

State

of the

and

either

disadvantage

State

with

a greater

or

amount

banks

capital

note

at a considerable

failed, many discount.

in order

or to decrease

because

reduced

them

assets

the

of Federal constituted

notes

the

this,

prices banks,

of tying

Federal

business soon proved to be for notes. It also had the

of making

on the while

effect

usually

Mortgage and other real estate too illiquid to provide backing

BANKING

movement

there

of State Indiana

of only in favour

took

place

monopolies.

and

Illinois

banks unless the State should judge its own funds. The Bank of Indiana

at

of

in some

Early had

a

in

the

prohibited

fit to establish one out of and the Bank of Ohio,

founded in 1834 and 1845, respectively, were both State monopolies. Illinois followed the New York free banking plan in 1851, and Ifldiana and _A'isconsin did the same a little later. The the

improvement

twenty

ticeable no

years in the

means

tional _a This sion went forbidden

eastern

perfect

crisis

took the

region.

at this

of 1857,"

was yet another to the winds. to the

that preceding

occasion Under the

Government

to pass

in American

Civil War The

period,

when

place

banking

but

except

suspensions when 1846 any

the penalty Constitution law

was

directly

banking especially

in no-

system

was

for the

interna-

of specie of liquidation of New York or indirectly

by

payments for suspenState it was sanctioning

THE

were

general

ORGANISATION

over

most

OF RANKING

of the

IN AMERICA

United

was far steadier than ever before. improvement was not attributable

5a

States,

the

situation

It is very probable that to any considerable

this ex-

tent to State regulations relating to bond deposit guarantees for notes. In fact, the State authorities seem to have become, after the

a time, State

was

weight

banking

South

to the

on

to the

they

support

North, to

operations

since

in the

North

keep and

regarding specie from the side

Secretary

of the

were,

from

Chase the

bad state of the finances Chase called a conference

Philadelphia

banks,

and

with

exchange of Suffolk system _

The

had

the

latter by

and

ceased

in re-

liabil-

lost heavily,

in a very

but their

strong

posi-

soon came howfinancial needs.

partly

they

net

contracting

excessive

diffi-

as a result

of the

in the preceding of the New York, him

banks

a large

experienced

public,

of

change

secession

in fact,

The

greater

for a radical

they water

same

clearing-house)

reserves. Pressure of Governmental

Treasury

in borrowing

above

the the

country.

to the

and

bank

enforcement

frequent of the

York

in

of windays.

Much

occasion whole

had

the

round

rigid

and

prepared

appropriate

more

New

the of the

the banks

managed

lending

of the

provided

bank

was

he paid

passed the

law,

for a system

ineffective.

attached

their

and

when scope

banks

rendered

system

gave

ity towards

very tion.

the

if the

assets

gave

for exhibit

institution

Civil War

mittances

culty

which

thereby

to the

in the

tion ever,

This

of the

satisfied

payments between banks by due in great part to the spread

The the

by

is to be

specie notes,

usually

prescribed

days.

of securities

law

enforcement

for his examination

certain

dow-dressing

and

the

them

on

in the

was

possession

to present

block

lax

Comptroller

its own visits

rather

drew

up

administraBoston and a plan

suspensions of specie payments, bu! in the 1857 crisis the authorities |'rom selling out the stocks deposited by the suspending banks and ing their notes: the Courts in New York distinguished between what momentary suspensions of specie payments and real insolvency _* 1855.

for

refrained withdrawthey called

54

THE RATIONALE OF CENTRAL BANKING

assisting the Government by advancing $50,000,000. Chase insisted on the loan being paid in specie, and at the same time he started the issue of United States notes payable on demand which further weakened the banks, since if they accepted the Government notes they were obliged to redeem them in coin. The result was that at the turn of the year (1861-62) the banks of New York, Boston and Philadelphia suspended payments. The Treasury followed by ceasing likewise to redeem the Treasury notes in coin. This was followed up by a bill for issuing legal tender irredeemable paper ''_ to the extent of $150,000,000, a measure which was strongly opposed by the banks, among others. One of the chief arguments for making the Government notes legal tender was to force the banks to accept them. Two further issues, each of $150,000,000, were made within the twelve months following. After that the issue of greenbacks was stopped, and Chase had recourse to a new scheme for obtaining funds by the sale of Government securities, namely, the National Bank system. This was an extension to a National or Federal, instead of a State, basis of the bond deposit system. By an Act of 1864 banks of not less than five associates, and having a capital of not less than $50,000, were allowed to form freely if they secured their notes by the deposit with the United States Treasurer of registered bonds of the United States. The amount of notes must not be more than

90 percent

of the market

value of the bonds

lodged

and

not more than 100 percent of their par value. In the event of a bank defaulting on its notes, the United States Treasury would sell the bonds and pay the notes itself. The Treasury also had a prior lien on the general assets of the failed bank for any claims that could not be met out of the proceeds of the bond sales, and, further, the shareholders were subject _ The notes were lawful money and legal tender m payment of all debts, pubhc and private, within the United States, except for duties on imports and interest on the public debt, which were expressly made payable in coin,

THE

ORGANISATION

OF BANKING

IN AMERICA

55

to double liability. The banks must also keep a certain reserve proportion of their notes plus deposits in the form of legal tender currency, which in the years of their foundation meant of course greenbacks as well as specie. The primary motive for setting up this system was, of course, the creation of a large market for Government bonds, but it was contemplated from the beginning that the new National banks would in time replace the old State banks and much emphasis was placed on the benefits of a uniform currency. Provisions were made in the original Act for State banks to come into the scheme by conforming to the conditions of the Act, and, as they failed to come in voluntarily as fast as the Government had hoped, an Act was passed in 1865 to penalise those not entering the system by the imposition of a tax of 10 percent on their note issues. This was practically the death-blow to a great number of the State banks so far as they were dependent on note issue. In the first years the notes of the National banks were not far short of being legal tender currency, since, although their acceptance between individuals was not compulsory, the Government was to receive them at par in all revenue collections except customs duties and to pay them at par for salaries, wages and debts, except for interest on the public debt and the redemption of greenbacks. Moreover, since lawful money in which notes were to be redeemable meant greenbacks as well as specie, there was an exceptionally large volume of reserve material available against which the National banks could expand their note issues. In spite of all this, by 1867 a large part of the National bank-notes were circulating at a discount against greenbacks and a number of the National banks had already failed in that year. It seems that people at first placed undue faith in the security of the new notes and perhaps regarded them as not liable to over-issue. For this reason the notes tended to keep out in circulation longer without being sent in to the issuing

56

THE

bank

RATIONALE

for redemption

check

on the

lation,

until

regard

a security

The

amount it was

really

for a branch banks were to establish

and

there

that

any

presently backing

substantial

effected through authorities failed

OF CENTRAL

was one

banking forbidden, branches.

system. except

the

lems up

in connection in a later

to the

with

have chapter

Federal

could that

occasion on

Reserve

the Act.

an effective keep

in circu-

it is a mistake

to

as specie. that

might

have

been

one that the of facilities

On the contrary, the National under special circumstances,

tioned

shall

lacking

the National Banking Law was to realise, namely, the provision

of the issues

We

bank

improvement

Some of the peculiarities means of regulating note York.

thus

realised as good

BANKING

free

bond have

deposit already

banking

to refer American

again

system been

system to these

experiences

as a men-

of New probleading

CHAPTER

The

VI

Development

of Central in

Banking

Germany'

Te history of banking in Germany, like that of the United States, should properly be considered in terms of the separate States, but it is impossible to do that here and we shall concentrate our attention on the main events in Prussia, with

an occasional

reference

to the

States. The setting in Germany is dissimilar other countries we have so far considered,

policy

of other

to that in the for the reason

that Germany at no time adopted true laisser-faire principles in her commercial policy, and therefore it is less surprising to find State intervention in banking in this countrv than in any other. The longer retention of mediaeval restrictions on the free circulation of goods and services witnessed a corresponding lag in the development of banking. _'But a good deal of literature was written about banks in the early eighteenth century, and there was detectable in most of these writings a mercantilist idea that the setting up of banks would produce a sudden and conspicuous increase in wealth.' 1This chapter is based mainly on tile account given by W. Lotz ' Geschlchte und Kritlk des Deutschen Bankgesetzes, vom 14 Marz, 1875." z In the more modern sense, that is. of discounting and note issue as opposed to the kind of business carr|ed on by the early Giro banks. "_Cf H. Schumacher, "Geschichte der deutschen Bankliteratur im 19 57

58

THE RATIONALEOF CENTRAL BANKING

The tivated

first steps by fiscal

time,

before

they the

were taken by princes and nobles needs, attempted to start banking

commercial

consequently note-issuing

first

bank

conditions

met

with

branch

of issue

were

scant

of the

to prove bank even

founded this one

tunate

in these

years

had

it not

certain

deposits,

_ and

been

der

paternal

The

first

Wars,

effects The

from

heavy

and

they

were

sult of the tain

of this

loans later

in close

were

was

assigned the

as

The

the

Royal

the been

Great. 4 so for-

to it by

law

management

of the it made

intensified

of Tilsit,

territories

relations

witnessed

cash

difficulties

Peace

Polish

and

it suspended

sanction. the

and

concerned.

by Frederick would have

also

it, so far

of

funds. As it began, so it continued, throughof its existence, as a privileged institution unprotection

when

was

had

given

for

at least

at all successful

Bank of Berlin, a State It is doubtful whether

the Exchequer out the whole

ripe

success

business

who, mobefore its

in the

payments bank

with

arose

to the

in which on

took

first

place

as a re-

Prussia

invested

of its deposits

completely an enormous

lost to the bank. It emerged from the war with deficit, and after the cessation of hostilities it as a result independent but its Chief

cial

to the

responsible

way

all lines

of the

were

experiences and was Treasury and the Fiof course, a State offi-

existed at this other than the

establishment

of business.

assets

King.

No specific prohibition mation of private banks the

of the war of the remained,

These

cer-

a large

proportion

was reorganised made nominally nance Minister,

mortgage.

Napoleonic

Government,

from

had

State.

Government

it suffered

away

the bank

the

in the

Prussian

by losses

which

with

In the

of joint

time against the forobstacles that lay in

'twenties

stock

two

organisations

private

banks

in set up

Jahrhundert" m Schmollers Festsehrift, "Die Entwicklung der deutschen Volkswirtschaftslehre im 19 Jahrhundert," Pt. VII. 4In 1765 Frederick was unable to obtain the private capital, otherwise he would have made it a private joint stock bank, Vlz., the moneys of wards, courts and charity institutions.

THE DEVELOPMENq?OF CENTHALBANKINGIN GERMANY in Prussia dertaking the Berlin Stettin. _

and broke the monopoly of the Royal Bank by unboth deposit business and note issue. These were Kassenverein and the Pommersche Privatbank at

But this when

period

of relative

freedom

was

a complete

reversal

there

year

made

the

issue

approval

of the

prompted

not

leged

Royal

circulation the time tended.

it must

Royal

came

Bank

almost

at the

Mortgage

and

monopoly

of the

desire

to give

tion

none in the

itself

note

priority

sphere with

way

included

set

not

but

of note this

when

up

in this

because issue

dread

changes

The

Leipzig with

Bank an

of Saxony,

exclusive

case

the

in several other In Bavaria the as the

given

result

of which

fear

that

notes,

in 1838, but

was

a of a

there

competi-

be dangerous, many

founded

privilege

in in-

enormously

notes,

would

of too

prohibi-

in 1835 _ was

of the

in ex-

had to give on bank-

and

in

find

a

we

maximum limit to the note issue. A less understandable ulation was that which compelled the bank to invest three-fifths of its funds in land loans.

dowed

privifor the

in the

to swell

to Government

in Bavaria,

accordance

but to make

being set up was restrictive.

Bank issue,

was

of the

moment

were case

Exchange

prohibition

the

which had originated and was now to be

was

about

of that on

interests

note-issuing banks increased restrictions

very

were

About this time banks States: the policy in each

were

money Wars

in 1833,

A law

dependent

virtual

the

be noted,

of the Prussian of notes. These

technique for credit.

notes

for

to an end

of policy.

This

of regard

Bank,

The

dustrial demand

Government. out

came

of all bearer

of State paper of the Napoleonic

tion; all three up the issue ing

_9

was

regat least not en-

subjected

to

hThe latter had royal aid at its foundation, and was bolstered up by the Government on several other occasions at a later date. : This was the first note-issuing bank to be set up in Bavaria, but the Royal Bank of Nurnberg, a non-note-issuing bank, dated from 1780

60

THE

RATIONALE

OF CENTRAL

BANKING

equally rigid restrictions. In this case the proportional reserve requirement (of two-thirds) was imposed in preference to the maximum limit on the note issue. It was in the 'forties that the struggle for free trade in banking became acute. In the preceding years capital had been relatively abundant and interest rates low, but about the middle of the decade a reversion set in as the result of increased capital needs for railway development, and interest rates rose. The public mind entertained exaggerated hopes as to the power of banking. It was a widespread belief that all that was necessary to relieve a scarcity of capital was an elastic note issue, and the issue of notes was still thought to possess something akin to a magic power of transforming poverty into wealth. The philosophy of the Saint Simonians, which conceived of a reformed society in which the banking system was given a central organising role in the assembly and distribution of capital, had also spread to Germany. These notions gave an impetus to two movements, the one demanding increased note issues and the other looking towards the creation of credit mobilier institutions. Added to the demand for more capital, there was at this time a genuine currency difficulty. Very little gold was then in circulation, and in the absence of notes, payments had to be made in silver, which was very heavy to carry out. Notes were therefore found of very great convenience, and since they wer e relatively scarce, they were often sought even at a premium. There began an agitation against the repression of private initiative, and the Prussian Government was overwhelmed with schemes for the creation of private banks of issue to exist alongside the Royal Bank, all of which it strongly opposed. The demand for private initiative took two forms. One group merely wanted a private joint stock bank in place of the existing State bank; others wanted to go much further and demanded nothing less than a system of independent freely-organised competitive banks.

TIrIE DEVELOPMENT

The tion

Prussian

by the

ing state

OF CENTRAL

Government

news

that

of Dessau

was

on one

the

BANKING

IN GERMANY

led out

of passivity

of its borders

authorities

had

61

in the

into

ac-

neighbour-

approved

the

project

for a note-issuing bank which had plans for extending its activities over the border into Prussia. Although William IV commissioned Rother, the then Minister at the head of the Royal

Bank,

private not

more

much

that

liberal

bank tainly

academic

alternative

was

owing

to the

fell back on the bank. So it was partly

the

which

it had

interest,

State.

lack

by It was

formerly

i

of funds

private given

exercised,

reserve

proportion

to the

note

circulation.

The

retained

Royal

Bank,

public

transactions.

lishing

the

bank

and

its notes

An irnportant and

of

as being adopted

the

Royal

of capital and the the

in the

of private in 1846

metal

bank

and

to replenish

ually to replace the State paper law specified both a maximum

as the

idea

characteristic

State

share as the

Bank. arising scheme

assets

of the

and

the

cerbut,

Treasury,

he

capital into the Prussian Bank,

shareholders back

of the

its lending capacity. Rother bank as the most desirable,

introduction reconstituted

controlled

by

establishment

the

of reorganising

intended

and so strengthen envisaged a State

wholly

for the

dismissed

still handicapped by lack left by the French Wars,

adopted

probably

now

a scheme

Rother

mere

bank was the deficit was

out

of issue,

than

less

This from

to work

banks

instead

right

of

of note

issue

were

grad-

its notes

then in circulation, but the limit to the note issue and a extent the were

of one-third privileges made

clause of the

legal

in the banking

_ of the

it had

held

tender

decree

for estab-

notions

of

_ The "Drltteldeckung" (cash reserve of one-third), which h_(im this time onwards was a common provision In the laws on German banks of issue, seems to have been the adoption by legal prescription of the conventional practice said by Horsley Palmer to have been followed by the Bank of England before the Commission of 1832 In England. Palmer's pamphlet on the policy of the Bank of England prior to the crisis of 1836-7, which we mentioned in a previous chapter, was translated into German under the title "Die Ursachen und Folgen der Wirksamkeit der Bank yon England in dem Zeitraume vom 10 Oktoher 1833 bls 27 Dezember,

1836"

(1837).

6Z

THE

RATIONALE

OF CENTRAL

BANKING

the period was that which stated specifically that it was its express task to prevent any great rise in the rate of interest, and it was, in fact, forbidden to raise the rate for lombard business above 6 percent. But the extension of the note issue and the lending powers of the Prussian Bank did not suffice to quieten the agitation for greater freedom. The year 1847 was a year of very heavy demand for credit. This was especially true of the west, in the lower Rhineland and Westphalia, where industrial development was proceeding fast, and, although provision had been made in the constitution of the Prussian Bank lor the establishment of branches, it had been particularly slow to develop them in these parts. Opinion in favour of private note-issuing banks became very strong, and its adherents began to hold organised discussions on the subject. _ The excitement of 1848 brought a sharp turn of events. The Government was persuaded to allow note-issuing powers to the Bank of Breslau and to the Chemnitzer Stadtbank; it also set up itself State loan banks in connection with the Prussian Bank; finally, it took the far more radical step of granting concessions for the creation of private note-issuing banks. But this was only a very grudging gift to the freebanking party; the concession was in each case given for a period of ten years only, and, moreover, the banks were over-regulated in the extreme. The celebrated NormativBedingungen, under which they were established, restricted the scope of their business to a minimum. Besides the stipulation that they must keep a metal reserve of one-third against their note issue, they were tied down to the smallest possible level of funds, and the lines of business in which they might engage were likewise restricted. Their paid-up capital must not exceed a certain very low fgure. The maxi"_As in the

Erste

Vereinigte

Landtag

in 1847

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN GERMANY

63

mum note issue for all the provinces together was fixed at a figure only one-third of the limit for the Prussian Bank and this total was divided equally among the provinces with no regard to their relative business needs. The banks were not allowed to have agents in other centres; they were not allowed to deal in Government securities that were not Prussian; neither could they discount bills whose acceptor lived outside the business place of the bank, and bills must be three-named; moreover, they were not allowed to pay interest on deposits, thus leaving such business entirely in the hands of the Prussian Bank. So urgent was the demand for notes, however, that the Berliner Kassenverein and the Stettin Bank TM immediately subjected themselves to these regulations in order to be able to exercise rights of issue. Alongside the note issue campaign a second notion was beginning to exert an influence on the development of banking institutions in Germany. Almost as soon as the credit mobilier idea was first evolved in France it was taken up in Germany, and by the turn of the decade a number of joint stock banks were setting up in various parts of Germany in credit mobilier business. The Disconto-Gessellschafl in Berlin, the

Schaffhausen'schen

Bankverein

in Cologne

and the

Darmstadter were among the most important. In Prussia it was still difficult to establish even these, since joint stock :_ _

companies had to obtain special Government concession before they were allowed to go into business. So it was that the Bank f_r Handel und Industrie (later known as the Darm-

i

could obtained either because in Prussia no orconcession in Frankstadter) be had to set atup theat time Darmstadt

_

furt am Main, and the Disconto-Gesellschaft ship for six years before it could obtain become a joint stock concern. The rate of progress _0 The

Stettin

Bank

was

was a partnera concession to

in the setting up of note-issuing allowed

to retain

its interest-bearing

deposits.

banks

t_4

THE RATIONALEOF CENTRAL BANKING

was

slow,"

Free

Banking

and

did

Party.

not

Chamber

of Deputies,

1851--2

of a parliamentary

conditions public

in Prussia,

attention.

relaxation side

On

of the

go far

Under this and

standing

tried

but unsuccessfully of the

Some

In the founded began

ony,

banking

channels

side

the

Prussian

credit

it gained

more

party and

demanded

on the

Bank

of private

Bavaria laws

in

and

a

negative

as a half-State

enterprise.

Harkort

passed

for the

place

in the

policy

of the

Prussian

to adopt a more liberal lending policy its branches in the western provinces.

just

note-issuing numbers, over

the

and

banks their

boundary

'-' and

were notes

being soon

in Prussia

and

small States issued notes for lower denominaPrussian Bank, and the Prussian Government

to exclude them fi'om its territory by forbidding in non-Prussian notes for sums less than 10 Rthlr.

the

and had

they were aimed Rthlr. notes. The lution

in the

institution

to get legislation

smaller States in considerable

Saxony. These tions than the

but

in the way

did take

to circulate

sought ments

the

of the

the

into

via these

demands of Harkort

Normativ-Bedingungen.

reforms

Bank; it began also extended

secured

positive

against

institution removal

party enquiry

the

the

leadership

Normativ-Bedingungen,

it declaimed hard

to meet

the

W(_rttemberg no effect merely

followed

because replaced

P_ossian Government was I0 increase the

the their

saw that note issue

the banks

paySax-

same

course,

against

whom

1 Rthlr.

notes

by

10

the only logical soinside Prussia. Two

u The total result of all the concessions even up to 1857 was that m that year there were in Prussia nine noteqssuing banks, including the Bank of Prussia _eIt started the practice of lending out part of its deposits on current account. Much of the progress in Prussia during these years had been due to the efforts o| one man, David Hansemann. It was under his leadership as President of the Bank that the Prussian Bank changed its policy He had also been responsible as Finance Minister for obtaining the 1848 concessions for the formation of private note-issuing banks and for securing the royal consent to the foundation of the Schaffenhausen'schen Bankverein as a joint stock company. It was again he who, a few years later, founded the Disconto-Gesellschafl.

THE

:

DEVELOPMENT

OF CENTRAL

BANKING

IN GERMANY

65

alternative ways of doing this were conceivable. One was to change the law relating to the foundation of private banks and the other to centralise the banking system, and give unlimited rights of note issue to the Prussian Bank. Finally a compromise was adopted. The Government gave unlimited rights of note issue to the Prussian Bank and allowed it to issue notes of low denominations in return for a financial operation which the Government regarded as very favourable to itself, namely, the commutation of half of its State paper money into interest-bearing State debt. Secondly, concessions were made in favour of private note-issuing banks. Four more received Government sanction to set up, and certain of the clauses of the Normativ-Bedingungen were modified so as to allow the private banks to discount two-named bills, to set up agencies, to issue small notes, and to take interest-bearing deposits. The concession regarding interest-bearing deposits was subject to the condition that the amount taken must not exceed the amount of the original capital of the bank,

i

and

that

the

two months'

deposits

should

not be callable

at less than

notice.

i

effect Then onthethecrisis later oftrend 1857 of occurred, policy.

,_

against the bank creations of the 'fifties '_ and brought the beginnings of a change in attitude. The Prussian Bank was ac-

I

and It provoked this had aa reaction marked

:_

cused and of having kept effect the discount crisis, one good that came rate of ittoo waslow the before renuncia-the rate percent. tion of the limitation of the of interest to 6 In the crisis itself the bank assumed what had come to be con-

2 :_

sidered the functions reputable firms who

._,

nounced, unlimited H Although

of a central bank by lending freely to found themselves in difficulties. The

and there was a crop of literature right of issue of the Prussian there

were

still in 1858

onlv

thirtv.

Zettelbanken

in iavour of a Bank was dem twenty.

States

66

THE RATIONALEOF CENTRAL BANKING

100

percent

Zettelbanken

specie

backing

for

of the

border

States

bly justifiably in many cases, impossible thing of combining note

issue.

Prussia

Steps

and

payments bition

were

in non-Prussian of foreign

bank either

The

notes;

all that

were

to exclude Prussian

was

issue.

'4 The

proba-

attempted business

their

notes

Government only

the

if the

was

that

the

notes

punishment. was by now

into

the

question,

a leaning the

over

towards

one

banking

full freedom

extreme

for all banks

to a preference

for

border

States,

of policy The

systematic

gether taken gress

and

the

negotiations

separate

discussion

States

of the

deutscher

State

beginning interest. "'wilden

Volkswirte,

to be

divided

to issue

was

unity

to obtain met

whole

foremost

relegated

no longer

with

over-supervision this time given up vate banks in note

at

in the

uniformity little

banking

among

success.

question

whom

was Kon-

was

and

of purely

was

academic

They

all hope of ever securing freedom issue, and henceforth concentrated

Dr.

had alwithout

the too lax regulations States, but condemned

of the Normativ-Bedingungen.

to-

programme traders, the

so prominent

to a position

The Congress opposed Banken'" of the border

from notes

The free-banking (Bankfreiheit) party changed its ground. Bankfreiheit

intervention

to a

as yet unpractical beout the notes of the

with the formulation of a positive up by a private association of free

Otto Michaelis. ready somewhat any

Prussia's

among

was in of for-

ranging

complete

note issue at the other. The latter was cause of the impossibility of keeping

prohi-

went

risk of legal of Deputies

factions

in all

note-issuing

discount because of the The Prussian Chamber many

both

centre in Saxony. The law in preventing the circulation

happened

the with

forbade

In Saxony

to apply

small

condemned,

bank-notes.

notes

had no redemption case ineffective

eign

note

since they had credit mobilier

taken

in Saxony.

the

_

of the the had

by

for pritheir

14 Notable exponents of this view were Tellkampf and Geyer. See Chapter IX.

THE

DEVELOPMENT OF CENTRAL

efforts

on trying

to secure

joint stock basis, people persisted

BANKING

freedom

IN GERMANY

for deposit

pointing out that in regarding note

67

banking,

on a

it was unfortunate issue as the chief

that object

of banking. The was ment

swing

towards

slowing

up.

in 1863 when

issuing banks take additional twice the teen deal

certain

of once of their

of the

restrictions

amount

of their was

right passing

In the

the south

stringent.

of note

issue,

of a Peel's

of Germany

Where

there

note

was

issue

acknowledg-

on private

note-

allowed to now being

paid-up

extended

years. In the Chamber of Deputies of criticism of the Prussian Bank,

mending

in the its last

modified; they were deposits, the limit

concession

its unlimited _.

the

freedom

practically

were slightly interest-bearing

instead period

increasing

It received

capital,

and

ten

to fif-

from

there was still a good and most especially of

and

Michaelis

was

recom-

Act for Germany.

the

restrictions

not

monopoly

were there

still

very

was

com-

ic l_ !f.

plete prohibition of note issue, as was the case in Baden and Wurttemberg. In both these States the Governments had persistently opposed the establishment of a note-issuing bank, and it was onlv in the Franco-Prussian War that one

i:

was

_:

conceded

Most

ibr

forces

observers

were

with

the

the

first

now

time.

operating

advantages

in the

direction

of a strong

bank

of securwhich

can

give liberal accommodation in a 1866 crisis, crisis The continual ing further centralisation. The impressed consolimany dation of political authorities helped to widen the area over which a common policy could be pursued. Prussia acquired new territories after the war of 1866 to which the business of the Bund

Prussian in 1870

member

Bank gained

States.

was

extended,

control

A reform

over of the

and

the

banking law

Norddeutscher

legislation relating

in all the

to joint

stock

companies freed them from the obligation to obtain authoritative concession, and this at last opened the way to the establishment

of non-note-issuing

banks,

which

was

all

that

the

68

THE RATIONALE OF CENTRAL BANKING

free-banking party now demanded. The final impulse to the adoption of central banking was given to Germany's experiences in the first years of her operation of the gold standard. At the formation of the Reich in 1871 the laws of the Norddeutscher Bund were extended to the whole of German territory and a uniform currency was established for the first time; it was based on the gold standard, and the payment of the French indemnity provided an easy opportunity for accumulating the necessary reserves. As early as 1873 a crisis occurred, however. The note issues of those banks which had had no maximum limit or which had never previously reached their limit had risen very rapidly after 1871, and this was especially true of the Prussian Bank. When the French indemnity stopped, the exchanges went against Germany, and gold started to flow out. Germany had had very little experience of external specie flows, because when silver had been the standard it had been very expensive to collect specie and export it, and the specie points had therefore been very wide. Neither were the Germans familiar with the effect of a gold flow in rectifying the exchanges, and the immediate consequences of the first gold exports was a scare that all the gold was going out and that Germany would be off the gold standard. The undue alarm that thus arose had an important influence on bank policy. It brought in the first place a sudden realisation of the uses of discount policy. German opinion had been very much influenced by English events, and especially by Peel's Act, and following on English doctrine, it was believed that in order to manipulate a discount policy it was necessary to have a specially constituted central bank, which would be responsible for controlling specie flows. These ideas were embodied in the German Bank of 1875. `5 The Act was closely 15Both Tellkampf

modelled

and Michaehs

on the English Act of 1844, but

took part in the drafting.

THE

far

more

tion

DEVELOPMENT

statutory

of the

Reich issues

note

banks

were

banks

were

was

maximum,

against

their

and

total

relinquished

its

issue

issue,

in the

Thus, not

torm

if banks engage

certain

The Bank,

not

Reichsbank which

was

must

discount was

of the

to acquire

an issue. how-

of business.

notes

might

they

trade

must only

in mortgage

having out

more of the

a wholly

bank

fiduciary disabilities, types

engage

one-third

If any

was

they

not bills

into

of

to issue

constituted

turned

posi-

whole

imposed.

on certain

business;

of bonds,

ness, and could months to run.

also

to continue

in acceptance

classes

the

to its legal Act involved

of a restriction

wanted

for

Reichsbank

addition to the same amount Submission to the terms of the ever,

The

Thirty-three

proportion

was

the

imposed.

69

be established. The fiduciary the Reichsbank, were given

a reserve

note

IN GERMANY

as follows:

recognised

and no new ones might of all the banks, including

a legal

BANKING

requirements

private

note-issuing

OF CENTRAL

than old

privately

in

busithree

Prussian

owned

con-

cern, but retained the official administration with still very little control left in the hands of the shareholders; it was consequently considerably control than the Bank Reichsbank was restricted bard

business

was

subject

less independent of Government of England. The business of the to certain lines: discount and lomto the

same

limitations

as in the

case of the private banks, deposits was permissible

and only

the taking of interest-bearing up to a fixed sum. The notes

of the

not

made

were

given

banks, notes

Reichsbank much

in that, of any

for payment

were wider whereas

other to the

legal

circulation

than

a private

bank

private

bank

place

wherein

A private provisions

note-issuing of the

bank Act,

but

the

but

notes

might to the

issuing

the

issuing

bank

was

be

paid

allowed

if it did

this

out to stay

it was

they

of private

not

except

ated, notes of the Reichsbank might ceiving bank without restriction. the

tender,

pay bank was

by

the

out or siture-

out from to have

its

70

THE

operations

restricted

it its right

of note

The position

provisions

RATIONALE

to the

OF CENTRAL

territory

BANKING

of the

State

which

gave

Reichsbank

the

issue. of this

of a modern

Act secured

central

bank.

to the

CHAPTER

VII

Discussions the

Theory

of the

in England

and

Prior

Although ning there the

the

in England, as it did much

in England

to

discussion it never

on the

greater

rise

Subject America

1848

of free reached

Continent,

degree

giving

on

banking such

This

of freedom to a more

may that

rapid

there than in either France or Germany, less pressing need for reform, Moreover, faire

politics

nopolies, had

had

the

become

taken

Bank the

up

pivot

were

easily remodelled, whereas systems were less firmly subject to discussion. The

discussion

nection with ing with the attention

was

its stand

of England

and far

on the established

in England

seems

the agitation for joint pamphlet of Thomas drawn

"The General Principles Scotland with Observations atlon in the Character of the in order to effect it,"

to the

greater

have had

its begin-

proportions been

due

always

growth

to

existed

of banking

and therefore to a bv the time laisser-

against the

too

had

large

privileged

system

well

established

Continent the and therefore to have

mo-

of which

opened

it

to be banking more in con-

stock banking, commencJoplin,' of 1822, in which stability

and

freedom

and Present Practice of Banking m England and on the Justice and Pohcy of an Immediate AllerBank of England, and the Measures to be pursued

71

72

THE RATIONALE

OF CENTRAL BANKING

from failures of the Scottish banks in comparison with the English, a circumstance which he attributed to the greater financial strength and general superiority of the joint stock organisation in which the number of subscribing shareholders was unrestricted compared with private concerns in which the number of the partners was by law not allowed to rise above six. It was impossible to ignore the anomalies of a law which, as Lord Liverpool remarked, permitted "every description of banking except that which is solid and secure.' ,2 The partial victory of what we may already call the fleebanking party, in the law of 1826, gave added impetus to the general discussion, and it was brought forward at several meetings of the Political Economy Club. This club had been founded by Tooke to support the principles of Free Trade, and it was not unnatural that reference should be made to the possibilities of extending Free Trade principles to banking. The chief adherent of such an extension was Sir Henry Parnell, who moved a discussion '_on whether "a proper currency (might not) be secured by leaving the business of banking wholly free from all legislative interference." Much the same question was brought up on several subsequent occasions? Parnell continued to hold that the issue of bank notes should be subject to free entry in London as well as in the provinces, and not subject to the monopoly of the Bank of England, although three of the leading economists of the day, Tooke, G. W. Norman and MacCulloch, argued against him. Parnell's defence of free banking is contained in a pam-

' See J Horsley Palmer, Money Markel," 1837.

"Causes

and Consequences

of the Pressure

on the

See "Pohtical Economy Club. Minutes oI Proceedings," VoI.VI., February 6th, 1826 (p. 28) 4Ibid., May 4th, 1829 (p 33); January 13th, 1831 (pp 220-1); March 1st, 1832 (p. 38 and pp. 231-2); May 3rd, 1832 (p 39t

DISCUSSIONSON THE THEORY PRIOR TO 1848 phlet before

written in 1827. * The evidence of the the House of Commons Committee

drawn

his

attention

regularly ances.

clearing This

to the each

practice,

in a free-banking on the over-issue

a free

system

keep

its

power much

it was

own

notes return any than

Scotch

banks

and

paying

the

was

of primary

interests

within

of each

bounds,

every other circulation.; either banks,

bank

but bank Banks

bank

A receives

B receives

presenting cally doing

means there

was

one

This which

than

one

to

to exert

its

of the

its own. It will issuers. Now if notes

arise

of bank

a clearing

B bal-

require to be paid in gold out that if one bank over-issued

control

by

depended

notes for redemption so, and it was a check quickly

efficient that in

not only

also

more will

banks would acquire consequent drain on

in its expansion.

ing mechanism

such

of A, and A will So it is concluded

its notes the other against it, and the it up

by

bal-

impor-

as deposits or in repayment and no banks will re-issue

of A's notes,

in

from forcing too will receive every

of other banks in preference to issuing the notes of the other banks to their

ance in favour of B's reserve.

pull

in the

issues

of the

notes

submitted,

Scotch bankers 6 in 1826 had

system and acted as a very of bank notes. He contended

in preventing of its paper into

day from customers, loans, notes of other

other's

he

tance check

practice

73

positive balances its reserve would way

of the

but on the banks" which was likely

which

clear-

not on the public's

much

more

drain rates.

of bullion set in motion by the falling foreign In Parnell's own words: "It is this continual

waited

on

the

reciproto work external exchange demand

for coin, by the banks on one another, that gives the principle of convertibility full effect, and no such thing as an excess

of paper

or as a depreciation

of its value

can take

place

_ "Observations on Paper Money, Banking and Overtrading. including those parts of the evidence taken before the Committee of the House of Commons which explained the Scotch System of Banking." 6Committee of the House of Commons on Scotch Banking. 70p. cir., pp. 86-87.

74

THE RATIONALE OF CENTRAL BANKING

for want of a sufficiently early and active demand for gold. If in England the power of converting paper into gold has not prevented an excess of paper, because the demand does not occur until long after the excess has taken place, this is to be attributed to the system of English banking."_ The opposition between the views of Parnell and MacCulloch was given more definite expression in a pamphlet of MacCulloch's" and a reply to that pamphlet by Parnell?" MacCulloch's contribution contains the first important theoretical arguments ibr the case against free banking. So far as the whole circulation of the country is concerned, his view was that so long as convertibility on demand is enforced, the issue of paper money cannot depreciate its value below that of coin. An over-issue can admittedly depress the value of the whole circulation, gold as well as paper, in the countrv concerned, but immediately this over-issue takes place, gold starts going abroad, notes are presented to the issuers for payment, and they, in order to prevent the exhaustion of their reserves and to maintain their ability to redeem their obligations, are obliged to contract their issues, raise the value of money and stop the gold efflux. There is, therefore, in his opinion always a check on over-issues by way of the public's bringing notes to the banks for redemption. Now on the evidence of this argument alone it was open for Parnell to reply, as in fact he did, that the obligations to pay notes in gold, which MacCulloch invoked as a safeguard against the Bank's over-lssuing its notes, is just as effective in a system of a number of banks as in the case of a single bank like the Bank of England, that, in fact, this Bank had often overOp. ctt., p. 88. _ "Historical Sketch of the Bank of England with an Examination of the Quesnon as to the prolongation of the exclumve privileges of that Establishment," 1831. _0"A Plato Statement of the Power of the Bank of England and the Use it has made of it, with a Refutation of the Obiections made to the Scotch System of Banking, and a Reply to the Historical Sketch ot the Bank of England," 1832.

DISCUSSIONS

ON THE THEORY

PRIOR

TO

1848

7_

issued and that the principle of contraction had worked very imperfectly in these cases because the Bank had always applied it too late. MacCulloch had, however, developed his argument further than this in an attempt to show that the free system of banking would be more liable than a restricted svstem to lead to the frequent appearance of the phenomena of overissue, the reason being that competition among a number of banks would cause one bank to lower its discount rate in order to increase its business, and all banks would be forced to do the same. He anticipates that his opponents might argue that the notes of the bank, taking the initiative in the process of expansion, would be returned to it and that, therefore, its own interest and the integrity of its reserves would hold it back. In reply to this argument he denies that any such check would operate because when falling exchange rates cause merchants to demand gold in exchange for notes they will send in for redemption any notes that first come into their hands. They will not enquire which bank has been the cause of the over-issue, and consequently only the same proportion" of the excess issue will be returned to the over-issuing bank as to the non-over-issuing banks. Thus the non-over-issuing banks have to sustain part of the pressure, and if they wanted to maintain their reserves at the same level as before they would have to reduce their issues while the policy of the expanding bank continued to encroach on their reserves. It is exceedingly unlikely that these banks would be content to go on losing business and reserves indefinitely, because carried to extremes the process would finally result in their extinction and in the de facto monopoly of the expanding bank. Thev would thus be virtually forced to follow the policy of expansion in selt:de_It would be more praclical to assume thal the proportions m which are returned to each bank are the same as the proportions existing between cu'culatlons outstanding of the different banks

notes the

76

fence.

THE

The

RATIONALE

conclusion

OF CENTRAL

BANKING

is that if one bank

such a policy, it will become drain of gold will fail to check it be a large over-issue and finally The essence of MacCulloch's bank is not subservient to the

should

decide

on

general; the tendency to a in its early stages; there will a very acute crisis. thesis is that the expanding control of the conservative

banks, but that the latter are, on the contrary, subservient to the former. It should be noted that MacCulloch spoke only of the presentation of notes for gold directly by the public, a check that can be held in any case to come too late, since the exchanges are only affected after the over-issue has worked out its effects on the price and production structure and sown the seeds of a crisis. He ignored altogether Parnell's point about the operation of the clearing mechanism. MacCulloch gives also a second and distinct reason for not allowing free entry into the note-issuing business. This relates not so much to the possibilities of a general over4ssue, but to the evils that may result from over-issue on the part of a single bank or a number of banks. It is obvious that when a failure of any particular bank occurs, certain people, viz., the holders of the notes of that bank, will suffer loss, and it was MacCulloch's view that the Government should regulate banking in order to prevent such loss accruing to people who were possibly unable to distinguish the note of a good house from the note of a bad house, or, even if they did have sufficient knowledge to do this, might in practice not be in a position to refuse to accept payment in the notes of any form for fear of losing their claims altogether. '2 This is a particularly forceful argument in favour of the suppression of notes 12 Op. cir., pp 8-9 "It is said by those who are hostile to interference that coins are legal tenders whereas notes being destitute of that privilege, those who suspect them are at liberty to refuse them, but whatever notes may be in law, they are in many districts practically and in fact legal tenders, and could not be rejected without exposing the parties to much inconvenience. It should also be observed, that labourers, women, minors and every sort of person, however incapable of judging the stability of banking establishments, are dealers in money and are consequently liable to be imposed upon."

DISCUSSIONS ON THE THEORY PRIOR TO 1848

77

of small denomination, since it is the class of people who will not usually be in receipt at any one time of sums above a fairly small amount (say less than £5) who are mainly concerned. Actually the argument that MacCulloch himself stresses in favour of the prohibition of £1 notes is the greater facility with which forged notes of small denomination are likely to pass. '3 Another argument, in support of which MacCulloch gives very little evidence, is that whereas the Bank of England takes care to keep gold reserves of a size commensurable with demands liable to arise in time of a crisis, if there were a number of competitive banks, no particular bank would incur any sort of general public responsibility and each would trust to the efforts of the others. This was, as stated, an argument that was weak a priori, and for which there was, furthermore, little practical evidence. Influenced no doubt by the experiences of 1825 he was led also to remark on the advantages of an institution like the Bank of England, which could render aid during a crisis by expanding its issues and lending freely to reputable firms in distress. With the alternative system of a number of firms, no bank would be able to inspire the same confidence and to get its notes accepted; in time of general distrust they would all have to contract their operations instead of expanding them. Parnell's reply to MacCulloch was directed mainly towards a criticism of the policy in the previous half century of the Bank of England, and no attempt was made to answer MacCulloch's main grounds of objection to a diffusion of the rights of note issue. Events in America at about this time were also calling forth comments from writers in that country on the problems raised by the issue of bank-notes. An influential 7_Presumably notes for smaller sums are likely to be subjected scrutiny than notes involving larger sums,

to less careful

78

THE

RATIONALE

OF CENTRAL

BANKING

contribution was made by Albert Gallatin at the beginning of the 'thirties. '4 In reviewing American banking history he was inevitably most impressed by the frequency of suspensions of cash payments and was chiefly interested to discover effective methods of controlling note issues within their proper limits. To this end he recommended the placing of much narrower limitations, both on the amount of the note issue and on other obligations that any bank might legally incur. '_ He believed that the best method of giving complete security against the danger of insolvency was for the bank capital to be invested in Government securities, '_ but he doubted whether this would be practicable in the United States because there was not a large volume of Government stocks in existence. He was, however, very favourably impressed bv the Scottish system,': and refers to the extensive deposit business and the system of cash credits '_ developed bv the Scottish banks. The most efficacious method of preventing excessive issues was, he believed, the frequent exchange of each other's notes by the banks as practised successfully by the Scottish banks, the allied banks of Boston and the Bank of the United States." In spite of his praise of the Scottish system, Gallatin was not in favour of extending free competition to note issue as opposed to discount and deposit business. He did not explain the distinction by reasoning as did so many of his contemporaries that deposits, unlike bank-notes, had no effect H "Considerations States," 1831

on

the

Currency

and

Banking

System

t5 The figure he suggested was that loans should not extend the amount of bank capital This would m itself act as a cheek on recommended that m addition there should be a specific restriction issue to two-thwds ol the bank's capital _'The bond deposit system proved, in fact, later, that it adequate_ 17 Op. c_t., p 94, '_ This corresponded more or less to what we should now call loan by overdrall _ Op. ctt,, p. 95

of

the

Umled

beyond twice issues, but he of the note was

lar

the

method

from

of

DISCUSSIONS ON THE THEORY PRIOR TO 1848

79

on the total circulation and therefore on prices. On the contrary, he specifically states that "The credits in current account or deposits of our banks are also in their origin and effect perfectly assimilated to bank-notes--and we cannot therefbre but consider the aggregate amount of credits payable on demand standing on the books of the several banks as being part of the currency of the United States."-" There is no doubt that he saw clearly not only the part played by checks drawn on current account on the total amount of circulating media, but also the exact similarity between creating additional loans by placing credits to current account as by issuing notes over the counter. Presumably the reason he had in mind for distinguishing between notes and deposits was the difference in generality of acceptability/' Among Gallatin's readers was G. W. Norman, a Director of the Bank of England. 2-'Norman rejected the thesis of Gallatin and Parnell that the clearing mechanism can act as an efficient control over note issues; he reasons that if the will to expand is common to all or to a majority of the banks the frequent exchange of notes will be powerless as a check on over-issues, because so long as the banks expand in step with one another, no debits will arise in the clearings. It was his own view that while what he calls "the true and legitimate objects of banking" could and ought to be left to free competition,-'_note issue was the one case in a hundred where monopoly should be maintained, -'_and he favoured to this end the complete abolition of all the country note issues. -'-_ 20 Op. Clt,, p 31. -'1"Checks differ from bank issues m that the bank-note is taken m payment solely from the general confidence reposed m the banks, the check from the special confidence placed in the drawer." See Gallatm, "Suggestions on the Banks and Currency of the Several United Slales, etc ," 1841, p 13 22 "Remarks on Currency and Banking," 1833 2._Op cir., pp 27 and 42 z40p. cir., pp. 25-26. z_ Op. cit, p 58

SO

THE RATIONALEOF CENTRALBANKING

The

first

writer

competition tion

in other

Lord

to give

an

in note

issue

cannot

trades

seems

Overstone).

"The

explicit

explanation

be assimilated

to be have

ordinary

been

of why to competi-

S. J. Loyd

advantages

to the

i

(later

commu-

nity arising from competition are," he says, "that excite the ingenuity and exertion of the producers,

it tends to and thus

to secure

being

to the

public

to the

quality

and

price,

while

all the

tions not

on the part on

the

the

best

quantity evils

supply,

of the

With

from

the

end

to be sought

or miscalculation portion

upon

Loyd,

the

Norman

become

and

upon public and

prominent

herents of Peel's them among the

the

this

Tooke

sides

being

one

leaders

This

gal restrictions ties under mine the views open

were

of the

in the of the

group on the

be left to the

was

opposed

amount

of the

discretion

the force of the amount. In spite

pro-

''z_

all in later

currency

school

less entry

surprising into the

years

to

and

ad-

to find banking

same

camp,

for he,

Free

Trade

movement,

to the note

of the

a is

error

greater

issuers.

foremost representative of that school and credit which came to be known

ing school. it should

the

Act. It is therefore opponents of free

it is to find

was the currency

of any

falls in a much

of the

than

how-

evil consequence

MacCulloch

trade

and

currency,

different kind; by fixed law

upon

members

lowest

or miscalcula-

is of a very of its amount

point

than

had

fall on themselves

to a paper

ever, the interest of the public steady and equable regulation

at the

errors

will

respect

regard

commodity,

arising

of the producers

public.

due

be-

of thought on as the bank-

imposition

issue,

and

note-issuing

of lethought authori-

demand of the public, to deterof the support he gave to these

2: Tooke was violently opposed to leaving banking to free trade. "As to free trade in banking in the sense

in which

it is sometimes

contended

for,"

he

said,

"I agree

z_From hispamphletentitled "Further Reflections on theState oftheCurrencvandthe _ct_onoFtheBank o_England," %S57,p.4_. Z:=At least by IS40

l i

DISCUSSIONSON THE THEORY PRIOR TO 1848 with

a writer

in one

of the

American

papers,

that free trade in banking swindling." Such claims

is synonymous "do not rest

grounds

claims

analogous

to the

in production--. comes

It is a matter

within

Tooke's was free banking thing

nature

nental Carey,

police.

of competition by the

State

''2_ This

of number and became

the and

lowed

considerable

monopoly,

defended

protectionist

contended

to replace the

and

dictum

of

by opponents of for them some-

influence

on later

thought. Two writers, Richard Hildreth made out a strong case for free banking.

banking

in on

suspensions in America again led to on that side of the Atlantic, and these

exercised

denounced

and

observes

of a motto.

1837 cash discussion

discussions

of freedom

of

times out Continent

who

with free trade in any manner

for regulation

province

quoted on the

in the

The renewed

the

al

spirit that

the

existing

there

would

American

prevailing

if free

in

of political

be far

fewer

banking

and H. C. Hildreth 29 American

competition

system

system

Conti-

were

al-

interference

excesses.

on the

Carey

whole,

3°

point-

ing out that even if not satisfactory in all respects it provided more facilities than the banks of any other country, and he maintained

that

in England. applied

by

failures

had

in fact

3' In a comparative different

States

been

study

of the

within

America

where entry into the banking trade were least frequent, and he submitted ple behind expansions, arises

from

the

restrictive

for, he says, the

erroneous

system "the idea

less

that

various he

bound

systems

to lead

of privilege banking

than

found

was most free, that the whole

was

system

frequent

that

failures princito over-

in banking

is different

from

2s"History of Prices," 1838, Vol. III., p. 206 z_"The l_istory of Banks to which is added a Demonstration of the Advantages and Necessity of Free Competition in the Business of Banking," 1837 '_a"The Credit System in France, Great Britain, and the United States," 1838. 3_He says that from the first institution of banks in America until 1837 the failures had been less than those of England m the three years 1814, 1815 and 1816.

82

THE

RATIONALE

OF CENTRAL

BANKING

all other trades; that it affords the means of making large profits, and that the right to bank should be held as a privilege to be sold to a few individuals. Communities acting under this false impression demand large bonuses for its use, thus imposing upon the parties a necessity for trading much beyond their capital. ''_-' The Scotch system, although superior to the English, he regarded as still not entirely satisfactory, because it did not allow banks to form with limited liability." The weakest part of Carey's work was the theoretical explanation he invoked in support of the thesis that a restricted banking system is more likely to cause economic crises. _ The argument he gives is one that gained some considerable following later in France and which is generally, though erroneously, believed to have been started by Coquelin. It begins by assuming that if there are only one or a few privileged banks, there will be a scarcity of long-term investments. Part of those available will have been bought by the banks themselves and the public will possess in the form of savings a quantity of spare funds for which at the moment there is no very profitable outlet in investment. These funds will consequently be left on deposit at the banks. On the basis of this the banks will be in a position to extend their issues, and they will, in doing so, make liquid capital still further superabundant and deposits will again increase. The process will repeat itself until at last the depositors find an outlet for their funds, let us say abroad, and therefore withdraw their deposits from the banks, thus causing an embarrassment to the latter, who are forced to call in their loans, and a scarcity of capital ensues. All this arises because as a result of the first impediment to investments a great deal of capital has been only temporarily lent "_aOp. _ Op. "_ Op

cir., p 89. ltahcs cn., pp. 80-82 ctt., pp 57 ff

ours.

DISCUSSIONSON THE THEORY PRIOR TO 1848 to the cannot

banks but has be immediately

been invested liquidated.

83

by them in forms that _' The theory contends

that if more banks themselves would

were allowed to set up, the bank provide the public with opportunities

direct

and

the

investment, banks

only

on

instead

short

term

of these they

funds

would

stocks for

being

be

lent

lent

on

to

long

term and there would be less tendency to disturbance. '_ In contrast a very unfavourable attitude towards American banking was of a more general tried

to sketch

taken and

the

relevant

to the

out that

the

whole

principle which

exchange arising out

town

was

already

of trade

familiar

of banks this

of money

in the

in different would

was and credit

He pointed

and

applicable of different

principle

and

payments.

balance

was equally of the issues

or groups

to function,

theory

of specie

of the

ternational of claims lowed

of the

suspensions

adjustments

same

up by Condy Raguet. '_ His book theoretical nature than Carey's

specie

flow

theory

of in-

to the balance banks in the

towns, keep

and

the

if al-

issues

of

individual banks in check. This emphasised the importance of enforcing immediate redemption of notes on demand, and

of the

balances system limited such

frequent

between

exchange banks.

Carey,

and he

payment

thought

the

of best

would be to establish individual responsibility (unliability) of the shareholders, but doubted whether a system

could

ever

States where the limited tion was far too deeply freedom favourably

to issue

notes

disposed

_ P. 57 1,.: "The loans community at large "_'P. 59. Jr "Treatise

on

Money

be put liability rooted. in

towards

system. His explanation leads first to an industrial

the

of notes

Unlike

into

the

wide

in the

the

New

sense York

United

organisaopposed to

but

was

bond

very

deposit

of how an over-supply of credit boom and then to a crisis contains

of banks to individuals they may be deemed and

practice

form of company He was strongly

Banking,"

1839

are temporary, permanent "

but

as regards

S4

THE RATIONALE OF CENTRAL BANKING

points which anticipate modern of the boom comes when there

trade cycle theory. The end is a demand for coin for ex-

portation; the banks are called upon to pay their notes and must in turn call upon their debtors; so money becomes scarce and the prices of property and commodities fall. "At the winding up of the catastrophe, it is discovered that during the whole of this operation consumption has been increasing faster than production--that the community is poorer in the end than when it began--that instead of food and clothing it has railroads and canals adequate for the transportation of double the quantity of produce and merchandise that there is to be transported--and that the whole of the appearance of prosperity which was exhibited while the currency was gradually increasing in quantity was like the appearance of wealth and affluence which the spendthrift exhibits while running through his estate, and like it, destined to be followed by a period of distress and inactivity. ''3_ A fourth contribution was another essay by Gallatin. 3"This is in the main a plea for the rapid resumption of specie payments. He had by this time adopted an attitude that was unfavourable to paper issues in general. He consequently takes up the point of view that there should be a shift of emphasis away from the issue of notes to other banking facilities such as exchange operations, the remittance of money, the collection of debts, the investment of idle balances, all of which could be carried on without the issue of paper money, and he looks forward to the time when banks will set up for these purposes without possessing rights of note issue. He distinguished two senses of the term "free banking .... -"First, that all persons or associations should be permitted to _ Op. cir., p. 137 Italics in the original J9 "Suggestions on the Banks and Currency of the Several Reference principally to the Suspension of Specie Payments," _o Op. ctt., p. 69

United 1841

States in

DISCUSSIONS ON THE THEORY PRIOR TO 1848

S5

issue paper money on the same terms; secondly, that paper money may be issued by all persons or associations, without any legislative restrictions." The first sense in which, after the New York legislation of 1838, the term came almost exclusively to be used by English-speaking writers, Gallatin was prepared to uphold, but competition in general was not applicable to banking 'I because the objects that it attained in the case of the production of a commodity, viz., a reduction in the cost or an improvement in the quality were not relevant to banking. We have referred already on several occasions to the contention of the free-banking school that there exists in the competitive system an automatic mechanism which operates to check expansions of the note issue. The mechanism consists in the return of notes for gold to the bank or banks that over-issue. It has been already rejected (by MacCulloch) in so far as it depends on the presentation of notes by the public for gold. But it was held also to work through the reciprocal claims of the banks themselves upon each other's reserves. We have mentioned, too, the obiection (of Norman) that this also would be ineffective if all or most of the banks decided to expand, and each kept in step with the others. We come next to an argument introduced by Mountifort Longfield, 42denying the force of the mechanism, even in the case of an expansion by only one bank. He illustrates the argument by an arithmetical example. Let us suppose that there are two banks, A and B,"t who both carry on the same kind of business, all of which consists in lending by way of the issue of notes. Suppose also that in the initial period of

"_ Op. cir., p. 70. 42He wrote a series of four articles on "Banking and Currency" in the Dubhn University Magazine in 1840. The argument referred to comes in the second of these articles (February, 1840). 43 A and B may be equally well taken to denote two groups of banks, one of which is conservative and the other expansive.

86

THE RATIONALEOF CENTRALBANKING

time

A and

equal

gold

and

B did

every

week

partly

in its own

5,000

issue

= £40,000

Gold

reserve

= £15,000

bank

notes

the

same,

notes

will

just

discounts

and

partly

being

and

held

£10,000

in bills

in the

roughly

and

notes

of the

the same

notes

so that balance

and

the

5,000

daily

with

no

as the

other

propor-

of B's, and

or

weekly

transfer

re-

discounts. to be made

note issues of the two banks bear In this situation bank A will receive

of its own

ceive

of business case--

amount in repayment of previous the repayments to each bank

the separate circulation.

week

amount in each

Note

the proportions

tions total

same

so that

each

ceives the same We may assume bank,

the

reserves,

to the each

B will

re-

exchanges

of gold

from

of

the

re-

serve of one bank to the reserve of the other. Now suppose that bank A decides to lend £20,000 more and increases its issues

for this

purpose

by

tains the old position. portion between the

the

Then, note

changed from 1:1 to 3:2, and and 4,000 of its own notes, 6,000

of A's notes

B's business

since

has gives

in its own to return

proportion

no

debit

transferred. expansion.

tion

and to their

and

of 3:2 also,

or

credit

stage

this

the

demand

on

shares

the

either

public

of the

prohas

side

exceeds

A will

discount

starts

so that

it also

account

and

gold

no

demanding two

circulation.

in any will be

clearing

no automatic

fall on the total

now

in B's notes,

Thus

B has

will

B main-

due for payment of which _9,000

£6,000

notes.

Consequently,

At a later ever,

notes

to B 6,000

while

A's business

weekly, and thereibre have falling week, bills to the extent of £15,000, paid

amount

new situation, the of the two banks

B will receive 6,000 of A's notes and it will return in the week

to A. But

in the

same

in the issues

still

will

check gold,

banks Suppose

be

on A's how-

in proporthat

the

DISCUSSIONSON THE THEORY PRIOR TO 1848 total have

and

demand

B will

Thus

the

is £20,000,*'

in the

final

Note

issue

= £48,000,

Gold

reserve

-----£3,000,

Note

issue

---=£32,000,

Gold

reserve

_

position

A will

have

gold

circulation

then

8"I'

has

reserve been

£7,000.

of the bank

which

diminished

did not increase

in greater

ratio

than

its

its cir-

culation, and if the managers wish to keep the same reserve proportion as before (viz., 15:40) they must reduce their discounts "from £40,000 to about £30,000." "Hence a bank of issue

may

capital

have

enough,

its gold may

calamity it contracts extend its business bank is obliged may be driven trading eral

stock

alterations

by its competitors,

panic

excitement

jurious this sue time when

its

is coming. to the

of permitting that which that the

low

and

and the

prices,

there

will

and

prosperity

can

of a great

panic,

of trade.

to discount

scarcely

That

during resolute

the in

when

the

be devised

commercial

sev-

under

and

depression

refusing

A system

are

suffer

of confidence

general

this

its rival to moderate

Thus a bank system of over-

where

country

if it has

If to avoid

which does most business and is quickest and most

issues

more nation

inthan

everybody who wishes it to make and isis to be its circulating medium at the same

it is their spirit

of issue,

and

bank will gain most period of excitement contracting

which,

its competitor.

its issues, it thereby enables still more, until at last the more

banks

of high

of great

off by a rival

ruin

to give up business altogether. in self-defence to take up the

adopted

ioint

drained

even

interest

of overtrading

to

issue

as

is prevalent

much and

as

possible

to reduce

44Longfield assumes that the circulation must fall back to the previous level; but this makes no difference to the maul argument

SS

THE

their ulus

RATIONALE

issues when to revive it."

Longfield's

trade

begins

general

MacCulloch's,

that

the

contrary,

the

among

and

wants

is therefore expanding

bank the no automatic

rivalry

BANKING

to stagnate

conclusion

far from

mercy of the conservative the former; there exists on

OF CEN_FRAL

a stim-

the

bank

same

being

as

at the

latter is at the mercy of check on over-issues;

the

banks

leads

to general

expansion. The

point

raised

by

the

Longfield

argument

is by

most important controversial point in the banking. No attempt was made in subsequent reply

to it, and

of its validity

we

shall

until

our

postpone final

We have tried in what ries of rather disconnected ganised

discussion

There

was

Bank the

of

all along

banking

problem

precedes remarks. the

bank

editor of The Economist, in that journal between

question country

to concentrate

controversy

and

organisation.

cussion of the advantages thing like systematic was

Probably

in a series of articles 1845 and 1847. "_When

the final decision against business had already been

Act

and

of 1844,

system than

that to make

by

as a not

nature

time

become

this

also

and their currency and in book

itself. the

attention

on

the

general

the

first

dis-

"Capital,

of the

consequence, the

origin

established,

for the

adoption

of an alter-

to denounce

Bank

of England

and

of the rather

was

Currency

anyfirst

free entry into the made in the Bank and

main object school.

monopoly form,

by to accept

he published these articles

unnatural

out the

recommendations

privilege

4s Published

are,

to point

had

native system, theories of the The

they

an attempt

a seor-

no

of free competition that was that given by James Wilson,

were written note-issuing more

free to

examination

to connect together There had been

in this

and

currency

of central

detailed

free-banking

position

and

theory of literature

chapter.

a tendency

of England's

the

far the

Banking,"

the is, in 1847

DISCUSSIONS

Wilson's

opinion,

especially secure the

ON THE THEORY

the

cause

of England's

in the development basis

of, and

Scottish

banks

the

was

PRIOR

the

89

Scotland,

business.

confidence

outcome

1848

lag behind

of deposit

greater

TO

_ The

of the

of the

more

public

eminently

in,

satisfac-

tory working of fi'ee competition. There had never been any restriction in Scotland on the number of partners allowed to combine of the

to form joint

a large

a banking

stock

number

no doubt,"

even

firms

of known

and

wealthy

he says, formation of the

wealthy

joint

"that

were

had

before always

men.

it not for the

the

advent

consisted

"There legal

of

can be

restrictions

of banks for the purpose of protecting Bank of England, numerous large

stock

in the

and

the

as to the monopoly tence

firm,

company

banks

metropolis

would

as well

have

been

as in the

called

provinces

the and

into

exis-

years

ago,

and would thus have prevented the establishment of those inferior banks, the failure of which from time to time has caused so much distress and ruin. ''4_ He asks the

the

question

legislature

banking,

they

mission currency bank Such

are did

why

it is that

content not consider

to issue school

whereas

to allow

free

it a safe

notes payable usually gave

denied

of the

that

desirable

the

issue

extent

in many

the

circulation,

admitted

,6 See Article 4_ "Capital, "Theory

and up

that

of thought

could

be increased

it was to the

the difference was invalid. demand probably

time

p. 282. 1855.

was

per-

reason was

the that

by

did not. to Wilson

which

both

to any strictly

un-

main-

claimed between But it was still de-

deposits

of MacLeod.

III. Currency and Banking," and Practice of Banking,"

to give

and deposits acceptable

school

and

in deposit

practice

as convertibility

out that liabilities

quarters

right

of notes

so long

tained, and pointed notes and deposit nied

banking

public

on demand. The for this distinction

notes increased the circulation an argument was not, of course,

as a member

the trade

formed

no means *_

part generally

of

90

THE RATIONALE OF CENTRAL BANKING

The

events

of

commercial implied

a choice

ments

bound

to

impression It

is

rather who

for

the

over-production

and

depressionsY'

that

first

give

of

fixed

A similar

it

the

way the

of all these he

was

under

returned.

should to the which was

is and

from

relation

is never

capital theory

about

labour;

support

con-

fixed

replaced

the

future,

cycle

between

were

about

imple-

the

trade

confused

capital

remarkable should

the

of

capital

immediately

of

employing

fixed

in

draws

capital and

fund that

he

somewhat

community the

theory

causes of

to produce

of goods

His

of

nature

production

production

floating

the

labour

for

distinction

and

analysis

that

applying used

He was

fixed of the

variables

school

the

to an

clear

present.

capital:"

income

the

the

with

which

Wilson

was

be

it to the

in up

floating in

could

applying

sumable

led He

between

which

and

1847

crises.

held

be

the

theory

that

leads also

banking

to by

it is

booms

Bonamy

a,_"It is . not difficult to see that _t becomes a most essential thing to the continued prosperity ol a country that Its floating capital, on which the continued reproduction of commodltms ol everyday use depends, as well as the continuous employment of labour, should not be withdrawn fl-om those necessary purposes and converted lntofixed capital 11/a greater degree than the surplus accumulation of the country, after replacing the whole fund needful to continue the production ol such commodities . . will admit. I1 the foating capital of the country is thus misdirected into fixed capital, it is quite plain that the ultimate result must be, that as the labour employed in the works representing the fixed capital does not reproduce the eommod_tms whmh are consumed in supporting Jr, or an,,. commodHy which can be exchanged either with the home or foreign producers of such commodities, they must become scarce and dear, and u!)$mately the fund for the employment of labour must be dlrninished "It is quite true that for a time, while the process of the conversion of floating into.fixed capital was proceeding, there would be a momentary appearance of great prosperity.... The production of commoditms required for daily use would he unequal to the consumption, they would continue to rise in pmce • . The ultimate effect of such a disturbance or misdirectton of the.Jloatmg capltal of the country would be to create a great scarcity of it whmh will be evinced bv the high rate of interest." (Op. c_t., pp. 127-8 ) s,, Speaking of the railway development and the conversion of floating capital into fixed which this entailed. Wilson says that it is clear that "the first effect of this process would be to render capital scarce and in proportion to raise the rate of interest, and that the next effect would be hy rendering commodities of consumption scarce, to increase their demand, and to afford thus a stronger

DISCUSSIONS

ON THE

THEORY

PRIOR

TO

1848

91

Price, and contributions

we shall notice it yet again when we come to the made by Horn, in France. But the banking

school did tion as the

not, of course, connect up their theory with inflaroot cause: this was left for a much later member

of the currency From Wilson's free-banking

school to do. "_' time onwards for more

question

Continent it was now to France.

just

was

dropped

beginning

than

in England, to gather

inducement to continue capital in its exmting channel new one " The inevitable result would be that a great schemes must be abandoned (op. cir., p. 148) 51 Viz., Geyer See Chapter IX.

torce.

a decade while So we

the on the turn

than to dwert it into a malority ot the railw'ay

CHAPTER

The

VIII

Discussions in France

and

Belgium

At about the time when the issue in England had already been decided and the discussion had practically ceased, the controversy was just beginning to take shape in France. The slow development of banking facilities in France, particularly as compared with America, was first given literary emphasis by Michel Chevalier,' who was travelling in America between 1833 and 1835, just at a time when the whole banking question was foremost in the public mind in that country. Chevalier himself upheld the retention of the United States Bank, and suggested that France would greatly benefit by adopting a system of banks linked together like the twenty-five branches of the Bank of the United States. 2 Chevalier's remarks on the backward state of French banking were endorsed also by Carey, who testified to the beneficial effects of free competition. But an exactly opposite impression of the effects of freedom was created in France by Condy Raguet, and the translator 3 of his book in_"Lettres sur l'Am_rique du Nord," 1836. "A long time must elapse before we can enloy in France a system of credit as extensive as that which exists in England and the United States. We are in that respect in a state of barbarism" (Vol. II., p 248) 2Op. ctt., Letter IV '_Translated under the title "Traite des banques et de la circulation," by L. Lemaitre, 1840 92

THE DISCUSSIONSIN FRANCEAND BELGIUM voked

it in evidence

petition

of the

in banking

system

like that

and

All attempts

Cieszkowski

ory

of money

at this

time

to state

credit,

of theoretical be

left

almost

but

the

The

from

discussion

tion

of the

for greater

mo-

exclusive taken up

with

the

in fact,

the-

very

little

banks

interference,

"_This

appeal

freedom

written

became

report

of the

Non-note-issuing legislative

juristic.

a pamphlet

The

com-

may, but

the

is the right to coin money and must controlled by the State. The reasons

purely

agitation

with

rationale

to deal

rogative was to remain for many years the restrictionist school in France.

gan

by

of a restrictive

containing,

value.

free

right to issue notes either exercised or are

wrought

superiority

in a book 4 purporting and

he

gives

of the

were

issue had recourse to the State's of money. This was an attitude

material says,

that

of France.

nopoly in the note right to the coining by

evils

93

to the

by

more

the in the

in that

banking after

same

pre-

argument

of

trade

Courcelle-Seneuil

important

Senate

to the royal chief

be he

be-

in 1840." the

year

presenta-

on the

proj-

ect for the renewal of the privilege of the Bank of France and the debates on this report. The rapporteur, Rossi, gave a very

gloomy

of paper

picture

money,

of the and

any similarity between try and its application support for the

each only

to the way

of the

7 claiming of

of competition

emphatically

in the

issue

there

was

that

the application of free trade to industo the issue of bank notes. He gave his

retention

locality,

effects

denied

overcoming

old

system

at the

same

the

of a single time

French

that

bank

this

public's

was

"bank

shyness." After Coquelin,

this

the one

free-banking of the

leading

party

became

members

of the

more free

prominent. trade

4 "Du Credit et de la Circulation," 1839. 5 Op. cit., Chapter III. 6 "Le Credit et la Banque." r Quoted by Wolowski, "La Question des Banques," pp 192, 176 ff.

asso-

94

THERATIONALE OF CENTRALBANKING

ciation and an economist of some repute at that time in France, wrote several articles _ in its support and followed them up by a book." His argument was based largely on the theory that economic crises are caused by restrictions on the investment of funds in bank capital, an argument to which we have referred already in connection with Carey. A more general and comprehensive statement of the case came from Courcelle-Seneuil, '_'whose ideas had been much influenced by the writings of James Wilson. He tries to justin his conclusions in favour of free banking by an attempt to show that over-issues of notes are not the cause of crises," and that if banks make mistakes, it is never in their issues but always in their investments. He was in favour of absolute freedom and unlimited competition and was the most uncompromising of all the free bankers in France. The sole permissible regulation, in his view, was one aimed simply at the prevention of fraud. The distinction made between deposit banks and note-issuing banks, bv which freedom was tolerated for the former but denied to the latter, was, in his opinion, all the more absurd when regard was had to the fact that the deposit liabilities of any bank are usually less widely spread over large numbers of people than its note liabilities; the failure to repay deposits might cause more harm than the failure to cash notes, because default in paying back deposits was likely to bring complete ruin to sevSee an article entitled "D'une Rdtorme du Regime Mondtaireen France" in La Revue des Deux Mondes. Vol III., (1844). "Du Crddit et des Banques," 1848. ,0"Tra_teTheorique et Pralique des Operations de Banque," 1852 " A view that was also supported later (1862)by Juglar in his "Des Crmes Commerelales et leur Retour Perlodique en France, en Ang|eterre et aux EtatsUrns." in which, while noting the marked correlation between the increase in the volume of discounts and of the note issue on the one hand, and m prices and the diminution of the metallic reserves on the other, he regards such movements as the results of other underlying factors rather than as the causes; he says "Les exces de l'emiss_onne sont pas la cause prmcipale des crises" (p. 34)

THE

eral

families,

whereas

distributed The

DISCUSSIONS

among

IN FRANCE

in the large

free-banking

case

AND

of notes

numbers

position

BELGIUM

the

a5

loss

would

be

of people.

was

also

supported

by

Du Puy-

node, another adherent of the trade cycle theory of Carey and Coquelin. In common with the maiority of the free bankers in France he favoured the allowance of limited liability.

He looked

upon

the

unlimited

liability

provisions

of

the English law as the chief fault of the English banking tem, claiming that they had actually caused the total rity

given

by

depositors

the

shareholders

to

to be

smaller

than

in the

subiect

was

the

syssecu-

note-holders

it would

be

under

and limited

liability.'" Interest

Bank of France the discussion the better-known The circle which gland,

where

touched the

leading

subject a group

Joseph

Garnier,

the

of the day. than in En-

few

subject.

of the

In France of the

of "La Libert6 which

time.

des

included

academic

it was,

economists

among

In 1857

by the Soci_t6 d'Economie Politique, the general question of the limitation among

when

writers on economic subiects it interested was much wider

controversy

specific

increased

in 1857, and of most of

exceedingly

on the

greatly

raised the rate of discount early was soon attracting the attention

economists,

it was

taken

up

at whose meetings both of note issues," and the Banques,

'''4 were

Wolowski,

Courcelle-Seneuil,

Paul

debated

Chevalier, Coc l and

Horn,

Leonce

de

Lavergne. Garnier

spoke

administrative

against supervision

so unreservedly

in favour

vention. He declared to demand a regime

du Credit in La Revue

,4 See 1857).

in Le Journal

reporl

in banking, of entirely

that he was of complete

'_' "De la Monnale, 1_ See the report p. 471. the

all intervention

of authority but Chevalier withdrawing

not prepared liberty for

et de L'Imp6t," 1853. p des Deux Mondes, 2me des

Economistes,

2me

and was

all not

all inter-

to go so far as institutions of

237. serle, serie,

Vol. XXI., (1857), Vol

XIV, (May,

96

THE RATIONALE OF CENTRAL BANKING

issue and credit, and this was regarded by the restrictionist school as an important admission from one of the promoters of free trade in France. '_ The next important contributions were called out in response to the propaganda writings of anonymous pamphleteers TM in connection with the Bank of Savoy affair and the attack on the Bank of France, _ and by 1864 the controversy was at its height. The counter-attack on the pamphlets and on the general question of plurality, even of the most restricted variety, was opened by Victor Bonnet. '_ Generalising from the case of the old departmental banking system he concluded that if there are a number of banks, the notes of each bank do not circulate beyond a certain locality. Anybody who wants to make payment in another locality has to procure notes issued by a bank in that locality and has therefore to submit to the same inconveniences and extra trouble as he does in buying foreign exchange to make payments to another country. The advantage of having a single note issuer is that all this is avoided, because the notes of this issuer circulate everywhere within the country. Bonnet gave this as the reason why the people had been far more willing to accept notes, and the total circulation had extended, since the suppression of the departmental banks. This argument against a plural system was really quite valueless, because it ignores the circumstance that the departmental banks had been de_ He was the French negotiator and therefore Cobden's counterpart in the 1860 Commercial TI,eatv between France and England. 1_"Reorganisation des Banques: Legalite et Urgence d'une Reforme," 1861; "R_organisation du syst/_me des banques" Banque de France, Banque de Savole," 1863. both ascertained later to have been written by the Pereire brothers. 17See also Gustave Marqfoy, "La Banque de France dans ses rapports avec le credit et la circulation," 1862, in which it is contended that it is the duty of the Bank of France to keep the price of credit invariable by counteracting by its own lending any tendency to a rise in the rate of interest on the market. 18"La Liberte des Banques d'Emisslon et le Taux de L'Inter6t" in La Revue des Deux Mondes, Tome XLIX., January 1st, 1864.

THE DISCUSSIONSIN FRANCEAND BELGIUM prived

by

change

law

of all

of notes.

England banks, others,

after the the solidarity and if there

affected

to a greater is one more

whole On

credit system the other side,

resumed

rate

reserves the

effect

lesser

Pereire.

the

gland)

did

should

be

was

taken

better

rate the

invariable by

Maurice

example

than

active ever since the but also in Germany, of banks trine

of issue

which,

insufficient,

any

method

In

Aubry,

for the the Much

z_ a Paris

book

metallic

and

to augment

opinion

at 3 percent."' this

was of rais-

then

if

its capi-

enable it to buy the gold He denied, in the second

necessity his

has the

of proce-

its capital,

a neighbouring

Bank

of France

country

(e.g.,

rate

of discount

the

banker.

of Aubry's

same

attitude

There

of the

En-

is no

influence

time of Napoleon, 2_ not only in France of the doctrine that the chief function

is to keep

when

the

were

when same.

of protecting proper

was

there

in

contrary,

policy

to realise

place,

her

the

the

bank

obtained would specie reserve.

_° that

inter-

used

more stable. Bank of France

He denounced

TM

that

this

if, on

rendered on the

tal; the resources necessary for the to raise

for the

argument

degree;

as a means

for the

of doing

the

the Bank of France, the public in it, panics are avoided and

suggested

first

mechanisms also

is thereby the attack

of discount

and

was

or

bank like confidence

by Isaac

ing the

normal

crisis of 1825 that if there are several of one tends to depend on that of the is a run on one, the others will also be

there much

dure

the

He repeated

97

adopted

the

rate

of discount

as a rule

of bank

down, policy,

a docwas

1_"La Banque de France et l'Organlsation du Credit en France" _1864). zoOp. cir., p. 40. 2_Op. czt., p. 73. 22"Les Banques d'Emission et d'Escompte" (1864). 23The low discount rate school in France made frequent reference to the words of Napoleon written to his Minister of Finance, Mollien, in 1808: "Ce que vous devez dire au gouverneur de la Banque et aux regents, c'est qu'its doivent ecrire en lettres d'or dans le livre de leurs assemblees ces roots: Quel est le but de la Banque de France? D'eseompter les credits de routes les malsons de commerce a 4%."

98

THE RATIONALEOF CENTRAL BANKING

bound the

to lead

Bank

issue

to credit

of France

was

given

discount,

:_ and

charge

a high

different whereas

inflations.

on the

to the

bank

it was

therefore

rate;

and

Aubry

grounds

bases

that

solely

the

in order highly

in this

improper

respect

it was

to control

movements

of specie,

the

policy

of calling

on

the

shareholders

capital in times of crisis and no further need for it. 2_

cheap for

Pereire

was

into

mands

by no

the

to one

Bank

of

means

in favour

note-issuing rival

:8 the

Bank

since dis-

of France

additional

as soon

2_ He

to break

substitution

of

duty to keep the an alternative

of general

business.

establishment

France,

it back

it to

in an entirely

to supply

paying

on

of note

to favour

could not do so because it was its declared rate of interest low. 23 So he, also, recommends

the

attack

position from that of the Bank of England, the latter might legitimately use the rate

count

entry

his

privilege

as there

is

freedom

limited the

his

of de-

monopoly

of a duopoly

of for

a

monopoly. Aubry

wanted

the

no better

reason

than

monopoly that

the

retained, coining

and

seemingly

of money,

and

for there-

fore the issue of bank-notes, was a royal prerogative/_' a proposition that was, according to him, one of the fundamental tle

axioms

later

application money riences reproach prerogative

by

of political Etienne

of the that most of paper

economy.

Duran"' royal countries money,

free banking had been

that

It was it was

prerogative

pointed as

to the

issue

had had their most and it was a grave

with the errors the sole cause.

Of). cit, p 10 2._Op. cir., pp. 127-8. _"Op. cit., pp. 172-3 27Op. cir., p 6 _ Op. cit., p. 115. 2_Op. cir., p 55. 3o"Encore la Question des Banques." 1865.

out a lit-

a result

of which

of the of paper

fatal expemistake to the

royal

THE

The

idea

minds

DISCUSSIONS

of free

the

vision

IN FRANCE

banking

had

of anybody

and

firms

under

the

would

the

practical

cise

a close

scrutiny

in getting

of the

royal

d'Eichta131

away

the

because

examine

each

that

likely

was

likely

to be in that

A Belgian "men notes

to this

to set up notes,

being they

purely it was

to exer-

accepted.

It was

political

to assure

of a note

was

bankers would

of issues themselves.

exercise

to pay

Adolphe

the

public

of

almost

never

in

it or by

issued one

by a bank

that

was

assumption the notes

3_ of the line

free-banking

of argument,

school

that

would

the

become

largely

pointed

danger

scrutiny

at all,

to make that the of his own banker

trader and

and

which

31 "De la Monnaie 32 Op. clt., p. 13. 33 Brasseur. 3_ "Manuel

referred de Papier

d'Economie

to the et des

Politique,"

for the

that

public

it was

Vo].

the

a reasonable

would willingly accept the notes of such other

unduly

Banques

that

for their that the

a matter

not to be expected

banks as his own banker was also willing was, of course, only a very partial solution difficulty

not

position.

It was no

was suc-

argument by

of straw" would be able to obtain acceptance was much diminished when it was realised

supervision

and

able

argued

to see if it was

able

economist

out _4 in reply

note

in the circulafeared that un-

position of the debtor/_' and unity the inconveniences of having to

carefully

to be

the

holder

the real avoided

note

public

intervened

the

a position to know in the note issue

people's

becoming

of different

notes

Thus

State

many

for unity in the note issue the restrictionists who

from

prerogative. that

guarantees

all the

99

encouragement

of the

the case among

in

difficulties bankers and

multiplicity

over

lines that by those

raised

a positive

of the

impossibility

along these formulated ceeded

have

shadow

BELGIUM

everybody

issuers, and they saw insuperable tion of the notes of innumerable sound

AND

to receive. This of that particular heavy

d'Ermsslon,"

II., 1864,

p

277.

pressure 1864

of

laO

THE RATIONALEOF CENTRAL BANKING

insolvencies come into The

on the small note-holder, who was contact with the banks as a customer.

case

for competition

Mannequin

and

was

Chevalier.

the Pereire brothers that the Bank of France had risen destruction

of

the

of the

banks

it would

lead

to over-issue

school,

that

so long

needs

Chevalier

window,"

of trade,

was

by

Paul

the

Coq,

views

had

given

of

it an

of the note issue. Mannequin's a defence of free banking against

that

out of the

the

up

to

rate of discount charged by the as soon as, and because, the

banking

thrown to

taken

Coq "_ endorsed

departmental

unrestricted monopoly tribution 3' was simply allegation

also

Paul

unlikely

but

they

responsible

are

only

be

bringing

usual

notes

issued

cannot for

on the

as the

lines

"are

not

in response

issued the

conthe

in

excess.

subject

to the

notice of a wide circle of readers by his contributions to the newspapers, notably to the Journal des D_bats. CourcelleSeneuil also Economistes.

re-expounded 3:

A publication was

an

posed

as the

provision tem

bv

to replace

completely said it was tre

which

article

his provoked

Leonce the

views

de

a good

monopoly

of France

of banking

of the

of eight

or ten regions,

branches. This was departmental banks

was

offices

deal

Lavergne/_

free competition but impossible to manage Bank

in the

each

Bank

to do,

best having

des

of discussion

in which

he

of France

by a limited a large area

trying

could

Journal

not by

plurality. from one

and

He cen-

an adequate

be provided its parent

pro-

by a sysbank

a plea for something similar to the but without the old restrictions.

with old

3_Article "Les Banques de France et de Savoie," m the ,Journal des Economistes, 2me serle, \%1. 121., January, 1864. See also his book, "Les Circulations e_nBanque ou l'Impasse du Monopole, Emission et Change," 1865 '_"Article "De la Liberte des Banques" m the above number of Le Journal des Economzstes. 3:Articles on "La Liberte. des Banques" in the Journal des Economlstes, 1864 and 1865 _ "La Banque de France et les Banques Dt_partementales" in La Revue des Deux Mondes, April 15th, 1864

THE DISCUSSIONS IN FRANCE AND BELGIUM

1111

Probably the most influential disputants were Wolowski and Chevalier, who were on opposite sides in the controversy and undertook a direct discussion and exchange of views. Wolowski had begun his career as a lawyer, and his arguments were characteristically based on juristic rather than economic reasoning. Chevalier had been in his earlier years, before going to America, associated with the Pereire brothers in the Saint-Simonian movement. Although his arguments were much less specious than those of the Pereires, we find him again by their side in this discussion supporting the main tenets of their position. There is no doubt that all three carried with them in their later days the ideas of the Saint-Simonians on banking and credit. In the newly constructed society envisaged by the Saint-Simonians the bank was to play a great directing and centralising role. The banks were to be responsible for estimating the quality and quantity of the needs of the community for capital, and for this purpose there were to be large numbers of them specialising in the separate industries and linked up to a central bank. The outer banks were to infbrm the central bank of the circumstances of their localities and industries, and the central bank was to distribute the credits between them. In all discussions of the plan great emphasis was placed on the importance of credit facilities and of the wide dispersion of agencies for the distribution of credit. _' As a member first of the Chamber of Deputies and later of the Senate, Chevalier had plenty of opportunity of attracting public attention to his views. He adopted the attitude 4°that since free trade and all that laisser-faire principles implied was now the accepted policy, since the era of monopolies was said to have passed and competition was regarded as 3_See J. B Vergeot, "Le Credit comme Stimulant l'Industrle--La conception samt-simonniene, ses reahsatlons, probleme bancalre d'apres-guerre." 4(JLetter in Le Journal des Debars, February 4th, 1864.

et Regulateur son application

de au

102

THE RATIONALEOF CENTRAL BANKING

being

beneficial

to the

of the

contention

that

banking

was

community, the

on those

who

asserted

oppose also freedom to build in general, which, as he knew,

the

attitude

the

other

they side

contained, already

said

no

importance

in the

school

as the

of discount This

for

most

as a means

brings

enquiry

arose

eve

out

of the

of the

specie French

Bank

travaux

publics,

members,

and

witnesses.

The

of which

both

therefore report

prises

altogether

called

as w_tnesses,

close

on

five

besides

Hankey, from

William

England,

memoranda Newmarch,

Professor

Enqu_te.

affair

and

and

4_ the

d'Eichtal

were

examination

pages.

anything

on subjects connected of foreign economists written

had

thousand delegates

writers number

and

who

rate

flows.

in six volumes

the

all those

of the

Banque

in the

gained

France,

views,

part

is contained

use

not

French

and was entrusted to du commerce et des

Chevalier

took

must the

of Savoy

raising of the rate of discount in 1864, the Conseil superieur de l'agriculture

had a rep-

a commentary matter. But his

of the

of controlling

us to the

wholly

among

adherent

up

which

to what

almost

out

for

took

developments

stood

emphatic

reason

additions

It was

French

free

Wolowski

by others and adopted in the

he

who

oppose

proportions,

original

subject.

to

on those

who

no sufficient

banking.

very

proof

railways, and free exthey did not do, and

given

towards

on the

under-estimated,

The

as yet

of the views expressed trend of policy already

doctrinal be

took

not

of it those

in a book 41 of extensive

however, been

etition on the

had

of the

not applicable

it and

banking change

they

face

was

it; because

that

the

burden

system

denied

he insisted

on

the

same

from

and

of com-

The

Council

the

Bank

of

of a reputation

as

with money and banking. A were also invited to state their were

submitted

R. H. Patterson

de Laveleye,

from

by Thomson and

Belgium,

J. S. Mill, and

Pro-

41"La Question des Banques," 1864. 42"Enquire sur |es principes et les faits generaux qui regissent la circulation monetaire et fiduciaire," 1865-66.

THE DISCUSSIONSIN FRANCE AND BELGIUM fessor Tellkampf, had the distinction Commission.

their

d'Eichtal,

Aubry,

Coq),

and

chi,

Lavergne,

shall and

of value

Chevalier icy in the

have

occasion who

some

Isaac

Chevalier,

Horn),

from

of France.

the

rate

had

to refer

point

already

Pereire,

Bonnet,

Courcelle-Seneuil,

were

Paul

to others

writing

of view

He doubted

no matter

a gold

efflux. 4' The was

that

emphasised the bank which

the

of discount

general,

lier,

witnesses

(Cernus-

contemporathe evidence amount of

of monetary

theory.

made clear his views on the subject of discount course of his examination of the representatives

Bank

using

one,

French

(e.g. Wolowski,

with the enquiry. Looked at as a whole, be said to have contained any considerable

material

the

the

views

we

Coullet,

neously cannot

from Germany. In addition, Walter Bagehot of being called as first witness before the

Among

published

IO8

what

the

policy

of the

the

or even means,

that

sale

was,

might

not

with

be available

the the

other

as Aubry

and

securities

by the Bank

by

the

contract

the

that

of funds

sold,

and

This

school

in the shape

must

thought

they

of an open

the Bank more money market. More

acquired

so there

careful

by

the

Bank

be a tendency

the

had market

liquid

without

attention

was

for the

discovered causing by this

time

such

which

would

stringency being

of as

by the of the

securities rates

an ingenious

operation

of

sale

just as certainly

for loan

he

Cheva-

policy,

a direct contraction of the amount of bills discounted Bank. It would deprive the short-term loan market amount

correct

capital obligations

What

same

was credit

the

Bank, _ and

purpose. of the

in

for stopping

immobilising Government

for this

of

of credit

as a remedy

overlooked,

must

necessity

in his opinion,

supporters

Pereires,

or the

restriction

of its "rentes"

the necessity of not in quasi-irredeemable

along

utility the

polof

given

it

to rise. device make in the to the

43"Depositions de MM. les delegues et les regents de la Banque de France." pp. 81-117 44Op. cit., p. 112.

104

THE

comparative ume by

effect

of money no

held sue

why

its issue

free-banking

had

of trade

were openly ber of people

inflationary who took

de

Laveleye,

omy,

attacked

school

on

claimed, sion heavy

*_ the

cheaply

namely,

that

drain

free

he

system case

of a large

reserves

dence But

of the in the

bankers would of the that

number

of a privileged

be

wrong

in

involve

system circulation.

free-banking

to the at this

45 "Le

Marche

on

condition

time Monetalre

there

followed

the

their

times. the

free

system

in the upward swing contrary, conceivable

that

depum

the confi-

such

that

reserves lead

the

of unlimited

et ses Crises

with

at

than

actually

willing

an

a con-

out that under a

unlimited that

of larger

condition

by a

by

argued

would himself

they

to an expan-

be followed

its issues

keeping

began

if what

lead

assuming

therefore He was

system

Just

the

and

Econ-

free-banking

that

as compared

Laveleye

the

school

a crisis. He pointed of greater violence

extend de

favour

of this

of the

having

a

attack of a numattitude.

must

of banks

a

which,

of Political

of specie

which,

could place,

this

prov!de easier credit conditions cycle, and that it was, on the

it would

subjected

public,

might

present smaller

bank

second

thus

ideas

said

is-

that

money

would

true,

the

argued

in replacing

and

section

traction of the circulation, and the crisis would be, moreover,

than

had

Professor

banking

was

on bank

had

free-banking

The

Firstly,

circulation,

of them

and provoked the up an anti-inflationist

expansionist

grounds.

Some in the

fiduciary

industry.

volhad

advantage

be lent

total

bankers

expansive

by

a Belgian

two

of the

a positive

and

free

Others

money

could

development

Emile

be more

system.

on the

the

inherent

should

of metallic

nothing,

systems

opinion.

reason

banking

system

part

costing

no

BANKING

Up to now

of identical

was

of a central

large

credit.

been

there

OF CENTRAL

of the alternative

and

means that

system

RATIONALE

to consider banks

should

the to

a

the be

liability.

attack Cmquante

on

bank-notes Ans,"

1865.

in

THE

DISCUSSIONS

IN FRANCE

AND

BELGIUM

10/5

general. It was opened by Cernuschi: _ who held that the vital question was not one of whether the note issue should be in the hands of a few or of many banks, but whether banknotes should be issued at all. They had the effect of spoliating the holders of metallic money by depreciating its value, and if they had any use at all they should be made to represent mere certificates for gold deposited and the fiduciary or uncovered issue should cease entirely. But he joined in the demand for free banking because he thought that if any and every bank were allowed to issue notes, nobody would accept them any longer, and so they would disappear. The same attitude towards the bank-note was taken up by ModesteY Courcelle-Seneuil, Du Puynode and Mannequin entered the discussion on the other side: _ Perhaps the best analysis of the point of view of the central banking school was that made by Coullet. ''_ He sets out the advantages and disadvantages of each of the alternative systems, and decides that the weight of the argument is in favour of monopoly and centralisation. He defends the distinction commonly made between notes on the one hand, and bills of exchange and deposits on the other, because of the element of compulsion in the acceptance of the former and the fact that it is not the people who are enabled to borrow on easier terms and so benefit by the extension of the banks' issues who are likely to suffer when the notes depreciate, since the notes will by this time have passed into the hands of third parties, t'' 4_,"Mecamque de l'echange," 1865, and "Contre le Billet de Banque," 1865, latter being the evidence he gave before the Banque Enquire 57 "Le Billet des Banques d'Emission el la Fausse Monnale" in Le ,Journal des Economistes, Vol Ill. August 15th, 1866 _8 Courcelle-Seneuil. "Le Billet de Banque n'est pas Fausse Monnaie" in lhe same Iournal, September 15th, 1866 See also a letter by Du Puynode in the same number, a reply by Modeste m the October number and an article by Mannequin in the December number 4,_"Etudes sur la Circulation Monetaire," 1865 the

_o Op.

ciL, pp.

78-80:

"Les

billets

_i ordre

et les lettres

de change

les eflets

de

1106

THE RATIONALEOF CENTRAL BANKING

Coullet believed its own destruction, ilar

though

not

that freedom of issue would accomplish and was, therefore, in a somewhat simso extreme

position

as

Cernuschi.

posed bound

that as the result to occur under

would tween

happen: either the public, struck by the contrast the majority of the banks and a few or even perhaps

single

bank,

this

bank

nopoly,

would

and or

in future

so there

the

solid

not a lowering

of the

rate

because

anxiety

the

adequate same

of banks

reserves

of a single

serves crisis.

had The

ion, more

would

than

the Government's issue.

the

afflicted

to be

as a source of monopoly

sufficient abusing

mothe

If, however, of well-organised

it

would of the

in normal

be rate,

times)

to

times,

and

against

reserves

of

a large

greater the

or

and

but a raising

united

Moreover,

to these

of plurality

(even

bea

a de facto

be

in ordinary

have

bank.

an advantage advantages

of interest Even

circulation,

number

established

would

banks

that were two things

its dealings

(he thought)

of the

reserves.

total

failures one of

abandoned altogether. to build up a system result

of the

be

system

the

keep

banks,

confine

would

whole

bank-note would be should prove possible and

of the numerous such a system

He sup-

than

centralisation

the

total of re-

of strength in periods of were, in Coullet's opin-

to outweigh

the

its power

over

avowed the

single

danger bank

of of

commerce proprement dits, les promesses de payer _i une date fixe eta une personne designee, ne peuvent circuler, nous l'avons d(_montre, qu'entre individus qul se connaissent, il y a examen du titre cede, discussion de sa valeur. endos, garantie nouvelle et additionelle donnee par le cedant au cessionnaire. • . Quand ces promesses demeurent impayees a I'echeance, les detenteurs se reprochent a eux-m_mes leur imprevovance ou leur peu d'aptitude aux affalres . Ce que nous disons des effets de commerce ordinaires peut s'appliquer exactement aux dep6ts chez les banquiers. Nulle raison ge.nerale ne pousse les'particuliers a laire le dep6t de leurs fonds chez un autre. Le choix parfaitement libre d'un depositaire est toujours determine par des considerations mdividuelles... Si les billets _ivue et au porteur ne circulaient comme les autres effets de commerce que dans un petit nombre de mains, si leur transmission pouvait _tre precede d'un examen d_taillee et accompagnee d'une garantle du cedant au cessionalre, les pouvoirs publics n'auraient pas a mtervenir pour les reglementer .... Mais chacun salt qu'il n'en est point ainsl."

THE

The

best

DISCUSSIONS

exposition

J. E. Horn. 51In the ative

argument

it was age

of the

first

place

industry

of specie,

he

submitted later

why

oly

claimed

BELGIUM

free-banking terms)

that

it had

reasons

AND

had

as a royal

of the

_ While first

that been

there

were

One

was

generally

enough

dence

that

the

weight

and

fineness,

and

assay

coins

every

known

were and

coin

before

probably

two

in order

to facili-

of exchange over the only institution sufficient

professed it. The

confito be

it unnecessary

accepting

coin-

monop-

was

they

so to make

out that the

as a State

to inspire

what

from prerog-

pointing

over

tate the circulation of coins as a medium wide areas at a time when the State was that

came royal

commenced

taken

right.

107

case

he disposed

in economic

private

and

IN FRANCE

in

to weigh

second

reason

was that the King found it the most convenient way of acquiring revenue. In our day, he continues, however, it is no longer true

necessary any

as a budgetary

more

that

the

could

provide

the

child,

in Paris,

or Baring,

stamping of coins, as the coin of the Horn, also

ing, one

denied of the

ski.

It was

adopted,

service

many

of the

that major an

in London,

Chevalier

less

prominent

which

rather

were

bring bank-notes outside the coinage of money, and was

des

Banques,"

the

accepted

on

of course,

prerogative little more

Roths-

Courcelle-Seneuil,

writers

free

this and

bank-

became Wolow-

in many

merely

cases

in order

to

of the Crown in the than the playing off

of sophistry against sophistry. A great deal voted to this discussion of a matter which s_ "La Liberte

like

to undertake

and

unnecessarily,

is it which

as willingly

money, and these writers

was,

neither

institution

If a firm

be just

with

"_'_and

only

of coinage.

bank-notes were issues between

attitude

perhaps

source, is the

they would realm.

in company

and

State

of space was was, in the

delast

1866.

sz Op. cir., p. 62. s3 It would still, even in our day, seem importance as a budgetary source in time

that the of war.

note

issue

is of the

utmost

108

THE

analysis, should

RATIONALE

a question be denoted

a certain

of definition by the

characteristic

on the

and

substitutes view

ior,

which

must lead Turning nopoly, the

be

of such

a bank with

of notes

into

liquidation

The

history

others

were

should

into,

insisting as merely

coin,

of strict

and

to pay

since

any

convertibility

greater out into

on

the

emphasised,

Government

to abuse can

be no

specie

on

of coin.

that

demand

pure

paper

A bank

under

Government

to re-

to pay when nearing insolvency, legalised instead of its having the banks of issue

usual

penalties

had were

be as prudent There was the

guarantee

been

to understand,

temptation the

failures

full of

irremediably to bear the

in their policy also, as Chevalier

over that

of insolvency.

given

ever-present

its power

and to go

undeniably

that they were positively and tor their acts, and had themselves

sequences, they would other business concern?'

mo-

possibility

consequence

counted

suffer

If banks

to the its

of privileged

bankruptcies.

There

possessed they

bank-notes

convertible

always

lieve it of its obligation its bankruptcy became

already

the

condition

attention

revoked

patronage

however, sponsible

and

convertible

the

called

in place

State

they

things

to their over-issue and unlimited depreciation. to the positive disadvantages of a privileged

liability

monev

because or whether

regarding

always

neglected

Horn

would

Chevalier

for always and

term

two

because they differed in respect of a _Nolowski was defining bank-notes as bank-notes and coin exert like effects

prices.

necessity

same

BANKING

as to whether

in common,

be sharply contrasted second characteristic. monev because both on trade

OF CENTRAL

under either system, but in the case of a plural the notes of the failed firms depreciate, whereas

as any _5 had for

privileged will

recon-

never

the

bank. occur

system only in the case

_4 0p. cir., p. 3(,16 _5 "On a porte l'abus /l ce point, que la facihle d'emisslon dont les banques etaient mvestles rut pour le gt)uvernement la planche aux assignats, de la resultalt blentbt l'msolvabilite de la banque." Quoted by Wolowski, "La Banque d'Angleterre," p. 199

THE DISCUSSIONS IN FRANCE AND BELGIUM

1109

of a privileged monopoly the legalised suspension, and therefore the depreciation, affects the whole of the note issue. Moreover, if banks temporarily suspended payments under a free system, the competition of banks still maintaining cash payments would wipe them out of business if they did not hasten to resume payments, and suspensions would therefore be of shorter duration. Banking freedom in the true sense of the word, and the system which Horn favoured, was a system in which companies would be allowed to set up in the banking business, whether issue, discount or deposit, under just the same regulations as those under which companies were allowed to set up, in other industriesff regulations which concentrated on the prevention of fraud. But he permitted that it was not unreasonable that people should want to add to these stipulations some others specially relating to companies undertaking the issue of notes, z_because of the circumstance that, in addition to the shareholders and the people who contract with the company, there is a third class involved, namely, the indirect and to a certain extent involuntary acceptors of bank-notes, and it was on these grounds that he thought the 1863 legislation of the United States was admissible. Such regulations, however, he still regarded as not entirely indispensable. In sympathy with the tradition of the banking school, Horn was of the opinion that a crisis could never be caused by an over-issue of notes, since no more would get into circulation than just sufficed to satisfy a genuine demand. Banks, therefore, made mistakes not in the quantity of their issues but in the lines in which they made their investments, and crises were caused according to him by a scarcity of circulating capital. In periods of "over-investment" too much circulating capital is transformed into fixed capital un5_,Op. cir., p. 392. z= Op. ctt., p. 414

1 IO

THE RATIONALEOF CENTRALBANKING

til it is discovered iary materials The direct continued lished

that

there

necessary discussion

for some

years,

by Wolowski

is an insufficiency

of the

to co-operate with between Wolowski and

the

in his later

it. 5_ and

Chevalier

correspondence

book.

auxil-

was

pub-

5_ Courcelle-Seneuil

also

made another final statement of his position, u° again pointing out the extreme lack of banking facilities in the provinces in general,

and

of agricultural

Courcelle-Seneuil free

nor

bankers

pected

who

Horn

of the

was

supported

it to increase

lowering

credit

the

rate

in

particular.

a member their

of that

case

possibilities

of interest.

Neither group

because

be greater under would be lowered,

so far as the

latter

he thought

not by way

of increased

and

utilisation

all the stood

issues,

but

by way

savings.

He was

the

insisting

on

of idle bankers,

in other

consider case

free

at all likely

the

of banking,

branches

of trade

application and

emphatically

the

most

denied

compeand in

of

as under-

He refused

regulations the

come,

collection

unyielding

liberty

industry.

special

not re-

it would of the

complete and

of any

and did

gard it as certain that issues would tition, nor that the rate of interest was

ex-

of expansion

Courcelle-Seneuil

of

they

favourite

to

to the con-

tention of the restrictionists _ that banking firms, unlike those in other industries, cannot be made to bear themselves the

consequences

of their

mistakes.

_ Op. cir., p. 12/_. "C'est l'huile qui manque pour graisser la machine, l'eau qui falt defaut pour alimenter la chaudiere, toutes les entreprlses s'en ressentlront; les plus solides marcheront avec difficulte, les moins forts s'arr6teront, les faibles s'eclateront." 5_"La Banque d'Angleterre et les Banques d'Ecosse," 1857. _o"La Banque Libre, expose des fonctions du commerce de banque et de son apphcatlon/t l'agriculture suivi de divers ecrlts de controverse sur la liberte des banques," 1867 _1"Ils raisonnent comme s'll etait indifferenl aux banques de faire faillite, c'est a dire comme si elles devaient 6tre dirigees uniquement par des personnes decidees/1 faire une banqueroute frauduleuse II nous semble que les personnes de ce caractere, blen que trop nombreuses, sont une exception dans le monde commercial, et que ce ne sont pas celles qui commandent habituellement la confiance publique."

THE DISCUSSIONS IN FRANCE AND BELGIUM

II1

It will be remembered that in England, prior to 1844, it had been a constantly recurring complaint that the efforts of the Bank of England to contract credit in time of a specie outflow were always rendered nugatory by the failure of the country banks to do the same, and it was held up against the free note-issuing rights of these banks that they were insensitive to the foreign exchanges. This same argument was re-introduced in a slightly more sophisticated form by Clement Juglar. 6_He used it in favour of a certain type of centralisation. His argument ran that there was a practical difficulty in a plural system in distributing the demands for specie to send abroad because the settlement of commercial operations with foreign centres tends to concentrate in the large towns and the demands for specie will fall on the banks in these places, while others are unaffected by the drain on reserves and have no incentive to check their issues. From this he drew the inference that the best system would certainly be one that was free and competitive in the sense that there should be a large number of banks spread over all localities, but that it should be controlled from the centre by the Bank of France acting as a clearing-house. The chief purpose of his central bank was to render the banks lying outside the trading centres sensitive to the forces necessitating a contraction of the currency by facilitating clearing operations. But it is extremely doubtful whether any such externally imposed institution as the Bank of France or any other is necessary to effect these operations. With reasonable communications and no artificially imposed obstacles, clearing arrangements will be made by the banks themselves. Thus, if one group of banks (A) near the ports or in Paris is affected directly by gold withdrawals for export and contracts its note issue, but another group (B) is not so affected, group A 62 "Du Change

et de la Liberte

d'Emission,"

1868.

11_

THE

will

have

less

culation gold

and

the

it did

the

will

system.

The

primary

will

difficulty

will

claims

on

B to contract

be

diffused

raised

importance

cir-

balances

acquire

constrain

contraction

to the

clearing

consequently

of B. This

of such

BAN_NG

in proportion

before;

will

so the

whole

position

OF CENTRAL

in circulation

of A, who

reserves

liabilities out

notes

of B than

go in favour the

RATIONALE

was

its

through-

by

Juglar

imaginary

to a rather

than real and would certainly not in itself provide the sole reason for the existence of institutions endowed with such privileges

and

France.

position

Juglar

which banks,

was

of

really

ascendancy advocating

rights of issue should be but in which there should

controlling

influence,

the pure in vogue

sense and in France.

something the

as

Bank

a mixed

in

competitive bank with

free

privileged

of

system

given to the be a central between

single

the

a

banking

monopoly

in

system

What and the

is the connection banking school,

between the free-banking school on the one hand, and between the

central

banking

and

school

other?

It is not unnatural

cases.

It is especially

free

bankers

were

the

to expect noticeable

Seneuil,

Coq of the

adherents

He was school

be

metal,

but

fixed, that

He supported as we

system

respondingly

and there

free have

would

Adherence

of the any

destroy to the usually

the was

section

merely

that

above

this

however, explained,

the tenets carried

of the which

note

issue

of the with

he

con-

currency

fiduciary limit the

issue

covered

circulation

for that

most

an exception.

of the the

be no fiduciary

banking,

already

the

in both

most theory

among

Cernuschi

issue

should

close

that

banking

were strictest

not

on

be over-issued so long as conBrasseur, Horn, Courcelle-

theorists.

believed

it to be very

of the

Mannequin

a member which

should

son,

and banking

school

in France

denied that bank-notes could vertibility was maintained. vinced

currency

peculiar

thought

by at all. rea-

such

altogether.

central it the

banking

school

cor-

support

of the

prin-

a

THE

ciples

of the

Coullet, ciary the the

currency

who issue

Among

DISCUSSIONS

so long

the

there of the

proportion.

The

of the

currency

admirer

of Peel's

Act,

reserve

reason

proportion

that

the

ment in time and Adolphe By the tary

beginning

theorists

Wolowski ers of the

of specie d'Eichtal had

only

was

doctrine.

and

been

turned

bank

was

the

fidu-

of issue.

right

a rather

less

Wolowski also

of issue

rigid was

preferred

of controlling

'seventies

case

on

of

time a discussion of issue and the fixed

to cause

withdrawals, both iavoured of the

in this

one

Cernuschi

tended

113

limits

unlimited

began at this fixed fiduciary latter

BELGIUM

exception

the

method

latter

AND

of any

was

opposed

pretation the

The fixing

as there

who

Bank of France relative merits

reserve

school.

opposed

those

IN FRANCE

issues

greater

intera great this

for the

embarrass-

but Leonce de Lavergne the second method. the

to the

attention

of mone-

bi-metallic

and Cernuschi both figured among retention of the double standard.

question. the

to

support-

CHAPTER

The

IX

Discussions in Germany

In Germany the question of banking freedom came to the forefront of discussion later even than in France. An early book that had some considerable influence was the account given by F. A. von Gerstner I of the impressions he gathered when travelling in America, and in which he attributed the swift development of American industry and commerce to the banks.: He was responsible for arousing a good deal of false optimism as to the effects of credit expansion, and led some readers to believe that banks were vested with a kind of magic power. It was not until the 'fifties that any modern literature on banking and currency of any importance was written, and then within a few years three writers came into the foreground--Otto Ht_bner, J. L. Tellkampf and Adolf Wagner. The first of these, H13bner, was an active member of the German Free Trade Party. His book '_consisted for the most part of a survey, largely historical and statistical, of the chief banking institutions then in existence all over the world. His 1 "Berlcht

aus

den

Vereinigten

Staaten

Nord

Amerika's

uber

Eisenbahnen,

Dampfschiffahrten, Banken und andere offentliche Unternehmungen," -"Drei Gegenstande sind es vorzuglich, welchen die Vereinigten ihren Wohlstand verdanken: die Schulen ... : die Banken, 800 an

1839 Staaten der Zahl,

welche jedermann mit Leicht]gkeit Geldmittel, seinem Vermogen angemessen. darbieten, und ihn in die Lage setzen, an Spekulafionen jeder Art Theil zu nehmen: endlich Eisenbahnen, Canale und Dampfschiffahrt . . " Op. cir., p. 1. "Die Banken," 1854.

ll4

THE DISCUSSIONS IN GERMANY

I 1/$

general conclusions were strongly in support of free banking. Practical experience had shown, he said, that banks were least often insolvent where they were least restricted? States never gave privileges without demanding a quid pro quo, and if banks wanted to keep their privileges they had got to fulfil the wishes of the Government. "For exclusively privileged banks," he said, "insolvency is as a rule the entrepreneur's best speculation"; foremost in his mind was the case of the Austrian National Bank; without declaring itself insolvent it could never have lent such large sums to the Government, but if it had not lent the Government what it did, its profits would have been much smaller? The contrast is between privileged banks which are protected by the law from the consequences of their mistakes (if they should become insolvent, the Government gives forced currency to their notes) and the free-banking system where the bankers must bear the results of their own acts. Moreover, the mere fact that the State supports warranted trust.

a privileged

bank

gives it an un-

H_bner did not base his case for free banking on the theories of the banking school--on the contrary: he was the first of a group that became rather fashionable in Germany, that held that only so many notes should be issued as there was metal to back them? The rule was that banks should not lend more than they receive. It followed that Htibner was also not a member of that division of the free-banking school which looked upon terest rates. If such company an increase an expression of the produces. _ If it were 40p. tit., Vol. 1., p. Op. cit., Vol. I., p. 013. cit., Vol. I., p. ' Op. cir., Vol. I., p. Preise aller Dinge, sind

free banking as a means of lowering ina lowering of interest rates were to acin the circulation, it would, he said, be unhealthiness which such an increase true that the State could be trusted al-

32. 33. 73. 73. "Die Papier ein scheinbarer

ohne Metallhinlage, Vermogenszuwachs.

die Erhohung der genossen

der und

1116

THE

RATIONALE

OF CENTRAL

BANKING

ways only to issue notes to the amount of its specie holdings, a State-controlled note issue would be the best system, _ but as things were, a far nearer approach to the ideal system was to be expected from free banks, who for reasons of selfinterest would aim at the fulfilment of their obligations. The same rigid interpretation of the currency doctrine found a second supporter in Tellkampf. In his earlier years he had travelled in America, and it was his observations of the abuses of the banking system in that country which were supposed to have led him to his conclusions that the amount of paper should be regulated strictly by the amount of specie deposited in exchange and that the issues should be in the hands of a single bank. He had published these views in America as early as 1842, 9 but they did not at that time attract much attention. Having returned to Germany he became Professor of Political Economy at Breslau and was also elected to membership of the Prussian Senate, where he took a leading part in the discussions on bank legislation. One of the points with which he was concerned in his first book" was to combat the idea still pervading some circles in Germany that banking possessed the power to effect unlimited increases in real wealth." On the question of freedom he drew a sharp distinction between note-issuing and deposit banking. It was, in his view, impossible to allow the former to be carried on by all private persons without legal limitation, but he makes an exception to this rule under two conditions. Firstly, the issuers must be subjected to unlimverzehrt wird Da dies Vermogen aber eben nur scheinbar, da es kern Kapltal, kein ersparter Uberschuss, ist, so wirkt sein verzehrter Betrag, schliesslich als ein Deficit zwischen Haben und Soll. Man hat keinen Vermogenszuwachs, sondern das ahe Vermogen verzehrt " Op. cir., Vol. I., p 123. ') Hunt's "Merchants' Magazine and Commercial Rewew," Vol. IV., p. 70. 1,_"Uber die Neuere Entwicklung des Bankwesens in Deutschland mit Hlnwels auf dessen Vorbilder in England, Schottland und Nord-Amerika und auf die franzosische Societe Gdnerale du Credit Mobilier," 1856. _1 He attacks

particularly

von

Gerstner's

views

THE

ited that

DISCUSSIONS

IN GERMANY

117

liability. Limited liability was, he contended, could be demanded in the name of free trade

ilege

by the

natural

granting

of which

principle

Secondly, the note lend to the State. While

Tellkampf

as the

the

State

of responsibility

ultimate

had

undermined

underlying

issuers

must

looked

to centralisation

end

be free

to be sought,

from

these the

new

was

principle

would

that

provide the

herent

of the

currency

issue

time

in

unity in the of banks and led him to fa-

on the

shareholders

extent

were

of their

necessary known

Scotch

liable

property,

limitation

among

model,

the

on

1_ on

for their

self-interest

note

German

issuesY

economists

of

was Adolf Wagner. As strictly as Tellkampf of the currency tradition, Wagner was an adbanking

doctrine

tinent,

be set up

if the full

the best

his generation was a follower

was

should

to the

By far

note

at this

to

setting up her own private banks so as to keep of these other States. He recommended that

banks

obligations

trade.

all obligation of the

1_'there

the

free

Prussia no prospect of attaining any effective note issue, and the increase in the number their unlimited issues in the "Border States" vour Prussia's out the notes

not a right but a priv-

school.

was

he set out in this to explain

the

Writing

at a time

becoming

very

first

''_to do two

book

disadvantages

from

powerful the

when

the

on the

Con-

things:

economic

The

one

point

of

view of the ruling system of privileged banks, and the other to examine the basis of Peel's Act. He had made a very close study

of English

had been especially son. It was through 1., See also his Great Britain and _'_"Uber

die

literature

on

influenced Wagner

this

and

by the that the

Entwicklung,

etc.,"

subjects

and

writings of James chief accusations

"Essays on Law Reform, Commercial the United States of America," 1859

Neuere

allied

Policy,

Banks,

Wilthat etc.,

p. 5,

*a Note that Tellkampf was responsible m co-operation with E J Bergius translating under the title "Geld und Banken" (1859) MacCulloch's "Treatise Metallic and Paper Money and Banks," in which the currency' doctrine defended. 15 "Beitrage

zur

Lehre

von

den

Banken,"

in

1857

for on is

• la

THE

had

already

RATIONALE

been

currency

made

doctrine

His own

opinion

without

legal

made

that

issues

porting

free-banking

being

unsound,

taken

theories

tional

ground

and

he

of the

currency

Peel's

the

the

readers. to set up

statutory thus

fix-

fully

sup-

Act he regarded

it was school,

Bank

Act and

be allowed

opposed

because

the

Peel's to German

proportions,

position. only

that

against should

or of reserve not

BANKING

available

banks

hindrance,

ing of note the

in England

were was

OF CENTRAL

based

but

on

also

of England

on

had

as

the

mis-

the

addi-

through

its

privileged position acquired a responsibility to render during a crisis by liberal lending, and now Peel's Act had its privileges

intact

defect

in the

system

of the

great

which

he gave

most

weight

was

makes

of the

power

aging

it to discount

State

paper.

sessed the of keeping opposite

but

too

'7 While

the

more

lending

he published

a few to the

Germany

This was closely of the automatic were

assets, after

-tlley

the

issue

ject

to check.

assumed banking

the

over

such

a bank

and

was

rates years

banks by encour-

in too

in France

central Wagner

to

Government

to invest

group

'_ The

much

had

as-

bank to be one held it to be the

too low. of the later,

theory

TM

of

currency

doctrine

prominence

was

"'bankmassige'"

first

cover.

connected up with the celebrated principle reflux of notes. The theory was that so long

lent

the

central

misuse

criticism

in

term

privileged

Pereire

detailed

its obligations.

the

fault of a single privileged discount rates too high,

given

ness

away

cheaply

which

as notes

taken

it exercises

of keeping

In the

had

aid left

out in true came

elapse

back

of the

banking in the loan

supposed

for this

From

time

a position discussions

this

1_ Op. cir., p. 212. 1tOp cit., p. 233. _8 "Die Geld-und Kredittheorie

natural

period reason

onwards

of considerable and

business, and

that course the

"'bankmhssige"

Peelschen

Bankakte,"

of sub-

cover

in German

legislation.

der

of busiamount

to be constantly importance

is short-

1862

THE

DISCUSSIONS

IN GERMANY

119

The most interesting treatment of the proposals for free banking in Germany is contained in the discussions of the Congress of the Deutsche Volkswirte 1_in the early 'sixties and the separate writings of one of its most prominent members, Otto Michaelis. The Congress set out to formulate a legal framework for free banking. It decided that provided unlimited liability were imposed on banking companies, special legal conditions were unnecessary. If limited liability were the rule, however, it might be necessary to formulate certain legal requirements (Normativbestimmungen). As to what exactly these conditions should consist of was a matter of some considerable debate, and full agreement was not reached on every point. All the speakers seem to have agreed that no fixed limit should be put on the note issue and that no stipulated reserve proportion should be imposed. They were not quite unanimous on the question whether only certain specified types of assets should be permitted for use as note cover. Max Wirth was of the opinion that all notes should be covered by metal plus "'bankm_ssige'" bills. He regarded both Government as well as other long-term securities as being too unstable in value to be good note cover. 2° Michaelis thought that neither lombard loans nor State paper were proper cover for notes, and the New York bond deposit system was on this account indefensible. But although he accordingly believed that it was good counsel to recommend to a bank that notes should be covered by "'bankmi_ssige" bills, he considered that it was not necessary to lay this down as a legislative condition. The Congress was not for the most part in favour of stipulating that bills discounted by 19 See report of proceedings in the "Vierteljahrschrifl fur Volkswirtschafl Kulturgeschichte," 1863, Vol. III., pp. 241 ff. zo This discussion m detail of note cover was a new departure in the discussion of banking, and was probably due to two factors peculiar to Germany firstly, the extreme fluctuations that certainly did take place in the securities of all the German States, including Prussia, and secondly, the fatal experiences m the outlying States of the attempt to use crddlt mobilier assets as note cover und

1_,0

THE

a note-issuing did

such

bank

or type for the

of deposit

The

question rights

of a liquidation tance

was

bank

should

attached

for the

for a failure

on any

period

the

enforcement

imposition

in the

negative.

speakers to cash

be given

pref-

in the

event

point

notes

on

of the

obligations

was

Great

to the

enforcement

for which

the

of quick

of penalties suspension

It as

importhat

the

emphasis

on

liquidation

something

resumptions varying

lasted,

the

length

for liquidation

of the

penof a depast. need

of payments,

with and

the

day

parture from what had been customary in the Observations had from time to time been made on the for the

pro-

amount

support.

(depositors)

This

to meet

the

legal the

as to the

receive

of liquidation)'

rigid

on

issue,

should

creditors

all the

Neither

"'Normativbedingungen"

be obliged

on pain

note

requirements

answered by

always

presentation necessity

was

than

note-holders

other

names.

limitations

Prussian

whether

two

of restrictions

of deposits,

the

over

at least

other

or special

all

BANKING

placing

of deposits,

for withdrawal

erential

have the

of business cover

thus rejected inappropriate.

alty

as

liabilities,

of notice

OF CENTRAL

must

measures

amount visions

RATIONALE

for

of time after

a

21 Michaelis says "Das einzlge reeUe Sicherungsmittel 1st das bei der Bank stets wache Gefuhl der Notengefahr. Man sage daher, so viel Noten als einer Bank jeden Tag zur Einlosung prasentiert werden, so vlel muss sle an dem Tag der Prasentierung unter allen Umstanden einlosen, und wenn sie das nicht tut, so ist sie bankrott." See "Vlerteljahrschrlfi fur Volkswirtschaft und Kulturgeschlchte," 1863, .VOI IIL, p. 251. It is important that it should be clear that this does not mean that a bank would never be able to tide over a temporary embarrassment, or, alternatively, that it would be compelled, m order to be perfectly secure, to keep reserves of 100 percent It is, indeed, to be expected that the volume of notes flowing back to any bank will, from time to time, surpass the normal anticipated movement plus a certain allowance for some margin of deviation for which the bank can be expected to provide adequate reserves. But if such a surprise demand _br cash suddenly arises and the bank's position m such as to allow it to meet all its obhgatlons, provided it had the time to call in loans and so liquidate its position, it will surely be able to borrow for the necessary period from the market. A bank which is solvent to the extent that it could meet its liabilities within a reasonably short period, but was suffering from insufficient liquidity at the moment, should not experlence difficulties in arranging such a loan

THE DISCUSSIONS IN GERMANY

121

more or less lengthy period, but it was usually taken for granted that a suspension for a certain length of time was permissible and normal. Particular emphasis was placed by Michaelis, and the Congress as a whole, on the, up till now, neglected importance of deposit banking, and the Congress resolved that the setting up of discount and deposit banks should be recommended/: and when it again approached the subject two years later, 2' Michaelis was very much in favour of making the campaign for the development of banking independent of the fight for freedom in note-issuing, because he recognised how remote were the chances of success of the latter. This was in spite of his being in sharp disagreement so far as the theory of the subject was concerned with the common view that notes and deposits were to be rigidly contrasted. In an article published in 18657 _ Michaelis argued that by establishing unity in the note issue, one of the most important checks on over-expansion was removed. With a large number of banks the average period of circulation of notes was shortened; each note had more chance of coming back to the issuer for cash payment. Now in the case of deposit credits, he says, the limits to expansion are even narrower. The test of cashability comes very early; a check is not likely to change hands many times by endorsement and will often be paid in immediately to his bank by the person in whose favour it is drawn. Every check drawn in favour of someone outside the circle of customers of that bank on which it is drawn will be paid in at another bank, thus giving the latter a claim on the former, and unless it is balanced by a counterclaim, the one will lose cash to the other. While admitting to zz Op. ctt., p 258. 27 See "Vlerteljahrschrlft Vol. lI., pp. 206 ft. 24 "Noten und Deposlten,"

fur Volkswlrtschaft published

und

in Faucher's

Kulturgeschichte," "Vierteliahrschrift

1865. "

1_2

this extent

THE

RATIONALE

a certain

OF CENTRAL

difference

BANKING

between

checks

and

notes

(the latter were likely to remain for a longer average period in circulation outside the banks before being paid in), and this was the only distinction of any importance that had yet been recognised, Michaelis did not see in it sufficient reason for withholding freedom from the note-issuing business while allowing it to deposit banking. In both cases, so long as there were a number of banks, a strict control would be exercised by and among the banks themselves. In both cases monopoly increased the circulation period and deferred the test of cashability. Michaelis was convinced that there exists in a multiple banking system an automatic mechanism which checks any tendencies to expansion of the note issue. And this, he said, will work so long as there are some or even one of the banks that does not expand? '_ He thus regards it not only as a means of checking any single bank getting out of step with the rest, but as a mechanism which, since not all banks without any exception are likely to set the going at the same time, will keep the control. Longfield's objection would, if tiori to this case, but it remained more

process of expansion whole system under it is valid, apply aforor less unknown.

To those who argued in favour of unity ened the area over which the notes of any used, Michaelis replied that it was a positive the point of ¼ew of limiting the note issue 2._"Nehmen wir an, das alle leichtsinnig in der Ausdehnung solche gegenseitige Abrechnung ahsation der Notenversprechungen

because it widbank could be advantage from if the territorial

nebeneinander bestehenden Banken gleich ihres Notenumlauf waren, so wurde durch im Ganzen eine Kompensation, nicht eine Restattfinden. Da indess die verschiedenen

Banken verschiedenen Grundsatze verfahren, so fuhrt diese Abrechnung zur Notwendigkeit barer Ausgleichungen sobald nur eine unter ihnen ist, die im Verhaltniss zu ihren Umsatzen wentg Noten lm Umlauf hat. Denn diese eine empfangt immer mehr fremde Noten als andere Banken von den ihrigen empfangen haben konnen .... " Article "Noten und Depositen," pp. 130-131, in Faucher's "Vierteljahrschrift," 1865; also republished by Michaelis in his "Volkswwtschaftliche Schriften," Vol. If., 1873.

THE

DISCUSSIONS

IN GERMANY

lZa

area of circulation of the notes of any bank were small, since it made their return to the issuer more frequent. 2_ It was at about this time that the first publication _: appeared of a writer who has, perhaps, received far less attention than his work merited. We refer to Philip Joseph Geyer. He was, in common with Tellkampf, an adherent of the stricter form of the currency theory. He started off from the thesis that the amount of money in circulation should always remain constant, _ and that the movement away from an approximation to such a state of affairs had been caused by the issue of bank notes not covered by specie. He held that only fully-covered note issues are a "real" economic factor, uncovered note issues merely bring "artificial" capital (kimstliches Kapital) into operation, and if more artificial capital comes forward than there is real (nattJrliches) capital lying idle, a crisis results from the phenomenon of overproduction. 2_ While being violently opposed to freedom of note issue, he was very much in favour of giving freedom to set up deposit banks which would collect and use the idle real savings. He speaks of such a process making the uncovered note issue unnecessary. After the crisis of 1857 and the operations as lender of last resort then carried out by the Bank of England, there had 2f' "Je grosser leichter sammelm

der territoriale Umlaufsbezirk der sich also Notenmassen im Verkehr

Noten einer Bank, um so an, auf deren Ruckkehr

die Bank mcht vorbereitet ist, je kleiner derselbe, um so ofter kommen die NotCh in den Fall, gegen Bar umgewechselt werden zu mussen, well sie um so offer m H_mde kommen die Zahlungen aus dem Umlaufsbezirk heraus zu machen haben"--Article above quoted, p. 132. Actually the principle of limitmg the area served by one bank would lead to conditions of monopoly rather than of competition. The more natural system would be a branch system in which the area over which the notes of any bank circulate is wide and in which branches of different banks compete in the same district. If Michaelis' other check--namely, the clearing mechanism which he supposed to function between banks in the same district--works, then inter-bank control will not be lacking in effectiveness in such a system. 2: "Banken und Krisen," 1865. z80p. 2_ Op.

cir., cir.,

p. 7. pp. 33 ff.

1_4

THE RATIONALEOF CENTRAL BANKING

been

noticeable

emphasis cates

even

in the

of a strong

because they issues within

in Germany

arguments

something

for

central

bank

central ceased

18667"

Whereas

during

a crisis,

satisfy

the

small the

note

notes

internal

issuers

currency

necessity

of the

posed

Bank

Act, which

were

it merely

always

bank

demands.

of providing

Prussian

Peel's

to support

of

advo-

attitude was clearly stated he published early in

of a central ibr

on top of the external drain, crisis less serious. For these idea

The

thought it was the only way of keeping note the necessary bounds and increased the em-

phasis on panic financiering. This by Professor Nasse in a pamphlet

ing the

of a change

banking.

becoming takes

banking Nasse

such

by

drain

to

avoid-

of metal

rendered welcomed

a central

from

continue

Therefore,

an internal

central reasons

discredited

could

bank

a bank

and

the

ity of filling up the gaps made in the credit country by a crisis. His attack on the principle

the the op-

possibil-

system of a of Peel's Act

was directed against a Bill just introduced into the Prussian legislature by Michaelis for the fixing of the fiduciary issue of the Prussian Bank. It would

at first

sight

seem

should

be sponsored

by

favour

of the

freedom

minimum ever, there

on

the

this

limit

note

that

had

note-issuing

with his of banks, case

His general there

such

always banks

and

therefore

Michaelis

that

note

in

and

attitude

a

is, how-

thesis. Where is an automatic

of a privileged

is absent

a Bill

been

monop-

some

external

be imposed?'

agreed

possible

for

in the

strange who

interference.

issue;

mechanism

must

Nasse as

of legislative

perfectly consistent are a large number

check oly

fullest

a little

Michaelis,

be

with kept

"'bankm_ssige"

cover

(short-term

should

as far

commit-

3o"Die Preussische Bank und die Ausdehnung ihres Geschaftskreises in Deutschland," 1866 " "Volkswlrtschaflliche Schriflen," Vol. II , p 383: the relevant passage was absent from the article ("Noten und Depositen") as published in Faucher's ,,Vlertellahrschrift ,,

THE

ments). rect

This

excluded

opposition

fiduciary securities.

and

ing system rial

for

could

be

under

two

capital"

up

of capital

produced

the

and

crisis,

first,

to a point

of the

able

explanation

Austrian

and

depression.

theory.

over-production

lieves mand

there secondly,

price,

here

is an excessive that

and

while

it is true

this

is so small

credit

any

of the into

ceptible

in the

final

He approaches lines

of the

ment

and solution

price

the

modern real

theory

savings.

of the

of goods

theory

bank

ory, he says, as in the uncovered note issue

cheaper

of the

The

results

in

he

be-

which

question practice? should

lie not

capital

the dea fall in reduces per-

for consumption. somewhat

equation

difficulties

crisis

as to be hardly

ready

of banking

accept-

an under-

of capital

an item

and of the the-

cause

goods,

that

having

to give

develops

of consumption

charges,

mate-

producing

of the original "over-investment"

over-supply

interest

bank-

the

by

and,

immediate

the

further

cannot be absorbed by the market, because for consumption goods will only increase with

their

the

it provides cycles

but he failed

more The

views

it by contracting

His reasoning

consumption the

school,

of the

in di-

present

where

it intensifies

was which

Government

of the

that

causing forced sales. His explanation boom came very close to the modern ories

by their

faults

production

in existence,

and under

only

elaborated the

heads:

crises

Act,

backed

both

125

securities

of Peers

summarises

trade

"artificial amount

basis

Tellkampf

in 1867. 3"_Geyer

IN GERMANY

Government

to the

issue 32

Geyer

DISCUSSIONS

along

between which

so much

4 The theory be brought

the

invest-

accompany in the

the-

is clear, that the into equilibrium

32 The reason, as Nasse explains, was that Prussian Government securities were far less stable than English ones, and in case of need could often only be reahsed at a considerable loss. He even suggested that it might be advisable for the Prussian Bank to invest its spare funds in English Treasury Bills "_'_P. J. Geyer, "Theorie und Praxis des Zettelbankwesens nebst einer Charakteristik der Englischen, Franzosischen und Preussischen Bank," 1867, J L. Tellkampf, "Die Prinzipien des Geld-und Bankwesens," 1867. _4 Op. cit., p, 227.

126

THE

RATIONALE

OF CEN_rRAL

BANKING

with the amount of capital lying the amount of this idle capital,

idle, but as we it is impossible

equilibrium.

it is advisable

together tal could In the

period

money and

He concluded

of change-over,

should

follow

this

be centralised

realised

that

would

the

in step

to accomplish

should

that

the issue of uncovered notes and better be collected by extending

confined

given

this

still be international

creation

of bank

probably be unable rates elsewhere. Peel's

Act

problem

for any capital," capital

to hold

was

not

because

in other

idle

could

money

not

capital.

prevent

carry

The

attitude

the

manding

the

several as they

important do, from

total

contains

100

percent

by

posite

more likely

by both

and

to Geyer's

currency

crises

Geyer

principle

forbid should arose,

to

things

it led

it

to fur-

of easing

Tellkampf

fiduciary

to

uncovered be equal

of these

and

would

discount

panics instead trade losses.

of the

notes

metal,

in large

they

issue

violent to occur

and

lasting

from

the

And.

what

proportion

underestimate

process which "ideal" situation,

direction.

be point-

solution the

once

abolition

already

was

up

He there

in deignored

aspects of the monetary problem. Starting, a situation where the existing money sup-

ply

much

and

issue

issue

lower

it did neither

by provoking so as to reduce taken

the deflationary back to their

Since

crises,

ther complications credit conditions

note

countries

against

its logical conclusion. It should either notes altogether or else arrange that they the

note

one country in isolation to since it would be affected

out

not

bank

institution.

it would

a commendable

it did

the

in the

complications;

less as well as difficult give up "artificial bank by the

that

al-

in deposits,

to a single

unity

up

idle capibanking.

of artificial

increase

it is necessary

and

even

the

to give

that the deposit

reduction

with

do not know to effect an

would and

the

covered

difficulties

of

be involved in getting which would entail a

disturbance movement

is more

not

than they

important,

any

fear

which

in the

perhaps,

opthe

THE

DISCUSSIONS

IN GERMANY

IZ'/

objective would have no real value, since there is no special sanctity of any specific figure for the total quantity of money. All that is important are fluctuations in this total quantity, and all that Geyer's theory required was that no further increases should take place, so that the economic system, once having got into equilibrium with the amount of money in existence at the moment, will not be required to readjust repeatedly in the future. In confining their considerations to bank-notes and the effect of these on the total quantity of money, they ignore also complications introduced by the existence of demand deposits and the effects of changes in their velocity+ We start from a position where we have a volume of demand deposits which have arisen, not (or not all) from payments into the banks of an equivalent amount of cash, but from the redeposit of loans (also not backed 100 percent by cash) made previously by the banks, and these demand deposits alter the volume of effective circulating media of exchange by changes in their velocity of circulation (number of checks drawn per period of time). The criterion of keeping the amount of the circulation constant may at times, then, positively require the amount of currency in the form of bank-notes to increase. Such would, for instance, be the case where a decline in the activity of deposits (increase in the average period for which they remain idle) requires the banks to make fresh loans if they are to keep the effective circulation the same as it was before, and the new borrowers prefer bank-notes to demand deposits. Once the deposits have been created, it is immaterial so far as the economic results are concerned what part of them is changed into currency, tor would seem to be the choice

and the only deciding facof the public as to which

they prefer, deposits on current account or bank-notes. The less extreme currency school writers, as well as the banking

school,

regarded

notes

as rendering

a service

in

I_S

THE

RATIONALE

OF CENTRAL

BANKING

what they called "economising specie," which is usually to be interpreted as "providing easier credit." Geyer and Tellkampf, adherents of the very strictest currency doctrine, look upon them only as a more convenient form in which monev can be carried about or transported. It is noticeable also that where people like Tooke and Wagner saw as the sole evil of increasing the amount of currency the possibility that it might depreciate its value (raise the price level), and therefore concluded, that since an increase in its volume had frequently taken place without causing a decrease in its purchasing power, it was not alwavs an evil, 3_Geyer did at least see that changes in the quantity of circulating media produced changes in the structure of production with certain undesirable repercussions. In his later work Tellkampf still considered that if the plan of unifying the note issue and restricting it to the amount of specie deposited could not be put into operation, then the next best alternative was the Scotch system, and he seems to have regarded this as a very good second best. The discussions conclude in Germany with a few publications at the beginning of the 'seventies, just prior to the foundation of the Reichsbank. Among these was a pamphlet by Leopold Lasker, 3' who alleged, probably not unjustifiably, _ that it had still not been conclusively shown why banking should be made the exception from the rule of private enterprise in all br_nches of economic life, and that no case had yet been made out against "Bankfreiheit." Two treatises on banking and credit were also published in these years by Wagner and Knies _ respectively. These two were supportzs See Wagner, 36 "Barlkfreiheit

"Beitrage zur Lehre oder mcht r_'' 1871.

von

den

Banken,"

pp.

81-86

mr Especially as Longfield's argument remained practically unknown 3s A. _,Vagner, "System der deutschen Zettelbankgesetzgebung unter Vergleichung mit der Auslandischen, zugleich ein Hal'ldbuch des Zettelbankwesens," 1870-73 C. G A Knies, "Geld und Kredit" (two volumes}, 1873-79.

THE

DISCUSSIONS

IN GERMANY

129

ers of opposite sides in the controversy, but Wagner had by now obviously come under the influence of the historical school and therefore was no longer so uncompromisingly in favour of the free-banking system, and insisted that there could be no absolute solution in favour of one system; all systems can be justified in the appropriate circumstances. He had, however, abandoned few of the essentials of his old position, and the bias is still towards the free-banking ideal. One of the theories he sought to destroy was the idea that note-issuing brought in a fabulous profit. This idea was one of the grounds of objection to free banking held by Knies, who wrote that the creation of bank-notes must be subject to special regulations, _ because their creation was costless. Wagner pointed out the existence of costs of management, and especially the costs of the substantial capital that was necessary for a note-issuing business. Neither did Wagner admit that it was necessary to single out banking from among all other branches of industrial activity and subject it to unlimited liability provisions. But he allowed that it might be an advantage to reform the whole of the company law so as to enforce special requirements for different types of undertaking, and with this idea in mind he set out to formulate the "Normativbedingungen" that might be applied to the case of banking. Accordingly, he suggested that the bank's capital should be required to attain a certain figure, that there should be a limit on the lowest denomination for notes, that there should be a regular exchange of notes once or twice a week between banks, and that the principle of publicity should be enforced. Such regulations as these he regarded as being perfectly compatible with the idea of full "Bankfreiheit." Other clauses frequently to be found in bank laws, such as regulated the business of the banks, fixed the relation between the amount of the note 3_ Op.

cir., Vol

I.. p

313.

|30

THE RATIONALEOF CENTRAL BANKING

issue the

and

the

form

amount

of the

of the

note

"Bankfreiheit,"

but

upon with conceded.

bank's

cover,

presented

some

chief

place

clauses

and

suggests--the

creditor

the

can

bank

courts

for

Wagner

took

still

not

German

cover)

method

or

the

Michaelis the

Peel

both

"Dritteldeckung,"

figure

than the Peel Commenting had

turned

eration

was

affirmation that

of the

mits,

however,

that

only

be gained

by privileged

banks,

and

great banks and Bremen

or

that

not

they only

one-third Wagner

it was

towards

a considbank, He sub-

such

monopolistic but

the rigid

system. which

of a central

Bank

and

that less

advantages.

necessarily

Prussian

true

bond deposit in Germany,

advantages not

specie preferred

as could central

also

in important cities such as the Frankfurt, banks, smaller central banks or central

Op. cir., p. 634.

of

Knies

it is far

people

or entirely the

as a

question

system.

evidenced

were

such

the

issue).

arbitrary,

of many

it had

extenuating

fiduciary

system or the American on the 1866 experiences

agrees

any

a demand

only

on

although

purely

tl_e thoughts

and

Wagner

Peel

because,

of one-third

time

to impose reserve requirebetter to use the Continental

(fixed the

and

is the

majeures,

Michaelis

bank's

its obligations,

The

("Dritteldeckung,"

favoured

be

counters

to bring

of forces

against

system

looked

the

days

pay

its liquidation.

whether, once it was decided ments for the note issue, it was or

full

might

at

redemption

be allowed

be cases

sides

kind

paid

period--three

should

circumstances should foreign invasion. A°

with was

of this

is not

at its

a short

bank

of the

before

or

within

determined

he placed emphasis on the neof insolvent hanks. If a note

redemption

of business

branches, he

for

or

compatible

"Bankfreiheit"

In common with Michaelis, cessitv for a speedy liquidation when

not

if complete

suspicion,

capital

were

similar Leipzig banks of

i i

THE

second

order

DISCUSSIONS

as they

might

IN GERMANY

be called,

had

131

given

reputable firms at the height of the crisis. 41 The partial recantation of Wagner, the once champion of Bankfreiheit, of the active opposition

at Op.

cir., p

357

support

to

relentless

may be fairly regarded as the to central banking in Germany.

end

CHAPTER

The

X

Post-1848

Discussions in England

T

•he account we have so far given of the development of English thought on the merits and demerits of a flee-banking system, as eompared with one in which the note issue was monopolised, brought us up to James Wilson's contribution at the close of the 'forties. In England, at least after 1844, if not before, the only practical problem was always whether, given central banking, there should be limitations or no limitations on the amount of the note circulation. The question of whether there should be freedom or privilege in the issue of notes was scarcely ever raised. But the discussion of its latter problem on a much more extensive scale by the economists and financial experts on the Continent could not fail entirely to draw the attention of their English contemporaries. The economic literature of the 'fifties in England showed an almost complete neglect of this problem: there were not many more than a couple of references to it. Of these one was due to R. H. Mills, professor in one of the Irish Universities, who treated the subject in the course of a series of lectures which were later published? In his view, "a violent expansion and contraction of the currency.., is the inevitai "The Principles

of Currency

and Banking," 132

1857.

THE

POST-1848

DISCUSSIONS

IN ENGLAND

13a

ble result of a system which has still many advocates and which has but late been checked.., that of allowing a number of banks of issue to subsist in the country. ''2 In support of this statement he quotes verbatim the argument given by Longfield, and this citation appears to be right up to the present day 3 the only instance of any mention of Longfield's point, in spite of its being the most important single controversial point in the theory of the problem. The other reference to which we have referred came from the pen of Herbert Spencer,' and is a denunciation of all State interference in banking and a plea for the strict application of the laws of bankruptcy to banks which suspend cash payments. He believed that this would be a sufficient and effective check against over-issues. In the 'sixties several circumstances combined to bring the controversy again into the open. The currency disorders in the United States of America, and the publication of Coullet's book, "La Circulation Mon_taire," in France in 1865, invited comments in The Economist. This journal, following in the tradition of Wilson, under the editorship of his son-in-law, Walter Bagehot, continued to make frequent reference to the superior qualities of a plural banking system. The evidence given before the French Banking Commission and the not very encouraging first experiences of the new National Banking system in America provided the occasion for further remarks to the same effect from time to time in 1867. The French influence was particularly strong. Bonamy Price, Professor of Political Economy at Oxford, drew attention to the points of disagreement between the leading pro-

20p. . clt., Nelsser freiheit?" in 4 "Essays Westminster Political and 3

p. 70. has recently used the same argument in his article "Notenbankthe Weltwirtschaflliches Archiv., October, 1930. on State Tampering with Money and Banks," first published in the Review, 1858, and later included in Vol. HI. of "Essays Scientific, Speculative."

1 34

THE RATIONALEOF CENTRAL BANKING

tagonists,

Wolowski

connections French give

and

were

established

economists evidence

via

before

memoranda were son and J. S. Mill. tended

the

was reading the principal

banking several

liabilities banks.'"'

The

prova]. in

its pages

though

as yet

effects,

and

structure

position

for

The

which

many

especially

banking

general, as the had

of

on

the

recognition

under _ who

the influence had at least

discount

rate, of all its

and

received

rate

income

fairlv

could

be used

flows. low discount

school

higher

must ing

in France, which

_ and

had

be interpreted with

the

natural

insisted

prevailed as the state

that over

result, of things

the the

rate

preceding

not of the

gen-

of the writings made it clear to

fluence the balance of payments and gold Goschen made a direct attack on the

count

at

advocating

discount

price

had

to

of ap-

as to the details

concerned,

the

one

been

theory

of its effects

that

of France

in response

Economist The

where

it between

Bank

this journal

understood

country

world

by the in

Patterand at-

Club,

of discount was,

years.

imperfectly

of the

rate

to

written

it was better "to reserves against

or to distribute

adoption

reserve

era] acceptance in England of MacLeod; and Goschen, the

bank

and

called

and

Economy

on whether of the bullion

to the

by

English was

in person,

Political

to a single

hailed

direct

by Hankey, Newmarch, visited London in 1866

the

It was

the

Bagehot

Commission

a paper custody

long last of a principle

addition,

between

of moving

in its

"_ In

Enqu_te.

of the

reaction

policy

changes

the

meeting

English

the

submitted Wolowski

Bagehot entrust

of the

Chevalier.

rate of dis-

few

artificial

as Pereires

to in-

years

tamper-

claimed,

but

5 see Fraser's Magazine, 1868, "The Controversy on Free Banking between M. Wo|owski and M. Michel Chevalier " Bonamy Price's own treatment of the problem contributed nothing very new. See his "Principles of Currency," 1869. See "Political Economy Club, Centenary Volume," Vol. VI., p. 86. r "Theory and Prac_ce of Banking," 1855. "Foreign Exchanges," 1861. " Article entitled "Seven Per Cent." m the Edinburgh Review, January, 1865; republished in his "Essays and Addresses on Economic Questions."

THE POST-IS48

DISCUSSIONS IN ENGLAND

I a_

as the result of the free play of natural forces which had raised the demand for free capital and therefore its price. Nevertheless, the views of the Pereire group in France were not without protagonists in England. Best known among them was a journalist named Patterson, who gained sufficient recognition to be invited to submit a memorandum to the French Commission." He extended to the case of the Bank of England the view that it was the monopoly of the note issue and the monopolist's attempt to maximise profits which caused it to raise the rate of interest. Changes in the rate of discount were an unmixed evil to be avoided at all costs except in so far as under a free and competitive system of note issue they would become "natural."" The monopoly of the Bank of England was attacked also by Guthrie. '_ Although in many respects a crank, he called attention to one important aspect of a free-banking multiple reserve system. He submitted that under free banking, where each bank would be obliged to hold its own gold reserves, there would be a much closer connection between note

issues

and

gold reserves,

and

that

over-issues

and

the

drains of bullion to which they led could be checked before they became dangerous. Should the tendency show itself, he said, "All the banks, being at the same time dealers in bullion and in discounts and holding only the quantiw of bullion required as the basis of their own trade, would at once feel the withdrawal of gold from their coffers and be all constrained immediately without reference either to their issues or deposits to reduce the amount of their discounts in proportion to the cash they hold.'"_ This would mean that in a free-banking system banks could not escape from a strict adherence to the rules of the gold standard and the currency it) See "Evidence," Vol V, p 559 11"The Economy of Capital," 1864 12"Bank Mon@ly, The Cause of Commercial l:_Op. ciL, p. 41,

Crises,"

1864.

1_16

THE RATIONALE OF CEN_I?RALBANKING

principle, but the whole tenour of these remarks was in curious contradiction to a thesis of the same author's, that it was a mistaken policy for the Bank of England to keep a fixed price for gold instead of allowing its price to vary just like that of any ordinary commodity in response to changes in supply and demand. The monopoly of the Bank of England was, according to Guthrie, the primary cause of commercial crises. MacLeod also stated this view but did not effectively substantiate it?" Another feature of Continental thought at this time which had its counterpart in England was the attack on all fiduciary issues, led by Cernuschi and Modeste in France, and Tellkampf and Geyer in Germany. The English sponsor of these doctrines was Edmund Philipps. '_ He was chronologically prior to the Continental exponents except for Tellkampf, but attracted much less attention. He believed that so long as the Bank of England issued more notes than it had gold to redeem, it would be forced on occasions to suddenly call in its notes and raise discount rates, and he went so far as to suggest that if the Bank of England would not accept a charter under the condition that convertibility in his sense should be maintained, any of the joint stock banks would be pleased to do so. '_ This kind of argument never gained any following in England, however, and passed practically unnoticed. Let us now revert to the more general aspects of the question of unity as against plurality in the note issue. Bagehot's remarks before the French Commission were confined to the specific questions relating to the French case. The French system was inferior to the English system, he said, because in England each little town had its two or three 14See his "Theory and Practice of Banking," Vol. I (p. 479 in the 1902 edition). is "A Plea for the Reform of the British Currency and the Bank of England Charter," 1861. _ Op. cir., p. 11.

THE

POST-1848

DISCUSSIONS

IN ENGLAND

137

banks and these provided facilities for the collection and utilisation of savings such as did not exist in France. On being asked whether unity or plurality in the banking system would be the best system for England, he replied that the question was at the moment indifferent to her, because the result that the multiplicity of banks serves to obtain had already been reached: the collection of idle savings and the prevention of "their going to waste" was already well accomplished. On the theoretical question, he added, he was not required to speak. 1_ It was the opinion of J. S. Mill, as expressed in his written memorandum to the Enqu_te, that the importance of the choice between unity and plurality of banks had been exaggerated. It had been generally assumed that a plural banking system would increase credit facilities, and this assumption had been the reason both for the praise of the partisans and for the opposition of the enemies of a plural system. But Mill thought that, in fact, the system would realise neither the benefits claimed by the one side nor the inconveniences envisaged by the other, because after a period of adjustment, we should, he believed, find the note circulation distributed among a certain number of banks who would collectively conduct themselves in much the same way and provide just about the same credit facilities as the single bank under the old system. No one bank could augment its issues except momentarily, because of losing its reserves to other banks, and an increase in credit would take place only when it was provoked or favoured by general causes acting on all banks at once, and every time such causes came into play they exerted an exactly similar influence on the single bank in a unitary system. There would consequently be no very great practical difference between the two systems. '8 1_ "Evidence," Vol. I., p. 35. 18 See "Evidence," Vol. V., pp. 592-3. See also his evidence Select Committee on the Bank Acts, 1857, Q. 2039.

before

the

English

138

THE

RATIONALE

OF CENTRAL

BANKING

That Bagehot, on the other hand, thought that there would be very real and important differences between the two systems became clear in his writings in The Economist and in his book "Lombard Street," which he published in 1873. In the first place, it was the advantage of the multiple system of local issues that it produced a much more rapid development of banking over the countrv. A diffused system of note issue prepares the way for deposit business by establishing the credit of the banker. It is much easier to establish this by way of note issue, because the initiative is more on the side of the banker than in pure deposit banking. Moreover, such a system was better adjusted to loan business, because the partners in provincial banks usually belong to the district and have local knowledge which puts them in a better position to estimate the risks involved in lending to particular enterprise of individuals. Whatever had been the faults of the country note-issuing bankers, and acknowledging that we might not wish to see their return, they had done us a great service in the beginning. It was because we in this country had had a diffused system of note issue in the early days that we had outstripped other countries in all types of banking business. Admittedly, after a country has once succeeded in developing a paper currency and the other banking business to which this is an introduction--by whatever means this has been accomplished and however slowly or rapietly--the case for a multiple system of note issue ceases to be of so much practical importance, and Bagehot always refers to the question as being one of deciding whether it is advisable, in the abstract, and when we begin de novo to grant a monopoly. Accordingly, there was in his view no case for the Pereire plan of setting up a second bank of about equal strength alongside the Bank of France, in Paris, because Paris had already become accustomed to a note circulation, and in any case he thought the plan deserving of grave suspicion, since it came from the same people

THE

POST-1848

DISCUSSIONS

IN ENGLAND

|89

who objected to a rise in the discount rate. So far as provincial banking was concerned, it was plain that facilities were poorly developed as compared with England and Scotland, and this must be attributed to the lack of country issues in France. Nevertheless, he did not feel justified in advocating a return to a system similar to the old departmental banking system, because, he remarks rather cynically, "we may lay down a principle that every credit currency permitted in France should be such as could be made legal tender the dav after a revolution."" Considering the problem quite apart from such questions of expediency, however, he was convinced that a country starting de novo would do better to have a multiple reserve system, such as that of New York, rather than the English or French system 2('of a privileged monopoly which was essentially a single reserve system. It was not yet generally understood that the Banking Department of the Bank of England did in fact hold the only reserve of ready cash against the banking liabilities of the country, and it was important to make clear the effects of this on the position of the Bank. We had in England evolved a system in which not only practically the whole of the gold reserve (i.e., the reserve against notes), but also the whole of the banMng reserve (i.e., the reserve against deposits) of the country was kept by a single institution. This had grown oui of the privileged position in which that institution, the Bank of England, had been placed bv Government interference in banking. "The natural system--that which would have sprung up if the Government had left banking alone--is that of many banks of equal or not altogether unequal size."-" Instead of that, we had a central bank, and a central banking system

had certain

characteristics,

liable to become

"_ See The Economist, February llth. 1865, p 158 2o In Germany the Prussian Bank was not yet a bankers' bulk of the cash of the other banks, and therefore differed the Banks of England and France. See Nasse, "Die Preussische 2_ "Lombard Street," p. 66.

danger-

bank holding the in this respect from Bank, etc.," p. 59.

140

THE

RATIONALE

OF CENTRAL

BANKING

ous if not very carefully handled, which distinguished it from decentralised multiple reserve system. The two respects in which the centralised system showed the most marked difference were, firstly, in the effect on the total cash reserves of the banking system as a whole, and secondly, the reliance on a "lender of last resort." The commercial banks under this system, instead of keeping each its own gold reserves, keep their reserves in Bank of England notes or in claims, in the form of deposits at the Bank, on Bank of England notes. Each bank in estimating the proper distribution of its assets between immediately realisable and less immediately realisable, so as to ensure what it thinks is the necessary degree of liquidity, regards what it holds on deposit at the Bank of England as "as good as cash," so that according to the calculations of the commercial banks their cash reserves should amount, in addition to the sums of actual cash they keep in their tills, to the whole of that sum which appears on the Bank of England's books as bankers' deposits. But what the Bank of England has at any time available in cash, that is, notes in the Banking Department, is always very much less than this--it is only half or even a third of its deposit liabilities--because the Bank relends part of the reserves of the commercial banks. The virtual pooling of the reserves of all the separate banks means that in normal times the Bank of England can count on withdrawals by one bank being counterbalanced by additional depositing by others. The difficulty arises in times of pressure all round, when all banks are likely to be requiring cash at the same time, and it is then that the disadvantages of the single reserve system become apparent. The actual reserve held by the Bank is smaller than the sum of the amounts calculated by all the separate banks to ensure safety and which would really exist in reserve under a decentralised system. The spare cash of the money market is thus reduced to a smaller amount than under the alterna-

THE POST-1848

DISCUSSIONS IN ENGLAND

141

tive multiple reserve system. MacCulloch had supposed that banking reserves would be larger under a unitary than under a plural system; Bagehot showed that they were smaller. The second weakness of a central banking system is its tendency to create points in the system at which distress support is given. The existence of such refuges becomes part of the data on which the banks base their policy. It destroys some responsibilities and creates others. It is bound to happen that a central banking system being created by State aid is more likely than a natural system to require State help, and what it knows it can depend on, it will not hesitate to utilise. This circumstance in turn leads the public to demand extra services from the central bank in times of extremity and expects that it should help the smaller establishments, and "it is," says Bagehot, "a serious difficulty that the same bank which keeps the ultimate reserve should also have the duty of lending in the last resort. The two functions are, in practice, inconsistent--one prescribes keeping money and the other prescribes parting with money. ''22 It is this part of the central bank's activities--acting as "lender of last resort' '--that has been singled out by Hawtrey 23as constituting the primary function of a central bank. In what Bagehot called "the natural system," no bank would have any special claim on any other. In spite of the, in his opinion, manifested disadvantages of a central banking system, Bagehot saw no chance of giving it up and going over to a many reserve system: such an idea he admitted was childish, because it would take decades to build up another system of credit to replace the trust that had now come to be placed in the Bank of England as the pivot of the whole structure. Instead, therefore, of advocating the adoption of the alternative system, he tried only to 22See The Economist, September 1st, 1866. 23 See "The Art of Central Banking," Chapter

IV.

142

THE RATIONALEOF CENTRAL BANKING

elucidate

canons

imperfect

working

It had ise

the

been

of policy

Bagehot's

double

strain

times of stress side as holder

which

of the

one

aim placed

(viz.,

secondly, institutions This

Bank

him

facilitate

the

less

had.

to make

the

on the

Bank's

it must of what

of England

it must provide as find their

led

now

Bank

Directors

cash

real-

resources

in

by the dual nature of its position, on the one of the banker's reserves, and on the other as

lender of last resort. Firstly, cash to the banks in respect own

would

we

up

be prepared to provide was in all respects their

deposits cash own

to his final

held

as reserve),

by way of loan cash resources

conclusion

that

and

to help such insufficient. _4

the

Bank

adopt a more cautious policy and that a banking one-third in normal times was too low.

must

reserve

of

Bagehot's must have

influence been more

on the shaping of central bank policy considerable than that of any other sin-

gle writer

either

or on the

result

here

of his continued

admitted sis was deal

that the correct policy to lend freely at a high

to secure

the

Continent.

emphasis

recognition

that

It was

it came

for the central rate of interest. of the

mainly

as a

to be commonly

nature

bank in the criHe did a great of the

special

re-

sponsibilities tat of what

of a central bank. His accepted thesis was a rebutwas considered at the time to be one of the cardinal

principles

of the

should public

1844

be released

from

interest-in

act for the agement

by

any

framing

benefit the

Act, namely,

that

obligation

its policy

Banking

being

regulating

any

large

deposit

bank.

posed

principle

to have

been

already

not

to obtain

But

this it was

other

should the

Department

easy

general

Bank

to pay

and

of its shareholders,

the

of England

attention

to the

be at liberty

principles the

same

J. S. Mill rejected

agreement

to

of manas those had by among

sup1857. _ the

.,4The fact that in England the Bank does not lend directly to the banks (by redlscountmg) but to the bill brokers is immaterial It provides the bill brokers with the wherewithal to make repayments to the banks z_See the Select Committee on the Bank Acts, 1857, Q 2032.

THE POST-1848

DISCUSSIONS IN ENGLAND

143

Bank Directors. Immediately after the crisis of 1866 the Governor of the Bank made a public announcement before the proprietors that the Bank had conceived a duty to have been imposed on it of supporting the banking community and had accordingly lent unflinchingly during the crisis at a cost of a great reduction in its reserves. _' Bagehot took this as an acknowledgment by the Bank that it kept not merely the currency reserve (gold) of the country, but also the banking reserve, and that it should use the funds of which it was thus given command to help the banking community in time of a crisis. 2: One of the Bank Directors and a former Governor, Thomson Hankey, denied vehemently that any such responsibfli_ had been admitted. _ He regarded it as a most pernicious doctrine to expect the Bank to do what was quite inconsistent with the ordinary workings of a deposit bank, namely, to make advances when the public demanded them to an almost unlimited extent, and maintained that the banking community must be taught not to rely on the Bank coming to their aid when they had rendered their own assets unavailable. In these circumstances a banking reserve of one-third against deposits was ample. Hankey's views were defended also by G. W. NOiTflan. _'_' Bagehot replied that whether the Bank Directors approved in principle or not, the Bank had, in fact, established a guiding precedent by lending freely in previous panics (as in both 1857 and 1866), and such action had become the legitimate expectation of the money market. If the Bank Directorate wanted to repudiate this obligation, it should make an official and unequivocal announcement to that effect. '° Bagehot's "Lombard Street" really concluded controverThey fell from £5,800,000 to £1,200,000 m a week 2_See'The Economist, September 22nd, 1866. See his "Principles of Banking, Its Ufilily and Economy, with Remarks on the Working and Management of the Bank of England" (2nd Edition. 1867), pp 1-39 2_ See The Economist, December 22nd, 1866, p. 1488. 3° Ibid., December 8th, pp 1418-9.

144

THE RATIONALE OF CENTRAL BANKING

sial

discussion

on

central

banking.

session

of

perfect

if we

now

that

an

we

recognising creates, We ing in

find

the

show

that

banking to

able

have

it we

must

Goschen

make

the

chief

cross-grouped

the

and

of it by

currency

of

disputants their

most but clearly

responsibilities

hand

in

them. respect-

twenty 1890.

it

to meet

warnings

about

crisis

with

the

best

Bagehot's

Baring

not

the

the

of reserves

below

It is

beginning,

on

and in pos-

the

funds

the

banking

ourselves

from

accepting

adequate

free

find

system.

re-echoing

with

of

we

choose

weaknesses,

keeping

controversy banking

merits

was

were

inadequateness

connection

We

relative

theme

anomalous

its and

the

Its

years

later

3'

the

free-banking

standpoint

towards

controversy:

Free

Central

Parnell

Tooke

Wilson MacLeod

Bonamy Price Cairnes 3z

Courcelle-Seneuil

Coullet

Coquelin Chevalier Banking

School

Coq Garnier Mannequin Brasseur Horn

Wagner Lasker

71"Essays and Addresses Cash Reserves and Central

on Economic Questions," Stock of Gold."

1891. Essay entitled

3z See his pamphlet (1854), "An Examination into the Principles involved in the Bank Charter Act of 1844," pp. 62 ff.

"Our

of Currency

THE POST-1848 DISCUSSIONS IN ENGLAND

145 MacCulloch G. W. Norman Loyd Longfield 1t. H. Mills

Cernuschi Currency

School

Lavergne d'Eichtal Wolowski

Hubner

Tellkampf

Michaelis

Geyer Knies

Mises

Neisser

CHAPTER

XI

Discussions

in America

Prior

Foundation

to the

of the

Federal

Reserve

System

After

1875 the

which

already

cussion, ence

and to

came

the

the

Moreover,

world

the

the

banking were

practical

systems

accepted

choice

a dogma

still lacked

chapter

to examine

adoption

of s_lch

dis-

in prefer-

questioned. banking

any

very

be-

clear

un-

of the advantages, but there commercial countries of the banking

of America.

some

system

of central

a central

States

countries further

again

without

of the exact nature one among the chief United

one

never

superiority

than

of those without

of the

was

declared less

which

was

them

alternative

nothing

derstanding remained

central

had

of the

organisation:

It is the

molives

an organisation

which

by that

this

purpose

of this

led to the

country

final

in 1913.

As we have previously described, the banking structure of the United States consisted of a multitude of small independent banks, each with its business confined to a narrow area. There

were

were

National

issuing but

was

application

over

Banks

banks

under

This

in 1913

operating,

the

banking

frequently of

the

20,000

issuing not law cited

principles

banks, notes

and

under of the as an

the States

the

about

rest

National

banking.

7,000

non-noteBank

in which

example

of free 146

of which

they

of the But

Law, lay.

practical while

it

THE FEDERAL RESERVESYSTEM was

true

with

that

any

certain

that

the

were

business

at least

the

person was

two

American

open

ated,

more

banking"

Law,

specified

a peculiar

lacked banking

view

which

had

lution

of

pressly

the

manifested

National

jurisdiction

authorised

Law,

banks

had

individual in one

the

confines

tice

varied.

it; others Bank

of the had

Act

stated

that

individual

State

mostly

of the

come

to

formed

this

under

ex-

before

the

under

banking

firms of ex-

or otherwise the territory banking

the prac-

had

permitted

it. The

situation.

beof

within

concerned, south,

its

evo-

been

possibility

forbidding

alter

natural

days

and

was

of free

exclusively no

a

banking

had

In the

in the

and

of branch

of branch

legislation

nothing

a bank

allowance

States,

passed

did

banking

had

oper-

organisation

States,

State

the

banks

It is at least

by branch office of this State into

as the

Some

Secondly,

issue.

as part States.

up

of developing the big cities

elsewhere

United

in

bank

growth

in the

tending their operations yond the boundaries So far

to the

themselves

of the

to set

another.

of note central

banking

used by the banks were

"free"

American

development

Banking

the

there

between

free

monopolies.

which

and

terms,

was the

to local

all tendencies

excluded

and

possibilities banks outside

of both

banking

same

all most

system

that

the advantages proper.

Practically

the

of issue,

of divergence

so called

under

complying

a bank

in which the term of Europe. Firstly,

or less

Banking

supportable

the

points

from practically organisation, and

National

of persons

open

to all on

important

"free

approached

group

could

the more general sense writers on the continent excluded branch

or

requirements

147

National

It expressly

provisions

should

not

carry on business elsewhere than at specified in its certificate of association.

the offices in places All that the law al-

lowed

had

branches into the

was

that

should National

State

banks

which

have the right to retain Banking System.

previously them

if they

had came

14S

THE RATIONALE OF CENTRAL BANKING

The method of issuing notes against bond deposit instead of against commercial assets had shown weaknesses at a very early stage, as we have already intimated in a previous chapter. Its advantages became increasingly doubtful as time went on. The obligation to tie up capital in a particular type of asset as a condition for the issue of notes made the volume of the note issue dependent in the long run on the profitability of these assets, and besides affecting the distribution of a bank's assets had reactions also on the form of its liabilities. When note issue does not entail bond deposit, the bank has an unhindered choice in determining how much of the sight liabilities it can safely create against a given cash reserve shall be in the form of notes and how much in the form of deposit credits. Since both are payable on demand in legal tender, it would be a choice ruled by the public's preference for notes as against deposits which can be checked against, and it would be a matter of some indifference to the bank if it were suddenly called on by the public to vary the proportion between the two. But if a bank is forced as a condition of note issue to invest in State bonds, it will, if these are unprofitable, be encouraged to get out its loans as far as possible by way of deposit credits rather than by the issue of notes.' We must now examine the actual facts of the case as they presented themselves in America. State bonds, being as they 1It has sometimes been supposed, on an analogy with the English system, that by controlling the amount of note issue, control was at the same time established over the total amount of bank credit created, But the analogy was incomplete. In England, Bank of England notes formed the legal tender cash of the other banks. In the case of a National Bank the bank's own notes were not legal tender cash. It was liable to pay cash for notes equally with deposits, and it was against the two together that it bad to provide adequate cash reserves and the numerical relation between them was flexible within wide limits The danger was that the banks might overstep these limits and find themselves with a level of deposits involving a much higher demand for hand-to-hand currency than they had the means to supply.

THE

FEDERAL

RESERVE

SYSTEM

149

were in great demand as a basis for the note issue and at the same time a decreasing rather than an increasing amount on the market, generally stood at a premium. This factor, together with the provision by which a bank could only issue notes to the extent of 90 percent of the face value of the bonds it purchased, greatly reduced the profitability of locking up funds in these bonds for the purpose of obtaining notes, and where a bank could get out its loans otherwise than by notes, it naturally preferred to do so. This caused variations from district to district as well as from year to year, and tended to increase deposit credits disproportionately to the increase in the note issue. In parts of the country where people insisted on having notes, banks charged a higher rate of interest than in those parts of the country where borrowers could be induced to take deposit credits and where check payments predominated over demands for currency withdrawals in the form of notes. Looking at the long period movements in the circulation we find that between the inception of the National Banking System and 1900 they exhibit a trend which cannot but be considered as exceptional if compared with that of the note issues in other countries not working on a bond deposit basis. At the beginning of the 'eighties the Federal Government began to reduce its indebtedness by paying off its bonds; so that a scarcity of note-backing medium arose, and what there was stood at a high premium and gave a correspondingly small return. There consequently ensued a rapid reduction in the National Bank circulation outstanding, and between 1881 and 1890 there was a decrease of some 60 percent. During the whole of the period, when notes were diminishing or practically constant in volume, there was on the other hand a rapid increase of bank reserves of cash (chiefly of specie; legal tender notes remained a fairly constant element), and also a steady increase in deposits. This was quite contrary to what would be expected under an or-

150

THE RATIONALEOF CENTRAL BANKING

dinary

asset

currency,

where

inflows

from abroad or from internal increases in note issues. A great

deal

exhibited shown

of comment

by the under

note

was

issue

an ordinarv

its large agricultural mands for cash. The spond the

to these

money The

lay

explanation

as much

of the

Comptroller

do

so was

could

only

through was

in any

were

usually

keep

but

same limit one

a very

heavy

times

when

them

bv

such

lack

lent fluctuations steep rise in the The

popular

and

on

the

they were in order

expense.

once

bank

taken

to the on

hand

arose,

the

cash

reserves

pressed to meet

that

the

notes

by

going

Moreover, that out

there

might by

be re-

any

bank

It did

for periods

banks

and

could and

not

of exso,

only

paying

in

meet out

le-

to a sharp restriction their obligations. led

in interest autumn.

rates.

There

the

to

passed,

currency,

of notes

that

of ex-

incentive

full extent.

reserve

illusion

on

circulation

the

fact

had

hand-to-hand

their

note

and

of notes

proportion

demands

of any

by

Notes

for

strain

as in its lack

need

number

by that

small

drawing

gal tender, and credits all round The

the

demand

of the

arose,

the

formalities month.-'

used

need

after

on

autumnal

deto re-

and slow to negotiate the purto obtain additional notes from

diminished

be retired

the

a legal

tired

tra

further

between to seasonal in spite of

system.

inflexibility

the

inelasticity

crop-moving circulation

of contractibility

when

by

fluctuations

in response in America

the

banking

pansibility. It was expensive chase of new bonds in order the

The

in the proportion

intensified

in its lack

by the

run.

and heavy of the note

the

whether

accompanied

raised

especially no parallel

interest failure

and

are

short

system

demands

market

also

in the

note and deposit liabilities, changes in demand, found

of specie,

hoards,

securing

2 $3,000,000 up to 1908 and after that $9.000,000

to frequent was

and

every

of notes

of vio-

year by

bond

a

THE FEDERAL RESERVE SYSTEM

deposit would guarantee full had been dispelled.

15 1

that they would alwavs be paid in Later observers came, moreover, to

realise that the system was responsible for suppressing some of the natural checks to over-expansions. It made the return of notes to the issuing bank for redemption in the ordinary course of business very infrequent. The uniformity of the form of the notes of different banks, as well as the semblance of indubitable security with which they were endowed by the law, caused the public to regard the notes of one bank as being as good as those of any other. More important still was the failure of the banks reciprocally to return each other's notes. Instead of sending in the notes of its rivals for clearance, a bank usually paid them out again over its own counter. This was due, in the first place, to the trouble and expense involved in sending notes back to the redeeming agencies which, in the absence of branch banking, were few and far between, _ and in the second place, to the absence of any immediate incentive, in view of the costliness of the issue, for a bank to replace foreign notes by its own. These circumstances removed one of the tests which warns a bank when it is over-expanding by drawing on its reserves at an early stage. A series of acute financial crises occurred in fairly quick succession--1873, 1884, 1890, 1893, 1907. Crises occurred on most of these occasions in London as well, but they were nothing like as stringent. Money rates in New York rose to fantastic heights as compared with London, and there was one other even more marked dissimilarity. In America there took place in three out of the five cases (1873, 1893 and 1907) widespread suspensions of cash payments, either partial or complete, with currency at a premium over claims on banking accounts. These tendencies culminated in the crisis of "_Up to 1874 notes were redeemable at the counter of the _ssumg bank and at some bank in one of the cities designated as redempuon cities. After 1874 they were redeemable a| the bank's own counter and at the Treasury.

1_2

THE

RATIONALE

1907, when suspensions of over two months.

OF CENTRAL

lasted

BANKING

in some measure

for a period

There had been for some time a growing dissatisfaction with the fundamentals of the American system. The most obvious distinguishing feature, and the one to which attention was first directed, was of course the method of note issue, and some of the critics believed that the defect was connected solely with this system of issue against bond deposit, and that it would not be present under an ordinary asset currency. Its failings were summarised under the term "inelasticity." This is a term which has frequently had a dangerous connotation, being more often than not a cloak for the advocacy of inflation, but, as we have already explained in a previous section, there was some justification in the American case for the accusation that the note issue lacked necessary elasticity. It failed to provide for fluctuating demands for cash, firstly with seasonal, and secondly with crisis needs. It was the deficiency in supplying the latter that was given most prominence. The problem was how to provide an "emergency currency." It was observed after 1879 _that it was chiefly pressure exerted on the banks by depositors to withdraw hand-to-hand cash and not by note-holders to withdraw legal tender money that precipitated suspensions. It was contended, not unreasonably by the banks that their suspensions were the direct result aftheir being unable to issue extra notes. If they had been able to do this, they could have satisfied the demands of their depositors for cash by giving them notes, and in these circumstances the demand of customers for cash, both in the narrower sense and in the wider sense (that is, in the sense of paying out legal tender for either notes or deposits if and when demanded), could have been maintained. The demand of the public was only to change the form of The

date

when

specie

pavments

were

resumed.

THE FEDERAL RESERVE SYSTEM

ll_a

the medium--from deposits to notes: they wanted simply hand-to-hand currency and would have been as well satisfied with bank-notes as with legal tender. Reserves of legal tender could then have been kept practically intact--the additional note-holders would not have drawn on them; but as it was in the face of the inability to issue notes, the demand for cash by the depositors could only be satisfied if at all out of the reserves of legal tender, and these would soon have been exhausted. The suspension of cash payments was, according to this view, due to the lack of variability in the form of the currency (current accounts to notes)? Some attempts were made to remedy the situation along the lines of this argument. It had been suggested by the promoters of what was known as the Baltimore Plan in 1894 that the bond deposit system should be abandoned altogether in favour of an ordinary asset currency accompanied by a safety fund guarantee. This proposal was, however, never taken up very enthusiastically. In 1900 measures were introduced to make the note issue more profitable. An Act was passed to allow banks to take out notes equal in value to the full face value of the bonds they deposited instead of only to 90 percent of that value, and the tax on the note issue was reduced from 1 percent to ½ percent. After 1900, too, the Secretary of the Treasury interpreted the s The Comptroller of the Currency in his report for 1907 (pp. 73-4) remarks: "The only way in which bank credits can be properly protected from sudden and unexpected calls, when all may be involved at the same time, is by a system of note credits which can be at any time immediately exchanged for the deposit credits. They are essentially the same thing, and should be daily and hourly if necessary, convertible from one to the other at the option of the creditor who is the depositor or note-holder. The bank of issue should be required, and must in self-defence, keep the same reserves against notes as against deposits. If this is done, there is no expansion or inflation when a note is paid out to a depositor and no contraction when a note is returned to the bank for deposit. With a given amount of reserve money a given total of deposits and notes can be maintained, and it makes no difference to the bank or anyone else but the customer who uses either at his option, whether the deposit remains m the bank as a credit to be checked against or is taken away in the shape of a circulating note."

154

THE RATIONALEOF CENTRALBANKING

law

in a very

stocks

liberal

for note

way

backing

and

accepted

where

municipal

previously

and

only

ernment securities had been eligible. The object was to increase the circulation in the autumn demands

of crop

moving.

It was

intended

other

strictly

Gov-

of this step to meet the

to be

purely

a

temporary seasonal increase, but failed to serve this purpose because the circulation did not contract again after the seasonal demand for cash had fallen off, and so there was in the next

year

cash

drain

to make creasing

just

the

same

as before.

lack

of provision

In general,

these

for the

measures

up

progressive

in an

increase

emergency. in the

The

result

circulation

of 1907,

the

bond

of modification

deposit

in the

system

direction

bank currency for emergencies. Other attempts at interpreting laid

less

stress

on the

primary

explanation

structure.

One

of

more these

was

ratios. '1 So far as the possibilities concerned, the requirements probably otherwise what

the

did

not

would; banks

cause the

the legal

of their

the

had

of

of credit of minimum

incapa-

difficulties sought

to expand was

legal

reserve

less than

a good

thought

the

American

expansion reserve

banks accord

and of the

system

and

increased

of the

features

a

for the by the

proved

issues

minimum

own

1900

currency evidenced

cause

of note

in other

merely

of providing

the

question

was

between

1907 of over 90 percent, which provided inflationary boom of those years. As was ble

only

a permanent increase in the circulation without inits short period elasticity. It still left no slack ready

to be taken

events

autumnal

served

deal

were ratios they below

fit to keep

in

_1Up to 1874 National Banks m New York had to hold in lawful money in their own vaults 25 percent of deposits plus circulation. Banks in other cities designated "redemption" cities or "reserve" cities as they were later called, must also hold 25 percent, but half of this might be held on deposit in New York All other hanks had to keep 15 percent, of which three-fifths might be on deposit with approved banks in an3, of the "reserve" cities. After 1874 this legal reserve requirement was revised to apply to deposits only and not to note c_rculation as well After 1887 Chicago and St. Louis were given the position of "central reserve" clt_es_the same as New York

THE

FEDERAL

RESERVE

SYSTEM

1_5

normal times. But immediately the sort of event occurred tor the very purpose of which such reserves should be kept, namely, an extra heavy demand for cash, the banks could only use their reserves to a very small extent before thev approached the legal minimum. If they were not to be allowed to fall below the legal minimum, there was very little slack for taking up in times of pressure. So if deposits were being withdrawn rather more rapidly than usual, the situation could only be met by immediately calling in loans, thus cancelling some deposits and thereby diminishing the total amount of necessary reserve money. Such a procedure forces as much liquidation as if the banks were without cash reserves, and if the process is at all general, affecting a large number of banks, the liquidity of the individual bank is lost in the liquidity of the whole system. The banks were faced with these alternatives: either they could suspend cash payments immediately, or they could use their cash reserves as far as possible to meet current demands in the hope of stemming the demand for cash and rendering such a suspension unnecessary. Under the American law a bank falling below its legal reserve requirements was obliged to discontinue lending operations until the deficit had been made good. This enforced on the banks endeavouring to maintain cash payments in the crisis a policy of immediate loan contraction. Given the choice, then, between falling below legal reserve requirements and suspending payments immediately, it was a much easier way out for the banks to choose the latter course. Such a procedure stopped the claims of depositors and made it possible for the banks to give their debtor customers time to repay their loans and even to give new loans so far as people were still willing to take payment in uncashable checks, or (in the case where payments were still made on a certain percentage of deposits) in partly cashable checks. The banks might find that this policy promised more likelihood of their cus-

156

THE

RATIONALE

OF CENTRAL

BANKING

tomers being able to pay back their loans in the end than if they immediately caused them to go into liquidation. At all events, the banks seemed to have suspended payments immediately as they approached the legal reserve limit, which means while they were still in a very strong reserve position. The figures of the reserve positions, given in the Annual Reports of the Comptroller of the Currency, are averages for all the banks in each State or Reserve City, and so cover up the individual movements, but it seems fairly certain that the banks did not in many cases allow their reserves ratios to go below the legal limit to any significant extent. The action of the banks in suspending payments was technically, of course, an act of insolvency, but this was given official sanction in a number of ways and a long tradition of wholesale suspensions both before and after the inception of the National Banking System had accustomed the public to their legality. The Comptroller allowed the banks to restrict payments for a period of several months on end and then permitted them to resume business as long as he considered their assets were "sound." This happened in some cases even after a bank had been put into the hands of a receiver in bankruptcy.: The circumstances in which the banks resorted to suspensions lent a good deal of support to the view that it was primarily an elastic reserve policy rather than an elastic currency that was in urgent need? A third line_ of argument laid emphasis on the necessity for some rearrangement in the existing system of holding and utilising reserve funds. At a very early stage the practice had developed among the country banks of depositing balances, which they counted as equivalent to cash, with banks in the large cities. They kept on an average about half of their total reserves on redeposit in this way and about half

7 E.g., E.g.,

see see

"Report Sprague,

of the Comptroller "Banking Reform,"

of the Currency," 1910, p. 68.

1891-2,

p. 36.

THE

in their

own

"reserve" designated,

RESERVE

banks

officially

SYSTEM

in

reserve"

as bankers'

"redemption"

cities,

recognised

banks

by

157

cities

as they as being

the

National

or

were

later

in a special Banking

Law.

conspicuous position held by the banks of New York in this respect--in 1912 six or seven of them held be-

tween

them

about

ances-seemed tendencies and

three-quarters

to point to the

the

country

since

banks

been 1857

of

with

with the banks of these banks an unhealthy

the

city

of reserves

a quasi-central

the

complaint

in

more

loan

market

by

the

particularly by a number deposits, gave

on the with

un-

financial

of re-deposit and

to speculation

call

banking

as exceedingly

practice banks,

bal-

of spontaneous

in New York City, encouraged who paid interest on demand stimulus

flooding

the

bankers'

centralisation

a frequent

that

the

existence

and

development

It had

ever

the

if one is not superimposed. as it stood was regarded

satisfactory. circles

to

of all

pyramiding

natural

agency, even The position

by

_ The

"central

were

category The city

vaults.

and

FEDERAL

Stock

cheap

Exchange

accommoda-

tion. It was, what is more important, nearly always mands for withdrawals of these bankers' balances

the deby their

country

financial

owners

system The

of the the and

nancial of branch the level tainly The 9 See

of the

town banks, the extreme

structure,

unimportant

crises

in the

if there

it more

debtor

position

of one

group

of

to the other group, the country instability of this element in the fi-

is one

which

had

organisation of the amount

made

precipitated

country.

development

banks, banks,

branch

which

would

been

branch

probably banking.

have The

been

absence

may have tended somewhat to raise of call loan money, and it most cer-

unstable

than

it would

have

been

with

organisation. difficulties Laughlin,

of a unit

"Banking

Reform,"

bank pp.

as compared 199

ff.

with

a branch

15S

THE

RATIONALE

OF CENTRAL

BANKING

system in diversifying risks both in its assets as well as in its deposit liabilities was partly compensatable bv the possibility open to the country banks of putting funds on deposit with a town bank and so indirectly taking advantage of the opportunities for investment offered by the money market. The country banks regarded these deposits as their second line of defence--as part of their liquid funds which they would be able to withdraw immediately the demands _br cash from their customers increased, as happened regularly in the crop-moving season, and they were given official recognition as such by the provision of the National Bank Act, which allowed such deposits to be counted by the country banks as a certain portion of their legal reserves. It is not denied that under a branch system funds from the countrv would still find their way to the call loan market via the head office or town branches of the parent bank, but the much more restricted range of alternative investments available to one bank in a unit system probably caused rather more to seek this particular outlet. The unit system with the practice of re-deposit showed great susceptibility to the spread of panic both in the case where the originating disturbance started in the affairs of a country bank, and in the case where it arose at the city bank end. Firstly, a country bank in a unit system is less able to obtain funds from outside when it is under pressure. It may, it is true, be able to borrow from another bank, but this is more difficult and takes longer to negotiate than a transfer of funds from the cash reserves of other branches of the same bank, and it is the ability to obtain funds in time that is im+ portant in order to stop the loss of confidence among the public which leads to a panic run liable to spread to other banks as well. A single weak spot in the system is less likely to affect the whole system under branch organisation than under unit organisation. Secondly, the call loan position in New York was rendered

THE FEDERAL RESERVE SYSTEM

l_a

exceedingly vulnerable in the event of extra heavy demands for withdrawals, and especially in the circumstances associated with the break of a boom when call loans proved to be among the most illiquid of assets. Experience taught the country banks that their correspondents in New York found it difficult to cash their deposits in such a situation. Consequently, immediately the slightest indication of defect occurred, there was a scramble by the country banks to withdraw their balances en bloc from New York. The ibar that they would in a few days' time find their balances frozen led them to withdraw them immediately, whether they were actually in need of cash themselves or not. Those banks who got their balances out in time were often found on such occasions to have far larger reserves of cash in vaults than at periods of less acute demand from the public. The New York banks were driven to suspend payment, and those country banks who had not withdrawn their funds in time had to suspend also. The difference in a branch system would be, not that there would not still occur a flow of funds from the interior of New York, but that the greater part of these funds would be disposed of bv the town branches or head offices of the banks remitting them, and each bank would retain direct control over its own reserves.'" And in a period of pressure, branches would not attempt to withdraw all the spare funds from their head office, regardless of whether they needed them or not. There would be a concentration of funds on points where they were needed most to satisfy the demands of customers and stop a run. It was realised in some quarters that many of the difficulties could have been remedied by the institution of branch '_ It is not likely that banks would deposit with each other except m so lar as it might be necessary for one bank to keep balances in a place where it had no branch for making payments in that place. The amount of such balances would normally be small

160

THE RATIONALEOF CENrFRALBANKING

banking litical

along

Canadian

impossibility,

practical expedient more economical general rely secure

this

nature

had

of the

regarded

turned

as a po-

to the

more

and

Some

already

system.

apparent

independent end.

was

was

existing

increasingly

on the

but this

so attention

of finding some systematic means of the utilisation of reserves in a crisis within the

framework

It seemed

lines,

and

attempts

been

that

unaided

it was efforts

impossible of the

of a somewhat

made

by

them.

to

banks

to

unsystematic

One

of these

was

the use practice

of the which

clearing-house loan certificate." had been started by the banks

This was a of New York

and

banks

of Boston

of the

the

belonging

to the

Clearing

agreement

under

which,

ing balance, it should, bank, deposit collateral against

which

certificates The

scheme was able clearing

lending

(with

agreement

by the

and

New

York

banks

for treating

the

specie

holdof

the

(with favourto those in a bank

baltrying

to

of the others, because bank could extend its

induced

to other

of the public for cash that the clearing-house

by the

bank

clearing-house each

expense no

all were

varving

essence

position loans

to prevent

reserves

bank.

rate,

creditor The

loan

creditor

high

to the owed.

an

clear-

clearing-house

unfavourable

intended

of losing

the demand first occasion

issue

went

balances

into

an adverse

cash to the creditor House Association,

at a fairly

which

banks

entered

had

in payment

interest

of

operations

used

should

its.position at the such an arrangement,

fear

Association a bank

that the banks in a strong balances) should make

It was

strengthen without of the

lieu

position

ances).

was

bore

in

A majority

instead of paying with the Clearing

latter

5 to 10 percent, them

weaker

House when

to be received

certificates

from ing

the

in 1860.

to contract banks

was increasing. loan certificate

it was reserves

because

at a time

when On the device

accompanied of all banks

by an as a

_ cf. sprague. "Crises under the National Banking System" (U.S.A. National Monetary Commission).

THE

FEDERAL

RESERVE

SYSTEM

161

common fund so that the banks having to bear the greatest strain not from other banks, but from the claims of the public, should be able to draw on the reserves of banks less subject to such strain. This pooling of reserves, or "reserve equalisation" as it was called, meant that it was quite impossible for a bank to affect its individual reserve position by contracting its loans. In the 1860 crisis the banks in both Boston and New York succeeded in maintaining cash payments with the aid of the loan certificate. In the 1873 crisis the device was used again, this time by the clearing-house associations in no less than seven of the principal cities. It did not succeed in averting entirely a suspension of cash payments, but the suspension lasted the comparatively short period of less than three weeks. In subsequent crises the clearing-house loan certificates were used by the associations in nearly all the leading cities, but without the equalisation of reserves. The banks could not reach agreement to pool their reserves in these later crises. Those of 1884 and 1890 were, however, slight, and the banks did not suspend, but in 1893 and 1907 the use of clearing-house loan certificates, without the equalisation of reserves, itself led almost immediately to suspension. The issue of certificates without the equalisation of reserves proved fatal to individual banks. A bank which received a large number of checks drawn on other banks from customers who wanted to withdraw cash, experienced heavy drains on their reserves. At the same time they might have favourable clearing-house balances with other banks (those on which the checks were drawn) but be unable to obtain any cash from these banks on account of the clearinghouse arrangement, while these other banks might be exceptionally strong in cash reserves because customers did not happen to be drawing directly on them for cash. The banks which were subjected to the heavy demand for cash

162

THE

RATIONALE

OF CENTRAL

BANKING

by the public, or the tried to sidetrack this

country banks, as the case might be, effect of the clearing-house agreement

by

encouraging

customers

rect

to the

handing

into

This

was,

measure;

the run

loan on Both

their

they

own

certificates

had

for

adversely

that

there

device

should

gave

be

settlement

force

by

payment;

to the

somewhere

an

of

in the a cer-

the this

also. of the

di-

instead

to do beyond

affected

to suspend

for cash

drawn

impossible

others and they suspended successes and the failures

certificate

checks

were

banks

however, banks

loan

issue

of

started

a

clearing-house

conclusion,

adequate

firstly, reserve

of

power for use in the crisis, and, secondly, that this be available ior the collective benefit of all banks.

Fharther, provided

the by

operations that

to take

which

the

the the

lending should

on

them

clearings. tain

their banks

idea was gaining ground that it could an organisation in some man_aer aloof

of ordinary

was

in normal

Some

such

commercial times

sort

not

of relief

banks.

fully

during

"lent

up."

a crisis

had

by the Treasury. that the Treasury

The principle had been should be independent

is, that

keep

it should

positing

them

with

the

It must

only be from the be a bank

been

provided

established in 1846 of the banks, that

its own

surplus

funds

banks.

It was

objected

instead

of de-

that

this

had

an inconvenient effect on the money market if collections exceeded disbursements for any length of time, because in that case it_ Caused sudden withdrawals and returns of funds from and to the market; and from the time of the Civil War onwards

the

preserved. National times make early 1-,See

Independent

The

Treasury

Banks

and

Treasury began

adopted

System

depositing

the

practice

was

not

funds

strictly

in selected

of giving

relief

in

of crisis. The methods of using its funds in a way to the money market more liquid were various. '_' As as 1857,

even

U S. National

before

Monetary

the

National

Commission--"The

Banking Independent

System

had

Treasury."

THE

come

into

bonds.

being,

In

it had

1873

$5,000,000

it

banks.

the

debt.

public

the

In 1884 In 1890

amount

it had

deposited

most

SYSTEM

the

163

market

bought

proceeds

by

bonds

it prepaid

also

it put

some

prepaid

purchasing

and

of which

it again

bonds. In 1893 the Treasury it actually had a deficit and banks. In 1907 it transferred the

RESERVE

helped

again

of gold,

in certain

FEDERAL

on

of the

sold deposit

interest

interest

and

on

bought

was unable to give any aid at all; needed to borrow itself from the some funds to the banks, but

on hand

was

of its surplus

small,

with

since

them

it had

before

already

the

crisis.

The Treasury had thus been undertaking some of the functions of a central bank by carrying out what was equivalent to open

market

operations

(purchases

of securities)

and

by

lending directly to the banks. The rather fortuitous nature of this kind of relief led bank reformers to demand a more "scientific" the the

mode

of relief

in crises.

Treasury happened crisis came. There

body

of opinion

grounds

that

which

it gave

to receive

assistance

expanded

on the

It became reform that

denounced

an impetus if they

basis

also part it should

It was

only

a lucky

chance

if

to have surpluses at the time when was, on the other hand, a considerable the

got into

of these

Treasury

to expansion.

relief

expected

and

therefore

difficulties,

anticipations.

of the positive programme provide for an institution

act as the Government's ences during the course

on the

Banks

for banking which could

fiscal agent. '3 The Treasury experiof the previous century, both of the

system of keeping its own funds and of the system of depositing them with various State or National Banks at the risk of not being able to obtain them in the event these banks, had directed attention towards

of the failure of the possibility

of finding

free

from

countries

the

tions services

some

of both were

13 Cf. Parker

depositary

these

systems.

performed Willis,

"The

Federal

which

was

In other by the Reserve

Central System,"

the

objec-

necessary

Bank. Book

I., Chapter

2.

164

THE RATIONALEOF CENTRALBANKING

One

other

formers tion.

feature

hoped

The

American was

of the

banks

majority

of making

of the

to remedy

a charge

the

system

which

cost

of check

high

in America

known

as the

were

the

in the

"exchange"

actually expense room

bank had either to shift in a distant centre. What

able to charge involved, but in the

old

was there

system

probably is little

It was the

the

crisis

growing

a difference the

or

there

was

of note with

some kind the purpose ing.

the

a strong

to the sisted

the

1907

crisis

that

a purely

gave the

legal

reserve

regulations.

could bank

there of real

given

in the

impetus

fault On

still

lay with organis-

the

whole,

introduction

of existing for panic to the

to

was

of branch

of the

organisation reserve funds was

final

chief

real was

necessary

but there

lack

in favour

the

the

reform, the

support

introduction

reduction

or with

majority

or to were

above the that there

reducing

as to whether

the necessary changes tablishment of a central after

much doubt

issue

of co-operative of providing

Authoritative

which

for banking

of opinion

system

ation

of 1907

agitation

for

to cover a distant

currency the banks

for a considerable

real cost of check collection by amount of transmission of funds."

habit

charge

paying their own checks. This charge purported the cost of providing funds to pay the check in place because the maintain a balance

re-

collec-

of

banks for financier-

suggestion

that

best be made through the esof issue and reserve. '_ But even

was

still a good

central

emergency

deal

banking, organisation

and

of opposition the for

idea

per-

"relief"

_4It was part of the services of the Federal Reserve System to secure the payment of checks at par The twelve Federal Reserve Banks and their branches hold the reserves of the member hanks, and these act as clearing balances Checks can be presented at the nearest Federal Reserve Bank, and if the check is drawn on a bank which is a member ol the same Federal Reserve district, funds are already available. Where checks move out of the district, the Federal Reserve Bank pays the cost of any necessal\v currency shipments The system also exerts pressure on non-member banks because l_deral Reserve Banks will not collect checks on banks which refuse to clear at par. _ See "Report of the Comptroller of the Currency," 1907, pp. 71-79.

THE FEDERAL

would

meet

the

case.

This

RESERVE

was

SYSTEM

the

attitude

165

behind

the

Aldrich-Vreeland Act of 1908, which provided for the issue of emergency currency against securities other than United States Bonds and adopted commercial bills as a basis for note issue for the first time. The Act authorised banks to form voluntary associations under the arrangement that a bank belonging to such an association could deposit with it any securities (including commercial bills) against which it might receive additional notes. All the banks belonging to the association were then jointly and severally liable ibr the redemption of the additional circulation. National Banks were also given the option of applying rency for additional notes United States Bonds.

to the Comptroller secured by assets

of the Curother than

The same Act set up the National Monetary Commission to report on banking reform. The Commission sat tbur years and carried out investigations, not only into the details of the American system, but also into the experiences and practices of European countries with central banks. The fact that these countries had escaped general suspensions of cash payments was attributed to the strength of the central institutions, the concentration and mobilisation of reserves and the prompt use of these reserves in a crisis. Stress was, moreover, placed on the part played by these central banks of issue in regulating the money market via the discount svstern. TM The influence of the publications of the Commission was to turn the thvour of the reformers towards a permanent central organisation which should issue a currency based on gold and commercial paper, act as a lender of last resort and control the credit situation through the bank rate and open market dealings. z6See, for example, "The Discount System in Europe," by Paul M. _Varburg {U.S. Monetary Commissiont See also "Intervmws on the Banking and Currency Systems of England, Scotland, France, Germany, Switzerland and Italy" (U.S Monetary Commission)

IOO

THE

The ation

final

RATIONALE

outcome

of the

of the

Federal

considerably

from

twelve

regional

which

those

OF CENTRAL

recommendations

Reserve the

banks

System.

European

Federal

Reserve

who

guidance

the

tasks

member

of the of

Its organisation

banks

and

as

rediscounting. A retrospective

consideration

cumstances

foundation

would

of the

seem

to suggest

that

of

in the

ownership

of

members

per

se that was

was

admittedly

reserves

in principle, than not the root

a partial

devolved of

the

to them

by

and

cir-

Reserve

perhaps

at the

system--

background

Federal

could,

naturally remedied otherwise of a central bank; that it was this

there

the

many,

more ment

bank

Board, agency

of the of the

of American

although

of the

on all National Banks-capital. On these, under

lending

fects

tral

banking

differed

Banks

keeping

acting

cre-

it consisted

Reserve

notes,

the

bank:

became

Federal

issuing

was

central

and membership was compulsory took a share by contributing to their the

BANKING

most,

of the

of the have

by the absence

remedy

System

evil,

debeen

establishof a cenand

that,

for things

for

which other remedies were politically or technically impossible of realisation, there remained certain fundamental defects

which

overcome

could by the

not Federal

be entirely, Reserve

or in any System.

great

measure,

CHAPTER

The

XII

Arguments

in Favour Central

of

Banking

Reconsidered

It

has

been

the

purpose

of the

preceding

chapters

to eluci-

date the reasons, historical as well as logical, for the growth of the form of bank organisation which we now call central banking.

Its

origin

is to be

monopolies,

either

Monopolies

in this

tionism

in other

partial

or

sphere

branches

found

in

complete,

outlasted of economic

they

Looking

had at the

established,

we

not previously that

the

activity.

growth new

note

abolition

of issue.

of protecThose

of free creations

which

trade dococcurred

existed.

circumstances find

establishment in

the

had been in existence prior to the trine were retained and reinforced: where

the

in which

the

early

most

ones

of them

were

were

founded

for

political reasons connected with the exigencies of State finance, and no economic reason for allowing or disallowing free

entry

been

given

into

the

at that

note-issuing time,

but

trade once

lies persisted right up to and beyond economic justification did at last come verdict

of the

choice

in favour

opposed

discussions of unity

to competition,

round

this

problem

thereafter

167

or

could the

in the the

have

monopo-

the time when to be questioned.

or monopoly and

was,

established,

their The

vindicated note

issue

superiority

the as of

16a

THERATIONALE OF"CENTRALBANKING

central banking over the alternative system became a dogma which never again came up for discussion and was accepted without question or comment in all the later foundations of central banks. In this chapter we shall recall and examine the main points in the defence of central banking against its logical alternative in an attempt to weigh up the evidence and to judge whether or not it is conclusive. It may be useful first to recapitulate the broad differences in the characteristics of the two alternative systems. The primary definition of central banking is a banking system in which a single bank has either a complete or a residuary monopoly in the note issue. A residuary monopoly denotes a case where there are a number of note issuers, but all of these except one are working under narrow limitations, and this one authority is responsible for the bulk of the circulation, and is the sole bank possessing that measure of elasticity in its note issue which gives it the power to exercise control over the total amount of currency and credit available. It was out of monopolies in the note issue that were derived the secondary functions and characteristics of our modern central banks. The guardianship of the bulk of the gold reserves of" the banking system is obviously an accompaniment of the monopoly in the note issue: the holding of a large proportion of the bankers' cash reserves is also bound up with the same factor--it is a matter of convenience for the banks to keep their surplus balances at the central bank but it is safe for them to entrust a major part of their cash reserves to a single outside establishment only if they can be absolutely certain that this authority will be able in all circumstances to pay out such reserves in a medium which will be always acceptable to the public. This can only be guaranteed if the notes of this authority can be given forced currency in time of need. Last, but not least, control over the note issue gives the central bank power to exercise control

CENTRAL BANKING RECONSIDERED

169

over the general credit situation. These considerations justi_ us in using the term "central banking" to cover the narrower as well as the wider concept. A central bank is not a natural product of banking development. It is imposed from outside or comes into being as the result of Government favours. This factor is responsible for marked effects on the whole currency and credit structure which brings it into sharp contrast with what would happen under a system of free banking from which Government protection was absent. "Free banking'" denotes a regime where note-issuing banks are allowed to set up in the same way as any other type of business enterprise, so long as they comply with the general company law. The requirement tbr their establishment is not special conditional authorisation from a Government authority, but the ability to raise sufficient capital, and public confidence, to gain acceptance for their notes and ensure the profitability of the undertaking. Under such a system all banks would not only be allowed the same rights, but would also be subjected to the same responsibilities as other business enterprises. If they failed to meet their obligations they would be declared bankrupt and put into liquidation, and their assets used to meet the claims of their creditors, in which case the shareholders would lose the whole or part of their would be paid, at least ble for the policy of the would be "promises to met on demand in the

capital, and the penalty for failure for the most part, by those responsibank. Notes issued under this system pay," and such obligations must be generally accepted medium which

It must be understood that the use of the term "free banking" in the subsequent analysis is not synonymous with that particular system of so-called free banking which was put into practice m the United States ot Ameraca m the middle of last century. As was pointed out m the previous chapter, the American system was characterised by certain features which render it quite inappropriate as an example of the working of free banking m lhe more general sense

170

THE RATIONALE OF CENTRAL BANKING

we will assume to be gold. No bank would have the right to call on the Government or on any other institution for special help in time of need. No bank would be able to give its notes forced currency by declaring them to be legal tender for all payments, and it is unlikely that the public would accept inconvertible notes of any such bank except at a discount varying with the prospect of their again becoming convertible. A general abandonment of the gold standard is inconceivable under these conditions, and with a strict interpretation of the bankruptcy laws any bank suspending payments would at once be put into the hands of a receiver. A central bank, on the other hand, being founded with the aid either direct or indirect of the Government, is able to fall back on the Government for protection from the disagreeable consequences of its acts. The central bank, which cannot meet its obligations, is allowed to suspend payment and to go off the gold standard, while its notes are given forced currency. The history of central banks is full of such legalised bankruptcies? In the natural development of a free-banking system there is no apparent reason why a single bank should acquire a position of hegemony in which the bulk of the gold and cash reserves of the banking community were concentrated in its hands. The dictum of Bagehot, that a centralised reserve system is entirely unnatural and that the natural system would be one where each bank kept its own reserves in its own vaults, has been challenged by reference to the position of New York as a reserve centre prior to 1913. We cannot doubt the tendencies to a concentration of balances on a considerable

scale

in financial

centres,

and

under

a unit

banking system the out-of-town banks will carry deposits with the banks in such a centre. The extent of this holding of balances by some banks for the account of others would be Cf. W. Scharling,

"Bankpolitik,"

pp. 337-8.

CENTRAL BANKINGRECONSIDERED much

smaller,

own

however,

branches

where

finds

it convenient

then

generally

city, where management.

were they

to keep

be they

held

the

bank's under

system each bank issue, or of its total

close

its reserve

watch

on

to have

balances

financial

remain

In a multiple ume of its note that the standing

allowed

The

in the

by

would

banks

chose.

171

that centre,

own

would

branch

its own

in that

control

must determine demand liabilities,

position,

and

their a bank

and

the volwith a

it is to be expected

total volume of credit a bank could safely leave outwould be very sensitive to changes in its reserve

position.

The

reserve

central

bank

proportion

can,

on the

to undergo

large

other

hand,

changes

allow

its

on

ac-

partly

count of the concentration of reserves and partly on the expectation that it will be released from its obligations, if it finds itself in difficulties. 3 We

can

now

issue

between

who

defended

nected

turn those

to the who

analysis

it. Historically

predominantly

with

credit which were the central banking

of the

attacked

sponsored case was

free

major

banking

points and

the

free-banking

case

those

theories

of currency

by the likewise,

at

those

was

conand

banking school, and but perhaps a little

less closely, linked up with the theories school. It was not true in all instances that

of the currency a member of the

free-banking school supported the one and a member of the central banking school the other, but because this was true in the was

majority claimed

of cases,

the

as a victory

success

for the

of the central

currency banking

school school

as

well. Actually the second controversy could be judged independently of the first and should be regarded as distinct. We shall not deal here in detail with the contents of the rival theses are

in the

fairly

banking

familiar

versus

ground.

currency

It will

"_cf. footnote 32 on p. 194 of this chapter

suffice

controversy, to remark

which how

far

172

THE

the link weighted

with the

banking

RATIONALE

OF CENTRAL

the banking evidence in

versus the free

BANKING

currency banking

controversy versus central

controversy.

The

circumstance

in France,

that

placed

argument

the

free-banking

so much

which

sprang

emphasis from

school, on

the

that

theories

especially

part

of their

of the

banking

school, tended, it is true, to cast suspicion on the free-banking case. A not inconsiderable number of the free bankers denied that

the

were

recalled over-issue only

quantity

of money,

to the

"needs

is maintained.

as notes

are

issued

in repayment be no

banks are The demand

of loans

demand

ation

of credit

mercial

by way

dealings,

particular issue. If the of exchange,

falling

from there

of bills

of lending

banks they

their

contention

continu-

"bankmassige") for loans, and

and will

issued

on

short-term

of exchange

for which

takes

there

had

an

automatic

be

It was also a on the cre-

in ordinary

to place

com-

a limit

place

on

that

via the

note

with which they discount changing the form of the

bills lend-

loan,

the

become only temporarily part of the was held to constitute a vital distinction which

as

they there-

consequently

ing. Since the bills would have existed in any case, the made no net addition to the total volume of credit. Notes

that

(or so long

the circulation. is no restriction

which

issue notes are merely

loan

due they

it is inconsistent

mode

be

to limits imposed by the profthe issue be found to be in notes will come back to the

for renewal;

automatically withdrawn prevalent idea that since

and

It was

fore for notes, will be confined itability of borrowing. Should excess of the needs of trade,

will

ideas

It may

of trade"

on short-term

the assets of note-issuing cannot be issued in excess.

bank

promoted

character.

to this school no such thing as an can take place so long as they are

in response

ous convertibility

and

inflationary

that according of bank-notes

issued

so long

theory

of an obtrusively

reflux

and

argument circulation, between "pure

paper

banks

continues, and this bank-notes money"

CENTRAL

BANKING

RECONSIDERED

! 73

which, instead of being paid out by way of short-term loan, was permanently released in payment for goods and services. Real paper money made a permanent addition to the amount of the circulation, and neither was its quantity controlled by the needs of trade. It therefore exerted a marked and lasting influence on prices. In the case of bank-notes, the flowback after the expiry of the term of the loan served also a second purpose by providing saibguards ibr the maintenance of continuous convertibility, since at the time of such repayments either the note issue was decreased or the gold reserves were increased. It has been pointed out, in criticism of this doctrine, that it failed to perceive that borrowing on bills of exchange or on any other security will not be a given quantity fixed independently of bank policy, but will be a function of the rate of interest charged, and can be expanded indefinitely, provided the banks offer a low enough rate. Secondly, if the banking school argued that the principle of "bankmassige Deckung" provided against all dangerous contingencies, such as a threat to reserves and therefore to convertibility, simply because notes were always only temporarily issued and could be withdrawn at short notice, they ignored the truth that an over-issue even for so short a period as the normal echeance of bills of exchange cannot (if it is general to a majority of banks in the case of a free-banking system, and without qualification in a unitary banking system) be suddenly rectified without causing all those effects characteristic of a credit contraction which are to be regarded as the evil aftermath of any over-issue. A net reduction of loans cannot take place without causing disturbances both in the financial and in the industrial structure. One bank can only make heavy reductions without causing widespread liquidations and losses in the system if another bank will lend to fill the gap. It is a matter of shifting, and the whole system cannot shift at the same time. The mere fact that the banks'

| 174

THE

loans are on short

RATIONALE

OF CENTRAL

term does not mean

BANKING

that a credit

[ !

contrac-

tion can take place in the nick of time without causing just those disturbances which the currency school aimed at preventing. There remains, however, one point connected with the principle of "bankmhssige Deckung" and the automatic reflux of notes which might have a certain validity in a freebanking system which it could not have in a centralised system of note issue. This point relates to the possibility of the mutual control between banks operating as a check on overissue. In a multiple system of issue the notes of any individual bank will be continually flowing into other banks and cleared. Now the shorter the period for which loans are made, the more frequent will be the repayment of outstanding loans; and the larger the proportion of total loans outstanding that are coming forward for repayment each day, the larger will be the proportion of the outstanding note issue coming into the banks on any day. If we suppose that one bank starts to expand while other banks maintain only the same issues as before, the flow of adverse claims required to be met in gold by the former through the clearings will be affected by the shorter or longer length of the term for which loans are made. How far this mechanism can be effective as a break on over-issues we shall discuss in a later section of this chapter? The currency school intended to make the total circulation vary with outflows and inflows of gold in the supposed manner of purely metallic currency. They thought that this end could be accomplished by fixing the fiduciary note issue. Their error was to have ignored the fundamental similarity of deposit credits to the issue of notes. This error would not have been crucial in so far as it concerned only the deposit credit creating facilities of the commercial 4 See

p. 179

ft.

! I

CENTRAL

BANKING

RECONSIDERED

banks. _ In so far as these banks between their cash reserves and total

volume

gold

movements

ple

of

banks would the

of credit

such

be made

(its changes movements),

are made to move require the fixing,

Bank

of England

of its notes the

can

Bank

but

fairly constant ratios deposit liabilities, the

to move

will

be a fairly

provided

the

in response constant

reserves

of the

quantity

plus can

vary

of gold

its lending

movements,

eration within

to affect its own reserve limits that are of course

of the

Government

and

emergency. There were

mistakes

both

and

schools,

as

seems actual

not to be such results secured

sential

to impose

amount

of the

that

only

the

some

into

banking

was

regard

to the

definite

they

such note

rule

out

regulation

and was

in

op-

case

limitation

that

of there

between that it was

those

of

doctrines

in practice

as a fixed

issue,

banking

that two

who

on

the esthe

believed

notes

should

be

solely

logically, in so far as the disagreeparties free banking and central on the

versus

positions

currency

for presumption

or the other. It is, furthermore, true dent arguments in the free-banking

from banks

Act

in the

worked

the

It can do this the willingness

Bank

omissions

the

specie.

based ground

allowing

a great deal of difference by those who insisted

fiduciary

We may conclude ment between the

no

and

necessary

convertible

merely

the

As it is,

so alter

of the commerof those banks,

"proportion." widened by

to abrogate

by gold,

liabilities.

volume of deposits on its books to the credit cial banks, and therefore the cash reserves independently

But this issue of

not covered

its deposit

to multi-

of these

in the same way as gold. not of the fiduciary note

in circulation of England

keep their

| 75

they

took

controversy, in favour that,

up with there

of either

given the case which

There seems to be no generally recognised term to distinguish the central bank. We shall here use the term "commercial" other than the central bank.

is one

indepenwe are other banks to describe all

176

THE

about

to examine,

rency which

school, there

credit,

are

The

it was

the

in this

decisive

case

can

troduced

OF CENTRAL

perfectly

consistent

free-banking

arguments,

case.

and

Both

either

side

of the

free

those,

the

curin of

Michaelis

are

additional

of these

and

which

runs

in the

under

a multiple

versus

which in-

independent

of,

central

terms. system

banking

con-

been raised in defence of the other can be

argument

following banking

on arguments

the banking and currency turn our attention to the major

banking

is an

the

to, and

troversy proper. The points that have of the one system or in condemnation dealt with under five heads. first

therefore,

discussed,

the points at issue between schools. We shall, therefore,

The

for

to find a system in the volume

position.

be exclusively

by

arguments

BANKING

in so far as their aim was were checks on fluctuations

to sponsor

Mises the

RATIONALE

against

free

It is always that

even

banking,

to be expected

if the

general

sta-

bility of the whole system is assured, individual banks from time to time,

there will be failures of just as there occur bank-

ruptcies

industries.

any

among

bank

enabled

the

do not

firms

stay

to borrow

in other

in the

from

that

efit from its note issue. They third parties who have no bank concerned. sion of the notes will suffer

the

notes

person tairs

would

munity the notes, and communitv

who bank

proportion

people

therefore

which

reject bank.

because

In other

a more

of

who

are ben-

away into the hands of connection with the happen to be in possesat the time of its failure

of such

informed

of suspicion words,

notes

directly

notes

is likely

of those who are either too ignorant, subordinate position, unable, to refuse

of a bank

of that

of those and

are paid immediate

Those people of the failed

loss. A large

in the hands son of their

hands bank

The

there

to be

or by reato accept

or better-placed attaching

is placed

to the

af-

on the com-

burden of discriminating between good and bad it falls especially hard on those sections of the who are least able to bear it. It is, therefore, con-

CENTRAL

BANKING

RECONSIDERED

177

eluded that the Government should intervene and protect the note-holder by introducing some uniformity into the note issue. In the last analysis this is an argument fbr spreading the risk evenly among all note-holders. Whether or not we accept it is not dependent on economic analysis, and it is a question which we cannot decide on scientific grounds. We can but call attention to the suggestion of the Dee bankers that the spreading of the risk could only be done at the expense of increasing the losses all round. The second point and the one to which most attention has usually been devoted is the question of the relative probability of inflations of the currency leading up to the phenomena of crises and depressions. The central banking school supposed that under a Dee-banking system fluctuations in the volume of money and therefore in economic activity in general would be much more violent than in a system where there was a single note issuer. In a free-banking system competition among the banks would provoke a constant tendency to the lowering of discount rates and increases in the volume of credit. It would be followed eventually by an external drain of gold, but this was a check which operated too late, because by the time the drain began to affect the banks' reserves the seeds of the depression had already been sown, and the crisis would only be made more intense by the sudden contraction of lending forced on the banks by the urge to protect their reserves. It was further argued that any tendency to expansion would become cumulative, because it was useless for some banks, who might be more acutely conscious of the difficulties that would arise in the event of an expansion and the resulting pressure on reserves, to hold off from expanding. They could not hope for escape from the strain by pursuing a conservative policy while others were inflating. The reasoning on which this conclusion was based is the following. When the public starts to demand gold for export, they will

17S

THE RATIONALEOF CENTRAL BANKING

not select

the

notes

payment.

They

of the

will

guilty

send

banks

in any

hands, and the proportions ent banks will be returned

and

notes

present

that

in which the will roughly

come

part of the pressure resulting bank. Should a non-expanding

the expanding bank and taking business

latter

are

finally

tains more

a de facto conservative

driven

out

their differto the

banks banks

bear have

as a result its lending.

of the If this

of business

and

the

former

ob-

the banks with the or not, they could

not help losing reserves, and if they did not expand, would lose business. Consequently, the argument runs,

The result ous

flaw

contraction

flow

falling

passu,

and

that

The

banking

argument

the

the

be induced

is its failure

expansion

by on

entirely before of business.

ability notes

of self-preservation,

in this argument

of continuous

other

by the

expanding

the

reserves

the

conservative

one

proportion group

of this

so far considered

of the

group

party

laid

particular

stress

automatically upon each

as a

continugold

increase

outpari

will be exhausted has

refers

that

and

must

group

to join

to observe group

they they

been

only

driven

to the

on another

check

out

unreli-

of a check on inflation by way of the presentation to the banks for redemption by the public. The

they contended worked cal claims of the banks

to to

(or group of banks) can go on away from its rivals until the

monopoly. So whether tendencies expanded

will, in the interests in the inflation.

for

from the expansion of a bank insist on retaining

its former reserve ratio, it will be compelled encroachment on its reserves to decrease happens, expanding

into

notes of the correspond

proportions the note issues of the individual the total circulation. Hence the non-expanding bear rival

these

of freewhich

through the reciproother's reserves. _ Any

GProfessor Mises has recently defended free banking along these lines in his "Geldwertstabilisierung und Konjunkturpolitik," 1928. Professor Neisser has, in reply to Mises. taken up the counter argument that the "automatic mechanism"

CENTRAL BANKINGRECONSIDERED bank

will

either in on

continually

be receiving

in payment of loans deposit. In a system

for business, one its own counter them

to their

therefore step with

earlier cause

customers

through

the

to pay out over but will return

clearing

process.

It is

bank expands will go against

out of it and

will draw on its gold reserves to the extent of its balance. This mechanism would work at a much

stage than the reserves

mediately.

the external drain of gold to feel the effects of expansion

It is unlikely

to decrease

their

tive

group

which

will

be

group.

not be prepared of rival banks,

to be supposed that if one the rest, the clearing balances

its rivals adverse

from

or in the form of cash being paid where all banks are competitors

bank will the notes

issuers

payments

179

the

reserve

all hanks

ratios,

is not

check

A bank

that

of these

which

and

desirous

will the

and would almost im-

decide

bigger

the

of so doing,

on

the

conserva-

the

expansion

contemplates

in concert stronger

of the

an expansion

other

has

got to

take into account not only the direct effect on its reserve ratio, which comes about in the first instance when it increases

its issue

before, drawal

against

the

same

afford

to make

reserve

ratio

will react

to its loans

on the

to the benefit

stances

may

occur

willing unlikely

to allow some reduction that they will ever risk

reserves.

an over-expansion

the

as those

by the therefore was

reserve

by the addition

of a given reduced,

While

in which

like as great

parative equanimity The free bankers tem

basis

of the

to their

total

occasioned size of the

will be correspondingly

partly

an accretion

anything

absolute

but also the indirect effect of cash to other banks. The

other

drop

and

banks

admitting

majority

in its

its action

who that

of the

as

withit can

secure circum-

banks

are

in their reserve ratios, it is fluctuations of dimensions

which

are

viewed

central bank. submitted that not only

not any

with

com-

under

their

sys-

more

likely,

but

of credit control does not, in most circumstances, work. See his article "Notenbankfreiheit?" in the Weltwirtscha_tliches Archly., October, 1930+

laO

THE RATIONALEOF CENTRALBANKING

even

much

In the

less

latter

bank

likely

system

receives

than

are

mand

much

quent pared

longer

only

public.

The

central

average

banking

clearing

functions creases

its issues

crease

in

the

by

same

alleges

special a given

as they

no

ings

and

It was

no claims

on reserves. denied

as

frecom-

control

illusion,

and

If one

therefore

only

bank

in-

will

the

in-

larger

have falling due in any of claims on rival banks

differences

consequently

de-

(less

its business

and

al-

in the

inter-bank

an

proportion,

proportion,

it, so that

is the

circulation

that

this

can

be seen

circumstances.

it will number

on

and

neither gives as inter-bank

could

of

is largely

amount of loan repayments week will give it the same have

notes,

under a unit system of note issues.

school

very

system. bank:

of claims

effect

period

mechanism

under

source

The

redemption) of notes with a multiple system

via the

banking

by a single

in, in its own

The

by the

a central issued

out again; it therefore specie reserves so far

concerned.

for gold

very

are

all payments

ways pay its own notes nor receives claims on claims

under

all notes

that,

arise

failing

in the

recourse

clear-

to the

sit-

uation where the notes of any one bank circulate, not over the whole area, but only over a narrowly circumscribed area,

in which

would

be sent

is analogous raises

The increase

in the

will

A) and

public

out

note

as stated no

and

circulation the

increase

area

exchanges is any

issues

account

of their

for collection_--a

of international of

argument of it take

passing

of its own--there

expansion

call

notes

in by the to that

objections

on the system. port

case

the

in

of the

which

and

which

automatic

expanding

check banking

_ given

occurring

in its loan

case

a multiple

illustrations

of a lag

of issue

in sup-

between bank

repayments.

(which

the we If we

r A case considered by Mlchaelis. See his article, "Noten und Depositen" in Faucher's "Vlerteljahrschrilt," 1865, p. 132. s See Chapter VIl., p. 85 ft.

CENTRALBANKINGRECONSIDERED assume be

such

a drain

will

a lag which in the

only

first

in practice

instance

be a temporary

on

efflux,

repayments increase, there to A. _'It seems, therefore,

clearing

mechanism

It is always the

which ences

expands between

clearing

on

spends

it, will

ately,

and

other bank.

banks None

will

pass

in the

mechanism

out of step the two cases

porary withdrawals the check case than drawn

that

the

additional

those

drawn

in

will give rise of the checks

through

the

will

the

function

to check

A's

A can stand period.

the

against

in via loan

as the

tbr

clearance

of people

Eventually it previously

the

borrower immedi-

banking

with

to cash claims on the expanding will remain out in circulation; all

clearings.

repayments

a bank

will be more rapid in All checks which are

In the

case

of the

on the other hand, only a small part of the issue back from circulation to the banks--viz., those come

credit

'° The only differto be that the tem-

credit,

banks

favour

when

of a deposit

with others. would seem

deposit into

will this

period,

tending

case

in the lag period in the note case.

be paid

there though

will be a return of these that whether or not the

on whether or not during this interim

assumed

system,

at a later

will act as a factor

will depend in its reserves

occur,

A's reserves,

and

A's loan reserves expansion reduction

must

ISl

or in the

expanding bank lost in the deposit

form

of new

note

issue,

will come notes that deposits.

would get back the reserves case no less than in the note

_)It is immaterial to the general conclusmn what assumption we make regarding the way m whmh the increased lending takes place We may assume (al that A gives out all the additional loans at the same date, and that they are all of the same echeance. (b) that it gives them all out at the same date, but that they are distributed over different periods of echeance, or Ic) that it increases its loans gradually over a period of time. In all cases A receives back sooner or later the reserves it previously lost. See the illustration m an appendix to this chapter [pp 197-200] 10The same principles apply in the case of an accretion of cash to one bank and the demonstration (cf. Phillips, "Bank Credit") that the bank in question cannot expand its loans to anything approaching the extent represented by the amount of liabilities the additional reserves would support on the basis of the old reserve ratio, because withdrawals of cash will take place to other banks.

iS2

case, but because serves in at a later

THE RATIONALE OF CENTRAL BANKING

the clearing mechanism exerts a controlling the bank cannot stand a heavy reduction the interim period; it cannot wait until their date.

effect of rereturn

The difference is a matter of degree rather than of kind. Whether or not the check will operate in the note case will be dependent on the importance of the drain of cash during the lag period. That there must be some lag, whether we take the note case or the deposit case, is indisputable" unless we adopt the unreal assumption that all the additional loans are lent out only "over night." The existence of the lag presupposes merely that the additional loans do not mature at the next settlement day but only one or more settlements later, or that the shortest period for which the loans may be made cannot make their repayment coincide with the repayment of those old loans which are the next in time to be repaid. It must be supposed that the borrower makes use of the loan proceeds and therefore transfers of funds must have taken place between the time of borrowing and the time of repayment. The borrower must first use the funds to make a purchase and later realise them again by making a sale. The purchases which the new borrowers make will partly provide the funds out of which previous borrowers, whose loans are falling due, make their repayments to the banks. At a later date other borrowers will provide the funds out of which Bur so-called new borrowers again become liquid and can pay back their loans. The most rapid rate at which such transactions can proceed must allow at least one settlement to take place in which the effect of the increased circulation of the expanding bank becomes apparent in the clearing balances, but has as yet no effect on the volume of loans falling due for repayment. 1_Neisser seems to have neglected this factor, although he would need to assume it in order to prove that there is a basis for distinction between the check case and the note case,; cf. his article, pp. 454-5.

CENTRAL

We

can

old and

make

the

various

new

for assuming

greater

under

der

system

the

fact

that

the banks customers remains

near

however,

18a

about

term

the

of loans

term

the

length

of loan

of the

form

average

lag period seems no

lag

by deposit

in the

of the

is on the

in their volume, the is not the case. There

will

credit

of notes.

The

be any than

un-

only

dif-

the size of the temporary drain will be larger case than in the note case. Even allowing for some

additional

notes

will

find

at an early stage in the form as well as by way of current true

where

that system

of lending

ference is that in the deposit the

If the

an increase than if this

reason

RECONSIDERED

assumptions

loans.

increased with will be longer

the

BANKING

that the

that

this is extremely extent

the

of the

drain

unlikely

return

of cash

their

into by it

to approach

of checks.

caused

way

of new deposits loan repayments,

any-

It is possible,

by the

reflux

of notes

to other banks during the lag period may still be sufficient to act as a deterring influence on individual bank expansions. That it can be sufficient would seem to have been borne out in the note folk

experiences

of these the

of such

issues as are (Massachusetts) systems

power

notes

seem the

What influence loans in general lag period? the

to have

of holding

through

It will

average

term

tem

the

greater

after

the

expansion,

practical

afforded by the and Canadian other

a sharper

been

banks

of competitive

definitely

in check

conscious

by the

of

return

of

clearings. will the are made affect

the

of all loans will

be the but

the

average period for which have on the withdrawals rate

pressure

12 Cf. "U.S. National Monetary Currency Systems of Canada,"

of withdrawals.

outstanding shorter

will

The

in the

withdrawals

we assume that the expanding term for its loans as the banking be that

examples

history of the Scotch, Sufsystems. '_-Banks in each

shorter

banking

of cash be the

bank in the

per

sysweek

lag period,

if

bank has the same average system as a whole. It may

on reserves Commission, p. 70.

at an early

Interviews

on

the

date Banking

will and

154

THE RATIONALEOF CENTRAL BANKING

act as a more immediate incentive to the expanding bank to hold back, and if this is the case it gives some justification for the

principle

flux

of notes

banking Besides

that

on

and

which

Deckung"

so much

free-banking

questioning

exercise banking cept

of "bankm_ssige

and

emphasis

was

of the

the

so-called

profit

ability

by

of a non-expanding

conservative

motive

laid

rethe

schools."

any control over the expanding school has also cast doubt on the

the

automatic

may

lead

bank

banks realism

bank

and

all banks

to

the central of the con-

has

to join

submitted

in an expan-

sion. 14The term conservative bank for some reason resists

was intended to imply that the the forces causing others to ex-

pand

that

credit.

demand

If we

suppose

for capital

is possible

(a rise

for all banks

there

in the

occurs

"natural"

to get out more

a rise

rate credit

in the

of interest) so long

it

as they

keep the market rate of interest at or about its old level, if the elasticity of demand for credit is greater than unity gross the

profits old

they

of all banks

rates

lend

reduction

insist the the

the the

if they

be greater

lend

of course,

in their

are unwilling serve ratios "natural"

than

more,

will

reserve

the

same

they

do

ratios.

if they

but

on retaining

the

fewer

their

rise in the money volume of credit.

are and

the

the the

ratios

of them

of banks

the

greater

smaller the

If

of a

and lower their will rise towards number

at

rate.

expense

If all or a majority

old reserve rate

more

at a higher

it at

to increase their lending the market rate of interest

rate,

lend

and the

rethe who

will

extension

be in

A bank which is conservative must be supposed to foresee events following on the boom, so that it anticipates that profits

subsequently

it could

gain

by

counterbalanced

joining by

in the the

boom

losses

would

of the

be crisis

_ See p. 174 of this chapter. 14See Nelsser, "Notenbankfrefl_eit _'' in the Weltwirtschaflhches Archly., October, 1930, pp. 449-50 Also Carl Landauer, "Bankfreihelt '_'' in Der deutsche Volkswirt, September 7th, 1928.

CENTRALBANKINGRECONSIDERED when

credit

ers are

customers

unable

withdraw

to repay

their

loans.

that such banks, even though consequences of an expansion, to hold the

off from

boom

and

it, because

more

compensate

and

the

and

debtor

custom-

But it has been

suggested

they are fully aware will not have any

they

than

depression;

cash

1185

will

find

that

for the

larger

is the

of all the incentive

the

losses

profits

of the

number

of

crisis

of the

banks

who want to expand, whether because they do not foresee the crisis and depression or because they compute the gains as greater for any

than

of escaping about

the

individual

losses, bank

entirely

by the

the

from

policy

more

to stay

out,

the

of its rivals.

still open to the would exceed

question whether the losses, and

would

banks

there crisis

be many

willing

unprofitable since

effects

of the

1_This

argument

in the

case

necessary boom

to lower

crisis

their

of a suspension

to take

would

in order

include

the

of specie to make

possibility

the

confidence

placed

difficulties

banks

in it bv

of a crisis.

in a free-banking

from

their

pelled, position,

brought

is however

reserve

ratios,

The

profits

risk

in the

of insolvency.

public

of central by reason

the

power

It was

explained

system

would

be

in cash

and

for payment

if

during the of liquida-

payments. extra

profits there

that

bankof the

to mollify

in a crisis

under would

the

pressure be com-

in consideration of the safety of their own reserve to contract their lending. All banks would be doing

same

would

creditors

the

it be

chance

it is likely that the therefore whether

The third argument, advanced in favour ing, is that a central banking institution has

the

small

were no central bank to give external aid and the banks were always under the threat

tion

the

will

it has

and

borrowers

be forced

into

previously liquidation.

accommodated Many

of the

by them banks

them-

is The only chance the minority have of escaping is if they have been able to select their assets so carefully that they are easily realisable even in the crmis. and if thmr more liquid position is sufficient to retain the confidence of the public, so that instead of thmr having deposits withdrawn they actually receive new deposits transferred to them from other banks.

IS6

THE

RATIONALE

OF CENTRAL

BANKING

selves must fail in the process. No bank would be willing to increase its circulation for fear of getting more notes brought back for gold and there would be no other lending agency to ease the situation. If there is a central bank, on the other hand, such a bank can increase its circulation in the crisis without fearing an internal demand for gold, since people are willing to accept its notes without question. The gaps that would otherwise be left by the commercial banks in the credit structure when the crisis constrains them to draw in their loans, can therefore be filled by the central bank acting as the lender of last resort. It can carry out this function of making the market more liquid either by lending direct to the banks or by lending to those who are called on by the banks for repayment. TM When the public withdraws large quantities of cash from the banks the lender of last resort lends to fill the deficiencies. This doctrine is one which establishes of banking policy, that in time of a crisis

the practical rule the lender of last

resort should lend freely on good security at a high rate of interest. Its action implies technically an increase in the total amount of money, but this is held to be harmless at such times and in no way inflationary, because the additional cash merely goes into hoards and is not used to increase the volume of money coming forward in purchase of goods, and so long as the rate of discount is high the amount borrowed is kept wel_ within these limits, while at the same time deposits are attracted back to the banks. The addition made to 16 Going off the gold standard assists the commercial banks in a direct way, as it no doubt did in this country in 1931. The withdrawal of balances to abroad, in so far as it takes place via an export of gold, sees a reduction in the reserves of the banks at the Bank of England unless the latter is in a position to offset, which it cannot do if the external drain of gold is exceptionally heavy. If it goes off the gold standard there is no need for any offsetting. The exporter of capital cannot withdraw gold from the Bank; he must buy foreign exchange at an enhanced rate, and there is merely a transfer between deposits at the banks from his account to the account of the seller of foreign exchange and the bankers' balances at the Bank of England suffer no net change.

CENTRAL

cash

resources

tendency velop

by the

to a panic into

BANKING

central

and

a chronic

RECONSIDERED

bank

slows

in time

up what

process

la7

of crisis

would

allays

otherwise

a central

ing one.

The

this

the

counter-argument

tion

regularly

difficulties, lied

school

aid

has

become

part

this

of the

commercial banks and will itself expand their lending operations would

give

pendence support

ceased

if they ders

them

the

entirely were

giving

rise

the

credit

fact

that

there

until

non-expanding impact of the

banks policy

and if anything affect all to such be able

percent would

entirely

on

banks,

the

remains bankingD

a very

consistent

banks

be

above

Unless eliminate the

the

argument

powerful

the

be trade for

argument

some

This

to assume

that,

banks

since

no

proved cycle

disor-

occur. who

becomes

the

to crash the

not

have

a de-

if distress

allowed

expand

suspect,

escape entirely by their less

water

it can

with

self-help,

in future

solvency

cannot followed

bv

and

were by

if we

will

is in

to be re-

anticipated

resources,

would

their

market

from cautious

in the nature of a panic starts an extent that even the prudent

to keep

liquid.

data

going

is weakened

unwisely

not

and

to a crisis

money

to

institu-

be a reason why they will beyond the limits which

own

to keep

opposed

or other

is continually

of safety

their

to be given unable

counter-argument given

margin

on

sometimes

the

that

this bereason

to a free-bank-

if a central

whenever

knowledge

will

organisation

1; that

gives the

upon

banking

free-banking

de-

of liquidation.

If crises are bound to occur under either system comes, according to the one school, in itself adequate for preferring

the

bank

it is likely to banks may can

be

that

free

and

general

lender in defence

the

the evil rivals,

100

banking

of last of

runs resort central

_: See Mises, "Geldwertstabilisierung und Konjunkturpolitik," pp 62-63. _ The case might be analysed along Pigovian lines (see "Economics of Welfare," 4th Edition, Part II., Chapter IX., Section 10) as one where uncompensated damage is inflicted by the guilty banks on their innocent rivals, and as such giving grounds for some kind of intervention.

lS$

THE RATIONALE OF CENTRAL BANKING

Before proceeding to the fourth and fifth arguments in favour of central banking, we may digress here to consider what was the relation of the arguments we have already discussed to two subsidiary problems: the prohibition of small notes and the justification of the exclusion of deposit banking from the strictures applied to the note issue. The arguments we have so far examined in connection with the note issue in general were held to apply afortiori to the case of notes of low denomination. Small notes were, in the first place, particularly liable to come into the hands of the poorer and more ignorant classes who were most unable to discriminate between the issuers. In the second place they tend to return less frequently to the banks and so are not often put to the test of convertibility, whereas the larger notes not only come back for change but are also mainly in the hands of those who make and receive large payments and are most likely to use them in transactions with the banks. Again, while in normal times small notes are seldom converted, they become particularly dangerous at the least sign of alarm, because it is the poorer and more uneducated people who are the first to "panic. ''1_ We notice that even Wagner, who was in favour of keeping restrictions at a minimum, thought that the prohibition of small notes might be wise in a free-banking system. Most of tim supporters of restrictions on freedom to issue notes conceded that the same strictures did not need to be applied to deposit banking, and many of them fought enthusiastically for freedom in this sphere. Various reasons were offered at different stages in the development of currency and credit doctrine as to why deposit banking came into another category than that of the issue of notes. The distinction was first supported on the grounds that notes were money and deposits subject to 19See, for example, Horsley Palmer's evidence before Q. 273, where he obiects to £1 notes on these grounds.

the 1832 Commission,

CENTRAL

BANKING

RECONSIDERED

IS9

check were not, and therefore they did not have the same effect on prices. Other writers based it on the less fallacious reasoning that the public had less choice in accepting notes than in accepting checks. Later, it was attributed to the circumstance that the creation of deposits is more subject than that of bank-notes to the redemption check via interbank clearings. Finally, it has been justified by reference to the proposition that the control over the creation of bank-notes gives the central bank indirect control over the amount of deposits as well, since central bank money constitutes the cash reserves of the deposit banks. T_vo subsidiary arguments in favour of central banks have become prominent, especially in post-war years. The first of these claims that we must have some central monetary authority in order that we may pursue what is called a "rational" monetary policy. The policy of the central bank is no longer conceived to be automatic in the manner envisaged by the founders of the currency school. The volume of circulating media does not change in response to specie movements. These may be ignored or offset as the central bank management thinks fit. With the aid of discount rate and open market operations it adopts an active policy of increasing or decreasing the cash reserves of the money market and the total volume of credit. We retain in this country merely a semblance of the principle underlying the Act of 1844. If the deposits the Bank creates cause, in the course of time, a demand for notes which it cannot supply under the fixed fiduciary issue, it can rely on a suspension of Peers Act; if they cause an increase in foreign claims and a drain of its gold reserves, it can go off the gold standard. Out of the realisation of the central bank's power to determine the volume of credit there arose the notion that it should consciously direct lines." The question then

monetary policy along "scientific arises: What is to be the criterion

190

THE

RATIONALE

OF CENTRAL

BANKING

of this "scientific" management? The criterion which has so far usually been adopted, namely, that of the stability of the general price level, has been suspect in theory and just as unfortunate in practice. Although the contributions of Mises, Hayek, Keynes, Myrdahl _'°and others have gone far to elucidate the forces at work, we have yet to wait for the formulation of some other criterion in clearly delineated enough terms to allow of its adoption as a rule of monetary policy. Meanwhile, it is the efficacy of central bank control rather than the objective so far followed that is most called into question by monetary reformers, and consequently the demand is raised for the concentration of still more control in the hands of the central monetary authority by extending its direct control to deposits as well as the note issue. The other argument is of a similar nature. It looks on the central bank as an essential instrument for securing international co-operation in monetary policy. In the past, at least, this has usually meant arriving at understandings in the field of discount policy to obviate the necessity of a deflation in a country which, under the rules of the gold standard, should undergo a decrease in its money incomes. As such it is regarded as an essential link in price stabilisation policy. Thus Mr. Hawtrey -_'conceives of it as a means of surmounting the difficulties raised by the circumstance that stable exchange rates between countries may not always be compatible with a stable price level within each separate country. If the level in one country A is to be kept stable, it may be necessary to have a rise in country B, or, alternatively, if B's price level is to be kept stable, there may have to be a fall 20 L. von Mlses, "The Theory of Money" and "Geldwertstabilis_erung und Konjunkturpolitik": F. A. yon Hayek, "Monetary Theory and the Trade Cycle" and "Prices and Production", J. M Keynes, "Treatise on Money"; G. Myrdahl, "Der Gleichgewichtsbegriff als Instrument der geldtheoretischen Analyse," and T. Koopmans, "Zum Problem des 'neutralen' Geldes," m "Beitrage zur Geldtheorle," edited by F. A. yon Hayek. z_ See "Monetary Reconstruction," pp. 144-5.

CENTRAL

BANKING

RECONSIDERED

191

in country A. He looks to arrangements between central banks to determine how "these departures from the norm" can best be distributed between the countries concerned. The securing of international co-operation was hinted at as being the most important modern function of central banks both at the Brussels Conference in 19202-' and at the Genoa Conference in 1922.-'" Central bank leaders see it in the same strong light, and we find Mr. Montagu Norman describing his efforts to bring about co-operation among the central banks of the world as one of his two main tasks during recent years. 2_That his efforts did not go unrecognised is evidenced by the widespread opinion that the forcing down of discount rates by the Federal Reserve in the latter half of 1927 took place under persuasion from representatives of other central banks. 2_ But more impressive results are evidently envisaged by those who deplore the fact that co-operation has not yet succeeded in going much beyond "an ad hoc agreement that certain steps may be taken about rates."_'_ If it were really true that central bank co-operation is directed towards the observation of the rules of the "gold standard game," as some of its disciples pretend, 2: there would, even if there were nothing to be said in its favour, be at least nothing to be said against it. In effect, however, the theory underlying it amounts to a complete negation of the principles under which the international gold standard works. Less objectionable would seem to be that aspect of international co-operation which has had a long history of practical application and which is an extension of the concept of z2 International -"_International "MacMillan 2._See

"Committee

pp. 6162, 213-14. "MacMillan 27 Ibid., 1597

I

Financial Economic Committee, on

Committee, (Sir Robert

Conference. Conference. Minutes of Evidence," National

and

Minutes Kindersleyt.

Federal

3317

Reserve

of Evidence."

6720

Systems," (Sir Otto

U.S.A., Niemeyerl

1931.

19_

THE

RATIONALE

OF CENTRAL

BANKING

the "lender of last resort" to the international sphere. Where the banking system of any country is faced by a run of foreign depositors, the assistance which can be rendered by the central bank of that country to the deposit banks may not be able to go very far on the basis of its own gold reserves, and it has not infrequently happened in the past that a foreign central bank or group of foreign banks has lent funds to the central bank in difficulties. Mr. Hawtrey looks forward to the time when this function of the international lender of last resort tional SettlementsY

will be assumed

by the Bank for Interna-

The two arguments last mentioned have become in our time the almost exclusively motivating reasons for the foundations of new central banks. A clear example of this is to be found in the recommendations of the recent Royal Commission on Banking and Currency in Canada. z9They are characteristic of the change that has taken place in the theory of central banking. The classical theory of central banking was that it should make monetary movements as far as possible automatic. The modern theory is to substitute "intelligent planning" for automatic rules. To those who would prefer to place their trust in semi-automatic forces rather than in the wits of central bank managers and their advisers, free banking would appear to be by far the lesser evil. Banks which have not-the possibility of abrogating their liability to pay their obligations in gold cannot go very far wide of the path following movements in their gold reserves. Any attempt to make a final evaluation of the relative merits of alternative systems of banking must look primarily to the tendencies they manifest towards instability, or more particularly to the amount of causal influence they exert in cyclical fluctuations. Most modern theories of the trade cycle seek the originating force of booms and depressions in 28 R. G. Hawtrey, 29 1933. See the

"The Art Commission's

of Central Report,

Banking," pp. 62-64.

p. 228.

CENTRAL

BANKING

RECONSIDERED

193

credit expansions and contractions with the banks as the engineering agencies. A more comprehensive view considers that these movements are not features exclusively of the banking system, but that, while liable to be aggravated by the banking system, they will occur under any monetary system. It was apparently assumed by writers of the currency school s° that with a purely metallic currency, and therefore with a strict operation of the currency principle, there would be no disequilibrating monetary factors. In this connection there was some valid point in the classical theory of the hoards. The banking school held that even in a purely metallic currency where there is no creation of bank credit, the effective circulation will still vary with the movements of money in and out of what they called the hoards?' Modern theory essentially generalises this concept to cover all changes in the rate of spending cash balances in general, and comes to the conclusion that it is possible that these fluctuations in the effective circulation which come about as the result of spontaneous action on the part of the public may be sufficient to generate cyclical fluctuations in business activity without the guilt of the banks. It is difficult to judge how great would be these primary changes in the public's demand for cash: the movements which have recently made such a marked impression on the financial structure have arisen largely as secondary movements consequent on prior disturbances in the banking system. They were caused either directly or indirectly by credit expansions and contractions. The non-existence of a banking system would eliminate the very large element caused by panic hoarding, but there would remain such facs0 Particularly Tellkampf and Geyer. sl See, e.g., Fullarton, "On the Regulation of Currencies," ner, "Beitrage zur Lehre yon den Banken," p. 126; J. S. Mill, cal Economy," Vol. II.. Bk. II., pp. 204, 210-11.

pp. 138-41; "Principles

A. Wagof Politi-

|a4

THE RATIONALEOF CENTRAL BANKING

tors

as integrations

and

disintegrations

in industry,

changes

in population, alterations in the attitude of the public towards different risk distributions of their assets. If these "natural" accelerations and decelerations in the turnover of balances may

are

likely

become

part

to reach of the

appreciable

object

and

counteract them, and a fiduciary of uncovered notes or of check necessity, How cause

if monetary to discover

factors

to introduce

oscillations

adjustments

to

public, is the our day.

most

changes

acute

out

they

major

cash

provided

mercial that

arise. by

banks

their

keep

lending

the pit of the money. _ These coefficient icy mind. port

activities

theory,

side

of this

ten

reserve

times,

the kind

recently

put

the of

system difficult of the that

amount

that

the

of com-

proportions closely

and

(except

in central magnified

but central

knowledge which

of

fact

in the

movements are, of course, with

itself

correct

problem

We find fairly

be the

features

changes

follow

say,

most

the

to be an indisputable

stable

depression) movements

It is propositions to the

the

economic

banks.

relatively

conducted

not likely

to make

particular

from

central

of expansion,

is always

of what

come the

will

that the present banking disturbances. The more

But it seems

fluctuations

in the form we find, be a

is least

from

unsettled

task

is to determine

likely

it to

neutral.

which which

most

counteract

doubt for

the

system

and

There is not much is actively responsible system

to be kept

disturbances,

then

of banking

issue (whether deposits) may, are

a banking

of catastrophic

dimensions,

usefulness

bank

of this seem

forward

in

bank by the

to lend by

pol-

fact

in

sup-

Mises, 33

_2Between November, 1925, and March. 1935, the monthly figures of the average percentage of cash to deposits held by the London Clearing Banks showed an absolute range of between a maximum of 12.0 percent and a miramum of 10 0 percent. During the same period the Bank of England "proportion" showed a range of 65.5 to 11.5 percent, and. even ignoring these extremes, fluctuations between 50 and 30 percent, or even 25 percent, may be considered as quite a normal spread. 3J "Geldwertstabilislerung und Konjunkturpolitik," p. 61.

CENTRAL BANKINGRECONSIDERED that

fluctuations,

while

be much

reduced

true

such

that

than

whatever

is much

a system may

entirely

free banking.

a system

manipulation But

not being

under

be

of monetary

control.

verdict

as to the

comparative

outcome of the two systems in terms that the choice can ever again become

of stability a practical

vast

interference

majority

of people

of banking

has

cepted institutions vite ridicule. One the

sphere

plied

government

become

so much

that result

lines

to banking

has

clusion free

that

we

actual

competition

Such

won

exception

should

that also almost

be diffident

experiences

prove

the

as are

occasionally

come

provide

century

from

made

They are the product of theories demand for free banking is based practically by bank

tendencies When

in favour

sources

and

tary be

This

power the

rule

paid

ap-

for by

the

con-

unworkability

of

consistent

for free

of "money magic." on the notion that it

evils

of credit

and

to deficiencies

'_ As a matter

of

of practical

are all in the direction of increased the choice was made in the nineteenth

of controlling

would

in the

day

do not commend

supplies

social

monopoly.

the

ing was for various reasons left there are signs of an approaching deposits.

the

be

in our

which

unlimited

all industrial

caused

policy the centralisation.

from

of drawing

them. Their

banking

ac-

in banking.

pleas

ascribe

of the

to point out that since never been strictly ap-

in banking

they

part

it must

trade

would

in matters

an integral

of business

liquidation, and it is important the laws of bankruptcy have plied

it is unlikely one. To the

to suggest its abandonment is to inof this attitude is that insolvency in

of banking

in other

would

it is undoubtedly

capable

of central

our

eliminated,

And

less

195

secure hands outcome

note

the final

of the

issue,

deposit

bank-

"free." At the present time extension of the control to central

of central

concentration authority bank

of moneand

philosophy

would and

34See Hake and Wesslau, "Free Trade in Capital," 1890; Henry Meulen, "Free Banking" (lst Edition, 1917, 2nd Edition, revised, 1934)

196

THE

RATIONALE

OF CENTRAL

BANKING

the currency doctrine. There are already strong movements in this direction in both Germany and the United States. In the United States it is as yet only a plan, 35in Germany it is an accomplished fact.

35 See the Chicago 100 percent Plan for Banking Reform, is given by A. G. Hart in an article entitled "The Chicago form in the Review of Economic Studies, February, 1935

an account of which Plan" of Banking Re-

Appendix

On the

Working

"Automatic

Mechanism"

of Credit

In

order

last chapter

Control

to make clear the argument we append

of the

the following

on pp. 178-184 arithmetical

of the

example:

1. THE NOTE-ISSUING CASE Assume that there are two banks (or groups of banks), A and B. Both carry on the same volume of business in the first instance. Each lends 10,000 and has 10,000 loans falling due on each settlement day. A now increases its lending on a given day by 10,000 and all these extra loans fall due for repayment four clearing periods later, so that there are three clearings in between. Assume further (a) that if B draws gold from A, B does not immediately increase its note issue to the extent that would bring its reserve ratio back to its former level, but only to the extent necessary to replace the notes that have not come in as usual, but have stayed out in the circulation (this merely makes it possible for it to lend currently the same amount as before); (b) that A correspondingly reduces its outstanding note issue by the amount of the loss of gold, that is, by the amount of extra notes it has returned to it by B through the clearings. Then the total note issue outstanding of A and B 197

198

THE RATIONALE OF CENTRAL BANKING

together

remains

the

same

throughout

the

period

under

consideration.

Orig/na/Position A. Notes

...................................

Gold

....................................

Loan

repayments

A receives B

5,000 ,,

Notes

........................

of its own ,,

therefore

cleared

are

,,

Position

at First

notes

and

,,

5,000

Clearing

any

40,000

40,000

4,000

4,000

10,000

10,000

of B's.

,,

without

A's. transfer

after

A's

of gold.

Expansion A.

Notes

...................................

Gold

...................................

Loan

repayments

A receives

5,555

B

4,444

,,

B draws

1,111

Second Notes

notes

gold

4,444 5,555

from

B. 40,000

4,000

4,000

10,000

10,000

A.

B.

48,889

41,111

of B's. ,, A's.

A.

Clearing ...................................

Gold

....................................

Loan

repayments

........................

5,433 of its own notes

B

4,567

B draws

and

......

A receives ,,

50,000

........................

of its own

B.

826 gold

...... from

A.

and 4,567 5,433

of B's. ,, A's.

2,889

5,111

10,000

10,000

WORKING OF CREDIT CONTROL

Third

Clearing

Notes

...................................

Gold

....................................

Loan

repayments

........................

A receives

5,341

of its own notes

B

4,659

......

,,

B draws

682 gold

Fourth Notes

B

At the

10,530

gold

and

......

9,470

A.

B.

47,381

42,619

1,381

6,619

20,000

10,000

of B's.

5,265

,, A's.

to A.

of the fourth

Gold

5,937 10,000

,, A's.

........................

of its own notes

4,735

Notes

2,063 10,000

of B's.

...................................

repayments

end

B. 41,937

Clearing

....................................

4,205

4,659

A. 48,063

A.

Gold

,,

B loses

from

and

5,341

Loan

A receives

199

clearing

the

position

is:

................................... ....................................

2. THE

DEPOSIT

CREDIT

A.

B.

51,586

38,414

5,586

2.414

CASE

We may assume in this case that the recipients of checks paid out by the borrowers of the additional 10,000 pay these checks into their banks for collection immediately. It is reasonable to suppose, unless there is an uneven distribution of deposit business between the two banks, that half of these checks will be paid into each bank.

ZOO

THE RATIONALEOF CENTRAL BANKING O_wJna!

PosOHo.

Deposits ................................ Cash .................................... Position

at First

A.

B.

40,000 4,000

40,000 4.000

Clearing

Deposits ................................ Cash ....................................

A.

B.

50,000 4,000

40,000 4,000

B receives 5,000 in checks drawn on A against which there is no counterclaim of A on B; B therefore claims 5,000 in cash from A. The position

aJler

#he flrst

clearing

Deposits ........................ Cash ............................

is already A. 45,000 --1,000

untenable

_r B.

A:

45,000 8,000 + 1,000

Bibliography

Andreades,

A. History

Meredith. Aretz,

of the Bank

London:

Peter.

P. S. King,

Die Entwicklung

1780-1850;

eine

geldwesen.

Berlin:

Bagehot,

Walter.

Lombard

Beckhart,

Benjamin New

Burgess,

Banques

York:

Harper

Cairnes,

John

volved 1854.

aus

d'Emission London:

Holt,

E. An

Henry

United

Charter

C. The

States.

Paris:

Henry

1873.

Credit

and

into

the

of 1844.

Henri.

Contre

Cernuschi,

Henri.

M_canique

Chevalier, 1837.

Michel.

Lettres

Coquelin, 1876

Charles. (Preface

System

le Billet

Principles Dublin:

Guil-

Reserve

Market.

New

sur

Du Credit

l'Amerique

Great Paris:

Paris:

by

Britain,

du

ou l'lmpasse

and

Guillaumin,

Nord.

du

3rd ed.

Jean-Gustave

201

In-

Smith,

the

1838.

A. Lacroix,

et de la Circulation.

et les Banques,

and

Currency in Canada. Reand Currency in Canada.

de Banque.

en Banque

annotation

of Currency Hodges

Lea, & Blanchard,

de l'Echange.

Le Credit and

of the Federal

the Money

in France,

Carey,

Cernuschi,

Coq, Paul. La Circulation Guillaumin, 1865.

S. King,

Policy

Banks

Act

Philadelphia:

Cieszkowski, Auguste. Wurtz, 1839.

Papier-

et d'Escompte.

Canada. Royal Commission on Banking and port of the Royal Commission on Banking Ottawa: J. O. Patenaude, 1933. Carey,

und

1927.

Examination

in the Bank

von England,

Notenbank-

1924.

The Reserve

& Brothers,

der Bank

dem

The Discount

Henry

by Christabel

1916.

Street.

Haggott.

W. Randolph.

York:

Studie

C. Heymann,

Les

Translated

der Diskontpolitik

kritische

Aubry, Maurice. laumin, 1864.

System.

of England. 1909.

Paris: Paris:

1866. 1865. Gosselin,

Treuttel

Monopole. Paris:

Paris:

Guillaumin,

Courcelle-Seneuii.)

et

202

THE RATIONALE OF CENTRAL BANKING

Coullet, Paul Jacques. Etudes sur la Circulation le Credit. Paris: Furne, 1865. Courcelle-Seneuil, 1867.

Jean-Gustave.

La Banque

Courcelle-Seneuil,

Jean-Gustave.

Traite

erations Courtois laumin,

de Banque. ills, Alphonse. 1875.

Dabritz.

Walther.

Berlin.

in den .lahren blot, 1931.

zur

1850 der

.lahrhundert.

Gustav

Geburtstages, S. P. Altmann, blot, 1908. The

Dublin

Dunbar, Dunbar,

Du

The

Guil-

Disconto-Gesellschafl Deutschlands

Leipzig:

Duncker

& Hum-

im neunzehnten

siebenzigsten

1840.

Economic

Macmillan,

Essays.

The

Theorv

and

M. W. Sprague.

Gustave. 1853.

Edited

by

O.

M.

W.

5th

ed.

1904. York:

du

credit

De la monnaie

Encore

la Question

le._ principes

et les faits

History

New

des

of Banking, G. P. Putnam's et de

Banques.

l'lmpOt.

Paris:

Sons, Paris:

Guillaumin,

Economist

Enqu_te

sur

tion monetaire etfiducialre, riale, 1867. Fanno, Mar. Le banche eil 1912. Feavearyear,

A. E. The

London. Fraser's

Oxford Magazine,

Fullarton,

John.

Murray, Gallatin, the

zur

Magazine,

Franklin.

Duran. Etienne 1865.

Paris:

yon & Hum-

Oliver

Puynode, Guillaumin,

and

Op-

seines

London: by

der

des

24. Juni 1908, in Verehrung dargebracht W. J. Ashley, C. Ballod, et al. Leipzig: Duncker

Franklin.

Charles

France.

Volkswirtschaflslehre

Schmoller

Universiw

Revised 1929.

et Pratique en

et

Guillaumin,

Wirtschaflsgeschichte

Munich

deutschen

Paris:

Theorique

Anfange

und

la Banque

Wiederkehr

Charles

Sprague.

und

Bank-

his 1875.

Die Entwicklung

Libre.

Paris: Guillaumin, 1853. Histoire des Banques

Grundung

Ein Beitrag

Monetaire,

mercato

Pound

University

generaux

1865-66.

monetario.

Sterling: Press.

qui

regissent

6 vol. Paris:

la circula-

Imprimerie Rome:

A History

Impe-

Athenaeum,

of English

Money.

1931.

1868. On the Regulation

of Currencies,

2nd ed. London:

John

1845. Albert.

United

Considerations

States.

Philadelphia.

on the Currency Carey

& Lea,

and Banking 1831.

System

of

BIBLIOGRAPHY

Gallatin, United

Albert. States.

Suggestions New York:

Gerstner,

Franz

yon

Nordamerika,

und

andere

Anton

Ritter

offentliche

Philipp.

Banken

Geyer,

Philipp.

Theorie

Charakteristik mann's

der

Great Great

Krtsen.

und

Gregory,

The

on

Committee

Guthrie,

George.

inburgh: Hake,

Select

Bank

Bank.

nebst Munich:

einer

Fleisch-

on

Economic Exchanges.

Minutes

Industry.

Committee Bank

Acts.

Documents

Sons,

Foreign

Industry.

and

Oxford

the Cause

and

on

of

Evi-

1931.

and

Oxford:

Monopoly

and

and

Select

Statutes,

Report.

London:

on Bank

Acts.

Re-

[House

of

Relating

to

London: Reports

University

Press,

of Commercial

1929.

Crises.

Ed-

1864.

O. E. Wesslau.

des

Bankwesens.

and Paul Quittner. Berlin: Hankey, Thomson. Principles 1873. Hawtrey, 1932.

R. G. The Art

Hawtrey, Green,

R. G. Monetary 1926. Sven.

Entwicklung.

Free

7Pade

ed.]

Herausgegeben

J. Springer, of Banking,

of Central

1933. 2nd

Banking.

Reconstruction,

Theorie Jena:

[Higgs, Henry, 1921.

Business

1865.

in Capital.

London:

1890.

Handworterbuch

Hildreth, stration

1839.

of the

Office,

Finance

1832-1928.

A. Egmont,

Helander,

Theory

Committee

W. Blackwood

Remington,

preuss.

Finance

on

the Select 1857.

Banking,

Staaten Banken

T. O. Weigel,

Essays and Addresses E. Arnold, 1905.

H. M. Stationery

T. E., ed.

British

Vereinigten

Zettelbankwesens

und

H. M. Stationery Office, 1931. Great Britain. House of Commons. port from Commons]

of the Several

1867. Viscount. London:

Committee

Britain.

aus den Leipzig,

des

engl., franzos,

Currency 1841.

Dampfschiffahrten,

Leipzig:

Praxis

[George J.], Viscount. E. Wilson, 1861. London:

Berichte

Unternehmungen.

Buchhandlung,

Britain.

dence.

von.

Eisenbahnen,

und

Goschen, [George J.], Questions (1865-93). Goschen, London.

on the Banks and Wiley and Putnam,

uber

Geyer,

Z03

und

G. Fischer, Political

Politik

Melchior

ed. London:

London: 2nd

der

yon

ed.

E. Wilson,

Longmans, London:

Zentralnotenbanken

Palyi

Green,

Longmans, in ihrer

1916.

Economy

Club,

vol.

6. London:

Macmillan,

Richard. The History of Banks: To Which Is Added a Demonof the Advantages and Necessity of Free Competition in the of Banking.

Boston:

Hilliard,

Gray,

1837.

204

THE RATIONALE OF CENTRAL BANKING

Horn, J. Edouard. La Liberte des Banques. Paris: Guillaumin, H(Jbner, Otto. Die Banken. Leipzig: Ht_bner, 1853, 1854. Joplin,

Thomas.

An Essay

on the

General

tice of Bankin_ in England ward Walker, 1822. Le Journal des Economistes.

and

Juglar, Clement. laumin, 1868.

et de

Juglar,

Du

Clement.

Des

Change Crises

ed. Princeton:

Landauer,

und

Laughlin,

Ans. Andre.

Guil-

P_riodique

1932. Buchhandlung.

Volkswirt.

7, 1928):

Zeitschro_

fOr

Rucksicht 1871.

auf

1670-73.

oder nicht? Mit besonderer Berlin: J. Springer Verlag, Reform.

Chicago:

Le Marche

Monetaire

et ses

Guillaumin,

1865.

Evolution

Walther.

of Credit

of France

Printing

vom

49 (Sept.

ed. Banking

de. Paris:

ing of the Bank Lotz,

Ed-

Paris:

Retour

Weidmann'sche

Der deutsche

no.

Bankfreiheit Deutschland.

Emile

quante

ment

Prac-

National

Citizens'

1912.

Laveleye, Liesse,

d'Emission.

et de leur

Press,

Berlin:

"Bankfreiheit?"

J. Laurence,

League,

la Libert_

University

Kredit.

Wirtschafl,

Lasker, Leopold. Preussen und

Present

et aux Etats Unis. Paris: Guillaumin, 1862. The A B C of the Federal Reserve System, 9th

Princeton

Carl.

Politik

and

Newcastle-upon-1]yne:

Commerciales

en France, en Angleterre Kemmerer, Edwin Walter. Knies, Carl, Geld und 1873, 1876, 1879.

Principles

Scotland.

1866.

Office, 1875.

in France Time.

depuis

from

Cin-

the Found-

Washington:

Govern-

1910.

Geschichte

14. M_rz

and Banks

to the Present

Crises

und

Leipzig:

Kritik

des

Duncker

deutschen

Bankgesetzes

& Humblot,

1888.

Loyd, Samuel Jones [Lord Overstone]. Tracts and Other Publications on Metallic and Paper Currency. Edited by J. R. McCulloch. London: n. p.,

1857.'(Contains

Macleod, don:

material

originally

Henry

Dunning.

The

Theory

Longman,

Brown,

Green,

and

Marqfoy, Credit

Gustave. La Banque et la Circulation. Paris:

[McCulloch, Longman, McCulloch,

J. R.] Historical Rees,

Orme,

J. B. A Treatise

Sketch

Practice

Longmans,

de France Guillaumin,

Brown, on

published and

Metallic

Green, and

Bank

Rapports

of England.

Paper

Money

Macmillan,

1934.

Michaelis,

Schriflen.

vol.

Volkswirthschaflliche

avec London:

1831.

Edinburgh: A. & C. Black, 1858. Meulen, Henry. Free Banking. London: Otto.

Lon-

1855.

dans ses 1862.

of the

and

1837-57.) of Banking.

and

Banks.

1: Eisenbahn-

le

205

BIBLIOGRAPHY

fi-agen.

Handelskrisis

anleihen. Mill, John 1848. Miller,

Stuart.

Harry

London:

Principles

vol. 2: Von der Berlin:

of Political Theories

Economy.

in the

Bi_rse.

Herbig,

Mises, Ludwig G. Fischer,

yon. 1928.

Wesley

and

London:

United

to the

cago:

University

A History

Economic

und

J. W. Parker,

States

Before

of Their

Press,

Banking,

Erwin.

Die preussische

Bank

und

in Deutschland.

Bonn:

A. Marcus,

with

fore the Economic Club of New Work of the National Monetary Printing

Andrew

System. Dewey,

Davis

die

Ausdehnung

David.

Its Relations ment

Warburg,

Paul

1

(1930

M.

Systems and

of

Printing

W. Aldrich

29, 1909, Washington:

Beon the Gov-

Before

the

the

National

Office, Civil

Banking

1910.

War.

Washington:

1910. Treasury

of the

Discount Office,

of the United

Country.

States

Washington:

and

Govern-

System

the National Banking Office, 1910.

in Europe.

Washington:

1910.

Commission.

Interviews

of Canada. Commission.

on

Washington:

the

Banking

Government

Interviews

of England,

Italy. Washington:

"Notenbankfreiheit?"

II): 446-61.

Ges-

1910.

Monetary

Currency

ihres

1910.

Systems

Office,

National

Hans.

The

Monetary

Switzerland, 1910. Neisser,

Office,

Currency

Printing and

Banks

Printing

National

U.S.

Origins

O. M. W., History of Crises Under Washington: Government Printing

Government and

Office,

Independent

to the

Printing

Sprague, System.

U.S.

The

The

Banking

Printing

Chi-

1866.

York, November Commission.

Government

R. State

Refer-

1862-65.

1910.

McFartand.

Washington:

Government Kinley,

Office,

ed.

Jena:

Special

Issue:

National Monetary Commission, Publications, 1910-12 Aldrich, Nelson W. An Address by Senator Nelson

ernment

2nd

1903.

chi_flskreises

Davis,

1860.

Konjunkturpolitik.

of the Greenbacks,

Consequences

of Chicago

Staats-

1857.

Geldwertstabilisierung

Clair.

ence

Sons,

Uber

1873.

Mass.: Harvard University Press, 1927. Homer. The Principles of Currency and

Groombridge

Mitchell,

1857.

Bankfragen.

E. Banking

Cambridge, Mills, Richard

Nasse,

von

Theoretisches.

Scotland,

on

the

France,

Government Weltwirtschaflliches

Banking Germany,

Printing

Office,

Archiv

32

_06

THE RATIONALE OF CENTRAL BANKING

Norman,

George

Respect

Warde.

to Currencv

Palmer, J. Horsley. the Monev-Market. Parnell,

Henry.

Remarks

upon

and Banking.

The Causes London:

Some

London:

and Consequences Pelham Richardson,

Observations

on

Paper

the Use

It Has Made

Patterson, Sons,

R. H. The Economy 1865.

Pereire,

Isaac.

France.

La Banque

Paris:

Phillips,

Chester

Phillips,

Edmund.

Bank

Grigg

& Elliot,

Reports quire

Credit. the

yon.

New

Whittaker,

Bankwesen

und

de la Banque

1920.

Currency

and

1861.

of Secrecy

bv the Lords

Committees

into

of the Bank

the State

de France.

in Preussen

R. D. The

Early

Paris:

on the Bank

Appointed

with

Bernard

of England

a Secret

of England,

of

3

GrasCharter,

Committee

respect

to en-

to the Expedi-

Parliamentary

Banking

Papers

in England.

London:

1929. William.

Bankpolitik.

Herbert.

Essays,

D. Appleton,

G. Fischer, Political,

cial Bulletin,

1900. and

Speculative.

New

1891.

O. M. W. Banking Harvard

Jena:

Scient(_c,

University

Reform Press,

in the

United

States.

Cambridge,

1911.

Sumner, William Graham, et al. A History Nations. 4 vols. New York: The Journal

Tellkampf,

en

1839. Histoire

Historv

Mass.:

Credit

Oxford: J. Parker, 1869. and Banking. Philadelphia:

Richards,

Sprague,

British

Bankpolitik

Payments.

York:

and

1878-79.

of Cash

Scharling,

du

Macmillan,

of the

ency of the Resumption 1819 (291), vol. III. La Revue des Deux-Mondes.

Spencer,

1832.

W. Blackwood

York:

Reform

London:

the Committee

P. S. King,

of England

Ridgway,

et l'Organisation

The Principles of Currencv. A Treatise on Currency

Ramon, Gabriel. set, 1929. Report from 1831-32.

Bank

J. Springer,

Price, Bonamy. Raguet, Condy.

Over-

1864.

Charter

Heinrich

Berlin:

Edinburgh:

upon

and

of the Bank

of Capital.

A Plea .for

of England

Poschinger, vols.

Arthur.

Banking

James

France

with 1838.

of the Pressure 1837.

of It. London:

de

P. Dupont,

Errors

Richardson,

Money,

trading. London: James Ridgway, 1827. Parnell, Henry. A Plain Statement of the Power and

Prevalent

Pelham

of Banking in All the Leading of Commerce and Commer-

1896.

J. L. Essays

on Law Reform,

Commercial

Policy,

Banks,

Peni-

BIBLIOGRAPHY

tentiaries, don:

etc.,

the United

States

of America.

Johann Ludwig. Die Prinzipien des Puttkammer & Muhlbrecht, 1867.

Geld-

und

Williams

Tellkampf, Berlin: Tellkampf,

in Great Britain & Norgate,

Johann

Bankwesens

and

_07

Ludwig.

Uber

in Deutschland

die

neuere

mit Hinweis

a_

Bankwesens.

Entwicklung

des

Vorbilder

in En-

dessen

gland, Schottland, und Nordamerika und auf die franzOsische generale de Credit mobilier 4th ed. Breslau: Morgenstern, Tippetts, York:

Charles S. State D. Van Nostrand,

Tooke, Thomas. 1840.

A Histo_

U.S. Comptroller

of the

ernment

Printing

Lon-

1859.

Banks 1929.

and

the

of Prices

Federal

[vol.

Currencv.

Reserve

3]. London:

Annual

Reports.

Societe 1857.

System.

New

Longman

et al.,

Washington:

Gov-

Office.

U.S. Congress. Senate. Committee on Banking and Currency. Banking and Currency. Hearings . . . on . . . a Bill to Provide for the Establishment

of Federal

Reserve

Banks.

Printing Office, 1913 U.S. Congress. Senate. Committee of the

National

Washington:

and

gegeben

fur

von

Wagner, 1857

Reserve

Adolph.

Printing

Faucher,

Beitrage

Adolph.

Vergleichung

System mit der

tlebankwesens.

Mit

Baden,

die

sowie

norddeutschen 1870. Wagner, sicht

theilweise

Rucksicht

das

System

auf die und

Freiburg der

zation

Henry and

Recht

umgearbeitete

und

und

Parker.

The

Federal New

York:

1865.

Leipzig:

Voss,

Bankacte.

Zettelbankgesetzgebung,

auf

unter

ein Handbuch

Errichtung das

. . .

Herausand

der Peel'schen

des Zet-

yon Zettelbanken

in

Staatspapiergeldwesen

im

Buchhandlung,

mit deutsche

vervollst_indigte

Buchhandlung,

Operation.

Banken.

i. Br.: Wagner'sche

White, Horace. Monev and Banking ed. Boston: Ginn, 1914. Willis,

den

Zettelbankpolitik,

geltende

Br.: Wagner'sche

et al., 1863

Zugleich

Bankreform

Bunde.

Adolph. auf

der deutschen

Operation Hearings

Kulturgeschlchte.

Credittheorie

auslandischen.

Currency.

1931.

und yon

Government

Svstems.

Michaelis,

Lehre

Wagner, Adolph. Die Geld- und Vienna: Braumuller, 1862. Wagner,

Office,

Otto

zur

and

Banking

Volkswirthschafl

Julius

Washington:

on Banking

Federal

Government

Vierteljahresschrifl

3 vols.

besonderer

Ruck-

Verhaltnisse. Ausgabe.

2.

Freiburg

i

1873. lllustrated Reserve Ronald

by American System: Press,

Histo_,

Legislation, 1923.

5th

Organi-

• OS

Willis,

THE RATIONALE OF CENTRAL BANKING

H. Parker,

and John

can Post-war versity Wilson, 1847.

Problems

Press, James.

M. Chapman.

Situation:

New York:

Ameri-

Columbia

Uni-

1934. Capital,

Currency

Wolowski, Louis. Les Banques Paris: Guillaumin, 1867. Wolowski,

The Banking

and Developments.

Louis.

La Question

and Banking. d'Angleterre des Banques.

London: et les Paris:

The

Economist,

Banques

d'Ecosse.

Guillaumin,

1864.

Index

Aldrich-Vreeland Act of 1908, 165 Assignats (France), 28-29, 33 Aubry, Maurice, 97-98, 103 Austrian National Bank, 115 Austrian school, 125 Ayr Bank, 26, 27

Banking

Bagehot, Walter, 22, 23. 103, 133, 134, 136-144, 170

130 Bankmassige

Balance of payments, 83, 134 Baltimore Plan (1894), 153 Bank Act

125, 172-174, 184 Bank-notes cover for, 118-120, 123, 124-126,

of of of of of of

1694 (England), 1709 (England), 1825 (England), 1826 (England), 1833 (England), 1844 (England), 68, 88, 142, 189

14 13 23 18, 27, 72 18-19, 23 4, 21-22, 23,

of 1875 (Germany), Bank Charter Renewal 18-19

i I

t

t

cover,

118-119,

124-

129-130 of U.S. National banks, 54-56 See also Bankmassige cover, Money; Note circulation; Note clearing; Note issue Bank of Breslau, 62 Bank of England, 18, 37-38, 136

68-70 Act (England),

foundation and early history, 11-14, 25 as lender of last resort, 17, 22,

Bank currency. See Coin; Money; Note issue; Specie Bank failures, 5, 26-28, 81, 106, 108109

118, 123, 140 monopoly status of, 12-13, 2124, 71, 88-89, 135-136, 139 Bank of France

Bank for International Banking, international. Settlements, See Cooperation, international Banking

i i I [

school, 80, 89, 90-91, 100, 112, 115, 117, 127-128, 144, 171-174, 184, 193 Banking system, mixed, 111-112 Banking versus currency controversy, 21, 88, 144, 171174, 175 Bank law, 9, 10, 43, 47-50, 52, 129-

Banking

Commission 134, 136 reform 166

(France),

(United

States),

192

133-

attack on, policy 35-41, of,93,36-38, 96, 9740 discount founding and activity of, 29-32 monopoly

for note issue of, 32-35

Bank of Indiana, 52 Bank of North America, Bank of Ohio, 52

164-

_09

42-43

210

THE

Bank Bank

RATIONALE

of Savoy, 38-40, of Scotland, 25 See

Bank

also

Royal

of the

96, 102

Bank

United

of Scotland

States,

rate runs,

Enqu_te,

Banque

Generale,

Baring

crisis

Berlin

(1890),

m the 154 See

Bonnet, Boom

75, 76,

96,

Trade

banking, 64, 100

130,

148-

John

Cazsse

d'Escompte

crisis;

62,

45-47, 112,

47,

for,

118,

on,

Palmer

105,

184-187

136-144 of, 168-169

123,

111

17, 22,

140-143,

165,

186,

20-21

on,

weakness 139-143

19-20,

22

191

16

System; Central

Charles

Commerce,

school,

126,

Salmon,

123,

6, 105,

112112,

145 of England),

11

53-54

Checking

system, 164 Chemmtzer-Stadtbank,

18, 79, 121-122,

Chevalier,

92, 95-96,

103,

fixed and floating, 90-91 real opposed to artificial,

role,

171, 177, 180, 184 Henri, 103, 105-106,

I1 (king

Chase, 29

of, 135-136,

Government

Reichsbank banking

113, Cernuschi,

144

59, 67-68

of system

See also Bank of England; Bank of France; Federal Reserve

144

Capital

127

160-161

Juglar on, 111-112 as lender of last resort,

56,

192

125,

52-54,

151-153,

in Prussia/Germany,

28-30, 36 Caisse des Comptes Courants, Call loan market, 157-159 Canada,

120-121

cooperation for, 3, 190-192

Loyd

report,

do

58,

of, 46-48,

191-192

Economic

Elliot,

95

bank

113, Calrnes,

of, 15-16,

house,

theol\v

Committee

92, 94,

international potential

National

British Linen Company. 26 Brussels Coriference of 1920, Bulhon

Specie

as clearing

103

99-100,

Gold;

suspension

Bagehot on, characteristics

83, 119,

18, 25, 31-32,

Hubert,

105,

113

in the Umted States, 92, 147, 151, 157 Brasseur,

84, 85,

banks

See cycle

See

arguments

era,

Act; State

\qctor,

Central

52-56,

States,

economy.

Branch

40,

Greenback

Bank

flight. outflow

U.S.

94,

cycle

suspension

137

59

United

Inflation,

78, 81,

system,

also

170

134,

also

Carey, H C., 44n, 81-83, Cash payment, 34

144

question,

deposit 130

Investment,

28

Bills of exchange, 172-173

Bond

133.

102-103,

Kassenverem,

Bnnetallic

See Capital

17, 51, 108,

Banque

of, 82-83,

Trade

See Discount policy 15. 19, 28. 33, 97. 158

Bankruptcy,

BANKING

scarcity or excess 98, 109-110

78, 92

First, 44-46 Second, 46-47 Bank Bank

OF CENTRAL

62

Michel, 107-108,

110,

Cieszkowski, Auguste, 93 Clearing House Association, Clearing-house

banks,

53

134,

100144 160

INDEX

Clearing-house 162 Cobden, Coin,

loan

Richard,

certificates,

160-

Currency

bills,

Commercial crisis

crisis.

165 See

Economic

Currency

See

Bank

law Currency

arguments 85-88,

for 92-94

in France,

and

30,

against,

Convertiblhty 108,

Free

95,

Coquelin, Coullet,

100,

Deposit

89,

14,

3, 190-192 112, 103,

Depression

144 95,

144

Discount

Jean 103,

23, 26-27, 49,

deposit

system,

See

Trade

banks,

cycle

Economic theory

29, 121 wqth

free

effect of, 102-103, m France, 29-30,

156-158

97-98,

G., 4, 35, 93, 105, 107, 110,

33-34

banking,

in Prussia

for, 58-59,

effect of over-supply 83-84 expansion also control

automatic

61-63,

in the

49

United

of, 33-35,

m England Banking

98, 138 Gustave,

Etienne,

Economic causes for,

197-

200

crisis of, 6-7,

91, 109, in 1802

the central 168-169

bank,

Crodit

Mobtlier,

37-41

Cre.dit

mobilier

concept,

95, 105

98

of, 15

school

mechanism

States,

65,

Rediscount policy See Specie

Puynode,

Duran,

95,

134

m Prussia/Germany, 68-69, 97-98

Duopoly, Du

134-135 35-38, 40,

102-103,

See also Dritteldeckung.

60-62

by

24, 35, 88-89,

system

Discount pohcy connection

144

demand

Credit

18-19, 66-67,

economy.

crlsm,

105-106,

16-17,

States,

Coureelle-Seneuil, 94-95, 100,

See

8-9,

58-59,

115-116

United

112,

banking,

Checking

82, 93-94,

in England, 79

fl)rce,

banking

120-123 See also Bond

banks

Coors Credit

193

43-44,

103,

Charles,

m the

school, 21, 80, 91, 112-113, 127-128, 171, 174-176,

controversy. See Banking versus currency controversy

Money

Paul Jacques, 113, 133, 144

Counti\v

123-

26

international,

Paul,

115-118,

135-136

versos

trade

Coin;

Cooperation, Coq,

4, 80,

principle, 73-74, 112, 173, 175

also

68, 74-

39

in Scottish banking, Wilson on, 88-89 also

128,

189,

Competition

See

doctrine, 126, 118,

law.

Economic crisis 1, 8-10, 28-29, 55,

I

75

17, 107-108

See

Crisis See Currency,

96n

Commercial

Company

II

9-10,

22-23,

(France),

in 1825 (England), in 1836, 19 m

60, 63, 66

1839,

19

in 1847,

22

75-76,

124-126,

82-84, 136,

194

30 17, 77,

97

90-

_12

THE RATIONALE OF CENTRAL BANKING

Economic crisis (cont.) m 1857, 22, 37, 52-53, 65, 123124, 162 in 1860, 161 in 1866, 22, 143 in the United States, 68, 151-163 d'Eichtal, Adolphe, 145

99, 102-103,

113,

Free-banking school, 6, 27, 42, 99, 104, 112, 115, 119, 171-172, 184, 187 Free trade for banking, 4, 80-82 movement for banking, 72, 80, 93-94, 114

60, 66,

principles of, 72, 80 Fullarton, John, 193n

Feaveryear, A. E., 12n, 22n Federal Reserve System, 6, 164n, 166 Fiduciary issue, 21-22, 104-105, 112113, 124-127, 130, 136, 174175, 189

Gallatin, Albert, 16, 43n, 44n, 46, 48n, 78-79, 84-85 Garnier, Joseph, 95, 144 Genoa Conference of 1922, 191 Gerstner, F. A. yon, 114, 116n

Financial crisis. See Economic Trade cycle theory Franco-Prussian War, 67

Geyer,

Frederick (king of Prussia), Free banking arguments 176-185

crisis;

58

agaunst, 74-77, 80-81,

arguments for, 81-83 Brasseur on, 99-100, 112, 144 Carey on, 81-83 versus central banking controversy, 3, 5-7, 35-43, 139, 176-188 Courcelle-Seneuil on, 110 Gallatin on, 84-85 m Germany. 114 Hildreth on, 81 Horn on, 107-110

Philip J., 66n, 91, 123, 125128, 136, 145, 193n Gladstone, William, 23-24 Glasgow Gold

Bank, 27

effect of discount rate on, 134 in England, 16-17 fixed versus floating price for, 136 flight of, 68, 74 in Germany, 60 Gold reserves, 18-19, 27, 73, 77, 135 Gold standard in free-banking system, 135-136 in Germany, 68 Goschen, George, 24, 134-135, 144 Government bonds (France). See Assignats Government role

Hubner on, 114-116 Longfield against, 85-88

in banking, 6-9, 12-15, 76-77, 80-81, 93-96, 133, 195

MacCulloch against, 74-77 Parnell on, 72-74 Tellkampf on, 116-117 Wilson on, 88-90

in France, 28-36 in privileged central banking, 22-23, 58, 108-109, 115-118, 124, 139-141, 170, 175

See also Note issue; Plural

in Prussia/Germany,

banking system Free-Banking Law (New York), 51, 56 Free-banking party Bankfreiheit, 62, 64, 66-68, 128131 in England, 72

57-69

in Scotland, 26-27 in the United States, 42-43, 5356 Governor and Company of the Bank of England, 12 Greenback era, 53-56

INDEX

Hake,

A. Egmont,

Hankey,

195n

Thomson,

Lasker,

24,

102,

134,

de

Hansemann, Hart, Albert

David, 64n G., 196n Ralph

Hayek, Hildreth, Hoards

190-192

A. von,

Richard, theory,

112,

Laveleye,

Law,

190

81

John,

crises. Trade

Inflation,

See

ratios.

tender

currency,

54-55,

152-153

of last

145

123, 192

cycle

Economic

crisis,

104,

177

York

Interest rates. See Investment, 82-83,

Discount policy 94, 109-110

Italy,

41

exclusion

47

18-19

in Prussia/Germany, 67-68 in Scotland, See

also

58-59,

17, 25-26,

Country

banks;

72

banks;

Six-partner

Joplin,

Thomas,

17, 71-72

Juglar,

Clement,

111-112

63,

(Lord),

Insurance;

Loans

120-121

to Government 15

of England,

to Government to Government

of France, 34 of the United

44-45,

53

172-174 an XI, 30

business,

Lombard

loans

62, 69

as note

cover,

Longfield, Mountifort, 128n, 133, 145 W.

Loyd,

rule

119

85-88,

122,

57n

S. J. (Lord 80,

12-

Overstone),

20-21,

145

MacCulloch. John Ramsay, 13n, 74, 75-77, 80, 85, 88, 141, Keynes,

John

Kindersley, Knies,

Maynard, Robert, T., 190n

Laisser-faire Landauer,

principles, Carl, 184n

MacLeod,

191n

C. G. A., 128-129,

Koopmans,

190

Theodore,

38, 89, 130,

145

Mannequin, Marqfoy, Meulen,

101

Henry

134, 136, 100,

105,

72, 145

Dunning,

144 112,

144

Gustave, 96n Henry, 195n

Michaelis, 4, 57, 71,

118,

191-

18, 72

Lombard

Lotz, Private

186,

83, 95, 116-117,

Credit;

short-term, Loi du Germinal

of, 13

in London,

33,

17, 22, 47, 165,

penalty,

States, Jackson, Andrew, Joint stock banks

Reserves

59-60

resort,

also

Liverpool Loans

State

103,

15-16,

140-143,

Liquidation

Insurance, 50-51 See also New

See

14, 25, 43,

See

154,

104

100,

119

theory

12, 91,

95,

28

Legal

Liability, Industrial

157n L. V., 102,

reserve

Lender 114-116,

144

Leipzig Bank (Saxony), Lemaitre, L., 92n

107-110.

144

Otto,

Emile

Legal

193

Holland, 41 Horn, J. E., 16, 91, 95, 103, Hubner,

128,

J. Laurence,

de Lavergne, Leonce, 113, 145

G., 141,

Friedrich

Leopold,

Laughlin,

143

Hawtrey,

Z1

Otto,

121-123, 180n

66, 67, 124,

130,

68n, 145,

119-120, 176,

I114

THE

Mill,

John Stuart, 193n

Mills,

102,

134,

R. H., 132-133,

Mises,

RATIONALE

137,

OF CENTRAL

142,

145

Ludwig von, 4n, 145. 176, 178n, 187n, 190, 194-195

Modeste,

Victor,

105,

Monetary

disturbances.

Monetary

pohcy,

under free 194-195

New

central

9-10,

28-29,

108,

ballklng,

theory

See

Assignats:

Currency, Legal

tender

See

also

59, 74-75, 126-127

currency,

of Bank 88-89

of England,

of Bank

of France,

conditions

for

Note

Specie

140-141,

Montagu,

12-13,

72,

100

107,

167

and

and

(United

Exchange

(Bavaria),

States),

quanoty

Bank

Gunnar,

of, 127

clearing, 26, 46, 49, 73, 79 cover. See Bank-notes

Note Note

exchange, issue

26, 32

automatic check on of, 85-88, 121-122, exclusion

denomination

with

expansion 124

from, size,

12-14 15-18

of, 8-11

by Federal in France,

Reserve, 28-35

166

41

metal

over-issue 33-35,

59

banking,

Note Note

in Italy

banking

119 2, 20-24

development with, 108-109, 124, 139 for central bank as,

in State

62, 64-66,

circulation

bank of,

143,

129

velocity

25, 27

98,

53,

191

in unitary or plural 132, 137-138

bills,

maintenance

52n,

of, 50-51

tn England,

143,

79 privilege rationale

Myrdahl,

Fund

Normatlvbestimmungen, issue,

banks, 105-106

134

m, 43, 47-48,

120,

business

among Scottish argument for,

52 Mortgage

banking 56

Norman,

Corn,

Commercial

Lombard Monopoly

102,

State

Normatrv-Bedmgungen,

of, 72,

40, 103,

13

Bank, 23-24 178-179n, 182n,

William,

York

Safety

Fiduciary

market, 151, 162

(England),

133,

Nlemeyer, Otto, 191n Norman, G. VV., 72, 79, 80, 84, 145

172-173

quantity

Money

Provincial Hans, 145,

3, 190-192

84-85, also

Debt

54-56,

184n

Money bank-notes as, 107-108 coin or metallic, 104, 105 paper,

Act (1864), 157-158

National Nelsser,

Newmarch,

126-127

international.

Bank 146-147,

National

126 7

and

National

BANKING

backing,

115-116

problem of, 26, 28, 30, 73-76, 79, 85, 109, 133,

135 190

in Prussia, 123

58-59,

in Scotland, Napoleon

(emperor of France), 30, 36-37, 40, 97

Nasse,

Erwin,

124-125,

139n

29-

or

69, 119-

25, 27

in the United 56, 148 unity

65-66,

States,

plurality

43-44,

54-

in, 5, 10, 96,

INDEX

99-100,

105-106,

125-126, 167

128,

See

also

issue; stock

redemption;

Prwileged

Note

18n,

Quantity

188n

Raguet,

Bank

runs

Real

See

Paper

currency.

Paper

money.

See See

72-74,

79,

Reflux

135

Peel,

Robert,

Peel's

Act,

22, 27, 67, 68, 80, 113,

117,

118,

101,

189

118,

Chester

134-135,

136

Competition; Note

crisis

Political

Economy Bonamy, banks

m England,

Club, 90-91,

cover 157,

170-

140,

161

of, 106 9

on,

74-76,

86-87,

124,

135,

161

111

Free

poohng

of, 140,

in specie,

(France),

32-35

72, 134 133-134,

14, 16-17,

20

Reserve

118,

161

37, 53

systems,

Restrictionist 144

of, 113,

legal ratios, 154-156 metal, 19.34, 61, 97

issue

of 1848

172,

19

drain

10, 96-97,

also

118,

cities,

fixed proportion 171

banking: Political

Price, Private

or

centrahsation

A., 181n

banking system, notes of, 108-109 See

166

principle,

equalisation,

Reserves cash,

Pigou, A. C., 187n Pitt, Wilham, 14-15 Plural

Bankmasstge

of notes

policy,

of currency, Edmund,

Phillips,

See

92-93

See

Reflux

centers

Reserve

138 Philipps,

banks

130

171

Fiduciary issue 38-39, 40, 97, 98, 103,

83-84,

doctrine.

of notes 174

Reserve

124-126,

124,

See also Bankmasslge Reichsbank, 69-70, 128

22

Peel system. See Pereire brothers,

Country

principle

76, 77, 134,

bank,

of money.

Condy,

cover,

Bank-notes,

Patterson, R. H, 102, Peace of Tilslt, 58

100,

theory Money

Rediscount

Henry, 144

See

Bank, 61-69, also Reichsbank

bills

Money

Money Parnell,

Central

22,

72n,

Panic

See

banks.

Prussian See

issue

19-20,

60-

26

banks.

Provincial

54, 56, 73,

See

58-59,

Government role; Monopoly Protectionism, 9, 81, 167

Reserves

J. Horsley, 61n,

banks,

Greenback banks; Note

49-50,

of notes

31-33

m Prussia/'Germany, 62, 65-66, 69-70 in Scotland,

Country

redemption, 75, 178-179

Palmer,

m France,

136-142,

Bank-notes,

Fiduclarv era, Joint

Over-issue

121-123,

133,

Competition;

Note

2 15

19, 21,

school

106,

(France),

Rossl, Pellegrmo L. E., 93 Rouland, M., 36n Royal

Bank

ot' Berlin,

58-61

139-142 93

_16

THE RATIONALE OF CENTRAL BANKING

Royal Royal

Bank of Scotland, 25 Commission on Banking and Currency (Canada), 192

Saint Simonian

movement,

60, 101

Savoy, 38-39 See also Bank of Savoy; Credit Mobilier Scharling, William, 170n Schumacher, H., 57n Scotland bank failures in, 26-28 banking system in, 6, 26, 71-73, 78, 82, 89, 117, 128 )oint stock banks m, 17, 25-26 Scott, Walter, Silver, 60

27

Six-partner rule, 13, 17, 89 Societe d'Economle Politique,

Tellkampf, J. L., 66n, 68n, 103, 114, 116-117, 123, 125, 126-128, 136, 145. 193n Tooke, Thomas, 72, 80-81_ 128, 144 Trade

cycle theory,

6-7, 83-84,

95, 192-195 Treasury bills (England). Tunnage Act, 12 Turgot, Anne R. J., 28

88,

14

Underconsumption theory, Unit bank system, 146-166 Unity/plurality arguments. issue

125 See Note

U.S. National Monetary Commission, 162, 165-166, 183n U.S. Treasury,

48, 54-55, 162-163

95

Specie cover, 61n, 62-63, 69, 130 hoarding of, 33 outflow of, 15, 20-21. 37, 68.83-

Vergeot,

J. B., 101n

84, 111 reserves. See Gold reserves; Reserves Spencer, Herbert, 133 Sprague, O. M. W.. 156n, 160n State banks in Prussia/Germany, 59-60, 6263 in the United States, 43-45, 4748, 55-56, 147

Wagner,

State (Government) paper, 119 Suffolk Bank (Massachusetts), 49, 53

Wolowski. Louis F. M R., 93n, 95, 101, 102, 103, 107, 108, 110,

Specie

Suspension

laws, 47-48

Adolf, 114, 117-118, 128131, 144, 188, 193n Warburg, Paul M., 165n Weslau, O. E., 195n Wilham IU (king of England), 12 William IV (king of Prussia), 61 Willis, Parker, 163n Wilson, James, 88-91, 94, 117, 132, 133, 144 Wirth, Max, 119

113, 134, 145

This

book

national

was

designers, Aldus,

different

two

design

famous

type hv

eccentricity

ters,

with

"Type

is the

Book

family

exquisite

fusion

design

by

Typography

primary each

between

Sources

Shepard

and

bound

by

Stevens

and

is never in a working and

Strohbach,

typeof

New

York,

Chevy

with

Chase,

Publishing

York

Maryland Corporation,

Company,

are

let-

To Zapf,

Service,

Indiana

Wisconsin

single

text.

New

the

innovation

reader."

Communications

Worzalla Point,

first first

All of his typefaces

author

Research,

by

in Nurem-

his the

distinction,

other

Poorman

distinguished

later,

services by Harkavy Publishing New York, New York

Primary

spent of four

letterforms

in 1918

typefaces,

concern

Indianapolis, Printed

born

years

quiet

elegant

Bodoni,

forty

ten

introduced.

by Hermann

by

than

1940;

Melior,

Zapf

as a family

The

was

was

with

tie or ligature

and

Zapf

design,

Zapf's

their

Editorial Index

in

Book

Inter-

typeface

Palatino,

Hermann

italics.

Melior,

of more

marketed

without

matching

Hermann

Designer

Palatino

but

with

for the

foremost

of Optima,

typefaces, ITC Zapf

of Walbaum,

was

characterized

creator

developing

refinements.

Germany.

face

The

designed

of the world's

acclaimed

of type

blend

subtle

berg,

years

weights

an artful

many

other

a typeface

by one

Zapf.

many

than

Book,

Corporation

Hermann and

more

are

set in ITC Zapf

Typeface