THE RATIONALE OF CENTRAL BANKING

A Liberty Press Edition

Vera

C. Smith THE

RATIONALE OF CENTRAL and the Free Banking Alternative BANKING

PREFACE BY LELAND

B. YEAGER

,'7/

Liberty

Fund

Indianapolis

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 Publisher's

by

Leland Note

B. Yeager

xiii xxvii

Foreword

by Vera

C. Smith

xxx

Introduction Universal cussion banking" the acceptance in recent times of central Meaning examples banking Lack and problem of dis"free of

of "central" The general

Historical

responsibility

of banks

in trade

cycle

causation.

II

The General tion early

Development in remarks England on the banking; discussions Alternative business in the

of

Central origin the of the note of the and in the issue_ note its relaissue in suthe of early in N

Banking

to deposit banking

priority policy, of trend countries period: was

and forms

its partial in evolution

persession note-issuing banks period which tion The tion more sults

organisation England: circumstances

General leading

of issue

of freedom the nature in the Bank and

Second of England in return consequences War of the

the founded;

its accumula the Government intervenacquired the reto bank; gold

of privileges

for financing period; modern the

of Government Bank central

Napoleonic

characteristics of "legal tender"

character
v

of notes;

began

vi

THE RATIONALE OF CENTRAL BANKING

be concentrated the The greater banking as in the of gold serves banks; on the Bank was

in the looked for

Bank

of England; as the "lender

as early of last third provinces; in London

as 1825 resort" period deposit as well of

upon joint

agitation freedom opened country reserves

stock issuing

banking; in the

for note to free

competition tendency

Increasing and then

to centralisation of banking note-issuing its influence period after re-

to centralisation joint banks centralised stock Fourth to acknowledge

Antagonism the Bank's operations consolidation

towards reluctance of other of the

1844;

systems.

II1

The of free

Scottish banking Development in

System beginnings . The introduction and in 1845. success Legmlative of interference Central

25

Monopolistic

IV

The

28

Banking Development Law's riod of the notes

France of banking retarded by the assignat banks of France rates low of The by the experiences Short restitution on of inof pe-

and

then

regime The

of freedom the monopoly to Bank

for note-issuing of the discount the rigid Bank keep

Pressure Period departmental events

creased banks,

liberalism; but under

establishment restrictions adopted the

of 1848 pressure extreme new The policy

Complete on lack The {the policy Bank the Bank

centralisation prolonged facilities by the Bank inertness an attack controversy upheld.

. Treasury The in the rate)

suspension kinds

of banking adoption previous provoked of Savoy

of all of

provinces The

of France discount

of a discount

on the The

Bank

of France

Banque

Enquire--

centralisation

The Organisation Decentralisation Misleading Developments interpretations

of Banking in without Freedom The States; Bank prevalence

America: of North America

42

in the

of restriction

CONTENTS 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.

vii

57

viii

THE RATIONALE OF CENTRAL BANKING

VII

Discussions Subject Prior Discussion Liverpool cussions defence and at

on

the

Theory and

of

the

71

in England to 1848 not the prominent Political banking on

America

in

England stock Club

Joplin banking mechanism

and Dis to ex-

the campaign

for joint Economy The

Parnell's

of free

clearing

MacCulloch's pansion fects ones; tages policy quent no the

attack

free

banking because as well

tendencies the gold

become

cumulative banks

drain expanding

af-

non-expanding note holders banks emphasised of notes

as the

small

should in a crisis the

be protected; and as regards effectiveness

the advanreserve of the freprovides

of central Gallatin exchange

G. W. Norman--this in step to the consumer school, Carey and Condy it; rule

check

if all banks trade

expand

S. J. Loyd--the that competition although banking recomwas was the not also

banking is wholly

is an exception to the banking writers,

beneficial of the banking

Tooke, opposed free Raguet Hildreth,

an adherent The mended so free

American

for America; towards

favourably

disposed Longfield's is no of the check defence

Gallatin that James

reprehensive mechanism capitulation

argument to expansion; of the Scotch

clearing re-

Wilson's

system.

VIII

The

Discussions

in

France

and

92

Belgium Influence America The quelin, Politique; necessitates low discount tiplicity case that for of literature The royal on the development of banking in prerogative argument--Cieszkowski Cod'Economie plurality; The mulreal the The it

rise of free banking Du Puynode the

agitation--Courcelle-Seneuil, in the Soci_te

Debates

Pamphleteers interlocal rate raises school--the

The exchanges difficulties d'Eichtal;

case against (Victor which Aubry

Bonnet) provide

Pereires,

of notes

unity--Adolphe

Brasseur's notes had been

argument exagger-

the difficultj'es

of scrutinising

CONTENTS

ix

ated lier, basis tants the

Competition Mannequin

in banking Limited

demanded plurality on

by

Coq, Chevadispubefore de

a departmental

proposed by Lavergne The Wolowski versus Chevalier Banque Enqu_te attacked and of the The the Modeste central

most prominent The evidence school of free notes by

anti-inflation group bank case

Emile bankers

Laveleye Cernuschi Summary mary

inflationist attacked banking

in general Sum-

Coullet

of the flee banking Chevalier,

case by Horn Courcelle-Seneuil bank between

Later

publications argu-

of Wolowski, ment system banking for

Juglar's

a central schools.

clearing

within the free,

a competitive banking and

The

connection

IX

The Foreign erature ing there dom ing

Discussions influences in the 100

in

Germany Gerstner Hi_bner's currency Rise support doctrine issue of German of free litbank-

114

via von and

'fifties percent

The should along from

Tellkampf: or real free freebankof

be either Scottish banking

unity lines and school

in the note standpoint Michaelis;

Wagner Otto

supported The

the

Kongress

Deutscher the legal banking credit again trade change merely argument doctrines Wagner's

Volkswirte framework Michaelis'

formulation on deposit for checking doctrine of modern banking; banking issue

of free banking; automatic The by 100 Geyer;

emphasis

mechanism percent support control resort currency his anticipation

expansion represented cycle theories

Nasse's from better

of central for central the note

of emphasis because

argument

it would lender and

to

for the of Geyer change

of last Tellkampf

Critique and

of the Knies

Wagner

of attitude.

The

Post-l$4$

Discussions

in

132

England The absence of discussion Spencer in the French 'fifties except for R. H. in the 'six-

Mills and

Herbert

influences

THE RATIONALE OF CENTRAL BANKING

ties

The by

English the Bank

reactions

to the The

adoption Economist

of a discount and Gos-

policy chen; Guthrie's

of France; Pereire

support attack versus

of the issues

doctrines of England The general

bv

Patterson; attack of J. S. and question

on the Bank by Phillips plurality

monopoly; evidence Commission reserve of central central school to the

on fiduciary unity Mill's hot's the Table banking XI Discussions Foundation System The American

Bagehot's to the French single theory between currency Prior

memorandum analysis of effects of the last banking in of

. Bageand free

of the resort" versus

system banking versus

"lender and

of cross

groupings

adherents. 146

America the Federal

Reserve

system

at the between

beginning the

of the

twentieth system and

century

Differences proper by

American of branches; encouraged notes

free banking deposit get loans sequent deposits flexibility pensions American issue, system out

(a) prohibition issue credit public which

(b) bond banl_ with instead to of insusthe in con-

of note deposit

for preference, wanted

difficulties Long-run

if the trend

in the note issue of redemption The

Short-run with of

Sluggishness of cash system were reserve

Crises deficiencies inelasticity

payments attributed policy,

to the

of note

to inelastic of reserves house

and to lack of economv to remedy and by the latter Tt'easury

the use clearing

Attempts certificate,

by the relief

loan

The need for a Government fiscal agent check collection The 1907 crisis and land Act to provide emergency Swing currency

The high cost of the Aldrich-Vree The work of of

the Monetary a permanent Xll The Tbe ences

Commission central banking in

of opinion

in favour

institution. of Central The main systems differ Mo167

Arguments acceptance between

Favour

Banking

Reconsidered of central central and banking free banking

CONTENTS

xi

nopoly banking cludes central banking

of note defined a general bank keeps

issue

and

centralisation enforcement of the policy The to legalised

of reserves of obligations gold standard, dependent bankruptcy closely case

Free prebut a Free on

Strict can the resort banks'

abandonment

movements connections versy up small cies The with note

in gold with free holder

reserves the banking

tbr and against-currency necessarily controbound of the tendenbankers they there how that profit that

versus is not

banking school argument

thesis

banking

doctrines The

Protection comparative

to expansion drain

Arguments affects

of the central whether that

an external or not tomatic can are causes lender no

all banks

expand is an aufhr this there motive for a to

Argument mechanism conservative all banks of last

of the free of control argument banks

bankers

via clearings; of central because bankers the

be sustained;

to ioin in an expansion resort Application notes and

Argument arguments banking tendencies

of these

the cases ern

of (a) small

(b) deposit and

Modin the moneremarks in causing ex-

arguments of central policy;

for central banking: tendencies Future

banking la) pursuit

theory tary

of a rational Final systems

(b) international policy

co-operation of the two Tendencies banking.

on comparative disturbances tension

towards

of control

to deposit

Appendix: "Automatic Bibliography

On the Working Mechanism"

of

of the Credit

197 Control 201 209

Index

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 experience, systems have continued work to perform of James Bu-

as well

as the

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 system of a centralized of competitive monopolistic banks sketch book. how reform. The Rationale of Central Banking as a at the University of London the supervision of Friedrich Ph.D. degree in there 1930. in 1935, She School of A. Hayek. having enwith all banking possessing Smith, some current on system equal and rights a to the of

trade" (p. 3). After a biographical leading on them Vera money themes and and Smith of her consider banking wrote

of Vera I then they offer bear

I survey embroidery issues

doctoral dissertation Economics under She rolled received as an her

undergraduate

studied

Hayek, Lionel nis Robertson; assistant. a group nowned

Robbins, T. E. Gregory, J. R. Hicks, in 1933-34 she was Hugh Dalton's not only who, Smith to the like school's herself, faculty were the

and Denresearch but also to re-

Thanks of students economists,

to become London

experienced xUi

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

xv

Vera

and

Friedrich

Lutz

were

both

prominent

members its president membership

of

the Mont Pelerin Society, and Friedrich was from 1964 to 1967. The Society's international consists ness mainly also. of scholars It was with but the includes purpose people established liberalism. on several Policv Firm of the under

journalists of fighting works,

and busiof socialism Monand The by

the leadership

F. A. Hayek

in 1947

and revitalizing classical The Lutzes collaborated etarv Theory Mrs. ment An and Lutz Analysis Foreign alone and of Investment include Central (1962)

including (1950) Books Market written

Exchange

in lta(v (1951). for and the

Ita(v, a Study Planning Theory

in Economic Experience

DevelopEconomy: (1969). Be-

of the French

sides writing many articles on money, credit, lic finance, the theory of the firm, economic economic lated books planning, by and the labor market, Oskar Wilhelm Ropke,

banking, pubdevelopment, Mrs. Lutz transand

Morgenstern,

Fritz Machlup from German into A central bank, as Smith notes, development. bears serves banks special as banker and It originates privileges for the monopolizes through and or

English. is not a product government and the for the

of natural favors Typically, ordinary of paper and it

responsibilities. dominates

government

issue

money. From this and characteristics bulk form of its country's a large portion

privilege derive the of a modern central gold of the reserve, cash and reserves

secondary functions bank: it guards the its notes though obligation this off the gold and deposits banks. of ordinary

It is constrained than competing notes typically redeemable. suspends

under a gold standard, banks would be, by the When payments unable and goes

less tightly to keep its obligation, standard, it

to meet

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

RATIONALE

OF CENTRAL

BANKING

safe note size and

only

if its notes suspended.)

remain

in circulation over the

even volume

with

their

redemption

Control

of its own over the system banks. profit-

and deposit issue gives the central or scale of the country's money over the bank general on may credit the aims originate situation. and touches

bank power and banking of central owned

Smith A central

origins

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 privileges shows and similar motivations position at work of a central or override its central banks System central ordinary for notes. to to the nowand feasible allowing no re-

dominant

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 banks currency, is supposed during lending to come them shortages of reserve its own

the Federal Reserve of last resort," the rescue funds freshly and of the issued scramblings bank

to the

Disregarding narrow profit considerations, use its influence over money, credit, and serve public objectives such as, before

it is supposed interest rates 1914, keeping

country's currency firmly on the gold standard and, adays, resisting inflation while promoting production employment and banks compatible). banking, to operate as and Smith even defines to issue it, is a regime bank notes under Free (to the extent that those objectives are

strictions beyond compliance (pp. 169-170). A bank may permission capital, has the terprises. and same Its if it can win rights notes show and are public

with general enter the field profit prospects, in itself to pay,"

company law without special raise and sufficient its notes. business It enin

confidence responsibilities "promises

as other

redeemable

PREFACE whatever dard, this gold). gold tion the basic money might be (under is gold or instruments redeemable points could them out, keep declared "A general under irredeemable legal tender. declared to meet lose all is inconceivable these notes Any

xvii the gold stanat full value in of the in circulabank susand of its their conditions"

As Smith standard No bank having by

abandonment

(p. 170). pending liquidated, creditors. investment. Smith France,

redemption its assets Stockholders reviews Germany, the in these whether and

would be being applied would banking the

bankrupt the claims or part of

histories United

of England, States. She also

Scotland, surveys

and

controversies century, over sponsibilities

countries, a central

mainly in the nineteenth bank with its distinctive reor, on the contrary, of central of Italian rather than be notes, left free a review

powers

is desirable

private banks might advantageously domination. (She sets aside, as she and Spanish writings.) She reviews by topics, presumably gether the arguments menting Smith on page on each other's according currency of either are the theory from cross-groups 144-145)

by countries

finding it convenient of writers who were writings. into four camps acceptance writers

to group tolargely com(as in her of the table doc-

to their school central mainly 1820s of

trines of either the and their advocacy ing. The first the two monetary accepted wanted behave banking trines debates

or the banking school banking or free bankassociated money and with British school generally currency

schools

on. 2 The

quantity

to make a mixed system of gold and paper currency much as pure gold money would have done. The school about accepted bills," doctrines about tinged with fallacy, the doc"real accommodating 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

RATIONALE

OF CENTRAL

BANKING

of money,

even

over

the

business about versus 176): of the schools. (1987)

cycle,

to changes

in the

supposed needs of trade, and reflux of excessive bank notes. The tinct, ditional banking (1984) and controversy says Smith and to and Anna over (pp. currency Schwartz categories school, is that British independent free

a supposed central it raises points Both have

automatic is disadby collapsed the White

banking arguments disputed Lawrence since

171-172,

Smith's four the currency explanation sively with

into three: the and the banking and Schwartz

free-banking school, school. Perhaps the dealt almost excluSmith extended

White

controversies,

whereas

her study to the continent. Few writers hered to the currency and free-banking Smith did find at least the Germans Otto Huebner, man Henri the Austrian Ludwig in that von position. Mises,

seem to have adschools both, but Michaelis and Otto and the says French(p. 176),

Cernuschi

As she

theirs could be a perfectly consistent aimed at checking fluctuations in and credit. Historically, connected and was with support the for central currency than

position so far as they the volume of money was the more closely school,

banking with

banking

the currency school's claimed as a victory school placing and inflationaiLv claims that provided came for even

success in theoretical for central banking under ideas, that are they suspicion, on the bv notes emphasis including bank issued

controversy as well. The especially banking-school denial of the of on term in

free-banking France, ideas, quantity in excess

so much

theory

cannot way

be issued of loans

appropriate kinds (p. 172). The banking school placed bankable assets. Smith repeatedly evidently "bankwise bankmassige Deckung, able. Literally, it means idea that a bank's

ill-conceived uses regarding cover" should the

emphasis German

it as untranslatand refers to the be matched by

monetary

liabilities

PREFACE holdings "real-bills liquidating the very would goods few of suitable doctrine," commercial or months. assets. were and marketing Banking match to market. the These, according quintessentially industrial conducted money Besides loans, on supply overlooking school general of additional

xlx to the notorious short-term, selfloans goods such to the the ignored overissue disturbing that the assets might to finance within a principle supply fallacy of of a

production properly coming

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

the banking short-term

the point of bank business currency

be quickly remedied without It was just such disturbances at preventing (pp. 173-174).

aimed

The supposed principles of bankable of automatic reflux of excessive notes validity not other (p. 174 apply and and competing applied banks' the later to a free-banking system. posed by demands in chapter to a centralized restraint The

and especially have a certain but they would involves on each balances and not a dediffer

system,

difference of claims clearing

for settlement adverse

XII). In practice,

a centralized

fiduciary centralized greatly Smith mise view

note issue constrained by a fixed limit system with gold convertibility would in their interprets results. Walter Bagehot Britain's as adopting banking

a comprosystem anom-

(p. 143). He found

alous-not what people would from scratch. But it existed, and of it by Bank hold clearly recognizing accept its adequate of England reserves concluding

have deliberately designed Britons had to make the best and having the and responsibilities them. Smith reconsiders free banking. superiority of a dogma accepted of was

its weaknesses attendant especially, for meeting

In her

chapter

the main arguments This reconsideration central which without banking never question over again

on central banking versus was necessary, for "the the came alternative up system for discussion in all the and later

became

or comment

foundations

xx

THE

RATIONALE

OF CENTRAL

BANKING

central ments,

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

ill

Nowadays, central fortable Before ponder

furthermore, banks jobs. what are valued to specific calls

it seems

reasonable

to suppose and reform,

that comlet us contro85to 1840, volone on,

for providing issues "by

prestigious

turning

of monetary most

Smith

far the

important

versial point 88, 177-185, Mountifort imagined ume bank

in the theory of free banking" (p. 88; cf. pp. 197-199). She attributes the controversy Longfield, who, of two and expands holding demanding expansion in an banks equal its loans article gold and of February doing note the issue. same Now Later reserves. initially

a system

of business aggressively

as the public starts after the monetary has caused selectively tion. This the gold present demand reserve

gold, let us say for export and resulting price inflation deficit, the public will not guilty bank both banks. did not for redempAs a result, its note

a balance-of-payments the notes of the falls, rather, on of the bank that

increase

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 moderate To its aggressive may rival be driven aggressively a country will suffer depression, expanding to contract to a country's this argument and interpretation argument, expansion moderate group to expand even further. altogether, or many The unnoteexwill bank out of business in self-defense. with several

less it too expands generalize: banks and by quick issuing citement gain and

under alternations of business of high and low prices. A bank during as the the prosperity in her she by one will period could concluding says, group cause is that panic arrives.

most being

of excitement A system scarcely chapter; here. it overand be

more injurious devised. Smith some One looks flaw how examines restatement

may

be in order of banks

in Longfield's continuous by the

contraction

an increasing

xxii

THE

RATIONALE

OF CENTRAL

BANKING

proportion of the gold banks' reserves, which ate banks have been minor return

outflow to impinge will be exhausted driven flaw flow out of business.

on the expanding before the moder-

A relatively stress and their val on the

in Longfield's to an expanding as its borrowing of the argument

argument bank customers neglected of loans, of the

was

his

of its own repay the lag an interexpanding

other banks' loans. That the notes during which would

notes strand and

between bank's at the

granting

the

repayment amounts be presented

increasing nevertheless

for settlement the the other borwill If It will at the

clearinghouse. Longfield's argument considers only for redemption of notes. It overlooks bank loans. has to them banks demand from over with redemption depositors system, its own the the rest, clearing of or from no bank counter. balances process.

Furthermore, public's demand incentive banks' rowers pay return one each notes out the them bank repaying notes

as it receives of rival issuers out

In a competitive through

to their

expands

of step

clearinghouse will go against its rivals in settlement. This earlier begin stage to than the reserve external drain

it, and it will lose mechanism would drain almost of gold; the

gold paid to work at an bank would (a point

suffer

immediately

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 Smith's two kinds note issue. brings bank to mind notes and one distinction between Pasof a by acreto the checking accounts.

discussion of money,

sively and at least temporarily, the ordinary transactions member of the public will thrust onto him notes issued banks counts. ceived, banks besides which thev are his own. promptly will quickly drawn on. The same deposit be is not true or cash for routed of checking any checks payment He will

PREFACE If money gold bullion, consisted perhaps, exclusively serving of checking as the were in the bank out be reserve accounts and

xxili (with redemp-

tion medium) and if all payments clearing process would operate way. checks any mand Unlike would bank for some be expanding deposits portion promptly in it would of

made by check, the tightest conceivable substantially settlement; with punished accounts, clearing only continue would the all and deand then, profor

notes,

presented

its business

of step

promptly

restrained by adverse clearing balances. The coexistence of bank notes with bank somewhat cess. tion. Surely, dilutes or delays return notes free with the relax banking discipline to their the but Not all notes quickly

of the issuers

for redempslightly. reto concontinue particuto send in other

though,

discipline operating

In an economy spects as it does sist of checking routinely lar banks, notes One

today, most money would accounts. Retail merchants cash receipts would have the clearing

depositing their each of which banks leading

in their own an incentive process. assessment

of other of the

through issues

of monetary

and

re-

lorm concerns the monetary implicit in Smith's work and major of free starting banking. point for the

standard. This was clearly has in recent years been the of interest in the question

revival

Many questions suggest themselves: money unit be defined? Should the dollar with able bank larly, kind the money, all other in gold? with under kinds Should the instructions of money the unit money directly be the the dollar managed price

How should the be defined in gold, redeemfiat central Simithe stable? of government by level

or indirectly

supply to keep

what should the of money in which redeemable? States at all--and any United

base or dominant other kinds are (Federal central Reserve bank Is it necessary

money be--the denominated and notes fill this role any and manage in it? to have base

ultimately money

nowadays.)

to issue

xxiv

THE

RATIONALE

OF CENTRAL

BANKING

Nobel laureate authorizing the linked ably and free well with have George banking as

F. A. Hayek (1976, issue of competing him. (1988) propose which either amount D.C., for Books survey freedom would by

1978, 1984) has proposed private currencies. Ideas dissertation Lawrence history be and to issue presumWhite (1984) of as notes theory

his supervision influenced Selgin and

of Smith's the

of banks probably

deposits,

denominated

and redeemable money, whose enth entirely annual in Washington, to ideas

in gold or in government base would have been frozen. The sevconference of the 1989, Cato was reform Institute, devoted along held almost private-

monetary

in February radical

monetary

enterprise lines; and a book of papers from earlier conferences (Dorn and Schwartz 1987) contains much discussion of similar themes. An idea (1983, or exerting that any seems special promising bar the control to Robert over might quoted, to replace the new the Greenfield from money issuing and and me

1989)

would

government

money banking

system. But the count in which counts unit. kept, which and

government prices are so forth, dollar promote

define a new unit of accontracts written, actoday's unit unsatisfactory fiat money. by employing The it in

is the would

bill of government

government its own quantity value, dle ble

operations. of gold. however, and

The unit might be defined Because of gold's probable a unit defined would by some possess services a more services money

by a specific instability in bunstanearly

comprehensive

of goods

purchasing power With the government be free new unit. to keep probably to issue Each its notes take

over goods and barred from notes bank, and place and faced deposits not with in the

in general. issue, banks in would and ser-

would this have would

deposits redeemable. actual

denominated Redemption goods

competition,

vices defining the amounts of some

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

PREFACE

xxv

probably

designated

securities.

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

A., and

Anna

J. Schwartz, Press,

editors, Chicago,

The 1987.

Search

fi)r

Stable

Money,

University

of Chicago

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, 1984. Greenfield, Robert L., and to Monetary Stability," 15:302-315, Gusman, Ente... Haberler, August 1983. (1912-1976)," famosa coppia in di Leland B. Yeager, "A Laissez-Faire Approach Journal Qf Money, Credit, and Banking,

Rosaria Giuliani, "Note Bio-bibliografiche Einaudi, 1984, pp. 89-110. Gottfi'ied, "Vera e Friedrich Lutz. Una

economisti dei nostri tempi," in Enle Hayek, Friedrich A., Choice in Currency, Occasional Paper 48, London, 1976. Hayek, Friedrich A.. Denationalisation Economic Affairs, London, 1978 Hayek, Siegel, Friedrich editor, A., "The Money Future in Crisis, and School,

. . . Einaudi, 1984, pp. Institute of Economic of _donev, 2d ed.,

47-53. Affairs, of N.

Institute in Barry Company,

Monetary Pacific Ballinger

Unit of Value," Institute for Publishing School,

Public

Policy

Research, Cambridge, Schwartz, School,"

San Francisco, Mass., 1984. Anna The J., "Banking New Palgrave,

Currency

Free

Banking Stockton

A Dictionary

of Economics, Rowman Neue

Press, New York, 1987, vol. 1, pp 182-185. Selgin, George, The Theory of Free Banking, Totowa, N.J., 1988. Velt-Bachmann, graphie, 1987, Verena, vol. "Friedrich 565-567 Banking m Britain, August 15. pp.

&. Littlefield, Deutsche Bio-

Lutz,"

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

Cambridge

University Dis-

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

Publisher's

Note

The and

publisher Mr.

would back into

like

to thank for their Their

Mrs. help

Brenda

K. Fowler their has sisbeen

A. _A'ilson-Smith

in bringing assistance

ter's book invaluable. The in 1936 subtitle reflect

print.

Rationale and the

of Central and and Banking

Banking

was

originally _*e have to more

published added adequately set the type. the

by P. S. King the Free breadth LibertyPress

Son in London. Alternative of the we have spirit edition, work.

For this

newly

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 as they has been were in the original. enhanced. The bibliography, Citations in the

however,

significantly

original edition have provided

included only full bibliographic

last name, title, and year. We information. For their assison American, we would like White English, to thank of the UniUniversity v. Klinckfull index

tance in providing French, German, the following

this information and Italian titles, Professor

scholars:

Lawrence

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

Foreword
[to the Original Edition]

This the

essay

is a study

of the

historical Banking,

and the

analytical reasons

bases why

of the

development

of Central

note issue was of laissez-faire

made the exception to the general application principles, and why Central Banking was to "Free and Banking" with competition for the of London. De-

adopted in preference in the note issue. It has gree been submitted

approved in the

as a thesis University

of Doctor

of Philosophy

My grateful thanks are due to Professor F. A. von Hayek, who first suggested the topic as a subject worthy of research and ish some London October 1935 gave Library of the me valuable advice the and on many occasions. given Science I should Britin obtaining like also to acknowledge of Political less easily assistance Economic me by the

accessible

material. Vera C. Smith

xxix

THE RATIONALE OF CENTRAL BANKING

CHAPTER

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

THE

RATIONALE

OF CENTRAL

BANKING

teenth the tem not take. were cerned, gory. possible willing was some

century as it stood

(at least and after the

up

to 1875), United

again,

most

especially the

on syswas

Continent seriously

in the

States--in of the Bank that date--it the banking

England, was

passage after of form

Act of 1844 system

challenged as to what sort

still a matter should and politics were concatethe with

of dispute

It is notable that at their height banking Even the was most

when laisser-faire so far as other already regarded doctrinaire

theories industries free-traders,

as in another

exception of Courcelle-Seneuil in France, were unto apply their principles to the business of banking. It contended regulations, take has that that banking must what an open paid be the precise question subject form of special although remained been we these for sevlitin

widely

regulations should eral decades. Very erature system little to the attention

in modern rationale

economic of the particular in evolving,

consideration

of the have

of banking

succeeded

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 fathers gland, is, moreover, with which is surprisingly responsible one of the controversies among our fore-

this generation, more especially unfamiliar. Neither do we find for introducing have central any clear

in Enthat the into of idea

authorities

banks

countries previously without them the benefits-to'be obtained therefrom. It is the that have banks ing eventual to a free and such purpose in the motives. decision banking of this past led the An system

essay to investigate to the establishment theoretical of a central foundations of the in most

by

the motives of central underlyfor the as opposed a combihis "Geldwert-

to discover

examination reveals

reasons

in favour

banking countries
Mises in

'The only stabilisierung

recent challenge und Konjunkturpolitik,"

zs that made 1928.

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.

THE RATIONALEOF CENTRAL BANKING banking is concerned, drawn at a comparatively established, quoted by was never interest, every example system is of particular practically conclusive of the as the functioning the broad outlines early date, and verv seriously the of readvomember of the they because

So far as English were quite clearly the system, system once Scotland was threatened. Scotch the markably

free-banking

school

successful

cated. The United States of America were likewise cited by the protagonists of the central banking school as the clearest disproof rather ries of the practicability later of moves than England banking and system. countermoves of any in finally such and before system. irrevocably went at last France through deciding was a sein adopting

a centralised favour of the the discussion more many of the

Germanv

same plan in 1875, but to consider Germany to consider a unit was practically the closed till 1871. The

here it rather distorts as a whole, and it is States, since Gertime theoretical discussion

appropriate did not form subject

separate

by 1875,

by which

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

to assume a far points of interest to of the the United be concenat variand, manplace in the phe-

later in the debates preliminary Federal Reserve System. chronological development

banking systems of England, Scotland, France, States and Germany, our main emphasis will trated ous secondly, on those stages which facts, refer firstly, which mark and aspects the between monopoly to other

choice

competition, of Government in general. treatment economy causation cycle versus of the lies of the have

agement and interference in banking The chief interest of any theoretical of the part nomena to consider evolved banking of booms some by the system and in the to play depressions. theories in the Free general in the it may be assumed of the

We shall of trade Banking

occasion causation Central

disputants

INTRODUCTION

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

I!

The

Development Banking

of Central

in England

It posit

must

have

been preceded and

generally the in the early

true issue

that,

chronologically, At least this and at Hamburg

dewas Am-

banking

of notes. banks

so in England sterdam. with the deposit they

But banking development coin and bullion something

in general only became important of the issue of notes. People would with a banker more such readily when in exchange as a bank-note, which could be ariel- the bankers banks by cirto leave book-entry. great part of

received

originally in the passed from hand had large won sums the their culating Moreover,

form of a mere receipt, to hand. And it was only over that could to confidence the public security lend was out

public notes

in the of a mere any

persuaded

on deposit bankers

on the

only

what was dei_osited with them if they could pay out notes in case depositors should suddenly want more cash. And so it was to be that when those most arose, strongly the advantages where then, here of deposit the most the that that use the banking rapid of bank earliest under first strides came were generally recognised, countries widespread. issuing, and it was

made by had been It was problems ened most

currency banking threatthe sys-

in note

Governments

to establish 8

monopolies

THE DEVELOPMENT

OF CENTRAL BANKING IN ENGLAND

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 of notes, credit. Assuming countI\V'S alternative a) It may it also

THE RATIONALEOF CENTRAL BANKING controls, a paper though currency less rigidly, the volume adjunct of to a three

that

is a desirable

commercial development, ways in which its issue be subject delegated to the

we may conceive may be undertaken: control of the

exclusive control

State; private number

b) It may be institution;

to the free

of a single of a large

c) It may be left to the of banks of issue. The forms. latter system It may mav of a single be entirely control

competition

private over

institution it either

may of the by taking

take State,

various or the in in

independent

exercise

a share

its capital and thus entbrcing its will through its representatives on the directorate, or by subjecting it to the dictates, matters when the of general system policy, is nominally of a Minister free from such of Finance. State a right control, will

Even howbe very

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

may varv in the nature of the legal it functions. There have been adwho have favoured certain special clauses a single from the of concase it of inand before period

of a free

regulations; a well-devised Again trolling where certainly we

others have company should has the

assumed that the general law would be sufficient. the case mixed but where system an absolute monopoly in which

distinguish

instittltion it is the centre holds

of a so-called major power, bv the some

in which its monopoly

is to some extent qualified other institutions exercising side narrower limitations. We swings 1875 can under roughly four

existence of a number of the same functions the course of banks was of events

summarise in the phases. evolution The first

of policy

of issue

a preliminai[v

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

1l 1

when were because of the either

banks were theoretically they legislative absolute were

only just beginning to emerge, and at liberty to form freely even if it was not yet obtrusive authority. In the extent enough second qualified, to catch period, was the

they only eye

monopoly, dominant. and increasThe tourth either centralisawith differFrance historto our what to be when ab-

or to some

The third phase was characterised by plurality ing liberty, but by no means complete freedom. witnesses the return the to restrictions lines of a mixed or less and monopoly, with solute or along tion of control. This scheme system,

is more

representative,

ences as to dates, of the course of events in England, and Prussia. Scotland and America fall outside it. Let us now ical topic. later fhcts turn to the more detailed that other account are which of the relevant produced sense are century, of banking a model development with tor England, many

We commence became

countries.

The origins found in about merchants lion with ing interest rates, higher

of banking the middle

in the modern of the seventeenth

took to depositing their balances of coin and bulthe goldsmiths. The goldsmiths then began offeron and deposits, the since they they could gave re-lend them at receipts in acknowledgment thus equal and the in II

of the deposits arose a number

began to circulate of small private on the issue control. English

as money. There firms, all having of notes banking, unrestricted dating from

rights, and carrying free from Government The second period

in

foundation of the Bank by an event of a rather had had to rely from to a very the London on loans

of England in 1694, was fortuitous political nature. large extent bankers. He ran heavily

ushered Charles needs into

for his financial

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

RATIONALE

OF CENTRAL

BANKING

provide destroyed

a substitute that

for the

sources his

of accommodation Government fell

thus in with

William

III and

the scheme foundation and Company

of a financier by the name of Patterson for the of an institution to be known as the Governor of the Bank of England. Its establishment many clauses minor event, the Exchequer of was of as

described by the _nnage Act, among the which its incorporation looked an absurdly being of the The favours with "for the better raising sum of 1,200,000." early history of the a needy In the amounting first between a capital and Bank paying was into

a series and the and same This

of exchanges an accommodatwas same founded sum

Government instance, to 1,200,000.

ing corporation.

Bank

was

immediately lent to the Government was authorised to issue notes to the den issue of so many of a currency and extended its capital notes the and produced

in return the Bank amount. 2 This sudusual the Bank, issue, accompaallowing and also

all the In 1697 of the its note

niments renewed

inflation. therefore

Government

privileges

it to increase

giving it the monopoly balances by ordering Government that the the the ture added provided that must no be other considerably

of the possession that henceforth paid bank through should to its prestige.

of the Government all sums due to the the ever Bank, Further, establish a provision it was itself also by

method of acquiring a special Act of Parliament. Lastly, Act stated that no act of the Governor and Company of Bank the of England particular of the was private to subject and a clause or make personal which liable property bestowed to forfeiof any on it which for an-

member

corporation,

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

was a favour associations new

not

just

about

this

time

that

the

type

of business
to this amount.

2 In practice Feavearyear,

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

restricted

THE DEVELOPMENTOF CENTRAL BANKINGIN ENGLAND entity known as the joint stock and it was therefore an obvious the Bank's sort which business of was already privileged in this respects Accordingly, monopoly association. company step in the type when was taking reinforcement it with

IS hold, of some of

position particular

to endow to the in 1709

of organisation, old forms the Bank's

in so many

superior

charter was renewed, in return for a loan specified notes This issuing that no firms at demand payable effectively business,

besides allowing to the Government, of more joint than stock with note or at any since banking time

it to raise its capital the relevant Act might the was issue noteheld before other less firms than from days from six months.

six partners

excluded and, synonymous

in those issue,

to be practically

banking

business altogether. More than the application of the prohibition than the issue of notes was In 1713 for a loan loan were

a century was to pass to banking business into question. again resources

to be called

the charter was further renewed, to the Government, and as the to be obtained by raising

in return for the the

additional

capital,

Bank gained at the same time the right note issue. The 1742 renewal reaffirmed clusive banking business," and was the now customary out interest. After ministration renewal 110,000. 1781 fited the from the and no the beginning charter ordinary of the of its charter There was the less same than of the short-term course of the loan transaction, 1751 the Bank was National Debt.

to an increase in its its privileges of"exaccompanied by a loan withwith the adfor the 1764

again

this time entrusted In return

the Bank paid the Government another renewal and another in 1800. In short, century times by the of England, between the Treasury this, by successive 3 and given transactions. 1694 had

a fee of loan in and the of apart Bank in bene-

nineteenth seven Bank

renewals quite the

accommodation of its daily

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

14 The result

THE RATIONALEOF CENTRALBANKING of the accumulation of an arrav of privileges and prithe by beBank

was to give the Bank of England influence in the financial world vate pete banks in the to experience same lines

a position of prestige such as to cause small in continuing and in London

difficulties of business, had that

to com-

majority of private about 1780. A further gan to adopt the

note issues effect was

been abandoned the smaller banks balances beginning from on the our Bank, with the

practice

of keeping

of England, which the characteristics The view, of the because period not torce the only

was thus already of a Central Bank. is interesting it provides pressure consequences

to acquire point example but also polof

1797-1819 because of Government ultimate

an outstanding of the Government's

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. Now to the the Bank Act of 1694 had without the forbidden express it to make authorisaneverat the as for it had

advances

Government

tion of Parliament. For a long time theless been advanced on Treasury Bank. doubtful; made such that time came The legality so in 1793 of the this Bank practice

small amounts had Bills made payable had for been the regarded loans to the Government

applied liability

a Bill indemnifying in the past transactions they should to insert

it against

and giving it legal authority in the future, on the condition, be kept the below limiting a certain Parliament, clause, figure. but so that to comply

to continue however, Pitt lost no very the usefully Bank with beGov-

in getting henceforth

the Bill through virtually

neglected ernment borrowings exchanges tion, asking and Pitt

compelled

requirements had become and the seriously Bank down

to any amount. By 1795 these so excessive as to affect the foreign endanger his the Bank's to the on the reserve Bank, posiand at appealed demands Government

directors

to keep

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

15

the What

same

time

it contracted however, was

discounts to take

to private all possible

customers. steps to facil-

Pitt did,

itate the of small sued issued junction pension

Bank's lending to the Government. The old dislike notes was thrown to the winds: 4 5 notes were isfirst time in 1795, and of that 1 and small year, of the 2 notes the were in consusThis notes.

for the in 1797 with

in order another payment

to provide measure in cash

currency namely, Bank's

of the

suspension of cash payments was procured ment by Act of Parliament in order to meet tion in which had the action Bank was faced weak by a "run" reserve it already ernment's an extremely amounted

by the Governa critical situaat a time The the of when Govbank-

position.

to a legalisation

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 a discussion of the contribu-

tion of causes other than Bank's difficulties before the expansion of credit take under Government itself deal with must a cause, with these also have other

the Government borrowings, to the 1797. Let it suffice to remark that that the pressure weakened since causes, Bank was forced to undermust, besides having been the the whatever Bank's method cause capacity of dealing it arises, of the increases notes tender to 1812, had curbut peracto

an outflow of be a contraction

specie, from of credit.

Throughout pound after in bank rency. since haps cepted for all practical They

the period of the rapid depreciation 1800, when there were phenomenal for war purposes were finance, the Bank character so declared of England of legal prior

credits

not officiallv

they were taken in all Government partly out of patriotic motives, at par.
of notes for less

payments, and they were usuallv Government

been forbidden

Finally

in

1812

the
1 had

declared
In 1775 and the

4 The issue issue of notes

for sums less than than 5 m 1777

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 fell 16 percent. conditions in 1819 the Bank of

resumption of cash payments its shares The return to more or less normal brought with it, already, a tendency

to regard

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 and Ranking System of the United States,"

Banques," Papers,

1866, p. 301. Reports from

Committees,

1819/'

Vol. III.,

Re-

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

17

small notes,

since

the Bank did not issue notes

below

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

RATIONALE

OF CENTRAL

BANKING

the

foundation

of the

National

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

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

19

Bank

Charter

accorded

the

permission

for joint

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 der and (except County by Bank.'" made Bank) tendency Bank for sums towards in the of England above The making hands notes result the legal of this metallic Bank tenwas reof the the 5 so long as they The should serve 1833 Act also their reserve followed of London, by the London and the Lon-

maintain a single

convertibility." system

to strengthen

of the

England. Gold still had to be kept times for making payments below heavy banks were mate it was the demands, paid demand not practice presented, a very especially or their for gold of keeping in times out Bank of England deposits fell on the the greater

on hand at all ordinary 5, but in times of extra of panic, when their the and banks country notes ultithis in the From reserves own

notes Bank step

withdrawn, of England. for the they way of their

tar or unnatural at the Bank necessary. only 1836 the of the about and last three banking

to adopt

part

the form of balances Bank notes whenever came country, Between of issue been that the had formed the holder but also 1826 been during and 1839. Governor not and

to which In this gold (cash) of these years,

looked to get the Bank beof the stock seventy it was the 1_ and
companies;

reserve reserve. joint about and

whole banks had crithe

lim-

of the tounded,

a hundred

on these Horsley

opponents then

of a freer Criticism

banking came Bank

system especially of

blamed from

ses of 1836 Palmer,

of the

England,
liability

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

unlimited 1858

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. Causes and Consequences of the Pressure on the Mone

had been _t was not it granted 3 Market,"

20

THE

RATIONALE

OF CENTRAL

BANKING

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

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
13 Report 1831-2. the

the Bank
of the

had, during
of Secrecy

the years
on the Bank

under
of

discussion,
Charter,"

Committee

England

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

of Mr Pressure

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
_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

tion year

_2 the fixed reached rights were right

THE RATIONALEOF CENTRAL BANKING to issue, case the to lapse by, their in were absorbed but at period the the just maximum average preceding if they bank, the or Bank limit figure the of the their Act, issues issues and with, voluntarily was to was had their or

in each

altogether another and

amalgamated if they of England

renounced

rights,

acquire such rights to the extent of two-thirds ised issues of the banks concerned. No new quire rights of issue. the position the "lender It would, 1839. to be the it was of the in some issue Peel's much for rendering and situations

of the authorbank could ac-

Horsley Palmer now invoked what Bagehot later christened, grounds Bank ket occur 1857 Bank was the paper Bank on the for opposing in a very in times was, and from naturally Act, limiting provision of England only would as 1866 the difficult like 1825, render events crises Peel's position 1836 such proved, showed when

of the Bank of last resort" he said, aid hope less always and that Bank, the the was put that likely The to exempt clause to the

as, as the marhis to

Act."

measure

unfulfilled.

1847, ready, the of the to

Government necessary, Bank quarters of the Act,

occasions expressed the having could

provisions

opinion a mere

fiduciary

no practical always rely

application, since on the Government

legalise a breach tion. The relations were, Bank, thing in fact, or other the

of it every between too the

time it got into a difficult posithe Bank and the Government long established support for either to envisage to the Bank the anyin

a tradition _public, than full or

Government,

Government

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 Bank's were extremely loath to recognise which, as the the re-

of the

position

in a system

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

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

23

sult of a long series of Government it the controlling element in the was the nature of this lysing in his "Lombard Looking knowledge development, quarter the anomaly at the 1844

manipulations, countrv's credit that our Bagehot

had made structure. It was ana-

responsibility Street." Act from

position

of superior

of what were in particular nineteenth of the situation

to be the features of later banking the amalgamations of the last century, it is impossible this Act left to ignore the proin which

of the

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 banks cluded note issue by which from obtained for profits them to combine, because it might to be obtained from the retention of to be greater concern. note-issuing and had than business to pay those joint were corresponto be stock exSecondly,

were joining engaged the

estimated a larger in the

London

market

dents to pay out their notes point in this respect was the had been founded, not like Bank as a London bank

in London. A striking case in National Provincial Bank. This the London and Westminster note issue under the 1833

without

Act, but under the notes. Thus, although from which the was conducted, ing business

1825 Act as a joint stock bank issuing this bank had a head office in London administration of all its branches on any It was bankthese

general

it was excluded from carrying whatsoever in the metropolis.

anomalies that Gladstone sought to remove in the Country Note Issues Bill he introduced in 1865. In return for the removal choosing permissive authorised have the of the disadvantages advantage mentioned above, those (it was banks to be a

to take

of its provisions

Act only) circulation, right

were to pay a tax of 1 percent on their and the Government was, besides, to their issues altogether after ape-

to terminate

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 der the ordinary of partners stage, strength. smaller number ber and after credit went banks The which tries. thev each the

charter was granted: this was to the in 1746. All the other banks formed law. and, joint There after stock The banks; and their was a short came collapse did a great most place companies no into restriction of abuses hands the on period

Britunthe in th_ size

experimental financial of the

banking

of a numin 1772 to the banks stock

of substantial an over-issue out of business or private Scottish early There kept other's balances was very notes; almost with

of considerable of the deal was Avr Bank of damage private by joint little taken

of notes

of the capital certain the

banks system keen strictly

with larger deve]oped it from competition to the practice were settled. the countries,

resources. characteristics in other the twice banks a week branch there rapid was, growth counand and oras clearing

distinguished

systems between made

of regularly adopted and more

exchanges from

immediately other

They a much

ganisation compared of deposit In 1826 (with (with whereas permit time of Englan there

beginning,

banking and there were,

development besides the and was any

of loan technique. three chartered banks joint stock banks banks, passed the up to Bank to that of a eleven only and failure private not even Right in the

twentv-four ninety-seven in England joint stock had only d had yet

branches), branches) legislation banks set been up one

twenty-two

just being

to establish, serious

branches.

history

Scotch banking--the Ayr that the total loss sustained figure The of 36,000. Scottish network

disaster--and by the public institutions,

it was computed had not exceeded free from legisla-

of solid

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

highly developed its freedom ii_om

deposit 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

IV

The

Development Banking

of Central

in France

T
years. and after

.he

unfortunate banking The monopoly G_n_rale bank but

first

experiences given to John

of note in that Law The

issues in

in France for many for his

retarded Banque the

development resulted after firms restrictions

country over-issue Government on other and before with Minister into very The practically Treasury of

1716

in a disastrous five years. on the set up

of paper, therebranches exchange 1776. This liabilrelaFinance. close a branch promise in 1783 The to to its

closed the

raised

formation to carry

of note-issuing

banks,

although business, no bank by

of banking transactions, was ity, From tions of the of an caused exigencies the Caisse, notes in The first selves ment the the with founded

chiefly discounting of issue was founded a partnership the this became, of the frs. and giving French bank came in fact, to the already of forced

Caisse very

d'Escompte, Turgot, and beginning department of 6,000,000 bank in the State on the

limited

Lhe State,

financial advance a "run"

Government. it suspended

payments. heavily in debt currency

of the resulted 1788, and assignats, tender

finances,

after this followed the issued in 1789, which but by short-dated the biens 28 nationaux,

assignat r_gime. were not themGovernwere usually

legal bonds,

interest-bearing

backed

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

DEVELOPMENT

OF CENTRAL

BANKING

IN FRANCE

31

It soon ward, opment at they which apart

became of banking they small

apparent with grew firms in facilities; the

that England

France and

was

extremely in the was so authority the far,

backdevelpace and had

as compared

America, slow where, on exchange Special

particularly provinces

from were

specialising non-existent.

business,

practically

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 Lyons, a very in the also mands serve rights Rouen of issue. and Lille, It set but they up its first were branch offices down in

all closed

after

brief existence, difficult years in favour

because in which of their

they had proved unprofitable they had begun, and it was suppression that their on the the Bank outside liberalism, by the Govof private Banks of But these were business. of dereof encroach by

argued

might, in periods of tight credit, of the central bank in Paris. immediately of the there attempt was a short on the abandonment

Almost France Paris, during ernment

to establish period of

credit

facilities

increasing

which three projects were of the Restoration for the

sanctioned establishment

departmental Rouen, Nantes banks a nature were to

banks of issue. These and Bordeaux, formed to severe any great notes towns defeat expansion

were the in 1817-18. which of their

subjected

restrictions,

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

only for their headquarmentioned in their statbills payable in their own

discount

district; and their times the amount tions inability the title of their

sight liabilities might not of their metallic reserves. to such Their narrow sphere

exceed three The restricand their belied was

operations branches

districts agents

to set up

or employ

almost

"Departmental."

of operations

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

they were, in six additional 1835 and 1838,

3_

THE

RATIONALE

OF CENTRAL

BANKING

and

the

Bank

of France,

now

taking

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 Comptoirs branch of the of the the note Bank Bank issue opened in its was own of course given town. Moreover, for their authoria

of France royale, of the

required

sation only an ordonnance on the recommendation Banque, tain which conduct whereas Act the Comptoir departmental

which would be granted Conseil G_n_rale de la after the 1840 greater over had area the to obover could depart-

banks Also

a special

of Parliament. as a member gave it a great

of a branch advantage

system

business

mental bank. partmental nevertheless, they cant. rendered They

There never even developed among the debanks any system of exchange of notes: the success of these banks and the services to the met with community the disapproval refused So the were far from Bank insignifiof France any more towards brought

of the

and after charters greater

1840 the for their freedom

Government foundation. in the

to grant movement was

note-issuing

business

to an end. The representations to the Chamber of Deputies, sions of the renewal of the asking for modifications of the removing some also unsuccessful.' The note 1848 Bank trend issue

of the departmental banks on the occasion of the discuscharter of the Bank of France, statutes they in the direction were of the of the of contained,

of their restrictions

of policy reached

towards its logical

complete conclusion

centralisation as a result

political disturbances, but the opposition of France to the renewal of the charter in that year makes it practically

voiced by the of the Bank of certain that the

Bordeaux

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 the gone, amount Bank's it did,

THE RATIONALEOF CENTRALBANKING of the of small as we note issue. to pay notes. have Now seen, It had specie that impose been on both content demand, these a limit, to raise to lend but to rely, and checks this on were the on a

obligation

prohibition

Government showed itself ever ready form anv obstacle to the Bank's readiness sury. The difficulties in cash, its bankruptcy, of the which had, Bank been so far

if it should to the Treaits for

of France the

in meeting reason commer-

obligations legalising

had

avowed

as its private

cial obligations were concerned, tion, and it showed itself ready cash ings June, had was payments. at the 1848, arrived to make two time, Bank and But the again scale continued

been of very at an early date Government 1849, sums the its position

short durato revert to borrowunstable. Government the the Bank latter suchad frs. In

at which made

in November, with advances years. to increase it had and of fixed At the end

at agreements regular or three however, frs.),

the Bank

by which during the metal begun of 1849 strong

ceeding received By this (about

permission 400,000,000

its issue a very already

to 525,000,000

reserve suppressof its of a

it had

ing the restrictive measures relating notes, and it would probably have complete resumption had not been for the sury Bank demands believed were its cash

to the redemption decided in favour

of cash payments much earlier if it Government borrowing factor. If Treagoing to continue would at the same rate, the reserve be inadequate. On the the new either of or be

other hand, its note issue very soon approached maximum, and the Bank was faced with the choice applying of reverting for a further to its old increase statutes of its legalised under which

circulation it would would on the only

obliged to redeem its notes and cours force ished, but there would be no legal limitation ume of notes it was allowed to issue. agreement had been duction of the Bank's

be aboltotal volafter an

It was

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

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN FRANCE

3_

safe

in reverting 1850. seen with round

to its old how The about France

statutes, emerged

and

this from

it finally the 1848

did

in

August, cal bank France crisis

We have

politiin

a completely progress 1850 of credit in Paris

centralised, of the brought into

single, greater

monopoly prominence in the for the was contrast country a

of issue.

industrial

revolution especially facilities there the the and

the extreme provinces, spread was corresponding

paucity but even

facilities, most itself. Where had been banking,

of a paper particularly

circulation absence strong with

withheld where

of deposit

England

bankers with had rendered timid provincial

local connections no other service, mind to banking

and knowledge, even if they had at least accustomed the habits. Courcelle-Seneuil,

especially, districts through the their the slowly

stressed of France the local the and had a much

the practical impossibility in the rural of either borrowing or lending, except notaire. Moreover, received in lump their period longer sums as he also the proceeds disbursements meant that pointed of the much they out, 3 sales time were of in in

fact that crops year and over

iarmers stocks

at a particular

to make

more

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 simply for the erful during count torrent
"La

banks went

to deal into now less next the

with hoards,

the

business. and the savings features but by of

As it was, were which controversy nevertheless the the gradual beginnings not

the set

balances the stage pow-

used. in France. very emergence of a disevoked This partica

We have In addition, grounds the policy,

described of the were two commendable

opening

free-banking provided decades the

occasional against
1867.

stringency Bank

of which of France.

of criticism
Banque Libre,"

36 ular of the the aspect nature the very

THE RATIONALEOF CENTRALBANKING of the and earliest discussion object days Government of is explained which banking. imposed French had by had a conception its origins from on in the the

of banking

Right limitations

beginning flexibility d'Escompte cent. The provisionally first 1806 years leon. must standing being rate again to have possible and tract of the short nally strain rationing, order charged policy when credit, doing was until

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 the Government held invariable to 5 percent. conditioned that the at 6 percent, at that Discount by the aim of the and figure, policy claims Bank for until the in

six years it was

it was reduced

in these of Napoof France

was primarily It was his idea be to discount at liberal 4 percent, enough, 1814, the Bank other its loans. of charging when

for all commercial and and he criticised at his in 1807. raised Bank sticky any

firms the It was

of reasonable Bank not for that not the

it was

instance

reduced been the so for

to 4 percent it was of the policy rate, found adopt than

changed It seems as far as

to 5 percent. to maintain in both to extend conceivable 4 the for some on

a stable

for it was almost that a lower of

directions, or to conmeans price months bills of it

it necessary

it would

adjusting

In 1819

it adopted rate

(4 percent)

date (having less than thirty decided to reduce all rates it kept or the rate of interest purchase its reserve. to the

days to run) to 4 percent. constant and at for the

before it fiIn times of resorted first time to in in

of specie It was

a premium,

to strengthen

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

OF CENTRAL

BANKING

IN FRANCE

37

1847 that it discovered

the effectiveness

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 rates some tuated oscillate rate. on the weeks much more

THE RATIONALEOF CENTRAL BANKING longer-dated at 7 percent, more or less the bills. and In 1861 from than that with rate big the time the was writings attack quarters Many by of the which rate was and Bank now on held began of England fairly the genBank, for to

onwards

it fluc-

violently

heretofore,

in harmony of bank owing the demand first

In England erally But and sion accepted, in France to establish view

doctrine largely

to the in some of issue. the charter

of MacLeod. for permisadherents the Bank estaba monot oc-

it provoked other banks out that

a corresponding pointed

of this

of France lishment nopoly was cupied sion 1864, the by and more free by

was granted its privilege in France of other banks not by law to give the but in fact to other significance out the only, rights Bank.

did not prevent the of issue, that it was and that the in places given to the

Government

institutions was

Increased

practical it was general and in the new This around

discusin that least the

incidents

arising question perhaps

of the Bank

annexation

of Savoy Not the among brothers,

of Savoy

controversy

came the

to be focussed. most were prominent the Pereire

disinterested participants

discussion type was

founders of the Credit Mobilier. writing, the

of credit institution known a bank which carried out and equities, and

as the undereven di-

marketing

of bonds

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 imitated up similar directly, institutions although outset always the business that proved for the in other the French in Germany. hoped of note had countries. Credit The This MobiPereire to do

independently

brothers had other financial incidentally

from the business

to add to their issue; this was little

a combination as was consist

exceedingly

chance of success, Investments which

by German experiences. most part of industrial se-

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN FRANCE

a9

curities market hold

and except against

which

are

difficult loss of the

to sell in certain prove very very shortest dangerous term,

states

of the to

at heavy liabilities

assets viz.,

notes

payable on demand. The Pereires, however, ity of obtaining note-issuing rights until Bank whole The lished should they voy of Savoy Bank came of free up for discussion in banking the the question treaties that trade

saw no possibilthe rights of the and versus reopened the the monopestabas

oly of the

of France. accompanying annexation same rights of Savoy and to exercise institutions belonging to Savoy in France Bank of Sato establish

individuals under from

be allowed had held concluded

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

branches able on chance. by raise and Bank of the rival. notes count no less bills. lege, fying with France which gain

over the whole of France and to issue notes paydemand. It was here that the Credit Mobilier saw its It concluded the Pereires of the much of Savoy's an agreement were, bank influence alarmed business at by to ten the were with their times in the especially likely the Bank of Savoy to of the amount Bank teatures it a keen

own concern.

subscription, The

a capital was of Savoy Bank

its present

a controlling

prospect

of having to make

as a competitor,

as certain

The Bank of Savoy paid for as low a denomination two-named on 100 Bank obtained Bank than The and the the paper, deposits frs., 5 and of France contractual from the and Government's of Savoy, and had

interest to depositors, issued as 20 frs., and could disthe not only Bank as yet discount on of France issued the notes plea its a letter into three-named of the privisignipaid for

whereas could made

interest

a protest

Government's

obligation Minister then opposition

to maintain of Finance to the Pereire itself

agreement negotia-

entered

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

of its charter m 1857 first took advantage

it had acquired of this in 1864,

the right to issue notes at the time of the Bank

40

THE

RATIONALE

OF CENTRAL

BANKING

tions agreed

with

that

Bank,

as a consequence its claims to issue the

of which notes raising

the

latter for an

to renounce

in return of the

indemnity. This incident,

together

with

discount

rate to 8 percent in 1864, ple to the hitherto rather the into ceived count money lor policy a petition rate by the the market. the of the from on the Bank Its demand pamphlet

directed the attention of many peoneglected subject of the theory of immediate effect was to produce to enquire wrote a redisrea of a Commission of France. an enquiry, Paris that had Isaac and the led Pereire the also raising to the

appointment Bank such 300

demanding

Emperor demanding of the periodic

merchants

an investigation,

grounds of France

turn of crises. Finally the Bank itself suggested demands should be satisfied, so that its position, the attacks elucidated. The Conseil l'lndustrie. did not earlier discussion new and, from policy secondly practically preferable to a plural that were of the du discussions until June, had primarily died being enquiry Commerce opened 1866, two: by down. made was de which The rate bank banks. any against it,

that these in face of might bv et 1865, much the of strain raised be the de and of the for was Bank's

direction Superieur The finish were

undertaken l'Agriculture time problems whether in times of issue Evidence competence its rate was

in February,

enthusiasm of raising

firstly,

its discount a single having

to its old policy whether system all those

of maintaining

invariable, superior was taken to speak majority so the by the

of competing

on the subject. on both issues

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

tar

This may be taken as the practical academic it was writers question. superseded

to mark the close of the discussion issue was concerned, but among it continued at the It was for several of the years beginning a strange 'seventies that

more until

longer,

the bimetallic

coincidence

THE DEVELOPMENT OF CENTRAL BANKINGIN FRANCE Credit the Bank's to lead At the ised same Mobilier, acquittal same the find time the chief should itself into engineer almost in serious liquidation was the in neighbouring debates of the at the only accusation very moment which later. her was on the centralagainst

41

Bank

of France, to its going

of the were

difficulties, a year countries in 1863 consolidating

as France

system, direction.

trend

in the proby in

In Holland

posal to replace free trade in the favour with of the political

the monopoly issue of notes of the note issue

of the Netherlands Bank had resulted in a decision monopoly. was In Italy increased pari

retention of the unification.

centralisation

proceeding

passu

CHAPTER

The

Organisation in America:

of Banking

Decentralisation Without Freedom

The

Scottish

experiences

served

as a forceful school, to have

example

in

support of the claims to American history tunate. The American controversy, it cannot sides in the is concerned, ther. sential banking The It was

of the free-banking can hardly be said case was evoked

but appeals been so forby both

as evidence

but so far as the system as a whole be described as an illustration for eiwithout both freedom; it lacked and the of and esfree the

decentralised

characteristics proper. distribution

of central between

banking the

of powers

Federal

State authorities left in the hands of both. dislike individual of centralised State rights.

legislative control in banking The country started off with institutions Nevertheless, and a jealous the need

matters a natural regard for in

for funds

the War of Independence impelled ment to take the first initiative in the promotion uine early great period difficulty of the Bank need in America's in getting of North for commercial banking industrial private 42

the Federal Governbanking sphere in the The lack at of a genthis very caused an enterfacilities development for such

America.

capital

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 of the organ-

that it was only as a result

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 was that the Bank

47 of the

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

emergency that banks, contribute

might menace its resources early bank

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. Bank sented on the dency gave and The was Bank came

This is a very of the central

of the United States and its twenty-five into conflict with the defenders of State the State banks by their backed the notes up latter and the opposithe pre-

of course chief that

objection

brought

against then

it "accumulated

them Bank orders

for redemption in coin." "War" by Jackson when he succeeded The the first blow was struck deposits for Government

was declared to the Presiwhen removed he to be

in 1829.

in 1833

from the Bank and Shortly afterwards toed. This put central bank. General except

deposited instead in selected State banks. the renewal of the Bank's charter was vefor many of cash where decades payments the banks to all projects occurred again kept for a in 1836, above system of the was State the were of provi-

an end

suspensions England,

in New

water. Probably the worst feature and the one to which, combined entry extreme applied New York. of new laxity firms, with much which banks. granted of the Take

of the American with the exclusion chaos was due, the were of bankruptcy 1828 there

principles before

to insolvent In charters

as an example

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

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 its rights the these rules it still did altogether. were not resume Charters period made allowed completely payment, created to ten it should after days. ineffectual 1828 surrender shortened all the because

unconditional

But in 1837

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 mand, either

THE RATIONALEOF CENTRAL BANKING by the imposition of a percentage tax on the

amount involved or by making the offending the forfeiture of its charter. This latter measure been many culation In other over-issues but to giving event States assets. which bank shares vested the banks ing this the out ceeded adopted the most effective States. deposits. were directed redeemability to the such of giving following practice The if it had requirements most stringent reserve a specie been rigidly also

bank liable to should have Speciin of cirthat

enforced. was

fications Louisiana

as to reserve of the plus requiring

began of these

to emerge against

of one-third

cases efforts and ensuring some the

not to preventing the of notes on demand, note-holder an notes in the a prior actual Several lien on over-issue.

protection

of suspensions

Another measure adopted made bank shareholders to an amount equal

was that of double liability, liable for the debts of the respective of capital ambitious '1 This was unmet banks holdings actually scheme a system liabilities. to the they expense especially basis of on efof parby this where a tendency at the ones, of inwas of The payexof under

to their

over and above the amount by them in the bank. The most York Safety-Fund system. to a fund of insolvent was, weak prudently was merely It also public of the not had scrutiny banks insurance contributions liabilities There more premium but was bank. the and many assets. and of the their of banks against

New paid

compulsory

to be allocated

of course, institutions managed assessed the computed over were

scheme stronger

to subsidise

as the actuarial the fect

insurance risks, of the

on the

as a percentage further the unhealthy issues tempted

capital

of weakening banks,

ticular

fact itself to risk of the safety-fund the solvent

_1Estabhshed

bigger issues. Between 1840 and 1842 eleven banks failed, the fund was exhausted, and had to be called upon for increased contri-

banks
in 1829

THE

ORGANISATION

OF BANKING

IN AMERICA

51

butions. Future contributions vance for charges in respect

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

RATIONALE

OF CENTRAL

BANKING

The

bond

deposit in certain

system lines,

had

the

effect Federal

of tying or State

up

bank bonds.

investment

usually

Mortgage and other real estate too illiquid to provide backing rather culation meant could deeming circulation, doing first them this, reduced securities peculiar depend also that realise their the which their notes bond they their effect of making prices banks, on the while assets

business soon proved to be for notes. It also had the the amount and of the note cirof Federal constituted either the had tied free State bonds. It on other lines, funds for rein of had put the of notes chance they which with

in order banks

to get amount very up

or to decrease deposit their note were capital not was

little

because

in Government

to sell until a feature in comparison

circulation,

at a considerable

disadvantage

chartered banks. perfect guarantee failed, many discount. Parallel a greater other nineteenth with measure century State the

Moreover, the system was by no means a of note redemption, because when a bank stocks beginnings of competition, of State Indiana and could be disposed movement took of only in favour place Early had in at a of the

of this

there Illinois

in some

States

foundations

monopolies.

prohibited

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

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 no ticeable means crisis tional
_a This sion went forbidden

improvement years in the perfect eastern

that preceding at this

took the period, region.

place The but

in American was banking except

banking especially was internapayments

in noby

twenty

Civil War

system for the

of 1857,"

when

suspensions
when 1846 any the penalty Constitution law directly

of specie
of liquidation of New York or indirectly

was yet another to the winds. to the

occasion Under the to pass

for suspenState it was sanctioning

Government

THE

ORGANISATION

OF RANKING

IN AMERICA

5a

were

general

over

most

of the

United

States,

the

situation this ex-

was far steadier than ever before. improvement was not attributable

It is very probable that to any considerable

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 rather lax the days. by thereby is to be which rendered attached in the prescribed This the gave banks on the more enforcement satisfied assets when scope passed and of the if the was law, had and in Comptroller possession them certain was usually bank the the days. the

its own to present visits block law weight specie notes, and The in the the mittances on

prepared bank same The of greater of win-

for his examination

he paid round Much

for a system appropriate rigid frequent of the

dow-dressing was

of securities

for exhibit

ineffective. to the

enforcement

payments between banks by due in great part to the spread to the institution system their North, to keep and of the of the support and in the were, New York Civil War banking gave to the provided the occasion whole to the since North they the water in fact,

exchange of Suffolk system _ change banks ceased net in reliabilbut their posi-

clearing-house) for a radical country. The and a large contracting strong

South

secession had latter by

ity towards they lending tion ever, managed

the banks

lost heavily,

above

operations

in a very

regarding specie from the side of the Treasury from

reserves. Pressure of Governmental Chase the experienced partly

soon came howfinancial needs. excessive as a result diffiof the

Secretary culty very tion.

in borrowing

public,

bad state of the finances Chase called a conference banks, and with

in the preceding of the New York, him they drew up

administraBoston and a plan for

Philadelphia

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.

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

RATIONALE

OF CENTRAL

BANKING

bank check lation, regard The

for redemption on the until really amount it was

and that

there any

was one realised

thus bank that

lacking could

an effective keep in circuto been

presently backing

it is a mistake might have

a security

as good improvement

as specie. that one that the of facilities

substantial

effected through authorities failed for a branch banks were to establish

the National Banking Law was to realise, namely, the provision system. except

banking forbidden, branches.

On the contrary, the National under special circumstances, bond have deposit already again system been to these as a menprobleading

Some of the peculiarities means of regulating note tioned York. lems up in connection We shall Federal have chapter in a later to the with occasion on

of the issues the the Act. free

banking

system

of New

to refer American

experiences

Reserve

CHAPTER

VI

The

Development Banking

of Central in

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 policy of other States. The setting in Germany is dissimilar other countries we have so far considered, 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 tivated time, they the first

THE RATIONALEOF CENTRAL BANKING first steps by fiscal before note-issuing bank consequently of issue were taken by princes and nobles needs, attempted to start banking conditions with of the bank even had been scant business were success was ripe at least was met branch who, mobefore its for it, so far the the been and as The Royal Great. 4 so forlaw of

commercial

concerned.

to prove

at all successful founded this one it not given had also

Bank of Berlin, a State It is doubtful whether tunate certain in these deposits, years _ and

by Frederick would have assigned the

to it by

management

the Exchequer out the whole der The Wars, sanction. from and tain the they Polish paternal first when The heavy were Peace effects

funds. As it began, so it continued, throughof its existence, as a privileged institution unprotection of this difficulties loans later it suspended and were cash of the it made intensified which on in which in close relations with with the State. witnessed payments bank to the took arose in the in the it suffered from These had invested assets Napoleonic Government first place Government, as a recerwere a large Prussia

Prussian away

by losses the bank mortgage.

sult of the proportion completely an enormous

of Tilsit,

territories

of its deposits

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 to the King. existed at this other than the of joint 'twenties two time against the forobstacles that lay in stock organisations banks in set up private of the war of the remained, experiences and was Treasury and the Fiof course, a State offi-

was reorganised made nominally nance Minister, cial responsible

No specific prohibition mation of private banks the way of the all lines of business. In the

establishment

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? CENTHALBANKINGIN GERMANY OF in Prussia dertaking the Berlin Stettin. _ But this when year approval prompted leged Royal circulation the time tended. there made

_9

and broke the monopoly of the Royal Bank by unboth deposit business and note issue. These were Kassenverein and the Pommersche Privatbank at period was the of the not Bank, of relative a complete issue out Government. of regard it must freedom reversal This for money Wars itself was the be noted, came notes virtual interests but to make to an end A law dependent prohibition of the way in 1833, of that on the was privifor the in ex-

of policy.

of all bearer

of State paper of the Napoleonic The Royal Bank of the Prussian of notes. These at the were

which had originated and was now to be included in the

prohibi-

tion; all three up the issue ing came dustrial demand

note-issuing banks increased restrictions moment when about to swell

had to give on bankin inthe

almost technique for credit.

very

changes enormously

About this time banks States: the policy in each Mortgage monopoly desire were tion none in the and to give Exchange note priority of the

were case Bank not

being set up was restrictive. set up in this case notes, of the many

in several other In Bavaria the given there and we find regat least not ento in a a of a as the result

in 1835 _ was of which that

issue, but dread

to Government because issue of too would

in Bavaria, sphere with this

fear

competi-

of note

be dangerous, notes,

accordance

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. The dowed Leipzig with Bank an of Saxony, founded but in 1838, was was

exclusive

privilege

subjected

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

OF CENTRAL

BANKING

IN GERMANY

61

The tion

Prussian news

Government that the on one

was

led out had

of passivity in the the

into

ac-

by the

of its borders

neighbourproject

ing state

of Dessau

authorities

approved

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 private not much This from that bank tainly Bank, banks than liberal less more to work of issue, mere out a scheme for the the interest, establishment idea and the as being adopted Royal of of the Bank. arising scheme of the cerbut, he

Rother academic

dismissed of reorganising

alternative

bank was the deficit was adopted

still handicapped by lack left by the French Wars, was intended to replenish

of capital and the the assets

and so strengthen envisaged a State owing to the lack introduction reconstituted by It was State. formerly

its lending capacity. Rother bank as the most desirable, of funds in the State Treasury, of private in 1846 private given back and share as the the

probably

fell back on the bank. So it was now wholly which partly by it had the

capital into the Prussian Bank, instead of note were of issue grad-

controlled

shareholders right its notes

exercised,

ually to replace the State paper law specified both a maximum metal note as the public i lishing reserve circulation. Royal the transactions. bank and proportion The Bank, bank and to the retained its notes

then in circulation, but the limit to the note issue and a extent the were clause of the of one-third privileges made legal in the banking _ of the held for estabof tender notions it had decree

An irnportant characteristic

_ 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 :_ _ i _ 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 Darmcould obtained in Prussia no orconcession in Frankstadter) be had to set at the time either because up at 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 banks

in the setting up of note-issuing

allowed to retain its interest-bearing deposits.

t_4 was Free slow," Banking and

THE RATIONALEOF CENTRAL BANKING did not Under this and the go far the party enquiry via these positive the side Prussian of private to meet leadership secured into the channels party and Bank the demands of Harkort the banking institution and it gained demanded negative Harkort for the Prussian '-' and being soon and as a half-State passed of the on the of the in the in credit more a

Party.

Chamber 1851--2 conditions public relaxation side tried institution hard removal Some

of Deputies, of a parliamentary in Prussia, On of the standing of the reforms attention.

Normativ-Bedingungen, against in the way

it declaimed

enterprise.

but unsuccessfully did take place

to get legislation in the policy

Normativ-Bedingungen. to adopt a more liberal lending policy its branches in the western provinces. note-issuing numbers, over the and banks their were notes

Bank; it began also extended In the founded began

smaller States in considerable just

to circulate

boundary

in Prussia

Saxony. These tions than the sought ments ony, but

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

to exclude them fi'om its territory by forbidding in non-Prussian notes for sums less than 10 Rthlr. Bavaria and had W(_rttemberg no effect merely because replaced followed the their the banks 1 Rthlr. same against notes

course, whom by 10

the

laws

they were aimed Rthlr. notes. The lution

P_ossian Government was I0 increase the

saw that note issue

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,

and

that

the

deposits notice.

should

not be callable

at less than

two months' i ,_ I :_ 2 :_

effect onthe crisis oftrend occurred, Then the later 1857 of policy.

andprovoked It this had a reaction a marked

against the bank creations of the 'fifties '_ and brought the beginnings of a change in attitude. The Prussian Bank was accused and having good effect discount rate ittoo low before the kept the that came of crisis, of one was the renunciarate percent. tion of the limitation of the of interest to 6 In the crisis itself the bank assumed what had come to be considered the functions reputable firms who nounced, unlimited of a central bank by lending freely to found themselves in difficulties. The in iavour of a Bank was dem twenty. States

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

there were still in 1858 onlv thirtv. Zettelbanken

._,

H Although

66 100 percent

THE RATIONALEOF CENTRAL BANKING specie of the backing border for States the note issue. '4 The small probathe with both prohiwas in of forto a in all

Zettelbanken

were

condemned, attempted business notes the

bly justifiably in many cases, impossible thing of combining note Prussia payments bition bank either eign issue. and Steps were taken The was in Saxony. in non-Prussian of foreign notes

since they had credit mobilier to exclude their Government

Prussian bank-notes. to apply

forbade note-issuing

In Saxony only if the

had no redemption case ineffective notes; all that

centre in Saxony. The law in preventing the circulation was that the notes risk of legal of Deputies the banking for punishment. was by now question, complete ranging to issue unity

happened

went

discount because of the The Prussian Chamber into the many one factions towards extreme over a leaning

divided from notes at in the

full freedom to a preference

for all banks

note issue at the other. The latter was cause of the impossibility of keeping border of policy The gether taken gress States, systematic and Prussia's the separate negotiations States among

as yet unpractical beout the notes of the to obtain met with banking uniformity little success. towas KonDr. question

discussion

of the

whole

with the formulation of a positive up by a private association of free deutscher Volkswirte, foremost among

programme traders, the whom was

Otto Michaelis. ready somewhat any State beginning interest. "'wilden to be

The free-banking (Bankfreiheit) party changed its ground. Bankfreiheit was no longer to a position so prominent of purely relegated

had alwithout and was of the the had by academic

intervention

The Congress opposed Banken'" of the border

the too lax regulations States, but condemned They

over-supervision this time given up vate banks in note

of the Normativ-Bedingungen.

all hope of ever securing freedom issue, and henceforth concentrated

for pritheir

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

THE

DEVELOPMENT OF CENTRAL BANKING IN GERMANY 67

efforts

on trying

to secure

freedom

for deposit

banking,

on a that object issue note-

joint stock basis, people persisted of banking. The was ment swing

pointing out that in regarding note increasing certain of the

it was unfortunate issue as the chief in the its last note

towards up.

freedom restrictions

slowing

It received

practically

acknowledgallowed to now being capital, ten and to fif-

in 1863 when

on private

issuing banks take additional twice the teen deal instead period

were slightly interest-bearing of once the concession

modified; they were deposits, the limit of their was paid-up from extended

amount

of their

years. In the Chamber of Deputies of criticism of the Prussian Bank, right passing there of note issue, the not and the south Where of a Peel's was

there was still a good and most especially of Michaelis was were there recomstill was very com-

its unlimited mending _. In the stringent. ic l_ !f. i: _:

Act for Germany. restrictions monopoly

of Germany

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 was conceded forces with ibr were the the first time. in the of a strong direction bank of securwhich can

Most observers

now

operating

advantages

give further in crisis, The impressed consoliing liberal accommodation centralisation. The a 1866 crisis continual many 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 Bank gained was extended, over of the and banking law the Norddeutscher in all the stock to joint

control

legislation relating

member

States.

A reform

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

on the English Act of 1844, but

and Michaehs

took part in the drafting.

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN GERMANY

69

far tion

more of the

statutory private banks

requirements note were banks was recognised

were for

imposed. the

The

posiof the

as follows:

Thirty-three whole

note-issuing Reich issues a legal against

and no new ones might of all the banks, including maximum, their total its and note issue, issue the

be established. The fiduciary the Reichsbank, were given proportion also imposed. was of one-third bank an issue. howmust only in busithree was If any to acquire

a reserve

relinquished

Reichsbank

addition to the same amount Submission to the terms of the ever, Thus, not certain in the engage torm of a restriction if banks classes wanted of bonds, not

to its legal Act involved on certain to issue they engage having out

fiduciary disabilities, types notes they

of business. trade than old

to continue business; must not bills

in acceptance

might more of the privately

in mortgage

ness, and could months to run. The Bank, Reichsbank which was

discount was

constituted into a wholly

Prussian con-

turned

owned

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 and only not same limitations as in the

case of the private banks, deposits was permissible of the were banks, notes Reichsbank given of any much other to the in that, were wider whereas private place

the taking of interest-bearing up to a fixed sum. The notes made legal than bank the tender, the notes not bank out to stay it was issuing by might to the issuing be allowed this paid but pay bank was the they out or situreof private

circulation a private bank wherein

except

for payment

ated, notes of the Reichsbank might ceiving bank without restriction. A private the provisions note-issuing of the Act, bank but was if it did

out from to have its

70

THE

RATIONALE

OF CENTRAL

BANKING

operations it its right The position

restricted of note of a modern

to the issue. of this

territory

of the to the

State

which

gave the

provisions

Act secured bank.

Reichsbank

central

CHAPTER

VII

Discussions the Theory of the and to

on Subject America 1848

in England Prior

Although ning there the as it did much

the

discussion it never Continent,

of free reached This

banking such may that large have had growth

had

its begindue existed to

in England, greater giving

proportions been always

on the rise

degree

of freedom to a more

in England

rapid

of banking

there than in either France or Germany, less pressing need for reform, Moreover, faire had politics the become had Bank the taken pivot up were its stand and far too nopolies, of England the well

and therefore to a bv the time laisserprivileged of which banking more in conestablished moit to be system

against

easily remodelled, whereas systems were less firmly subject to discussion. The discussion in England nection with ing with the attention was

on the established seems

Continent the and therefore to have opened

the agitation for joint pamphlet of Thomas drawn to the greater

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

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

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 drawn regularly ances. tance check a free keep power much This written in 1827. * The evidence of the the House of Commons Committee his attention clearing practice, to the each he practice notes was of the and

73

Scotch bankers 6 in 1826 had Scotch paying banks the imporefficient that in to its in bal-

other's submitted,

of primary

in a free-banking on the over-issue system its own it was issues

system and acted as a very of bank notes. He contended interests bounds, of each but bank Banks bank also

in the within

not only to exert

in preventing of its paper into

every other circulation.; either banks,

from forcing too will receive every of the

day from customers, loans, notes of other notes return any than

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

of other banks in preference to issuing the notes of the other banks to their bank A receives by such means there more will arise

its own. It will issuers. Now if notes of bank B bal-

B receives

of A's notes, of A, and A will So it is concluded

a clearing

ance in favour of B's reserve.

require to be paid in gold out that if one bank over-issued positive balances its reserve would way of the clearnot on the public's reciproto work external exchange demand

its notes the other against it, and the pull it up ing mechanism presenting cally doing much drain rates. more was

banks would acquire consequent drain on This which control depended by one

in its expansion.

notes for redemption so, and it was a check quickly than one

but on the banks" which was likely waited on the

which

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

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

THE

RATIONALE

OF CENTRAL

BANKING

fence.

The

conclusion

is that if one bank

should

decide

on

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

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 of the Umled

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

beyond twice issues, but he of the note was lar from

the

method

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 tion Lord first

THE RATIONALEOF CENTRALBANKING writer in note trades to give issue seems "The an cannot explicit explanation been of why to competi(later to the commuit tends to and thus being had lowest and howa is i l i

competition in other

be assimilated advantages

to be have

S. J. Loyd

Overstone).

ordinary

nity arising from competition are," he says, "that excite the ingenuity and exertion of the producers, to secure to the price, tions not on to the public and all the public. the evils With best arising respect supply, from will due errors regard quality while the quantity of the commodity,

at the

or miscalculacurrency,

on the part

of the producers

fall on themselves

to a paper is of a very of its amount evil consequence

ever, the interest of the public steady and equable regulation the end to be sought upon the public and upon and this the than or miscalculation portion Loyd, become Norman prominent point

different kind; by fixed law of any greater ''z_ years and error

falls in a much the were less entry same Free issuers.

proto ad-

upon of the

MacCulloch

all in later school surprising into the camp, Trade

members

currency

herents of Peel's them among the trade sides than being one

Act. It is therefore opponents of free Tooke leaders in the of the of the

to find banking be-

it is to find

for he, movement,

was the currency

foremost representative of that school and credit which came to be known This group on the was amount discretion opposed of the to the note issue,

of thought on as the bankof lethought authoriand

ing school. gal restrictions it should ties under mine the views open

imposition

be left to the

of the

note-issuing

the force of the amount. In spite

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 it is sometimes contended for," he said, "I agree

in which

z_From hispamphletentitled "Furthereflections theState ftheCurR on o rencvandthe _ct_on oFtheBank o_England," S57, % p.4_. Z:=At least IS40 by

DISCUSSIONSON THE THEORY PRIOR TO 1848 with a writer in one of the American is synonymous "do not rest claims of for regulation police. of number and became papers, who observes

al

that free trade in banking swindling." Such claims grounds comes analogous within the quoted on the nature to the province in production--. Tooke's was free banking thing The renewed in the

with free trade in any manner of competition by the ''2_ This State dictum

in on and of

of freedom

It is a matter times out Continent of a motto.

by opponents of for them some-

1837 cash discussion exercised

suspensions in America again led to on that side of the Atlantic, and these considerable influence on later Conti-

discussions nental Carey, denounced banking lowed and defended and

thought. Two writers, Richard Hildreth made out a strong case for free banking. the protectionist that existing would banking the there American spirit if free system be far prevailing competition of political fewer on the excesses. in contended

and H. C. Hildreth 29 American were interference Carey point3 al-

to replace monopoly, the

system

whole,

ing out that even if not satisfactory in all respects it provided more facilities than the banks of any other country, and he maintained in England. applied by that failures had States in fact study within been less frequent he found than systems that failures princito overfrom 3' In a comparative different of the America various

where entry into the banking trade were least frequent, and he submitted ple behind expansions, arises from the the restrictive erroneous system "the idea was that for, he says, system

was most free, that the whole bound to lead is different of privilege banking

in banking

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 stocks for lent on to long

that if more banks themselves would direct the investment, banks only on

were allowed to set up, the bank provide the public with opportunities and short instead term of these they funds be being lent would

term and there would be less tendency to disturbance. '_ In contrast a very unfavourable attitude towards American banking was of a more general tried relevant out that adjustments ternational of claims same lowed town to sketch to the the the taken and whole up by Condy Raguet. '_ His book theoretical nature than Carey's of the theory of money payments. of trade applicable of different would keep and in the and specie theory of specie balance already was and credit flow of in-

suspensions of the was

He pointed

principle which

familiar

exchange arising out or groups

was equally of the issues of banks this principle

to the balance banks in the and issues if alof the

in different

towns,

to function,

individual banks in check. This emphasised the importance of enforcing immediate redemption of notes on demand, and system limited such of the frequent exchange banks. Unlike of notes Carey, he and payment the of best balances between thought

would be to establish individual responsibility (unliability) of the shareholders, but doubted whether a system could ever be put liability rooted. in the the into practice in the United form of company He was strongly wide New sense York but bond organisaopposed to was very deposit

States where the limited tion was far too deeply freedom favourably to issue disposed notes

towards

system. His explanation leads first to an industrial

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

the

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

of banks to individuals they may be deemed and 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 time equal A and gold

THE RATIONALEOF CENTRALBANKING B did reserves, the same amount in each of business case-and held

so that Note Gold issue

= 40,000 = 15,000 10,000 in bills and re-

reserve bank

and

every

week

each

discounts

ceives the same We may assume partly bank, tions total week ceive notes in its own

amount in repayment of previous the repayments to each bank notes and being partly roughly in the notes the same

discounts. to be made of the other to the each reof repropor-

the proportions the separate circulation. 5,000 the will

as the

note issues of the two banks bear In this situation bank A will receive notes the with and daily no 5,000 or transfer of B's, and weekly of gold

of its own same, just so that balance

B will the

exchanges from

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 Then, note the same amount while B mainprohas

tains the old position. portion between the

in the issues

new situation, the of the two banks

changed from 1:1 to 3:2, and and 4,000 of its own notes, 6,000 of A's notes in the to A. But proportion

B will receive 6,000 of A's notes and it will return in the week since A's business of 3:2 also, now A will exceeds discount in any will be it also still be on A's howthe will

B's business

weekly, and thereibre have falling week, bills to the extent of 15,000, paid has gives in its own to return no debit notes or and on 6,000 Thus either B has public will total to B 6,000 credit Consequently, stage shares the notes.

due for payment of which _9,000 in B's notes, the side clearing and no so that

account gold check gold, that

transferred. expansion. At a later ever, tion and to their

no automatic demanding two banks

starts

this

demand

fall on the

in propor-

of the

circulation.

Suppose

DISCUSSIONSON THE THEORY PRIOR TO 1848 total have demand is 20,000,*' Note Gold and B will have Note Gold Thus the gold has reserve been issue reserve ---=32,000, _ 7,000. which in greater did not increase ratio than issue reserve then in the final position

8"I' A will

= 48,000, ----- 3,000,

of the bank diminished

its

circulation

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 capital may have its gold may drained ruin off by a rival its competitor. which, if it has this its rival to moderate enough, even If to avoid

calamity it contracts extend its business bank is obliged may be driven trading eral ioint alterations of great adopted stock

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

to give up business altogether. in self-defence to take up the by its competitors, banks and and of issue, low general the prices, and where country depression

Thus a bank system of overthere suffer and of trade. during resolute when more nation are sevunder panic, That the in the inthan

will

of high excitement

of confidence

bank will gain most period of excitement contracting panic jurious this sue time when to the its issues is coming. of permitting that which that the spirit

which does most business and is quickest and most and refusing can scarcely of a great to discount be devised commercial

A system prosperity

everybody who wishes it to make and isis to be its circulating medium at the same interest to issue as much and as possible of overtrading is prevalent to reduce

it is their

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

SS

THE

RATIONALE

OF CEN_FRAL

BANKING

their ulus

issues when to revive it."

trade

begins conclusion the

to stagnate

and

wants the

a stimsame as

Longfield's MacCulloch's,

general that

is therefore expanding bank

far from

being

at the

mercy of the conservative the former; there exists on the The contrary, point raised rivalry by

bank the no automatic among the the

latter is at the mercy of check on over-issues; banks argument leads to general is by far the free to

expansion. Longfield most important controversial point in the banking. No attempt was made in subsequent reply to it, and we until shall our postpone final chapter. to connect together There had been question country and Probably by to accept attention the the general first disanyfirst no a seorprecedes remarks. the the detailed of its validity theory of literature examination

We have tried in what ries of rather disconnected ganised There Bank the problem discussion was banking all along and of England's of central of

free-banking in this controversy and

itself. the on

a tendency position currency bank

to concentrate

organisation.

cussion of the advantages thing like systematic was editor of The Economist, in that journal between were written note-issuing Act more system than of 1844, that to make

of free competition that was that given by James Wilson,

in a series of articles 1845 and 1847. "_When

he published these articles

the final decision against business had already been and had they by are, this as a not out the time to point nature become for the

free entry into the made in the Bank consequence, the origin of the rather of an alterthe is, in
1847

unnatural and

an attempt

established, adoption was Bank

and

recommendations and their currency and

in book

native system, theories of the The privilege

also

main object school. of the

to denounce of England
Banking,"

monopoly
form, "Capital,

4s Published

Currency

DISCUSSIONS

ON THE THEORY

PRIOR

TO

1848

89

Wilson's especially secure the

opinion, basis

the

cause the

of England's of deposit outcome confidence

lag behind business. of the eminently

Scotland, _ The public more in,

in the development of, and banks greater the was

Scottish

of the

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 a large as to the monopoly wealthy tence to form joint stock number a banking company of known "that firm, the and were and wealthy even had before always men. legal the advent of can be the and exisago, firms consisted restrictions

"There

no doubt,"

he says, formation of the joint stock metropolis

it not for the

of banks for the purpose of protecting Bank of England, numerous large banks would have as in the been called into years as well provinces

in the

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 banking, mission currency bank Such denied desirable the they question are did why content not consider notes payable usually gave it is that to allow it a safe whereas free practice the trade public to give reason was and perthe that

legislature to issue school

in deposit

on demand. The for this distinction and deposits acceptable of thought be increased was

notes increased the circulation an argument was not, of course, of the the issue banking of notes school could that

did not. to Wilson both unmainto any

as a member extent

which strictly

so long

as convertibility the difference was invalid. demand probably time by

tained, and pointed notes and deposit nied the in many circulation, right
III.

out that liabilities that it was to the

claimed between But it was still deformed *_ part generally of no means

quarters and up

deposits

admitted

of MacLeod.

,6 See Article 4_ "Capital, "Theory

Currency and Banking," and Practice of Banking,"

p. 282. 1855.

90

THE RATIONALE OF CENTRAL BANKING

The

events

of crises.

1847 He between

led was

Wilson clear applying used for

to an that

analysis the nature

of

causes of capital implefuture,

of

commercial implied ments and

a choice which

labour production of goods

to produce in the

could it to the the

be

applying in up

production His

immediately the trade cycle fixed the from

conis and way the

sumable bound floating in which

present. the distinction

theory he draws

of

with

between about replaced relation he returned. be the

capital:" fixed of the to

He was and

somewhat capital and for about

confused were the

floating

income variables the It school the and

community the fund that

of all these was under

employing capital that give

labour; is never it should to the which was held

impression is rather who

fixed

remarkable should first of

banking that to it is

support capital theory

theory leads also by

over-production depressionsY'

fixed

booms

A similar

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 school did tion as the

we shall notice it yet again when we come to the made by Horn, in France. But the banking not, of course, connect up their theory with inflaroot cause: this was left for a much later member school to do. "_' time onwards for more was dropped than a decade while So we the on the turn

of the currency From Wilson's free-banking

question just

in England, to gather torce.

Continent it was now to France.

beginning

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.

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

CHAPTER

VIII

The

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 petition system it in evidence in banking like that at this of the and time evils of the that were wrought by

93 com-

superiority the

of a restrictive of the mo-

of France. to state rationale issue had recourse to the State's of money. This was an attitude to deal with banks but credit, from but value. containing, Non-note-issuing legislative interference, in fact, exclusive taken up the very thelittle may, the be he preof be-

All attempts

nopoly in the note right to the coining by ory he Cieszkowski of money says, be and left

in a book 4 purporting

material

of theoretical free

right to issue notes either exercised or gives are almost

is the right to coin money and must controlled by the State. The reasons juristic. "_ his T appeal the in the to the royal chief argument trade

purely

rogative was to remain for many years the restrictionist school in France. The gan The tion agitation for greater written more Senate became to the freedom by

banking after the

with of the

a pamphlet report

Courcelle-Seneuil same year

in 1840." presentaprojon the

discussion

important in that

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 picture and of the effects of competition that in the there issue was of paper money, denied emphatically

any similarity between try and its application support for the each only After Coquelin, to the locality, way this the one of retention

the application of free trade to industo the issue of bank notes. He gave his of the old the party system same French became of the of a single time that public's more free this bank was "bank at the

7 claiming overcoming

shyness." free-banking of the leading prominent. trade assomembers

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.

94

THERATIONALE F CENTRAL O BANKING

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

DISCUSSIONS

IN FRANCE

AND

BELGIUM

a5

eral

families,

whereas among large

in the position

case was

of notes of people. also

the

loss by

would

be

distributed The

numbers

free-banking

supported

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 syssecuand limited when the

the English law as the chief fault of the English banking tem, claiming that they had actually caused the total rity given by the shareholders smaller subiect than was to the note-holders be under depositors liability.'" Interest in the greatly increased Bank of France the discussion the better-known The circle which gland, touched the leading where on the raised the rate of discount early was soon attracting the attention writers on economic subiects it interested was much wider few In France of the of the time. academic among In 1857 to be it would

in 1857, and of most of of the day. than in Eneconomists economists, taken up

exceedingly subject. controversy

it was,

it was

by the Soci_t6 d'Economie Politique, the general question of the limitation specific among Joseph Lavergne. Garnier administrative so unreservedly spoke against supervision in favour all intervention in banking, of entirely subject a group Garnier, of "La Libert6 which included Courcelle-Seneuil, des

at whose meetings both of note issues," and the Banques, '''4 were Chevalier, Coc l and of authority but Chevalier withdrawing debated Horn, de all not Leonce and was

Wolowski, Paul

all inter-

vention. He declared to demand a regime

'_' "De la Monnale, 1_ See the report p. 471. ,4 See 1857). the reporl

that he was of complete

not prepared liberty for

237. serle,

to go so far as institutions of
Vol. XXI., (1857), Vol XIV, (May,

du Credit in La Revue in Le Journal

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

serie,

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 change England banks, others, affected there much whole On resumed ing the reserves dure the was effect by law of all the normal mechanisms also the for the

97 interin

of notes. after the the solidarity and if there

He repeated

argument

used

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 or lesser degree; if, on the contrary, has the was of raismetallic of proceand then its capiif the Bank of France, the public in it, panics are avoided and rendered on the more stable. Bank of France the policy the

to a greater is one more bank like confidence

credit system the other side, by Isaac rate and first of discount suggested for the this

is thereby the attack

TM

Pereire.

He denounced the proper

as a means that bank were

of protecting method its capital,

to realise insufficient,

of doing

to augment

tal; the resources necessary for the place, gland) should was better _ that her did be taken there rate the by to raise

obtained would specie reserve. was when any In necessity his

enable it to buy the gold He denied, in the second for the the Much Bank rate the of France (e.g., Enof discount same There attitude is no influence country

a neighbouring opinion z_ a Paris

same. Maurice than

invariable

at 3 percent."' Aubry, this book

banker.

example

of Aubry's

of the

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

time of Napoleon, 2_ not only in France of the doctrine that the chief function the rate of discount of bank down, policy, a docwas adopted as a rule

is to keep

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 bound the issue charge different whereas count to lead was given :_ and a high

THE RATIONALEOF CENTRAL BANKING to credit to the it was rate; and inflations. grounds solely bank Aubry that highly respect bases the his attack on

Bank

of France

on the

privilege to favour

of note cheap for it to since dis-

in order

discount,

therefore in this

improper it was

in an entirely of

position from that of the Bank of England, the latter might legitimately use the rate to control movements of specie, the Bank

of France

could not do so because it was its declared rate of interest low. 23 So he, also, recommends policy of calling on the shareholders paying capital in times of crisis and no further need for it. 2_ Pereire entry mands the monopoly. Aubry no better wanted reason the than monopoly that the retained, coining into Bank was the of to one by no rival France, means it back

duty to keep the an alternative additional as there freedom his monopoly for is of deof a for thereas soon

to supply

in favour business. substitution

of general 2_ He the

note-issuing establishment :8 the

limited

to break

of a duopoly and seemingly and

of money,

fore the issue of bank-notes, was a royal prerogative/_' a proposition that was, according to him, one of the fundamental tle later application money riences reproach prerogative axioms by of political Etienne of the that most of paper Duran"' royal countries money, economy. that prerogative It was it was as to the pointed a result issue out a litof the of paper fatal expemistake to the royal

had had their most and it was a grave of which

free banking had been

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.

THE

DISCUSSIONS

IN FRANCE

AND

BELGIUM

99

The minds

idea the

of free vision

banking

had and

raised everybody

in

many

people's note

of anybody

becoming

issuers, and they saw insuperable tion of the notes of innumerable sound under the cise firms the practical a close would shadow scrutiny lines that by those have of the over a positive

difficulties bankers and

in the circulafeared that unto set up notes, able and It was was sucto exer-

encouragement of different public notes being they

multiplicity of the all the

impossibility

accepted.

along these formulated ceeded of the d'Eichta131 guarantees royal

the case among from Thus

for unity in the note issue the restrictionists who the purely it was of a note political argued was by the almost

in getting that the

away State the

argument Adolphe public never of in

prerogative. because

intervened holder

to assure

a position to know in the note issue examine that likely was each likely note

the real avoided carefully able position.

position of the debtor/_' and unity the inconveniences of having to to see if it was to pay it or by issued one that school the by a bank was not

to be

to be in that to this

A Belgian out _4 in reply "men notes

economist

3_ of the line

free-banking that

pointed that for their that the for the public

of argument,

danger

of straw" would be able to obtain acceptance was much diminished when it was realised of issues themselves. exercise no would It was scrutiny become at all, trader and largely and a matter that

supervision bankers would assumption the notes

not to be expected it was

the

a reasonable

to make that the of his own banker

would willingly accept the notes of such other to receive. This of that particular heavy pressure
1864

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

to the
et des

unduly

of

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

Banques

d'Ermsslon,"

d'Economie

Politique,"

Vo].

II., 1864,

277.

laO insolvencies come into The case

THE RATIONALEOF CENTRAL BANKING on the small note-holder, who was contact with the banks as a customer. for competition and Chevalier. was Paul also taken up by the unlikely Paul to Coq, of

Mannequin

Coq "_ endorsed

views

the Pereire brothers that the Bank of France had risen destruction of the

rate of discount charged by the as soon as, and because, the banks had given it an conthe lines not

departmental

unrestricted monopoly tribution 3' was simply allegation of the thrown to the Chevalier that banking needs was it would school, of trade,

of the note issue. Mannequin's a defence of free banking against lead that they for to over-issue so long but are cannot bringing issued be the on the notes only issued in usual "are as the

out of the

window,"

in response excess. to the

responsible

subject

notice of a wide circle of readers by his contributions to the newspapers, notably to the Journal des D_bats. CourcelleSeneuil also Economistes. A publication was posed an article to replace re-expounded 3: which bv Leonce the his provoked de monopoly views a good of the Bank in the deal Journal des

of discussion he proHe cennot by

Lavergne/_

in which of France

completely said it was tre tem as the provision

free competition but impossible to manage Bank of France was of banking offices could each

by a limited a large area to do, and best having

plurality. from one

trying

an adequate by a sysbank with old

be provided its parent

of eight

or ten regions,

branches. This was departmental banks

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

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 4that 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(J Letter in Le Journal des Debars, February 4th, 1864. et Regulateur son application de au

102 being of the banking denied banking change the the beneficial contention was

THE RATIONALEOF CENTRAL BANKING to the that on on those community, the who the same face asserted the system burden was not who of the on those oppose proof to who free

not applicable

it and

it; because

of it those

oppose also freedom to build in general, which, as he knew, that they side been however, said they had as yet towards no on the very given took banking. original It was

railways, and free exthey did not do, and no sufficient Wolowski proportions, additions almost wholly reason took for up had a rep-

he insisted attitude other

in a book 41 of extensive subject.

which

contained, already etition on the doctrinal be school This The

to what

of the views expressed trend of policy already importance as the brings most in the for emphatic eve he

by others and adopted in the French stood adherent of the Bank out among of the specie French of Savoy

a commentary matter. But his must the use flows. of the not rate 4_ the French

developments

under-estimated, as a means

of discount enquiry

of controlling of the

us to the arose out

Banque affair

Enqu_te. and

raising of the rate of discount in 1864, the Conseil superieur de l'agriculture travaux members, witnesses. prises called France, writers number views, Hankey, from publics, and The of which therefore report close who on had both took is contained five the gained besides Chevalier part thousand

and was entrusted to du commerce et des and d'Eichtal examination and The the Council Bank of as were of comin the

in six volumes pages. from delegates anything

altogether as w_tnesses, all those

of a reputation

on subjects connected of foreign economists and written memoranda Newmarch, William

with money and banking. A were also invited to state their were submitted from by Thomson and Belgium, J. S. Mill, and ProR. H. Patterson

England,

Professor

de Laveleye,

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. published d'Eichtal, Coq), chi, neously cannot material Chevalier icy in the the using general, a gold one, was Bank the and Coullet, their Aubry, we and

IO8

from Germany. In addition, Walter Bagehot of being called as first witness before the the French witnesses Isaac some had already Bonnet, Paul (Cernusviews (e.g. Wolowski, Chevalier, occasion who were Pereire, to others

Among

Lavergne, have Horn),

Courcelle-Seneuil, writing contempora-

shall

to refer

with the enquiry. Looked at as a whole, be said to have contained any considerable of value from the point of view

the evidence amount of theory. polof of in

of monetary

made clear his views on the subject of discount course of his examination of the representatives of France. rate no matter He doubted what policy sale the that the utility the or the necessity of credit of discount or even means, was, restriction

as a remedy in his opinion, by the immobilising Government purpose. of the credit same that was

for stopping the the correct he of Bank, _ and capital obligations

efflux. 4' The that of the

of its "rentes"

emphasised the bank which lier, along

the necessity of not in quasi-irredeemable not the the be available other Pereires, must with and supporters

might

for this overlooked, contract

What policy, the

Chevasuch sale of as

as Aubry securities

by the Bank

just as certainly

a direct contraction of the amount of bills discounted Bank. It would deprive the short-term loan market amount sold, This and school of funds so there thought acquired must they by had market without was the Bank for the for loan which be a tendency discovered operation causing by this time rates would

by the of the it to rise. device make in the to the

securities

an ingenious stringency being given

in the shape

of an open liquid attention

the Bank more money market. More careful

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

104

THE

RATIONALE

OF CENTRAL

BANKING

comparative ume by held system sue large costing no of money means that

effect and been was

of the alternative credit. no of identical reason system. a positive by be lent and money should had

systems the

on the free

total

volhad had

Up to now opinion. inherent be more Others

bankers of them free-banking than argued the

Some in the expansive had

there

why

its issue system of metallic could of trade

isa a the

of a central part

banking

that which,

free-banking

advantage fiduciary and The ideas

in replacing money thus of this favour

nothing,

cheaply

development were openly ber of people Emile omy, school claimed, sion heavy de on of the drain attacked two

industry.

school

inflationary who took Laveleye, *_ the grounds. that

and provoked the up an anti-inflationist Professor section he this said would must

attack of a numattitude. of Political Econthey by a a confree-banking if what to an expanby

a Belgian expansionist Firstly, free was reserves banking true,

of the that lead followed

namely,

circulation, on bank

be followed

of specie

traction of the circulation, and the crisis would be, moreover, system case dence But bankers would of the that present smaller subjected Just
45 "Le

a crisis. He pointed of greater violence as compared the argued that unlimited at such that their its issues having

out that under a with the confitimes. the free system

of a large of a privileged of the public, be

number bank place, wrong could

of banks which, extend de in

in the

second

Laveleye assuming

might

prov!de easier credit conditions cycle, and that it was, on the involve and the keeping himself of unlimited began an
depum

in the upward swing contrary, conceivable reserves lead the than the to the be in a actually to consider banks on should

it would

of larger would that willing

system circulation.

therefore He was on condition

free-banking at this
Marche

system to the time

Monetalre

condition there

liability. bank-notes
Ans," 1865.

attack
Cmquante

et ses Crises

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 that freedom of issue would accomplish and was, therefore, in a somewhat simso extreme position as Cernuschi. failures one of He supthat were two things bea or mothe it be rate, to

Coullet believed its own destruction, ilar posed bound would tween single this nopoly, though not

that as the result to occur under

of the numerous such a system

happen: either the public, struck by the contrast the majority of the banks and a few or even perhaps bank, bank and or the would in future would system confine be would its dealings be afflicted to these and so there whole established a de facto If, however, of well-organised would of the and of times)

bank-note would be should prove possible and solid banks, of the adequate same total of banks of a single had The the of the anxiety reserves. not a lowering because keep the number reserves serves crisis.

abandoned altogether. to build up a system result rate (he thought) of interest banks the have Even

of plurality but a raising in normal times, reserves greater the than

of the

(even

in ordinary united to be

against a large the total of re-

circulation, would bank.

Moreover,

centralisation

an advantage advantages than sufficient

as a source of monopoly to outweigh its power

of strength in periods of were, in Coullet's opinthe over avowed the single danger bank of of

ion, more

the Government's issue.

abusing

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

DISCUSSIONS

IN FRANCE

AND

BELGIUM

107

The ative it was age oly reasons and

best argument private why

exposition first

of the place that been

free-banking he disposed terms) had that first there over was One _ While

case of the pointing

came royal

from prerog-

J. E. Horn. 51In the

in economic industry he it had later submitted as a royal

out that the cointwo monopto facili-

commenced were as a State in order

of specie, claimed

probably

taken

right.

tate the circulation of coins as a medium wide areas at a time when the State was that dence weight and was generally the every and assay fineness, coin enough coins were and before known what accepting so to make that they

of exchange over the only institution sufficient confito be to weigh reason in professed

to inspire

it unnecessary it. The second

was that the King found it the most convenient way of acquiring revenue. In our day, he continues, however, it is no longer true could child, necessary any more provide in Paris, the as a budgetary that the service State source, is the only were "_'_nd a If a firm as willingly and neither like is it which Rothsthe institution to undertake

of coinage. in London, be just

or Baring,

stamping of coins, as the coin of the Horn, and ing, one ski. also in company many that major an perhaps

they would realm. with less

accepted

Chevalier prominent

Courcelle-Seneuil, on free bankthis and became Wolowcases to

of the

writers

denied of the It was

bank-notes were issues between which was, rather

money, and these writers of course, merely

attitude

in many

adopted,

unnecessarily, prerogative little more

in order

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

of the Crown in the than the playing off of space was was, in the delast

of sophistry against sophistry. A great deal voted to this discussion of a matter which
s_ "La Liberte des Banques," 1866. that the of war. note

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

issue

is of the

utmost

108

THE

RATIONALE

OF CENTRAL

BANKING

analysis, should a certain

a question be denoted characteristic

of definition by the same in common,

as to whether term because or whether they

two they

things should

possessed

be sharply contrasted second characteristic. monev because both on trade on the substitutes view which must lead Turning nopoly, the would monev State liability be and necessity ior, prices. and

because they differed in respect of a _Nolowski was defining bank-notes as bank-notes and coin exert like effects Chevalier always the and regarding convertible condition the others into, of strict were coin, insisting as merely since any convertibility mothat paper under to reand to go full of recon-

for always

bank-notes

neglected

to their over-issue and unlimited depreciation. to the positive disadvantages of a privileged called of such revoked attention a bank with its counted to the to pay greater out into on the specie of coin. possibility on pure A bank

Horn

demand

consequence

in place patronage

of notes always

convertible

Government

lieve it of its obligation its bankruptcy became into The liquidation history and of privileged If banks

to pay when nearing insolvency, legalised instead of its having the banks of issue usual had were penalties undeniably given been

suffer

of insolvency. to understand, irremediably to bear the

bankruptcies. however, sponsible

that they were positively and tor their acts, and had themselves be as prudent There was the guarantee ever-present over that the failures its power

sequences, they would other business concern?' already Government There can emphasised, to abuse be no

in their policy also, as Chevalier temptation privileged will never

as any _5 had for bank. occur the

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

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 til it is discovered iary materials The direct continued lished

THE RATIONALEOF CENTRALBANKING that there is an insufficiency of the it. 5_ and auxil-

necessary discussion years,

to co-operate with between Wolowski and the

Chevalier was pubalso

for some

correspondence 5_ Courcelle-Seneuil

by Wolowski

in his later

book.

made another final statement of his position, u again pointing out the extreme lack of banking facilities in the provinces in general, free pected lowering and of agricultural nor who rate Horn the supported of interest. credit was their in case particular. of that because Neither group they and did of exthe Courcelle-Seneuil bankers a member

it to increase of the

possibilities

of expansion be greater under would be lowered,

Courcelle-Seneuil

not recompeand in come, of to the con-

gard it as certain that issues would tition, nor that the rate of interest so far as the not by way and stood consider case utilisation free in other the of banking, all the latter was at all likely issues, savings. insisting on of increased of idle bankers, branches application and but

he thought by way the most

it would of the liberty unyielding

collection as underto

He was and

complete industry. special denied

of trade of any emphatically

He refused favourite

regulations the

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

RATIONALE

OF CENTRAL

BAN_NG

will

have

less

notes

in circulation it did before; will will

in proportion the clearing acquire be was diffused by imaginary

to the balances claims

cirwill on its to a

culation the out gold the

of B than reserves and whole of such

go in favour liabilities position

of A, who so the system. primary

consequently constrain will

of B. This The

B to contract throughJuglar rather

contraction importance

difficulty

raised

than real and would certainly not in itself provide the sole reason for the existence of institutions endowed with such privileges France. which banks, and Juglar position was really of ascendancy advocating as a mixed the Bank system competitive bank with banking system of in a in

rights of issue should be but in which there should influence, sense and in France. the something single

given to the be a central between free

controlling the pure in vogue What and the central other? cases. free

privileged

monopoly

is the connection banking school, banking school It is not unnatural It is especially

between the free-banking school on the one hand, and between the and the currency it to be very in France of the banking that school close most theory on the to expect in both of the which

noticeable adherents

bankers

were

denied that bank-notes could vertibility was maintained. Seneuil, vinced He was school should metal, son, Coq of the which be but as we that have and banking believed and there free Mannequin theorists. of the not any should banking, the tenets carried

be over-issued so long as conBrasseur, Horn, Courcellewere among was the this for that central it the he section that the of the limit the most conCernuschi an exception. currency issue by at all. reasuch corprina fiduciary covered peculiar circulation thought school of the

a member fixed,

strictest merely issue

above

be no fiduciary however, explained, note of the with issue

He supported system would

already destroy

altogether. banking support

Adherence respondingly

to the usually

THE

DISCUSSIONS

IN FRANCE

AND

BELGIUM

113

ciples Coullet, ciary the the

of the who issue

currency opposed so long who

school. the as there opposed there of the The

The fixing was the

exception of any only one unlimited

in this limits bank right on

case the

was fiduof

of issue. of issue

Among

those

Bank of France relative merits proportion. of the of Peel's that the

began at this fixed fiduciary latter was doctrine. Cernuschi to cause method

time a discussion of issue and the fixed less rigid was issues intera great this to for the

reserve pretation admirer the

a rather Wolowski also

currency Act, latter and

preferred

reserve

proportion of specie d'Eichtal had been

of controlling greater

reason

tended

embarrass-

ment in time and Adolphe By the tary Wolowski ers of the theorists

withdrawals, both iavoured of the 'seventies turned

but Leonce de Lavergne the second method. the attention bi-metallic the of monequestion. support-

beginning

to the

and Cernuschi both figured among retention of the double standard.

CHAPTER

IX

The

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, 1839 Staaten der Zahl, Dampfschiffahrten, Banken und andere offentliche Unternehmungen," -"Drei Gegenstande sind es vorzuglich, welchen die Vereinigten ihren Wohlstand verdanken: die Schulen ... : die Banken, 800 an

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

DISCUSSIONS

IN GERMANY

117

ited that ilege

liability. Limited liability was, he contended, could be demanded in the name of free trade by the granting of which issuers looked must the State had from principle of responsibility underlying be free

not a right but a privthe trade. to issue in free

undermined all obligation of the note

natural

Secondly, the note lend to the State. While as the Tellkampf ultimate end

to centralisation 1_'there

to be sought,

was

at this

time

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 these the would new principle provide the

unity in the of banks and led him to fa-

setting up her own private banks so as to keep of these other States. He recommended that should if the full known be set up shareholders of their limitation the extent on the Scotch model, 1_ on

banks that to the

were property, on German

liable note

for their

obligations By far

self-interest issuesY of economists

the best

necessary

among

his generation was a follower herent currency tinent, was of the

was Adolf Wagner. As strictly as Tellkampf of the currency tradition, Wagner was an adbanking was school. becoming first book Writing very from at a time powerful the things: when on the The point the Conone of

doctrine the

he set out in this to explain

''_to do two

disadvantages

economic

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 literature influenced Wagner on this and allied subjects and Wilthat
etc., in

had been especially son. It was through

1., See also his Great Britain and _'_"Uber die

by the that the

writings of James chief accusations

Policy, Banks,

"Essays on Law Reform, Commercial the United States of America," 1859 Entwicklung, etc.," p. 5,

Neuere

*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," 1857

for on is

 la

THE

RATIONALE

OF CENTRAL

BANKING

had

already

been doctrine

made were was

in England made banks and he that

against should opposed proportions, Peel's it was

Peel's to German be allowed the thus based also had

Act and

the

currency His own without porting being taken tional

available

readers. to set up fixsupas misaddiits aid left to fully

opinion legal the issues

hindrance, free-banking not of the that only the

statutory

ing of note

or of reserve position. because Bank currency

Act he regarded on on the the but

unsound, theories ground

school,

of England

through

privileged position acquired a responsibility to render during a crisis by liberal lending, and now Peel's Act had its privileges defect which makes aging State in the he gave of the paper. intact system most power '7 While but had taken great was away privileged the over and misuse such its obligations. central the a bank in France of the weight too the banks

'_ The

Government by encourin too much ashad

it exercises cheaply Pereire

it to discount

to invest

group

sessed the of keeping opposite In the which given in

fault of a single privileged discount rates too high, of keeping more lending a few to the rates years theory detailed criticism

central Wagner too low. of the

bank to be one held it to be the doctrine was first cover.

currency

he published Germany

later, of

TM

prominence

"'bankmassige'"

This was closely of the automatic as notes term ness the ject after issue were the was lent -tlley assets,

connected up with the celebrated principle reflux of notes. The theory was that so long out in true came back of the this and time banking in the loan reason period business, natural and the that course is shortof busiamount of subcover

elapse supposed From

for this of considerable

to be constantly "'bankmhssige" importance

to check.

onwards

assumed banking

a position discussions

in German

legislation.

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

der

Peelschen

Bankakte,"

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

RATIONALE

OF CENTRAL

BANKING

a note-issuing did such amount visions of deposit of notice or type for the

bank measures cover

must as the

have other

at least than

two note

names. issue, on any the

Neither on legal the pro-

placing

of restrictions limitations

of business or special the

of deposits,

amount period It as prefevent importhat day on the of the penof a depast. need for after a

liabilities, for withdrawal all

requirements receive

as to the

of deposits, Prussian

support.

thus rejected inappropriate. The erential tance bank question rights was should

"'Normativbedingungen" should (depositors) negative. to the notes This of the was be given in the Great point on the

whether over was always on pain other by

note-holders creditors in the speakers to cash

of a liquidation

answered all the be obliged

attached

presentation necessity alty

of liquidation)' enforcement obligations

emphasis liquidation something

for the

rigid to meet

for a failure

parture from what had been customary in the Observations had from time to time been made on the for the the for which enforcement the of quick resumptions varying lasted, with and of payments, the length for liquidation

imposition

of penalties suspension

of time

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

Kulturgeschichte," "Vierteliahrschrift "

1865.

in Faucher's

1_2

THE

RATIONALE

OF CENTRAL

BANKING

this extent

a certain

difference

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. because it widbank could be advantage from if the territorial

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 ew of limiting the note issue
2._"Nehmen wir an, das alle leichtsinnig in der Ausdehnung solche gegenseitige Abrechnung ahsation der Notenversprechungen

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 been cates noticeable

THE RATIONALEOF CENTRAL BANKING even in Germany for bank something central ceased of a change The it merely of

emphasis

in the

arguments central

banking. to support

advo-

of a strong

because they issues within

thought it was the only way of keeping note the necessary bounds and increased the emattitude was clearly stated he published early in were bank an internal banking Nasse a central such a bank always could Therefore, drain discredited continue by to avoidthe the op-

phasis on panic financiering. This by Professor Nasse in a pamphlet 18667" during satisfy ing the Whereas a crisis, the necessity internal small the note issuers notes currency of providing

of a central demands. ibr central reasons

of metal

on top of the external drain, crisis less serious. For these idea posed of the Peel's Prussian Bank

rendered welcomed bank the and

becoming takes from

Act, which

possibil-

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

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 should favour minimum ever, there check oly limit as this must Nasse at first fullest sight by seem a little for strange who had His general there therefore note cover that such a Bill in a and is, how-

be sponsored of the of legislative

Michaelis, interference. with his of banks, in the case and that

always banks

been

freedom

note-issuing

attitude

perfectly consistent are a large number on the note issue; mechanism be imposed?' with kept agreed be

thesis. Where is an automatic monopexternal as far some should

of a privileged

is absent Michaelis

possible

"'bankm_ssige"

(short-term

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

DISCUSSIONS

IN GERMANY

125

ments). rect fiduciary securities. Geyer

This

excluded to the could

Government basis be both heads: and of Peers backed

securities Act, only by their of the cycles there secondly,

and under

was which

in dithe

opposition issue 32 and

Government views present the by further bankmate-

Tellkampf two up

elaborated the first, faults that

in 1867. 3"_ Geyer ing system rial for "artificial amount produced under capital" of capital the trade

summarises crises

it provides

production where and,

producing that having and of the theacceptcrisis in be-

to a point it intensifies

is an excessive credit

in existence,

crisis,

it by contracting

causing forced sales. His explanation boom came very close to the modern ories able and the lieves mand their interest ceptible lines ment the of the Austrian school, more The explanation depression. over-production of the theory.

of the original "over-investment" to give cause of capital goods, which into any of the

but he failed immediate here over-supply

His reasoning

develops

an underresults he

consumption

of consumption

cannot be absorbed by the market, because for consumption goods will only increase with price, and while this final the savings. bank it is true is so small price theory theory The practice? should that cheaper ready equation lie not capital charges, in the of the and solution an item

the dea fall in reduces perthe

as to be hardly for consumption. somewhat between which so much along

of goods of the

He approaches modern real of the

of banking difficulties

investthe-

accompany in the

question

ory, he says, as in the uncovered note issue

4 The theory be brought

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 "_'_ . J. Geyer, P "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, equilibrium. together tal could In the money and should realised would He concluded that

idle, but as we it is impossible it is advisable

do not know to effect an to give up alidle capibanking. bank issue He there

the issue of uncovered notes and better be collected by extending of change-over, follow in step this and given the with reduction the should

that the deposit

period

of artificial that the note it would note issue

increase

in deposits, institution.

to accomplish be centralised that even

it is necessary confined this unity

to a single in the

still be international

complications; for any capital," capital out

be point-

less as well as difficult give up "artificial bank by the creation of bank probably be unable rates elsewhere. Peel's problem Act was not it did

one country in isolation to since it would be affected in other against countries the lower and would discount to Geyer's principle uncovered be equal things to furof easing in deignored it led to to it

to hold

a commendable not carry the

solution currency forbid should arose,

because

its logical conclusion. It should either notes altogether or else arrange that they the could idle money prevent capital. crises, Since and it did neither once crises not

of these

ther complications credit conditions The manding several as they ply 100 attitude the

by provoking so as to reduce taken up by both

panics instead trade losses. Geyer and

Tellkampf issue

total

abolition

of the

fiduciary

important do, from by

aspects of the monetary problem. Starting, a situation where the existing money supnotes they in large would and movement is more proportion the not covered of metal, underestimate difficulties

already percent

contains

the deflationary back to their much was posite more likely

process which "ideal" situation, violent and from lasting the what

be involved in getting which would entail a than they fear any perhaps, which opthe in the

disturbance important,

to occur

direction.

And.

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 issue the and form the

THE RATIONALEOF CENTRAL BANKING amount note but suspicion, of the cover, if complete some bank's were clauses not capital or determined with was kind might full be looked

of the

compatible of this

i i

"Bankfreiheit," upon with conceded.

"Bankfreiheit"

In common with Michaelis, cessitv for a speedy liquidation when chief he branches, creditor before presented place and of the the courts for within bank bank for redemption or a short can should be cases against of business

he placed emphasis on the neof insolvent hanks. If a note is not period--three still not pay The be allowed of forces Michaelis paid at days to bring only majeures, on the the bank's and time any redemption counters is the

at its

suggests--the

its obligations, extenuating such question

a demand as a of

its liquidation.

circumstances should foreign invasion. A Wagner took sides

whether, once it was decided ments for the note issue, it was or German or the both method Peel cover) Michaelis the figure system (fixed the because, was purely

to impose reserve requirebetter to use the Continental or one-third issue). Wagner it was true it is far bond deposit in Germany, towards advantages. such but also monopolistic Bank of a central Knies that less specie and the rigid preferred fiduciary system. arbitrary, although

("Dritteldeckung," Peel

favoured

"Dritteldeckung," of one-third

than the Peel Commenting had turned and however, be gained and eration Wagner mits, only banks,

system or the American on the 1866 experiences tl_e thoughts affirmation that that they only of many of the it had were the advantages not

system. which a considbank, He subas could central similar Leipzig banks of

people

agrees

evidenced or entirely Prussian

necessarily

by privileged not

that

great banks and Bremen

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

Op. cir., p. 634.

THE

DISCUSSIONS

IN GERMANY

131

second

order

as they

might

be called,

had

given

support relentless

to

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

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

end

at Op.

cir., p

357

CHAPTER

The

Post-1848

Discussions in England

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 tagonists, connections French give evidence

THE RATIONALEOF CENTRAL BANKING Wolowski were before economists via the and established the Chevalier. Enqu_te. "_ In Bagehot in person, addition, the English was and called written Patterand atwhere direct and to

between

Commission

memoranda were son and J. S. Mill. tended Bagehot entrust banking several The of the changes prova]. in the meeting

submitted Wolowski of the a paper custody

by Hankey, Newmarch, visited London in 1866 Political Economy Club,

was reading the principal liabilities banks.'"' English policy in its It was

on whether of the bullion bank

it was better "to reserves against it between of France to at rate, of all its income genone recognition advocating discount and of ap-

to a single to the the

or to distribute by the in Bank

reaction of moving reserve hailed for many by

adoption rate was, Economist this journal The

of discount as the had of

in response

position The years. which

general, been

long last of a principle its pages as yet and though effects, structure imperfectly especially country

theory on the

understood of its effects concerned, under _ who

as to the details price received had

of the

fairlv

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

the influence had at least rate could

of the writings made it clear to be used to inrate of disyears but tamper-

discount

fluence the balance of payments and gold Goschen made a direct attack on the school count must ing in France, which with the had natural be interpreted _ and insisted over result, of things that the the

flows. low discount higher rate few claimed,

prevailed as the state

preceding artificial

not of the

as Pereires

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 danger-

"_ 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.

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 elucidate imperfect It had ise the

THE RATIONALEOF CENTRAL BANKING canons working been double strain of policy of the placed aim which one we to make on the would now the Bank's had. Bank cash Directors resources realin facilitate the less

Bagehot's

times of stress side as holder

by the dual nature of its position, on the one of the banker's reserves, and on the other as it must of what deposits cash own be prepared to provide was in all respects their held as reserve), and to help such insufficient. _4 Bank reserve must of

lender of last resort. Firstly, cash to the banks in respect own (viz., Bank of England secondly, institutions This led it must provide as find their him up

by way of loan cash resources that

to his final

conclusion

the

adopt a more cautious policy and that a banking one-third in normal times was too low. Bagehot's must have gle writer result admitted sis was deal influence been more either here

on the shaping of central bank policy considerable than that of any other sinor on the emphasis Continent. that it came It was mainly as a to be commonly bank in the criHe did a great of the special re-

of his continued

that the correct policy to lend freely at a high the recognition

for the central rate of interest. of the nature

to secure

sponsibilities tat of what principles should public agement regulating posed But this it was

of a central bank. His accepted thesis was a rebutwas considered at the time to be one of the cardinal of the 1844 from framing Banking other easy Act, namely, any its policy Department deposit been general that and the to pay should the being bank. already the Bank of England to the to of manas those had by among sup1857. _ the

be released interest-in benefit the any not by

obligation

attention

be at liberty same

act for the

of its shareholders, large to have to obtain

principles J. S. Mill rejected

principle

agreement

.,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 central session perfect now

discussion banking. of an

on Its

the theme

relative was banking to must

merits that we system. from the

of find

free

banking

and in pos-

ourselves It is the not the

anomalous were have its able it we

most but clearly it them.

if we that we

choose make accepting funds

beginning, of it by

best the

recognising creates, We ing in the and find

weaknesses, adequate re-echoing

responsibilities to meet

keeping Goschen

on

hand

Bagehot's about of

warnings twenty 1890. 3'

respectyears later

inadequateness with the

of reserves Baring crisis

connection

We

show

below

the

chief

disputants with their

in

the

free-banking towards

controversy the banking

cross-grouped and currency Free Parnell Wilson MacLeod

standpoint

controversy: Central Tooke Bonamy Price Cairnes 3z Coullet

Courcelle-Seneuil 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

"Our

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

of Currency

THE POST-1848 DISCUSSIONS IN ENGLAND MacCulloch

145

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

Cernuschi Currency School

Lavergne d'Eichtal Wolowski

Hubner Michaelis

Tellkampf Geyer Knies

Mises

Neisser

CHAPTER

XI

Discussions Prior of the to the Federal

in America Foundation Reserve

System

After which cussion, ence came to Moreover,

1875 the already and the the the had

central them practical

banking were choice was superiority a dogma

systems of the never without one

of those without system again

countries further disin preferbeun-

accepted

alternative declared less than

questioned. banking very clear

of central any

nothing

derstanding remained world was chapter adoption the

of the exact nature one among the chief still lacked States some a central United to examine of s_lch

of the advantages, but there commercial countries of the banking It is the which by that organisation: purpose led to the this of this final

which

of America. of the

molives

an organisation

country

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 issuing but This were National banks the of was under in 1913 Banks operating, banking the frequently over 20,000 not law cited principles banks, notes under of the as an and the States of which the rest National in which of the But about Bank they 7,000 Law, lay. it issuing non-note-

example banking.

practical while

application

of free 146

THE FEDERAL RESERVESYSTEM was with that were the true certain the at least American that business two "free any person was open or group open of persons a bank the same and free was the complying of issue, terms, banking

147

requirements important banking"

could points

and there in

to all on so called

of divergence

between used by the banks were

the more general sense writers on the continent excluded branch approached National ated, lacked banking which lution pressly National the authorised supportable specified

in which the term of Europe. Firstly, all most to local system the of both

from practically organisation, and more Banking view or less Law, a peculiar that

possibilities banks outside monopolies. the "free" issue. bank banking of note central growth as part elsewhere States. had In the and no come States, had

of developing the big cities Secondly, banks It is at least organisation and of free banking evoexthe firms of exbeof been before the opera

under

which American

the advantages proper. all tendencies manifested banking Banking to set in the Law, of the up had of

Practically

to the

of branch of the days had exclusively banking possibility

themselves development United banks individual in one State

natural

excluded

under

jurisdiction

tending their operations yond the boundaries another. the tice Bank stated varied. Act that So far Some had did as the States, confines of the

by branch office of this State into allowance State mostly to alter under of branch was in the this its south,

or otherwise the territory banking had it. The

within the pracpermitted National not

individual legislation formed

concerned,

it; others

passed nothing

forbidding situation.

It expressly should

a bank

provisions

carry on business elsewhere than at specified in its certificate of association. lowed branches into the was that State banks which should National have the right to retain Banking System.

the offices in places All that the law alhad 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 dinary asset

THE RATIONALEOF CENTRAL BANKING currency, where inflows hoards, also of specie, are raised run. whether by

from abroad or from internal increases in note issues. A great exhibited shown deal of comment note issue an ordinarv was

accompanied by the The inelasticity fluctuations between

by the under

in the system

short

in the proportion in response in America

note and deposit liabilities, changes in demand, found its large agricultural mands for cash. The spond the lay The to these explanation demands and of the

especially no parallel

to seasonal in spite of deto reon

interest failure

and heavy of the note the

crop-moving circulation autumnal note

intensified the banking inflexibility

strain circulation

money as much

market

system. of the as in its lack of ex-

in its lack

of contractibility

pansibility. It was expensive chase of new bonds in order the do could through was tired were keep tra times them Comptroller so was only the in any usually but heavy when bv a legal further be retired same limit one used demand such drawing on on when the after the by that for demands their they were in order reserve in interest autumn. illusion that

and slow to negotiate the purto obtain additional notes from need the and arose, by need the had expense. of notes once on the taken hand banks and to the and fact the that passed, Moreover, that out might by any It did and only paying so, out incentive the by to notes going there be rebank not in leof vioa of exmeet

diminished formalities month.-' Notes bank

number

full extent. currency, could

a very

small

proportion hand-to-hand arose, cash pressed to meet of notes rates. the

for periods

reserves

gal tender, and credits all round The lack lent fluctuations steep rise in the The popular

to a sharp restriction their obligations. led There securing to frequent was every by and year bond

of any

of notes

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

THE FEDERAL RESERVE SYSTEM

15 1

deposit would guarantee full had been dispelled.

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

OF CENTRAL

BANKING

1907, when suspensions of over two months.

lasted

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 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 law stocks in a very for note

THE RATIONALEOF CENTRALBANKING liberal way and where accepted previously municipal only and strictly other Gov-

backing

ernment securities had been eligible. The object was to increase the circulation in the autumn demands of crop moving. It was intended

of this step to meet the purely a

to be

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 cash year drain just the same lack of provision these for the autumnal only as before. In general, measures served

to make creasing progressive

a permanent increase in the circulation without inits short period elasticity. It still left no slack ready up in an emergency. in the The result was merely 1900 and for the by the incapaincreased difficulties sought the American reserve were ratios they below in a increase circulation between currency evidenced had proved

to be taken

1907 of over 90 percent, which provided inflationary boom of those years. As was events ble of 1907, the bond in the deposit system of modification direction the of note the

of providing cause issues of features system of the and of the legal

bank currency for emergencies. Other attempts at interpreting laid less stress One on the of question more these was primary structure. explanation in other

ratios. '1 So far as the possibilities concerned, the requirements probably otherwise what the did banks not cause the of their the legal own would;

of credit of minimum to expand was thought

expansion reserve less than deal a good

banks minimum accord

fit to keep

_1 to 1874 National Banks m New York had to hold in lawful money in Up 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

FEDERAL

RESERVE

SYSTEM

157

in their "reserve" designated, category The city tween tendencies and the

own and

vaults. were

_ The

banks

in

"redemption" as they as being National

cities were

or later

"central officially

reserve" banks by

cities, the

recognised

in a special Banking Law.

as bankers'

conspicuous position held by the banks of New York in this respect--in 1912 six or seven of them held bethem about to the natural three-quarters to the and of pyramiding development of all existence centralisation a quasi-central the bankers' balto point of spontaneous of reserves banking unby the

ances-seemed

agency, even The position satisfactory. circles country ever banks

if one is not superimposed. as it stood was regarded It had since with been 1857 the that a frequent the practice banks, and city

as exceedingly complaint more in of re-deposit

financial

particularly by a number deposits, gave

with the banks of these banks an unhealthy by flooding the

in New York City, encouraged who paid interest on demand stimulus call to speculation loan market on the with cheap

Stock

Exchange the deby their financial group of

accommoda-

tion. It was, what is more important, nearly always mands for withdrawals of these bankers' balances country system The banks, banks, nancial of branch the level tainly branch The
9 See

owners of the the and development

which country.

precipitated debtor

crises position

in the of one

of the

town banks, the extreme is one had if there

to the other group, the country instability of this element in the fiwhich been would branch probably banking. have The been absence

structure,

unimportant

organisation of the amount it more organisation.

may have tended somewhat to raise of call loan money, and it most certhan bank
pp.

made

unstable

it would

have with

been

with

difficulties
Laughlin,

of a unit
Reform,"

as compared
199 ff.

a branch

"Banking

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 banking litical along

THE RATIONALEOF CENrFRAL BANKING Canadian and lines, but this was regarded as a pomore

impossibility,

so attention

was

turned

to the

practical expedient more economical general rely secure nature the use practice and the belonging agreement framework

of finding some systematic means of the utilisation of reserves in a crisis within the of the existing apparent and attempts made been unaided by system. that it was efforts them. One impossible of the banks unsystematic of these was This was a of New York of the entered an adverse banks into an clearto to

It seemed on the this had

increasingly independent end. Some already

of a somewhat

of the which banks to the under

clearing-house loan certificate." had been started by the banks of Boston Clearing which, in 1860. House when A majority had Association a bank

ing balance, it should, bank, deposit collateral against certificates The from ing which certificates them in the bore lieu of

instead of paying with the Clearing should issue in payment went

cash to the creditor House Association, clearing-house by the high creditor The position loans each creditor rate, bank loan bank. varving holdof the

latter

to be received which

interest balances

at a fairly to the owed.

5 to 10 percent,

essence

scheme was able clearing weaker ances). strengthen without lending of the

that the banks in a strong balances) should make (with intended unfavourable to prevent expense no to other

(with favourto those in a baltrying to bank

position It was

clearing-house

its.position at the such an arrangement, operations and of losing reserves

of the others, because bank could extend its to contract banks because when On the device by an as a at a time

all were

induced

fear

the demand first occasion was used agreement

of the public for cash that the clearing-house New York the banks specie for treating

was increasing. loan certificate accompanied reserves

by the

it was

of all banks

_ 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 by rect encouraging to the banks into was, the This them their on

country banks, as the case might be, effect of the clearing-house agreement customers which own they banks impossible their to take were for affected payment; also. of the an adequate checks drawn settlement to do beyond by the this for cash instead diof a cerissue started of a

handing clearings. tain the run loan on Both

in the

however, banks had

measure; the the

adversely to suspend

certificates

others and they suspended successes and the failures device be gave force should somewhere

clearing-house firstly, reserve of

loan that lending should

certificate there

to the

conclusion,

power for use in the crisis, and, secondly, that this be available ior the collective benefit of all banks. the by idea was gaining ground that it could an organisation in some man_aer aloof commercial times of relief not fully during banks. "lent a crisis It must up." had been provided established in 1846 of the banks, that funds objected instead that of dethis had only be from the be a bank

Fharther, provided operations that was Some

of ordinary in normal such sort

by the Treasury. that the Treasury is, that positing it should them

The principle had been should be independent keep its own banks. surplus It was the

with

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 preserved. National times make early
1-,See

the Banks

Independent Treasury and adopted

Treasury began the

System practice

was funds

not

strictly relief in

The

depositing

in selected

of giving

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

System

had

U S. National

Monetary

Commission--"The

Treasury."

THE

FEDERAL

RESERVE

SYSTEM

163

come bonds.

into In

being, 1873 of gold, banks. debt.

it had it again the

helped bought it prepaid it again proceeds

the

market bonds

by and it put of the

purchasing also on and interest sold deposit on bought

$5,000,000 in certain the public

of which some prepaid

In 1884 In 1890

interest

bonds. In 1893 the Treasury it actually had a deficit and banks. In 1907 it transferred the amount it had most on hand deposited of its surplus

was unable to give any aid at all; needed to borrow itself from the some funds to the banks, but was with small, them since before it had the already 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 body grounds to receive expanded It became reform that mode of relief in crises. It was only a lucky chance if

Treasury happened crisis came. There of opinion that which it gave

to have surpluses at the time when was, on the other hand, a considerable denounced if they got into the Treasury relief Banks and on the an impetus of these to expansion. difficulties, anticipations. for banking which could expected therefore

assistance on the also part it should

basis

of the positive programme provide for an institution

act as the Government's ences during the course

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 finding tions services some these were depositary systems. performed
Willis, "The Federal

of the failure of the possibility from the the objecnecessary

which In other by the

Reserve

was Central
System,"

free

of both

countries Bank.
Book

13 Cf. Parker

I., Chapter

2.

164 One formers tion. The of making other hoped

THE RATIONALEOF CENTRALBANKING feature of the of the American was banks the as the high system cost which of check were in the charge the re-

to remedy known

collechabit for

majority a charge

in America

"exchange"

paying their own checks. This charge purported the cost of providing funds to pay the check in place because the maintain a balance actually expense room bank had either to shift in a distant centre. What was there probably is little much doubt

to cover a distant or to were real was

currency the banks above the that there reduction the final

able to charge involved, but in the old system

for a considerable reducing gave reform, the lack the the

in the

real cost of check collection by amount of transmission of funds." It was the the ation there a difference system or was with the crisis agitation of opinion of note the a strong issue legal of 1907 which

necessary impetus was to still

growing

for banking as to whether or with reserve

but there chief fault On the of branch

lay with organiswhole, of

regulations. of the

majority

in favour organisation reserve funds was given

introduction

some kind the purpose ing.

of co-operative of providing support

of existing for panic to the

banks for financierthat

Authoritative

suggestion

the necessary changes tablishment of a central after to the sisted the 1907 crisis there

could bank was

best be made through the esof issue and reserve. '_ But even still a good banking, organisation deal and of opposition the for idea per"relief"

introduction that a purely

of real

central

emergency

_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

RESERVE

SYSTEM

165

would

meet

the

case.

This

was

the

attitude

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

RATIONALE

OF CENTRAL

BANKING

The ation twelve which

final of the

outcome Federal from banks

of the Reserve the

recommendations System.

was

the

cre-

Its organisation bank: in the

differed of of

considerably regional those

European Reserve became

central Banks members

it consisted ownership system-of the

Federal who

and membership was compulsory took a share by contributing to their the the guidance tasks of banks of the issuing and Federal notes, acting Reserve keeping as

on all National Banks-capital. On these, under Board, the agency background Reserve most, by the absence evil, have there reserves devolved of the by cirdebeen to them and of the

member

lending of the of the

rediscounting. A retrospective cumstances would fects more ment tral although seem of the

consideration foundation that banking many,

Federal perhaps than not the

System

to suggest

of American

could,

in principle,

naturally remedied otherwise of a central bank; that it was bank per this se that was was at the admittedly

establishof a cenand that, for

root

of the remedy

a partial

for things

which other remedies were politically or technically impossible of realisation, there remained certain fundamental defects which could by the not Federal be entirely, Reserve or in any System. great measure, overcome

CHAPTER

XII

The

Arguments of

in Favour Central

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. monopolies, Monopolies tionism Its origin either in this is to be partial sphere found or in the growth new the in activity. establishment the note Those of protecwhich trade dococcurred of issue. complete,

outlasted of economic

abolition of free creations

in other

branches

had been in existence prior to the trine were retained and reinforced: where they had at the we not previously circumstances find that the

existed. in which early ones most were of them founded were for

Looking established,

political reasons connected with the exigencies of State finance, and no economic reason for allowing or disallowing free been entry given into the note-issuing time, but once trade was, or could the have their The the as of issue at that established, monopo-

lies persisted right up to and beyond economic justification did at last come verdict choice opposed of the discussions of unity round and this in favour or monopoly thereafter

the time when to be questioned. problem in the the vindicated note superiority

to competition,

167

16a

THERATIONALE CENTRAL OF" BANKING

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 own finds then smaller, branches generally they however, where be held would they to keep by were banks The bank's under in the the allowed balances own financial to have that centre, branch control

171 their a bank would in that and

chose.

it convenient

city, where management.

remain

its own

In a multiple ume of its note close watch on that the standing position. reserve

system each bank issue, or of its total its reserve position,

must determine demand liabilities, 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 The central bank can, on the large other changes hand, partly allow on its acproportion to undergo

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 issue who nected can now turn those to the who with sponsored case was analysis attacked the those of the free theories major case points and was at conand

between defended

banking

those

it. Historically

free-banking

predominantly

of currency

credit which were the central banking

by the likewise,

banking school, and but perhaps a little of the currency a member of the

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

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, as a victory the success of the central currency banking school school as for the

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 banking versus currency suffice controversy, to remark which how far

fairly

familiar

ground.

It will

"_ f. footnote 32 on p. 194 of this chapter c

172

THE

RATIONALE

OF CENTRAL

BANKING

the link weighted banking The argument in France,

with the

the banking evidence in that sprang the

versus the free

currency banking

controversy versus central especially of their banking

controversy. circumstance placed which free-banking emphasis from the on theories school, that part of the so much

school, tended, it is true, to cast suspicion on the free-banking case. A not inconsiderable number of the free bankers denied that recalled over-issue only the quantity theory of money, inflationary and promoted ideas be were of an obtrusively that according of bank-notes in response are character. It may

to this school no such thing as an can take place so long as they are to the "needs It was of trade" their loan and continuthat as they therecontention (or so long

issued

ous convertibility so long as notes

is maintained. issued

on short-term banks are The demand

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

"bankmassige") for loans, and

fore for notes, will be confined itability of borrowing. Should excess of the needs of trade, bank will in repayment be no demand of loans

to limits imposed by the profthe issue be found to be in notes will come back to the falling due they and will for which consequently there be

for renewal; from there

automatically withdrawn prevalent idea that since ation mercial particular issue. If the of exchange, of credit dealings, mode banks they by way

the circulation. is no restriction of exchange to place takes

It was also a on the crecomon that note bills lendbanks a limit

of bills

in ordinary place via the

it is inconsistent of lending issue notes are merely which

with which they discount changing the form of the

ing. Since the bills would have existed in any case, the made no net addition to the total volume of credit. Notes issued on short-term loan, the argument circulation, between "pure paper

continues, and this bank-notes money"

become only temporarily part of the was held to constitute a vital distinction which had an automatic reflux and

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 RATIONALE OF CENTRAL BANKING [ !

loans are on short

term does not mean

that a credit

contrac-

!
I

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.

CENTRAL

BANKING

RECONSIDERED

| 75

banks. _ In so far as these banks between their cash reserves and total gold ple banks would the the volume movements of such of credit movements), can (its changes will

keep their

fairly constant ratios deposit liabilities, the in response constant to multiof these But this issue of by gold, As it is, the

be made provided

to move be a fairly the

reserves

are made to move require the fixing, of England of England but in circulation can

in the same way as gold. not of the fiduciary note of the plus vary quantity its deposit its lending not covered liabilities. and

Bank Bank

of its notes

so alter

volume of deposits on its books to the credit cial banks, and therefore the cash reserves independently eration within of the of gold movements, merely "proportion." widened by the Bank to affect its own reserve limits that are of course Government mistakes and as to abrogate and they

of the commerof those banks, allowing the opIt can do this the willingness Act in case of of there the esthe be

emergency. There were both seems actual sential amount that the convertible schools,

omissions worked out

in the

doctrines

in practice

not to be such results secured to impose of the only into some fiduciary necessary specie.

a great deal of difference by those who insisted such note rule as a fixed and was that issue, those

between that it was on should who notes

limitation

believed

regulation that two

We may conclude ment between the banking regard no definite was to the based banking ground

logically, in so far as the disagreeparties free banking and central on the positions they took up with there is one currency that, controversy, in favour given the case which

solely

versus

for presumption

of either

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

indepenwe are
other banks to describe all

from banks

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.

176

THE

RATIONALE

OF CENTRAL

BANKING

about rency which credit, Mises The the

to examine, school, there

it was

perfectly

consistent

for

the

curin of and which inof,

in so far as their aim was were checks on fluctuations the free-banking and additional case. those,

to find a system in the volume Both therefore, Michaelis on arguments

to sponsor are in this can by decisive

position. arguments, discussed, are to, and the

case

be exclusively either side

troduced

independent

the points at issue between schools. We shall, therefore, arguments of the free banking

the banking and currency turn our attention to the major versus central banking conbeen raised in defence of the other can be against It is always that even free banking, sta-

troversy proper. The points that have of the one system or in condemnation dealt with under five heads. The which under first runs of these in the is an argument terms. system

following banking

to be expected general

a multiple

if the

bility of the whole system is assured, individual banks from time to time, ruptcies any bank enabled among do not to borrow the stay from firms that in other hands bank are paid immediate who bank in the

there will be failures of just as there occur bankindustries. of those The people notes who of are ben-

and

therefore

directly

efit from its note issue. They third parties who have no bank concerned. sion of the notes will suffer in the hands son of their the tairs notes person would of that

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

Those people of the failed proportion

loss. A large

of such

of those who are either too ignorant, subordinate position, unable, to refuse which because In other a more words, informed there reject bank. of suspicion attaching is placed

or by reato accept to the af-

of a bank

or better-placed on the com-

munity the notes, and communitv

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 not select payment. the They

THE RATIONALEOF CENTRAL BANKING notes will of the send guilty in any banks notes and that present come these into for their differto the bear have to to

hands, and the proportions ent banks will be returned

in which the will roughly

notes of the correspond banks banks

proportions the note issues of the individual the total circulation. Hence the non-expanding bear rival part of the pressure resulting bank. Should a non-expanding

from the expansion of a bank insist on retaining as a result its lending. of the If this

its former reserve ratio, it will be compelled encroachment on its reserves to decrease happens, expanding latter tains more are the expanding bank and taking business finally driven out

(or group of banks) can go on away from its rivals until the of business and the former obthe banks with the or not, they could they they to join that gold as a outpari out

a de facto conservative

monopoly. So whether tendencies expanded

not help losing reserves, and if they did not expand, would lose business. Consequently, the argument runs, will, in the interests in the inflation. The result ous flow passu, flaw of continuous contraction falling and on that by the the the of self-preservation, is its failure by the one proportion group of this group has group refers must be induced to observe group and of the

in this argument expansion the other expanding reserves conservative

continu-

increase been driven

will be exhausted

entirely before of business. The ability notes banking argument

so far considered

only

to the

unreliof freewhich

of a check on inflation by way of the presentation to the banks for redemption by the public. The party laid particular stress on another check automatically upon each

they contended worked cal claims of the banks

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 either in on will continually be receiving payments from customers

179

in payment of loans deposit. In a system bank will the notes

or in the form of cash being paid where all banks are competitors not be prepared of rival banks, the clearing to pay out over but will return process. It is out of it and

for business, one its own counter them to their

issuers

through

therefore step with its rivals adverse earlier cause

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

bank expands will go against

will draw on its gold reserves to the extent of its balance. This mechanism would work at a much the external drain of gold to feel the effects of expansion that all hanks and the the will decide the the reserve is not ratios, desirous on bigger and would almost imin concert conservastronger other got to has

stage than the reserves their which check

mediately. to decrease tive will group. group be the

It is unlikely

of so doing, expansion an expansion

of these

of the

A bank

which

contemplates

take into account not only the direct effect on its reserve ratio, which comes about in the first instance when it increases before, drawal afford reserve will react an accretion stances willing unlikely anything may its issue against the same absolute occasioned size of the basis total reserve as but also the indirect effect of cash to other banks. The to make ratio partly to its loans on the by the addition drop who that withit can in its secure circumare

of a given reduced, and banks of the

will be correspondingly to the benefit reserves. in which of the While the to their occur

its action

other

admitting

majority

banks

to allow some reduction that they will ever risk like as great as those by the therefore was

in their reserve ratios, it is fluctuations of dimensions are viewed under more with their likely, comsysbut

which

parative equanimity The free bankers tem an over-expansion

central bank. submitted that not only not any

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

laO even In the bank much latter receives

THE RATIONALEOF CENTRALBANKING less likely than under are a central issued banking notes, and system. bank: can this al-

system

all notes

by a single

all payments

in, in its own

ways pay its own notes nor receives claims on claims mand very quent pared The via the functions creases crease in are much concerned. by the longer for gold

out again; it therefore specie reserves so far The only The period source effect of could

neither gives as inter-bank is the (less as defrecombe seen in the

of claims circulation

public. average

redemption) of notes with a multiple system central clearing under its issues the banking very by same school special a given proportion, mechanism

under a unit system of note issues. alleges is largely proportion, and that an inter-bank illusion, If one its business therefore the

control and bank will only inin-

circumstances.

larger

amount of loan repayments week will give it the same as they ings and It was have on it, so that denied no claims consequently

it will number no

have falling due in any of claims on rival banks arise recourse in the clearsit-

differences that, failing

on reserves. to the

uation where the notes of any one bank circulate, not over the whole area, but only over a narrowly circumscribed area, would raises on the system. The port will increase call in which be sent objections expansion argument of it take in the A) and no the case to that notes passing public out of their exchanges is any in a multiple _ given between bank repayments. (which area case and of issue which which check banking in supthe we If we in by the for collection_--a

is analogous

of international of note and issues the

of its own--there

automatic

as stated account circulation

illustrations occurring expanding

of a lag of the

increase

in its loan

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 will only such a lag which in the first in practice on efflux, and must occur, there though period,

ISl will this when

a drain

instance

A's reserves, at a later

be a temporary

A's loan reserves clearing expansion reduction system, which ences

repayments increase, there to A. _'It seems, therefore, mechanism will depend in its reserves assumed clearing the

will be a return of these that whether or not the tending to check A's the credit a bank A can stand period. against

will act as a factor

on whether or not during this interim that in the will case function

It is always expands between

of a deposit

mechanism

out of step the two cases

with others. would seem

' The only differto be that the tem-

porary withdrawals the check case than drawn spends ately, other bank. will on and banks None pass the those

in the lag period in the note case. deposit into in the banks favour

will be more rapid in All checks which are as the clearance borrower immediwith

additional be paid drawn

credit, tbr

it, will

of people

banking

will give rise of the checks the

to cash claims on the expanding will remain out in circulation; all In the case of the note issue, will come notes that deposits.

through

clearings.

on the other hand, only a small part of the issue back from circulation to the banks--viz., those come in via loan the repayments or in the form of new

Eventually it previously

expanding bank lost in the deposit

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

_) is immaterial to the general conclusmn what assumption we make reIt garding 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] 10 The 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

THE RATIONALE OF CENTRAL BANKING

case, but because serves in at a later

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

BANKING

RECONSIDERED

18a

We old and

can the

make new

various loans.

assumptions If the term

about of loans

the

term

of the average

is on the

increased with will be longer reason greater der the under system

an increase than if this that system the

in their volume, the is not the case. There the length form of the lag of loan in the by deposit of notes. credit

lag period seems no will be any than only undif-

for assuming

of lending

The

ference is that in the deposit the fact that the banks customers remains where however, near

the size of the temporary drain will be larger case than in the note case. Even allowing for some additional notes will find their way into by it anyof notes of new deposits loan repayments, to approach reflux

at an early stage in the form as well as by way of current true that that the the this is extremely extent drain of the return caused of cash unlikely

of checks. by the

It is possible,

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 the notes experiences issues as are (Massachusetts) systems the power through of such practical examples of competitive

afforded by the and Canadian seem to have other clearings. will the are made affect will the of all loans be the but the banks

history of the Scotch, Sufsystems. '_-Banks in each definitely conscious return of of in check by the

of these

been

of holding

What influence loans in general lag period? the tem after average the the It will term expansion, greater

average period for which have on the withdrawals rate of withdrawals. in the be the of cash The per outstanding withdrawals shorter will banking

bank in the shorter sysweek if

lag period,

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

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

on the

on reserves
Commission, p. 70.

date
Banking

will
and

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

Interviews

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 flux principle of notes and of "bankm_ssige on which so much schools." the ability of a non-expanding banks realism and has to join bank to the central of the consubmitted in an expanfree-banking Deckung" emphasis and automatic laid by rethe was

banking Besides exercise banking cept that the

questioning

any control over the expanding school has also cast doubt on the so-called motive conservative may lead bank all banks profit

of the

sion. 14The term conservative bank for some reason resists pand demand is possible credit. If we suppose (a rise for capital

was intended to imply that the the forces causing others to exthat in the there "natural" occurs rate credit a rise so long in the it and the at If of a rethe who will be in as they of interest)

for all banks

to get out more

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 they profits old rates lend of all banks than if they of course, reserve more, in their will lend ratios. be greater the same do it at they if they the lend more rate. at a higher expense

reduction

If all or a majority

of them

are unwilling serve ratios "natural" insist the the

to increase their lending the market rate of interest but the their fewer rate are and the the

and lower their will rise towards number the of banks smaller the extension

rate,

on retaining

old reserve

ratios greater

rise in the money volume of credit.

the the

A bank which is conservative must be supposed to foresee events following on the boom, so that it anticipates that profits it could gain by joining by in the the boom would be crisis counterbalanced losses of the

subsequently

_ See p. 174 of this chapter. 14 See 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 ers are credit unable customers to repay withdraw their loans. cash and debtor

1185 customsuggested of all the incentive profits of crisis banks

But it has been

that such banks, even though consequences of an expansion, to hold the and off from more it, because than and the boom compensate larger

they are fully aware will not have any will is the find that losses the for the

they

of the of the

depression;

number

who want to expand, whether because they do not foresee the crisis and depression or because they compute the gains as greater for any about of escaping by the than individual entirely policy the losses, bank from the the more out, effects 1_This unprofitable since it has of the argument crisis will small it be to stay chance brought profits there ratios, if

of its rivals.

is however

still open to the would exceed would there crisis tion boom be many

question whether the losses, and banks willing

it is likely that the therefore whether their reserve

to lower

were no central bank to give external aid and the banks were always under the threat in the would case of a suspension in order the of specie to make possibility the payments. extra to take

during the of liquidaThe risk in the bankof the the

necessary

profits

include

of insolvency. of central by reason power that be and under would

The third argument, advanced in favour ing, is that a central banking institution has confidence the banks from pelled, position, the same would difficulties their placed in it bv the public explained would in cash the of a crisis. It was system

to mollify pressure be com-

in a crisis

in a free-banking creditors

for payment

in consideration of the safety of their own reserve to contract their lending. All banks would be doing and borrowers into previously liquidation. accommodated Many of the banks by them thembe forced

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

BANKING

RECONSIDERED

la7

cash velop

resources into

by the

central slows process

bank

in time

of crisis

allays

the de-

tendency

to a panic a chronic

and

up what

would

otherwise

of liquidation. this bereason to is in bv the

If crises are bound to occur under either system comes, according to the one school, in itself adequate for preferring ing one. this tion lied the The a central free-banking gives the will become aid banking school 1; that whenever that part this of the organisation has sometimes money if a central the data

to a free-bankopposed instituto be remarket or other

counter-argument knowledge

regularly upon

difficulties,

is continually anticipated

commercial banks and will itself expand their lending operations would pendence support if they ders given credit give them entirely ceased were giving the rise fact unable the on margin their to keep is weakened that banks policy there their cannot followed will be until and own

be a reason why they will beyond the limits which consistent and allowed the occur. who from cautious not were by with a deresources, if distress to crash disorThis that, expand the the evil rivals,

of safety banks going

to be given to a crisis

self-help, have banks

would

in future if we some

counter-argument unwisely

to assume suspect,

solvency

becomes

non-expanding impact of the and if anything affect all to such not would on the remains bankingD be able percent liquid. entirely banks, a very

escape entirely by their less

in the nature of a panic starts an extent that even the prudent above water be trade for argument the since proved cycle the no bank that and lender in defence Unless eliminate the powerful it can

it is likely to banks may can free of last of general be 100 runs resort central banking

to keep

argument

_: 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 Financial Economic Committee, on Conference. Conference. Minutes of Evidence," National and Federal

3317 Systems," (Sir Otto U.S.A., Niemeyerl 1931.

Reserve 6720

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

Committee, (Sir Robert

Minutes Kindersleyt.

of Evidence."

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 tors

THE RATIONALEOF CENTRAL BANKING 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 part to reach of the appreciable and dimensions, then it to

become

object

usefulness

of banking

counteract them, and a fiduciary of uncovered notes or of check necessity, How cause if monetary to discover of catastrophic oscillations to counteract most acute doubt for out factors a banking disturbances, and

issue (whether deposits) may, are to be kept which which likely from system

in the form we find, be a neutral. not likely the side of be the itself the of correct

will is least

to introduce adjustments public, is the our day.

most changes unsettled

to make the

economic

problem system difficult

There is not much is actively responsible task system the cash mercial that their is to determine they provided banks arise. fluctuations by keep the major

that the present banking disturbances. The more of what from stable follow particular changes reserve fairly features in the that to be an indisputable banks. We find

of the fact that of comand in bank by the polin supfact

But it seems come central relatively activities

amount the (except

proportions closely in central magnified of this seem to lend by

lending

the pit of the money. _ These coefficient icy mind. port is always to the

depression) movements say, conducted

movements are, of course, ten the kind times, with knowledge which put

of expansion,

but central

bank

It is propositions theory,

of this most

recently

forward

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 true But fluctuations, reduced such than that while under a system may be not being is much our verdict entirely And less eliminated, capable control. as to the of stability a practical interference an integral part comparative

195 would

be much manipulation

free banking. of central

it is undoubtedly of monetary

a system

whatever

outcome of the two systems in terms that the choice can ever again become vast majority has of people become that result government so much of banking

it is unlikely one. To the in matters of the ac-

cepted institutions vite ridicule. One the plied sphere in other

to suggest its abandonment is to inof this attitude is that insolvency in has won exception that also almost prove made which from be the paid rule apit must for by

of banking lines

of business

liquidation, and it is important the laws of bankruptcy have plied clusion free trade them. Their would they banking Such to banking that pleas competition in banking we should experiences in banking. as are come occasionally from actual

to point out that since never been strictly apof drawing the the conof for free unworkability day

be diffident

in our

sources

do not commend

They are the product of theories demand for free banking is based provide ascribe caused practically all industrial by bank tendencies When unlimited and social monopoly.

of "money magic." on the notion that it supplies of credit and of to deficiencies of practical

evils

'_ As a matter

policy the centralisation. century

are all in the direction of increased the choice was made in the nineteenth the note issue, deposit bank-

in favour

of controlling

ing was for various reasons left there are signs of an approaching deposits. tary be power the This would secure hands outcome in the of the

"free." At the present time extension of the control to concentration authority bank of moneand would and central

the final of central

consistent

philosophy

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 "Automatic

Working

of the

Mechanism" Control

of Credit

In

order

to make clear the argument we append the following

on pp. 178-184 arithmetical

of the

last chapter

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 consideration.

remains

the

same

throughout

the

period

under

Orig/na/Position A. Notes Gold Loan ................................... .................................... repayments ........................ 40,000 4,000 10,000 B. 40,000 4,000 10,000

A receives B Notes ,, are

5,000 ,, therefore

of its own ,, cleared

notes ,, without

and

5,000 ,, any

of B's. A's.

transfer

of gold.

Position Notes Gold Loan

at First

Clearing

after

A's

Expansion A. B. 40,000 4,000 10,000 50,000 4,000 10,000

................................... ................................... repayments ........................

A receives B ,,

5,555 4,444 1,111

of its own ...... gold from

notes

and

4,444 5,555

of B's. ,, A's.

B draws

A.

Second Notes Gold Loan

Clearing A. ................................... .................................... repayments ........................ 48,889 2,889 10,000 B. 41,111 5,111 10,000

A receives B ,,

5,433 of its own notes 4,567 826 gold ...... from A.

and 4,567 5,433

of B's. ,, A's.

B draws

WORKING OF CREDIT CONTROL

199

Third Notes Gold Loan

Clearing A. ................................... .................................... repayments ........................ 48,063 2,063 10,000 B. 41,937 5,937 10,000

A receives B ,,

5,341 4,659

of its own notes ...... from A.

and

4,659 5,341

of B's. ,, A's.

B draws

682 gold

Fourth Notes Gold Loan

Clearing A. ................................... .................................... repayments ........................ 47,381 1,381 20,000 B. 42,619 6,619 10,000

A receives B B loses ,,

10,530 4,735 4,205 gold

of its own notes ...... to A.

and

9,470 5,265

of B's. ,, A's.

At the

end

of the fourth

clearing

the

position

is:

A. Notes Gold ................................... .................................... 51,586 5,586

B. 38,414 2.414

2. THE

DEPOSIT

CREDIT

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 O_wJna!

THE RATIONALEOF CENTRAL BANKING PosOHo. A. Deposits ................................ Cash .................................... Position at First Clearing A. Deposits ................................ Cash .................................... 50,000 4,000 B. 40,000 4,000 40,000 4,000 B. 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 is already A. 45,000 --1,000 untenable _r B. A:

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

45,000 8,000 + 1,000

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1873. J. W. Parker, Before 1860. 2nd ed.

Principles

Harry

E. Banking

in the

Cambridge, Mills, Richard London: Mises, Ludwig G. Fischer, Mitchell, ence cago: Nasse, to the Erwin.

Mass.: Harvard University Press, 1927. Homer. The Principles of Currency and and Sons, 1857. und yon. 1928. Geldwertstabilisierung A History

Banking,

Groombridge

Konjunkturpolitik. with Issue: Special 1862-65. ihres

Jena: ReferChiGes-

Wesley University

Clair. Economic

of the Greenbacks, of Their 1903. und die

Consequences Press, Bank Bonn:

of Chicago in Deutschland.

Die preussische

Ausdehnung 1866.

chi_flskreises

A. Marcus,

National Monetary Commission, Publications, 1910-12 Aldrich, Nelson W. An Address by Senator Nelson fore the Economic Club of New Work of the National Monetary ernment Davis, Dewey, Kinley, ment Sprague, System. Warburg, U.S. and U.S. and System. Printing Washington: Davis David. Printing R. State Printing The to the Office, Office, 1910. The Origins Before 1910. Treasury of the Country. the of the Andrew McFartand. Banking Office, Banks 1910. York, November Commission.

W. Aldrich

Beon the Gov-

29, 1909, Washington: National 1910. War.

Banking

Government

Printing

Office, Civil

Washington: States and

Government Its Relations

Independent

of the United Washington:

Govern-

O. M. W., History of Crises Under Washington: Government Printing Paul M. The Discount Office, System 1910. Printing Monetary Systems 1910. Commission. of England, Monetary Systems and Office,

the National Banking Office, 1910. Washington: on the Banking

in Europe. Interviews Washington: Interviews on France,

Government National Currency National Currency

Commission. of Canada.

Government the Banking Germany, Office, 32

Printing

Scotland, Government

Switzerland, 1910. Neisser, 1 (1930 Hans.

Italy. Washington:

Printing

"Notenbankfreiheit?"

Weltwirtschaflliches

Archiv

II): 446-61.

_06

THE RATIONALE OF CENTRAL BANKING

Norman, Respect

George

Warde.

Remarks

upon London:

Some

Prevalent

Errors

with 1838. upon Over-

to Currencv

and Banking.

Pelham

Richardson, of the Pressure 1837. Banking and

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

The Causes London: Observations

and Consequences Pelham Richardson, on Paper Money,

trading. London: James Ridgway, 1827. Parnell, Henry. A Plain Statement of the Power and Patterson, Sons, Pereire, France. Phillips, Phillips, Bank vols. Poschinger, Berlin: the Use It Has Made of It. London: of Capital. de Bank France Credit. the James R. H. The Economy 1865. Isaac. Paris: Chester Edmund. of England Heinrich La Banque P. Dupont, Arthur. Charter yon.

of the Bank Ridgway,

of England 1832. and en

Edinburgh:

W. Blackwood du Credit 1920.

et l'Organisation New York: of the und

1864. Macmillan, British 1861. Bankpolitik in Preussen 3 Reform Currency and

A Plea .for

London: Bankwesen 1878-79.

Whittaker,

J. Springer,

Price, Bonamy. Raguet, Condy. Grigg & Elliot, Ramon, Gabriel. set, 1929. Report from 1831-32. Reports quire

The Principles of Currencv. A Treatise on Currency 1839. Histoire de la Banque of Secrecy

Oxford: J. Parker, 1869. and Banking. Philadelphia: Paris: Bernard GrasCharter, to enPapers

de France. on the Bank

the Committee

of England Committee

bv the Lords into the State

Committees of the Bank

Appointed of England, Payments.

a Secret with

respect

to the Expedi-

ency of the Resumption 1819 (291), vol. III. La Revue des Deux-Mondes. Richards, P. S. King, Scharling, Spencer, York: Sprague, Mass.: R. D. The 1929. William. Herbert. D. Appleton, Harvard Early

of Cash

Parliamentary

Historv Jena:

of

Banking

in England. 1900. and Speculative. States.

London:

Bankpolitik. Essays, 1891.

G. Fischer, Political, in the

Scient(_c, Reform Press,

New

O. M. W. Banking University

United

Cambridge,

1911. of Banking in All the Leading of Commerce and Commer-

Sumner, William Graham, et al. A History Nations. 4 vols. New York: The Journal cial Bulletin, Tellkampf, 1896. on Law Reform,

J. L. Essays

Commercial

Policy,

Banks,

Peni-

BIBLIOGRAPHY

_07

tentiaries, don: Tellkampf, Berlin: Tellkampf, Bankwesens

etc.,

in Great Britain & Norgate, 1859.

and

the United

States Geld-

of America. und

Lon-

Williams

Johann Ludwig. Die Prinzipien des Puttkammer & Muhlbrecht, 1867. Johann Ludwig. Uber die in Deutschland mit Hinweis a_

Bankwesens. des in EnSociete 1857. New et al., Gov-

neuere dessen

Entwicklung Vorbilder

gland, Schottland, und Nordamerika und auf die franzOsische generale de Credit mobilier 4th ed. Breslau: Morgenstern, Tippetts, York: Charles S. State D. Van Nostrand, A Histo_ of the Banks 1929. and the [vol. Annual Federal Reserve

System. Longman

Tooke, Thomas. 1840. U.S. Comptroller ernment

of Prices Currencv.

3]. London: Reports.

Washington:

Printing

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. 3 vols. on Banking Reserve Printing Otto Lehre Banking Office, und Michaelis, yon den Washington: and 1931. Kulturgeschlchte. et al., 1863 Banken. and Leipzig: Heraus1865. Voss, Currency. Svstems. Government Operation Hearings . . . Printing Office, 1913 U.S. Congress. Senate. Committee of the National and fur Julius Federal Washington: Vierteljahresschrifl gegeben Wagner, 1857 von Adolph. Government Faucher, zur

Volkswirthschafl

Beitrage

Wagner, Adolph. Die Geld- und Vienna: Braumuller, 1862. Wagner, Adolph. System mit der Mit die Vergleichung tlebankwesens. Baden, sowie norddeutschen 1870. Wagner, sicht theilweise Adolph. auf das

Credittheorie

der Peel'schen

Bankacte. unter des Zetin im

der deutschen auslandischen. auf die und

Zettelbankgesetzgebung, Zugleich Errichtung das ein Handbuch yon Zettelbanken

Rucksicht Bankreform Freiburg der

Staatspapiergeldwesen Buchhandlung, besonderer Verhaltnisse. Ausgabe. by American System: Press, Freiburg Histo_,

Bunde. System geltende

i. Br.: Wagner'sche mit deutsche

Zettelbankpolitik, und auf vervollst_indigte 1873. lllustrated Reserve Ronald

Ruck2. i 5th

Recht und

umgearbeitete

Br.: Wagner'sche

Buchhandlung,

White, Horace. Monev and Banking ed. Boston: Ginn, 1914. Willis, zation Henry and Parker. Operation. The Federal New York:

Legislation, 1923.

Organi-

 OS

THE RATIONALE OF CENTRAL BANKING

Willis,

H. Parker, Press, James.

and John Problems 1934. Capital,

M. Chapman. and Developments.

The Banking

Situation: Columbia The

AmeriUni-

can Post-war versity Wilson, 1847.

New York: London: et les Paris:

Currency

and Banking. d'Angleterre des Banques.

Economist, d'Ecosse. 1864.

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

Banques Guillaumin,

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

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, 129130 Bankmassige cover, 118-119, 124-

Bagehot, Walter, 22, 23. 103, 133, 134, 136-144, 170 Balance of payments, 83, 134 Baltimore Plan (1894), 153 Bank Act 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, 68-70 Act (England),

125, 172-174, 184 Bank-notes cover for, 118-120, 123, 124-126, 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 foundation and early history, 11-14, 25 as lender of last resort, 17, 22, 118, 123, 140 monopoly status of, 12-13, 2124, 71, 88-89, 135-136, 139 Bank of France attack on, policy of, 36-38, 9740 35-41, 93, 96, discount founding and activity of, 29-32 monopoly for note issue of, 32-35 42-43

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

Bank currency. See Coin; Money; Note issue; Specie Bank failures, 5, 26-28, 81, 106, 108109 i I Bank for International Banking, international. Settlements, See Cooperation, international Banking i i I [ t Banking Commission 134, 136 reform 166 (France), States), 192

133164-

(United

Bank of Indiana, 52 Bank of North America, Bank of Ohio, 52 _09

210

THE

RATIONALE

OF CENTRAL

BANKING

Bank Bank

of Savoy, 38-40, of Scotland, 25 See also Royal United

96, 102 of Scotland 78, 92

scarcity or excess 98, 109-110 See Capital also Inflation, cycle See Gold;

of, 82-83, Investment, Specie

94,

Bank States,

Bank

of the

Trade flight. outflow

First, 44-46 Second, 46-47 Bank Bank rate runs, See Discount policy 15. 19, 28. 33, 97. 158 17, 51, 108, 102-103, 28 144 59 75, 76, 40, 84, 85, 113 52-56, 130, era, banks 83, 119, 148National 105, 133. 134, 170 137

Carey, H C., 44n, 81-83, Cash payment, 34 suspension U.S. Central 78, 81, bank for, 105, arguments Bagehot on, characteristics as clearing international potential of, 15-16, 151-153,

92, 94, 58,

95

Bankruptcy, Banque Banque Baring Berlin

120-121 52-54,

Enqu_te, Generale, crisis Kassenverem,

suspension

of, 46-48, 160-161 184-187

(1890),

Bills of exchange, 172-173 Bnnetallic Bond question,

136-144 of, 168-169 house, 111

deposit 130 m the 154 See Bank

system, United

cooperation for, 3, 190-192 17, 22, 165, 186,

States,

Juglar on, 111-112 as lender of last resort, 47, 118, 123, 140-143, 191-192 Loyd on, on, 20-21 19-20, 22

also

Greenback Act; State 96, See cycle 103

Bonnet, Boom

\qctor, economy. Trade

Economic

crisis;

Palmer

theol\v 18, 25, 31-32, 45-47, 112, 62, 56, 144 191

in Prussia/Germany, weakness 139-143 of system

59, 67-68 of, 135-136,

Branch

banking, 64, 100

in the Umted States, 92, 147, 151, 157 Brasseur, Hubert, 99-100,

See also Bank of England; Bank of France; Federal Reserve System; Central Reichsbank banking Government school, role, 6, 105, 112112,

British Linen Company. 26 Brussels Coriference of 1920, Bulhon Committee report, 16

113, Cernuschi, 113,

171, 177, 180, 184 Henri, 103, 105-106, 126, 145 of England), 53-54 18, 79, 121-122, 62 92, 95-96, 110, 134, 100144 160 11

Calrnes, Cazsse

John

Elliot, do

144 Commerce, 29

Charles Chase, Checking

I1 (king Salmon,

d'Escompte

28-30, 36 Caisse des Comptes Courants, Call loan market, 157-159 Canada, Capital fixed and floating, 90-91 real opposed to artificial, 125, 127 192

system, 164 Chemmtzer-Stadtbank, Chevalier, 103, Michel, 107-108,

123,

Cieszkowski, Auguste, 93 Clearing House Association, Clearing-house banks, 53

INDEX

II

Clearing-house 162 Cobden, Coin, Commercial Commercial crisis Company Competition arguments 85-88, in France, Richard, 17, 107-108

loan 96n

certificates,

160-

Crisis See Currency, 75 Currency

Economic crisis 1, 8-10, 28-29, 55, doctrine, 115-118,

68, 74123-

bills, crisis.

165 See Economic Currency

126, 118,

128,

135-136

school, 21, 80, 91, 112-113, 127-128, 171, 174-176, 193 versos banking

law.

See for 92-94 30,

Bank and 39

law Currency against, 4, 80,

189,

controversy. See Banking versus currency controversy

in Scottish banking, Wilson on, 88-89 See also Free trade

26 Deposit banking, 43-44, 89, 8-9, 18-19, 66-67, deposit 24, 35, 88-89, system, 58-59,

Convertiblhty 108, See also

principle, 73-74, 112, 173, 175 Coin; Money

120-123 See also Bond Checking

system See cycle 29, 121 wqth free banking, Economic theory

Cooperation, Coq, Paul, 95, Coquelin, Coullet, Counti\v

international, 100, 103, 112, 103, Charles, 82, 93-94,

3, 190-192 144 95, 105-106, 144

Depression crlsm, Discount

economy. Trade banks,

Paul Jacques, 113, 133, 144 banks 14,

Discount pohcy connection 115-116

in England, 79 m the United

16-17,

23, 26-27, 49, 156-158

effect of, 102-103, m France, 29-30, 97-98, 102-103,

134-135 35-38, 40, 134 61-63, 49

95,

States, Jean 103,

Coureelle-Seneuil, 94-95, 100, 112, Coors Credit fl)rce, demand 60-62 144 33-34

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

m Prussia/Germany, 68-69, 97-98 in the United States,

65,

See also Dritteldeckung. for, 58-59, Duopoly, Du of, 33-35, of, 15 Economic causes for, 197in 1802 bank, 9-10, 22-23, Puynode, Etienne,

Rediscount policy See Specie Gustave, 98 95, 105

in Prussia

98, 138

effect of over-supply 83-84 expansion See Credit also control m England Banking

Duran,

school

crisis of, 6-7, (France),

75-76, 30

82-84, 136, 194

90-

automatic 200 by Crodit Cre.dit

mechanism

91, 109,

124-126,

the central 168-169 Mobtlier, mobilier

in 1825 (England), in 1836, 19 m 1839, 19 22

17, 77,

97

37-41 concept, 60, 63, 66

in 1847,

_12

THE RATIONALE OF CENTRAL BANKING 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 principles of, 72, 80 Fullarton, John, 193n 60, 66,

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,

Feaveryear, A. E., 12n, 22n Federal Reserve System, 6, 164n, 166 Fiduciary issue, 21-22, 104-105, 112113, 124-127, 130, 136, 174175, 189 Financial crisis. See Economic Trade cycle theory Franco-Prussian War, 67 Frederick (king of Prussia), Free banking arguments 176-185 58 crisis;

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 Geyer, Philip J., 66n, 91, 123, 125128, 136, 145, 193n Gladstone, William, 23-24 Glasgow Gold Bank, 27

agaunst, 74-77, 80-81,

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 in banking, 6-9, 12-15, 76-77, 80-81, 93-96, 133, 195 in France, 28-36 in privileged central banking, 22-23, 58, 108-109, 115-118, 124, 139-141, 170, 175 in Prussia/Germany, 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

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 Hubner on, 114-116 Longfield against, 85-88 MacCulloch against, 74-77 Parnell on, 72-74 Tellkampf on, 116-117 Wilson on, 88-90 See also Note issue; Plural banking system Free-Banking Law (New York), 51, 56 Free-banking party Bankfreiheit, 62, 64, 66-68, 128131 in England, 72

INDEX

Z1

Hake, Hankey,

A. Egmont, Thomson, 143

195n 24, 102, 134,

Lasker, Laughlin, de

Leopold,

128,

144 157n 104 103,

J. Laurence, Emile

Laveleye,

L. V., 102, 95, 100,

Hansemann, Hart, Albert Hawtrey, Hayek, Hildreth, Hoards

David, 64n G., 196n Ralph G., 141, A. von, 81 193 107-110. 190-192 190

de Lavergne, Leonce, 113, 145 Law, Legal Legal John, reserve tender 54-55, 28 ratios. currency, 152-153

Friedrich Richard, theory,

See

Reserves 15-16, 33,

Holland, 41 Horn, J. E., 16, 91, 95, 103, 112, Hubner, 144 114-116, 145 Otto,

Leipzig Bank (Saxony), Lemaitre, L., 92n Lender of last 123, 192 Liability, resort, 140-143,

59-60 17, 22, 47, 165, 186, 118,

191-

14, 25, 43, 119 also Credit; penalty, (Lord),

83, 95, 116-117, Insurance; 120-121 Loans

Industrial

crises. Trade cycle

See

Economic

crisis,

theory 104, 154, 177

See Liquidation Liverpool Loans

Inflation,

12, 91,

Insurance, 50-51 See also New Interest rates. See Investment, 82-83, Italy, 41

18, 72 of England, 12-

York

State

Discount policy 94, 109-110

to Government 15 to Government to Government States, 44-45,

of France, 34 of the United 53

Jackson, Andrew, Joint stock banks exclusion in London,

47

short-term, Loi du Germinal Lombard Lombard 58-59, 72 Private 63, business, loans

172-174 an XI, 30 62, 69 cover, 85-88, 119 122,

of, 13 18-19

as note

in Prussia/Germany, 67-68 in Scotland, See also 17, 25-26,

Longfield, Mountifort, 128n, 133, 145 Lotz, Loyd, W. 57n

Country Six-partner

banks; rule

S. J. (Lord 80, 145

Overstone),

20-21,

banks; Joplin, Juglar, Thomas, Clement,

17, 71-72 111-112 MacCulloch. John Ramsay, 13n, 74, 75-77, 80, 85, 88, 141, 72, 145

Keynes, Kindersley, Knies, Koopmans,

John

Maynard, Robert, T., 190n 191n

190 130, 145

MacLeod, Mannequin, Marqfoy, Meulen, Michaelis,

Theodore, 134, 136, 100, 105,

Henry 144 112,

Dunning, 144

38, 89,

C. G. A., 128-129,

Gustave, 96n Henry, 195n Otto, 66, 67, 124, 130, 68n, 145, 119-120, 176,

Laisser-faire Landauer,

principles, Carl, 184n

4, 57, 71,

101

121-123, 180n

I114

THE

RATIONALE

OF CENTRAL

BANKING

Mill, Mills, Mises,

John Stuart, 193n

102,

134, 145

137,

142,

National National National Nelsser,

Bank 146-147, Debt

Act (1864), 157-158 (England),

54-56, 13

133,

R. H., 132-133,

Ludwig von, 4n, 145. 176, 178n, 187n, 190, 194-195 Victor, 105, 126 7

Provincial Hans, 145, 184n

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

Modeste, Monetary Monetary

disturbances. pohcy, 126-127 and

Newmarch, New ballklng, York banking 56 Safety

William, State

102,

134

under free 194-195 international.

central 3, 190-192

m, 43, 47-48, Fund of, 50-51

52n,

53,

Money bank-notes as, 107-108 coin or metallic, 104, 105 paper, 84-85, quantity See also Currency, Legal Money See tender market, 151, 162 also 9-10, 108, theory Assignats: Fiduciary currency, 40, 103, 28-29, 172-173 of, 72, Corn, issue, Specie 143, 140-141, bills, 126-127 59, 74-75,

Nlemeyer, Otto, 191n Norman, G. VV., 72, 79, 80, 84, 145 Norman, Montagu, 120, Note 129 119 2, 20-24 banking, 191

143,

Normatrv-Bedmgungen, Normatlvbestimmungen, circulation tn England, in unitary or plural 132, 137-138 velocity Note Note 25, 27 12-13, 72, Note Note and quanoty

62, 64-66,

Commercial business banks, 105-106

of, 127

Lombard Monopoly

clearing, 26, 46, 49, 73, 79 cover. See Bank-notes exchange, issue 26, 32 expansion 124 12-14 15-18

among Scottish argument for, of Bank 88-89 of Bank conditions 79 privilege rationale 107, in State 52 Mortgage Myrdahl, and 167 banking

of England, of France, for

automatic check on of, 85-88, 121-122, bank exclusion from, size,

98,

100 of,

maintenance

denomination development

of, 8-11 Reserve, 28-35 41 backing, 115-116 166

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

by Federal in France, in Italy

(United Bank

States),

with

metal

Exchange 59 190

over-issue 33-35, 135 in Prussia, 123 in Scotland,

problem of, 26, 28, 30, 73-76, 79, 85, 109, 133, 58-59, 25, 27 States, 43-44, 5465-66, 69, 119-

(Bavaria), Gunnar,

Napoleon Nasse,

(emperor of France), 30, 36-37, 40, 97 Erwin, 124-125, 139n

29-

in the United 56, 148 unity or

plurality

in, 5, 10, 96,

INDEX

2 15

99-100, 125-126, 167 See also

105-106, 128, 133,

121-123, 136-142,

m France,

31-33 58-59, 60-

m Prussia/'Germany, 62, 65-66, 69-70 in Scotland, 26 See

Bank-notes, Country issue; stock banks,

Competition; Fiduclarv era, Joint redemption; Note redemption, 75, 178-179

Prwileged

banks.

Central

bank,

Greenback banks; Note

Government role; Monopoly Protectionism, 9, 81, 167 Provincial Prussian See banks. See Country 124, 130 banks

Reserves 49-50, 54, 56, 73,

Bank, 61-69, also Reichsbank

Over-issue

of notes

See

Note

issue

Quantity

theory Money

of money.

See

Palmer, Panic Paper Paper Parnell,

J. Horsley, 61n, See 72n, Bank runs See See

18n, 188n

19-20,

22, Raguet, Real bills Condy, doctrine. Reflux policy, 83-84, See 92-93 Bankmasstge

currency. money. Money Henry, 144

Money

cover, principle Rediscount

of notes 166 118, cover 157, 170172,

Bank-notes, 76, 77, 134, 135 79, Reflux

72-74,

of notes 174

principle,

Patterson, R. H, 102, Peace of Tilslt, 58 Peel, Peel's Robert, Act, 117, 22

See also Bankmasslge Reichsbank, 69-70, 128 Reserve centers 171 Reserve Reserves cash, equalisation, 19 of, 106 9 74-76, 86-87, 140, or cities,

22, 27, 67, 68, 80, 113, 118, 124-126, 189

161

Peel system. See Pereire brothers, 100, 138 Philipps, Phillips, Edmund, Chester 101,

Fiduciary issue 38-39, 40, 97, 98, 103, 118, 134-135,

centrahsation of currency,

136 A., 181n

drain 161

on,

124, 118,

135,

Pigou, A. C., 187n Pitt, Wilham, 14-15 Plural banking system, notes of, 108-109 See Political Political Price, Private also crisis Competition; Note of 1848 Club, 90-91, issue (France), 72, 134 133-134, 20 144 32-35 10, 96-97, Free 111

fixed proportion 171

of, 113,

legal ratios, 154-156 metal, 19.34, 61, 97 poohng in specie, Reserve systems, Restrictionist of, 140, 37, 53 19, 21, 106, 139-142 93 school (France), 161

banking: Economy Bonamy, banks

Rossl, Pellegrmo L. E., 93 Rouland, M., 36n Royal Bank ot' Berlin, 58-61

m England,

14, 16-17,

_16 Royal Royal

THE RATIONALE OF CENTRAL BANKING Bank of Scotland, 25 Commission on Banking and Currency (Canada), 192 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, 14 88, 95, 192-195 Treasury bills (England). Tunnage Act, 12 Turgot, Anne R. J., 28

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

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, 95 Vergeot, J. B., 101n 48, 54-55, 162-163

Six-partner rule, 13, 17, 89 Societe d'Economle Politique,

Specie cover, 61n, 62-63, 69, 130 hoarding of, 33 outflow of, 15, 20-21. 37, 68.8384, 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 Specie State (Government) paper, 119 Suffolk Bank (Massachusetts), 49, 53 Suspension laws, 47-48

Wagner,

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 Wolowski. Louis F. M R., 93n, 95, 101, 102, 103, 107, 108, 110, 113, 134, 145

This

book

was

set in ITC Zapf Corporation Zapf. other years

Book, by one

a typeface

designed

for the

Inter-

national designers, Aldus, more different are many berg, face

Typeface Hermann and than many two

of the world's of Optima,

foremost Palatino,

typeface Melior, spent of four

The acclaimed

creator

typefaces, ITC Zapf italics. and was forty years

Hermann Book The Bodoni, born

Zapf

developing with

as a family elegant

weights blend

of type

matching Melior, Zapf than ten

letterforms by

an artful subtle Germany. design

of Walbaum, Hermann of more in

distinguished in 1918 his the

refinements. Designer marketed type hv

in Nuremfirst first typeof the are

typefaces, later,

was

1940;

famous

Palatino

family

was design, primary

introduced. quiet

All of his typefaces distinction, is never in a working and reader." and with text. innovation single

characterized without ters, "Type but

exquisite Zapf's fusion

eccentricity with their

concern other author

let-

with

each

To Zapf,

is the

tie or ligature

between

Book

design Editorial

by Hermann

Strohbach,

New

York,

New

York

services by Harkavy Publishing New York, New York Sources Research, Chevy

Service, Chase, Maryland Corporation,

Index

by

Primary by

Typography

Shepard

Poorman Indianapolis,

Communications Indiana Publishing

Printed

and

bound

by

Worzalla Point,

Company,

Stevens

Wisconsin