THE

RATIONALE
OF CENTRAL
BANKING

A Liberty Press Edition

Vera

C. Smith
THE

RATIONALE
OF

CENTRAL

BANKING
and the
Free Banking
Alternative

PREFACE BY LELAND

Liberty

,'7/

Fund

Indianapolis

B. YEAGER

LibertyPress
is a publishing
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The cuneiform
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of Lagash
Reprinted
by permission
of A. Wilson-Smith.
Prelate
1990 by Leland B
Yeager All rights reserved.All
inquirms
should be addressed
to Liberty Fund,
lnc, 8335 Allison Pointe Trail, Suite 300, Indianapolis,
IN 46250-1687. This
book was manufactured
in the United States of America.

Library
Smith,

of Congress

Cataloging-in-Publication

Data

Vera C., 1912-1976

[Rationale of central banking]

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

(pbk)

Contents

Preface

by

Leland

Publisher's

xxvii

by Vera

C. Smith

xxx

Introduction
Universal

in recent

banking"
the

3
acceptance

cussion

II

xiii

Note

Foreword

B. Yeager

times

Historical

responsibility

The

in

General

early

of banks

on the
banking;

banking

discussions
business

of issue

period

of freedom

which

the

tion
more
sults

origin
the

of privileges
nature

of

causation.

leading

Second

tender"

issue_
note

and

of

organisation
in the

period:
was

the

period;

character

of
early
in

its accumula
the

the
central

of notes;

the

circumstances

founded;

modern

in

Government

of Government

War

in
su-

evolution

England:

for financing

of the

its relaissue

its partial

trend
countries

consequences

Napoleonic

note
of the

policy,

forms

in return

and

of the

and

of England

characteristics
of "legal

"free

problem

priority

General

in the

Bank

in the

and

general

cycle

of dis-

Central

Alternative

banks

The

of "central"
The

in trade

of

Lack

England

remarks

note-issuing

tion

Meaning

to deposit

persession

banking

examples

Development

Banking

tion

of central

interven-

Bank

acquired

bank;
gold

the

began

reto

vi

THE RATIONALE OF CENTRAL BANKING

be concentrated
the

Bank

The

looked

agitation

greater

for

for note
to free

as in the

country
reserves

serves

Antagonism

and

banks;

the Bank's

consolidation

The

Scottish

of

banking

and

to

period

of the

centralised

the

adoption

{the

previous

of

the
rigid

establishment

inertness

kinds

controversy

of 1848
pressure

The

extreme

provinces

of a discount
rate)

Bank

The

in-

departmental

in the

discount

on the

on
of

events

. Treasury

of France
of

an attack

restitution

Period
of

suspension

of all

pe-

Pressure

The

adopted

of

Short

The

low

restrictions

Bank

The

of France

Banque

policy
new
The

Enquire--

upheld.

The
Organisation
Decentralisation

Developments

banks
rates

the

experiences

regime

of France

discount

by the

Savoy

Misleading

by the

assignat

Bank

facilities

provoked

centralisation

in 1845.
28

retarded
by the

prolonged

The

success

Central

centralisation

Bank

and

interference

of the

under

of banking

Bank

after

systems.

introduction

for note-issuing
keep

lack

policy

Fourth

25
. The

then

liberalism;
but

Complete
on

its influence

of

monopoly

creased
banks,

re-

note-issuing

banks

of banking

Bank

of banking

stock

France

of freedom

the

as well

to centralisation

to acknowledge

Legmlative

in

notes

the

deposit

System

Development

riod

of

provinces;

to centralisation
joint

period

of other

Development

Law's

resort"

in London

tendency

towards

beginnings

Banking

in the

as 1825

of last
third

competition

reluctance

operations

1844;

The

issuing

then

as early

"lender

banking;

Increasing

of gold

the

of England;
as the

stock

opened

of free

joint

freedom

Monopolistic

IV

Bank

upon

banking

on

II1

in the

was

of Banking
in
without
Freedom

interpretations
in the

The
States;

Bank
prevalence

America:
of North

42
America

of restriction

CONTENTS

vii

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

The Development
of Central
Banking
in Germany
The late development
of modern
banking
business

The first semi-State

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

57

viii

VII

THE RATIONALE OF CENTRAL BANKING

Discussions
Subject
Prior

on

Discussion

not

Liverpool

and

cussions

Theory

the

MacCulloch's

the

ones;

small

tages

of central

free

note

holders

Gallatin

emphasised

quent

exchange

of notes

check

if all banks

banking

trade

is wholly
an adherent
The

American

mended
so

free

banking

is no

capitulation

of the

reserve
of the

that

it;

in

of the

France

although

free

banking
recom-

Raguet

Gallatin

argument

defence

competition

Hildreth,

Condy

that

to expansion;

fre-

provides

Tooke,

and

towards

check

Discussions

the advan-

opposed

for America;

af-

S. J. Loyd--the

rule

consumer

Longfield's

mechanism

drain
expanding

as regards

in step
to the

Carey

disposed

reprehensive

gold

as the

effectiveness

school,

writers,

banking

favourably

The

expand

to ex-

G. W. Norman--this

to the

of the

the

and

the

is an exception

beneficial

Parnell's
mechanism

be protected;

in a crisis

Dis-

tendencies

as well

should

banks

Club

because

banks

and

banking

clearing

banking

cumulative

non-expanding

Joplin

stock

Economy

on

71

England

The

policy

no

in

Political

become

fects

the

for joint

banking

attack

of

America

prominent

of free

pansion

and

the campaign

at

defence

VIII

the

in England
to 1848

not

was
the

James

Scotch

was

also

clearing

Wilson's

re-

system.

and

92

Belgium
Influence

of literature

America
The

The

royal

rise of free banking

quelin,

Du Puynode

Politique;

the

low

rate

discount

that

for

of notes

of banking

in

argument--Cieszkowski

in the

The
exchanges

school--the
raises

unity--Adolphe

the difficultj'es

development

agitation--Courcelle-Seneuil,

Pamphleteers
interlocal

tiplicity

the

Debates

necessitates

case

on

prerogative

Soci_te

case against
(Victor

Pereires,

difficulties
d'Eichtal;

of scrutinising

plurality;

Bonnet)

Aubry

which

Cod'Economie

The

provide

Brasseur's
notes

had been

it

The
the

mulreal

argument
exagger-

CONTENTS

ated

Competition

lier,

Mannequin

basis
tants

proposed
by Lavergne
The
Wolowski
versus
Chevalier

the

Banque

Limited

Enqu_te

Laveleye

attacked

Cernuschi

and

Summary

of the

mary

ment

for

system

The

Discussions

in the

The

by

bank

in general

Coullet

Later

Sum-

publications

Juglar's

within
the

de

bankers

argu-

a competitive

free,

banking

and

should

dom

along
from

and

unity
lines

banking

the legal

framework

banking

Michaelis'

again

represented

by

trade

cycle

merely

because

100

it would

argument

for the

lender

doctrines

of Geyer

and

Wagner's

change

Post-l$4$

better
of last

resort

of

for checking
doctrine
of modern

of central
for

control

Tellkampf

Kongress

on deposit

his anticipation
support

bank-

formulation

currency

argument

free-

free

The

mechanism

Nasse's

bank-

or real

emphasis

percent

Geyer;

from

issue

supported

Michaelis;

automatic
The

theories

Tellkampf:

of free banking;

expansion

of emphasis

of free

standpoint

Otto

lit-

support

in the note

school

of German

doctrine

Wagner

and

credit

change

Rise

currency

be either

Volkswirte

114

Gerstner
Hi_bner's

percent

Scottish
the

Germany

via von

'fifties

100

there

The

case

between

in

erature

Deutscher

connection

influences

ing

notes

case by Horn

Emile

of free

bank

dispubefore

schools.

Foreign

ing

school

Courcelle-Seneuil

clearing

Coq, Cheva-

a departmental

group

banking

Chevalier,

The

banking

anti-inflation

attacked

central

by

on

most prominent
The evidence

inflationist

Modeste

a central

demanded
plurality

The
the

of the flee banking

of Wolowski,

IX

in banking

ix

banking;

central
the

banking

note

Critique

Wagner

and

issue

to

of the
Knies

of attitude.

Discussions

in

132

England
The

absence

Mills and

of discussion

Herbert

Spencer

in the
French

'fifties

except

influences

for R. H.
in the

'six-

THE RATIONALE OF CENTRAL BANKING

ties

The

English

policy

by

the

chen;

support

Guthrie's

attack

the

analysis

Table

XI

and

French

of the

of the last

of cross

banking

to the

of effects

"lender

banking
in

Foundation

the

evidence

and

. Bage-

to

and

banking
versus

school

Prior

Federal

of
J. S.

system

central

currency

America

of

attack

question

of central

between

versus

monopoly;
general

reserve

theory

Gos-

Patterson;

Commission

single

resort"

groupings

Discussions

The

and

bv

of England

Bagehot's

memorandum

hot's

of a discount

Economist

doctrines

by Phillips

plurality

adoption

The

Pereire

on the Bank

issues

versus

Mill's

to the

of France;

of the

on fiduciary
unity

reactions

Bank

free

adherents.

the

146

Reserve

System
The

American

century

system

at the

Differences

free banking
deposit

proper

system

get loans

out

the

issue

deposit

encouraged

difficulties

if the

public

deposits

Long-run

trend

in the note issue

Sluggishness

pensions

of

American

system

issue,

cash

clearing

The

attributed

reserve

of reserves
house

of redemption

payments
were

to inelastic

the use

wanted

policy,

Attempts

loan

Xll

Act to provide

a permanent

central

and

The

Arguments

Banking
Tbe
ences

in

of
in-

with

sus-

of

by

the latter

the

of note

Tt'easury

in

by the
relief

The high cost of

the Aldrich-Vree-

currency

Swing

banking

instead

and to lack of economv

emergency

Commission

to

con-

Short-run

inelasticity

to remedy

certificate,

the Monetary

notes

Crises

The need for a Government

fiscal agent
check
collection
The 1907 crisis and
land

banl_
with

deficiencies

to the

and

(b) bond

for preference,

sequent

flexibility

twentieth
system

of branches;

which

credit

of the

American

(a) prohibition

of note
by

beginning

between

The

of opinion

work

of

in favour

of

institution.

Favour

of

Central

167

Reconsidered

acceptance
between

of central
central

and

banking
free

The

banking

main
systems

differ Mo-

CONTENTS

nopoly

of note

banking

issue

defined

cludes

a general

central

bank

banking

can

with

the

free

banking

small
cies

banking

note

banking
thesis

affects

of the free

mechanism

of control

can

be sustained;

are

no

causes

all banks

lender

of last

the cases
ern

the

and

banking:

(b) deposit

banking

and

la) pursuit
co-operation

policy

to deposit

is an au-

how

fhr this

that

profit

there
motive
for a

arguments
banking

tendencies

Final
systems

Tendencies

to

Modin the

of a rational

of the two

Future

there

that

expand

Argument

of these

tendencies

of control

Appendix:
"Automatic

notes

they

bankers

because

(b) international

on comparative

tension

that

tendenbankers

whether

via clearings;

Application

of the

comparative

of central

for central

of central

disturbances

bound

Protection

to ioin in an expansion

of (a) small

policy;

contro-

necessarily

bankers

banks

resort

arguments

theory
tary

argument

conservative

currency

is not

of the central

Argument

on

tbr and against--

versus

all banks

or not

Free

dependent

case

The

tomatic

prebut a

bankruptcy

doctrines

Arguments

drain

Free

standard,

closely

The

argument

to expansion

an external

policy

school

holder

gold

to legalised

reserves

connections

with

of the

banks'

versy
up

of reserves
of obligations

resort

the

in gold

The

centralisation
enforcement

abandonment

keeps

movements

and

Strict

xi

moneremarks

in causing
towards

ex-

banking.

On the
Working
Mechanism"

of

of the
Credit

197
Control

Bibliography

201

Index

209

Preface

Vera

Smith's

The

Rationale

of Central

Banking

invites

us to

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

monetary
Other

systems

experience,

have

as well

continued

as the

to perform

work

of James

Bu-

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

of a centralized

system

of competitive

monopolistic
banks

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

themes

them

money

and
and

Vera

sketch

of her

how

banking

I then
they

system

possessing

of Vera

book.

consider
banking

Smith

all

equal

Smith,

offer
bear

current

wrote

The

Rationale

of Central

Banking

She

Ph.D.

as

her
an

Hayek,
Lionel
nis Robertson;
assistant.

issues

degree

undergraduate

there
in

1930.

in

1935,
She

a group

of students

nowned

economists,

not

only
who,
Smith

to the
like

school's

having

herself,

were
the

xUi

en-

studied

faculty

experienced

as a

School
of
A. Hayek.

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

Thanks

of

reform.
at the University
of London
the supervision
of Friedrich

received

the

embroidery

doctoral
dissertation
Economics
under
rolled

a
to

I survey

some

on

and
rights

with

and Denresearch
but

also

to become
London

to
re-

School

xiv

THE RATIONALE OF CENTRAL BANKING

in what were perhaps

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

economist
Eucken in

Freiburg and had held a fellowship

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

on the reSection of

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

PREFACE

Vera

and

Friedrich

Lutz

were

xv

both

prominent

members

the Mont Pelerin

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

mainly

people

of scholars

but

It was

established

also.

F. A. Hayek

in 1947

with

and revitalizing
classical
The Lutzes collaborated
etarv

and

Theory
Mrs.

alone

(1962)

purpose

Central

Firm

works,
(1951).

lated

planning,

books

by

Books

in Economic

Planning

for

the

Theory

and

Experience

and

the

Wilhelm

labor

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

It originates

bears

privileges

special

serves

as banker

banks

and

for

monopolizes

money.
From
this
and characteristics
of its country's

gold

form

a large

of the

portion

It is constrained
than competing
notes
typically

redeemable.
suspends

reserve,

and

payments

and

for

the

and

of natural

the

issue

its notes

and
it

ordinary
of paper

and

of ordinary
though
obligation

to meet
goes

trans-

secondary
functions
bank: it guards
the

reserves

unable

Be-

Typically,

and

dominates

cash

Lutz

favors

responsibilities.

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

(1969).

banking,
pubdevelopment,

Morgenstern,

privilege
derive
the
of a modern
central

bulk

Develop-

government

government
or

by

English.
is not a product

through
and

the

The

written
Economy:

Mrs.

Oskar

Monand

Market

market,

Ropke,

socialism

(1950)

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

of

including

in lta(v

Ita(v, a Study

of the French

and busi-

the leadership

of fighting

Policv

of the

include

and

Analysis

the

journalists

under

liberalism.
on several

Exchange

of Investment
Lutz

ment
An

Foreign

includes

of

its president
membership

this

off the

deposits
banks.

less tightly
to keep its
obligation,

gold

it

standard,

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

to Mrs

Fowler

for

going

to the

trouble

of preparing

her

IVt

THE

safe

only

RATIONALE

if its notes

redemption

OF CENTRAL

remain

suspended.)

in circulation

Control

over

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

and

over

the

general

touches

A central

credit

on

bank

the

may

even

the

note
size

Smith

BANKING

with

volume

their

of its own

bank power
and banking

over the
system

situation.

aims

and

originate

origins

of central

banks.

owned

profit-

as a privately

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

special

shows

privileges

and

similar

motivations

dominant

position

of a central

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

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

is supposed

banks

during

currency,

to come

shortages

lending

to the

rescue
funds

its own

freshly

of the

and

public

objectives

such

as,

before

System
central
ordinary

scramblings

issued

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

or override
its
central
banks

the Federal
Reserve
of last resort,"
the

of reserve

them

at work

bank

it is supposed
interest
rates
1914,

keeping

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

those

for
notes.

(to the

extent

that

objectives

are

as

Smith

defines

it, is a regime

to issue

bank

to
to
the

nowand
feasible

compatible).

Free
banks

banking,
to operate

and

even

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

if it can

capital,

and

has

same

the

terprises.

win
Its

show

public

notes

with
general
enter
the field
profit

prospects,

confidence

rights

and

responsibilities

notes

are

"promises

in itself

no

re-

company
law
without
special
raise
and

as other
to pay,"

allowing

under

sufficient
its notes.

business

redeemable

It
enin

PREFACE
whatever
dard, this
gold).

the basic money

might
be (under
is gold or instruments
redeemable

As Smith

gold

points

standard
No bank

tion

having

pending
liquidated,

Smith
France,

could

"A general

reviews

legal

would
be
being
applied
would

the

Germany,

banking

and

controversies
century,
over

in these
whether

sponsibilities

and

United

countries,
a central

powers

all

or

part

of England,
States.

She

is desirable

or,

on

by countries

She

menting

on

Smith
on

page

each

cross-groups

The

first

two

monetary

debates

accepted

the

wanted
behave
banking
trines

into

from

quantity

four

to their

currency
of either

schools

their

surveys

contrary,
of central
of Italian
rather

than

to group
tolargely
com-

writings.

according

trines
of either
the
and their
advocacy
ing.

reviews

writers

144-145)

of

also

left free
a review

finding
it convenient
of writers
who
were

other's

and
of its

Scotland,

the

and

writings.)

sus-

mainly
in the nineteenth
bank with its distinctive
rebe
notes,

Spanish

bank

bankrupt
the claims

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

in circula-

Any

declared
to meet
lose

of the

conditions"

notes

tender.

histories

the

these

irredeemable

declared

Stockholders

the gold stanat full value in

abandonment

under

keep

them

redemption
its assets

creditors.
investment.

out,

is inconceivable

(p. 170).
by

xvii

are
the

camps

(as in her

table

of the

doc-

acceptance

school
central

or the banking
school
banking
or free bank-

mainly

associated

1820s

theory

on. 2 The
of

money

with

British

currency
and

school
generally

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

accepted

"real

bills,"

doctrines
about

tinged

accommodating

with

fallacy,
the

doc-

quantity

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

xviii

THE

of money,

even

RATIONALE

over

OF CENTRAL

the

business

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

controversy

tinct,

says

ditional

to and

banking

and

(1984)

over

Smith

and

(pp.

176):
of the

currency
Schwartz

central

banking
arguments

(1987)

is that

White

British

controversies,

and

man

the

Henri

Austrian

have

since

dealt

whereas

von

in that

Historically,
connected
and
was

support
with

the

for central
currency

the currency
school's
claimed
as a victory

free-banking
France,
ideas,

school

for
even

quantity
in excess

placing

provided

came

claims
that

that

they

are

Smith

repeatedly

bankmassige
Deckung,
able. Literally,
it means

evidently
"bankwise

idea

that

assets.

a bank's

the

monetary

(p. 176),

more

bank

especially

in

banking-school

the

notes

denial

cannot

bv

way

ill-conceived
uses

school,

controversy
as well. The

on

issued

closely

banking

suspicion,

of the

be issued
of loans

emphasis
the

regarding
cover"

liabilities

French-

says

was
the

including

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

with

emphasis

ideas,

exclu-

extended

position
so far as they
the volume
of money

under

so much

and

and

As she

success
in theoretical
for central
banking

inflationaiLv

theory

almost

seem
to have adschools
both,
but
Michaelis
and Otto

banking

than

collapsed

Smith

Mises,

position.

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

the

White

free-banking
school,
school.
Perhaps
the

Schwartz

Ludwig

Cernuschi

adby

Lawrence

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

is dis-

disputed

Both

into three:
the
and the banking

sively

in the

automatic

it raises
points

schools.

categories
school,

to changes

a supposed

versus

explanation
with

cycle,

about

171-172,

independent

Anna

Smith's
four
the currency

free

BANKING

should

German

of
on

term

it as untranslatand refers to the

be matched

by

PREFACE
holdings
"real-bills

of suitable
doctrine,"

liquidating
the

commercial

production

very

few

would

or

months.

and

school

loans,

the

on

money
Besides

at preventing

school
general

(pp.

not

applied

apply

competing

banks'

other

the

(p.

and
174

and

fiduciary
centralized
greatly

in chapter

in their

by

Bank
hold

Walter

clearly

recognizing
accept

reserves

adequate

concluding

they

difference

central

banking

which

never

would
involves

of claims

adverse

on each

clearing

balances

a centralized

Britain's

and
not

a dediffer

question

system

the

attendant

and

or comment

having

responsibilities

the
and

them.

especially,

alternative
up

anom-

have
deliberately
designed
Britons
had to make the best

for meeting

came

a compro-

banking

Smith

on central
banking
versus
was necessary,
for "the

over
again

as adopting

its weaknesses
its

chapter

the main arguments

This reconsideration

without

business
currency

and especially
have a certain
but

The

Bagehot

(p. 143). He found

of England

In her

assets
might

XII). In practice,

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

of

the point
of bank

results.

interprets

view

fallacy

the

note issue constrained

by a fixed limit
system
with gold convertibility
would

Smith
mise

later

of

disturbing
that the

for settlement

posed

supply

ignored
overissue

system,

system.

demands

restraint

173-174).

to a free-banking

to a centralized

within
a principle

to the

overlooking

the banking
short-term

to finance

such

supply

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

loans
goods

be quickly
remedied
without
It was just such disturbances

aimed

to the notorious
short-term,
self-

of additional
conducted

to market.

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

industrial

marketing

match

coming

These,
according
quintessentially

Banking

properly

goods

assets.
were

xlx

system

for discussion
in all the

reconsiders
free banking.
superiority
of

became
and

later

was

a dogma
accepted

foundations

of

xx

central
ments,

THE

RATIONALE

OF CENTRAL

BANKING

banks" (p. 167). For answers

to most of these
the reader should see Smith's own discussion.

argu-

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

PREFACE

Nowadays,
central
fortable

furthermore,
banks
jobs.

Before
ponder

are

Mountifort

calls

a system

ume

of business

bank

aggressively

who,
of two

and

caused

banks

holding

that

and

com-

reform,

let us

important

contro-

reserve

its loans

doing

gold
and

the

1840,

same

vol-

Now

one

Later

on,

reserves.
note

85to

issue.

gold, let us say for export

and resulting
price
inflation
deficit,

the notes
of the
falls, rather,
on
of the

of February

initially
equal

demanding
expansion

present
demand

gold

most

article

a balance-of-payments

selectively
tion. This
the

of monetary

far the

in an

expands

as the public
starts
after the monetary
has

issues
"by

to suppose

prestigious

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

imagined

reasonable

for providing

to specific

Smith

versial
point
88, 177-185,

it seems

valued

turning
what

ill

bank

that

the

public

guilty bank
both banks.
did

not

will

not

for redempAs a result,

increase

its note

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

its

moderate

aggressive

bank

may

less it too expands

To

banks
and

gain

most

and

being

will suffer
depression,

by

Smith
One
looks

flaw
how

contraction

in Longfield's
continuous
by the

the

as the

un-

or

panic

in her

interpretation
argument,
expansion

moderate

period

many

note-

group

could

she

A system
scarcely

concluding

may

says,
group

will

cause

is that

be

chapter;

be in order

by one

exwill

of excitement

arrives.

prosperity

this argument
and

several

during

to contract

examines

The

in self-defense.
with

to a country's

restatement

further.
altogether,

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

expanding

quick

even

out of business

a country

more
injurious
devised.
some

to expand

aggressively

generalize:

issuing
citement

rival
be driven

here.
it over-

of banks

and

an increasing

xxii

THE

RATIONALE

proportion
of the gold
banks'
reserves,
which
ate banks

have

on

and
their
val

the

during

granting

notes

at the

clearinghouse.

banks'
rowers
pay
return
one

bank

repaying

has

loans.

notes

them
bank

to

to their

demand

to

the

repay
the lag
an inter-

expanding

for settlement

banks

issuers
out

than

suffer

redemption

from

depositors

In a competitive

of rival

expands

stage

begin

of

be presented

them

the

through

the

with

the

drain

drain

of gold;

almost

bor-

no bank

clearing
rest,

other

counter.

will

It will

process.

balances

it, and it will lose

mechanism
would

external

reserve

its own

of

the
the

or from

system,

over

of step

clearinghouse
will go against
its rivals
in settlement.
This
earlier

of loans,

amounts

his

of its own

customers
neglected

repayment

nevertheless

as it receives

out the

the

was

bank

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

each
notes

argument

expanding

as its borrowing
of the argument

increasing

would

Furthermore,
public's
demand
incentive

to an

and

which

on the expanding
before
the moder-

of business.

in Longfield's

flow

notes
strand

bank's

out

flaw

return

other
banks'
loans.
That

between

driven

minor

the

BANKING

outflow
to impinge
will be exhausted

been

A relatively
stress

OF CENTRAL

If

at the

gold paid to
work
at an

the

bank

immediately

would
(a point

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

note

Smith's
two

kinds

issue.

discussion

brings

of money,

bank

to mind
notes

one

and

distinction

checking

between

accounts.

Pas-

sively and at least temporarily,

the ordinary
transactions
member
of the public
will thrust
onto him notes
issued
banks
counts.
ceived,
banks

besides

his own.

He will
which
thev are

The

promptly
will quickly
drawn
on.

same

is not true

deposit
be

or

cash

routed

for

of checking
any

ac-

checks

payment

of a
by
re-

to the

PREFACE
If money
gold

consisted

bullion,

exclusively

perhaps,

of checking

serving

as the

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

Unlike

checks
any

some

portion

be

promptly

would
bank

mand

expanding

for

xxili

were
in the

of

bank

substantially

for

out
be

dilutes

cess.

Not all notes

tion.

Surely,

or delays
return

though,

In an economy

routinely
lar banks,
notes

free

relax

through

leading

the

issues

major

starting

of free

point

for the

slightly.

in other

re-

to concontinue

in their own
an incentive

particuto send

clearing

process.
assessment

and

re-

standard.
This was clearly
has in recent
years
been
the

revival

of interest

in the

question

banking.

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

all other

able

in gold?

money,

with

kinds

of money

Should

the unit

the

money

bank

under

larly,
kind

what
should
the
of money
in which

instructions

ultimately

redeemable?

the

States

United

money

only
continue
would

of monetary

lorm
concerns
the monetary
implicit
in Smith's
work
and

pro-

for redemp-

operating

cash receipts
would
have

then,

clearing

discipline

but

deand

accounts,

issuers

today,
most money
would
accounts.
Retail merchants

banks

of the

the

the

punished

of the

to their

and

with

promptly

discipline

banking

depositing
their
each of which

of other

One

notes

with

spects
as it does
sist of checking

the

quickly

all

settlement;

of step

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

(with
redemp-

made by check,
the
tightest
conceivable

presented

in it would

and

notes,

its business

deposits

accounts

reserve

at all--and

supply
to keep

or indirectly

dollar

the

(Federal
central

by

price

Reserve

level

the

fiat
central

stable?

Simi-

money
be--the
denominated
and
notes

Is it necessary
bank

redeem-

of government

managed

base or dominant
other
kinds
are

nowadays.)
any

directly
be the

How
should
the
be defined
in gold,

to issue

fill this role

to have
and

any

manage

in

base
it?

xxiv

THE

Nobel laureate
authorizing
the
linked

with

ably

have

RATIONALE

F. A. Hayek
(1976,
issue of competing

his supervision
influenced

and

George

Selgin

free

banking

and

well

as

deposits,

annual

entirely

Books

(1988)

survey

Lawrence

the

history

presumWhite

and

theory

to issue

probably

be

(1984)
of

notes

as

denominated

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

monetary

conference

D.C.,

in February

for

dissertation

by

of banks

would

either
amount

to ideas

1978, 1984) has proposed

private
currencies.
Ideas

freedom

which

in Washington,

BANKING

of Smith's

him.

propose

and
redeemable
money,
whose
enth

OF CENTRAL

radical

of the
1989,

monetary

Cato

Institute,

held

was

devoted

almost

reform

along

private-

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

that

1989)

or exerting

seems

would
any

special

system.
But the
count
in which
counts
unit.

kept,
which

its own
quantity
value,
dle
ble

control

to replace

dollar

operations.
of gold.
however,

this
have
would

be free
new

unit.

to keep

defined

today's

banking

unsatisfactory
fiat money.

unit

Each
its notes
take

by some

notes
bank,
and
place

and
faced

deposits
not

by a specific
instability
in

a more
services
money

actual

bun-

nearly

sta-

in general.
issue,
banks

denominated

competition,

redeemable.

in the

it in

comprehensive

deposits
with

The

by employing

possess

over goods and

barred
from

to issue

vices defining
the
amounts
of some

and

define
a new unit of accontracts
written,
ac-

new

would

me

money

The unit might

be defined
Because
of gold's
probable
services

probably

the

and

issuing

money

bill of government

promote

a unit
and

Greenfield
from

the

so forth,

and

purchasing
power
With
the government

would

over
might
quoted,

would

of goods

to Robert

government

government
prices
are

is the

government

promising
bar the

in
would

Redemption
goods

and

ser-

unit but indirectly

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

PREFACE

probably

designated

securities.

xxv

Routine

interbank

settle-

ments at the clearinghouse,

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

should

play a promi-

Professor

of Economics

xxvi

THE RATIONALE OF CENTRAL BANKING

References

Dorn,

James

Money,

A., and

University

Anna

J. Schwartz,

of Chicago

editors,

Press,

The

Chicago,

Search

fi)r

Stable

1987.

Ente per gli Studi Monetari,

Bancari
e Finanziari
"Lulgi Einaudi,"
Moneta, Dualismo
e Pianificazione
nel Pensiero
di Vera C. Lutz, Societa
Editrice

il Mulino,

Bologna,

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

August

1984.

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

1983.

Gusman,
Ente...

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

Haberler,

Gottfi'ied,

"Vera

e Friedrich

Lutz.

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

Paper

48, London,

Friedrich

Siegel,

editor,

Research,
Cambridge,
Schwartz,

A., "The
Money

Future

Anna

School,"

The

and

J., "Banking
New

School,

Palgrave,

of _donev,

Pacific

graphie,

1987,

Verena,
vol.

Ballinger

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

for

coppia

di

47-53.
Affairs,

School,

Lutz,"

Neue

of

in Barry

N.

Policy

Company,
Free

of Economics,
Rowman

Institute

Public

Publishing

Currency

August

ed.,

Unit of Value,"

A Dictionary

"Friedrich

15. pp.

2d

Institute

Press, New York, 1987, vol. 1, pp 182-185.

Selgin,
George,
The Theory
of Free
Banking,
Totowa,
N.J., 1988.
Velt-Bachmann,

famosa

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

Monetary

in Crisis,

San Francisco,
Mass., 1984.

Una

in

1976.

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

(1912-1976),"

Banking
Stockton

&. Littlefield,
Deutsche

Bio-

565-567
Banking

m Britain,

Cambridge

University

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

Dis-

Publisher's

The

publisher

and

Mr.

ter's
book
invaluable.
The

would

like

A. _A'ilson-Smith
back

Rationale

to thank
for their

into

print.

of Central

by P. S. King

and

subtitle

and

Banking

reflect

the

For this

breadth

and

Their

Brenda

was

of the

their

assistance

has

originally

Alternative

edition,

K. Fowler

in bringing

Son in London.
spirit

LibertyPress

Mrs.
help

Banking

in 1936

the Free

Note

sisbeen

published

_*e have
to more

added

the

adequately

work.

we have

newly

set the

type.

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

styled

however,

as they
has

original
edition
have provided

following

in the

original.

significantly

included
only
full bibliographic

tance
in providing
French,
German,
the

were

been

enhanced.

Professor

bibliography,
Citations

on American,
we would
like

Lawrence

White

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

been

prepared

for this

edition.

xxvii

in the

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

this information
and Italian
titles,

scholars:

The

English,
to thank
of the

Uni-

University
v. Klinckfull index

Foreword
[to the

This
the

essay

is a study

development

note issue was

of laissez-faire

It has

been

of the

Edition]

historical

of Central

and

Banking,

the

analytical

bases

reasons

of

why

the

made the exception

to the general
application
principles,
and why
Central
Banking
was

adopted
in preference
in the note issue.

gree

Original

submitted

of Doctor

to "Free
and

of Philosophy

Banking"

approved
in the

with

competition

as a thesis
University

for the

De-

of London.

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

gave

like also
ish

me

Library

some

valuable

to acknowledge

of the

of Political
less

easily

advice

on

occasions.

assistance

given

and

Economic

Science

accessible

London
October

many

the

I should

me by the

material.
Vera

1935

xxix

Brit-

in obtaining

C. Smith

THE
RATIONALE
OF CENTRAL
BANKING

CHAPTER

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

teenth
the

century

(at least

Continent

and

tem

as it stood

not

seriously

of dispute
take.
were

RATIONALE

the

as to what

banking

gory.

Even

sort

possible
willing
was

BANKING

again,

of form

date--it
the

already

especially

England,

of the Bank
that

sys-

Act of 1844

was

was

still a matter

system

theories
industries

regarded

doctrinaire

on

the

banking

when laisser-faire
so far as other

most

most

States--in

passage
after

was

the

to 1875),
United

challenged

It is notable
that
at their
height

cerned,

up

in the

after

OF CENTRAL

should

and politics
were
con-

as in another
free-traders,

cate-

with

the

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

widely

some

contended

special

regulations
should
eral decades.
Very

that

regulations,

little

take

attention

erature

to the

system

of banking

banking

must

although
remained

has

been

consideration
that

what
an open

paid

of the
we

be the

have

subject

precise

form

question

in modern

of

these
for sev-

economic

lit-

rationale

of the particular

succeeded

in evolving,

in

the light of the progress

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

is, moreover,

fathers
gland,

one

with which
is surprisingly

authorities

of the

controversies

responsible

for

introducing

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

purpose
in the

banks

to discover

ing

and
such

motives.

of this
past led
An

the

our

decision

in favour

to a free

banking

system

recent
challenge
und Konjunkturpolitik,"

central
have

any

theoretical

clear

of the

reveals

zs that
made
1928.

by

of

in

for

the

as opposed

countries
Mises

idea

underly-

reasons

banking

in most

into

the motives
of central

foundations

of a central

fore-

in Enthat the

banks

essay
to investigate
to the establishment

examination

eventual

'The
only
stabilisierung

among

this generation,
more
especially
unfamiliar.
Neither
do we find

a combihis

"Geldwert-

INTRODUCTION

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

THE RATIONALEOF CENTRAL BANKING

So far as English
were quite clearly
the

system,

once

threatened.
Scotch
the

banking
is concerned,
drawn
at a comparatively
established,

Scotland

system

never

is of particular

was

free-banking

markably

was

quoted

school

successful

broad
outlines
early date, and
verv

interest,

by

practically

as the

conclusive

functioning

the

seriously

because

every
example

of the

the

member

of

of the

system

they

re-

advo-

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

of the practicability

rather

later

than

a centralised
ries

England

banking

of moves

and

favour
of the
the discussion

of any

such

in finally

system.

and

went

before

same plan in 1875, but

to consider
Germany

appropriate

many

did not form

to consider

of the

subject

was

a unit

the

till 1871.

practically

In

our

study

years
of the
of

The

ous

on those
stages

secondly,

facts,

which

States,

by 1875,

chronological

firstly,

to other

mark
and

aspects

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

banking

it may

nomena
to consider
evolved

system

in the

be assumed

of booms
some

by the

and

Ger-

by which

time

to assume
a far
points of interest

choice

at variand,

of Government

man-

causation

We shall
of trade

in the Free

of the
the United
be concen-

of the

place

lies

in the

economy

in the

depressions.
theories

the

to

competition,
in general.
treatment

general

to play

of the

disputants

since

discussion

development

which

monopoly

refer

in

later in the debates

preliminary
Federal
Reserve
System.

the

between

a se-

deciding

theoretical

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

adopting

here it rather
distorts
as a whole,
and it is

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

was

through

at last

separate

closed

France

irrevocably

Germanv

countermoves

more

system.

Banking

of the
have

cycle
versus

phe-

occasion
causation
Central

INTRODUCTION

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

that the maladjustments

mav be due, not to the

specific tbrm of the banking system, but rather to at present

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

in particular
that
of the volume of

credit to a single authority,

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

CHAPTER

The

I!

Development

of Central

Banking

in England

It

must

posit

have

banking

been

so in England
sterdam.
with the

and

coin

in the

and

received

had

won

culating
large

bullion

that,

chronologically,

of notes.
banks

At least

at Hamburg

a banker

more

in exchange

such

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

the

public

over

notes

that

sums

early

with

their

Moreover,

issue

on deposit
bankers

dethis

was

and

Am-

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

something

originally
in the
passed
from hand

true

the

But banking
development

deposit
they

generally

preceded

to confidence
the

public

on the
could

lend

banks

by

persuaded

of a mere
out

when

which
could
be
ariel- the bankers

in the
was

security

only

readily

as a bank-note,

any

cir-

to leave
book-entry.

great

part

of

what was dei_osited

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

that

to be

when

made
by
had been
It was
problems
ened

the

generally

most

those
most

advantages

of deposit

recognised,
countries
widespread.

in note
arose,
strongly

the
where

the

then,

that

issuing,
and

it was

here

to establish

banking

most

that

rapid
use
the

came
were

of bank

currency

earliest

banking

Governments

monopolies
8

first
strides

under

threatthe

sys-

THE DEVELOPMENT

OF CENTRAL BANKING IN ENGLAND

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

!0

THE RATIONALEOF CENTRAL BANKING

of notes,
credit.

it also

Assuming

controls,

that

countI\V'S
alternative

though

a paper

currency

a) It may

be subject

to the

delegated

free

The

private

latter

of a single

It may
mav

be

entirely

exercise

control

the

volume

control

control

to a
three

of the

State;

of a single

private

of a large

number

competition

institution

may

take

independent

of the

over

by taking

it either

of

adjunct

we may conceive
may be undertaken:

exclusive

to the

c) It may be left to the

of banks
of issue.
system

rigidly,

is a desirable

commercial
development,
ways in which
its issue

b) It may be
institution;

forms.

less

various

State,

or

the

a share

in

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

of general

policy,

system

is nominally

the

of a Minister
free

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

plural
system
within
which

of a free

regulations;
a well-devised
Again
trolling

we

should

where

has

it is the centre

certainly

who

holds

the

swings
1875

can

roughly

of policy
under

four

the

of a so-called
major

power,
bv the
some

summarise
in the

control,

a right

will

favoured

case

an absolute

phases.

State

howbe very

certain

assumed
that the general
law would
be sufficient.

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

such

have

distinguish

instittltion

from

in

Even

may varv in the nature

of the legal
it functions.
There
have been ad-

system

others
have
company

of Finance.

The

mixed
but

first

clauses
a single

from

system

in which

course
of banks

was

of
con-

the

case

in which

it

its monopoly

existence
of a number
of the same functions
the

evolution

where

monopoly

special

of

events

of issue

a preliminai[v

of
inand

before
period

THE

when
were

DEVELOPMENT

banks
were
theoretically

because

they

of the

legislative

either

absolute

OF CENTRAL

BANKING

IN ENGLAND

only just beginning

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

were

not yet obtrusive

authority.

In the

or to some

enough
second

extent

to catch
period,

qualified,

the

return

solute or along
tion of control.
This

to restrictions

the

scheme

lines

and

of a mixed

was

is more

or

less

the

and increasThe tourth

either

with

representative,

Let us now
fhcts

topic.

turn

became

merchants
lion with

with

differ-

tor

of banking
the middle

on

rates,

the

on loans

many

are

which

other

second

since

receipts

on

to rely
from

they
they

period

the issue
control.

in

foundation
of the Bank
by an event of a rather
had

England,

of the

histor-

relevant

to our

produced

what

countries.
sense
are
century,

could
gave

began
to circulate
of small
private

rights,
and carrying
free from Government

had

account

that

in the modern
of the seventeenth

deposits,

and

of the deposits
arose
a number

The

detailed

France

to be
when

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

interest

higher

with

a model

The origins
found in about

more

development

We commence

later

ing

to the

of banking

ab-

centralisa-

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

eye

dominant.

monopoly,

system,

they
only

monopoly,

The third phase was characterised

by plurality
ing liberty,
but by no means
complete
freedom.
witnesses

1l 1

London

large

of notes

extent

at

dating

and

from

heavily

the

ushered
Charles

for his financial

He ran

thus
equal

unrestricted

banking,

bankers.

them

as money.
There
firms,
all having

of England
in 1694, was
fortuitous
political
nature.

to a very
the

English

re-lend

in acknowledgment

in
II

needs
into

debt

and in 1672 suspended

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

ruined

for several

decades

to come,

and

it was

to

12

THE

provide

a substitute

destroyed

that

the scheme
foundation
and

RATIONALE

OF CENTRAL

for the

William

sources

III and

BANKING

of accommodation

his

Government

Company

of the

Bank

of England.

"for the better

raising
sum of 1,200,000."

The

early

favours

history

between

In the

a capital

and

of the

Bank

a needy

ing corporation.
with

Its establishment

paying
was

amounting

issue

niments
renewed

of so many

the

notes

and

accompa-

privileges

of the

Bank,

therefore

its note

issue,

paid

be

that

no

through

bank

the

should

allowing
and

also

of the Government
all sums
due to the

to its prestige.

other

was

Government

the

must

provided

usual
the

and

considerably

founded
sum

extended

Government
added

was
same

its capital

of the possession
that henceforth

of

in return
the Bank
amount.
2 This sud-

1697

giving it the monopoly

balances
by ordering
that

Exchequer

an accommodat-

all the
In

of
as

of exchanges

This

and
same

produced

inflation.

the

Bank

to 1,200,000.

of a currency

it to increase

into

and

instance,

was

many
clauses
minor
event,

a series

Government
first

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

in with

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

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

thus

fell

Bank,

a provision

Further,
ever

it was

establish

also

itself

by

the
the

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

the

Bank

ture

the

member

of England
particular
of the

was

to subject

private

and

corporation,

or make
personal

a clause

which

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

just

2 In practice
Feavearyear,

about

this

time

that

the

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

liable

to forfei-

property

of any

bestowed

was a favour
associations
new
not

type

restricted

on it
which
for an-

of business
to this

amount.

THE DEVELOPMENTOF CENTRAL BANKINGIN ENGLAND

entity
known
as the joint stock
and it was therefore
an obvious
the Bank's
sort

of

which

already

privileged

monopoly
was

business

in this

in so many

that

This

effectively

issuing

and,

than

joint

since

with

business
altogether.
More than
the application
of the prohibition
than

the

issue

In 1713
for a loan
loan

of notes

was

less

to be

obtained

banking

business,"

the now customary

out interest.
After
ministration
renewal
110,000.
1781

of the

the

beginning
fited
the
from
the

no

charter
the

same

of the
less

National

short-term
course

the

note-

was

held

from

banking

Debt.

before
other

question.

again
resources

additional

in return
for the

capital,

in 1800.
seven
Bank

In short,
century

times

by the

of England,

accommodation
of its daily

the

to an increase
in its
its privileges
of"ex-

again

accompanied

this time
entrusted
In return

for

between
the

by

a loan withwith the adthe

the Bank paid the Government

another
renewal
and another

nineteenth

than
of the

ordinary

was

loan transaction,
1751 the Bank was

of its charter
There
was

and

and

days

into

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

from

issue,

issue

six months.

a century
was to pass
to banking
business

raising

of

Bank's

might

in those
note

to be called

by

the

than

firms

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

were

some

old forms

in 1709

six partners

banking

synonymous

it with

it to raise its capital

the relevant
Act

time

stock

hold,
of

of organisation,
to the

when

or at any

excluded

business,

superior

of more

at demand

to be practically

to endow

besides
allowing
to the Government,

no firms

payable

was taking
reinforcement

type

Accordingly,

charter
was renewed,
in return
for a loan
notes

position
particular

respects

association.

specified

company
step in the

IS

1694

Treasury

and

had

successive

renewals

3 and

quite

given

this,
by

the

1764

a fee of
loan in
the

beneof
apart

Bank

in

transactions.

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

14

THE RATIONALEOF CENTRALBANKING

The

result

of the

accumulation

of an

was to give the Bank of England

influence
in the financial
world
vate

banks

pete

in

to experience

the

same

majority
of private
about
1780. A further
gan

to adopt

the

The

period
not

of the

torce

because

note
issues
effect was

had
that

of keeping

ultimate

in

balances

it provides

to com-

London

with

beginning

the

the

from

pressure

on

the

of the

by
beBank

to acquire
our

point

an outstanding

consequences

and
pri-

been
abandoned
the smaller
banks

is interesting

because

of Government

the

and

was thus already

of a Central
Bank.

1797-1819

only

of privileges

in continuing

of business,

practice

of England,
which
the characteristics

view,

difficulties

lines

arrav

a position
of prestige
such as to cause
small

of

example

Bank,

but

also

Government's

pol-

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

Bank.

advances

Now

the

to the

Bank

Act of 1694 had

Government

without

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

The

doubtful;

legality

of

so in 1793

a Bill indemnifying
made
such

they

time

in getting

neglected
came

tion,
asking

should

be kept

Pitt

the

the

been

to the

liability

for

seriously
Bank

to keep

authorisa-

clause,

neverat the

regarded

as

Government
the

loans

but
so that

to comply

for
it had

to continue
however,

figure.

Parliament,

compelled

Pitt lost no
very
the

usefully
Bank

with

beGov-

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

directors
down

a certain

limiting

virtually

requirements
had become
and

and

had

applied

below

the Bill through

henceforth

exchanges

Bank

express

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

to insert

ernment
borrowings

the

the

it to make

small amounts
had
Bills made payable

practice

it against

in the past
transactions

that

this

forbidden

his

the

Bank's

reserve

posi-

appealed

to the

Government

demands

on

Bank,

the

and

at

THE

the

same

What

DEVELOPMENT

time

it contracted

Pitt did,

itate the
of small
sued

however,

BANKING

discounts

was

to take

IN ENGLAND

to private

15

customers.

all possible

steps

to facil-

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

for the

issued

OF CENTRAL

first

in 1797

time

in

in order

junction

with

another

pension

of the

1795,

and

to provide
measure

payment

small

of that

in cash

1 and

notes

were

currency

year,

of the

in con-

namely,

Bank's

the

sus-

notes.

This

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

by the Governa critical

situa-

tion

at a time

in which

it already

the

had

ernment's

Bank

was

faced

by a "run"

weak

reserve

an extremely

action

amounted

position.

to a legalisation

when

The

of

the

Govbank-

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

here

enter

upon

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

a cause,
with

also

these

an outflow
of
be a contraction

Throughout
pound
after
in bank

that the
pressure

have

other

finance,

purposes

the

cepted

4 The issue
issue of notes

Bank's

the

method

whatever

were

par.

Bank

of England
of legal

not officiallv

of notes
for less

Finally

contribu-

capacity

so declared

in

1812

for sums less than

than 5 m 1777

the
1 had

prior

it arises,
of the
increases
notes

been

forbidden

had

tender

cur-

to 1812,

payments,
and
they were
usuallv
Government

to

of dealing

cause

character

they were taken in all Government

partly
out of patriotic
motives,
at

the

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

They

since

specie,
from
of credit.

credits

since
haps

of the

Bank was forced

to undermust, besides
having
been

weakened

causes,

for all practical

rency.

a discussion

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

but
perac-

declared
In 1775

and

the

16

THE

RATIONALE

OF CENTRAL

BANKING

them to be legal tender for all payments.

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

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

of its

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

with

it, already,

a tendency

fell 16 percent.
conditions
in 1819

to regard

the

Bank of

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

on

the Currency

Banques,"
Papers,

and

Ranking

1866, p. 301.
Reports
from

System

Committees,

of the

1819/'

United

States,"

Vol. III.,

Re-

THE

small notes,

DEVELOPMENT

since

OF CENTRAL

BANKING

IN ENGLAND

the Bank did not issue notes

below

17

5, but

in case of extra strain, the Bank's stock of gold in London

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

these
drain

served just as well as gold coin to

of cash. In the 1825 crisis the Bank

was at first hesitant

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

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

fifty of them had become bankrupt.

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

General

Principles

and

Present

Practice

of Banking

in England

and

18

the

THE

foundation

RATIONALE

of the

OF CENTRAL

National

BANKING

Provincial.

The

Bank

of En-

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

of the Bank
Consequences

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

THE

Bank

DEVELOPMENT

Charter

OF CENTRAL

accorded

the

BANKING

permission

IN ENGLAND

for joint

19

stock

banks,

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

and

The
der

County

1833

should

by

serve

made

the

maintain

to strengthen

Bank)

their
the

a single

Bank

of England

notes

above

5 so long

convertibility."

tendency

reserve

demands,

banks

paid

were

presented,

mate

demand

it was
the

not

The

towards

system

especially

out Bank

of England

a very

of keeping

came

the

country,

holder
but

Between
of issue
been
that

1826
had

1836

during

the

and

then

1839.
Governor

gold

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

ulti-

From

this

to adopt

reserves

whole

stock

banks

and

seventy
it was

of

blamed

unlimited
1858

the

from

England,
liability

Causes

and

Consequences

of the

Pressure

on

the

had

on these

companies;

Mone

cri-

Horsley

1_ and

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

in

of the

joint

especially

Bank

notes

the

looked
to get
the Bank be-

about

system

came

of the

of

reserve.

years,

banking

own

banks

reserve

of these

last three

Criticism

re-

country

and

they
way

a hundred

and

of a freer

their

of their

(cash)

about

the

for the

part

of the

was

Bank

of England.

to which
In this

banking

tounded,

opponents

ses of 1836
Palmer,

and

when

Bank

greater

only

of the

been

formed
the

not

also

the

metallic

of the

withdrawn,
step

at the Bank
necessary.

the

of panic,

notes

tar or unnatural

the form of balances

Bank notes
whenever

of this

hands

ten-

as they

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

deposits

fell on the

legal

result

making

in the

in times

or their
for gold

practice

the London
and the Lon-

for sums

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

by

Bank.'"

Act also

(except

followed
of London,

the
lim-

had been
_t was not
it granted
3 Market,"

20

THE

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

RATIONALE

OF CENTRAL

BANKING

was again raised of the relations

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

this policy had been rendered

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

the Bank

13 Report
1831-2.

of

the

the

had, during

Committee

of

the years

Secrecy

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

on

of Mr
Pressure

the

Bank

under
of

discussion,

England

Charter,"

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

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN ENGLAND

21

kept its securities

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

tion
year

_5 See his "Remarks

on the management
and conduct
of the Bank of England
1839 "

of the circulation
and the Country

and on the condiIssuers

during
the

_2

THE RATIONALEOF CENTRAL BANKING

the

right

fixed

to issue,

in each

reached

but

case

in

the

rights

were

were

absorbed

limit

average

just

preceding
if they

another

rights,

issues

was

their

issues

had

the

the

Act,

or
Bank

rights

Bank

for opposing
in a very

ket

in times

measure
and

on the
Bank

of England

as

only

paper
Bank

1825,

occasions

when

provisions
the

provision
of England

in fact,

a tradition

Bank,

or

_public,

thing

other

the

to

than

full

Act,

quarters

issue

of the

the
mar-

that

less

unfulfilled.

as,
as

put

to the

hope

his

likely

The
always

necessary,

no practical
always
rely

1847,
ready,

to exempt
and
that

the
the

Bank,

to

the

opinion
clause

was

of

a mere

application,
since
on the Government

the
to

time it got into a difficult

posithe Bank and the Government

too

or

Peel's

Bank

in some

were,

aid

Government

it was

of it every
between

he said,

much

to be
the

fiduciary

having
could

legalise
a breach
tion. The relations

1839.

of the

expressed

limiting

It would,

situations

proved,
showed

of the Bank
of last resort"

for rendering
and

such

events

the

Act."

1836

crises

naturally
Act,

was

of the authorbank
could
ac-

the position
the "lender

position

render

1866

from

was
the

like

was,

1857

Peel's

difficult

would

occur

or

voluntarily

of issue.

Horsley
Palmer
now invoked
what Bagehot
later christened,
grounds

their

with,

if they

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

and

amalgamated

bank,

and

of the

figure

altogether

by,

their

maximum

the

period

to lapse

renounced

the

at

the

long

established

Government,

Government

for either
to envisage

support

to the

the
any-

Bank

in

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

Bank

directors

of the

Bank's

were

extremely

position

loath

in a system

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

to recognise
which,

as the

the
re-

THE

DEVELOPMENT

OF CENTRAL

sult of a long series of Government

it the controlling
element
in the
was the nature
of this
lysing in his "Lombard
Looking

at

knowledge
development,
quarter
the

the

1844

Act

of the

from

that
our

23

had made
structure.
It

Bagehot

position

was

ana-

of superior

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

nineteenth
of the

IN ENGLAND

manipulations,
countrv's
credit

responsibility
Street."

of what were
in particular

anomaly

BANKING

century,

situation

it is impossible

in which

this

to ignore

Act left

the

pro-

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

note

issue

obtained
banks

by
which

cluded

for
profits

were

estimated

joining

a larger

engaged

from

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

the

to be greater
concern.

in the

London

Bank

as a London

bank

Act, but under

the
notes.
Thus,
although
from

which

the

was conducted,
ing business

Secondly,

note-issuing

market

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

than

and

had

those

to be

joint

stock

business

were

to pay

correspon-

ex-

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

without

note

issue

under

the

1833

1825 Act as a joint stock

bank
issuing
this bank had a head office in London

general

administration

of all

it was excluded
from carrying
whatsoever
in the metropolis.

its branches
on any
It was

bankthese

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

of the

choosing
permissive
authorised
have

the

disadvantages

to take

advantage

Act only)
circulation,
right

mentioned

above,

of its provisions

those
(it was

banks
to be a

were to pay a tax of 1 percent

on their
and the Government
was, besides,
to

to terminate

their

issues

altogether

after

ape-

24

THE

RATIONALE

OF CENTRAL

BANKING

riod of fifteen years. Hankey and Goschen got this clause of

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

longer,

CHAPTER

111

The
Scottish
System

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

26

THE

RATIONALE

OF CENTRAL

BANKING

Only one further

ish Linen
Company

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

der

law.

the

ordinary

number

of partners

experimental

stage,

ber

of substantial

and

financial

after

of the

went
banks
The

or private
Scottish

which

early

tries.

kept

each

was
very

other's

and

to the

compared

with

other

of deposit
In 1826

banking
and
there
were,

(with

twentv-four

(with

ninety-seven

permit

joint

of Englan
time

stock

d had

there

banks

had

only

set

The

taken

by joint

capital
certain

was

to establish,
up

been

any

one

and

clearing

twice

a week

and

branch

or-

and

there

more

was,

rapid

as

growth

of loan technique.
three
chartered
banks
joint

eleven
only
and

not even
Right

failure

disaster--and
by the public

stock

banks

private

just being

branches.

serious

coun-

banks

adopted

twenty-two
and

stock

in other
the

of regularly
made

banks

resources.
characteristics

systems

They

development
besides
the

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

to the

a much

legislation

yet

in 1772

of damage

beginning,

branches)

in England

Avr Bank

deal
was

were

branches),

size

of the

between

countries,

of a num-

private

the

settled.
the

hands

of considerable

practice

exchanges
from

the

the

in th_

little

place

it from

on

of abuses

of the

competition

strictly

almost

whereas

their

immediately

ganisation

most

with larger
deve]oped

keen

notes;

balances

collapse

banks;

banks
system

into

did a great

distinguished

There

thev
the

The

out of business

restriction

period

companies

of notes

smaller

no

a short
came

stock

strength.

was

after

banking
joint

an over-issue

credit

There

and,

Britun-

banks,
passed
the

up

in the

to

Bank
to that

history

of

it was computed
had not exceeded

of 36,000.
Scottish

network

of solid

institutions,

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

free

from

highly
developed
its freedom
ii_om

legisladeposit
the ex-

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

THESC03_FISH
SYSTEM

27

try banks in England were foundering.

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

CHAPTER

The

IV

Development

of Central

Banking

in France

.he

unfortunate

retarded

banking

years.

The

Banque

G_n_rale
bank

after

the

but

the

ity,

founded

Caisse

tions

with

very

financial

of

advance

an

caused
the

notes
in
The first

of

1788, and
assignats,

selves

legal

ment

bonds,

this

tender
backed

to carry

French
bank

became,

bank

and
giving

exchange
1776. This

into

short-dated
by

the

biens
28

limited
of
very

to the
already

liabil-

Finance.
close

practically

rela-

a branch
The

promise

Treasury

in

1783

payments.
heavily

of forced

after this followed

the
issued
in 1789, which
but

there-

and
before

it suspended

finances,

in the

of paper,

branches

Government.

frs.

his

on other

with

came

many
for

of note-issuing

Minister

in fact,

of the

State

resulted

formation

a partnership
the

6,000,000

on the

of the

Caisse,

set up

department

a "run"

exigencies

on the

Turgot,
and

1716

Government

The

chiefly
discounting
of issue was founded

beginning

in

over-issue

firms

Lhe State,

of the

Law

in France
for

five years.

d'Escompte,
by

to John

issues

country

in a disastrous

restrictions

business,
no bank

was

the

after

although

of banking
transactions,

From

resulted

of note
in that

given

closed

raised

banks,

experiences

monopoly

and

the

first

development

in debt

currency

Governwere

to

to its

assignat
r_gime.
were
not them-

interest-bearing
nationaux,

The

usually

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN FRANCE

_9

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

and his difficulty

in
chiefly owing to the
turned his attention

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

30

THE

RATIONALE

OF CENTRAL

BANKING

final result of which the Caisse d'Escompte

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

THE

It soon
ward,

became

with

France

England

IN FRANCE

was

and

America,

particularly

slow

they

in

provinces

where,

grew

small

were

the

firms

specialising

practically

on

non-existent.

31

extremely

facilities;

from

they

that

BANKING

of banking

which

apart

OF CENTRAL

apparent

as compared

opment
at

DEVELOPMENT

in the
was

devel-

the

so

pace

far,

exchange

Special

back-

and

business,

authority

had

been given to the Bank of France

in 1808 to set up branches,
and in those
towns
where
it established
them it was to have
exclusive

rights

of issue.

Lyons,

Rouen

a very
in the

brief existence,
difficult
years

also

and

argued

mands
serve

It set

Lille,

but

up

they

because
in which

in favour

of

its first
were

Almost

immediately
of the

their

Paris,

there

during
ernment

on

attempt
was

the

all closed

suppression

banks

were

period

a nature

to

defeat

to severe
any

great

They had the right to issue

ters and one or two other
utes;

thev

could

only

district;
and
their
times
the amount
tions

of

of their

branches

the

"Departmental."

to such

banks

were

founded

re-

Bank

of

by

the Govof private

Banks
of
But these

of their

were

of

business.

only for their headquarmentioned

in their
statbills

payable

narrow

or employ
Their

de-

the

outside

which

in their

sphere

between

own

exceed
three
The restric-

districts
agents

and

almost

of operations

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

after

liberalism,

were
the
in 1817-18.

expansion
notes
towns

the

sanctioned
establishment

restrictions,

discount

operations

to set up

title

by

facilities

sight
liabilities
might
not
of their
metallic
reserves.

inability

in

their
on

increasing

banks
of issue.
These
and Bordeaux,
formed

subjected

that

credit

which
three
projects
were
of the Restoration
for the

departmental
Rouen,
Nantes

down

encroach

abandonment

to establish

a short

offices

they had proved

unprofitable
they
had begun,
and it was

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

France

branch

their
belied
was

they were,
in
six additional
1835

and

1838,

3_

THE

and

the

Bank

RATIONALE

of France,

OF CENTRAL

now

taking

BANKING

fright

at the

threat

of a

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

branch
of the

Comptoirs

of the

the
note

Bank
issue

Bank

of France

sation
only an ordonnance
on the
recommendation
Banque,
tain

whereas

a special

which

the

conduct

they

rendered

cant.

They

and after
charters
greater

royale,
of the

to the
met

with

1840 the
for their

removing
some
also unsuccessful.'

had

to ob-

area

over

system
over

Government
foundation.
in the

of

note-issuing

the

the

could
depart-

towards

business

statutes
they

brought

complete
conclusion

it practically

direction

of

contained,

were

centralisation

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

any more
towards

was

in the

1848
Bank

year

insignifiof France

to grant
movement

issue

in that

from
Bank

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

restrictions

its logical

far

of the

refused
So the

of their

of policy
reached

were

disapproval

note

Bordeaux

authori-

greater

advantage

community
the

for modifications

trend

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

freedom

The

1840

the

of a branch

it a great

to an end. The representations

to the Chamber
of Deputies,
sions of the renewal
of the
asking

for their

after

Also

as a member
gave

of course
given
town.
Moreover,

which
would
be granted
Conseil
G_n_rale
de la

banks

of Parliament.

Comptoir

was
own

required

departmental

Act

business

mental
bank.
partmental
nevertheless,

opened
in its

as a result

of the
of the

voiced by the
of the Bank of
certain

that

the

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

THE DEVELOPMENT

OF CENTRAL BANKING IN FRANCE

33

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

banks were, it is true, given what were nomisame facilities,

and their notes subjected
to a
limit which amounted
to 102,000,000 frs. for all

nine banks together,

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

provincial

notes for that amount

had in

a4

THE RATIONALEOF CENTRALBANKING

the

amount

of the

the

Bank's

obligation

prohibition
gone,

note

of small

it did,

issue.

It had

been

content

to pay

specie

on

demand,

that

both

notes.

as we

Now

have

seen,

impose

The

difficulties

obligations

of the

in cash,

legalising

which

Bank

had

its bankruptcy,

had,

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

payments.

ings

at

June,

the
1848,

had

arrived

was

to make

ceeding
By this
(about

Bank
and

scale

regular
or three

years.

time,

however,

400,000,000

it had

frs.),

the Bank

and

end

a very

it had

for

commer-

borrowunstable.

during

of 1849

In

Government

by which
the

the

latter

the

suc-

Bank

had

to 525,000,000

strong

already

ing the restrictive

measures
relating
notes,
and it would
probably
have

its

short
durato revert
to

the

sums

its issue

the

reason

its position

At the

to increase

avowed

Government

of fixed

this

in meeting

as its private

1849,

were

if it should
to the Trea-

been
of very
at an early date

made
with

but

on
on

checks

to raise
to lend

the

in November,
advances

permission

been

at which

continued
again

at agreements

two

received

But the

these

of France

so far

and

a limit,

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

to rely,

metal
begun

frs.

reserve
suppress-

to the redemption
decided
in favour

of its
of a

complete
resumption
had not been for the

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

sury

demands

were

going

Bank

believed

its cash

to continue

reserve

would

at the

same

be inadequate.

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

for a further

reverting

to its

increase
old

statutes

of its legalised
under

ume

of notes

it was

agreement
had been
duction
of the Bank's

allowed

to issue.

On the

it would
would
on the

It was

only

the

the new
either
of

circulation

which

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

rate,

or
be

be aboltotal volafter

an

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

THE

safe

DEVELOPMENT

in reverting

August,
cal

to its old

crisis

seen

how

with
round

about

1850

paucity
but even

of a paper

corresponding

did

the

politi-

provincial

through

the

in

local

greater

withheld

England

in

prominence

especially
facilities

banking,

in the
for the

there

and

where

was

the

contrast

the

country

and knowledge,
even if they
had at least accustomed
the

to banking

notaire.

the

iarmers

crops

and

stocks

and

been

monopoly

revolution

habits.

Courcelle-Seneuil,

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

fact that

over

with

mind

stressed
of France

year

had

1848

single,

into

of deposit

strong

from

facilities,
most
itself. Where

local connections
no other
service,

especially,
districts

slowly

3_

it finally

industrial

brought

circulation

particularly

the

IN FRANCE

this

centralised,
of the

of credit
in Paris

absence

bankers
with
had rendered

their

and

emerged

a completely
progress

spread

the

France

The

the extreme
provinces,

timid

statutes,

of issue.

France

was

BANKING

1850.

We have
bank

OF CENTRAL

had

Moreover,
received

the proceeds

in lump

to make

a much

sums

their

longer

as he also

pointed
of the

at a particular

disbursements

period

out, 3

meant

sales

of

time

in

much

that

they

more
were

in

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

banks

simply

We have
for the

the

count

policy,

"La

hoards,

now
less

business.
and

next
the

the

Libre,"

decades

occasional
against
1867.

were

features

free-banking
provided

two

As it was,

savings

commendable
were

of criticism
Banque

the

described
of the

grounds

during
torrent

with

into

opening

In addition,
erful

to deal

went

which

but

nevertheless

by

the

of

the

Bank

set

gradual
beginnings
of which

of France.

balances

used.

controversy

stringency
the

the

not

the

stage

in France.
very

pow-

emergence
of a disevoked
This

partic-

36

THE RATIONALEOF CENTRALBANKING

ular

aspect

of the
the

of the

nature

very

discussion

and

object

earliest

is explained

of banking

days

of

which

French

Government

by

a conception

had

its origins

banking.

flexibility
d'Escompte
cent. The

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

six years

1806

the

it was

must

be to discount
at

rate
again

enough,

until

1814,

possible

a stable

when

tract
of

credit,
doing

charged
the
short
nally

so

other

than

its loans.
of charging

almost
that

In 1819

of

rationing,

it kept
or

the

rate

to the

to strengthen

of interest
purchase
its reserve.

instance

for

not

that

the

changed
It seems
as far

in both

or to conmeans

4 the
for

price

some

(4 percent)

as

directions,

conceivable

adjusting

rate

not

to extend

it adopted

a lower

in these

to maintain

any

in

of Napoof France

to 5 percent.

sticky

the

until

Bank

It was

it necessary

adopt

for

the

of reasonable

the

his

Bank

for it was
found

at

raised

date (having
less than
thirty
decided
to reduce
all rates

strain
order

rate,

Bank

firms

in 1807.

of the

and
figure,

claims
Bank

criticised

it was

it was

policy

it would

for

policy

and

when

the

the

he

to 4 percent

been

and

and

on

policy

by the
aim of the

for all commercial

reduced

to have

at that
Discount

conditioned
that the

4 percent,

liberal
was

at 6 percent,

invariable

to 5 percent.

was primarily
It was his idea

being

held

reduced

years
leon.

standing

Government

it was

limitations

in
the

the

first

imposed

from

beginning

provisionally

had

Right

on

it

months
bills

of

days to run)
to 4 percent.

before
it fiIn times
of

constant

resorted

of specie
It was

and
at

for

a premium,
the

first

time

to
in
in

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

THE

DEVELOPMENT

1847 that it discovered

OF CENTRAL

BANKING

the effectiveness

IN FRANCE

37

of a rise in the rate

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

still relied

partly

on the method

of charging

higher

38

THE RATIONALEOF CENTRAL BANKING

rates

on the

longer-dated

some

weeks

at 7 percent,

tuated

much

oscillate
rate.

more

more

the

But

in France

and

a corresponding

sion

to establish

of this

view

of France
lishment
nopoly
was

to give
by

the

Increased
by

1864,
the

the

first

of issue.

that

the

in fact

rights

practical

and

it was

the

question

on

that

gen-

the

Bank,

for permisadherents

which

the

institutions

founders
of the
Credit Mobilier.

was

of the
Bank

came

perhaps

in the

the

out

around

and

participants

fairly

of the

by

to

of MacLeod.

attack

Many

and

significance

arising

general

disinterested

now

the

Bank

did not prevent

the
of issue,
that it was

only,

to other

it flucbegan

of England

quarters

charter

for

estaba mo-

Government

in places

not

oc-

Bank.

incidents

more

writing,

but

Bank

was

big

held

and

writings

in some

banks
out

rate

was

onwards

the

to the

was granted
its privilege
in France
of other banks

free

sion

other

pointed

time

with

demand

not by law

cupied

that

heretofore,

owing

it provoked

rate

from

of bank

largely

the

than

in harmony

doctrine

accepted,

In 1861

and

violently

or less

In England
erally

bills.

the

type
was

marketing

to the

of Savoy

most

controversy

prominent

were

the

discus-

of Savoy

to be focussed.

discussion

new
This

given

annexation

that

Not the

least

among

the

Pereire

brothers,

of credit
institution
known
a bank
which
carried
out

of bonds

and

equities,

in

and

as the
undereven

di-

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

failed
was

up similar

to do
imitated

institutions

directly,

independently

brothers
had
other
financial

from the
business

incidentally

a combination

chance
of success,
Investments
which

in other

although

the

in Germany.

outset
always
the business

as was
consist

French

that
proved
for the

hoped
of note
had

countries.

This

Credit

Mobi-

The

Pereire

to add to their
issue; this was

exceedingly

little

by German
experiences.
most part of industrial
se-

THE

DEVELOPMENT

curities

and

market

except

hold

which

against

OF CENTRAL

are

difficult

at heavy
liabilities

BANKING

IN FRANCE

to sell in certain

loss

prove

of the

very

very

Bank

of

whole

Savoy

came

question

oly of the
The

that

should
they
voy

of free

Bank

treaties

lished

up

for

shortest

notes

reopened

versus

the

the

monop-

of France.
accompanying

individuals

be allowed
had held
concluded

viz.,

to

saw no possibilthe rights

of the
and

in banking

of the

assets

term,

discussion

trade

states

dangerous

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

a9

the

and
to exercise

under
from

annexation

institutions
the

of Savoy

belonging

same

estab-

rights

to Savoy
in France

the law of Savoy,

and the
this that it had the right

as

Bank of Sato establish

branches
able on

over the whole

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

chance.

It concluded

by

which

raise

the

a capital

and

gain

France
Bank

an agreement

Pereires
of the

were,
bank

a controlling
was

alarmed

at

Bank

rival.
notes

The Bank of Savoy

paid
for as low a denomination
two-named

no

interest

on

less

than

100

bills.

The

Bank

Government's
lege,

and

fying

the

with

the

business

paper,
deposits
frs., 5 and

from

Government's
Bank

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

of Savoy,

had

the

Minister

opposition
and

The

Bank

of having

of
the

teatures

to make

then

of its charter
m 1857
first took advantage

Bank

it a keen

of France

as yet

issued

discount

a protest

obligation
the

to

amount

as certain

likely

not
only

made

contractual
obtained

were

of Savoy

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

could

of France

concern.

prospect

whereas
and

Bank

subscription,

its present

especially

of the

count

times

the

the

own

in the

as a competitor,

of Savoy's

their

to ten

influence

much

of Savoy

with

by

on

the

plea

to maintain

entered

it had acquired
of this in 1864,

for

three-named

of Finance
to the

paid

notes

Pereire
itself

of the

its

privi-

a letter

signi-

agreement
into

negotia-

the right to issue notes

at the time of the Bank

40

THE

tions

with

agreed

that

RATIONALE

Bank,

its claims
together

money

into

the

Its

the

appointment

policy

pamphlet

of the

a petition

an investigation,
count

rate

on

by the

300

the

Bank

the

raising

of the

The

that

effect

was

to produce

of France.

Isaac

an enquiry,

and

Paris

to

Pereire
the

merchants

grounds

that

the

raising

had

led

to the

Conseil
not

earlier

finish

wrote

from

system

on the subject.
on both issues

tar

of the

more

academic
it was

the bimetallic

time

The

problems

rate

of competing
having

that
these
in face of
it,

bank

might

be

bv

the
et

1865,
much

banks.

Evidence

any

competence

the

writers
question.

for

Bank's
was

invariable,

was

superior
was

taken

to speak

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

superseded

of the

of strain

its rate
of issue

majority

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

for several

at the

beginning

It was

a strange

of the

de
and

raised

whether
in times

disre-

l'Agriculture

which

firstly,

re-

periodic

in February,

of maintaining
a single

all those

This may be taken

as the practical

until

two:

whether

practically

by

down.

demanding

undertaken

de

its discount

to its old policy

secondly

to a plural

1866,
died

primarily

of raising

was

opened

June,
had

were

policy

preferable
and,

until

against

Commerce

discussions

enthusiasm

made

enquiry

du

The

discussion
new

the

Superieur

l'lndustrie.
did

of

being

enquire

Emperor

also

of France

were

direction

for an
discount

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

latter

in return

of a Commission

such

from

the

immediate

Bank

demanding

ceived

notes

directed
the attention
of many
peoneglected
subject
of the theory
of

market.
lor

of which

to issue

with

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

BANKING

as a consequence

to renounce

indemnity.
This incident,

the

OF CENTRAL

years

longer,

'seventies

coincidence

so
the

that

by
the

THE DEVELOPMENT OF CENTRAL BANKINGIN FRANCE

Credit
the

Mobilier,

Bank

Bank's

acquittal

to lead

same

same

system,

find
time
the

direction.

of the

itself
into

trend

of the

almost

at the

in serious

only

was

the monopoly
issue of notes

retention

of the

of the

note

with

unification.

issue

a year

of the

which

were

later.

countries

debates

against

moment

consolidating

in neighbouring
the

accusation
very

difficulties,

liquidation

as France

centralisation
political

engineer

In Holland

posal to replace
free trade
in the
favour

chief
should

to its going

At the
ised

the

of France,

41

in 1863

her

central-

was
on

in the

the

pro-

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

In Italy

proceeding

by
in

increased
pari

passu

CHAPTER

The

Organisation

of Banking

in America:

Decentralisation
Without

The

Scottish

experiences

support
of the claims
to American
history
tunate.

The

American

case

controversy,
it cannot

ther.

decentralised

sential
The

as a forceful

was

school,
to have

evoked

in

but appeals
been so for-

as evidence

by both

without
both

freedom;

of central

it lacked

banking

the

and

es-

of

free

and

the

proper.
distribution

of powers

State authorities
left
in the hands
of both.
dislike

State

between

institutions

rights.

and

Nevertheless,

of the

commercial

early

period

great

difficulty

Federal

Bank

of North

need
in America's
in getting

for

a jealous
the

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

the

legislative
control
in banking
The country
started
off with

of centralised

individual

uine

example

but so far as the system

as a whole
be described
as an illustration
for ei-

characteristics

banking

served

of the free-banking
can hardly
be said

sides in the
is concerned,
It was

Freedom

42

for

for funds

The

lack

facilities

industrial
private

regard

need

in

the Federal
Governbanking
sphere
in the

America.

banking

matters
a natural

capital

at

development
for such

of a genthis

very

caused
an enter-

THE ORGANISATION

OF BANKING IN AMERICA

4a

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

was least stringency

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

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

44

THE RATIONALE OF' CENTRAL BANKING

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

THE

ORGANISATION

OF BANKING

IN AMERICA

45

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

4,6

THE RATIONALE OF CENTRAL BANKING

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

banking
institutions
of the Second Bank of

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

maintains

in the event of its failing to

in the form of a 12 percent

that it was only as a result

of the organ-

isation of this bank that the State banks were prevailed

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

on the Currency

and Banking

System

of the United

States,"

THE ORGANISATIONOF BANKINGIN AMERICA

tions

made

by

the

State

banks

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

was

that

the

emergency
that
banks,
contribute

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

and

chief

was

sented
on the
dency

them
Bank

The

for

toed. This put

central
bank.

except

banks

brought

first

the

from the Bank and

Shortly
afterwards

of new

blow

was

New

firms,
with

to insolvent
York.

the

latter

notes

struck

opposi-

against

the

then

pre-

and

was declared
to the Presi-

in 1833

deposits

for many

decades

of cash

payments

England,

laxity

applied

early
bank

when

to be

he

removed

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

suspensions

extreme

up

the

their

where

the

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

backed
by

Government

an end

in New

of the

This is a very
of the central

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

orders

General

State

it "accumulated

in 1829.

gave

the

objection

that

Bank

might
menace
its resources

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

of course

The

Bank

Bank
came

47

much
which

In charters

banks

granted

again

chaos

principles
Take

occurred

was

for a
in 1836,

kept

of the American
with
the exclusion

of the

banks.

to all projects

due,

above
system
of the
was

of bankruptcy

as an example

before

1828

sions that if a bank suspended

payment
(usually
three
months)
it should
cease

were

the

there

the

State

were

of

provi-

for a certain
period
operations
unless
it

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

it still did

its rights

altogether.

the
these

unconditional
rules

were

not resume
Charters
period
made

payment,
created

allowed
completely

it should
after

to ten

days.

ineffectual

surrender

1828

shortened

But in 1837
because

all
the

48

THE RATIONALE OF CENTRAL BANKING

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

Suspension

Laws of an even

more pernicious

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

the banks to continue

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

The losses sustained

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

of the Several

Umted

THE ORGANISATION

OF BANKING IN AMERICA

419

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

in 1819.

40

THE RATIONALEOF CENTRAL BANKING

mand,

either

by

the

imposition

of a percentage

tax

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

the

most

fications

effective

if it had

as to reserve

many

of the

Louisiana

States.

The

requiring

culation

plus

In other
over-issues

most

reserve

some

protection

adopted

assets.
which

Another
measure
adopted
made
bank
shareholders

ing

out

ceeded

the

York

practice

contributions

of the
their

scheme

to subsidise
and

capital

of weakening

of the
and

fact itself to risk

of the safety-fund
solvent
_1Estabhshed

banks

many

on

actually
scheme

inwas

a system

not
had

the

banks

The

to the

at the

pay-

they

on the

further

basis

were

issues

tempted

of
on

unhealthy

the

of

especially

as a percentage
over

ex-

under

expense

ones,

assessed

scrutiny

of

liabilities.
where

managed

of the

of

a tendency

computed

It also

lien

holdings

to be allocated

of course,

was

public

was

unmet

institutions

merely

bank.
the

'1 This

prudently

but was

fect

banks,

weak

actual
Several

a prior

of capital
ambitious

against

was,

premium

risks,

the

the

notes

of insolvent

more

insurance

system.

There

in the

over-issue.

respective

to a fund

liabilities

assets.

stronger

actuarial

of
cir-

was that of double

liability,
liable
for the debts
of the

of banks

the

ticular

an

to their

Safety-Fund

this

as the

in

that

against

note-holder

such
of giving

equal

insurance

paid

was

not to preventing
the
of notes on demand,

over and above

the amount
by them in the bank. The most

New

banks

following

amount

compulsory

Speci-

to emerge

of one-third

to the

States

the

enforced.

began
of these

were
directed
redeemability

of suspensions

shares
vested

the

deposits.

event

to an

rigidly
also

stringent

a specie

cases efforts
and ensuring

but to giving

bank

been

requirements

on

bank liable to
should
have

efof par-

by

this

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

banks
in 1829

had

to be called

upon

for increased

contri-

THE

ORGANISATION

OF BANKING

butions.
Future contributions
vance for charges in respect

IN AMERICA

51

were also mortgaged

in adof an issue of State bonds made

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

of the newly
banks.

granted

freedom

was a

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

fund

was

finally

wound

up

in 1866

52

THE

The

bond

RATIONALE

deposit

investment

OF CENTRAL

system

in certain

had

lines,

the

rather

peculiar

culation
meant

depend
also that

could

effect

realise

deeming

their

their

circulation,
doing

securities
first

bond

deposit
their

which

they
their

were

chartered
banks.
perfect
guarantee

Parallel
other

States

bank
bonds.

to get

the

amount

had

was

not

very

tied

free

funds

cir-

in

chance

of

little

up

for re-

of notes

in Government

to sell until

circulation,

note

State bonds.
It
on other
lines,

a feature

they

had

which

in comparison

put

with

the

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

the

could

beginnings

measure

be

century

disposed

of this

of competition,

foundations

nineteenth

up

State

of the

and

either

disadvantage

State

with

a greater

or

amount

banks

capital

note

at a considerable

failed,
many
discount.

in order

or to decrease

because

reduced

them

assets

the

of Federal
constituted

notes

the

this,

prices
banks,

of tying

Federal

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

of making

on the
while

effect

usually

Mortgage
and other
real estate
too illiquid
to provide
backing

BANKING

movement

there

of State
Indiana

of only
in favour

took

place

monopolies.

and

Illinois

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

at

of

in some

Early
had

in

the

prohibited

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

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

improvement

twenty

ticeable
no

years
in the

means

tional
_a This
sion went
forbidden

eastern

perfect

crisis

took
the

region.

at this

of 1857,"

was yet another

to the winds.
to the

that
preceding

occasion
Under
the

Government

to pass

in American

Civil War
The

period,

when

place

banking

but

except

suspensions
when
1846
any

the penalty
Constitution
law

was

directly

banking
especially

in
no-

system

was

for the

interna-

of specie
of liquidation
of New York
or indirectly

by

payments
for suspenState it was
sanctioning

THE

were

general

ORGANISATION

over

most

OF RANKING

of the

IN AMERICA

United

was far steadier

than ever before.
improvement
was not attributable

5a

States,

the

situation

It is very probable
that
to any considerable

this
ex-

tent to State regulations

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

a time,
State

was

weight

banking

South

to the

on

to the

they

support

North,
to

operations

since

in the

North

keep
and

regarding
specie
from
the
side

Secretary

of the

were,

from

Chase
the

bad state of the finances

Chase
called a conference

Philadelphia

banks,

and

with

exchange
of
Suffolk
system
_

The

had

the

latter
by

and

ceased

in
re-

liabil-

lost heavily,

in a very

but
their

strong

posi-

soon came
howfinancial
needs.

partly

they

net

contracting

excessive

diffi-

as a result

of the

in the preceding
of the New York,
him

banks

a large

experienced

public,

of

change

secession

in fact,

The

greater

for a radical

they
water

same

clearing-house)

reserves.
Pressure
of Governmental

Treasury

in borrowing

above

the
the

country.

to the

and

bank

enforcement

frequent
of the

York

in

of windays.

Much

occasion
whole

had

the

round

rigid

and

prepared

appropriate

more

New

the
of the

the banks

managed

lending

of the

provided

bank

was

he paid

passed
the

law,

for a system

ineffective.

attached

their

and

when
scope

banks

rendered

system

gave

ity towards

very
tion.

the

if the

assets

gave

for exhibit

institution

Civil War

mittances

culty

which

thereby

to the

in the

tion
ever,

This

of the

satisfied

payments
between
banks
by
due in great part to the spread

The
the

by

is to be

specie
notes,

usually

prescribed

days.

of securities

law

enforcement

for his examination

certain

dow-dressing

and

the

them

on

in the

was

possession

to present

block

lax

Comptroller

its own
visits

rather

drew

up

administraBoston
and
a plan

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

for

refrained
withdrawthey called

54

THE RATIONALE OF CENTRAL BANKING

assisting the Government

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

90 percent

of the market

value of the bonds

lodged

and

not more than 100 percent

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

THE

ORGANISATION

OF BANKING

IN AMERICA

55

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

56

THE

bank

RATIONALE

for redemption

check

on the

lation,

until

regard

a security

The

amount
it was

really

for a branch
banks
were
to establish

and

there

that

any

presently
backing

substantial

effected
through
authorities
failed

OF CENTRAL

was
one

banking
forbidden,
branches.

system.
except

the

lems
up

in connection
in a later

to the

with

have
chapter

Federal

could
that

occasion
on

Reserve

the
Act.

an effective
keep

in circu-

it is a mistake

to

as specie.
that

might

have

been

one that the

of facilities

On the contrary,
the National
under
special
circumstances,

tioned

shall

lacking

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

of the
issues

We

bank

improvement

Some of the peculiarities

means
of regulating
note
York.

thus

realised
as good

BANKING

free

bond
have

deposit
already

banking

to refer
American

again

system
been

system
to these

experiences

as a
men-

of New
probleading

CHAPTER

The

VI

Development

of Central
in

Banking

Germany'

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

an occasional

reference

to the

States. The setting in Germany

is dissimilar
other countries
we have so far considered,

policy

of other

to that in the
for the reason

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

58

THE RATIONALEOF CENTRAL BANKING

The
tivated

first steps
by fiscal

time,

before

they
the

were taken by princes

and nobles
needs,
attempted
to start banking

commercial

consequently
note-issuing

first

bank

conditions

met

with

branch

of issue

were

scant

of the

to prove
bank
even

founded
this one

tunate

in these

years

had

it not

certain

deposits,

_ and

been

der

paternal

The

first

Wars,

effects
The

from

heavy

and

they

were

sult of the
tain

of this

loans
later

in close

were

was

assigned
the

as

The

the

Royal

the
been

Great. 4
so for-

to it by

law

management

of the
it made

intensified

of Tilsit,

territories

relations

witnessed

cash

difficulties

Peace

Polish

and

it suspended

sanction.
the

and

concerned.

by Frederick
would
have

also

it,
so far

of

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

when

was

had

given

for

at least

at all successful

Bank of Berlin, a State

It is doubtful
whether

the Exchequer
out the whole

ripe

success

business

who, mobefore
its

in the

payments
bank

with

arose

to the

in which
on

took

first

place

as a re-

Prussia

invested

of its deposits

completely
an enormous

lost to the bank.

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

cial

to the

responsible

way

all lines

of the

were

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

existed
at this
other
than the

establishment

of business.

assets

King.

No specific
prohibition
mation
of private
banks
the

of the war
of the
remained,

These

cer-

a large

proportion

was reorganised
made
nominally
nance
Minister,

mortgage.

Napoleonic

Government,

from

had

State.

Government

it suffered

away

the bank

the

in the

Prussian

by losses

which

with

In the

of joint

time against
the forobstacles
that lay in

'twenties

stock

two

organisations

private

banks

in
set up

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

THE DEVELOPMENq?OF CENTHALBANKINGIN GERMANY

in Prussia
dertaking
the Berlin
Stettin. _

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

But this
when

period

of relative

freedom

was

a complete

reversal

there

year

made

the

issue

approval

of the

prompted

not

leged

Royal

circulation
the time
tended.

it must

Royal

came

Bank

almost

at the

Mortgage

and

monopoly

of the

desire

to give

tion

none
in the

itself

note

priority

sphere
with

way

included

set

not

but

of note
this

when

up

in this

because
issue

dread

changes

The

Leipzig
with

Bank
an

of Saxony,

exclusive

case

the

in several
other
In Bavaria
the
as the

given

result

of which

fear

that

notes,

in 1838,
but

was

a
of a

there

competi-

be dangerous,
many

founded

privilege

in in-

enormously

notes,

would

of too

prohibi-

in 1835 _ was

of the

in
ex-

had to give
on bank-

and

in

find

we

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

dowed

privifor the

in the

to swell

to Government

in Bavaria,

accordance

but to make

being
set up
was restrictive.

Bank
issue,

was

of the

moment

were
case

Exchange

prohibition

the

which
had originated
and was now
to be

was

about

of that
on

interests

note-issuing
banks
increased
restrictions

very

were

About
this time banks
States: the policy in each

were

money
Wars

in 1833,

A law

dependent

virtual

the

be noted,

of the Prussian
of notes.
These

technique
for credit.

notes

for

to an end

of policy.

This

of regard

Bank,

The

dustrial
demand

Government.
out

came

of all bearer

of State paper
of the Napoleonic

tion; all three

up the issue
ing

_9

was

regat least
not en-

subjected

to

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

60

THE

RATIONALE

OF CENTRAL

BANKING

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

TIrIE DEVELOPMENT

The
tion

Prussian

by the

ing state

OF CENTRAL

Government

news

that

of Dessau

was

on one

the

BANKING

IN GERMANY

led out

of passivity

of its borders

authorities

had

61

in the

into

ac-

neighbour-

approved

the

project

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

Bank,

private
not

more

much

that

liberal

bank
tainly

academic

alternative

was

owing

to the

fell back on the

bank.
So it was
partly

the

which

it had

interest,

State.

lack

by
It was

formerly

of funds

private
given

exercised,

reserve

proportion

to the

note

circulation.

The

retained

Royal

Bank,

public

transactions.

lishing

the

bank

and

its notes

An irnportant
and

of

as being
adopted

the

Royal

of capital
and the
the

in the

of private
in 1846

metal

bank

and

to replenish

ually
to replace
the State paper
law specified
both a maximum

as the

idea

characteristic

State

share
as the

Bank.
arising
scheme

assets

of the

and

the

cerbut,

Treasury,

he

capital
into the
Prussian
Bank,

shareholders
back

of
the

its lending
capacity.
Rother
bank
as the most
desirable,

introduction
reconstituted

controlled

by

establishment

the

of reorganising

intended

and
so strengthen
envisaged
a State

wholly

for the

dismissed

still handicapped
by lack
left by the French
Wars,

adopted

probably

now

a scheme

Rother

mere

bank
was
the deficit
was

out

of issue,

than

less

This
from

to work

banks

instead

right

of

of note

issue

were

grad-

its notes

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

of one-third
privileges
made

clause
of the

legal

in the
banking

_ of the

it had

held

tender

decree

for
estab-

notions

of

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

1836"

(1837).

6Z

THE

RATIONALE

OF CENTRAL

BANKING

the period was that which stated specifically

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

Erste

Vereinigte

Landtag

in 1847

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN GERMANY

63

mum note issue for all the provinces

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

Schaffhausen'schen

Bankverein

in Cologne

and the

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

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

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

furt am Main, and the Disconto-Gesellschaft

ship for six years before it could obtain
become a joint stock concern.
The rate of progress
_0 The

Stettin

Bank

was

was a partnera concession

to

in the setting up of note-issuing

allowed

to retain

its interest-bearing

deposits.

banks

t_4

THE RATIONALEOF CENTRAL BANKING

was

slow,"

Free

Banking

and

did

Party.

not

Chamber

of Deputies,

1851--2

of a parliamentary

conditions
public

in Prussia,

attention.

relaxation
side

On

of the

go far

Under
this
and

standing

tried

but unsuccessfully
of the

Some

In the
founded
began

ony,

banking

channels

side

the

Prussian

credit

it gained

more

party
and

demanded

on the

Bank

of private

Bavaria
laws

in

and

negative

as a half-State

enterprise.

Harkort

passed

for the

place

in the

policy

of the

Prussian

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

just

note-issuing
numbers,
over

the

and

banks
their

boundary

'-' and

were
notes

being
soon

in Prussia

and

small States issued

notes for lower
denominaPrussian
Bank, and the Prussian
Government

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

the

and
had

they were
aimed
Rthlr. notes.
The
lution

in the

institution

to get legislation

smaller
States
in considerable

Saxony.
These
tions than the

but

in the way

did take

to circulate

sought
ments

the

of the

the

into

via these

demands
of Harkort

Normativ-Bedingungen.

reforms

Bank; it began
also extended

secured

positive

against

institution
removal

party
enquiry

the

the

leadership

Normativ-Bedingungen,

it declaimed
hard

to meet

the

W(_rttemberg
no effect
merely

followed

because
replaced

P_ossian
Government
was I0 increase
the

the
their

saw that
note
issue

the
banks

paySax-

same

course,

against

whom

1 Rthlr.

notes

by

10

the only logical

soinside
Prussia.
Two

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

THE

DEVELOPMENT

OF CENTRAL

BANKING

IN GERMANY

65

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

and

that

the

two months'

deposits

should

not be callable

at less than

notice.

effect
Then onthethecrisis
later oftrend
1857 of
occurred,
policy.

,_

against the bank creations

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

and
It provoked
this had aa reaction
marked

:_

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

2
:_

sidered the functions

reputable
firms who

._,

nounced,
unlimited
H Although

of a central bank by lending freely to

found themselves
in difficulties.
The

and there was a crop of literature

right
of issue of the Prussian
there

were

still in 1858

onlv

thirtv.

Zettelbanken

in iavour of a
Bank was dem twenty.

States

66

THE RATIONALEOF CENTRAL BANKING

100

percent

Zettelbanken

specie

backing

for

of the

border

States

bly justifiably
in many
cases,
impossible
thing of combining
note

issue.

Prussia

Steps

and

payments
bition

were

in non-Prussian
of foreign

bank
either

The

notes;

all that

were

to exclude
Prussian

was

issue.

'4 The

proba-

attempted
business

their

notes

Government
only

the

if the

was

that

the

notes

punishment.
was by now

into

the

question,

a leaning
the

over

towards

one

banking

full freedom

extreme

for all banks

to a preference

for

border

States,

of policy
The

systematic

gether
taken
gress

and

the

negotiations

separate

discussion

States

of the

deutscher

State

beginning
interest.
"'wilden

Volkswirte,

to be

divided

to issue

was

unity

to obtain
met

whole

foremost

relegated

no longer

with

over-supervision
this time given up
vate banks
in note

at

in the

uniformity
little

banking

among

success.

question

whom

was
Kon-

was

and

of purely

was

academic

They

all hope of ever securing

freedom
issue,
and henceforth
concentrated

Dr.

had alwithout

the too lax regulations

States, but condemned

of the Normativ-Bedingungen.

to-

programme
traders,
the

so prominent

to a position

The Congress
opposed
Banken'"
of the border

from
notes

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

intervention

to a

as yet unpractical
beout the notes
of the

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

Otto Michaelis.
ready
somewhat
any

Prussia's

among

was in
of for-

ranging

complete

note issue at the other.

The latter was
cause
of the impossibility
of keeping

prohi-

went

risk of legal
of Deputies

factions

in
all

note-issuing

discount
because
of the
The Prussian
Chamber
many

both

centre
in Saxony.
The law
in preventing
the circulation

happened

the
with

forbade

In Saxony

to apply

small

condemned,

bank-notes.

notes

had no redemption
case ineffective

eign

note

since they had

credit mobilier

taken

in Saxony.

the

of the
the
had

by

for pritheir

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

THE

DEVELOPMENT
OF CENTRAL

efforts

on trying

to secure

joint stock basis,

people
persisted

BANKING

freedom

IN GERMANY

for deposit

pointing
out that
in regarding
note

67

banking,

on a

it was unfortunate
issue as the chief

that
object

of banking.
The
was
ment

swing

towards

slowing

up.

in 1863 when

issuing
banks
take additional
twice
the
teen
deal

certain

of once
of their

of the

restrictions

amount

of their
was

right
passing

In the

the
south

stringent.

of note

issue,

of a Peel's

of Germany

Where

there

note

was

issue

acknowledg-

on private

note-

allowed
to
now being

paid-up

extended

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

mending

in the
its last

modified;
they were
deposits,
the limit

concession

its unlimited
_.

the

freedom

practically

were
slightly
interest-bearing

instead
period

increasing

It received

capital,

and

ten

to fif-

from

there
was still a good
and most especially
of

and

Michaelis

was

recom-

Act for Germany.

the

restrictions

not

monopoly

were
there

still

very

was

com-

ic
l_
!f.

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

i:

was

_:

conceded

Most

ibr

forces

observers

were

with

the

the

first

now

time.

operating

advantages

in the

direction

of a strong

bank

of securwhich

can

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

Prussian
in 1870

member

Bank
gained

States.

was

extended,

control

A reform

over
of the

and

the

banking
law

Norddeutscher

legislation
relating

in all the

to joint

stock

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

of non-note-issuing

banks,

which

was

all

that

the

68

THE RATIONALE OF CENTRAL BANKING

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

modelled

and Michaehs

on the English Act of 1844, but

took part in the drafting.

THE

far

more

tion

DEVELOPMENT

statutory

of the

Reich
issues

note

banks

were

banks

were

was

maximum,

against

their

and

total

relinquished

its

issue

issue,

in the

Thus,
not

torm

if banks
engage

certain

The
Bank,

not

Reichsbank
which

was

must

discount
was

of the

to acquire

an
issue.
how-

of business.

notes

might

they

trade

must
only

in mortgage

having
out

more
of the

a wholly

bank

fiduciary
disabilities,
types

engage

one-third

If any

was

they

not
bills

into

of

to issue

constituted

turned

posi-

whole

imposed.

on certain

business;

of bonds,

ness,
and could
months
to run.

also

to continue

in acceptance

classes

the

to its legal
Act involved

of a restriction

wanted

for

Reichsbank

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

The

Thirty-three

proportion

was

the

imposed.

69

be established.
The fiduciary
the Reichsbank,
were given

a reserve

note

IN GERMANY

as follows:

recognised

and no new ones might

of all the banks,
including

a legal

BANKING

requirements

private

note-issuing

OF CENTRAL

than
old

privately

in

busithree

Prussian

owned

con-

cern, but retained

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

business

was

subject

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

same

limitations

as in the

case of the private

banks,
deposits
was permissible

and
only

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

of the

not

made

were

given

banks,
notes

Reichsbank
much

in that,
of any

for payment

were
wider
whereas

other
to the

legal

circulation

than

a private

bank

private

bank

place

wherein

A private
provisions

note-issuing
of the

bank
Act,

but

the

but

notes

might
to the

issuing

the

issuing

bank

was

be

paid

allowed

if it did

this

out
to stay

it was

they

of private

not

except

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

tender,

pay
bank
was

by

the

out
or
siture-

out from
to have

its

70

THE

operations

restricted

it its right

of note

The
position

provisions

RATIONALE

to the

OF CENTRAL

territory

BANKING

of the

State

which

gave

Reichsbank

the

issue.
of this

of a modern

Act secured

central

bank.

to the

CHAPTER

VII

Discussions
the

Theory

of the

in England

and

Prior

Although
ning
there
the

the

in England,
as it did
much

in England

to

discussion
it never

on the

greater

rise

Subject
America

1848

of free
reached

Continent,

degree

giving

on

banking
such

This

of freedom
to a more

may
that

rapid

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

politics

nopolies,
had

had

the

become

taken

Bank
the

up

pivot

were

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

discussion

nection
with
ing with the
attention

was

its stand

of England

and
far

on the
established

in England

seems

the agitation
for joint
pamphlet
of Thomas
drawn

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

to the

greater

have
had

its begin-

proportions
been

due

always

growth

to

existed

of banking

and therefore
to a
bv the time laisser-

against
the

too

had

large

privileged

system

well

established

Continent
the
and therefore
to have

mo-

of which

opened

it

to be
banking
more
in con-

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

and

freedom

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

71

72

THE RATIONALE

OF CENTRAL BANKING

from failures of the Scottish banks in comparison

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

' See J Horsley Palmer,

Money Markel," 1837.

"Causes

and Consequences

of the Pressure

on the

See "Pohtical Economy Club. Minutes oI Proceedings,"

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

DISCUSSIONSON THE THEORY PRIOR TO 1848

phlet
before

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

drawn

his

attention

regularly
ances.

clearing
This

to the
each

practice,

in a free-banking
on the over-issue

a free

system

keep

its

power
much

it was

own

notes
return
any
than

Scotch

banks

and

paying

the

was

of primary

interests

within

of each

bounds,

every
other
circulation.;
either
banks,

bank

but
bank
Banks

bank

A receives

B receives

presenting
cally doing

means
there

was

one

This
which

than

one

to

to exert

its

of
the

its own. It will

issuers.
Now if
notes

arise

of bank

a clearing

B
bal-

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

control

by

depended

notes
for redemption
so, and it was a check
quickly

efficient
that in

not only

also

more
will

banks
would
acquire
consequent
drain
on

in its expansion.

ing mechanism

such

of A, and A will
So it is concluded

its notes
the other
against
it, and the
it up

by

bal-

impor-

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

of A's notes,

in

from
forcing
too
will receive
every

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

ance in favour
of B's reserve.

pull

in the

issues

of the

notes

submitted,

Scotch
bankers
6 in 1826 had

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

in preventing
of its paper
into

day from customers,

loans,
notes
of other

other's

he

tance
check

practice

73

positive
balances
its reserve
would
way

of the

but on the banks"

which
was likely

which

clear-

not on the public's

much

more

drain
rates.

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

waited

on

the

reciproto work
external
exchange
demand

for coin, by the banks

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

of paper

or as a depreciation

of its value

can take

place

_ "Observations on Paper Money, Banking and Overtrading. including those

parts of the evidence taken before the Committee of the House of Commons
which explained the Scotch System of Banking."
6Committee of the House of Commons on Scotch Banking.
70p. cir., pp. 86-87.

74

THE RATIONALE OF CENTRAL BANKING

for want of a sufficiently early and active demand

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

DISCUSSIONS

ON THE THEORY

PRIOR

TO

1848

7_

issued and that the principle

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

notes
the

76

fence.

THE

The

RATIONALE

conclusion

OF CENTRAL

BANKING

is that if one bank

such a policy, it will become

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

should

decide

on

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

banks, but that the latter are, on the contrary,

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

DISCUSSIONS ON THE THEORY PRIOR TO 1848

77

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

to less careful

78

THE

RATIONALE

OF CENTRAL

BANKING

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

on

the

Currency

and

Banking

System

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

of

the

Umled

beyond
twice
issues,
but he
of the note
was

lar

the

method

from

of

DISCUSSIONS ON THE THEORY PRIOR TO 1848

79

on the total circulation

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

SO

THE RATIONALEOF CENTRALBANKING

The

first

writer

competition
tion

in other

Lord

to give

an

in note

issue

cannot

trades

seems

Overstone).

"The

explicit

explanation

be assimilated

to be have

ordinary

been

of why
to competi-

S. J. Loyd

advantages

to the

(later

commu-

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

it tends to
and thus

to secure

being

to the

public

to the

quality

and

price,

while

all the

tions
not

on the part
on

the

the

best

quantity
evils

supply,

of the

With

from

the

end

to be sought

or miscalculation
portion

upon

Loyd,

the

Norman

become

and

upon
public
and

prominent

herents
of Peel's
them
among
the

the

this

Tooke

sides

being

one

leaders

This

gal restrictions
ties under
mine the
views
open

were

of the

in the
of the

group
on the

be left to the

was

opposed

amount

of the

discretion

the force of the

amount.
In spite

pro-

''z_

all in later

currency

school

less
entry

surprising
into the

years

to

and

ad-

to find
banking

same

camp,

for he,

Free

Trade

movement,

to the
note

of the

a
is

error

greater

issuers.

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

ing school.
it should

the

Act. It is therefore
opponents
of free

it is to find

was the
currency

of any

falls in a much

of the

than

how-

evil consequence

MacCulloch

trade

and

currency,

different
kind;
by fixed law

upon

members

lowest

or miscalcula-

is of a very
of its amount

point

than

had

fall on themselves

to a paper

ever, the interest

of the public
steady
and equable
regulation

at the

errors

will

respect

regard

commodity,

arising

of the producers

public.

due

be-

of thought
on
as the bank-

imposition

issue,

and

note-issuing

of lethought
authori-

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

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

in which

it is sometimes

contended

for,"

he

said,

"I agree

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

l
i

DISCUSSIONSON THE THEORY PRIOR TO 1848

with

a writer

in one

of the

American

papers,

that free trade

in banking
swindling."
Such
claims

is synonymous
"do not rest

grounds

claims

analogous

to the

in production--.
comes

It is a matter

within

Tooke's
was
free banking
thing

nature

nental
Carey,

police.

of competition
by the

State

''2_ This

of number
and became

the
and

lowed

considerable

monopoly,

defended

protectionist

contended

to replace
the

and

dictum

of

by opponents
of
for them
some-

influence

on later

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

banking

in
on

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

exercised

denounced

and

observes

of a motto.

1837
cash
discussion

discussions

of freedom

of

times
out
Continent

who

with free trade

in any manner

for regulation

province

quoted
on the

in the

The
renewed

the

al

spirit
that

the

existing

there

would

American

prevailing

if free

in

of political

be far

fewer

banking

and
H. C.
Hildreth
29
American

competition

system

system

Conti-

were

al-

interference

excesses.

on the

Carey

whole,

point-

ing out that even if not satisfactory

in all respects
it provided
more
facilities
than the banks
of any other
country,
and he
maintained

that

in England.
applied

by

failures

had

in fact

3' In a comparative
different

States

been

study

of the

within

America

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

from

the

restrictive

for, he says,
the

erroneous

system
"the
idea

less

that

various
he

bound

systems

to lead

of privilege
banking

than

found

was most free,

that the whole

was

system

frequent

that

failures
princito over-

in banking

is different

from

2s"History of Prices," 1838, Vol. III., p. 206

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

82

THE

RATIONALE

OF CENTRAL

BANKING

all other trades; that it affords the means of making large

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

cir., p 89. ltahcs

cn., pp. 80-82
ctt., pp 57 ff

ours.

DISCUSSIONSON THE THEORY PRIOR TO 1848

to the
cannot

banks
but has
be immediately

been
invested
liquidated.

83

by them
in forms
that
_' The theory
contends

that if more banks

themselves
would

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

direct

and

the

investment,
banks

only

on

instead

short

term

of these
they

funds

would

stocks
for

being

be

lent

lent

on

to

long

term and there

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

to sketch

taken
and

the

relevant

to the

out that

the

whole

principle
which

exchange
arising
out

town

was

already

of trade

familiar

of banks
this

of money

in the

in different
would

was
and
credit

He pointed

and

applicable
of different

principle

and

payments.

balance

was equally
of the issues

or groups

to function,

theory

of specie

of the

ternational
of claims
lowed

of the

suspensions

adjustments

same

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

specie

flow

theory

of in-

to the balance
banks
in the

towns,
keep

and

the

if al-

issues

of

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

of the

balances
system
limited
such

frequent

between

exchange
banks.

Carey,

and
he

payment

thought

the

of
best

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

could

ever

States where
the limited
tion was far too deeply
freedom
favourably

to issue

notes

disposed

_ P. 57 1,.: "The loans

community
at large
"_'P. 59.
Jr "Treatise

on

Money

be put
liability
rooted.
in

towards

system.
His explanation
leads first to an industrial

the

of notes

Unlike

into

the

wide

in the

the

New

sense
York

United

organisaopposed
to

but

was

bond

very

deposit

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

of banks
to individuals
they may be deemed
and

practice

form of company
He was strongly

Banking,"

1839

are temporary,
permanent
"

but

as regards

S4

THE RATIONALE OF CENTRAL BANKING

points which anticipate

modern
of the boom comes when there

trade cycle theory. The end

is a demand
for coin for ex-

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

United
1841

States in

DISCUSSIONS ON THE THEORY PRIOR TO 1848

S5

issue paper money on the same terms; secondly,

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

"_ Op. cir., p. 70.

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

86

THE RATIONALEOF CENTRALBANKING

time

A and

equal

gold

and

B did

every

week

partly

in its own

5,000

issue

= 40,000

Gold

reserve

= 15,000

bank

notes

the

same,

notes

will

just

discounts

and

partly

being

and

held

10,000

in bills

in the

roughly

and

notes

of the

the same

notes

so that
balance

and

the

5,000

daily

with

no

as the

other

propor-

of B's, and

or

weekly

transfer

re-

discounts.
to be made

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

of its own

ceive

of business
case--

amount
in repayment
of previous
the repayments
to each bank

the separate
circulation.

week

amount
in each

Note

the proportions

tions
total

same

so that

each

ceives the same

We may assume
bank,

the

reserves,

to the
each

B will

re-

exchanges

of gold

from

of

the

re-

serve of one bank to the reserve

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

for this

purpose

by

tains the old position.

portion
between
the

the

Then,
note

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

of A's notes

B's business

since

has
gives

in its own
to return

proportion

no

debit

transferred.
expansion.

tion

and
to their

and

of 3:2 also,

or

credit

stage

this

the

demand

on

shares

the

either

public

of the

prohas

side

exceeds

A will

discount

starts

so that

it also

account

and

gold

no

demanding
two

circulation.

in any
will be

clearing

no automatic

fall on the
total

now

in B's notes,

Thus

B has

will

B main-

due for payment

of which
_9,000

6,000

notes.

Consequently,

At a later
ever,

notes

to B 6,000

while

A's business

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

amount

new situation,
the
of the two
banks

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

to A. But

in the

same

in the
issues

still

will

check
gold,

banks
Suppose

be

on A's
how-

in proporthat

the

DISCUSSIONSON THE THEORY PRIOR TO 1848

total
have

and

demand

B will

Thus

the

is 20,000,*'

in the

final

Note

issue

= 48,000,

Gold

reserve

-----3,000,

Note

issue

---=32,000,

Gold

reserve

position

A will

have

gold

circulation

then

8"I'

has

reserve
been

7,000.

of the bank

which

diminished

did not increase

in greater

ratio

than

its

its cir-

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

may

capital

have

enough,

its gold
may

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

stock

alterations

by its competitors,

panic

excitement

jurious
this
sue
time
when

its

is coming.
to the

of permitting
that which
that
the

low

and

and
the

prices,

there

will

and

prosperity

can

of a great

panic,

of trade.

to discount

scarcely

That

during
resolute

the
in

when

the

be devised

commercial

sev-

under

and

depression

refusing

A system

are

suffer

of confidence

general

this

its rival to
moderate

Thus
a bank
system
of over-

where

country

if it has

If to avoid

which
does most business
and is quickest
and most

issues

more
nation

inthan

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

it is their
spirit

of issue,

and

bank
will gain most
period
of excitement
contracting

which,

its competitor.

its issues, it thereby

enables
still more, until at last the more

banks

of high

of great

off by a rival

ruin

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

adopted

ioint

drained

even

interest

of overtrading

to

issue

as

is prevalent

much
and

as

possible

to reduce

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

SS

THE

their
ulus

RATIONALE

issues when
to revive
it."

Longfield's

trade

begins

general

MacCulloch's,

that

the

contrary,

the

among

and

wants

is therefore
expanding

bank the
no automatic

rivalry

BANKING

to stagnate

conclusion

far from

mercy
of the conservative
the former;
there
exists
on

OF CEN_FRAL

a stim-

the

bank

same

being

as

at the

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

the

banks

leads

to general

expansion.
The

point

raised

by

the

Longfield

argument

is by

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

to it, and

of its validity

we

shall

until

our

postpone
final

We have tried in what

ries of rather
disconnected
ganised

discussion

There

was

Bank
the

of

all along

banking

problem

precedes
remarks.
the

bank

editor
of The Economist,
in that journal
between

question
country

to concentrate

controversy

and

organisation.

cussion
of the advantages
thing
like systematic
was

Probably

in a series of articles
1845 and 1847. "_When

the final decision

against
business
had already
been

Act

and

of 1844,

system
than

that
to make

by

as a not

nature

time

become

this

also

and their
currency
and
in book

itself.
the

attention

on

the

general

the

first

dis-

"Capital,

of the

consequence,
the

origin

established,

for the

adoption

of an alter-

to denounce

Bank

of England

and

of the
rather

was

Currency

anyfirst

free entry
into the
made
in the Bank
and

main object
school.

monopoly
form,

by
to accept

he published
these articles

unnatural

out the

recommendations

privilege

4s Published

are,

to point

had

native
system,
theories
of the
The

they

an attempt

a seor-

no

of free competition
that was
that given by James
Wilson,

were
written
note-issuing
more

free
to

examination

to connect
together
There
had been

in this

and

currency

of central

detailed

free-banking

position

and

theory
of
literature

chapter.

a tendency

of England's

the

far the

Banking,"

the
is, in
1847

DISCUSSIONS

Wilson's

opinion,

especially
secure
the

ON THE THEORY

the

cause

of England's

in the development
basis

of, and

Scottish

banks

the

was

PRIOR

the

89

Scotland,

business.

confidence

outcome

1848

lag behind

of deposit

greater

TO

_ The

of the

of the

more

public

eminently

in,

satisfac-

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

to form
joint

a large

a banking

stock

number

no doubt,"

even

firms

of known

and

wealthy

he says,
formation
of the

wealthy

joint

"that

were

had

before
always

men.

it not for the

the

advent

consisted

"There
legal

of

can be

restrictions

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

stock

in the

and

the

as to the
monopoly
tence

firm,

company

banks

metropolis

would

as well

have

been

as in the

called

provinces

the
and

into

exis-

years

ago,

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

the

question

legislature

banking,

they

mission
currency
bank
Such

are
did

why

it is that

content
not consider

to issue
school

whereas

to allow

free

it a safe

notes
payable
usually
gave

denied

of the

that

desirable

the

issue

extent

in many

the

circulation,

admitted

,6 See Article
4_ "Capital,
"Theory

and
up

that

of thought

could

be increased

it was
to the

the difference
was invalid.
demand
probably

time

p. 282.
1855.

was

per-

reason
was

the
that

by

did not.
to Wilson

which

both

to any
strictly

un-

main-

claimed
between
But it was still de-

deposits

of MacLeod.

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

to give

and deposits
acceptable

school

and

in deposit

practice

as convertibility

out that
liabilities

quarters

right

of notes

so long

tained,
and pointed
notes
and deposit
nied

banking

public

on demand.
The
for this distinction

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

as a member

the
trade

formed

no means
*_

part
generally

of

90

THE RATIONALE OF CENTRAL BANKING

The

events

of

commercial
implied

a choice

ments

bound

to

impression
It

is

rather
who

for

the

over-production

and

depressionsY'

that

first

give

of

fixed

A similar

it

the

way
the

of all these
he

was

under

returned.

should
to the
which
was

is
and

from

relation

is never

capital
theory

about

labour;

support

con-

fixed

replaced

the

future,

cycle

between

were

about

imple-

the

trade

confused

capital

remarkable
should

the

of

capital

immediately

of

employing

fixed

in

draws

capital
and

fund
that

he

somewhat

community
the

theory

causes
of

to produce

of goods

His

of

nature

production

production

floating

the

labour

for

distinction

and

analysis

that

applying
used

He was

fixed
of the

variables

school

the

to an

clear

present.

capital:"

income

the

the

with

which

Wilson

was

be

it to the

in
up

floating
in

could

applying

sumable

led
He

between

which

and

1847

crises.

held

be

the

theory

that

leads
also

banking

to
by

it is

booms

Bonamy

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

DISCUSSIONS

ON THE

THEORY

PRIOR

TO

1848

91

Price, and
contributions

we shall notice it yet again when

we come to the
made
by Horn,
in France.
But the banking

school
did
tion as the

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

of the currency
From Wilson's
free-banking

school
to do. "_'
time onwards
for more

question

Continent
it was
now to France.

just

was

dropped

beginning

than

in England,
to gather

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

torce.

a decade
while
So we

the
on the
turn

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

CHAPTER

The

VIII

Discussions
in France

and

Belgium

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

THE DISCUSSIONSIN FRANCEAND BELGIUM

voked

it in evidence

petition

of the

in banking

system

like that

and

All attempts

Cieszkowski

ory

of money

at this

time

to state

credit,

of theoretical
be

left

almost

but

the

The

from

discussion

tion

of the

for greater

mo-

exclusive
taken up

with

the

in fact,

the-

very

little

banks

interference,

"_This

appeal

freedom

written

became

report

of the

Non-note-issuing
legislative

juristic.

a pamphlet

The

com-

may,
but

the

is the right to coin money

and must
controlled
by the State. The reasons

purely

agitation

with

rationale

to deal

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

gan

by

of a restrictive

containing,

value.

free

right to issue notes

either
exercised
or
are

wrought

superiority

in a book 4 purporting
and

he

gives

of the

were

issue had recourse

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

material
says,

that

of France.

nopoly
in the note
right to the coining
by

evils

93

to the

by

more

the
in the

in that

banking
after

same

pre-

argument

of

trade

Courcelle-Seneuil

important

Senate

to the royal
chief

be
he

be-

in 1840."
the

year

presenta-

on the

proj-

ect for the renewal

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

gloomy

of paper

picture

money,

of the
and

any similarity
between
try and its application
support
for
the

each
only

to the
way

of the

7 claiming
of

of competition

emphatically

in the

issue

there

was

that

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

retention

locality,

effects

denied

overcoming

old

system

at the

same

the

of a single
time

French

that

bank

this

public's

was

"bank

shyness."
After
Coquelin,

this

the
one

free-banking
of the

leading

party

became

members

of the

more
free

prominent.
trade

4 "Du Credit et de la Circulation," 1839.

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

asso-

94

THERATIONALE
OF CENTRALBANKING

ciation and an economist

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

THE

eral

families,

whereas

distributed
The

DISCUSSIONS

among

IN FRANCE

in the
large

free-banking

case

AND

of notes

numbers

position

BELGIUM

the

a5

loss

would

be

of people.

was

also

supported

by

Du Puy-

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

He looked

upon

the

unlimited

liability

provisions

of

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

given

by

depositors

the

shareholders

to

to be

smaller

than

in the

subiect

was

the

syssecu-

note-holders

it would

be

under

and
limited

liability.'"
Interest

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

where

touched
the

leading

subject
a group

Joseph

Garnier,

the

of the day.
than in En-

few

subject.

of the

In France
of the

of "La Libert6
which

time.

des

included

academic

it was,

economists

among

In 1857

by the Soci_t6 d'Economie

Politique,
the general
question
of the limitation
among

when

writers
on economic
subiects
it interested
was much
wider

controversy

specific

increased

in 1857, and
of most of

exceedingly

on the

greatly

raised
the rate of discount
early
was soon attracting
the attention

economists,

it was

taken

up

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

'''4 were

Wolowski,

Courcelle-Seneuil,

Paul

debated

Chevalier,
Coc l and

Horn,

Leonce

de

Lavergne.
Garnier

spoke

administrative

against
supervision

so unreservedly

in favour

vention.
He declared
to demand
a regime

du Credit
in La Revue

,4 See
1857).

in Le Journal

reporl

in banking,
of entirely

that he was
of complete

'_' "De la Monnale,

1_ See the report
p. 471.
the

all intervention

of authority
but Chevalier
withdrawing

not prepared
liberty
for

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

Economistes,

2me

and
was

all
not

all inter-

to go so far as
institutions
of

237.
serle,
serie,

Vol. XXI., (1857),

Vol

XIV, (May,

96

THE RATIONALE OF CENTRAL BANKING

issue and credit, and this was regarded

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

THE DISCUSSIONSIN FRANCEAND BELGIUM

prived

by

change

law

of all

of notes.

England
banks,
others,

after
the
the solidarity
and if there

affected

to a greater
is one
more

whole
On

credit
system
the other
side,

resumed

rate

reserves
the

effect

lesser

Pereire.

the

gland)

did

should

be

was

taken

better

rate
the

invariable
by

Maurice

example

than

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

of issue

which,

insufficient,

any

method

In

Aubry,

for the
the
Much

z_ a Paris

book

metallic

and

to augment

opinion

at 3 percent."'
this

was
of rais-

then

if

its capi-

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

necessity
his

has
the

of proce-

its capital,

a neighbouring

Bank

of France

country

(e.g.,

rate

of discount

the

banker.

of Aubry's

same

attitude

There

of the

En-

is no

influence

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

is to keep

when

the

were

when
same.

of protecting
proper

was

there

in

contrary,

policy

to realise

place,

her

the

the

bank

obtained
would
specie
reserve.

_ that

inter-

used

more
stable.
Bank of France

He denounced

TM

that

this

if, on

rendered
on the

tal; the resources

necessary
for the
to raise

for the

argument

degree;

as a means

for the

of doing

the

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

suggested

first

mechanisms
also

is thereby
the attack

of discount

and

was

or

bank
like
confidence

by Isaac

ing the

normal

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

there
much

dure

the

He repeated

97

adopted

the

rate

of discount

as a rule

of bank

down,
policy,

a docwas

1_"La Banque de France et l'Organlsation du Credit en France" _1864).

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

98

THE RATIONALEOF CENTRAL BANKING

bound
the

to lead

Bank

issue

to credit

of France

was

given

discount,

:_ and

charge

a high

different
whereas

inflations.

on the

to the

bank

it was

therefore

rate;

and

Aubry

grounds

bases

that

solely

the

in order
highly

in this

improper

respect

it was

to control

movements

of specie,

the

policy

of calling

on

the

shareholders

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

cheap
for

Pereire

was

into

mands

by no

the

to one

Bank

of

means

in favour

note-issuing
rival

:8 the

Bank

since
dis-

of France

additional

as soon

2_ He

to break

substitution

of

duty to keep the

an alternative

of general

business.

establishment

France,

it back

it to

in an entirely

to supply

paying

on

of note

to favour

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

the

attack

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

count

entry

his

privilege

as there

is

freedom

limited
the

his

of
de-

monopoly

of a duopoly

of
for

monopoly.
Aubry

wanted

the

no better

reason

than

monopoly
that

the

retained,
coining

and

seemingly

of money,

and

for
there-

fore the issue

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

axioms

later

application
money
riences
reproach
prerogative

by

of political
Etienne

of the
that most
of paper

economy.

Duran"'
royal
countries
money,

free banking
had been

that

It was
it was

prerogative

pointed
as

to the

issue

had had their

most
and it was a grave

with
the errors
the sole cause.

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

out a lit-

a result

of which

of the
of paper

fatal expemistake
to
the

royal

THE

The

idea

minds

DISCUSSIONS

of free

the

vision

IN FRANCE

banking

had

of anybody

and

firms

under

the

would

the

practical

cise

a close

scrutiny

in getting

of the

royal

d'Eichta131

away

the

because

examine

each

that

likely

was

likely

to be in that

A Belgian
"men
notes

to this

to set up
notes,

being
they

purely
it was

to exer-

accepted.

It was

political

to assure

of a note

was

bankers
would

of issues
themselves.

exercise

to pay

Adolphe

the

public

of

almost

never

in

it or by

issued
one

by a bank

that

was

assumption
the notes

3_ of the
line

free-banking

of argument,

school

that

would

the

become

largely

pointed

danger

scrutiny

at all,

to make
that the
of his own banker

trader
and

and

which

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

referred
de Papier

d'Economie

to the
et des

Politique,"

for the

that

public

it was

Vo].

the

a reasonable

would
willingly
accept
the notes
of such
other

unduly

Banques

that

for their
that the

a matter

not to be expected

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

not

position.

It was
no

was
suc-

argument
by

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

supervision

and

able

argued

to see if it was

able

economist

out _4 in reply

note

in the circulafeared
that un-

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

carefully

to be

the

holder

the real
avoided

note

public

intervened

the

a position
to know
in the note issue

people's

becoming

of different

notes

Thus

State

many

for unity in the note issue

the restrictionists
who

from

prerogative.
that

guarantees

all the

99

encouragement

of the

the case
among

in

difficulties
bankers
and

multiplicity

over

lines that
by those

raised

a positive

of the

impossibility

along these
formulated
ceeded

have

shadow

BELGIUM

everybody

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

AND

to receive.
This
of that particular
heavy

d'Ermsslon,"

II., 1864,

277.

pressure
1864

of

laO

THE RATIONALEOF CENTRAL BANKING

insolvencies
come into
The

on the small note-holder,

who was
contact
with the banks
as a customer.

case

for competition

Mannequin

and

was

Chevalier.

the Pereire
brothers
that the
Bank
of France
had
risen
destruction

of

the

of the

banks

it would

lead

to over-issue

school,

that

so long

needs

Chevalier

window,"

of trade,

was

by

Paul

the

Coq,

views

had

given

of

it an

of the note issue.

Mannequin's
a defence
of free banking
against

that

out of the

the

up

to

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

banking

thrown
to

taken

Coq "_ endorsed

departmental

unrestricted
monopoly
tribution
3' was simply
allegation

also

Paul

unlikely

but

they

responsible

are

only

be

bringing

usual

notes

issued

cannot
for

on the

as the

lines

"are

not

in response

issued
the

conthe

in

excess.

subject

to the

notice of a wide circle of readers

by his contributions
to the
newspapers,
notably
to the Journal
des D_bats.
CourcelleSeneuil
also
Economistes.

re-expounded
3:

A publication
was

an

posed

as the

provision
tem

bv

to replace

completely
said it was
tre

which

article

his
provoked

Leonce
the

views

de

a good

monopoly

of France

of banking

of the

of eight

or ten regions,

branches.
This was
departmental
banks

was

offices

deal

Lavergne/_

free competition
but
impossible
to manage
Bank

in the

each

Bank

to do,

best
having

des

of discussion

in which

he

of France

by a limited
a large area

trying

could

Journal

not by

plurality.
from one

and

He
cen-

an adequate

be provided
its parent

pro-

by a sysbank

a plea for something

similar
to the
but without
the old restrictions.

with
old

3_Article "Les Banques de France et de Savoie," m the ,Journal des

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

THE DISCUSSIONS IN FRANCE AND BELGIUM

1111

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

et Regulateur
son application

de
au

102

THE RATIONALEOF CENTRAL BANKING

being

beneficial

to the

of the

contention

that

banking

was

community,
the

on those

who

asserted

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

the

attitude

the

other

they
side

contained,
already

said

no

importance

in the

school

as the

of discount
This

for

most

as a means

brings

enquiry

arose

eve

out

of the

of the

specie
French

Bank

travaux

publics,

members,

and

witnesses.

The

of which

both

therefore
report

prises

altogether

called

as w_tnesses,

close

on

five

besides

Hankey,
from

William

England,

memoranda
Newmarch,

Professor

Enqu_te.

affair

and

and

4_
the

d'Eichtal

were

examination

pages.

anything

on subjects
connected
of foreign
economists
written

had

thousand
delegates

writers
number

and

who

rate

flows.

in six volumes

the

all those

of the

Banque

in the

gained

France,

views,

part

is contained

use

not

French

and was entrusted

to
du commerce
et des

Chevalier

took

must
the

of Savoy

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

had
a rep-

a commentary
matter.
But his

of the

of controlling

us to the

wholly

among

adherent

up

which

to what

almost

out

for

took

developments

stood

emphatic

reason

additions

It was

French

free

Wolowski

by others
and
adopted
in the

he

who

oppose

proportions,

original

subject.

to

on those

who

no sufficient

banking.

very

proof

railways,
and free exthey did not do, and

given

towards

on the

under-estimated,

The

as yet

of the views
expressed
trend of policy
already

doctrinal
be

took

not

of it those

in a book 41 of extensive

however,
been

etition
on the

had

of the

not applicable

it and

banking
change

they

face

was

it; because

that

the

burden

system

denied

he insisted

on

the

same

from

and

of
com-

The

Council

the

Bank

of

of a reputation

as

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

submitted

R. H. Patterson

de Laveleye,

from

by Thomson
and

Belgium,

J. S. Mill,
and

Pro-

41"La Question des Banques," 1864.

42"Enquire sur |es principes et les faits generaux qui regissent la circulation
monetaire et fiduciaire," 1865-66.

THE DISCUSSIONSIN FRANCE AND BELGIUM

fessor Tellkampf,
had the distinction
Commission.

their

d'Eichtal,

Aubry,

Coq),

and

chi,

Lavergne,

shall
and

of value

Chevalier
icy in the

have

occasion
who

some

Isaac

Chevalier,

Horn),

from

of France.

the

rate

had

to refer

point

already

Pereire,

Bonnet,

Courcelle-Seneuil,

were

Paul

to others

writing

of view

He doubted

no matter

a gold

efflux. 4' The

was

that

emphasised
the bank
which

the

of discount

general,

lier,

witnesses

(Cernus-

contemporathe evidence
amount
of

of monetary

theory.

made clear his views on the subject

of discount
course
of his examination
of the representatives

Bank

using

one,

French

(e.g. Wolowski,

with the enquiry.

Looked
at as a whole,
be said to have contained
any considerable

material

the

the

views

we

Coullet,

neously
cannot

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

Among

published

IO8

what

the

policy

of the

the

or even
means,

that

sale

was,

might

not

with

be available

the
the

other

as Aubry

and

securities

by the Bank

by

the

contract

the

that

of funds

sold,

and

This

school

in the shape

must

thought

they

of an open

the Bank
more
money
market.
More

acquired

so there

careful

by

the

Bank

be a tendency

the

had
market

liquid

without

attention

was

for the

discovered
causing
by this

time

such

which

would

stringency
being

of
as

by the
of the

securities
rates

an ingenious

operation

of

sale

just as certainly

for loan

he

Cheva-

policy,

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

correct

capital
obligations

What

same

was
credit

the

Bank, _ and

purpose.
of the

in

for stopping

immobilising
Government

for this

of

of credit

as a remedy

overlooked,

must

necessity

in his opinion,

supporters

Pereires,

or the

restriction

of its "rentes"

the necessity
of not
in quasi-irredeemable

along

utility
the

polof

given

it

to rise.
device
make
in the
to the

43"Depositions de MM. les delegues et les regents de la Banque de France."

pp. 81-117
44Op. cit., p. 112.

104

THE

comparative
ume
by

effect

of money
no

held
sue

why

its issue

free-banking

had

of trade

were
openly
ber of people

inflationary
who took

de

Laveleye,

omy,

attacked

school

on

claimed,
sion
heavy

*_ the

cheaply

namely,

that

drain

free

he

system
case

of a large

reserves

dence
But

of the
in the

bankers
would
of the
that

number

of a privileged

be

wrong

in

involve

system
circulation.

free-banking

to the
at this

45 "Le

Marche

on

condition

time
Monetalre

there

followed

the

their

times.
the

free

system

in the upward
swing
contrary,
conceivable

that

depum

the
confi-

such

that

reserves
lead

the

of unlimited

et ses Crises

with

at

than

actually

willing

an

a con-

out that
under
a

unlimited
that

of larger

condition

by a

by

argued

would
himself

they

to an expan-

be followed

its issues

keeping

began

if what

lead

assuming

therefore
He was

system

Just

the

and

Econ-

free-banking

that

as compared

Laveleye

the

school

a crisis. He pointed
of greater
violence

extend
de

favour

of this

of the

having

attack of a numattitude.

must

of banks

which,

of Political

of specie

which,

could
place,

this

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

it would

subjected

public,

might

present
smaller

bank

second

thus

ideas

said

is-

that

money

would

true,

the

argued

in replacing

and

section

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

than

had

Professor

banking

was

on bank

had

free-banking

The

Firstly,

circulation,

of them

and provoked
the
up an anti-inflationist

expansionist

grounds.

Some
in the

fiduciary

industry.

volhad

advantage

be lent

total

bankers

expansive

by

a Belgian

two

of the

a positive

and

free

Others

money

could

development

Emile

be more

system.

on the

the

inherent

should

of metallic

nothing,

systems

opinion.

reason

banking

system

part

costing

no

BANKING

Up to now

of identical

was

of a central

large

credit.

been

there

OF CENTRAL

of the alternative

and

means
that

system

RATIONALE

to consider
banks

should

the
to

the
be

liability.

attack
Cmquante

on

bank-notes
Ans,"

1865.

in

THE

DISCUSSIONS

IN FRANCE

AND

BELGIUM

10/5

general. It was opened by Cernuschi:

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

_o Op.

ciL, pp.

78-80:

"Les

billets

_i ordre

et les lettres

de change

les eflets

de

1106

THE RATIONALEOF CENTRAL BANKING

Coullet
believed
its own destruction,
ilar

though

not

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

position

as

Cernuschi.

posed
bound

that as the result

to occur
under

would
tween

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

single

bank,

this

bank

nopoly,

would

and
or

in future

so there

the

solid

not a lowering

of the

rate

because

anxiety

the

adequate
same

of banks

reserves

of a single

serves
crisis.

had
The

ion, more

would

than

the Government's
issue.

the

afflicted

to be

as a source
of monopoly

sufficient
abusing

mothe

If, however,
of well-organised

it

would
of the

in normal

be
rate,

times)

to

times,

and

against

reserves

of

a large

greater
the

or

and

but a raising

united

Moreover,

to these

of plurality

(even

bea

a de facto

be

in ordinary

have

bank.

an advantage
advantages

of interest
Even

circulation,

number

established

would

banks

that were
two things

its dealings

(he thought)

of the

reserves.

total

failures
one of

abandoned
altogether.
to build up a system
result

of the

be

system

the

keep

banks,

confine

would

whole

bank-note
would
be
should
prove possible
and

of the numerous
such
a system

He sup-

than

centralisation

the

total
of re-

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

to outweigh

the

its power

over

avowed
the

single

danger
bank

of
of

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

THE

The

best

DISCUSSIONS

exposition

J. E. Horn. 51In the

ative

argument

it was
age

of the

first

place

industry

of specie,

he

submitted
later

why

oly

claimed

BELGIUM

free-banking
terms)

that

it had

reasons

AND

had

as a royal

of the

_ While
first

that
been

there

were

One

was

generally

enough

dence

that

the

weight

and

fineness,

and

assay

coins

every

known

were
and

coin

before

probably

two

in order

to facili-

of exchange
over
the only institution
sufficient

professed
it. The

confito be

it unnecessary

accepting

coin-

monop-

was

they

so to make

out that
the

as a State

to inspire

what

from
prerog-

pointing

over

tate the circulation

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

came
royal

commenced

taken

right.

107

case

he disposed

in economic

private

and

IN FRANCE

in

to weigh

second

reason

was that the King found

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

necessary
any

as a budgetary

more

that

the

could

provide

the

child,

in Paris,

or Baring,

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

ing,
one

denied
of the

ski.

It was

adopted,

service

many

of the

that
major
an

in London,

Chevalier

less

prominent

which

rather

were

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

des

Banques,"

the

accepted

on

of course,

prerogative
little more

Roths-

Courcelle-Seneuil,

writers

free

this
and

bank-

became
Wolow-

in many

merely

cases

in order

to

of the Crown
in the
than the playing
off

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

like

to undertake

and

unnecessarily,

is it
which

as willingly

money,
and
these
writers

was,

neither

institution

If a firm

be just

with

"_'_and

only

of coinage.

bank-notes
were
issues between

attitude

perhaps

source,
is the

they would
realm.

in company

and

State

of space
was
was, in the

delast

1866.

sz Op. cir., p. 62.

s3 It would
still, even in our day, seem
importance
as a budgetary
source
in time

that the
of war.

note

issue

is of the

utmost

108

THE

analysis,
should

RATIONALE

a question
be denoted

a certain

of definition
by the

characteristic

on the

and

substitutes
view

ior,

which

must lead
Turning
nopoly,
the

be

of such

a bank
with

of notes

into

liquidation

The

history

others

were

should

into,

insisting
as merely

coin,

of strict

and

to pay

since

any

convertibility

greater
out
into

on

the

emphasised,

Government

to abuse
can

be no

specie

on

of
coin.

that

demand

pure

paper

A bank

under

Government

to re-

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

usual

penalties

had
were

be as prudent
There
was
the

guarantee

been

to understand,

temptation
the

failures

full of

irremediably
to bear the

in their policy
also, as Chevalier

over
that

of insolvency.

given

ever-present

its power

and
to go

undeniably

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

sequences,
they would
other
business
concern?'

mo-

possibility

consequence

counted

suffer

If banks

to the
its

of privileged

bankruptcies.

There

possessed
they

bank-notes

convertible

always

lieve it of its obligation

its bankruptcy
became

already

the

condition

attention

revoked

patronage

however,
sponsible

and

convertible

the

called

in place

State

they

things

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

liability

monev

because
or whether

regarding

always

neglected

Horn

would

Chevalier

for always
and

term

two

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

prices.

necessity

same

BANKING

as to whether

in common,

be sharply
contrasted
second
characteristic.
monev
because
both
on trade

OF CENTRAL

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

as any
_5 had
for

privileged
will

recon-

never

the

bank.
occur

system
only
in the case

_4 0p. cir., p. 3(,16

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

THE DISCUSSIONS IN FRANCE AND BELGIUM

1109

of a privileged monopoly the legalised suspension,

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

1 IO

THE RATIONALEOF CENTRALBANKING

til it is discovered
iary materials
The direct
continued
lished

that

there

necessary
discussion

for some

years,

by Wolowski

is an insufficiency

of the

to co-operate
with
between
Wolowski
and

the

in his later

it. 5_
and

Chevalier

correspondence

book.

auxil-

was

pub-

5_ Courcelle-Seneuil

also

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

and

of agricultural

Courcelle-Seneuil
free

nor

bankers

pected

who

Horn

of the

was

supported

it to increase

lowering

credit

the

rate

in

particular.

a member
their

of that

case

possibilities

of interest.

Neither
group

because

be greater
under
would
be lowered,

so far as the

latter

he thought

not by way

of increased

and

utilisation

all the
stood

issues,

but

by way

savings.

He was

the

insisting

on

of idle
bankers,

in other

consider
case

free

at all likely

the

of banking,

branches

of trade

application
and

emphatically

the

most

denied

compeand in

of

as under-

He refused

regulations
the

come,

collection

unyielding

liberty

industry.

special

not re-

it would
of the

complete
and

of any

and
did

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

ex-

of expansion

Courcelle-Seneuil

of

they

favourite

to

to
the
con-

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

consequences

of their

mistakes.

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

THE DISCUSSIONS IN FRANCE AND BELGIUM

II1

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

et de la Liberte

d'Emission,"

1868.

11_

THE

will

have

less

culation
gold

and

the

it did

the

will

system.

The

primary

will

difficulty

will

claims

on

B to contract

be

diffused

raised

importance

cir-

balances

acquire

constrain

contraction

to the

clearing

consequently

of B. This

of such

BAN_NG

in proportion

before;

will

so the

whole

position

OF CENTRAL

in circulation

of A, who

reserves

liabilities
out

notes

of B than

go in favour
the

RATIONALE

was

its

through-

by

Juglar

imaginary

to a
rather

than real and would

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

and

France.

position

Juglar

which
banks,

was

of

really

ascendancy
advocating

rights
of issue
should
be
but in which
there
should

controlling

influence,

the pure
in vogue

sense
and
in France.

something
the

as

Bank

a mixed

in

competitive
bank with

free

privileged

of

system

given
to the
be a central
between

single

the

banking

monopoly

in

system

What
and the

is the connection
banking
school,

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

central

banking

and

school

other?

It is not unnatural

cases.

It is especially

free

bankers

were

the

to expect
noticeable

Seneuil,

Coq
of the

adherents

He was
school

be

metal,

but

fixed,
that

He supported
as we

system

respondingly

and
there

free
have

would

Adherence

of the
any

destroy
to the
usually

the
was

section

merely

that

above

this

however,
explained,

the
tenets
carried

of the
which

note

issue

of the
with

he

con-

currency

fiduciary
limit
the

issue

covered

circulation

for
that

most

an exception.

of the
the

be no fiduciary

banking,

already

the

in both

most
theory

among

Cernuschi

issue

should

close

that

banking

were
strictest

not

on

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

theorists.

believed

it to be very

of the

Mannequin

a member
which

should

son,

and
banking

school

in France

denied
that bank-notes
could
vertibility
was
maintained.
vinced

currency

peculiar

thought

by
at all.
rea-

such

altogether.

central
it the

banking

school

cor-

support

of the

prin-

THE

ciples

of the

Coullet,
ciary
the
the

currency

who
issue

Among

DISCUSSIONS

so long

the

there
of the

proportion.

The

of the

currency

admirer

of Peel's

Act,

reserve

reason

proportion

that

the

ment in time
and Adolphe
By the
tary

beginning

theorists

Wolowski
ers of the

of specie
d'Eichtal
had

only

was

doctrine.

and

been

turned

bank

was

the

fidu-

of issue.

right

a rather

less

Wolowski
also

of issue

rigid
was

preferred

of controlling

'seventies

case

on

of

time a discussion
of
issue and the fixed

to cause

withdrawals,
both iavoured
of the

in this

one

Cernuschi

tended

113

limits

unlimited

began
at this
fixed fiduciary
latter

BELGIUM

exception

the

method

latter

AND

of any

was

opposed

pretation
the

The
fixing

as there

who

Bank of France
relative
merits

reserve

school.

opposed

those

IN FRANCE

issues

greater

intera great
this

for the

embarrass-

but Leonce
de Lavergne
the second
method.
the

to the

attention

of mone-

bi-metallic

and Cernuschi
both figured
among
retention
of the double
standard.

question.
the

to

support-

CHAPTER

The

IX

Discussions
in Germany

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

aus

den

Vereinigten

Staaten

Nord

Amerika's

uber

Eisenbahnen,

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

1839
Staaten
der Zahl,

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

ll4

THE DISCUSSIONS IN GERMANY

I 1/$

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

a privileged

bank

gives it an un-

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

free banking as a means of lowering

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

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

ohne Metallhinlage,
Vermogenszuwachs.

die Erhohung
der genossen

der
und

1116

THE

RATIONALE

OF CENTRAL

BANKING

ways only to issue notes to the amount of its specie holdings,

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

particularly

von

Gerstner's

views

THE

ited
that

DISCUSSIONS

IN GERMANY

117

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

ilege

by the

natural

granting

of which

principle

Secondly,
the note
lend to the State.
While

Tellkampf

as the

the

State

of responsibility

ultimate

had

undermined

underlying

issuers

must

looked

to centralisation

end

be free

to be sought,

from

these
the

new

was

principle

would

that

provide
the

herent

of the

currency

issue

time

in

unity
in the
of banks
and
led him to fa-

on the

shareholders

extent

were

of their

necessary
known

Scotch

liable

property,

limitation

among

model,

the

on

1_ on

for their

self-interest

note

German

issuesY

economists

of

was Adolf Wagner.

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

doctrine

tinent,

be set up

if the
full

the
best

his generation
was a follower

was

should

to the

By far

note

at this

to

setting up her own private

banks so as to keep
of these
other
States.
He recommended
that

banks

obligations

trade.

all obligation
of the

1_'there

the

free

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

not a right
but a priv-

school.

was

he set out in this

to explain

the

Writing

at a time

becoming

very

first

''_to do two

book

disadvantages

from

powerful
the

when

the

on the

Con-

things:

economic

The

one

point

of

view of the ruling

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

of English

had been especially

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

die

literature

on

influenced
Wagner

this

and

by the
that the

Entwicklung,

etc.,"

subjects

and

writings
of James
chief accusations

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

Neuere

allied

Policy,

Banks,

Wilthat
etc.,

p. 5,

*a Note that Tellkampf

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

zur

Lehre

von

den

Banken,"

in

1857

for
on
is

 la

THE

had

already

RATIONALE

been

currency

made

doctrine

His own

opinion

without

legal

made

that

issues

porting

free-banking

being

unsound,

taken

theories

tional

ground

and

he

of the

currency

Peel's

the

the

readers.
to set up

statutory
thus

fix-

fully

sup-

Act he regarded

it was
school,

Bank

Act and

be allowed

opposed

because

the

Peel's
to German

proportions,

position.
only

that

against
should

or of reserve
not

BANKING

available

banks

hindrance,

ing of note
the

in England

were
was

OF CENTRAL

based

but

on

also

of England

on

had

as

the

mis-

the

addi-

through

its

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

intact

defect

in the

system

of the

great

which

he gave

most

weight

was

makes

of the

power

aging

it to discount

State

paper.

sessed
the
of keeping
opposite

but

too

'7 While

the

more

lending

he published

a few
to the

Germany

This was closely

of the automatic
were

assets,
after

-tlley

the

issue

ject

to check.

assumed
banking

the

over

such

a bank

and

was

rates
years

banks
by encour-

in too

in France

central
Wagner

to

Government

to invest

group

'_ The

much

had

as-

bank to be one
held it to be the

too low.
of the
later,

theory

TM

of

currency

doctrine

prominence

was

"'bankmassige'"

first

cover.

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

lent

the

central

misuse

criticism

in

term

privileged

Pereire

detailed

its obligations.

the

fault of a single privileged

discount
rates too high,

given

ness

away

cheaply

which

as notes

taken

it exercises

of keeping

In the

had

aid
left

out in true
came

elapse

back

of the

banking
in the
loan

supposed

for this

From

time

a position
discussions

this

1_ Op. cir., p. 212.

1tOp
cit., p. 233.
_8 "Die Geld-und
Kredittheorie

natural

period
reason

onwards

of considerable
and

business,
and

that
course
the

"'bankmhssige"

Peelschen

Bankakte,"

of
sub-

cover

in German

legislation.

der

of busiamount

to be constantly
importance

is short-

1862

THE

DISCUSSIONS

IN GERMANY

119

The most interesting

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

1_,0

THE

a note-issuing
did

such

bank

or type
for the

of deposit

The

question
rights

of a liquidation
tance

was

bank

should

attached

for the

for a failure

on
any

period

the

enforcement

imposition

in the

negative.

speakers
to cash

be given

pref-

in the

event

point

notes

on

of the

obligations

was

Great

to the

enforcement

for which

the

of quick

of penalties
suspension

It
as

importhat

the

emphasis

on

liquidation

something

resumptions
varying

lasted,

the

length

for liquidation

of
the

penof a depast.
need

of payments,

with
and

the

day

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

pro-

amount

support.

(depositors)

This

to meet

the

legal
the

as to the

receive

of liquidation)'

rigid

on

issue,

should

creditors

all the

Neither

"'Normativbedingungen"

be obliged

on pain

note

requirements

answered
by

always

presentation
necessity

was

than

note-holders

other

names.

limitations

Prussian

whether

two

of restrictions

of deposits,

the

over

at least

other

or special

all

BANKING

placing

of deposits,

for withdrawal

erential

have
the

of business
cover

thus
rejected
inappropriate.

alty

as

liabilities,

of notice

OF CENTRAL

must

measures

amount
visions

RATIONALE

for

of time
after

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

THE DISCUSSIONS IN GERMANY

121

more or less lengthy period, but it was usually taken for

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

fur Volkswlrtschaft
published

und

in Faucher's

Kulturgeschichte,"
"Vierteliahrschrift

1865.
"

1_2

this extent

THE

RATIONALE

a certain

OF CENTRAL

difference

BANKING

between

checks

and

notes

(the latter were likely to remain for a longer average period

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

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

To those who argued

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

because
it widbank could be
advantage
from
if the territorial

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

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

THE

DISCUSSIONS

IN GERMANY

lZa

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

der territoriale
Umlaufsbezirk
der
sich also Notenmassen
im Verkehr

Noten
einer
Bank, um so
an, auf deren
Ruckkehr

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

cir.,
cir.,

p. 7.
pp. 33 ff.

1_4

THE RATIONALEOF CENTRAL BANKING

been

noticeable

emphasis
cates

even

in the

of a strong

because
they
issues
within

in Germany

arguments

something

for

central

bank

central
ceased

18667"

Whereas

during

a crisis,

satisfy

the

small
the

note

notes

internal

issuers

currency

necessity

of the

posed

Bank

Act, which

were

it merely

always

bank

demands.

of providing

Prussian

Peel's

to support

of

advo-

attitude
was clearly
stated
he published
early
in

of a central
ibr

on top of the external

drain,
crisis
less serious.
For these
idea

The

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

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

ing the

of a change

banking.

becoming
takes

banking
Nasse

such

by

drain

to

avoid-

of metal

rendered
welcomed

a central

from

continue

Therefore,

an internal

central
reasons

discredited

could

bank

a bank

and

the

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

the
the
op-

possibil-

system
of a
of Peel's Act

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

at first

sight

seem

should

be sponsored

by

favour

of the

freedom

minimum
ever,
there

on

the

this

limit

note

that

had

note-issuing

with
his
of banks,
case

His
general
there

such

always
banks

and

therefore

Michaelis

that

note

in

and

attitude

is, how-

thesis.
Where
is an automatic

of a privileged

is absent

a Bill

been

monop-

some

external

be imposed?'

agreed

possible

for

in the

strange
who

interference.

issue;

mechanism

must

Nasse
as

of legislative

perfectly
consistent
are a large
number

check
oly

fullest

a little

Michaelis,

be

with
kept

"'bankm_ssige"

cover

(short-term

should

as far

commit-

3o"Die Preussische Bank und die Ausdehnung ihres Geschaftskreises in

Deutschland," 1866
" "Volkswlrtschaflliche Schriflen," Vol. II , p 383: the relevant passage was
absent from the article ("Noten und Depositen") as published in Faucher's
,,Vlertellahrschrift ,,

THE

ments).
rect

This

excluded

opposition

fiduciary
securities.

and

ing system
rial

for

could

be

under

two

capital"

up

of capital

produced

the

and

crisis,

first,

to a point

of the

able

explanation

Austrian

and

depression.

theory.

over-production

lieves
mand

there
secondly,

price,

here

is an excessive
that

and

while

it is true

this

is so small

credit

any

of the
into

ceptible

in the

final

He approaches
lines

of the

ment

and
solution

price

the

modern
real

theory

savings.

of the

of goods

theory

bank

ory, he says, as in the

uncovered
note
issue

cheaper

of the

The

results

in

he

be-

which

question
practice?
should

lie not

capital

the dea fall in

reduces
per-

for consumption.
somewhat

equation

difficulties

crisis

as to be hardly

ready

of banking

accept-

an under-

of capital

an item

and
of the
the-

cause

goods,

that

having

to give

develops

of consumption

charges,

mate-

producing

of the original
"over-investment"

over-supply

interest

bank-

the

by

and,

immediate

the

further

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

their

the

it provides
cycles

but he failed

more
The

views

it by contracting

His reasoning

consumption
the

school,

of the

in di-

present

where

it intensifies

was
which

Government

of the

that

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

by
their

faults

production

in existence,

and
under

only

elaborated
the

heads:

crises

Act,

backed

both

125

securities

of Peers

summarises

trade

"artificial
amount

basis

Tellkampf

in 1867. 3"_Geyer

IN GERMANY

Government

to the

issue
32

Geyer

DISCUSSIONS

along

between
which

so much

4 The theory
be brought

the

invest-

accompany
in the

the-

is clear, that the

into equilibrium

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

126

THE

RATIONALE

OF CEN_rRAL

BANKING

with the amount

of capital
lying
the amount
of this idle capital,

idle, but as we
it is impossible

equilibrium.

it is advisable

together
tal could
In the

period

money
and

He concluded

of change-over,

should

follow

this

be centralised

realised

that

would

the

in step

to accomplish

should

that

the issue of uncovered

notes and
better
be collected
by extending

confined

given

this

still be international

creation

of bank

probably
be unable
rates elsewhere.
Peel's

Act

problem

for any
capital,"
capital

to hold

was

not

because

in other

idle

could

money

not

capital.

prevent

carry

The

attitude

the

manding

the

several
as they

important
do, from

total

contains

100

percent

by

posite

more
likely

by both

and

to Geyer's

currency

crises

Geyer

principle

forbid
should
arose,

to

things

it led

it

to fur-

of easing

Tellkampf

fiduciary

to

uncovered
be equal

of these

and

would

discount

panics
instead
trade
losses.

of the

notes

metal,

in large

they

issue

violent
to occur

and

lasting

from

the

And.

what

proportion

underestimate

process
which
"ideal"
situation,

direction.

be point-

solution
the

once

abolition

already

was

up

He
there

in deignored

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

ply

much

and

issue

issue

lower

it did neither

by provoking
so as to reduce
taken

the deflationary
back
to their

Since

crises,

ther
complications
credit
conditions

note

countries

against

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

note

one country
in isolation
to
since
it would
be affected

out

not

bank

institution.

it would

a commendable

it did

the

in the

complications;

less as well as difficult

give up "artificial
bank
by the

that

al-

in deposits,

to a single

unity

up

idle capibanking.

of artificial

increase

it is necessary

and

even

the

to give

that the
deposit

reduction

with

do not know
to effect an

would
and

the

covered

difficulties

of

be involved
in getting
which
would
entail
a

disturbance
movement

is more

not

than
they

important,

any

fear

which

in the

perhaps,

opthe

THE

DISCUSSIONS

IN GERMANY

IZ'/

objective would have no real value, since there is no special

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

and the only deciding facof the public as to which

they prefer, deposits on current

account or bank-notes.
The less extreme
currency
school writers,
as well as the
banking

school,

regarded

notes

as rendering

a service

in

I_S

THE

RATIONALE

OF CENTRAL

BANKING

what they called "economising

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

"Beitrage
zur Lehre
oder
mcht r_'' 1871.

von

den

Banken,"

pp.

81-86

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

THE

DISCUSSIONS

IN GERMANY

129

ers of opposite sides in the controversy,

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

cir., Vol

I.. p

313.

|30

THE RATIONALEOF CENTRAL BANKING

issue
the

and

the

form

amount

of the

of the

note

"Bankfreiheit,"

but

upon
with
conceded.

bank's

cover,

presented

some

chief

place

clauses

and

suggests--the

creditor

the

can

bank

courts

for

Wagner

took

still

not

German

cover)

method

or

the

Michaelis
the

Peel

both

"Dritteldeckung,"

figure

than the Peel

Commenting
had

turned

eration

was

affirmation
that

of the

mits,

however,

that

only

be gained

by privileged

banks,

and

great banks
and Bremen

or

that

not

they
only

one-third
Wagner

it was

towards

a considbank,
He sub-

such

monopolistic
but

the
rigid

system.
which

of a central

Bank

and

that
less

advantages.

necessarily

Prussian

true

bond
deposit
in Germany,

advantages
not

specie
preferred

as could
central

also

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

Op. cir., p. 634.

of

Knies

it is far

people

or entirely
the

as a

question

system.

evidenced

were

such

the

issue).

arbitrary,

of many

it had

extenuating

fiduciary

system
or the American
on the 1866 experiences

agrees

any

a demand

only

on

although

purely

tl_e thoughts

and

Wagner

Peel

because,

of one-third

time

to impose
reserve
requirebetter
to use the Continental

(fixed
the

and

is the

majeures,

Michaelis

bank's

its obligations,

The

("Dritteldeckung,"

favoured

be

counters

to bring

of forces

against

system

looked

the

days

pay

its liquidation.

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

full

might

at

redemption

be allowed

be cases

sides

kind

paid

period--three

should

circumstances
should
foreign
invasion.
A

with
was

of this

is not

at its

a short

bank

of the

before

or

within

determined

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

redemption

of business

branches,
he

for

or

compatible

"Bankfreiheit"

In common
with Michaelis,
cessitv
for a speedy
liquidation
when

not

if complete

suspicion,

capital

were

similar
Leipzig
banks
of

i
i

THE

second

order

DISCUSSIONS

as they

might

IN GERMANY

be called,

had

131

given

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

at Op.

cir., p

357

support

to

relentless

may be fairly regarded

as the
to central
banking
in Germany.

end

CHAPTER

The

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

THE RATIONALEOF CENTRAL BANKING

tagonists,

Wolowski

connections
French
give

and

were

established

economists
evidence

via

before

memoranda
were
son and J. S. Mill.
tended

the

was reading
the principal

banking
several

liabilities
banks.'"'

The

prova].
in

its pages

though

as yet

effects,

and

structure

position

for

The

which

many

especially

banking

general,
as the
had

of

on

the

recognition

under
_ who

the influence
had at least

discount

rate,
of all its

and

received

rate

income

fairlv

could

be used

flows.
low discount

school

higher

must
ing

in France,
which

_ and

had

be interpreted
with

the

natural

insisted

prevailed
as the
state

that
over

result,
of things

the
the

rate

preceding

not of the

gen-

of the writings
made it clear to

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

count

at

advocating

discount

price

had

to

of ap-

as to the details

concerned,

the

one

been

theory

of its effects

that

of France

in response

Economist
The

where

it between

Bank

this journal

understood

country

world

by the
in

Patterand at-

Club,

of discount
was,

years.

imperfectly

of the

rate

to

written

it was better
"to
reserves
against

or to distribute

adoption

reserve

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

bank

and

called

and

Economy

on whether
of the bullion

to the

by

English
was

in person,

Political

to a single

hailed

direct

by Hankey,
Newmarch,
visited
London
in 1866

the

It was

the

Bagehot

Commission

a paper
custody

long last of a principle

addition,

between

of moving

in its

"_ In

Enqu_te.

of the

reaction

policy

changes

the

meeting

English

the

submitted
Wolowski

Bagehot
entrust

of the

Chevalier.

rate
of dis-

few

artificial

as Pereires

to in-

years

tamper-

claimed,

but

5 see Fraser's Magazine, 1868, "The Controversy on Free Banking between

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

THE POST-IS48

DISCUSSIONS IN ENGLAND

I a_

as the result of the free play of natural forces which had

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

issues

and

gold reserves,

and

that

over-issues

and

the

drains of bullion to which they led could be checked before

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

Crises,"

1864.

1_16

THE RATIONALE OF CEN_I?RALBANKING

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

THE

POST-1848

DISCUSSIONS

IN ENGLAND

137

banks and these provided

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

before

the

English

138

THE

RATIONALE

OF CENTRAL

BANKING

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

THE

POST-1848

DISCUSSIONS

IN ENGLAND

|89

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

had certain

characteristics,

liable to become

"_ See The Economist,

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

danger-

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

140

THE

RATIONALE

OF CENTRAL

BANKING

ous if not very carefully

handled,
which
distinguished
it
from decentralised
multiple
reserve
system.
The two respects in which the centralised
system showed
the most
marked
difference
were, firstly, in the effect on the total
cash reserves
of the banking
system as a whole, and secondly, the reliance on a "lender
of last resort."
The commercial
banks under this system, instead of keeping each its own gold reserves,
keep their reserves
in Bank
of England notes or in claims, in the form of deposits at the
Bank, on Bank of England notes. Each bank in estimating the
proper
distribution
of its assets between
immediately
realisable and less immediately
realisable, so as to ensure what it
thinks is the necessary
degree of liquidity, regards
what it
holds on deposit
at the Bank of England
as "as good as
cash," so that according
to the calculations
of the commercial banks their cash reserves
should amount,
in addition to
the sums of actual cash they keep in their tills, to the whole
of that sum which appears
on the Bank of England's
books
as bankers'
deposits. But what the Bank of England has at
any time available in cash, that is, notes in the Banking Department,
is always very much less than this--it is only half
or even a third of its deposit liabilities--because
the Bank
relends
part of the reserves
of the commercial
banks. The
virtual
pooling
of the reserves
of all the separate
banks
means that in normal times the Bank of England can count
on withdrawals
by one bank being counterbalanced
by additional depositing
by others. The difficulty arises in times of
pressure
all round, when all banks are likely to be requiring
cash at the same time, and it is then that the disadvantages
of the single reserve system become apparent.
The actual
reserve
held by the Bank is smaller
than the sum of the
amounts
calculated
by all the separate
banks
to ensure
safety and which
would
really exist in reserve
under
a
decentralised
system. The spare cash of the money market
is thus reduced
to a smaller amount than under the alterna-

THE POST-1848

DISCUSSIONS IN ENGLAND

141

tive multiple reserve system. MacCulloch

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

IV.

142

THE RATIONALEOF CENTRAL BANKING

elucidate

canons

imperfect

working

It had
ise

the

been

of policy

Bagehot's

double

strain

times of stress
side as holder

which

of the

one

aim
placed

(viz.,

secondly,
institutions
This

Bank

him

facilitate

the

less

had.

to make

the

on the

Bank's

it must
of what

of England

it must provide
as find their

led

now

Bank

Directors

cash

real-

resources

in

by the dual nature

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

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

would

we

up

be prepared
to provide
was in all respects
their

deposits
cash
own

to his final

held

as reserve),

by way of loan
cash resources

conclusion

that

and

to help such
insufficient.
_4

the

Bank

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

must

reserve

of

Bagehot's
must have

influence
been more

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

gle writer

either

or on the

result

here

of his continued

admitted
sis was
deal

that the correct

policy
to lend freely at a high

to secure

the

Continent.

emphasis

recognition

that

It was

it came

for the central

rate of interest.
of the

mainly

as a

to be commonly

nature

bank in the criHe did a great

of the

special

re-

sponsibilities
tat of what

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

principles

of the

should
public

1844

be released

from

interest-in

act for the

agement

by

any

framing

benefit
the

Act, namely,

that

obligation

its policy

Banking

being

regulating

any

large

deposit

bank.

posed

principle

to have

been

already

not

to obtain

But

this
it was

other

should
the

Department

easy

general

Bank

to pay

and

of its shareholders,

the

of England

attention

to the

be at liberty

principles
the

same

J. S. Mill
rejected

agreement

to

of manas those
had
by
among

sup1857. _
the

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

THE POST-1848

DISCUSSIONS IN ENGLAND

143

Bank Directors. Immediately

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

144

THE RATIONALE OF CENTRAL BANKING

sial

discussion

on

central

banking.

session

of

perfect

if we

now

that

an

we

recognising
creates,
We
ing
in

find

the

show

that

banking
to

able

have

it we

must

Goschen

make

the

chief

cross-grouped

the

and

of it by

currency

of

disputants
their

most
but
clearly

responsibilities

hand

in

them.
respect-

twenty
1890.

it

to meet

warnings

about

crisis

with

the

best

Bagehot's

Baring

not

the

the

of reserves

below

It is

beginning,

on

and
in pos-

the

funds

the

banking

ourselves

from

accepting

adequate

free

find

system.

re-echoing

with

of

we

choose

weaknesses,

keeping

controversy
banking

merits

was

were

inadequateness

connection

We

relative

theme

anomalous

its
and

the

Its

years

later

3'

the

free-banking

standpoint

towards

controversy:

Free

Central

Parnell

Tooke

Wilson
MacLeod

Bonamy
Price
Cairnes 3z

Courcelle-Seneuil

Coullet

Coquelin
Chevalier
Banking

School

Coq
Garnier
Mannequin
Brasseur
Horn

Wagner
Lasker

71"Essays and Addresses

Cash Reserves and Central

on Economic Questions,"
Stock of Gold."

1891. Essay entitled

3z See his pamphlet

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

"Our

of Currency

THE POST-1848 DISCUSSIONS IN ENGLAND

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

Cernuschi
Currency

School

Lavergne
d'Eichtal
Wolowski

Hubner

Tellkampf

Michaelis

Geyer
Knies

Mises

Neisser

CHAPTER

XI

Discussions

in America

Prior

Foundation

to the

of the

Federal

Reserve

System

After

1875 the

which

already

cussion,
ence

and
to

came

the

the

Moreover,

world

the

the

banking
were

practical

systems

accepted

choice

a dogma

still lacked

chapter

to examine

adoption

of s_lch

dis-

in prefer-

questioned.
banking

any

very

be-

clear

un-

of the advantages,
but there
commercial
countries
of the
banking

of America.

some

system

of central

a central

States

countries
further

again

without

of the exact nature

one among
the chief
United

one

never

superiority

than

of those
without

of the

was

declared
less

which

was

them

alternative

nothing

derstanding
remained

central

had

of the

organisation:

It is the

molives

an organisation

which

by that

this

purpose

of this

led to the

country

final

in 1913.

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

were

were

National

issuing
but

was

application

over

Banks

banks

under

This

in 1913

operating,

the

banking

frequently
of

the

20,000

issuing
not
law
cited

principles

banks,
notes

and

under
of the
as an

the
States

the

about

rest

National

banking.

7,000

non-noteBank

in which

example

of free
146

of which

they

of the
But

Law,
lay.

practical
while

it

THE FEDERAL RESERVESYSTEM

was

true

with

that

any

certain

that

the

were

business

at least

the

person
was

two

American

open

ated,

more

banking"

Law,

specified

a peculiar

lacked
banking

view

which

had

lution

of

pressly

the

manifested

National

jurisdiction

authorised

Law,

banks

had

individual
in one

the

confines

tice

varied.

it; others
Bank

of the
had

Act

stated

that

individual

State

mostly

of the

come

to

formed

this

under

ex-

before

the

under

banking

firms
of ex-

or otherwise
the
territory
banking

the prac-

had

permitted

it. The

situation.

beof

within

concerned,
south,

its

evo-

been

possibility

forbidding

alter

natural

days

and

was

of free

exclusively
no

banking

had

In the

in the

and

of branch

of branch

legislation

nothing

a bank

allowance

States,

passed

did

banking

had

oper-

organisation

States,

State

the

banks

It is at least

by branch
office
of this
State
into

as the

Some

Secondly,

issue.

as part
States.

up

of developing
the big cities

elsewhere

United

in

bank

growth

in the

tending
their operations
yond
the boundaries
So far

to the

themselves

of the

to set

another.

of note
central

banking

used by the
banks
were

"free"

American

development

Banking

the

there

between

free

monopolies.

which

and

terms,

was
the

to local

all tendencies

excluded

and

possibilities
banks
outside

of both

banking

same

all
most

system

that

the advantages
proper.

Practically

the

of issue,

of divergence

so called

under

complying

a bank

in which
the term
of Europe.
Firstly,

or less

Banking

supportable

the

points

from
practically
organisation,
and

National

of persons

open

to all on

important

"free

approached

group

could

the more
general
sense
writers
on the continent
excluded
branch

or

requirements

147

National

It expressly

provisions

should

not

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

the offices
in places
All that the law al-

lowed

had

branches
into the

was

that

should
National

State

banks

which

have the right to retain

Banking
System.

previously
them

if they

had
came

14S

THE RATIONALE OF CENTRAL BANKING

The method of issuing notes against bond deposit instead

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

THE

FEDERAL

RESERVE

SYSTEM

149

were in great demand

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

150

THE RATIONALEOF CENTRAL BANKING

dinary

asset

currency,

where

inflows

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

deal

exhibited
shown

of comment

by the
under

note

was

issue

an ordinarv

its large
agricultural
mands
for cash. The
spond
the

to these

money
The

lay

explanation

as much

of the

Comptroller

do

so was

could

only

through
was

in any

were

usually

keep

but

same
limit
one

a very

heavy

times

when

them

bv

such

lack

lent fluctuations
steep
rise in the
The

popular

and

on

the

they were
in order

expense.

once

bank

taken

to the
on

hand

arose,

the

cash

reserves

pressed
to meet

that

the

notes

by

going

Moreover,
that
out

there

might
by

be re-

any

bank

It did

for periods

banks

and

could
and

not

of exso,

only

paying

in

meet
out

le-

to a sharp
restriction
their
obligations.
led

in interest
autumn.

rates.

There

the

to

passed,

currency,

of notes

that

of ex-

incentive

full extent.

reserve

illusion

on

circulation

the

fact

had

hand-to-hand

their

note

and

of notes

proportion

demands

of any

by

Notes

for

strain

as in its lack

need

number

by that

small

drawing

gal tender,
and
credits
all round
The

the

demand

of the

arose,

the

formalities
month.-'

used

need

after

on

autumnal

deto re-

and slow to negotiate

the purto obtain
additional
notes from

diminished

be retired

the

a legal

tired

tra

further

between
to seasonal
in spite of

system.

inflexibility

the

inelasticity

crop-moving
circulation

of contractibility

when

by

fluctuations

in response
in America

the

banking

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

The

in the proportion

intensified

in its lack

by the

run.

and heavy
of the note

the

whether

accompanied

raised

especially
no parallel

interest
failure

and

are

short

system

demands

market

also

in the

note and deposit

liabilities,
changes
in demand,
found

of specie,

hoards,

securing

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

to frequent
was

and

every

of notes

of
vio-

year
by

bond

THE FEDERAL RESERVE SYSTEM

deposit would guarantee

full had been dispelled.

15 1

that they would alwavs be paid in

Later observers
came, moreover,
to

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

1_2

THE

RATIONALE

1907, when suspensions

of over two months.

OF CENTRAL

lasted

BANKING

in some measure

for a period

There had been for some time a growing

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

date

when

specie

pavments

were

resumed.

THE FEDERAL RESERVE SYSTEM

ll_a

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

154

THE RATIONALEOF CENTRALBANKING

law

in a very

stocks

liberal

for note

way

backing

and

accepted

where

municipal

previously

and

only

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

of crop

moving.

It was

intended

other

strictly

Gov-

of this step
to meet the

to be

purely

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

year

cash

drain

to make
creasing

just

the

same

as before.

lack

of provision

In general,

these

for the

measures

up

progressive

in an

increase

emergency.
in the

The

result

circulation

of 1907,

the

bond

of modification

deposit

in the

system

direction

bank currency
for emergencies.
Other attempts
at interpreting
laid

less

stress

on the

primary

explanation

structure.

One

of

more
these

was

ratios. '1 So far as the possibilities

concerned,
the requirements
probably
otherwise
what

the

did

not

would;
banks

cause
the

the
legal

of their

the

had

of

of credit
of minimum

incapa-

difficulties
sought

to expand
was

legal

reserve

less than

a good

thought

the

American

expansion
reserve

banks
accord

and
of the

system

and

increased

of the

features

for the
by the

proved

issues

minimum

own

1900

currency
evidenced

cause

of note

in other

merely

of providing

the

question

was

between

1907 of over 90 percent,

which
provided
inflationary
boom
of those
years.
As was
ble

only

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

to be taken

events

autumnal

served

deal

were
ratios
they
below

fit to keep

in

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

THE

FEDERAL

RESERVE

SYSTEM

1_5

normal times. But immediately

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

156

THE

RATIONALE

OF CENTRAL

BANKING

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

7 E.g.,
E.g.,

see
see

"Report
Sprague,

of the Comptroller
"Banking
Reform,"

of the Currency,"
1910, p. 68.

1891-2,

p. 36.

THE

in their

own

"reserve"
designated,

RESERVE

banks

officially

SYSTEM

in

reserve"

as bankers'

"redemption"

cities,

recognised

banks

by

157

cities

as they
as being

the

National

or

were

later

in a special
Banking

Law.

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

tween

them

about

ances-seemed
tendencies
and

three-quarters

to point
to the

the

country

since

banks

been
1857

of

with

with the banks

of these banks
an unhealthy

the

city

of reserves

a quasi-central

the

complaint

in

more

loan

market

by

the

particularly
by a number
deposits,
gave

on the
with

un-

financial

of re-deposit
and

to speculation

call

banking

as exceedingly

practice
banks,

bal-

of spontaneous

in New York City, encouraged

who paid interest
on demand
stimulus

flooding

the

bankers'

centralisation

a frequent

that

the

existence

and

development

It had

ever

the

if one is not superimposed.

as it stood was regarded

satisfactory.
circles

to

of all

pyramiding

natural

agency,
even
The position

by

_ The

"central

were

category
The
city

vaults.

and

FEDERAL

Stock

cheap

Exchange

accommoda-

tion. It was, what

is more
important,
nearly
always
mands
for withdrawals
of these bankers'
balances

the deby their

country

financial

owners

system
The

of the
the
and

nancial
of branch
the level
tainly
The
9 See

of the

town
banks,
the extreme

structure,

unimportant

crises

in the

if there

it more

debtor

position

of one

group

of

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

is one

which

had

organisation
of the amount

made

precipitated

country.

development

banks,
banks,

branch

which

would

been

branch

probably
banking.

have
The

been

absence

may have tended

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

unstable

than

it would

have

been

with

organisation.
difficulties
Laughlin,

of a unit

"Banking

Reform,"

bank
pp.

as compared
199

ff.

with

a branch

15S

THE

RATIONALE

OF CENTRAL

BANKING

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

THE FEDERAL RESERVE SYSTEM

l_a

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

160

THE RATIONALEOF CENrFRALBANKING

banking
litical

along

Canadian

impossibility,

practical
expedient
more economical
general
rely
secure

this

nature

had

of the

regarded

turned

as a po-

to the

more

and

Some

already

system.

apparent

independent
end.

was

was

existing

increasingly

on the

but this

so attention

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

framework

It seemed

lines,

and

attempts

been

that

unaided

it was
efforts

impossible
of the

of a somewhat

made

by

them.

to

banks

to

unsystematic

One

of these

was

the use
practice

of the
which

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

This was a
of New York

and

banks

of Boston

of the

the

belonging

to the

Clearing

agreement

under

which,

ing balance,
it should,
bank, deposit
collateral
against

which

certificates
The

scheme
was
able clearing

lending

(with

agreement

by the

and

New

York

banks

for treating

the

specie

holdof

the

(with favourto those

in a
bank

baltrying

to

of the others,
because
bank
could
extend
its

induced

to other

of the public
for cash
that the clearing-house

by the

bank

clearing-house
each

expense
no

all were

varving

essence

position
loans

to prevent

reserves

bank.

rate,

creditor
The

loan

creditor

high

to the
owed.

an

clear-

clearing-house

unfavourable

intended

of losing

the demand
first occasion

issue

went

balances

into

an adverse

cash to the creditor

House Association,

at a fairly

which

banks

entered

had

in payment

interest

of

operations

used

should

its.position
at the
such
an arrangement,

fear

Association
a bank

that the banks

in a strong
balances)
should
make

It was

strengthen
without
of the

lieu

position

ances).

was

bore

in

A majority

instead
of paying
with the Clearing

latter

5 to 10 percent,
them

weaker

House
when

to be received

certificates

from
ing

the

in 1860.

to contract
banks

was increasing.
loan certificate

it was
reserves

because

at a time

when
On the
device

accompanied
of all banks

by an
as a

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

THE

FEDERAL

RESERVE

SYSTEM

161

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

162

THE

RATIONALE

OF CENTRAL

BANKING

by the public,
or the
tried to sidetrack
this

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

by

encouraging

customers

rect

to the

handing

into

This

was,

measure;

the
run

loan
on
Both

their

they

own

certificates

had

for

adversely

that

there

device

should

gave

be

settlement

force

by

payment;

to the

somewhere

an

of

in the
a cer-

the
this

also.
of the

di-

instead

to do beyond

affected

to suspend

for cash

drawn

impossible

others
and they suspended
successes
and the failures

certificate

checks

were

banks

however,
banks

loan

issue

of

started

clearing-house

conclusion,

adequate

firstly,
reserve

of

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

Fharther,
provided

the
by

operations
that

to take

which

the

the
the

lending
should

on

them

clearings.
tain

their
banks

idea was gaining

ground
that it could
an organisation
in some man_aer
aloof

of ordinary

was

in normal

Some

such

commercial
times

sort

not

of relief

banks.

fully

during

"lent

up."

a crisis

had

by the Treasury.
that the Treasury

The principle
had been
should
be independent

is, that

keep

it should

positing

them

with

the

It must

only be
from the
be a bank

been

provided

established
in 1846
of the banks,
that

its own

surplus

funds

banks.

It was

objected

instead

of de-

that

this

had

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

the

preserved.
National
times
make
early
1-,See

Independent

The

Treasury

Banks

and

Treasury
began

adopted

System

depositing

the

practice

was

not

funds

strictly

in selected

of giving

relief

in

of crisis. The methods

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

even

U S. National

before

Monetary

the

National

Commission--"The

Banking
Independent

System

had

Treasury."

THE

come

into

bonds.

being,

In

it had

1873

$5,000,000

it

banks.

the

debt.

public

the

In 1884
In 1890

amount

it had

deposited

most

SYSTEM

the

163

market

bought

proceeds

by

bonds

it prepaid

also

it put

some

prepaid

purchasing

and

of which

it again

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

RESERVE

helped

again

of gold,

in certain

FEDERAL

on

of the

sold
deposit

interest

interest

and

on

bought

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

on hand

was

of its surplus

small,

with

since

them

it had

before

already

the

crisis.

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

market

operations

(purchases

of securities)

and

by

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

mode

of relief

in crises.

Treasury
happened
crisis came. There

body

of opinion

grounds

that

which

it gave

to receive

assistance

expanded

on the

It became
reform
that

denounced

an impetus
if they

basis

also part
it should

It was

only

a lucky

chance

if

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

got into

of these

Treasury

to expansion.

relief

expected

and

therefore

difficulties,

anticipations.

of the positive
programme
provide
for an institution

act as the Government's

ences
during
the course

on the

Banks

for banking
which
could

fiscal agent. '3 The Treasury

experiof the previous
century,
both of the

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

of the failure
of
the possibility

of finding

free

from

countries

the

tions
services

some

of both
were

13 Cf. Parker

depositary

these

systems.

performed
Willis,

"The

Federal

which

was

In other
by the
Reserve

Central
System,"

the

objec-

necessary

Bank.
Book

I., Chapter

2.

164

THE RATIONALEOF CENTRALBANKING

One

other

formers
tion.

feature

hoped

The

American
was

of the

banks

majority

of making

of the

to remedy

a charge

the

system

which

cost

of check

high

in America

known

as the

were

the

in the

"exchange"

actually
expense
room

bank
had either
to shift
in a distant
centre.
What

able to charge
involved,
but
in the

old

was
there

system

probably
is little

It was
the

the

crisis

growing

a difference
the

or

there

was

of note
with

some kind
the purpose
ing.

the

a strong

to the
sisted

the

1907

crisis

that

a purely

gave
the

legal

reserve

regulations.

could
bank

there
of real

given

in the

impetus

fault
On

still

lay with
organis-

the

whole,

introduction

of existing
for panic
to the

to

was

of branch

of the

organisation
reserve
funds
was

final

chief

real
was

necessary

but there

lack

in favour

the

the

reform,
the

support

introduction

reduction

or with

majority

or to
were

above
the
that
there

reducing

as to whether

the necessary
changes
tablishment
of a central
after

much
doubt

issue

of co-operative
of providing

Authoritative

which

for banking

of opinion

system

ation

of 1907

agitation

for

to cover
a distant

currency
the banks

for a considerable

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

habit

charge

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

re-

collec-

of

banks
for
financier-

suggestion

that

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

was

still a good

central

emergency

deal

banking,
organisation

and

of opposition
the
for

idea

per-

"relief"

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

THE FEDERAL

would

meet

the

case.

This

RESERVE

was

SYSTEM

the

attitude

165

behind

the

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

to the Comptroller
secured
by assets

of the Curother than

The same Act set up the National Monetary

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

IOO

THE

The
ation

final

RATIONALE

outcome

of the

of the

Federal

considerably

from

twelve

regional

which

those

OF CENTRAL

recommendations

Reserve
the

banks

System.

European

Federal

Reserve

who

guidance

the

tasks

member

of the
of

Its organisation

banks

and

as

rediscounting.
A retrospective

consideration

cumstances

foundation

would

of the

seem

to suggest

that

of

in the

ownership

of

members

per

se that
was

was

admittedly

reserves

in principle,
than
not the
root

a partial

devolved
of

the

to them

by

and

cir-

Reserve

perhaps

at the

system--

background

Federal

could,

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

there

the

many,

more
ment

bank

Board,
agency

of the
of the

of American

although

of the

on all National
Banks-capital.
On these, under

lending

fects

tral

banking

differed

Banks

keeping

acting

cre-

it consisted

Reserve

notes,

the

bank:

became

Federal

issuing

was

central

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

BANKING

most,

of the

of the
have

by the
absence

remedy

System

evil,

debeen

establishof a cenand

that,

for things

for

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

which

overcome

could
by the

not
Federal

be entirely,
Reserve

or in any
System.

great

measure,

CHAPTER

The

XII

Arguments

in Favour
Central

of

Banking

Reconsidered

It

has

been

the

purpose

of the

preceding

chapters

to eluci-

date the reasons,

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

Its

origin

is to be

monopolies,

either

Monopolies

in this

tionism

in other

partial

or

sphere

branches

found

in

complete,

outlasted
of economic

they

Looking

had
at the

established,

we

not previously
that

the

activity.

growth
new

note

abolition

of
issue.

of protecThose

of free
creations

which

trade
dococcurred

existed.

circumstances
find

establishment
in

the

had been in existence

prior to the
trine were
retained
and reinforced:
where

the

in which

the

early

most

ones

of them

were

were

founded

for

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

entry

been

given

into

the

at that

note-issuing
time,

but

trade
once

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

of the

choice

in favour

opposed

discussions
of unity

to competition,

round

this

problem

thereafter

167

or

could
the

in the
the

have

monopo-

the time when

to be questioned.

or monopoly
and

was,

established,

their
The

vindicated
note

issue

superiority

the
as
of

16a

THERATIONALE
OF"CENTRALBANKING

central banking over the alternative

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

CENTRAL BANKING RECONSIDERED

169

over the general credit situation. These considerations

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

capital, and the penalty for failure

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

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

170

THE RATIONALE OF CENTRAL BANKING

we will assume to be gold. No bank would have the right to

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

scale

in financial

centres,

and

under

a unit

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

"Bankpolitik,"

pp. 337-8.

CENTRAL BANKINGRECONSIDERED
much

smaller,

own

however,

branches

where

finds

it convenient

then

generally

city, where
management.

were
they

to keep

be
they

held

the

bank's
under

system
each bank
issue, or of its total

close

its reserve

watch

on

to have

balances

financial

remain

In a multiple
ume of its note
that the
standing

allowed

The

in the

by

would

banks

chose.

171

that
centre,

own

would

branch

its own

in that

control

must
determine
demand
liabilities,

position,

and

their
a bank

and

the volwith a

it is to be expected

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

position.

The

reserve

central

bank

proportion

can,

on the

to undergo

large

other

hand,

changes

allow

its

on

ac-

partly

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

can

now

issue

between

who

defended

nected

turn
those

to the
who

analysis

it. Historically

predominantly

with

credit
which
were
the central
banking

of the

attacked

sponsored
case was

free

major

banking

points
and

the

free-banking

case

those

theories

of currency

by the
likewise,

at

those

was

conand

banking
school,
and
but perhaps
a little

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

of the currency
a member
of the

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

majority
claimed

of cases,

the

as a victory

success

for the

of the
central

currency
banking

school
school

as

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

in the

fairly

banking

familiar

versus

ground.

currency

It will

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

suffice

controversy,
to remark

which
how

far

172

THE

the link
weighted

with
the

banking

RATIONALE

OF CENTRAL

the banking
evidence
in

versus
the free

BANKING

currency
banking

controversy
versus
central

controversy.

The

circumstance

in France,

that

placed

argument

the

free-banking

so much

which

sprang

emphasis
from

school,
on

the

that

theories

especially

part

of their

of the

banking

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

the

were

recalled
over-issue
only

quantity

of money,

to the

"needs

is maintained.

as notes

are

issued

in repayment
be no

banks
are
The demand

of loans

demand

ation

of credit

mercial

by way

dealings,

particular
issue. If the
of exchange,

falling

from
there

of bills

of lending

banks
they

their

contention

continu-

"bankmassige")
for loans, and

and
will

issued

on

short-term

of exchange

for which

takes

there

had

an

automatic

be

It was also a
on the cre-

in ordinary

to place

com-

a limit

place

on

that

via the

note

with which
they discount
changing
the form of the

bills
lend-

loan,

the

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

as

they
there-

consequently

ing. Since the bills would

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

that

(or so long

the circulation.
is no restriction

which

issue notes
are merely

loan

due
they

it is inconsistent

mode

be

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

for renewal;

automatically
withdrawn
prevalent
idea that since

and

It was

fore for notes, will be confined

itability
of borrowing.
Should
excess
of the needs
of trade,

will

ideas

It may

of trade"

on short-term

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

bank

promoted

character.

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

in response

ous convertibility

and

inflationary

that according
of bank-notes

issued

so long

theory

of an obtrusively

reflux

and

argument
circulation,
between
"pure

paper

banks

continues,
and this
bank-notes
money"

CENTRAL

BANKING

RECONSIDERED

! 73

which, instead of being paid out by way of short-term

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

|
174

THE

loans are on short

RATIONALE

OF CENTRAL

term does not mean

BANKING

that a credit

[
!

contrac-

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

p. 179

ft.

!
I

CENTRAL

BANKING

RECONSIDERED

banks. _ In so far as these

banks
between
their cash reserves
and
total

volume

gold

movements

ple

of

banks
would
the

of credit

such

be made

(its changes
movements),

are made
to move
require
the fixing,

Bank

of England

of its notes
the

can

Bank

but

fairly constant
ratios
deposit
liabilities,
the

to move

will

be a fairly

provided

the

in response
constant

reserves

of the

quantity

plus
can

vary

of gold

its lending

movements,

eration
within

to affect its own reserve

limits that are of course

of the

Government

and

emergency.
There
were

mistakes

both

and

schools,

as

seems
actual

not to be such
results
secured

sential

to impose

amount

of the

that

only

the

some

into

banking

was

regard

to the

definite

they

such
note

rule

out

regulation

and
was

in

op-

case

limitation

that

of
there

between
that it was

those

of

doctrines

in practice

as a fixed

issue,

banking

that
two

who

on

the
esthe

believed

notes

should

be

solely

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

versus

positions

currency

for presumption

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

from
banks

Act

in the

worked

the

It can do this
the willingness

Bank

omissions

the

specie.

based
ground

allowing

a great deal of difference

by those who insisted

fiduciary

We may conclude
ment
between
the

no

and

necessary

convertible

merely

the

As it is,

so alter

of the commerof those banks,

"proportion."
widened
by

to abrogate

by gold,

liabilities.

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

But this
issue of

not covered

its deposit

to
multi-

of these

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

in circulation
of England

keep
their

| 75

they

took

controversy,
in favour
that,

up with
there

of either

given the
case
which

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

is
one

indepenwe are
other
banks
to describe
all

176

THE

about

to examine,

rency
which

school,
there

credit,

are

The

it was

the

in this

decisive

case

can

troduced

OF CENTRAL

perfectly

consistent

free-banking

arguments,

case.

and

Both

either

side

of the

free

those,

the

curin
of

Michaelis

are

additional

of these

and

which

runs

in the

under

a multiple

versus

which
in-

independent

of,

central

terms.
system

banking

con-

been raised in defence

of the other
can be

argument

following
banking

on
arguments

the banking
and
currency
turn our attention
to the major

banking

is an

the

to, and

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

therefore,

discussed,

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

The

for

to find a system
in the volume

position.

be exclusively

by

arguments

BANKING

in so far as their aim was

were
checks
on fluctuations

to sponsor

Mises
the

RATIONALE

against

free

It is always
that

even

banking,

to be expected

if the

general

sta-

bility of the whole

system
is assured,
individual
banks
from time to time,

there
will be failures
of
just as there
occur bank-

ruptcies

industries.

any

among

bank

enabled

the

do not

firms

stay

to borrow

in other

in the

from

that

efit from its note issue. They

third
parties
who have no
bank concerned.
sion of the notes
will suffer

the

notes

person
tairs

would

munity
the
notes,
and
communitv

who
bank

proportion

people

therefore

which

reject
bank.

because

In other

a more

of

who

are
ben-

away into the hands

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

of such

informed

of suspicion
words,

notes

directly

notes

is likely

of those who are either too ignorant,

subordinate
position,
unable,
to refuse

of a bank

of that

of those
and

are paid
immediate

Those
people
of the failed

loss. A large

in the hands
son of their

hands
bank

The

there

to be

or by reato accept

or better-placed
attaching

is placed

to the

af-

on the com-

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

CENTRAL

BANKING

RECONSIDERED

177

eluded that the Government

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

17S

THE RATIONALEOF CENTRAL BANKING

not select

the

notes

payment.

They

of the

will

guilty

send

banks

in any

hands,
and the proportions
ent banks
will be returned

and

notes

present

that

in which
the
will roughly

come

part of the pressure

resulting
bank. Should
a non-expanding

the expanding
bank
and taking
business

latter

are

finally

tains
more

a de facto
conservative

driven

out

their
differto the

banks
banks

bear
have

as a result
its lending.

of the
If this

of business

and

the

former

ob-

the banks
with the
or not, they could

not help losing

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

The
result
ous

flaw

contraction

flow

falling

passu,

and

that

The

banking

argument

the

the

be induced

is its failure

expansion

by
on

entirely
before
of business.

ability
notes

of self-preservation,

in this argument

of continuous

other

by
the

expanding

the

reserves

the

conservative

one

proportion
group

of this

so far considered

of the

group

party

laid

particular

stress

automatically
upon
each

as a

continugold

increase

outpari

will be exhausted
has

refers

that

and

must

group

to join

to observe
group

they
they

been

only

driven

to the

on another

check

out

unreli-

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

they contended
worked
cal claims
of the banks

to
to

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

monopoly.
So whether
tendencies
expanded

will, in the interests

in the inflation.

for

from the expansion

of a
bank insist on retaining

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

into

notes of the
correspond

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

these

of
freewhich

through
the reciproother's
reserves.
_ Any

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

CENTRAL BANKINGRECONSIDERED
bank

will

either
in on

continually

be receiving

in payment
of loans
deposit.
In a system

for business,
one
its own
counter
them

to their

therefore
step with

earlier
cause

customers

through

the

to pay out over

but will return

clearing

process.

It is

bank
expands
will go against

out of
it and

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

stage
than
the reserves

mediately.

the external
drain
of gold
to feel the effects of expansion

It is unlikely

to decrease

their

tive

group

which

will

be

group.

not be prepared
of rival banks,

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

its rivals
adverse

from

or in the form of cash being paid

where
all banks
are competitors

bank will
the notes

issuers

payments

179

the

reserve

all hanks

ratios,

is not

check

A bank

that

of these

which

and

desirous

will
the

and would
almost im-

decide

bigger

the

of so doing,

on

the

conserva-

the

expansion

contemplates

in concert
stronger

of the

an expansion

other

has

got to

take into account

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

its issue

before,
drawal

against

the

same

afford

to make

reserve

ratio

will react

to its loans

on the

to the benefit

stances

may

occur

willing
unlikely

to allow some
reduction
that they will ever risk

reserves.

an over-expansion

the

as those

by the
therefore
was

reserve

by the
addition

of a given
reduced,

While

in which

like as great

parative
equanimity
The free bankers
tem

basis

of the

to their

total

occasioned
size of the

will be correspondingly

partly

an accretion

anything

absolute

but also the indirect

effect
of cash to other banks.
The

other

drop

and

banks

admitting

majority

in its

its action

who
that

of the

as

withit can

secure
circum-

banks

are

in their reserve
ratios,
it is
fluctuations
of dimensions

which

are

viewed

central
bank.
submitted
that
not only

not any

with

com-

under

their

sys-

more

likely,

but

of credit control does not, in most circumstances,

work. See his article
"Notenbankfreiheit?" in the Weltwirtscha_tliches Archly., October, 1930+

laO

THE RATIONALEOF CENTRALBANKING

even

much

In the

less

latter

bank

likely

system

receives

than

are

mand

much

quent
pared

longer

only

public.

The

central

average

banking

clearing

functions
creases

its issues

crease

in

the

by

same

alleges

special
a given

as they

no

ings

and

It was

no claims

on reserves.
denied

as

frecom-

control

illusion,

and

If one

therefore

only

bank

in-

will

the

in-

larger

have falling
due in any
of claims
on rival banks

differences

consequently

de-

(less

its business

and

al-

in the

inter-bank

an

proportion,

proportion,

it, so that

is the

circulation

that

this

can

be seen

circumstances.

it will
number

on

and

neither
gives
as inter-bank

could

of

is largely

amount
of loan repayments
week will give it the same
have

notes,

under
a unit system
of note issues.

school

very

system.
bank:

of claims

effect

period

mechanism

under

source

The

redemption)
of notes
with a multiple
system

via the

banking

by a single

in, in its own

The

by the

a central
issued

out again; it therefore

specie
reserves
so far

concerned.

for gold

very

are

all payments

ways pay its own notes

nor receives
claims
on
claims

under

all notes

that,

arise

failing

in the

recourse

clear-

to the

sit-

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

in which

would

be sent

is analogous
raises

The
increase

in the

will

A) and

public

out

note

as stated
no

and

circulation
the

increase

area

exchanges
is any

issues

account

of their

for collection_--a

of international
of

argument
of it take

passing

of its own--there

expansion

call

notes

in by the
to that

objections

on the
system.
port

case

the

in

of the

which

and

which

automatic

expanding

check
banking

_ given

occurring

in its loan

case

a multiple

illustrations

of a lag

of issue

in sup-

between
bank

repayments.

(which

the
we
If we

r A case considered by Mlchaelis. See his article, "Noten und Depositen" in

Faucher's "Vlerteljahrschrilt," 1865, p. 132.
s See Chapter VIl., p. 85 ft.

CENTRALBANKINGRECONSIDERED
assume
be

such

a drain

will

a lag which
in the

only

first

in practice

instance

be a temporary

on

efflux,

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

clearing

mechanism

It is always
the

which
ences

expands
between

clearing

on

spends

it, will

ately,

and

other
bank.

banks
None

will

pass

in the

mechanism

out of step
the two cases

porary
withdrawals
the check
case than
drawn

that

the

additional

those

drawn

in

will give rise

of the checks

through

the

will

the

function

to check

A's

A can stand
period.

the

against

in via loan

as the

tbr

clearance

of people

Eventually
it previously

the

borrower
immedi-

banking

with

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

clearings.

repayments

a bank

will be more rapid

in
All checks
which
are

In the

case

of the

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

credit

' The only differto be that the tem-

credit,

banks

favour

when

of a deposit

with
others.
would
seem

deposit
into

will
this

period,

tending

case

in the lag period

in the note case.

be paid

there
though

will be a return
of these
that whether
or not the

on whether
or not
during
this interim

assumed

system,

at a later

will act as a factor

will depend
in its reserves

occur,

A's reserves,

and

A's loan
reserves
expansion
reduction

must

ISl

or in the

expanding
bank
lost in the deposit

form

of new

note

issue,

will come
notes
that
deposits.

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

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

iS2

case, but
because
serves in
at a later

THE RATIONALE OF CENTRAL BANKING

the clearing mechanism

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

effect
of rereturn

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

CENTRAL

We

can

old and

make

the

various

new

for assuming

greater

under

der

system

the

fact

that

the banks
customers
remains

near

however,

18a

about

term

the

of loans

term

the

length

of loan

of the

form

average

lag period
seems
no

lag

by deposit

in the

of the

is on the

in their
volume,
the
is not the case. There

will

credit

of notes.

The

be any
than

un-

only

dif-

the size of the temporary

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

additional

notes

will

find

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

where

that
system

of lending

ference
is that
in the deposit
the

If the

an increase
than if this

reason

RECONSIDERED

assumptions

loans.

increased
with
will be longer

the

BANKING

that
the

that

this is extremely
extent

the

of the

drain

unlikely

return

of cash

their

into
by
it

to approach

of checks.

caused

way

of new deposits
loan repayments,

any-

It is possible,

by the

reflux

of notes

to other banks during

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

experiences

of these
the

of such

issues as are
(Massachusetts)
systems

power

notes

seem
the

What
influence
loans
in general
lag period?
the

to have

of holding

through

It will

average

term

tem

the

greater

after

the

expansion,

practical

afforded
by the
and Canadian
other

a sharper

been

banks

of competitive

definitely

in check

conscious

by the

of

return

of

clearings.
will the
are made
affect

the

of all loans
will

be the
but

the

average
period
for which
have on the withdrawals
rate

pressure

12 Cf. "U.S. National

Monetary
Currency
Systems
of Canada,"

of withdrawals.

outstanding
shorter

will

The

in the

withdrawals

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

examples

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

shorter

banking

of cash
be the

bank
in the

per

sysweek

lag period,

if

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

on reserves
Commission,
p. 70.

at an early

Interviews

on

the

date
Banking

will
and

154

THE RATIONALEOF CENTRAL BANKING

act as a more immediate

incentive
to the expanding
bank to
hold back, and if this is the case it gives some justification
for
the

principle

flux

of notes

banking
Besides

that

on

and

which

Deckung"

so much

free-banking

questioning

exercise
banking
cept

of "bankm_ssige

and

emphasis

was

of the

the

so-called

profit

ability

by

of a non-expanding

conservative

motive

laid

rethe

schools."

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

the

automatic

may

lead

bank

banks
realism

bank

and

all banks

to

the central
of the con-

has

to join

submitted

in an expan-

sion. 14The term conservative

bank for some reason
resists

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

pand

that

credit.

demand

If we

suppose

for capital

is possible

(a rise

for all banks

there

in the

occurs

"natural"

to get out more

a rise

rate
credit

in the

of interest)
so long

it

as they

keep the market

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

profits
old

they

of all banks

rates

lend

reduction

insist
the
the

the
the

if they

be greater

lend

of course,

in their

are unwilling
serve
ratios
"natural"

than

more,

will

reserve

the

same

they

do

ratios.

if they

but

on retaining

the

fewer

their

rise in the money

volume
of credit.

are
and

the

the
the

ratios

of them

of banks

the

greater

smaller
the

If

of a

and lower
their
will rise towards
number

at

rate.

expense

If all or a majority

old reserve
rate

more

at a higher

it at

to increase
their lending
the market
rate of interest

rate,

lend

and
the

rethe
who

will

extension

be
in

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

subsequently

it could

gain

by

counterbalanced

joining
by

in the
the

boom

losses

would

of the

be
crisis

_ See p. 174 of this chapter.

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

CENTRALBANKINGRECONSIDERED
when

credit

ers are

customers

unable

withdraw

to repay

their

loans.

that such banks,

even though
consequences
of an expansion,
to hold
the

off from

boom

and

it, because

more

compensate

and

the

and

debtor

custom-

But it has been

suggested

they are fully aware

will not have any

they

than

depression;

cash

1185

will

find

that

for the

larger

is the

of all the
incentive

the

losses

profits

of the

number

of

crisis

of the

banks

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

than

of escaping
about

the

individual

losses,
bank

entirely

by the

the

from

policy

more

to stay

out,

the

of its rivals.

still open to the

would
exceed

question
whether
the losses,
and

would

banks

there
crisis

be many

willing

unprofitable
since

effects

of the

1_This

argument

in the

case

necessary
boom

to lower

crisis

their

of a suspension

to take

would

in order

include

the

of specie
to make

possibility

the

confidence

placed

difficulties

banks

in it bv

of a crisis.

in a free-banking

from

their

pelled,
position,

brought

is however

reserve

ratios,

The

profits

risk

in the

of insolvency.

public

of central
by reason

the

power

It was

explained

system

would

be

in cash

and

for payment

if

during
the
of liquida-

payments.
extra

profits
there

that

bankof the

to mollify

in a crisis

under
would

the

pressure
be com-

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

same

would

creditors

the

it be

chance

it is likely that the

therefore
whether

The third argument,

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

the

small

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

tion

the

will

it has

and

borrowers

be forced

into

previously
liquidation.

accommodated
Many

of the

by them
banks

them-

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

IS6

THE

RATIONALE

OF CENTRAL

BANKING

selves must fail in the process. No bank would be willing to

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

the practical rule

the lender of last

resort should lend freely on good security at a high rate of

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

CENTRAL

cash

resources

tendency
velop

by the

to a panic
into

BANKING

central

and

a chronic

RECONSIDERED

bank

slows

in time

up what

process

la7

of crisis

would

allays

otherwise

a central

ing one.

The

this

the

counter-argument

tion

regularly

difficulties,
lied

school

aid

has

become

part

this

of the

commercial
banks
and will itself
expand
their
lending
operations
would

give

pendence
support

ceased

if they
ders

them

the

entirely
were

giving

rise

the

credit

fact

that

there

until

non-expanding
impact
of the

banks
policy

and if anything
affect all to such
be able

percent
would

entirely

on

banks,

the

remains
bankingD

a very

consistent

banks

be

above

Unless
eliminate
the

the

argument

powerful

the

be
trade
for

argument

some

This

to assume

that,

banks

since

no

proved
cycle

disor-

occur.
who

becomes

the

to crash
the

not

have

a de-

if distress

allowed

expand

suspect,

escape
entirely
by their
less

water

it can

with

self-help,

in future

solvency

cannot
followed

bv

and

were
by

if we

will

is in

to be re-

anticipated

resources,

would

their

market

from
cautious

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

to keep

liquid.

data

going

is weakened

unwisely

not

and

to a crisis

money

to

institu-

be a reason
why
they will
beyond
the limits
which

own

to keep

opposed

or other

is continually

of safety

their

to be given
unable

counter-argument
given

margin

on

sometimes

the

that

this bereason

to a free-bank-

if a central

whenever

knowledge

will

organisation

1; that

gives
the

upon

banking

free-banking

de-

of liquidation.

If crises are bound

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

the

bank

it is likely to
banks
may
can

be

that

free

and

general

lender
in defence

the

the evil
rivals,

100

banking

of last
of

runs
resort
central

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

lS$

THE RATIONALE OF CENTRAL BANKING

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

the 1832 Commission,

CENTRAL

BANKING

RECONSIDERED

IS9

check were not, and therefore

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

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

190

THE

RATIONALE

OF CENTRAL

BANKING

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

CENTRAL

BANKING

RECONSIDERED

191

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

"Committee

pp. 6162, 213-14.

"MacMillan
27 Ibid., 1597

Financial
Economic
Committee,
on

Committee,
(Sir Robert

Conference.
Conference.
Minutes
of Evidence,"
National

and

Minutes
Kindersleyt.

Federal

3317

Reserve

of Evidence."

6720

Systems,"
(Sir Otto

U.S.A.,
Niemeyerl

1931.

19_

THE

RATIONALE

OF CENTRAL

BANKING

the "lender of last resort" to the international

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

will be assumed

by the Bank for Interna-

The two arguments

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

"The
Art
Commission's

of Central
Report,

Banking,"
pp. 62-64.

p. 228.

CENTRAL

BANKING

RECONSIDERED

193

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

pp. 138-41;
"Principles

A. Wagof Politi-

|a4

THE RATIONALEOF CENTRAL BANKING

tors

as integrations

and

disintegrations

in industry,

changes

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

are

likely

become

part

to reach
of the

appreciable

object

and

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

if monetary
to discover

factors

to introduce

oscillations

adjustments

to

public,
is the
our day.

most

changes

acute

out

they

major

cash

provided

mercial
that

arise.
by

banks

their

keep

lending

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

activities

theory,

side

of this

ten

reserve

times,

the
kind

recently

put

the
of

system
difficult
of the
that

amount

that

the

of
com-

proportions
closely

and

(except

in central
magnified

but central

knowledge
which

of

fact

in the

movements
are, of course,
with

itself

correct

problem

We find
fairly

be the

features

changes

follow

say,

most

the

to be an indisputable

stable

depression)
movements

It is propositions
to the

the

economic

banks.

relatively

conducted

not
likely

to make

particular

from

central

of expansion,

is always

of what

come
the

will

that the present

banking
disturbances.
The more

But it seems

fluctuations

in the form
we find, be a

is least

from

unsettled

task

is to determine

likely

it
to

neutral.

which
which

most

counteract

doubt
for

the

system

and

There
is not much
is actively
responsible
system

to be kept

disturbances,

then

of banking

issue (whether
deposits)
may,
are

a banking

of catastrophic

dimensions,

usefulness

bank

of this
seem

forward

in

bank
by the

to lend
by

pol-

fact

in

sup-

Mises, 33

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

CENTRAL BANKINGRECONSIDERED
that

fluctuations,

while

be much

reduced

true

such

that

than

whatever

is much

a system
may

entirely

free banking.

a system

manipulation
But

not being

under

be

of monetary

control.

verdict

as to the

comparative

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

of stability
a practical

vast

interference

majority

of people

of banking

has

cepted
institutions
vite ridicule.
One
the

sphere

plied

government

become

so much

that
result

lines

to banking

has

clusion
free

that

we

actual

competition

Such

won

exception

should

that
also
almost

be diffident

experiences

prove

the

as are

occasionally

come

provide

century

from

made

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

tendencies
When

in favour

sources

and

tary
be

This

power
the

rule

paid

ap-

for by

the

con-

unworkability

of

consistent

for free

of "money
magic."
on the notion
that it

evils

of credit

and

to deficiencies

'_ As a matter

of

of practical

are all in the direction

of increased
the choice
was made in the nineteenth

of controlling

would

in the

day

do not commend

supplies

social

monopoly.

the

ing was for various

reasons
left
there
are signs of an approaching
deposits.

the

be

in our

which

unlimited

all industrial

caused

policy
the
centralisation.

from

of drawing

them.
Their

banking

ac-

in banking.

pleas

ascribe

of the

to point
out that since
never
been strictly
ap-

in banking

they

part

it must

trade

would

in matters

an integral

of business

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

it is unlikely
one. To the

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

of banking

in other

would

it is undoubtedly

capable

of central

our

eliminated,

And

less

195

secure
hands
outcome

note

the final

of the

issue,

deposit

bank-

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

of central

concentration
authority
bank

of moneand

philosophy

would
and

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

196

THE

RATIONALE

OF CENTRAL

BANKING

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

35 See the Chicago

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

an account
of which
Plan"
of Banking
Re-

Appendix

On the

Working

"Automatic

Mechanism"

of Credit

In

order

last chapter

Control

to make clear the argument

we append

of the

the following

on pp. 178-184
arithmetical

of the

example:

1. THE NOTE-ISSUING CASE

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

198

THE RATIONALE OF CENTRAL BANKING

together

remains

the

same

throughout

the

period

under

consideration.

Orig/na/Position
A.
Notes

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

Gold

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

Loan

repayments

A receives
B

5,000
,,

Notes

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

of its own
,,

therefore

cleared

are

,,

Position

at First

notes

and

,,

5,000

Clearing

any

40,000

40,000

4,000

4,000

10,000

10,000

of B's.

,,

without

A's.
transfer

after

A's

of gold.

Expansion
A.

Notes

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

Gold

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

Loan

repayments

A receives

5,555

4,444

,,

B draws

1,111

Second
Notes

notes

gold

4,444
5,555

from

B.
40,000

4,000

4,000

10,000

10,000

A.

B.

48,889

41,111

of B's.
,, A's.

A.

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

Gold

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

Loan

repayments

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

5,433 of its own notes

4,567

B draws

and

......

A receives
,,

50,000

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

of its own

B.

826 gold

......
from

A.

and 4,567
5,433

of B's.
,, A's.

2,889

5,111

10,000

10,000

WORKING OF CREDIT CONTROL

Third

Clearing

Notes

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

Gold

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

Loan

repayments

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

A receives

5,341

of its own notes

4,659

......

,,

B draws

682 gold

Fourth
Notes

At the

10,530

gold

and

......

9,470

A.

B.

47,381

42,619

1,381

6,619

20,000

10,000

of B's.

5,265

,, A's.

to A.

of the fourth

Gold

5,937
10,000

,, A's.

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

of its own notes

4,735

Notes

2,063
10,000

of B's.

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

repayments

end

B.
41,937

Clearing

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

4,205

4,659

A.
48,063

A.

Gold

,,

B loses

from

and

5,341

Loan

A receives

199

clearing

the

position

is:

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

2. THE

DEPOSIT

CREDIT

A.

B.

51,586

38,414

5,586

2.414

CASE

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

ZOO

THE RATIONALEOF CENTRAL BANKING

O_wJna!

PosOHo.

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

at First

A.

B.

40,000
4,000

40,000
4.000

Clearing

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

A.

B.

50,000
4,000

40,000
4,000

B receives 5,000 in checks drawn on A against which there is no

counterclaim
of A on B; B therefore
claims 5,000 in cash from A.
The position

aJler

#he flrst

clearing

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

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

untenable

_r
B.

A:

45,000
8,000 + 1,000

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Office,

Otto

zur

and

Banking

Volkswirthschafl

Julius

Washington:

on Banking

Federal

Government

Vierteljahresschrifl

3 vols.

besonderer

Ruck-

Verhaltnisse.
Ausgabe.

2.

Freiburg

1873.
lllustrated
Reserve
Ronald

by American
System:
Press,

Histo_,

Legislation,
1923.

5th

Organi-

 OS

Willis,

THE RATIONALE OF CENTRAL BANKING

H. Parker,

and John

can Post-war
versity
Wilson,
1847.

Problems

Press,
James.

M. Chapman.

Situation:

New York:

Ameri-

Columbia

Uni-

1934.
Capital,

Currency

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

The Banking

and Developments.

Louis.

La Question

and Banking.
d'Angleterre
des Banques.

London:
et les
Paris:

The

Economist,

Banques

d'Ecosse.

Guillaumin,

1864.

Index

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

Banking

Bagehot, Walter, 22, 23. 103, 133,

134, 136-144, 170

130
Bankmassige

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

125, 172-174, 184

Bank-notes
cover for, 118-120, 123, 124-126,

of
of
of
of
of
of

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

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

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

i
I

cover,

118-119,

124-

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

68-70
Act (England),

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

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

118, 123, 140

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

Bank for International

Banking,
international. Settlements,
See
Cooperation,
international
Banking

i
i
I
[

school, 80, 89, 90-91, 100,

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

Banking

Commission
134, 136
reform
166

(France),

(United

States),

192

133-

attack on, policy

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

for note issue of, 32-35

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

164-

_09

42-43

210

THE

Bank
Bank

RATIONALE

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

Bank

also

Royal

of the

96, 102

Bank

United

of Scotland

States,

rate
runs,

Enqu_te,

Banque

Generale,

Baring

crisis

Berlin

(1890),

m the
154
See

Bonnet,
Boom

75, 76,

96,

Trade

banking,
64, 100

130,

148-

John

Cazsse

d'Escompte

crisis;

62,

45-47,
112,

47,

for,

118,

on,

Palmer

105,

184-187

136-144
of, 168-169

123,

111

17, 22,

140-143,

165,

186,

20-21

on,

weakness
139-143

19-20,

22

191

16

System;
Central

Charles

Commerce,

school,

126,

Salmon,

123,

6, 105,

112112,

145
of England),

11

53-54

Checking

system,
164
Chemmtzer-Stadtbank,

18, 79, 121-122,

Chevalier,

92, 95-96,

103,

fixed and floating,

90-91
real opposed
to artificial,

role,

171, 177, 180, 184

Henri,
103, 105-106,

I1 (king

Chase,
29

of, 135-136,

Government

Reichsbank
banking

113,
Cernuschi,

144

59, 67-68

of system

See also Bank of England;

Bank
of France;
Federal
Reserve

144

Capital

127

160-161

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

56,

192

125,

52-54,

151-153,

in Prussia/Germany,

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

120-121

cooperation
for, 3, 190-192

Loyd

report,

do

58,

of, 46-48,

191-192

Economic

Elliot,

95

bank

113,
Calrnes,

of, 15-16,

house,

theol\v

Committee

92, 94,

international
potential

National

British
Linen
Company.
26
Brussels
Coriference
of 1920,
Bulhon

Specie

as clearing

103

99-100,

Gold;

suspension

Bagehot
on,
characteristics

83, 119,

18, 25, 31-32,

Hubert,

105,

113

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

84, 85,

banks

See
cycle

See

arguments

era,

Act; State

\qctor,

Central

52-56,

States,

economy.

Branch

40,

Greenback

Bank

flight.
outflow

U.S.

94,

cycle

suspension

137

59

United

Inflation,

78, 81,

system,

also

170

134,

also

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

144

question,

deposit
130

Investment,

28

Bills of exchange,
172-173

Bond

133.

102-103,

Kassenverem,

Bnnetallic

See
Capital

17, 51, 108,

Banque

of, 82-83,

Trade

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

Bankruptcy,

BANKING

scarcity
or excess
98, 109-110

78, 92

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

OF CENTRAL

62

Michel,
107-108,

110,

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

banks,

53

134,

100144
160

INDEX

Clearing-house
162
Cobden,
Coin,

loan

Richard,

certificates,

160-

Currency

bills,

Commercial
crisis

crisis.

165
See

Economic

Currency

See

Bank

law
Currency

arguments
85-88,

for
92-94

in France,

and

30,

against,

Convertiblhty
108,

Free

95,

Coquelin,
Coullet,

100,

Deposit

89,

14,

3, 190-192
112,
103,

Depression

144
95,

144

Discount

Jean
103,

23, 26-27,
49,

deposit

system,

See

Trade

banks,

cycle

Economic
theory

29, 121
wqth

free

effect of, 102-103,

m France,
29-30,

156-158

97-98,

G., 4, 35, 93,

105, 107, 110,

33-34

banking,

in Prussia

for, 58-59,

effect of over-supply
83-84
expansion
also
control

automatic

61-63,

in the

49

United

of, 33-35,

m England
Banking

98, 138
Gustave,

Etienne,

Economic
causes
for,

197-

200

crisis
of, 6-7,

91, 109,
in 1802

the central
168-169

bank,

Crodit

Mobtlier,

37-41

Cre.dit

mobilier

concept,

95, 105

98

of, 15

school

mechanism

States,

65,

Rediscount
policy
See Specie

Puynode,

Duran,

95,

134

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

Duopoly,
Du

134-135
35-38,
40,

102-103,

See also
Dritteldeckung.

60-62

by

24, 35,
88-89,

system

Discount
pohcy
connection

144

demand

Credit

18-19,
66-67,

economy.

crlsm,

105-106,

16-17,

States,

Coureelle-Seneuil,
94-95,
100,

See

8-9,

58-59,

115-116

United

112,

banking,

Checking

82, 93-94,

in England,
79

fl)rce,

banking

120-123
See also Bond

banks

Coors
Credit

193

43-44,

103,

Charles,

m the

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

controversy.
See Banking
versus
currency
controversy

Money

Paul Jacques,
113, 133, 144

Counti\v

123-

26

international,

Paul,

115-118,

135-136

versos

trade

Coin;

Cooperation,
Coq,

4, 80,

principle,
73-74,
112, 173, 175

also

68, 74-

39

in Scottish
banking,
Wilson
on, 88-89
also

128,

189,

Competition

See

doctrine,
126,
118,

law.

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

75

17, 107-108

See

Crisis
See
Currency,

96n

Commercial

Company

II

9-10,

22-23,

(France),

in 1825 (England),
in 1836, 19
m

60, 63, 66

1839,

19

in 1847,

22

75-76,

124-126,

82-84,
136,

194

30
17, 77,

97

90-

_12

THE RATIONALE OF CENTRAL BANKING

Economic crisis (cont.)

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

99, 102-103,

113,

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

60, 66,

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

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

Gallatin, Albert, 16, 43n, 44n, 46, 48n,

78-79, 84-85
Garnier, Joseph, 95, 144
Genoa Conference
of 1922, 191
Gerstner, F. A. yon, 114, 116n

Financial crisis. See Economic

Trade cycle theory
Franco-Prussian
War, 67

Geyer,

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

crisis;

58

agaunst, 74-77, 80-81,

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

Philip J., 66n, 91, 123, 125128, 136, 145, 193n

Gladstone,
William, 23-24
Glasgow
Gold

Bank, 27

effect of discount rate on, 134

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

Hubner on, 114-116

Longfield against, 85-88

in banking, 6-9, 12-15, 76-77,

80-81, 93-96, 133, 195

MacCulloch against, 74-77

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

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

See also Note issue; Plural

in Prussia/Germany,

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

57-69

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

INDEX

Hake,

A. Egmont,

Hankey,

195n

Thomson,

Lasker,

24,

102,

134,

de

Hansemann,
Hart, Albert

David,
64n
G., 196n
Ralph

Hayek,
Hildreth,
Hoards

190-192

A. von,

Richard,
theory,

112,

Laveleye,

Law,

190

81

John,

crises.
Trade

Inflation,

See

ratios.

tender

currency,

54-55,

152-153

of last

145

123,
192

cycle

Economic

crisis,

104,

177

York

Interest
rates.
See
Investment,
82-83,

Discount
policy
94, 109-110

Italy,

41

exclusion

47

18-19

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

also

58-59,

17, 25-26,

Country

banks;

72

banks;

Six-partner

Joplin,

Thomas,

17, 71-72

Juglar,

Clement,

111-112

63,

(Lord),

Insurance;

Loans

120-121

to Government
15

of England,

to Government
to Government

of France,
34
of the United

44-45,

53

172-174
an XI, 30

business,

Lombard

loans

62, 69

as note

cover,

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

Loyd,

rule

119

85-88,

122,

57n

S. J. (Lord
80,

12-

Overstone),

20-21,

145

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

John

Kindersley,
Knies,

Maynard,
Robert,
T., 190n

Laisser-faire
Landauer,

principles,
Carl, 184n

MacLeod,

191n

C. G. A., 128-129,

Koopmans,

190

Theodore,

38, 89,
130,

145

Mannequin,
Marqfoy,
Meulen,

101

Henry

134, 136,
100,

105,

72,
145

Dunning,

144
112,

144

Gustave,
96n
Henry,
195n

Michaelis,
4, 57, 71,

118,

191-

18, 72

Lombard

Lotz,
Private

186,

83, 95, 116-117,

Credit;

short-term,
Loi du Germinal

of, 13

in London,

33,

17, 22, 47,

165,

penalty,

States,
Jackson,
Andrew,
Joint
stock banks

Reserves

59-60

resort,

also

Liverpool
Loans

State

103,

15-16,

140-143,

Liquidation

Insurance,
50-51
See also New

See

14, 25, 43,

See

154,

104

100,

119

theory

12, 91,

95,

28

Legal

Liability,
Industrial

157n
L. V., 102,

reserve

Lender
114-116,

144

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

107-110.

144

Otto,

Emile

Legal

193

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

128,

J. Laurence,

de Lavergne,
Leonce,
113, 145

G., 141,

Friedrich

Leopold,

Laughlin,

143

Hawtrey,

Z1

Otto,

121-123,
180n

66, 67,
124,

130,

68n,
145,

119-120,
176,

I114

THE

Mill,

John Stuart,
193n

Mills,

102,

134,

R. H., 132-133,

Mises,

RATIONALE

137,

OF CENTRAL

142,

145

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

Modeste,

Victor,

105,

Monetary

disturbances.

Monetary

pohcy,

under
free
194-195

New

central

9-10,

28-29,

108,

ballklng,

theory

See

Assignats:

Currency,
Legal

tender

See

also

59, 74-75,
126-127

currency,

of Bank
88-89

of England,

of Bank

of France,

conditions

for

Note

Specie

140-141,

Montagu,

12-13,

72,

100

107,

167

and

and

(United

Exchange

(Bavaria),

States),

quanoty

Bank

Gunnar,

of, 127

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

Note
Note

exchange,
issue

26, 32

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

denomination

with

expansion
124

from,
size,

12-14
15-18

of, 8-11

by Federal
in France,

Reserve,
28-35

166

41

metal

over-issue
33-35,

59

banking,

Note
Note

in Italy

banking

119
2, 20-24

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

in State

62, 64-66,

circulation

bank
of,

143,

129

velocity

25, 27

98,

53,

191

in unitary
or plural
132, 137-138

bills,

maintenance

52n,

of, 50-51

tn England,

143,

79
privilege
rationale

Myrdahl,

Fund

Normatlvbestimmungen,
issue,

banks,
105-106

134

m, 43, 47-48,

120,

business

among
Scottish
argument
for,

52
Mortgage

banking
56

Norman,

Corn,

Commercial

Lombard
Monopoly

102,

State

Normatrv-Bedmgungen,

of, 72,

40, 103,

13

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

William,

York

Safety

Fiduciary

market,
151, 162

(England),

133,

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

172-173

quantity

Money

Provincial
Hans,
145,

3, 190-192

84-85,
also

Debt

54-56,

184n

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

Act (1864),
157-158

National
Nelsser,

Newmarch,

126-127

international.

Bank
146-147,

National

126
7

and

National

BANKING

backing,

115-116

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

135
190

in Prussia,
123

58-59,

in Scotland,
Napoleon

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

Nasse,

Erwin,

124-125,

139n

29-

or

69, 119-

25, 27

in the United
56, 148
unity

65-66,

States,

plurality

43-44,

54-

in, 5, 10, 96,

INDEX

99-100,

105-106,

125-126,
167

128,

See

also

issue;
stock

redemption;

Prwileged

Note

18n,

Quantity

188n

Raguet,

Bank

runs

Real

See

Paper

currency.

Paper

money.

See
See

72-74,

79,

Reflux

135

Peel,

Robert,

Peel's

Act,

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

117,

118,

101,

189

118,

Chester

134-135,

136

Competition;
Note

crisis

Political

Economy
Bonamy,
banks

m England,

Club,
90-91,

cover
157,

170-

140,

161

of, 106
9

on,

74-76,

86-87,

124,

135,

161

111

Free

poohng

of, 140,

in specie,

(France),

32-35

72, 134
133-134,

14, 16-17,

20

Reserve

118,

161

37, 53

systems,

Restrictionist
144

of, 113,

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

issue

of 1848

172,

19

drain

10, 96-97,

also

118,

cities,

fixed proportion
171

banking:
Political

Price,
Private

or

centrahsation

A., 181n

banking
system,
notes
of, 108-109
See

166

principle,

equalisation,

Reserves
cash,

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

Bankmasstge

of notes

policy,

of currency,
Edmund,

Phillips,

See

92-93

See

Reflux

centers

Reserve

138
Philipps,

banks

130

171

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

83-84,

doctrine.

of notes
174

Reserve

124-126,

124,

See also Bankmasslge

Reichsbank,
69-70,
128

22

Peel system.
See
Pereire
brothers,

Country

principle

76, 77,
134,

bank,

of money.

Condy,

cover,

Bank-notes,

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

100,

theory
Money

Rediscount

Henry,
144

See

Bank, 61-69,
also Reichsbank

bills

Money

Money
Parnell,

Central

22,

72n,

Panic

See

banks.

Prussian
See

issue

19-20,

60-

26

banks.

Provincial

54, 56, 73,

See

58-59,

Government
role; Monopoly
Protectionism,
9, 81, 167

Reserves

J. Horsley,
61n,

banks,

Greenback
banks;
Note

49-50,

of notes

31-33

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

Country

redemption,
75, 178-179

Palmer,

m France,

136-142,

Bank-notes,

Fiduclarv
era, Joint

Over-issue

121-123,

133,

Competition;

Note

2 15

19, 21,

school

106,

(France),

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

Bank

ot' Berlin,

58-61

139-142
93

_16

THE RATIONALE OF CENTRAL BANKING

Royal
Royal

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

Saint Simonian

movement,

60, 101

Savoy, 38-39
See also Bank of Savoy; Credit
Mobilier
Scharling, William, 170n
Schumacher,
H., 57n
Scotland
bank failures in, 26-28
banking system in, 6, 26, 71-73,
78, 82, 89, 117, 128
)oint stock banks m, 17, 25-26
Scott, Walter,
Silver, 60

27

Six-partner
rule, 13, 17, 89
Societe d'Economle
Politique,

Tellkampf, J. L., 66n, 68n, 103, 114,

116-117, 123, 125, 126-128,
136, 145. 193n
Tooke, Thomas, 72, 80-81_ 128,
144
Trade

cycle theory,

6-7, 83-84,

95, 192-195
Treasury bills (England).
Tunnage Act, 12
Turgot, Anne R. J., 28

88,

14

Underconsumption
theory,
Unit bank system, 146-166
Unity/plurality
arguments.
issue

125
See Note

U.S. National Monetary

Commission,
162, 165-166, 183n
U.S. Treasury,

48, 54-55, 162-163

95

Specie
cover, 61n, 62-63, 69, 130
hoarding
of, 33
outflow of, 15, 20-21. 37, 68.83-

Vergeot,

J. B., 101n

84, 111
reserves. See Gold reserves;
Reserves
Spencer, Herbert, 133
Sprague, O. M. W.. 156n, 160n
State banks
in Prussia/Germany,
59-60, 6263
in the United States, 43-45, 4748, 55-56, 147

Wagner,

State (Government)
paper, 119
Suffolk Bank (Massachusetts),
49, 53

Wolowski. Louis F. M R., 93n, 95,

101, 102, 103, 107, 108, 110,

Specie

Suspension

laws, 47-48

Adolf, 114, 117-118, 128131, 144, 188, 193n

Warburg, Paul M., 165n
Weslau, O. E., 195n
Wilham IU (king of England), 12
William IV (king of Prussia), 61
Willis, Parker, 163n
Wilson, James, 88-91, 94, 117, 132,
133, 144
Wirth, Max, 119

113, 134, 145

This

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