Free Banking (Vol. I) Nineteenth Century Thought

Free Banking Volume I Nineteenth Century Thought

Edited by

Lawrence H. White Associate Professor Department of Economics University of Georgia, USA

An Elgar Reference Collection

The International Library of Macroeconomic and Financial History Series Editor: Forrest H. Capie Professor of Economic History and Head of the Department of Banking and Finance The City University Business School, London

1.

Major Inflations in History Forrest H. Capie

2.

Multinational and International Banking Geoffrey Jones

3.

Monetary Regime Transformations Barry Eichengreen

4.

Financing Industrialization (Volumes I and II) Rondo Cameron

5.

Financial Crises (Volumes I and II) Michael Bordo

6.

Price Controls Hugh Rockoff

7.

Protectionism in the World Economy Forrest H. Capie

8.

Commodity Monies (Volumes I and II) Anna J. Schwartz

9.

Debt and Deficits (Volumes I, II and ill) Lakis C. Kaounides and Geoffrey E. Wood

10. Central Banking in History (Volumes I, II and ill) Michael Collins 11. Free Banking (Volumes I, II and ill) Lawrence H. White Future titles will include: War Finance Larry Neal Stock Market Crashes and Speculative Manias

Free Banking Volume I

© Lawrence H. White 1993. For copyright of individual articles please refer to the Acknowledgements. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Gower House Croft Road Aldershot Hants GUll 3HR England Edward Elgar Publishing Company Old Post Road Brookfield Vermont 05036 USA

British Library Cataloguing in Publication Data Free Banking. - (International Library of Macroeconomic & Financial History;No.ll) I. White, Lawrence H. II. Series 332.1

ISBN 1 85278 597 7 (3 volume set)

Printed in Great Britain at the University Press, Cambridge

Contents Acknowledgements Introduction

PART I

PART U

vi vii

THE BRITISH FREE BANKING SCHOOL 1. Robert Mushet (1826), An Attempt to Explain from Facts the Effect of the Issues of the Bank of England upon Its Own Interests, Public Credit, and Country Banks, London: Baldwin, Cradock, & Joy, 180-207 2. Thomas Hodgskin (1827), 'Money', Popular Political Economy, London: Charles Tait, 178-218 3. G. Poulett Scrope (1832), 'The Rights of Industry and the Banking System' (excerpt), Quarterly Review, 47, July, 439-57 4. Samuel Bailey (1840), 'On Joint-Stock Banks, and Country Issues', A Defence of Joint-Stock Banks and Country Issues, London: James Ridgway, 1-100 5. James William Gilbart (1841), 'The Currency: Banking', Westminster Review, XXXV, 89-131

191

AMERICAN FREE BANKING THOUGHT 6. Richard Hildreth (1840), Banks, Banking, and Paper Currencies, Parts 1, 2 and 3, Boston: Whipple and Damrell, 109-13, 117-99

237

3 31 72

91

PART UI LATER BRITISH WRITERS 7. Herbert Spencer (1858), 'State-Tamperings with Money & Banks', Westminster Review, XIU, 210-32 8. O.E. Wesslau (1887), in Bancroft Cooke (ed.), Rational Banking (/he Remedy for Depression in Trade) Versus Bank Monopoly, London: Elliot Stock, 37-64

350

Name Index

378

327

Acknowledgements The editor and publishers wish to thank the following who have kindly given permission for the use of copyright material.

Greenwood Publishing Group, Inc. for excerpts: Richard Hildreth (1840), Banks, Banking, and Paper Currencies, Part 1, Chapter XXV, 109-13; Richard Hildreth (1840), Banks. Banking. and Paper Currencies, Parts 2 and 3, 'Argument for Open Competition in Banking' and 'An Apology for One-Dollar Notes', 117-99.

Every effort has been made to trace all the copyright holders but if any have been inadvertently overlooked the publishers will be pleased to make the necessary arrangement at the first opportunity. In addition the publishers wish to thank the library of the London School of Economics and Political Science, the Syndics of Cambridge University Library and the Photographic Unit of the University of London Library for their assistance in obtaining these articles.

Introduction The question of free banking - or laissez-faire in money - raises theoretical, historical and normative issues more fundamental than those confronted in ordinary modern discussions of monetary and banking policy. Ordinary discussions focus on secondary details and marginal adjustments. They take it for granted that a government monetary authority (a central bank) will continue to provide a basic fiat money, and that a government regulatory system will continue to decide what banks may do. Discussions of free banking, by contrast, consider non-governmental money and banking frameworks that are radically distinct from present arrangements. They contemplate the consequences of allowing unrestricted money issue by private banks, and of having a monetary system without a government central bank. The lineage of free banking thought extends back to the work of Adam Smith, as Sidney Checkland's essay (Volume II, Chapter 1) makes clear. In the nineteenth century, vigorous debate greeted legislative proposals to establish government-sponsored banks (like the second Bank of the United States) or to reinforce the central banking status of existing governmentsponsored banks (like the Bank of England). Central banking was clearly not yet taken for granted. Many economists shared a predisposition toward laissez-faire in economic policy. Although those who applied laissez-faire ideas to money and banking (as represented by the first six chapters of Volume I, and as discussed by the first five chapters of Volume II) were never the majority, they were a major force in the British and American debates over monetary institutions early in the century. By the end of the century (Volume I, Chapters 7 and 8) they had been relegated to fringe status. The fringe status of free banking thought persisted for the first seven decades of the twentieth century. With the decline of laissez-faire views on economic policy generally, defences of laissez-faire money and banking between 1900 and 1970 (Volume ill, Chapters 1 and 9) were especially scarce. The only noteworthy academic contributors to free banking thought were Ludwig von Mises (1978 [1928]) and Vera Smith (1990 [1936]), the latter providing a survey of the nineteenth-century debates in a doctoral dissertation written under F.A. Hayek. In addition there were a few rather isolated non-academic contributors, most notably Henry Meulen (1917, 1934) and E.C. Riegel (1944, 1978 [1954]).1 At the University of Chicago during this period, home to a well-known tradition of classical liberal economic thought stretching from Frank Knight and Henry Simons in the 1930s to Milton Friedman and George Stigler in the 1970s, the leading authorities considered money and banking to be exceptions to the desirability of free markets (Simons, 1948, pp. 161-2; Mints, 1950, pp. 4-7). They supported government monopoly of note-issue, and offered a , lOOper cent reserve plan' for the restriction of deposit banking. In 1957 Gary Becker offered a brief 'Proposal for Free Banking' that in retrospect represented an important departure from the 100 per cent reserve plan toward greater appreciation for laissez-faire (though it too argued for retaining government monopoly of note-issue). Becker's paper evidently circulated around the University of Chicago - it was cited by Milton Friedman (1960, p. 108, n. 10) in the course of an influential statement of a non-Iaissez-faire monetary and banking framework

viii

Free Banking I

that drew principally on Simons and Mints - but it remained unpUblished until now (Volume III, Chapter 2). Research on free banking questions has expanded tremendously since 1970. The proximate stimulus for most academic research is the work of other researchers, and I discuss below the specific developments in monetary theory that set the stage. Friedman and Schwartz (1986) cite three broad cvrrents in the economics profession generally that have helped promote free banking thought: (1) the emergence of public choice theory, with its skeptical view of government; (2) the 'rational expectations revolution', with its emphasis on studying the structure of policy regimes; and (3) the revival of Austrian economics, with its attention to institutional orders fonned spontaneously without central design. The most important realworld event in the background has undoubtedly been the poor performance of existing central banking regimes, especially the disturbingly high inflation rates of the 1970s and the painful disinflation of the early 1980s. These three volumes reprint the majority of what I consider to be the key articles of the earlier and modem free banking literatures. The modem theoretical literature is marked by a number of sharp controversies. I have an obvious intellectual stake in several of these controversies, and personal judgements have no doubt biased my selection of articles. But I have tried to include both sides of the debates that have occurred in print. I have avoided articles that are available in other collections. In particular, James A. Dorn and Anna J. Schwartz (1987) include at least eight relevant policy essays (Chapters 11-18) in their volume on monetary refonn, Dorn (forthcoming) another half-dozen more, and Kevin Dowd (1992b) assembles 11 chapters on free banking history.

The Nineteenth-Century Literature The English financial crises of 1825, 1836-37 and 1839, and the rechartering of the Bank of England in 1833 and 1844, fuelled a large pamphlet literature and volumes of Parliamentary testimony on alternative monetary institutions as causes of and potential cures for business cycles. Three major schools of thought emerged in a classic debate that has influenced monetary thinking around the world and to this day. The Banking School advanced a non-monetary theory of the cycle. The Currency School charged the banking system, but especially the country banks, with enlarging cycles by expanding pro-cyclically. The Free Banking School held that the Bank of England, by over-expanding and later having to contract to safeguard its reserves, both initiated and drove the business cycle. The country banks, closely constrained by competition, were innocent. Where the Banking School held the Bank of England blameless, and the Currency School proposed to strengthen its monopoly and fasten a policy rule upon it, the Free Banking School argued that the English monetary system could be made self-regulating by eliminating the Bank of England's monopoly over the London circulation. 2 The first five chapters of Volume II provide the first collection of Free Banking School works ever assembled. A complete bibliography of the School's writings between 1825 and 1845 would include at least 40 pamphlets and journal articles, but the five items included here are among the most important. The concluding chapters of Robert Mushet's 1826 book provide an early and influential analysis of the Bank of England's role in generating boom

Free Banking I

ix

and bust. Thomas Hodgskin, in the chapter on money from his 1827 economics text for working men, applies a laissez-faire philosophy widely enough to include a defence of private coinage. G. Poulett Scrope, though he diverged from the School in some respects (he was something of an inflationist with a weak allegiance to the gold standard), offers in his 1832 article one of the most sophisticated accounts of the market processes at work regulating the circulation of each issuer in a free banking system. Samuel Bailey's 1840 pamphlet, reprinted here in full, combines criticism of the Bank of England with defence of the English joint-stock banks (newly formed after reform legislation lowering legal barriers to their entry was passed in 1826 and 1833). Bailey (1840, p. 99) makes the proto-Hayekian3 argument that only competition, and not any system of deliberate central management, could provide 'the nice adjustment of the currency to the wants of the people' . James William Gilbart' s 1841 review article demonstrates the distinctiveness of the Free Banking School's position, as he criticizes the theories and proposals of authors both from the Banking School (Thomas Tooke) and from the Currency School (Samuel Jones Loyd). The American debate over free banking during this period was similarly inspired by business cycles and by legislation to recharter the government's bank (specifically, the 1832 bill to recharter the second Bank of the United States, vetoed by Andrew Jackson). The American debate was seldom as theoretically sophisticated as the British, and American writers were accordingly more prone to cite their British counterparts than the reverse. As George Selgin and I indicate in our secondary account of the Jacksonian era (Volume II, Chapter 4), the leading American proponents of free banking were John McVickar, William Leggett, Henry C. Carey and Richard Hildreth. The work of Hildreth (1840) is the most detailed and sophisticated of this group, and two long extracts from his second book have been chosen to represent American thought. American writers continued to discuss free banking in the late nineteenth century (see Selgin and White, 1990, Volume II, Chapter 5). They made few theoretical innovations, focusing instead on criticism of the national banking regulations imposed during the Civil War. The most comprehensive restatements of the case for free banking were those by William Brough (1895, 1898). British free banking writers similarly focused, from 1845 onward (Fetter, 1965, pp. 251-5), on restatement of principles and criticism of Peel's Act of 1844. Their ranks are represented here by Herbert Spencer's 1858 essay and an excerpt from O.E. Wesslau's 1887 monograph (Volume I, Chapters 7 and 8). Tyler Cowen and Randall Kroszner (1987, Volume II, Chapter 2), survey a diverse group of writers from the 1896-1917 period, crediting them with having anticipated certain ideas in the modern literature that collectively have been dubbed 'the new monetary economics' , particularly the idea that laissez-faire would separate the medium of account from the medium of exchange. (The 'new monetary economics' is represented by Volume ill, Chapters 9-20.) Scott Sumner (1990; Volume II, Chapter 3) persuasively challenges many of Cowen and Kroszner's characterizations of the views of two principal members of the group, namely Arthur Kitson and Henry Meulen.

The 'Free Banking' Era in the United States The modern reconsideration of historical experiences with systems of plural private note-issue

x

Free Banking I

began with Hugh Rockoff's 1974 article. Like Benjamin Klein's article on 'The Competitive Supply of Money' of the same year, which also appeared in the Journal of Money, Credit, and Banking, Rockoffs summarized a doctoral dissertation written at the University of Chicago. But neither article cites the other, and Rockoffs early work (1974, 1975a, 1975b) does not appear to have been motivated by its broader implications for laissez-faire monetary regimes. Rockoff dispels the misconceptions that (1) the 'free banking' laws passed by various American state governments in the 1837-60 period instituted laissez-faire, and (2) the laws typically led to 'wildcat' banking and other disastrous consequences. The laws did allow freer entry, but notes had to be secured by specified government bonds, so that 'it was a far cry from pure laissez-faire' (Rockoff, 1991, p. 75). Wildcat banking was rare, and in states where it did occur it was actually encouraged by poorly designed bond-security provisions. Little research followed Rockoffs work until interest in alternative monetary regimes had been rekindled. Robert King (1983) examines the record of New York State after first surveying the key theoretical questions raised by the idea of laissez-faire in money. Arthur Rolnick and Warren Weber (1983) explicitly motivate their account of four states' experiences by its relevance to modern debates over the stability oflaissez-faire banking. Rolnick's research agenda has perhaps been influenced by the work of his colleague Neil Wallace at the Federal Reserve Bank of Minneapolis. Rolnick and Weber's article reprinted below represents only a small sample of their output on the US free banking era (1982, 1983, 1984, 1985, 1986, 1988). Other noteworthy, recent and published work on the topic includes articles by Rolnick's student Andrew J. Economopoulos (1986, 1988, 1990) and by Kenneth Ng (1988). Rockoff (1986, 1991) has summarized the normative and positive lessons from this literature to date.

Other Experiences

Proponents of free banking in the nineteenth century did not point to the 'free banking' systems of the United States as models to be emulated, but pointed instead to the relatively unrestricted banking systems of Scotland (1716-1844), New England (1820-60) and Canada (1817-1914). Other episodes of banknote competition took place in Sweden, Switzerland, France, Ireland, Spain, Latin America, parts of China and Australia. In all, there appear to have been at least 60 countries or colonies that allowed note-issue by competing private banks, subject to varying degrees of regulation (for a list see Schuler, 1992). Only two such cases (Scotland and France) are represented below because several article-length histories remain unpUblished, while a number of others are readily available in a highly recommended collection of essays edited by Kevin Dowd (1992b). Two key books on the history of a leading free banking system are those on Scottish banking by Sidney Checkland (1975a) and Charles Munn (1981). My critique of the empirical relevance of the legal restrictions theory (White, 1987) draws heavily on these two sources, as do the comment by Tyler Cowen and Randall Kroszner (1989) and my replies to critics (White, 1990, 1991) debating how closely the Scottish episode represented laissez-faire. Richard H. Timberlake (1987) and Eugene N. White (1990) broaden our range of evidence by examining episodes of private money-issue under rather exceptional circumstances, in coal-mining communities and during the French Revolution.

Free Banking I

xi

Private Clearinghouses An important line of historical research has begun to investigate the capability and institutional mechanisms for self-regulation in a competitive banking system. Munn (1975) tells the story of the origins of the Scottish note-exchange system, often praised in the nineteenth century for regulating the note-issue of the Scottish banks. Timberlake (1984), Gary Gorton (1985), Donald J. Mullineaux (1987), and Gorton and Mullineaux (1987) examine the roles of clearinghouse institutions as private regulatory agencies. These studies indicate that more than simply the price system (or what Gorton and Mullineaux call 'the market') has operated to discipline banks, and to insulate the banking system against panics, at least in the cases of the Suffolk system of antebellum New England and the US National Banking system. Selgin and White (1988) and Steven Horwitz (1990, 1992) suggest that many of the 'hierarchical' aspects of clearinghouse institutions in these cases are attributable to legal restrictions peculiar to the United States, whereas Mullineaux (1988) attributes them to enforcement and incentive problems inherent to banking.

Modern Theory and Policy No collection of articles alone can fully represent the modern free banking literature. More so than in other topic areas of economics, many of the pioneering contributions have been made in books and monographs rather than in articles. The articles on theoretical and policy issues in Volume III often cite the important works by Kevin Dowd (1988a, 1989), David Glasner (1989), Charles Goodhart (1988) and George A. Selgin (1988a). I apologise to these authors for under-representing their importance in the following collection; this reference to their books is intended as partial compensation. I would also mention my own books (White, 1984a, 1989a) here, except that I have already clearly over-represented myself in the selection of articles. The most important author not represented below is F .A. Hayek, whose two monographs (1976, 1978) issued the first prominent challenge in the postwar era to state control over the provision of money. The modern free banking literature cannot be traced to anyone seminal article or monograph. Vera Smith's (1936 [1990]) important book, and the history-of-thought articles in Volume II, Chapter 1, make it clear that economists have been debating these questions periodically at least since Adam Smith's time. As the first four parts of Volume III indicate, there are at least four strands within the modern theoretical literature, respectively discussing (a) 'traditional' free banking systems with a distinct base money, (b) competing non-commodity base monies, (c) competitive payments systems without base money, and (d) the 'legal restrictions' theory of money.

Free Banking with a Distinct Base Money In a traditional banking system, bank-issued money can be redeemed for a more basic money. In an ideal free banking system of the traditional sort, the banking system is not politically regulated and the quantity of basic money is not politically manipulated. Most nineteenth-

xii

Free Banking I

century proponents of free banking (see Vera Smith, 1990 [1936]; White, 1984a; White and Selgin, 1990; Selgin and White, 1990), and early twentieth-century proponents (Mises, 1978 [1928]; 1981 [1912]), took it for granted that the basic money would be gold or silver coin. Drawing from the arguments of these writers and from the historical evidence they cited, my own work (White, 1984a, 1989a) has likewise focused on the features of free banking on a metallic standard, which I consider the most plausible outcome oflaissez-faire in money (Selgin and White, 1987; White, 1989b). The idea of free banking on a metallic standard has an obvious kinship with defences of the gold standard that stress its potential for automatic and non-political regulation of the money supply (Rothbard, 1962; Salerno, 1983; Sennholz, 1985), though not with the sometimes appended proposal that banks be required by law to hold 100 per cent gold reserves against their demand liabilities (see White, 1989a, pp. 156-7; White, 1992). Selgin (1987, 1988a, 1988b) argues that allowing decentralized money-issuers to choose their own reserve levels not only saves resources but also improves the macroeconomic performance of the monetary system. Restoring gold or silver to the role of monetary standard and reserve medium is not logically necessary for the system to have a distinct and unmanipulated basic money. Milton Friedman (1984), Richard Timberlake (1986) and George Selgin (1988a) have proposed free banking on a permanently frozen base of fiat dollars. Critics worry that an unregulated fractional-reserve banking system is prone either to serious fraud (Friedman, 1960; Cooper, 1989), pro-cyclical over-expansion of the quantity of bankissued money (Goodhart, 1988, p. 50), or contagious banking panics whose remedy requires government deposit insurance or a government lender of last resort (Diamond and Dybvig, 1983; Bordo, 1990). Historical studies (cited below) belie the first worry. Selgin (1987a, 1988a, 1992) and Dowd (l988b, 1988c, 1989) address the second and third of these worries with both historical evidence and theoretical arguments.

Competitive Non-commodity Base Money An important impetus to the literature on 'private fiat money', as Bart Taub (1985) calls it, was the debate in the late 1960s on monetary optimality. Monetary economists, originally concerned with the inefficiency of the US government policy prohibiting interest on demand deposits, tried to state precisely the conditions for efficiency or optimality in the holding of money balances. The question naturally arose as to whether competition would produce optimal results in the market for money balances, just as (under the right conditions) it produces optimality in competitive markets for ordinary consumption goods. Paul Samuelson (1968, 1969) influentially argued the 'nonoptimality of money holding under laissez-faire': the right conditions do not hold for competition to produce monetary optimality, he claimed, because money-holding involves an externality. Our individual efforts to economise on holding money end up restricting the value of everyone's money and make us all less wealthy than we could be. Milton Friedman's (1969) analysis of 'the optimum quantity of money' essentially coincided with Samuelson's. Among the several rebuttals to Samuelson, Robert Clower's articles (1969, 1970) are perhaps the most effective in showing that Samuelson's externality argument is logically incoherent. Clower indicated only in passing that Samuelson had not really specified an institutional setting

Free Banking I

xiii

consistent with laissez-faire in money. Phil Gramm (1974) also mentioned but did not fully develop this point. It was left to Benjamin Klein (1974), in an article based on his University of Chicago dissertation, to attempt to spell out what laissez-faire in fiat money would mean at the level of the individual money-issuing firm. As Taub (1985, p. 193) notes, Friedman (1969) did not connect the optimal supply of money with private competitive supply. In fact Friedman in an earlier work (1960, p. 7) had argued that the competitive supply of non-commodity base money was not feasible. It would lead to an infinite price level, because any individual issuer would keep printing dollars so long as a 10 dollar bill (or a 10-to-whatever-power dollar bill) was worth more than the paper on which it was printed. Klein (1974, pp. 429-31) points out that Friedman's argument, by implicitly assuming that anyone has the right to print indistinguishable 'dollars', neglects a critical feature of market competition, namely firms' enforceable brand names in their products. (This point was also made by Earl Thompson [1974].) In effect Klein brings to Chicago-school monetary theory a lesson from Chicago-school property-rights and industrial organization theory: suboptimal outcomes reflect poorly specified property rights. Friedman's own views have evolved significantly over the years, under the influence of research on public choice and to some extent on free banking. His 1960 monograph must now be contrasted with his 1984 article proposing a form of free banking, and with his 1986 article (co-authored with Anna J. Schwartz) explicitly reconsidering the question of government's proper monetary role. The central question of Klein's article is whether a profit-maximizing firm issuing a nonredeemable money will live up to a promise to preserve the money's purchasing power, or will instead choose to cash in its reputation for the one-shot profit available from over-issuing the money. Hayek (1978) never really considers this question. Taub (1985) restates it as the question of the 'dynamic consistency' of a policy of preserving the money's value, and brings a rational expectations model to bear. Lance Girton and Don Roper (1981) argue that competition would in fact compel a money-issuing firm to 'offer a goods-back guarantee', i.e. to make its money redeemable, so as to be bound by an enforceable contract. I concur with their view (White, 1989b, p. 383).

Competitive Payments Systems Without Base Money If money-issuing firms under laissez-faire do indeed offer a goods-back guarantee, in what

good or goods would they redeem their money? A group of authors, beginning with Fischer Black (1970), have contemplated non-traditional systems in which the redemption media would be non-money assets, so that no base money would exist. The only money would be bankissued or 'inside' money. Henry Meulen (1934) and E.C. Riegel (1944, 1954 [1978]) were neglected forerunners of some aspects of these ideas. 4 A more influential precursor to the development of pureinside-money models was the 'New View' of money and banking associated with James Tobin (1963; for a secondary account see Glasner, 1989, pp. 171-5). Tobin argued that under competitive conditions the quantity of bank-issued money is subject to a 'natural economic limit' determined by the interaction of demand (depositor preferences) and supply (cost conditions in banking). Though this analysis was meant to apply to banking in a traditional

xiv

Free Banking I

base-money setting, Tobin's critics argued that it slighted the distinctiveness of base money as the system's nominal scalar. Tobin (1969, p. 26) went on to claim that, absent legal ceilings on the interest rates paid on currency and deposits, 'there would be no room for monetary policy to affect aggregate demand'. Black (1970, p. 10) endorses this view, and elsewhere (Black, 1987) argues that monetary policy is passive even in our current monetary system. Black's 1970 article went apparently unnoticed for a decade, except for self-citations and a critical comment by George Benston (1972). During this decade the real-world deregulation of banking stimulated the interest of economists in the conceptual endpoint of the process. Eugene Fama (1980) made Black's article, together with articles by Tobin (1963) on the 'New View' and Harry Johnson (1968) on optimal money holding, the taking-off point for his own analysis of an unregulated banking system from the perspective of finance theory. Fama differs from Black in recognizing the uniqueness of base money as the nominal scalar in our current system, but argues that in principle the payments services provided by banks need have no connection to the numeraire good. Leland Yeager (1968, 1978), arguing from a monetarist perspective, was one of the sharpest critics of the applicability of Tobin's 'New View' and related passive-money-supply doctrines to a money and banking system of the current kind. But precisely because of his long-held understanding of the significance of the quantity of base money in our current system, particularly the role of monetary disturbances in driving inflation and business cycles (Yeager, 1956), Yeager has long had an interest in alternative monetary systems (Yeager, 1962), and has now been attracted to the possibility of a system without base money. (I and others used to call such a system 'cashless', meaning 'devoid of base money', but Yeager [1989] objects that this term misleadingly suggests the absence of hand-to-hand currency.) Crediting Black, Fama and Robert Hall (1982) for various constituent ideas, Robert Greenfield and Leland Yeager (1983, 1989; also Yeager, 1983) propose a competitive payments system without base money principally in the hope that monetary disequilibrium can be eliminated by abolishing base money. The unit of account in this system must obviously be something other than a unit of base money. A natural candidate, also endorsed by Dowd (1988a, 1989) and Glasner (1989), is a bundle of goods whose purchasing power is stable in terms of some significant price index. Critics of this proposal for' separation' of the unit of account from any medium of exchange or redemption (White, 1984b, 1986; O'Driscoll, 1985; McCallum, 1985; Hoover, 1988) have raised a number of questions about whether the Greenfield-Yeager system is feasible, efficient, or would naturally prevail under laissez-faire.

The Legal Restrictions Theory In a distinct line of development, a group of monetary economists centred around Neil Wallace has also concluded that a laissez-faire payments system could lack a base money of the current sort, although they have never detailed the alternative institutional arrangements they envision. As Gerald P. o 'Driscoll, Jr. (1985, p. 11) notes, there is an affinity between Wallace's theory that the demand for base money of the present-day sort rests on legal restrictions and Black's view that laissez-faire implies a world without money. Wallace (1983, 1987) believes that non-interest-yielding currency would not survive the competition it would meet under

Free Banking I

xv

laissez-faire (assuming that nominal interest rates are not close to zero) from interest-yielding payable-to-the-bearer bonds. In this view the rate-of-return discrepancy between government currency and bonds today is due to legal restrictions against private currency issue. Wallace's conclusion is driven by an arbitrage argument: financial intermediaries free to issue currencylike liabilities would bid away any rate-of-return spread between their assets and their liabilities that was wider than the costs of intermediation (which Wallace estimates to be about 1 to 2%). An unpublished early work by Bryant and Wallace (1980, p. 1) indicates that the legal restrictions theory grew out of a larger project, one that encompasses Wallace's (1980) wellknown work on the overlapping generations model of money, namely the New Classical macroeconomics project 'to render monetary theory subject to standard modes of analysis' . The New Classical critique of the older Keynesian monetary and macroeconomic theory is well known: Keynesian models are inconsistent with standard microeconomics, and are populated by agents who fail to recognize the regime under which they live (they lack 'rational expectations'). By alerting economists to the importance of studying alternative monetary regimes, the 'rational expectations revolution' has unintentionally played a vital role in stimulating interest in free banking research generally. With a nod to John Hicks (1935), legal restrictions theorists consider it a crucial task of monetary theory to explain why people hold an asset (money) that is dominated in rate of return. But where Hicks sought an explanation in 'frictions', Bryant and Wallace (1980, p. 3) believe that 'adequate modeling of the frictions that inhibit the operation of the law of one price has indeed proved refractory'. In particular, they find serious defects in partial-equilibrium macroeconomic models like Tobin's (1969), and general-equilibrium models with transactions costs like Heller and Starr's (1976) and their own earlier work (Bryant and Wallace, 1979). A satisfactory theory of transaction costs not being available, they advocate instead trying to study money using the zero-transactions-costs or perfect-arbitrage approach of finance theory. Against the predictions derived from the legal restrictions theory, Fama (1983) and I (White, 1987) argue that non-interest-bearing currency can survive, and historically has survived even under laissez-faire with interest on other assets above 2 %, because computation and transactions costs make the interest on small-denomination currency not worth collecting. Wallace (1987) and Bryant (1989) respond that competitive currency issue might instead eliminate the rateof-return discrepancy by driving nominal interest rates on all other assets down close to zero. This implies (assuming that the real rate of interest is not affected) that currency issuers would denominate their liabilities in an appropriately appreciating numeraire. Warneryd (1990) objects that the social adoption of such a numeraire is not automatic.

Policy Implications One of the most important recent critiques of free banking is Charles Goodhart's (1988) argument that private clearinghouse regulation inadequately addresses enforcement and incentive problems, creating a 'natural' need for the development of a government central bank. But does history actually show us central banks developing naturally, i.e. without government intervention? Friedman and Schwartz (1986, p. 54) remind us that Vera Smith's (1936 [1990], p. 148) conclusion was unequivocally no: 'A central bank is not a natural product of banking development. It is imposed from outside or comes into being as a result

xvi

Free Banking I

of Government favours. ' Few will regard this fact alone as sufficient evidence for a positive or negative verdict on the desirability of central banking. Governments around the world certainly have had their reasons for imposing central banks (that is, for monopolizing the issue of basic money and nationalizing clearinghouse functions), and for restricting the issue of money by private banks. But have they had good reasons, grounded in the welfare of moneyusers? Are there any good reasons? Modern neoclassical economists have two standard rationales for government involvement in the provision of a good: externalities or natural monopoly. Roland Vaubel (1984, 1985) confronts head-on the question of whether either of these rationales applies in the case of money. With respect to basic money, he finds that the externality or public-goods argument for imposing a common government money reduces to a natural monopoly argument, and points out that natural monopoly cannot justify barriers to entry by private producers. With respect to bank-issued money, as Friedman and Schwartz (1986, p. 49) note, Vaubel seems to allow that confidence externalities (like contagious bank runs) might justify government providing deposit insurance or acting as a lender of last resort. Martin F. Hellwig (1985) emphasizes the problem of dynamic inconsistency with competing non-commodity base monies, the problem also analysed by Taub (1985). With respect to bank-issued money, Hellwig (1985, pp. 585-6) finds that economists cannot draw welfare conclusions for or against laissez-faire. Possible problems of information asymmetry and moral hazard mean that 'we simply do not know very much about how competition among inside monies works' and that 'it is unclear whether government intervention is harmful or useful'. Hellwig does not consider any historical evidence on how competition among inside monies has in practice worked, e.g. on ways bankers and their customers have tried to minimize information asymmetry and moral hazard problems. Nor does he consider any evidence on whether government intervention has in practice proven harmful as compared with laissezfaire. These questions are taken up by the subsequent two articles. Friedman and Schwartz (1986, p. 40) emphatically conclude from their wide reading of monetary history that government intervention has indeed been harmful - destabilizing and efficiency-reducing - on net. They doubt that government will remove itself from the monetary arena, however. Richard E. Wagner (1986) offers a complementary public-choice analysis of both points: why government fails to provide good money, and why it deliberately persists. Unlike his fellow public-choice theorists H. Geoffrey Brennan and James M. Buchanan (1981), Wagner does not take it for granted that the market will 'fail' in the provision of money unless government intervenes.

Notes 1. For secondary accounts of Mises' and Meulen's writings see White (1992) and Dowd (1992a). 2. This paragraph draws on White (1984a, pp. 53-4). For other accounts of the debate that also emphasize the question of free banking versus central banking see Smith (1990 [1936]) and Schwartz (1987). 3. F.A. Hayek (1988, pp. 14-15) in fact calls Bailey 'an acute economic thinker of the nineteenth century' and quotes his statement (1840, p. 3) that detailed business decisions require 'minute knowledge of a thousand particulars which will be learned [sic; Hayek has 'learnt'] by nobody but him who has an interest in knowing them'.

Free Banking I

4.

xvii

Yeager (1989), however, has on at least one occasion adopted Riegel's 'valun' (short for 'value unit') as a name for the unit of account.

References Bailey, S. (1840), A Defence ofJoint-stock Banks and Country Issues, London: James Ridgway. Reprinted below, Vol. I. Becker, G. (1957), 'A Proposal for Free Banking', unpublished ms. Reprinted below, Vol. III. Benston, GJ. (1972), 'Controls on Banking and "a World Without Money''', Journal of Bank Research, 3 (4), Winter, pp. 59-61. Black, F. (1970), 'Banking and Interest Rates in a World Without Money: the Effects of Uncontrolled Banking', Journal of Bank Research, 1 (3), Autumn, pp. 9-20. Reprinted below, Vol. III. Black, F. (1987), Business Cycles and Equilibrium, Oxford: Basil Blackwell. Bordo, M.D. (1990), 'The Lender of Last Resort: Alternative Views and Historical Experience', Federal Reserve Bank of Richmond, Economic Review, January/February, pp. 18-29. Brennan, H.G. and Buchanan, J.M. (1981), Monopoly in Money and Inflation, London: Institute of Economic Affairs. Brough, W. (1895), The Natural Law of Money, New York: G.P. Putnam's Sons. Brough, W. (1898), Open Mints and Free Banking, New York: G.P. Putnam's Sons. Bryant, J. (1989), 'Interest-bearing Currency, Legal Restrictions, and the Rate of Return Dominance of Money', Journal of Money, Credit, and Banking, 21 (2), May, pp. 240-45. Reprinted below, Vol. III. Bryant, J. and Wallace, N. (1979), 'The Inefficiency of Interest-bearing National Debt', Journal of Political Economy, 87, April, pp. 365-8l. Bryant, J. and Wallace, N. (1980), 'A Suggestion for Further Simplifying the Theory of Money', Unpublished ms., Federal Reserve Bank of Minneapolis and University of Minnesota. Checkland, S.G. (1975a), Scottish Banking: a history, 1695-1973, Glasgow: Collins. Checkland, S.G. (1975b), 'Adam Smith and the Bankers', in A.S. Skinner and T. Wilson (eds), Essays on Adam Smith, Oxford: Clarendon Press, pp. 504-23. Reprinted below, Vol. II. Clower, R. (1969), 'What Traditional Monetary Theory Really Wasn't', Canadian Journal of &onomics, 2, May, pp. 299-302. Clower, R. (1970), 'Is There an Optimal Money Supply?', Journal of Finance, 25, May, pp. 425-33. Cooper, R.N. (1989), 'Is Private Money Optimal?', Cato Journal, 9 (2), Fall, pp. 393-7. Cowen, T. and Kroszner, R. (1987), 'The Development of the New Monetary Economics', Journal of Political Economy, 95, June, pp. 567-90. Reprinted below, Vol. II. Cowen, T. and Kroszner, R. (1989), 'Scottish Banking Before 1844: a Model for Laissez-faire?', Journal of Money, Credit and Banking, 21, May, pp. 221-3l. Reprinted below, Vol. II. Diamond, D.W. and Dybvig, P.H. (1983), 'Bank Runs, Deposit Insurance, and Liquidity', Journal of Political &onomy, 91, June, pp. 401-19. Dom, J.A. (ed.) (forthcoming), Alternatives to Government Fiat Money, Boston: Kluwer Academic Publishing. Dom, J.A. and Schwartz, A.J. (eds) (1987), The Search for Stable Money, Chicago: University of Chicago Press. Dowd, K. (1988a), Private Money: The Path to Monetary Stability, London: Institute of Economic Affairs. Dowd, K. (1988b), 'Automatic Stabilizing Mechanisms Under Free Banking' , Cato Journal, 7, Winter, pp.643-59. Dowd, K. (1988c), 'Option Clauses and the Stability of a Laisser Faire Monetary System', Journal of Financial Services Research, 1, pp. 319-33. Reprinted below, Vol. III. Dowd, K. (1989), The State and the Monetary System, New York: Philip Allan. Dowd, K. (l992a), 'The Monetary Economics of Henry Meulen', Journal ofMoney, Credit, and Banking, 24, May, pp. 173-83. Dowd, K. (ed.) (1992b), The Experience of Free Banking, London: Routledge.

xviii

Free Banking I

Economopoulos, AJ. (1986), 'The Impact of Reserve Requirements on Free Bank Failures', Atlantic Economic Journal, 14, pp. 76-84. Economopoulos, AJ. (1988), 'lliinois Free Banking Experience' , Journal ofMoney, Credit, and &nking, 20, pp. 249-63. Economopoulos, A.I. (1990), 'Free Bank Failures in New York and Wisconsin: a portfolio analysis', Explorations in Economic History, 27, pp. 421-41. Fama, E. (1980), 'Banking in a Theory of Finance', Journal of Monetary Economics, 6 (1), January, pp.39-57. Fama, E. (1983), 'Financial Intermediation and Price Level Control', Journal of Monetary Economics, 12, July, pp. 7-28. Fetter, F.W. (1965), The Development of British Monetary Onhodoxy, 1797-1875, Cambridge: Harvard University Press. Friedman, M. (1960), A Program for Monetary Stability, New York: Fordham University Press. Friedman, M. (1969), 'The Optimum Quantity of Money', in The Optimum Quantity of Money and Other Essays, Chicago: Aldine. Friedman, M. (1984), 'Monetary Policy for the 1980s', in J.H. Moore (ed.), To Promote Prosperity, Stanford: Hoover Institution Press. Friedman, M. and Schwartz, A.J. (1986), 'Has Government any Role in Money?', Journal of Monetary Economics, 17 (I), January, pp. 37-62. Reprinted below, Vol. III. Gilbart, J.W. (1841), 'The Currency: Banking', Westminster Review (American edn), 35, pp. 45-67. Reprinted below, Vol. I. Girton, L. and Roper, D. (1981), 'Theory and Implications of Currency Substitution', Journal ofMoney, Credit, and Banking, 13 (I), February, pp. 12-30. Reprinted below, Vol. III. Glasner, D. (1989), Free Banking and Monetary Policy, Cambridge: Cambridge University Press. Goodhart, C. (1988), The Evolution of Central Banks, Cambridge: MIT Press. Gorton, G. (1985), 'Clearinghouses and the Origins of Central Banking in the United States', Journal of Economic History, 45, June, pp. 277-84. Gorton, G. and Mullineaux, D.I. (1987), 'The Joint Production of Confidence: Endogenous Regulation and Nineteenth Century Commercial-bank Clearinghouses', Journal of Money, Credit, and Banking, 19, November, pp. 457-68. Reprinted below, Vol. II. Gramm, W.P. (1974), 'Laissez-faire and the Optimum Quantity of Money', Economic Inquiry, 12, March, pp. 125-33. Greenfield, R.L. and Yeager, L.B. (1983), 'A Laissez Faire Approach to Monetary Stability', Journal of Money, Credit, and Banking, 15 (3), August, pp. 302-15. Reprinted below, Vol. m. Greenfield, R.L. and Yeager, L.B. (1986), 'Competitive Payments Systems: Comment', American Economic Review, 76, September, pp. 848-9. Reprinted below, Vol. m. Greenfield, R.L. and Yeager, L.B. (1989), 'Can Monetary DiseqUilibrium be Eliminated?', CatoJournal, 9 (2), Fall, pp. 405-21. Hall, R.E. (1982), 'Explorations in the Gold Standard and Related Policies for Stabilizing the Dollar', in R.E. Hall (ed.), Inflation: Causes and Effects, Chicago: University of Chicago Press. Hayek, F.A. (1976), Choice in Currency, London: Institute of Economic Affairs. Hayek, F.A. (1978), Denationalisation of Money, 2nd edn, London: Institute of Economic Affairs. Hayek, F.A. (1988), The Fatal Conceit: The Errors of Socialism, London: Routledge. Heller, W.P. and Starr, R.M. (1976), 'Equilibrium with Non-convex Transactions Costs: Monetary and Non-monetary Economies', Review of Economic Studies, 43, June, pp. 195-215. Hellwig, M.F. (1985), 'What Do We Know About Currency Competition?', ZeitschriJtjUr WinschaJtsund SozialwissenschaJten, 5, pp. 565-88. Reprinted below, Vol. III. Hicks, J. (1935), 'A Suggestion for Simplifying the Theory of Money', Economica, n.s., 2, pp. 1-19. Hildreth, R. (1840), Banks, Banking, and Paper Currencies, New York: Whipple & Darnrell. Excerpt reprinted below, Vol. I. Hodgskin, T. (1827), Popular Political Economy, London: Charles Tait. Chapter 8 reprinted below, Vol. I. Hoover, K.D. (1988), 'Money, Prices and Finance in the New Monetary Economics', Oxford Economic Papers, 40, pp. 150-67.

Free Banking I

xix

Horwitz, S. (1990), 'Competitive Currencies, Legal Restrictions, and the Origins of the Fed: Some Evidence from the Panic of 1907', Southern Economic Journal, 56 (3), January, pp. 639--49. Reprinted below, Vol. II. Horwitz, S. (1992), Monetary Evolution, Free Banking, and Economic Order, Boulder: Westview Press. Johnson, H.J. (1968), 'Problems of Efficiency in Monetary Management', Journal of Political Economy, 76, September/October, pp. 971-90. Kahn, J.A. (1985), 'Another Look at Free Banking in the United States', American Economic Review, 75 (4), September, pp. 881-5. Reprinted below, Vol. II. King, R. (1983), 'On the Economics of Private Money', Journal of Monetary Economics, 12, May, pp. 127-58. Reprinted below, Vol. II. Klein, B. (1974), 'The Competitive Supply of Money' , Journal of Money, Credit, and Banking, 6 (4), November, pp. 423-53. Reprinted below, Vol. III. McCallum, B.T. (1985), 'Bank Deregulation, Accounting Systems of Exchange, and the Unit of Account: a Critical View', Carnegie-Rochester Conference Series on Public Policy, 22, Autumn, pp. 135-60. Meulen, H. (1917), Industrial Justice Through Banking Reform, London: Richard James. Meulen, H. (1934), Free Banking: an Outline of a Policy of Individualism, London: Macmillan. 2nd edn of Meulen (1917). Mints, L. (1950), Monetary Policy for a Competitive Society, New York: McGraw-Hili. Mises, L. von (1978 [1928]) 'Monetary Stabilization and Cyclical Policy', in Percy L. Greaves (ed.), On the Manipulation of Money and Credit, trans. Bettina Bien Greaves, Dobbs Ferry, NY: Free Market Books. Mises, L. von (1981 [1912]), The Theory of Money and Credit, Indianapolis: Liberty Classics. Mullineaux, D.J. (1987), 'Competitive Monies and the Suffolk Bank System', Southern Economic Journal, 53, April, pp. 884-98. Reprinted below, Vol. II. Mullineaux, D.J. (1988), 'Competitive Monies and the Suffolk Bank System: Reply', Southern Economic Journal, 55, July, pp. 220-23. Reprinted below, Vol. II. Munn, C.W. (1975), 'On the Origins of the Scottish Note Exchange', Three Banks Review, 107, pp. 45-60. Reprinted below, Vol. II. Munn, C.W. (1981), The Scottish Provincial Banking Companies, 1747-1864, Edinburgh: John Donald. Mushet, R. (1826), An Attempt to Explain from Facts the Effect of the Issues of the Bank of England upon Its Own Interests, Public Credit, and Country Banks, London: Baldwin, Cradock & Joy. Excerpt reprinted below, Vol. I. Ng, K. (1988), 'Free Banking Laws and Barriers to Entry in Banking, 1836-1860', Journal of Economic History, 48, December, pp. 877-89. O'Driscoll, G.P. Jr. (1985), 'Money in a Deregulated Financial System', Federal Reserve Bank of Dallas, Economic Review, May, pp. 1-12. O'Driscoll, G.P. Jr. (1986), 'Deregulation and Monetary Reform', Federal Reserve Bank of Dallas, Economic Review, July, pp. 19-3\. Reprinted below, Vol. III. Redlich, F. (1947), The Molding of American Banking: Men and Ideas, Part I, 1781-1840, New York: Hafner. Chapter 7 reprinted below, Vol. II. Riegel, E.C. (1944), Private Enterprise Money: A Non-Political Money System, New York: Harbinger House. Riegel, E.C. (1978 [1954]), Flight from Inflation: the Monetary Alternative, Los Angeles: Heather Foundation. Rockoff, H. (1974), 'The Free Banking Era: a Re-Examination', Journal of Money, Credit, and Banking, 6 (2), May, pp. 141-67. Reprinted below, Vol. II. Rockoff, H. (l975a), The Free Banking Era: A Re-examination, New York: Arno Press. Rockoff, H. (1975b), 'Varieties of Banking and Regional Economic Development in the United States', Journal of Economic History, 35, March, pp. 16O-8\. Rockoff, H. (1986), 'Institutional Requirements for Stable Free Banking', Cato Journal, 6 (2), Fall, pp. 617-34. Rockoff, H. (1991), 'Lessons from the American Experience with Free Banking', in F. Capie and G.E. Wood (eds), Unregulated Banking: Chaos or Order?, London: Macmillan.

Free Banking I Rolnick, A. and Weber, W.E. (1982), 'Free Banking, Wildcat Banking, and Shinplasters', Federal Reserve Bank of Minneapolis, Quarterly Review, 6, Fall, pp. 10-19. Rolnick, A. and Weber, W.E. (1983), 'New Evidence on the Free Banking Era', American Economic Review, 73 (5), December, pp. 1080-91. Reprinted below, Vol. II. Rolnick, A. and Weber, W.E. (1984), 'The Causes of Free Bank Failures: a Detailed Examination', Joul7Ull of Monetary Economics, 14 (3), November, pp. 267-91. Rolnick, A. and Weber, W.E. (1985), 'Banking Instability and Regulation in the U.S. Free Banking Era', Federal Reserve Bank of Minneapolis, Quarterly Review, 9, Summer, pp. 2-9. Rolnick, A. and Weber, W.E. (1986), 'Inherent Instability in Banking: the Free Banking Experience', Cato Joul7Ull, 5 (3), Winter, pp. 877-90. Rolnick, A. and Weber, W.E. (1988), 'Explaining the Demand for Free Bank Notes', Joul7Ull o/Monetary Economics, 21 (1), January, pp. 47-71. Rothbard, M.N. (1962), 'The Case for a 100 Per Cent Gold Dollar', in L. Yeager (ed.), In Search of a Monetary Constitution, Cambridge: Harvard University Press. Salerno, J.T. (1983), 'Gold Standards: True and False', Cato Joul7Ull, 3, Spring, pp. 239-67. Samuelson, P. (1968), 'What Classical Monetary Theory Really Was', Canadian Joul7Ull of Economics, 1, February, pp. 1-15. Samuelson, P. (1969), 'Nonoptimality of Money Holding Under Laissez-faire', Canadian JOUI7UlI of Economics, 3, May, pp. 324-30. Schuler, K, (1992), 'The World History of Free Banking', in K. Dowd (ed.), The Experience of Free Banking, London: Routledge. Schwartz, A.J. (1987), 'Currency School, Banking School, Free Banking School', in J. Eatwell, M. Milgate and P. Newman (eds), The New Palgrave Dictionary ofEconomics, New York: Stockton Press. Scrope, G.P. (1832), 'The Rights of Industry and the Banking System', Quarterly Review, 47, July, pp. 407-57. Excerpt reprinted below, Vol. I. SeIgin, G.A. (1987), 'The Stability and Efficiency of Money Supply under Free Banking', JOUI7UlI of Institutional and Theoretical Economics, 143 (3), September, pp. 435-56. Reprinted below, Vol. III. Selgin, G.A. (1988a), The Theory of Free Banking, Totowa, NJ: Rowman and Littlefield. Selgin, G.A. (1988b), 'Accommodating Changes in the Relative Demand for Currency: Free Banking vs. Central Banking', Cato Joul7Ull, 7 (3), Winter, pp. 621-41. Selgin, G.A. (1992), 'Bank Lending "Manias" in Theory and History', JOUI7UlI of Financial Services Research, 6 (2), August, pp. 169-86. Selgin, G.A. and White, L.H. (1987), 'The Evolution of a Free Banking System', Economic Inquiry, 25 (3), July, pp. 439-57. Reprinted below, Vol. III. Selgin, G.A. and White, L.H. (1988), 'Competitive Monies and the Suffolk Bank System: Comment', Southern Economic Joul7Ull, 55, July, 215-19. Selgin, G.A. and White, L.H. (1990), 'Laissez-faire Monetary Theorists in Late Nineteenth Century America', Southern Economic Joul7Ull, 56 (3), January, pp. 774-87. Reprinted below, Vol. II. Sennholz, H. (1985), Money and Freedom, Spring Mills, PA: Libertarian Press. Simons, H. (1948), Economic Policy for a Free Society, Chicago: University of Chicago Press. Smith, V. (1990 [1936]), The Rationale of Central Banking, Indianapolis: Liberty Press. Spencer, H. (1858), 'State Tampering with Money and Banks', Westminster Review, 69, n.s. 13, January, pp. 210-32. Reprinted below, Vol. I. Sumner, S. (1990), 'The Forerunners of "New Monetary Economics" Proposals to Stabilize the Unit of Account', JOUI7UlI of Money, Credit, and Banking, 22 (1), February, pp. 109-18. Reprinted below, Vol. II. Taub, B. (1985), 'Private Fiat Money with Many Suppliers', JOUI7UlI of Monetary Economics, 16 (2), September, pp. 195-208. Reprinted below, Vol. III. Thompson, E. (1974), 'The Theory of Money and Income Consistent with Orthodox Value Theory', in G. Horwich and P.A. Samuelson (eds), Trade, Stability and Macroeconomics, New York: Academic Press, pp. 427-53. Timberlake, R.H. (1984), 'The Central Banking Role of Clearinghouse Associations' , JOUI7UlI ofMoney, Credit, and Banking, 16 (1), February, pp. 1-15. Reprinted below, Vol. II.

Free Banking I

xxi

Timberlake, R.H. (1986), 'Institutional Evolution of Federal Reserve Hegemony', Cato Journal, 5, Winter, pp. 743-63. Timberlake, R.H. (1987), 'Private Production of Scrip-money in the Isolated Community', Journal of Money, Credit, and Banking, 19 (4), November, pp. 437-47. Reprinted below, Vol. II. Tobin, J. (1963), 'Commercial Banks as Creators of Money' , in D. Carson (ed.), Banking and Monetary Studies, Homewood, IL: Irwin, pp. 408-19. Tobin, J. (1969), 'A General Equilibrium Approach to Monetary Theory', Journal of Money, Credit, and Banking, 1 (1), February, pp. 15-29. Vaubel, R. (1984), 'The Government's Money Monopoly: Externalities or Natural Monopoly?', Kyklos, 37 (1), pp. 27-58. Reprinted below, Vol. III. Vaubel, R. (1985), 'Competing Currencies: the Case for Free Entry', ZeitschriftfUr Wirtschafts- und SoZialwissenschaften, 5, pp. 547-64. Reprinted below, Vol. III. Wagner, R. (1986), 'Central Banking and the Fed: a Public Choice Perspective', Cato Journal, 6 (2), Fall, pp. 519-38. Reprinted below, Vol. III. Wallace, N. (1980), 'The Overlapping Generations Model of Fiat Money' , in J. Kareken and N. Wallace (eds), Models of Monetary Economies, Federal Reserve Bank of Minneapolis, pp. 49-82. Wallace, N. (1983), 'A Legal Restrictions Theory of the Demand for "Money" and the Role of Monetary Policy', Federal Reserve Bank of Minneapolis, Quarterly Review, Winter, pp. 1-7. Reprinted below, Vol. m. Wallace, N. (1987), 'A Suggestion for Oversimplifying the Theory of Money', Economic Journal, 98 (390), conference supplement, pp. 25-36. Reprinted below, Vol. III. Wiirneryd, K. (1990), 'Legal Restrictions and Monetary Evolution', Journal of Economic Behavior and Organization, 13 (1), January, pp. 117-24. Reprinted below, Vol. III. Wesslau, O.E. (1887), Rational Banking (the Remedy for Depression in Trade) Versus Bank Monopoly, London: Elliot Stock. Chapters 6-10 reprinted below, Vol. I. White, E.N. (1990), 'Free Banking During the French Revolution', Explorations in Economic History, 27, pp. 251-76. Reprinted below, Vol. II. White, L.H. (1984a), Free Banking in Britain: Theory, Experience, and Debate, 18{)(}-45, Cambridge: Cambridge University Press. White, L.H. (1984b), 'Competitive Payments Systems and the Unit of Account', American Economic Review, 74 (4), September, pp. 699-712. Reprinted below, Vol. III. White, L.H. (1986), 'Competitive Payments Systems: Reply', American Economic Review, 76 (4), September, pp. 850-53. Reprinted below, Vol. III. White, L.H. (1987), 'Accounting for Non-interest-bearing Currency: a Critique of the Legal Restrictions Theory of Money', Journal of Money, Credit, and Banking, 19, November, pp. 448-56. Reprinted below, Vol. III. White, L.H. (1989a), Competition and Currency, New York: New York University Press. White, L.H. (1989b), 'What Kinds of Monetary Institutions Would a Free Market Deliver?', Cato Journal, 9 (2), Fall, pp. 367-91. White, L.H. (1990), 'Scottish Banking and the Legal Restrictions Theory: a Closer Look', Journal of Money, Credit, and Banking, 22 (4), November, pp. 526-36. Reprinted below, Vol. II. White, L.H. (1991), 'Banking Without a Central Bank: Scotland Before 1844 as a "Free Banking" System', in F. Capie and G.E. Wood (eds), Unregulated Banking: Chaos or Order?, London: Macmillan, pp. 37-62. White, L.H. (1992), 'Mises on Free Banking and Fractional Reserves', in J. Robbins and M. Spangler (eds), A Man of Principle: Essays in Honor of Hans F. Sennholz, Grove City, PA: Grove City College Press. White, L.H. and Selgin, G.A. (1990), 'Laissez-faire Monetary Thought in Jacksonian America', in D. Moggridge (ed.), Perspectives on the History of Economic Thought, vol. 4, Aldershot, UK: Edward Elgar. Reprinted below, Vol. II. Yeager, L. (1956), 'A Cash-balance Interpretation of Depressions', Southern Economic Journal, 22, April, pp. 438-47. Yeager, L. (ed.) (1962), In Search ofa Monetary Constitution, Cambridge: Harvard University Press. Yeager, L. (1968), 'Essential Properties of a Medium of Exchange', Kyklos, 21, pp. 45-69.

xxii

Free Banking I

Yeager, L. (1978), 'What are Banks?', Atlantic Economic Journal, 6 (4), December, pp. 1-14. Yeager, L. (1983), 'Stable Money and Free-Market Currencies', Cato Journal, 3 (1), Spring, pp. 305-26. Yeager, L. (1989), 'A Competitive Payments System: Some Objections Considered', Journal of Post Keynesian Economics, 11 (3), Spring, pp. 370-77.

Part I The British Free Banking School

[1] Excerpt from Robert Mushet, An Attempt to Explain from Facts the Effect of the Issues of the Bank of England Upon Its Own Interests, Public Credit, and Country Banks, 180-207

CHAPTER X. Recapitulation of the prindples attempted to be established jn the foregoing chapters.

IN the foregoing pages, I have endeavoured to establish the following principles: 1. That in a country with a paper currency, payable in gold on demand, any undue or unnecessary extension of its amount, such as would not be called for in the ordinary course of commercial transactions, and never would be made if the whole currency were metallic-but such as may be made by loans to Government, purchase of Exchequer bills, on loans, mortgage, or on stock-will lead to a reduction of the current rate of interest, an unnatural rise in the price of Government funds, and a general spirit of gambling in all money securities. 2. That if the currency of the country were entirely metallic, or the proportion of paper the lesser quantity of the two, we might be less subject to such violent and extensive fluctuations in the value of property, so productive of ruin and distress to the community, and rendering it a matter of doubt whether as a nation we derive any advantage from the substitution of a paper for a metallic circulation.

4

Free Banking I

181

3. That under a system of cash payments, the Rank of England could not add to the amount of the currency, beyond the legitimate demands of the country, or such as would be demanded if the whole circulation was metallic; unless she resorted to loans to Government, or on mortgage, purchase of Exchequer bills, or loans an stock; and that when she has recourse to such measures, so completely at variance with the soundest principles of banking, it is followed by an extension of the circulation of country bankers, in a far greater proportion than the increase to the basis of the currency, in the first instance, by the extension of the issues of the Bank of England; and sooner or later will produce a demand for gold on the Bank, so as to force her to a contraction of the currency -endangering her own safety, destroying the credit of the commercial community, and the banking estahlishments of the country. That when the Bank of England is obliged suddenly to contract its issues, either to preserve its gold, or to augment its amount, it may be followed by such a contl'action of the country circulation as for a length of time to keep the bullion value of our currency much higher than in other countries, and causing a fall of prices from diminished consumption, the want of confidence, and the means of exchanging commodities, that bears no true relation for the time to the state of the foreign exchallge~ 011 tile mal'lcet price of gold, as ap-

5

Free Banking I

pears to have been the case in

H~2(),

1821, and

18224. That while the Bank of England possesses

the monopoly of the currency-paper as well as metallic, by the existing regulations of the Mint she has the power of regulating the current rate of interest, which would otherwise be regulated by the current rate of profits on coinage; that under the operation of this monopoly, she may acquire an extent of treasure, which in the end may be attended with such a supposed sacrifice of her pro~ fits, by loss of interest, as to induce her to adopt measures to free herself from the encumbrance, and lead to very great fluctuations in the value of money and property generally. Lastly.-From the undue or unnecessary increase of the currency, which could not take place if the whole were metallic, we have the origin and sole cause of' general speculations and overtrading, which proceed with its increase, and in their progress demand or require new additions to the circulation and credit; and, from the conse~ quent facility of obtaining credit, may far outstrip the actual increase of the currency; a state of things that cannot be prolonged beyond the safety of the Bank, which again depends on the stodL of her treasure: the issues are then contracted, this is followed hy the contraction of the wuntry circulation, credit is destroyed, and sudtlCllly our markets assume tIll' appearance uf low

6

Free Banking I

pikes, over-production, or imlefil'ii.e supply.f. If thIs

principle is applied to tile contraction of our Cllrl'ency in 1815 and IHI6, with the low prices that followed; its extension in 1817 and 1818, and the general speculation, overtrading, and high prices, that succeeded; and again, to its cont.-actioll in 1819, 1820, 1821, and 1822, and the general COIllplaint of abundance of foreign and home pl'oduce, and low prices that continued throughout these years; and lastly, to the increase of the curl"ency in 1824 and part of 1825, with the accompanyillg" rage of speculation, overtrading, and high prices that followed, we see the establishment of the principle in all its forms and effects. In the opinion of Mr. Tooke, general speculation and overtrading may take place in a country where the currency is purely metallic, and instances the extensive failures in Hamburgh in 1798. But it must be remembered, that these failures were subsequent to, and I have hardly a doubt were consequent upon, a very sudden and violent contraction of the currency of England in 1797, and extended throughout the whole of 1798, as a reference to the then foreign exchanges will confirm. It is more than probable that the exten" High prices are not necessarily favourable to speculation and over-trading, but on the contrary, low, and rising I,rices; which imply a new relation between commodities and currency, from an increase of the latter. The cvils of such a system arc not wnlined to England, but must protillt'C a corresponding effect Oil thc l'ommcrciul relations and credit of every country with which Eng:lalld holds intcrc(lnr~l'.

Free Banking I

184 sive speculations in Hamburgh, which failed in 1798, had their origin in the extended currency and high prices of England in 1795 and 1796. In these years we had also our speculations and overtrading, and they were checked by the necessity imposed on the Bank to diminish its issues. The failure of credit in England would extend to Hamburgh, as a matter of course; Hamburgh at that time being most extensively connected with us in commerce. If we refer to the state of the money market in Hamburgh, in December last, we shall find, even with her purely metallic currency, that the state of her public credit was not different from our own ; but it was in this case also, as in 1798, subsequent to, or accompanying, the state of public credit in England.* If these are legitimate conclusions, it would appear, that the evils of our paper currency are not confined to England; and are far more extensive than has hitherto been conceived or admitted; and may be an argument, stronger than any yet produced, for remodelling our system of paper currency, and, if not abolishing it altogether, to confine it within such limits, as to diminish, as much as possible, the chances of its producing such extensive mischief. '" By recent accounts from Paris, we have been informed of extensive failures on their Stock Exchange; but these failures have been subsequent to the contraction of the circulation in England.

7

8

Free Banking I

185

CHAPTER XI. Proposed remedies for the regulation of our currency.

I SHAI.L now proceed to state such remedies as may enable us to avoid in future the evils that seem to be inseparable from the present system of our currency. It is necessary to begin with the Bank of England, as I think the cause of the late failure in commel'cial credit has in a great measure, if not altogether, been traced to her measures for unnecessarily, unless for her own interest, increasing the amount of the currency. I would, therefore, take the power from her of lending to G0vernment on Exchequer bills, on mortgage, or on stock. None of them seems consistent with the legitimate principles of banking. It would be desirable also, and I think it very practicable, for the Government to raise money at any time on Exchequer bills, for the arrears of the consolidated fund, without doing so through the medium of the Bank. If the Government would establish in the city a banking-house--call it the Exchequer and Treasury Banking-house, where every public accountant would have his accounts, by which the Treasury would at all times have the balances of every public account at command (which balam:cs

Free Banking I

186

amount on an average to from four to five millions) they could, through the means of theil' own bankers, raise money in the public market at the current rate of interest, Such a plan as this would avoid all interference with the current business of the Bank. If she retained the management of the natiolJal debt, the Treasury and Exchequer bankers would pay over to her the intel'est due quarterly, and no more intimate connection need exist. The Treasury and Exchequer bankers, according to the balance of cash on hand, could apply it to the purchal'e of Exchequer bills, and so diminish the charge of interest to the Exchequer. The profit which the Bank now makes on these balances would be transferred to the public, and would do more than pay the expences of the banking establishment. The result would be the same as if the Treasury kept the accounts of all its servants, and made a profitable use of the balance in hand. As it has been proved, and I hope satisfactorily, that our paper currency is in an undue proportion to its metallic basis, I would propose that the Bank of England should not issue notes below the value of 20l. If this became the general regulation for all banks issuing promissory notes, it might bring back our currency to the state it was in a few years previous to the suspension of cash payments in 1797, when our gold currency was estimated lJy LUI'd Liverpool, Mr. Rose, ami others, at ii'oUl

9

10

Free Banking I

IH7 twenty-five to thirty millions. That stich a measure would not entirely prevent the variations in the value of money, inseparable from the use of a paper currency and so injurious to the public welfare, I am willing to adDlit. The nearer the approximation to a currency entirely metallic, the more steady and uniform ",ill its value be; and perhaps the essential interests of the community would be consulted by prohibiting the circulation of any promissory note below the value of 501. giving the bank of England the power, for the convenience of the country, to issue Bank post bills for sums of 10/. and upwards. If these regulations were adopted, I would propose that the trade in coined money should be perfectly free; that the Mint, according to the plan I had the honour to propose before the Committee of the House of Lords on the Affairs of the Bank in 1819, should possess a fund, which would enable her, immediately on the quality of the bullion being ascertained by assay (and in no case should this exceed forty-eight hours) coined money would be given in exchange for it. I have already endeavoured to show how important and essential such a regulation is to the interests of the community, and the probability, that if such a regulation had been co-existent with Mr. Peel's bill, we should have escaped from the long continued ruinous prices that followed the

Free Banking I

188 measures of the Bank before and after the resump· tion of cash payments. I would further propose, for the general convenience of all classes, but particularly the lower, that an addition of three or four millions should be made to the silver currency at the rate of half a million per annum. The silver currency in the country can never be said to be proportioned to the wants of the community unless every labourer throughout the kingdom can receive his weekly wages in the current coin of the realm. That this is not, and has never been, the case in this country, I think I may safely affirm. On the contrary, we have had 58. and 28. 6d. notes, and checks upon provision shops, and meetings between masters and servants in public houses for the payment of wages, taking from the labourer the power of spending his wages where he pleases, and the advantages of a ready money purchase. The tendency of such a system is to render the labourer more dependant and degraded than he would otherwise be, and in point of fact it must operate, more or less, as a tax on his wages. I am satisfied that an abundant silver currency would add decidedly to the morality, comfort, and independence, of the labouring classes of the communit.y. The profit which the government would deri\Te from these progressive annual coinages (which can be suspended on the first appearance of excess),

11

12

Free Banking I

IH9 would defray the greater part of the charges of the Mint establishment. With regard to the circulation of the country bankers, I would propose, first, that the banking system should be thrown open to within sixty-five miles of London, as agreed upon by the Government and the Bank in 1822,* but that they should issue no notes of lower denominations than the Bank of England. If joint stock banking companies followed the freedom of the trade, there would be sufficient security for the public, and the power of overissuing considerably reduced by the paper currency being confined within narrower limits. That portion of the currency from a 11. note up to twenty or fifty, whatever may be the limit, will hereafter, being metallic, form the solid capital of those who think it their interest to follow the profession of banking. This portion of their capital bankers will lend at interest in the discount of bills, as formerly; but as it is a real and substantial capital, it will not be liable to the same changes from scarcity to abundance, or from abundance to scarcity, as if it were entirely paper. The effect of this plan would be, to give great solidity to our banking system; it would be men of real and substantial capital that would embark in the business, and the public would be freed from the • Since this was written this desirable point has been arranged between the Bank and Government.

Free Banking I

190 ruin OilS consequences that follow an extension and contraction of the paper circulation. A really useful system of paper currency. that !IIystem in fact that enables a nation to apply a portion of her metallic capital to other and productive purposes, ought to be the aim of the Government. If that portion of capital, whatever it may be, can be saved, without producing ruinous speculations and overtrading, it will be beneficial; but if it is attempted to save more capital, by the substitution of paper, than the nature of the system will bear, and subject the community to much more extensive loss by the attempt, it proves something bad in the system: it becomes a question, then, what are the proportions of paper and coin, if any, that can be maintained beneficially in a country, so as not to cause a greater destruction of capital, by speculations and overtrading, than the saving which re~lUlts from the substitution of paper for gold. This is the true mode of estimating the advantages and disadvantages of a mixed currency, such as we have in this country. Supposing the whole CUl'reDcy of the three kingdoms to be fifty millions. If twenty-five millions of gold and twenty-five millions of paper do not keep us free from the evils of a greatly varying value in money, we ought to try any other proportion, greater of gold, and less of paper. If every proportion fail in giving us a fixity of prices, such as would result from a purely metallic currency, ht'IWficial to all, and injllriom to none': we oug-ht

/3

14

Free Banking I

191

at once to come to the resolution of having no other than a metallic currency. Tn other words, make England as the county of Lancashire. An opinion prevails, and I think an erroneous one, that if we were to abolish our paper currency, neither rent nor taxes, of course the interest of the national debt, could be paid. We have attempted to prove that all the advantage to be derived from our paper currency, as a substitution for gold, is the profitable use of that capital for which the paper is a substitute. If this is five, ten, or twenty millions, then the reproduction of that capital, with a profit, is the limit, as it is the maximum, of the actual advantage of our paper currency. Inasmuch as it is an increase to the amount of the productive capital of the country, in so far it assists in the payment of taxes, but no further. Taxes are never paid from currency, though paid in currency. It is from the profits of capital alone that taxes are paid, and currency is the medium by which they are paid. It is of no consequence, therefore, whether the currency is all paper, or partly paper and metallic, or entirely metallic, as far as the payment of rent and taxes are concerned. There has been attributed to the paper currency of this country a sort of magic power, by which wealth has been created and the Government revenue collected, to a much greater extent than it could otherwise have been done, by which the intel'est of the nat.ional debt

Free Banking I

192 has been paid, and without which landlords could not have received their rents; and the inference drawn is, that if the paper currency was restricted in amount, or entirely abolished, the Government could not carry on the affairs of the nation, and landlords could not receive their rents. In this conclusion I cannot agree. If the paper currency at any time has kept prices in this country above their bullion value, which is admitted was the case during a considerable period of the restriction on cash payments, rents would also rise. The restoration of the currency to its Mint value would restore prices to their bullion value, and rents would fall to their proper level, but the landlord would sustain no further injury. The rise of rents from a depreciated currency was not all gain to the landlord, for the purchasing power of his rents was reduced in value from the rise in price of all the articles of consumption. When rents, on the other hand, fall to their bullion value, the loss to the landlord is more nominal than real. General prices are lower, and his diminished amount of rent can command a greater amount of the necessaries of life. I have thought it necessary to state thus much of the principles of currency, before noticing what regulations it may be advisable to introduce with regard to the circulation of the country banks. This subject has deservedly occupied a great

15

16

Free Banking I

198

deal of public attention of late, and several plans have been proposed with the view of introducing health and stability into this portion of our circulation. The assimilating of the country banks of England to those of Scotland has been urged as a remedy (or the evils of the present system. That the introduction of joint stock and chartered banking companies into England would be attended with great advantage, no one will deny-that is acquainted with the stability of the Scotch banks. It would operate as a complete protection to the holders of notes against the insolvency of any of the banks. Here the benefit would end; and great as it manifestly is, I think it the lesser of the two evils that exist in the present country banking system of England. The extensive dis.. tress at this moment felt throughout England, from the discredit and insolvency of the country bankers, has its origin in the power of adding largely and unduly to the amount of the currency. This evil was not confined to England. Scotland has had her currency augmented to the level of England; has had her joint stock speculations and overtrading; has also had her circulation contracted, and public credit impaired; her labourers thrown out of employment, and a general stagnation in trade. The only difference in the two cases is the distress and loss that the lower classes of England have sustained from being the holders of the notes o

Free Banking I

194 of such banks as have become insolvent. But even this distress, great and lamentable as it may be, is not to be compared with the far greater misery that afflicts the population in both countries, from the want of employment that follows the destruction of credit and capital during the stagnation of buying and selling. The poor must suffer until general confidence is restored; and supply and demand resume their ordinary level. The introduction, therefore, of the Scotch system of banking into England, though much superior to that now existing, would be no effectual remedy for the greater evils of our present paper currency, inasmuch as it would not take away the power of adding suddenly and largely to the currency, or diminish the necessity arising from the use of that power, of ~uddenly and extensively contracting the circulation. Another plan has been proposed in the Scotsman's newspaper, 17th of December last. The writer states, that " the repeal of the injurious and absurd restriction which has obtained for more than a century in England, by which more than six individuals are prevented from entering into any co-partnery for the issue of notes, has been suggested as a remedy for the evils complained of. But though this repeal would, by allowing the formation of great joint stock banking companies, possessed of adequate capital, be a very great improvement on the existing system, we are very far

17

18

Free Banking I

indeed from thinking that it would of itself be sufficient. There must always be infinitely more hazard in conducting the business of banking in a highly commercial country like England, than in Scotland; and nothing can be more absurd than to argue, that because few of the Scotch banks have failed, they would therefore succeed equally well in England. There is more speculation in Lancashire in a single week than there is in Scotland in a twelvemonth; and the risk incurred by the banking establishments there must be proportionably great. The fact is, that no company, whether it consists of sir, or si:r hundt'ed thousand partners, ought to be permitted to issue notes at pleasure. For you can have no security that they will not abuse the power to do so; at the same time, that it is certain that the ruin occasioned by the bankruptcy of any establishment will most commonly be directly proportioned to the number of its partners, and the credit and confidence it has enjoyed. To insure the public against the bad faith or the imprudent conduct of the issuers of paper money, it has always appeared to liS to be quite indispensable that a law should be enacted, compelling all individuals or associations who issue notes to hold a certain amount of Government securities proportioned to their issues,as a guarantee for the payment of their paper. There may he some difference of opinion as to the limit at which this proportion ought to he fixed. but we do not o 2

Free Banking 1

196 think it ought to be less than two thirds of the total amoullt of the stamps issued to them. It is to no purpo&e to contend that this would be laying banking companies under any improper restraint. Had the freedom they have hitherto enjoyed been productive of no bad consequences, they would have had some grounds for protesting against being subjected to any restriction; but after the wide-spread mischief, and destruction of individual fortunes, caused by their misconduct and want of capital, Ministers are not only warranted, but they are called upon by a just regard to the public interests, to interfere to put down the present system. Besides, it must be remembered that the bankers will get the same rate of interest on the funded property that is got by other individuals; while the obligation to hold it will have the effect to exclude all persons who are not possessed of capital from the trade, and will prevent those who are possessed of capital from improperly extending their issues. Neither do we attach any weight to the objection of those who contend that this measure would be opposed to the principle of the freedom of industry; for, though generally true, this is a principle that does not hold universally. It is, for example, admitted on all hands, that in order to prevent the confusion that would arise from the currency of coins of different values, but of the same denomination, it is expedient that Government should interfere to prohibit the circulation of

19

20

Free Banking I

197 private tokens, and of all coins which have not been struck at the public Mint. But if such a regulation be, as it most certainly is, expedient, why should it not also be expedient to endeavour to secure the public against loss from the issue of worthless paper money. Women, mechanics, J.. bourers, and individuals of all descriptions. who are no wise qualified to judge of the stability of different banking companies, are all dealers in money; and they have a clear and undoubted right to expect protection and security from such an obvious cause of loss as the granting of permission to everyone who chooses to send notes into circulation." This plan has for its object the protection of the public, who are the holders of the notes of the English country bankers, from any 16ss in case of the insolvency of any of the banks. In this respect, the plan would be productive of the same effects as the joint stock banking companies of Scotland; and beyond this security, the writer does not seem to have any other object in view; and admitting that it would be a guarantee to the public, which I think it would, it is clear, that it is obtained by a sacrifice of a portion of the rate of interest on banking capital in England, to which Scotland and the Bank of England are not subject. It is, I think, objectionable. The writer justifies the principle of his plan, because, in his

Free Banking 1

198 opinion, there must necessarily be more hazard in conducting the banking <:oncerns of a highly commercial country like England than in Scotland. N ow the competition of capital, and the consequent rate of profit, must be the same in Scotland as in Lancashire, and the relative amount of capital and currency will he the same in both. Consequently, there can be no higher state of commercial credit, or greater speculations, in the one country than the other, and no greater hazard to the banks of England than to the banks of Scotland. If, by any regulation the relative amount of currency could be decidedly greater in Lancashire than in Scotland, more extensive speculations and Illore decided hazard would attend banking in Lancashire than in Scotland-but this is supposing a case entirely a.t variance with the principles of currency, which reduces itself to one common level throughout a country. It is the operation of this principle, that renders speculation general, and never local in a country. Speculation and overtrading, as I have already endeavoured to explain, have their origin in an undue increase of the cllrrency, and such as could not take place if entirely metallic, and when this increase takes place in one part of the country, from the very nature and intimate connection of commercial transactions and banking, it becomes in a very short time general in all. There therefore cannot be two rates

21

22

Free Banking I

199 of speculation in a country, without a disproportionate amount of currency, which in the nature of things cannot exist. As far, therefore, as the principle of speCUlation is concerned, there seems no motive for placing the capital of country bankers in England upon a different footing from that of Scotland, which is admitted to give complete security to the holders of their notes. I doubt, however, that such a plan could be carried into effect. For if the rate of interest on banking capital was 5 per cent, a country banker would prefer converting that portion of his capital which he is required to hold in Government securities at 8-6- or 4 per cent into gold, and lend it at the current rate of interest at 5 per cent. The operation of the plan, therefore, if attempted, would be to bring us precisely to the same result, though in an indirect and objectionable way, that would be obtained by the plan that I have in conclusion to propose, that of reducing the paper currency, so as to leave the proportion of one-third paper and twothirds gold. This would leave the banking trade perfectly free, and the security of the public will be found in the amount of capital in gold and silver in circulation compared with the proportion of paper. I would, therefore, propose as a general plan for our currcucy, that 110 bank issuing promissOl'Y notes payaulc 011 dcmand iu England, Scotland,

Free Banking I

200

and Ireland, should be permitted to issue any note of less value than 20/. The accomplishment of this plan should he very gradual, lest the currency should be forced, as in 1819 and 1820, to an unnaturally high value. I would propose, therefore, two years for withdrawing all notes of the value of one and two pounds; in the third year, notes of the value of 51. may be withdrawn; and in the fourth those of the value of 101. ; so that in four years the plan would be in full operation. With a view to facilitate this measure, and give perfect freedom to the trade in money, I would Pl'OPOse to place the Mint under such regulations, with a capital of 250,000/. as would convert all the bullion brought for coinage into currency in forty-eight hours. If this plan was ohjected to as more expensive, and leading to more extensive coinages, I would answer, that from 1777, when the reformation of the gold coinage was completed, to 1797, the average ye.arly coinage was about one million and a half of gold: or about thirty millions; and from 1817 to 1825, a period of nine years, the average annual coinage has exceeded three millions and a. half, or upwards of thirty-two millions sterling.

23

24

Free Banking I

201

CHAPTER XII. Remarks on the plans proposed in Parliament for improving the currency of the country. SINCE the preceding pages were sent to press, Parliament have met, and the state of the currency has been matter of discussion. The general opinion seemed to be, that the circulation of the country bankers was the chief, if not the whole cause of the evils from which the public are suffering; more particularly that portion of it which consisted or notes of one and two pounds value. There can be no question that the insolvency of the country bankers, having a large amount of small notes in circulation, is an evil of great magnitude, and seriously affects the comfort of those in whose hands such notes ultimately fall. But this is a minor evil, in my opinion, to the existence of a power, which has been very frequently called into active operation, that of adding largely and unduly to the amount of the currency; originating schemes of speculation and overtrading, which in their reaction not only affect the comfort of the lowest classes, but ("'ith the exception of annui. tants and persons of fixed money incomes) all classes of the community, far beyond the failure of a few country Lanks. In the late pani<: aLout

Free Banking I

202 70 country bankers became insolvent; and let it be supposed, that the actual loss to the holders of their notes amounted to one million and a half; which is about one-eighth of the whole country circulation in 1825. And if it be further supposed, that one half of the whole, or 750,0001. was held by the working classes (which I think is a liberal calculation), and if their numbers be taken at 500,000/. in England and Wales, their indiviTo a labourer with a dual loss would be 11. lOs. family, I will admit, that the loss of thirty shillings is a matter of considerable consequence; but great as the injury done to him is, I think it comparatively trifling, with the sufferings he and his familyendure by his being thrown out of employment, during the stagnation of trade and manufactures, following such a crisis as we have lately experienced in the money concerns of the country. But the labourers are not the only sufferers; their employers and their families suffer also; and relatively, perhaps, to a much greater extent. Their capitals are deteriorated, and numbers of them sink from respectable stations in society, to a state not much removed from their servants. For such transitions from comfort and affluence to poverty and distress, a remedy ought if possible to be found. In the preceding pages, I have endeavoured, by facts, to tl'ace the calise of such overwhelming Jisll'CbS to its ol'ig'in, and I hope i:iuccessfully. If it

25

26

Free Banking I

is to be found, as 1 think it is, in the nature and management of our cUITency; the remedy can only be applied in a system that will protect the whole community from a recurrence of such extensive ruin and misery as we are now witnessing. The remedial measures proposed by his Majesty's Government, though in themselves beneficial, will not, in my opinion, be attended with such extensive benefit as may be supposed. The introduction of joint stock banking companies, upon the Scotch system, will be as complete a check against insolvency as now exists in Scotland; and here the benefit will cease. The lower classes, indeed all classes, will be freed from the risk of the insolvency of the country banks-as much so. as if the whole country circulation were supplied by branch banks of the Bank of England. The second measure, that of introducing gold fo), the one and two pound notes, will be of very little consequence, provision being made against the insolvency of the country bank; and ought to be no more necessary in England than in Scotland, under the same circumstances. N either measure, it appears to me, is even of the nature of a remedy for the main evil, because they do not take the power from the Bank of England of adding extensively to the currency. It is from the exel'cise of this power that I have endeavoured to trace the cause of general specula..

Free Banking I

204 tion and overtrading, the reaction of which produces such extensive mischief throughout the community. As this in my opinion is the greatest of the two evils, I should have been glad to see the remedy extend to both. The substitution of four or five millions of gold for the country one and two pound notes, will operate as a very slight protection against an overissue of paper by the Bank of England. It must be remembered, that in 1793, we had a very similar failure of commercial credit to the present; and at that time, I think I am correct in stating that the Bank of England had no notes in circulation under 101., and the country bankers none under 51. But even with this extensive metallic currency, we were not protected from general speculation and over-trading, the reaction of which produced such extensive calamity at that time. Mr. Tooke states in his recent work on currency,* that in 1790, the amount of treasure possessed by the Bank was 10,097,000/., and its notes in circulation amounted to 10,217,3601. In 1791, the Bank increased its issues by an advance to Govern. ment of 1,500,000/.; and it was followed by an increase of the country circulation; and I have no doubt to a greater extent than the mere issues of the Bank, upon the principle I have in the preceding pages explained. The consequence was a drain upon the Bank for golJ; so that its treasure ., State of the Currency. p. g.,!,

27

28

Free Banking I ~05

hy September, 1792, was reduced to 6,255,000/. Mr. Tooke states, that there was a further drain of nearly three millions more in the next six months, which he supposes snpplied the place of the discredited notes of the country bankers. In February, 1794, the issues of the Bank amounted to 10.963,380/., and in February, 1795, were increased to 13,539,160/., being 2,575,7801. or fully 18 per cent. By the 31st December, they were further reduced to 9,204,500/., being a reduction from February, 1795, of 4,334,660/., and equal to 32 per cent." There can be no surprise, with such facts as these, that the public should be subject to the mania of speculation and over-trading; nor at the re-action that follows the contraction of the currency. It was tampering with the currency that produced the dreadful crisis of 1797. If the Bank of England increased its portion of the currency 23 per cent in one year; the circulation of the country bankers, upon the principle that I have attempted to establish, would considerably exceed that of the Bank. The attempt, on the part of the Bank, to check the drain upon its coffers for gold, produces a general discredit of the country paper, as in December last; so that, in fact, to find a sufficient remedy for the unwholesome state of the currency, we should begin with the Bank of England; for it would seem that the

* See the Lords' Report of Secrecy,

1797.

Free Banking I

206 evils originate with that establishment. Any remedy, therefore, that does not impart to the currency an uniform value will not be attended with prospective benefit. The substitution, therefore, of gold for the one and two pound notes, will not protect us from an over-issue of paper. It is from this conviction I have proposed that the metallic basis of the country should be still further extended; and that no notes should be in circulation under 20/. I do not say that this will protect us entirely from an over-issue of paper by the Bank of England; but it will certainly operate as a check. When the monopoly of the Bank expires, and the trade in money is perfectly free, a better order of things may arise, and more paper and less coin may be employed, with perfect security to the public; for there is no reason why the competition of capital employed in banking should not produce a steady and uniform result, alike beneficial to the public and to the capitalist. The competition of capital would protect us from any fluctuation in the current rate of interest; the circulation would be always full, but it would never be in excess; any attempt at excess would be instantaneously returned upon the Bank that made the experiment: neither would there be any deficiency, as it would be the interest of every banker to keep the cil'culation to the level of the value of money in other countries, A similar result would follow, as if thf'

29

30

Free Banking I

207

whole currency were metallic; prices would be steady: capital would be freed from its present violent fluctuations in value; the wages of labour would be uniform; and there would be no transitions from comfort and affluence to poverty and want. The moral tone of the community would be improved; there would be a check to the spirit of gambling, general speculation, and over-trading. The completion of such decided improvements ought to be the aim of the legislature.

[2] Excerpt from Thomas Hodgskin, Popular Political Economy, 178-218

CHAPTER VIII. MONEY.

Definition of money.-Natural circumstances which occaaion the invention of money.--DHferent substances which have been used as money.-The precious metals now universally adopted.Reasons for the preference given to them.-Theyare natural or universal money.-Difference between money and wealth.Circumstances which determine the value of the precious metals, and the quantity of money in circulation. - Governments cannot alter the value of money, nor the quantity necessary. -Origin of coining.-It does not alter the natural relation of value in the precious metals.-Frauds practised by Govern .. ments by means of the coin.-Money is regulated in minute detail by natural circumstances, and does not, therefore, require to be regulated by governments.-Origin and evils of government paper.money.-Origin of commercial paper.monl"}'. -Promissory notes and bills.-Vast amount of these now in circulation.-Advantages of this species of money.-Natural cireu.mstances which give rise to bankers.-Their promissory notes form only a small part of commercial paper money.-Advantages of bank notes.-Their disadvantages result from the interference of government.-Amount of the issue of country bankers.-Natural ciroum8tances control and regulate paPil' money. " ~{ONEY ," to use

the definition of Dr. Smith, " is the instrument or means by which every individual in the society has his subsistence, conveniences, and amusements regularly distributed to him in their proper proportions." It is, in fact, only the instrument for carrying on buying and selling, and the consideration of it no more

32

Free Banking I NOT PROPERLY iNCLUDED IN THIS SCIENCE.

179

forms a part of the science of political economy, than the consideration of ships or steam-engines; or of any other instruments employed to facilitate the production and distribution of wealth. It is different from all other instruments, in respect to its being used by the whole community; and not being exclusively the property of any individual. It affords also a very instructive proof of the manner in which the general laws 6f nature operate on the minds of individuals, producing a uniformity of conduct, equal in regularity to any of the movements of the planets. Governments have meddled incessantly with money, which in our time has been the fruitful parent of intricate discussions and painful changes. Money has accordingly attracted much learned attention; and the principles which regulate it have been the subjects of much dispute. On these accounts it is worthy of a brief notice, though having of itself no stronger claims to be treated of in political economy than any of the other instruments or merchandizes useful to man. Into the history of the alterations made in it by our government. or into an examination of the conflicting opinions and schemes of theoretical writers and practical dabblers in legislation, I have no wish to enter; and I shall, therefore, confine my observations to the natural circu'mJ tances which gave occasion to the invention, first of metallic) and afterwards of paper money, and which regulate the quantity and value of both. I have already mentioned the natural circumstance of all commodities being produced in unequal periods, while the wants of the labourer must be supplied daily. This circumstance influences the conduct of mankind at all times and places, after a division of labour has been

Free Banking I

180

NATURAL CIRCUMSTANCES WHICH

introduced. In the rudest state of society, the fisher· man or hunter may obtain a supply of food in one ex~ cursion, but the maker of bows and arrows, canoes or stone hatchets, must employ some days to complete his task. So at present, the produce of the baker, the butcher, or the shoemaker, can be brought to market in a few hours, while the farmer, the tanner, or the grazier, must wait weeks, months, or even years, before he can oWer his produce for sale. This inequality in the time necessary to complete different commodities, would cause the hunter or the baker to have a surplus of game or bread, before the maker of bows and arrows, or the grazier, had any commodity completed to give for the surplus game or bread. No exchange could be made; the bow maker or the grazier, must be also a hunter and a baker; and division oflabour, could its advantages have been conjectured, would only have been regarded as the visionary scheme of some hot-brained enthusiast. The obvious utility of division of labour suggested the means of getting over this difficulty, wltich consisted in the invention of money. Another natural circumstance which influenced the invention of money, was the inequality in the value of commodities which cannot be divided. A bow and arrow could at no time have been precisely equal in value to each of such different things as a hut, a canoe, or a hatchet; or to an ox, a deer, a hare, or a salmon; and these things could not be exchanged for one another, without some measure to determine how much or how many of other commodities were equal in value to those which could not be divided without destroying them. This measure also, be it what it may, is money. H One man," says Dr. Smith, H we shall suppose has

33

34

Free Banking I OCCASION THE INVENTION' OF MONEY.

181

more of a certain commodity than he himself has occasion for, while another has less. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange except the different productions of their respective trades; and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can in tbis case be made between them. He cannot be their merchant, nor they his customers; and they are all of them less mutually serviceable to each other." "To obviate this difficulty," Dr. Smith adds, "each of tht!m would endeavour to obtain possession of some (additional) commodity, which he kne,v would be received by others at all times and places ;". this commodity is money. The language used by Dr. Smith might almost make us suppose that he regarded the invention of money as a chance occurrence; or, at least, that he had not formed any accurate idea of those specific circumstances which give rise to the employment of some one commodity as money, whenever the division of labour is introduced. Those circumstances are inequalities in the periods necessary to production, inequalities in the value of indivisible commodities, and one man not producing what another desires, while he desires what that other possesses. Owing to these natural circumstances, labourers cannot possibly supply their mutual wants by barter. The invention of money, therefore, or the employment of some one commodity as a measure of the value, or means of exchanging all commo• Wealth of Nations, book i., chap. 4.

Free &nking I

182

DIPPERENT ARTICLES USED AS MONEY.

dities, is a natural and necessary step in the progress of society; is introduced by division of labour, being essential to the continuance of this practice; is as equally useful, therefore, as it, and as generally adopted. METALLIC HONEY will first engage our attention, and we shall consider only the precious metals. For al. though some particular commodity, as a measure of the value of other commodities, has been used since the beginning of history, and amongst most of the nations of the earth, just as they have all had some measure of capacity and of linear extent; yet, as one nation selects a yard and another e metre as the measure of length, so different commodities have been employed as money at different times and places. In the early ages of the world, the articles most generally useful, such as cattle, salt, iron, cloth,· and in cold climates, among the ancient Russians for example, furs,t were used as money; in the West Indies, sugar; in N ewfoundland, salt fish; and in some parts of Africa, small shells,-have been the currency. On the western coasts of this continent it is still customary, as it was for .. • Wealth of Nations, book i. chap. 4. t Cour. d' Economie Politiqu.e. The armour of Diomede is said by Homer to have cost nine o.ren, but M. Garnier has shown, according to M. Say, Notes to Storch, that this valuation was made in a species of metallic money having an ox or a bull stamped on it, and so called from this circumstance; just as we calla certain coin a sovereign, from its bearing the image of the King's head. There is no reason to suppose that the King's head is stamped on the gold because it is worth about twenty shillings, but an ox was probably about equal in value to the piece of metal on which it was stamped, and was selected because oxen had previously been used as money.

35

36

Free Banking I

REASONS FOB. ADOPTING THE PRECIOUS METALS.

183

merly in Virginia, to reckon in rolls of tobacco or bars of iron; and in Bomou, Major Denham informs us in his recent travels} that gubkas, or narrow strips of cloth, constitute its money. The precious metals, however, or gold and silver, are now, and have been for ages, the money not only of all Europe, but of the greater part of Asia, Africa, and America, and they are willin~ly received at the islands of the Pacific Ocean. As natural circumstances dictate the use of some one commodity as a measure of the value of others, or as a means of exchanging them, so we may be sure that the preference universally given to the precious metals, has its source in some obvious natural circumstances. These natural circumstances are the peculiar proper· ties of the metals, and they are stated by Mr. M'Cul. loch to be, first, the capacity of almost infinite divisi. bility, so that they can be made to represent commodities of almost every degree of value; second, great durability, so that they are not deteriorated by time; third, great value in small bulk, 80 that they can be cheaply transported; fourth, sameness, so that pieces of metal of the same size and denomination, are always equal to one another; and fifth, steadiness in value, without which they would not serve to measure the value of other commodities. It is not affirmed that the value of gold and silver is invariable, but it is less variable than that of most other things. The other qualities mentioned also belong, in a higher degree, to the precious metals than to any other known substances; and these qualities have operated with such uniformity on the mind of man, at all times and places, that they have always induced him to act in a uniform

Free Banking I

184

THEY ARB UNIVERSAL MONEY.

manner, and employ the precious metals as money. The power of the mightiest conqueror the world ever saw, lasted only for his life; and his influence extended only over a very limited spaee, while the use of the precious metals as money, has been known for many centuries, and is now nearly universal. The employment of them as money, therefore, and it ought never to be forgotten, began, like division of labour. without the interference of any legislature. :Metallic money is not like an army of ruffian soldiers, the offspring of law, and the creature of governments, it is something instinctively adopted by the human race. "It has not been," says the philosophic Turgot, "in consequence of any agreement among men, or by the intervention of any law, but by the nature and force of things, that tbe precious metals have become universal money." It is sometimes supposed that money and wealth are synonymous, which is indeed true of individuals, but not of nations. During the late war, for example, when the notes of the Bank of England were declared by the legislature to be good and sufficient money, the precious metals were nearly banished from circulation. N otwithstanding the loss of our gold and silver, and notwithstanding a more profligate waste of public treasure than even the subjects of our most extravagant government ever before witnessed, the nation increased in population, power, and wealth. An individual gets all the money he can, and is said to be rich in proportion as he possesses or can procure a great deal of it; but the wealth of nations is exclusively measured by the conveniencies, comforts, and luxuries enjoyed by all their inhabitants. The money possessed by an in-

37

38

Free Banking I WHAT DETERMINES THE VALUE OF MONEY.

IB5

dividualmay be called his wealth, because he can buy with it whatever he wants j the money in anyone country will in general circulate as money only there, and the bullion, like cloth or corn, will only buy commodities from other countries, or exchange for them in proportion to its intrinsic value. We can hardly suppose, as natural circumstances dictate the employment of some one commodity as a measure of the value of others, and forcibly recommend the adoption of the precious metals for this purpose, that the quantity of money possessed or required by any country at any one time, is not also regulated by some natural circumstance. As money is not the offspring of legislation, 80 it is not by laws that its quantity or value are regulated. Two natural circumstances which exist quite independent of governments, though they interfere with and derange them; viz. the quantity of labour required to obtain or purchase the precious metals and other commodities, and the number of exchanges to be completed in any given time and place, always determine the relative value of these metals to all other commodities, and what quantity of them must be in circulation. As all commodities are exclusively the produce of labour, there is no other rule, and can be no other rule, for determining their relative value to each other, but the quantity of labour required to produce each and all of them. This circumstance establishes between the precious metals and all other commodities a natural relation, subject only to such variations as may be caused by an increased difficulty or facility of procuring anyone commodity, including the precious metals. I do not say that governments cannot alter and disturb this relation; that they may not, by prohibi-

Free Banking I

186

THE VALUE

or

THE PRECIOUS METALS

tions or bounties~ enhance the difiiculties of procuring some certain commodities; and that they may not, by particular taxes, derange the proportions in which they would naturally exchange for each other; but I say different quantities of labour are naturally necessary to procure, and different degrees of diffi.culty are naturally met with in procuring all commodities, and these different quantities of labour, these different degrees of difficulty, establish in our minds a natural relation of value between all commodities, including the precious metals, which, though it may vary, exists at all times and places, quite independent of any human laws whatever. The precious metals, therefore, have a settled value, both in relation to each other, and in relation to all other commodities, which is always determined by the quantity of labour necessary to produce each and all of them.· Thus when the harvest is short, the quantity of labour employed in preparing the ground and gathering in the crops, being about the same as if the harvest were abundant, more labour than usual has been employed in producing a given quantity of corn, and corn accordingly rises in value in relation to all other commodities. The apprehensions of scarcity may inter• It is perhaps necessary for me to notice that some authors reject labour as the exclusive standard of value; and add profit and include rent. With their trifling, verbal, and nonsensical discussions, I have no wish to take up the reader's time, particularly &8 all the observations in the text apply only to the relative value of commodities, which is, for all commodities, equally affected by rent and profit; which, therefore, as far as the relation I am considering is concerned, may be rejected, even on their theories, without leading to any error. The reasoning would be wrong, certainly, if I were to include labour, the creator of aU wealth, as they most erroneousl y do, under the term commodities.

39

40

Free Banking I

REGULATED BY THE COST OF PRODUCTION.

187

vene and raise this price far beyond what remunerates the agriculturist for his labour; but, independent of this apprehension, the corn would necessarily rise in value, because more labour had been expended on a given quantity. On the same principle, it is well known that the successive improvements introduced into the manufacture of all metallic articles and most articles of clothing within the last century, having diminished the quantity of labour necessary to produce them, they have all fallen in value. On the same principle also, the discovery of America lowered the value of the precious metals throughout Europe. The consequence of that discovery was to supply us with gold and silver, particularly the latter, by means of less labour than was necessary to obtain them from the mines of Europe. Accordingly, gold and silver in a few years fell so much in value, that the period of the discovery of America has become a remarkable era in the history of political economy, as well as in the more extensive history of mankind. After that period it became necessary throughout Europe, to give more than three times as much silver as was before given for corn.* This alteration was co-extensive with the use of the precious metals as money; and confirms to demonstration the statement, that their value in relation to other commodities is determined by natural circumstances. Having established this principle, we see clearly another principle which determines the quantity of money required in any country. Gold and silver are used for many other purposes besides money; and they are expensive articles. As money they facilitate the ex.. Wealth of Nations, book i. chap. ll.

Free Banking 1

188

WHAT RRGULATES THE QUANTITY OF MONEY.

changes which are necessary to the continuance of division of labour. Miners will not supply these metals without an adequate payment, and other men will not pay miners unless they require the precious metals. Their want of money is regulated by the number of exchanges to be made or the quantities of goods to be bought and sold; and thus the quantity of money required at any time and place, is always determined by the number of exchanges to be made. Of course the relative value of the precious metals to other commodities determines how much of them must be given for other things; and the number of sales to be made within a given period, determines, as far as money is the instrument for effecting those sales,-the quantity of money required. Governments may indirectly, but not directly influence the quantity of business, and thus the quantity of money necessary in a country. They may for example, by exorbitant taxation check all industry, and extinguish many productive enterprises, but producing nothing themselves, they have no powE'r whatever to increase business; and, therefore. no power to influence or determine the quantity of money required in any country. At all times, however, they have endeavoured to regulate both the value of the precious metals when used as coin, and the quantity of money in circulation. Not to enter any further into the history of their proceedings than is necessary to explain the principle and source of their interference, I shall here only remark, that whenever they have by their regulations departed from the standard established by the natural circumstances just pointed out, the tendency of thing& to regulate themselves by these natural circumstances

41

42

Free Banking I ORIGIN OF COINING.

189

is so much more powerful than all the restraints of the legislator, that sooner or later it has mastered his laws, and occasioned frightful convulsions in property. When the precious metals were first used as money, they were always weighed like any other commodity; a practice still continued in China and some other countries, and still adopted in all countries with foreign coin. "Abraham," we are told, "weighed to Ephron the silver which he had named in the audience of the sons of Heth, four hundred shekels of silver, current money with the merchant."· "The revenues of the ancient Saxon Kings of England are said to have been paid, not in money but in kind, that is, in victuals and provisions of all sorts. William the Conqueror introduced the custom of paying them in money. This money, however, was for a long time received at the Exchequer by weight, and not by tale."t At present, if we carry foreign coins} or even guineas, to a money changer, he weighs them to determine their value. The plan of dividing the metals into small pieces, certifying the weight and value of each piece by a stamp or mark, was an after invention; the utility and conveniency of which, as a means of telling every body that the metal was genuine, and what it was worth, must soon have forced themselves into notice. The visible characteristics of the precious metals are possessed by other substances, and it requires the art of the goldsmith or assayist to ascertain their genuineness. For every man to go through this proce!!s in buying and selling would be impossible; and even to weigh each piece of metal, would be almost ~

Genesis, chap. xxiii.

t Wealth of Nations, book i. chap. 4.

Free Banking I

]90

GOVERNMENTS THE ONLY COINERS.

an endless task. By the bullion being assayed in large quantities, then divided into small portions, each portion being marked to signify that it contains a certain weight of metal of a specific fineness, individuals were spared the trouble of assaying and weighing the metals. Such a process is therefore very useful, and accordingly coining has been introduced wherever the preciou~ metals have been employed as money. Governments having perceived the use which might be made of taking this process into their own hands, forbad individuals to coin money, and declared themselves the only lawful coiners. From money being used by the whole society also, it is not the peculiar business of anyone individual to regulate and arrange it, though I have no doubt, had the matter not been interfered with, that in the progress of society there would have arisen a class of labourers deserving the confidence of society, whose exclusive business it would have been to have supplied metallic, as such a class of men now sl.lpply paper money. It having been supposed, however, in this as in numberless similar eases, that unless the legislature made regulations, there would be only disorder and confusion, governments accordingly assumed the power of coining. Moreover, those who are allowed to coin money mu~t necessarily enjoy the public confidence, which governments have generally done,-whether justly or not, the reader must determine for himself,-or they have been able to compel obedience to their decrees, and having assumed the power to coin, were either tru~ed or obeyed. To me there seems no other grounds for governments taking on themselves the charge of providing the community with coined money.

43

44

Free Banking I EFFECTS Oll' COlKING ON VALUE.

19]

Coining, the reader will recollect, does not and cannot alter the natural relation of value which exists between the precious metals and all other commodities, except that it adapts them better to perform the functions of money, adding to their utility, and giving them a slight increase of value in proportion to the labour of assaying and coining them. We should immediately see the absurdity of any endeavour to alter the relative value of commodities, ,vere the attempt made with any thing but money. If the government, for example, should decree that an ox should be given for a sheep, and a sheep for a hat or a pair of stockings, its folly would be laughed at, its unjust interference would excite our indignation, and its decrees would be despised and disobeyed. The same would be the case with all other similar commodities; and what is there then in the nature of gold and silver which should release them from this general law, and enable governments by a fiat of theirs, to establish a relation of value between them and other things which does not naturally exist? There is nothing; and when it has been ascertained, for example, that a piece of gold as large as a sovereign is equal in value to a quantity of silver containing twenty shillings; or when it has been resolved to coin gold into pieces weighing a certain number of grains, the King's head, and the royal arms, or whatever else may be the chosen marks, are only intended to testify this fact to the community, on the authority of the sovereign. It is a declaration that the piece of gold is worth twenty shillings. Formerly it was the custom to mark on each coin its weight and value, in relation to some other commodity, and this good custom is still kept up in some of the nations on

Free Banking I

192

FRAUDS OF GOVERNMENTS.

the Continent. A piece of gold in France, though called a Napoleon, or a Louis d'or, tells you, or told you on the reverse side, up to a late period,-for the present government has substituted the lilies of the Bourbons for the words of common sense,-that it was worth twenty pieces of silver or francs. In this country the people are informed by a proclamation of the value of the coin; and his Majesty's head, and the royal arms, or Britannia, or George ancl the Dragon, are substituted for some plain expressions which we can all understand. When the reader iii aware that governments have no power to alter the natural relation of value between the precious metals and other commodities, and that they have only assumed the power of certifying this relation by issuing coin, in order, as they say, to guard the people against imposition and fraud, he will form a correct opinion of their honesty, honour, and trustworthiness, when he also recollects or is informed, that all governments have frequently used this power to delude and defraud their subjects. They have either mixed the precious metals with baser materials, or tlley have divided them into smaller pieces, certifying at the same time by their public seals, or by the busts of their chiefs, that the coin remained of the same value. It would carry me a great deal too far, were I to enter into a history of the proceedings of the different governments of Europe in debasing the coin of their respective dominions, endeavouring to cheat their subjects by tricks unworthy of the meanest sharpers :-though I know not if the whole history of the erring confidence of mankind affords a more instructive lesson; and I must content myself, therefore, with mentioning the single example of the English

45

46

Free Banking I FRAUDS OF GOVERNMENTS.

193

pound and penny, which had been so adulterated by successive governments, that when Dr. Smith wrote, they contained about one-third only of the quantity of metal they originally contained." It has been quite in vain, however, that governments have tried to give a value to their coin different from that of the precious metals they contained, settled as that is in our minds, by what Dr. Smith calls the" higgling of the market;" or rather by the labour required to procure them and all other commodities. Whether they have altered the denomination of the coin, while the quantityof metal in it has remained the same; or whether they have lessened the quantity or deteriorated the quality, and have preserved the same denomination; all the efforts of successive governments here and on the Continent, to keep the public coin in circulation at a fictitious value, have been quite fruitless: and whether the standard were a pound as in England, a livre as in France, aflorin as in Austria, it has always come, in a very short period, to exchange for the value of the precious metal it contained, and no more. TIle universality of this fact establishes to demonstration the uniformity as well as the universality of that law which settles and determines in the minds of all men, at all times and places, the natural relation of value between all commodities. Were it suitable to enter in this short treatise into • For the illultration of thp. statement in the text, I must refer to the" Wealth of Nations," book 1. chap.4; to Mr. Storch's Cours d'Eoonomie Politique, vol. 4, Note on " Banking;" and to an admirable article by Mr. M'Culloch entitled" MOM!J" in the Supplement to the Encyclopilldia Britannica. Such writings teach real practical wisdom. K

Free Banking I

194

GOVERNMENTS OUGHT NO'!' TO BE COINERS.

the question whether governments should have the power of coining money or not; and were the question worth discussion, which it hardly seems to be; for paper11UJne!l issued by private individuals, whatever may be the opinions and practices of legislators on the subject, will unquestionably supersede, even to a greater degree than at present, metallic money,-I think I could shew, as money is not, like an order of nobility or a regiment of dragoons, the invention and creature of governments, that they have no occasion to regulate the coin of any country. I am sure I could satisfy every reasonable man, that no individuals are so utterly and completely unfit for this purpose as those who possess and exercise political power. Experience tells us, that of all false coiners, none have so sported with the confidence of mankind, under the pretence of protecting them from false coiners, as governments. By making alterations in the coin, they have altered all the relations of property, and have produced longer confusion and more varied misery in every country of Europe, than could by any possibility have been caused by their subjects resolving not to submit to their power. In practice, moreover, the question seems already settled. To supply the necessary quantity of bullion is unquestionably a far more important part of the whole process than assaying it and certifying its value by a stamp. As the rule, our government never interferes with the supply of bullion; leaving it to individuals, who import or export bullion according to the state of the markets. The mint merely stamps what they bring, most injudiciously charging them nothing for the labour of coining; and taxing the nation for the benefit of those who deal in money. It would seem therefore, both in theory

47

48

Free Banking I MONEY REGULATED BY NATURAL CIRCUMSTANCES.

195

and practice, that the best way of keeping the metallic currency of any country steady in value, and to have a proper quantity in circulation, is to allow both bullion and coin to be freely imported and exported like all other commodities, and freely dealt with by all classes and conditions of men, like the equally useful articles of hats and shoes. * In all the works of Nature we may observe a delightful uniformity of purpose, a harmony in executing that purpose which never permits any collision, and a completeness which leaves to our finite understandings nothing to be desired. There are never any harsh interruptions of the general order: and as natural circumstances dictate in one stage of society the use of the precious metals as money, regulating both their value and quantity, it would be inconsistent with that general order to imagine that Nature ceases her instructions at this point, and leaves the numberless other circumstances connected with a safe and sound currency to be regulated by chance, or by the ignorant

'* There is abundant reason to believe that the practice of coining originated with individuals, and was carried on by them before it was seized on and monopolized by governments. "In many countries," says Mr. Storch, "the care of ascertaining the weight and stamping the metals was left to individuals."- " Such was for a long time the practice in Russia." The Royal prerogative of coining therefore, about which so much has been said in Parliament, is of no remote antiquity. It smacks much more of usurpation than the practice of issuing bank-notes. Individual coiners would always be responsible to the public; but the individuals who possess the powers of government are in almost all countries irresponsible. They alone may defraud the community uncontrolled; they therefore ought not to have temptation laid in their way, by being the only privileged coiners. x2

Free Banking I

196

MONEY REGULATEn BY NATURAL CIRCUMSTANCES.

presumption of ambitious men. Though money is sometimes supposed to be the invention of statesmen, and to require their control more than the other parts of that wonderful system of combined production which takes place in civilized society, I know no part of it which affords, better than money, an illustration of the important fact, that this system is regulated in its minutest details by natural circumstances. lVloney, we have seen, is a universal, and therefore a natural invention; and the precious metals are universal or natural money. Their value is determined by that natural law by which labour produces all wealth, and is the sole measure of value : and having a determinate natural value in relation to other commodities, the quantity of them required at any time and place is regulated by the quantity of produce to be exchanged, or of commodities to be bought and sold. A certain chemical proportion in alloying the metals must be observed, to make them answer the purpose of money in the best manner, and mathematical laws dictate into what aliquot parts they ought to be divided; though hitherto these latter circumstances have formed no part of the scientific researches of those who have discussed the theory of money, or have vainly attempted to regulate it by their decrees. In tracing the origin of money, I have mentioned its chief utility. It aids production, by facilitating barter and contributing to division of labour. "'Vhen money," says 1\I. Storch, "supplies the place of all other commodities, every man can more readily give himself up to one exclusive occupation; rejecting all other means of providing for his wants, than that of procuring, by the sale of his own produce, as much money as possible, being fully assured that with money

49

50

Free Banking I GOVERNMENT PAPER MONEY.

197

he can buy every thing else." As a man can dispose of small portions of produce that is corruptible, for what is incorruptible, he is under no temptation to throw it away; and thus the use of money adds to wealth, by preventing waste. The disadvantages sometimes eloquently attributed to it by poets and moralists, arise not from the convenient use of stamped pieces of gold and silver, but from the passions of men; they are examples of profusion or ambition, of fraud or avarice, or of the power possessed by some over the labour of others, of which money is only the sign, the representative, and the servant. PAPER MONEY, one kind or another of which is used in the greater part of the civilized world, is now to be treated of. We may distinguish two species of it, each of which possesses very different characteristics, and has very different eff~cts ; viz. paper money issued, regulated, and controlled by governments; and paper money issued and circulated by merchants, bankers, and tradesmen, for the purposes of commerce. Paper money of the former description has been issued by almost every government of Europe, either directly by its authority. or by some bank, the funds of which it has appropriated to its own use, while it has forcibly kept the notes of the bank in circulation. On the Continent, the sovereigns have generally issued their own paper, for the express purpose of supplying their wants by this mode of levying a tax on their subjects; or as a substitute for metallic coin. In this country the government, after borrowing the funds of the Bank, passed a law to make its notes a legal tender, and relieved it from the responsibility of paying ill specie. So far it acted on the same arbitrary principles

Free Banking I

198

ANTIQUITY OF THE INVENTION.

as the governments of the Continent. It converted the Bank into a state machine for emitting and keeping in circulation a forced and depreciated paper money. The reasons which should make us refuse to governments the privilege of coining money, have tenfold force against their becoming bankers and issuers of paper money of any description. "The payment of their notes depends," says Mr. Storch, "on the will of the government, which cannot be compelled, like individuals, to fulfil its engagements."· However they may debase the coin, it still possesses some value, and cannot be issued ill boundless excess; but paper money, which cannot be exchanged for specie, is quite valueless: and as there can be no limit to its issue, it confers on the individuals WllO possess the government a boundless power of working mischief. The invention of this sort of paper money is of great antiquity, and its use is of wider extent than the reader may probably suppose. H It was invented," says Mr. Storch, "long before the first bank of circulation was established. That of Saint George of Genoa, the most untient we know of, was not founded till 1407, while Koblai, the grandson of Genghis Khan, introduced paper money into China towards the end of the thirteenth century,-·an example which was immediately imitated by his cousin Kaigatou, the Klmn of Persia. Both were, however, soon obliged to abolish it, in COIlsequence of the great disorders it produced in their respective states. I do not on this account," Mr. Storch continues, "pretend to affirm that paper money was invented among the Mongols; on the contrary, the invention was so easily made, that it was probably •

COUl'S

d'Economie Politique, book vi. chap. 14.

51

52

Free Banking I A CAUSE OF GREAT DISORDER.

199

brought into use long before this period. Since that time," he adds, "the Chinese government has again introduced paper money into its dominions, and I possess a Chinese assign at, which was given me by a Russian traveller on his return from China."· It seems also, from the same author's statements, that paper money is used in Turkey. Paper money issued by governments is, therefore, very extensively known, and has been long in use. Of this description of paper money I have only to say, that it never is issued but for the purpose of surreptitiously and fraudulently levying a tax on the people. It is a complete cheat and a nuisance; and from the period when it was invented by the Tartar robber Koblai, it being the worthy offspring of ,Mongol rapacity, till the acts of the last session of our Parliament, or its authorised issue of Exchequer bills during the present session, paper money, issued, regulated, or controlled by governments, has ever been as at first, and in all countries, as in China and Persia, a source of innumerable disorders. Commercial paper money is something very different; promissory notes to pay certain sums of money at specific periods, are probably the most ancient species of commercial paper money, and must have come into use almost as early as the invention of writing and the beginning of trade. The merchant who undertakes a long voyage, or the manufacturer who plans an extensive project, requires the means of subsistence and of continuing his operations till his produce can be hrought to market. He accordingly borrows the goods which he needs daily, or the money to buy them, pro• Cours d'Eeollomie Politi(ple, vol. 4. note xvi.

Free Banking I

200

COMMERCIAL PAPER MONEY.

mising payment at some specific time, or when his own produce is sold. Persons are willing to supply him with this accommodation, because his future produce will be his only means of payment, and in fact the only commodities produced to exchange for what he immediately requires, and of course the oIlly market for it. Such was probably the origin of promissory notes, and, in their most legitimate form, they are merely a happy invention, like metallic money, for exchanging commodities requiring different periods to complete them; which, without such an invention, could never have constituted the market for each other, and neither of which, consequently, would ever have been produced. It is, however, to be considered as chiefly resulting from those long commercial undertakings, which extend over months or years before they produce any thing for sale, of which there are no examples in the infancy of society. All trade, though nominally transacted by money, is in fact the exchange of one commodity for another. The London merchant buys wine at Oporto for so many milreas, and the Portuguese merchant orders cloth from London to the amount of so many pounds sterling; but in fact, the wine pays for the cloth, and the cloth for the wine. The Portuguese merchant obtains from his neighbour, the wine-grower, for a proper consideration, an order to receive the price of his wine from the London importer, or the latter procures from the cloth-manufacturer an order to receive the price of his cloth from the Portuguese importer; and, by such an order, each of these merchants is enabled to pay his creditor. on the spot where he lives, without using money. The order to receive such a. sum is called a bill of exchange. In

53

54

Free Banking I PROMISSORY NOTES.

BILLS OF EXCHANGE.

201

fact, therefore, the cloth is bartered for the wine, money being used to reckon the value of each without any being transmitted, or even employed to effect the payment. Such orders or bills, it is obvious, are not confined to making payments between, politically speaking, foreign countries; they are also used to make payments between individuals of the same state. 'fo enable the person on whom they are drawn to provide for the payment of them, this depending principally on his selling or completing the article, on account of which credit has been given to him, they are made payable at or after some specific period. Like promissory notes, they have a settled and fixed term of payment,-and, in general, represent commodities on their way to the market. 'fhose who received promissory notes or held bills not yet due, might require to make purchases or pay-· ments when they had no money. In this case they would make over the notes or the bills to their creditors, pledging their credit as the credit of the issuers of the promissory notes, or of the acceptors of the bill, was already pled gd for its payment; and thus both promissory notes and bills of a long date would pass through many hands, and be the means of making many payments before they were finally discharged. In general all bona .fide commercial bills and notes orignated in a well-founded expectation of having the means at a subsequent period, by the production or sale of commodities, to take them up, or pay them. At least, they were in the vast majority of cases duly honoured, and thus they came to be considered as of equal value to the money they were to entitle the ho1der to receive at a K

5

Free Banking I

202

EXTENSIVE USE OF BILLS.

certain time or place. As long as they are so considered, and as long as they are in circulation, or passing from hand to hand, they perform all the function~ of money. " Bills of exchange," says Mr. Burgess, " have long ceased to be merely an instrument of commerce to render perfect a mercantile transaction between country and country, and internal bills have become gradually more and more a part of our circulation; they have ceased to be so currently used by the manufacturers in payment of small sums under ten pounds as they were thirty or forty years ago, owing to the high rates of stamps upon small SUIllS. Bills above the value of ten pounds form now as completely a part of the currency as bank of England notes. They are used to pay for minerals-for all kinds of raw produce used in manufactures-for all the principal articles of food or clothing, and recently, in some cases, for mere labour. If a butcher in the north of England buys cattle, he pays for them partly in these bills, and partly in country bank notes. If a miller buys corn, or a mealman or a baker flour, he does the same. If a Yorkshire wool-buyer purchase wool of the farmers in the country, or in Northumberland, or in Lincolnshire, he pays for it partly in these bills, partly in country bank notes, or sometimes wholly in one kind, and sometimes wholly in the other. In the manufacturing districts of Yorkshire and Lancashire, no man, generally speaking, thinks of paying for any commodities above the value of ten pounds, otherwise than by a bill after date. This practice is now very general through the northern and midland

55

56

Free Banking I AMOUNT IN CIRCULATION.

203

counties, and is increasing in other parts. ill" "A bill at three months is considered in Lancashire and part of Yorkshire, which as regards bills is almost half the kingdom, to be a money payment.+" Mr. Burgess then proceeds to make some conjectures as to the amount of such bills which are continually in circulation. The data on which he proc~eds seem worthy of confidence, and he concludes that the amount of such bills continually in circulation, continually performing the functions of money, is not less than three hundred millions S'rERLING. 'Vhether this statement be strictly accurate or not, it cannot be doubted by any man ill the least conversant with the present mode of managing business, that bills and promissory notes issued and circulated by manufacturers, merchants and traders, do at present constitute by far the greater part of the circulating medium, understanding by that the instrument used for buying and selling, of this commercial and euterprising country. This species of money is comparatively of such modern origin, and has grown up with such great rapidity, that governments have not yet thought of regulating its issue except by levying a stamp duty on bills and notes; we are all therefore fully sensible that this valuable instrument is not the offspring of legislation. It may be even doubted if there be any .. A Letter to the Right HOIl. G. Canning, &c. &e. Henry Bll1'g'ess, Esq., page 19.

t

By

Ihid. page 24. This letter is evi,lently written hy a man well aClluaillted with the commercial districts of England ; and the statement deserves, I am informed, the confidence of the reader.

Free Banking I

204

NECESSITY OF COMMERCIAL PAPER MONEY.

possibility either to regulate or control it by law without such an interference with private business as would not be tolerated. Whether the few presumptuous beings who call themselves, and who get a multitude of beings as unwise as their masters are presumptuous, to call them the state, sanction the issue of commercial paper money or not; whether they permit bankers' notes for every sum, or limit them to a specific amount, paper money must and will form the principal part of the circulation in every well-peopled and industrious country. It grows up in all count.ries, for it is in use in every part of the civilized world, unwilled by the legislature and almost unknown to it; and seems as necessary a step in progressive improvement as that metallic currency, which it has already superseded to a vast extent, and seems destined almost wholly to supersede. It is not a question of theory, whether paper can be substituted for gold and silver; it is not a proposed arrangement of some individuals, or of the legislature, to employ paper for metallic money; it is not a scheme of some hot-brained projector, hut it is found in practice and by general agreement, that by far the greater number of exchanges can be and are actually made without using metallic money. The costly commodities of gold and silver may therefore be dispensed with in the progress of society, and all the labour necessary to keep a money of the precious metals in circulation, amounting to several millions sterling per annum, in this country alone, may, hy the happy invention of commercial paper money, be directed to produce commodities adapted to supply our animal wants or add to our enjoyments. The promissory notes issued by bankers, commonly

57

58

Free Banking I BANKERS PROMISSORY NOTES.

205

known by the name of bank notes, are only one particular Idnd of commercial paper money. Properly speaking, they no more fall to be considered in the science of political economy, than the promissory notes or bills of any other class of traders. They form altogether, including the Bank of England. notes, and all the bank notes issued by private bankers, not above the sixth part of the commercial paper money of the country. Why they should have so exclusively attracted the attention of politicians, and why they should have been the subjects of so much censure, while every other description of paper money, particularly that authorised by governments, the very worst of all, should lmve been unnoticed or praised, cannot be accounted for on any scientific principles. But this being tile fact, I propose very briefly to explain the origin and utility of private bankers, and of the bank notes issued by them; from which we may probably learn, that they are a necessary part of that great social system of production which is not the offspring of legislation; and they therefore do not require, in any manner or degree, to be regulated by the legislator. With the exception of banks expressly established by governments, like the Bank of Assignats, at St. Petersburg, and the Bank of Stockholm,-and of banks incorporated and authorised by governments, to which they have granted exclusive privileges, like the Bunk of England, it is plain that the existence of such a class of tradesmen as bankers can no more be attributed to any act of the legislature, than the existence of such separate classes as farmers and merchants. As men multiplied, and division of labour was extended, one class of men came to deal only in money, as ano-

Free Banking I

206

ORIGIN AND UTILITY OF BANKERS.

ther class deals only in wine, or in Manchester goods. As trade extended, the exchanges between different states, and different parts of the same states, became more frequent, and many transmissions of money or bills of exchange became necessary. This species of business fell into the hands of those who dealt exclusively in money. In consequence, it was soon found convenient to employ them in settling all accounts between merchants living at different places} and even at the same place. From the extensive connexion they formed by this employment, they came to know, better than any other men, the mercantile character and credit of merchants and manufacturers: they were, therefore, enabled to lend out money to advantage; and most of the persons who had money to lend, placed it in their hands for this purpose. They accordingly became, and still are, the chief agents in supplying money or capital to those who engaged in useful undertakings, the produce of which could not be immediately brought to market. Thus arose that class of men called bankers, who are still very important, and have long been very useful labourers. We may be satisfied of their utility by observing, that they are found in every part of Europe, and that all classes and conditions of tradesmen and dealers 'Voluntarily employ them. They first sprang up in Italy, then the most enterprising and civilized part of the world; they came from that country to this,-Lombard Street, the great seat of our banking establishments, deriving its name from them,-and at present, while theirs is a branch of business almost extinct in Italy, it is established in every town of this country, now the great seat of commercial enterprise, and the farthest advanced in the

59

60

Free Banking I ORIGIN OF THEIR ISSUE OF NOII::S.

207

natural system of co-operating production. Their business results naturally, therefore, from division of labour, and is extended as men multiply. Being only one small, though a necessary branch of this vast system, why should their proceedings or business be in any manner regulated by that legislative authority, wllich had no hand in establishing, and is unable to extend division of labour? In fact, there is only one small part of their business with which our government does interfere, viz. the issuing of promissory notes. Let us look, therefore, at its natural origin. They receive money in deposit, and they lend money. They are, as the rule, therefore, persons of established credit, and worthy of confidence; and their promissory notes, on account of their transacting all the money transactions of the neighbourhood, are naturally much more acceptable than those of any other tradesmen. Instead, therefore, of lending money to a merchant or manufacturer to buy commodities, they lent him their credit. They exchanged the large promissory notes or bills of other tradesmen, for their own small promissory notes. To the merchant, on account of their established credit, these small notes were as valuable as gold. The bankers have confidence in the individual to whom they lend money, for the whole length of time his bills are to run j and their promissory notes are, to all other persons, better than his, on account of their general credit, and on account of being made payable at sight " while the large commercial bills drawn on account of commodities not yet in the market, are always made payable at some specific and distant time. Bank notes grew out of bills of exchange and promissory notes, and only differ from

Free Banking I

208

BANK NOTES A PART OF THE NATURAL SYSTEM.

other species of commercial paper money, in being the promissory notes of a particular class of tradesmen deserving general credit; and in general having the great advantage of being payable at sight. The circumstances which led to the invention of them are made so palpable by these gradual steps, and they are obviously so useful, being adopted without the interference of the legislature,-and, generally, adopted in proportion as the community advances in opulence,-that we can, I think, have no hesitation in supposing them also to be a necessary part of the great natural system of co-operative production. I see no scientific reason, therefore, why the issuing of promissory notes by bankers should in any respect or degree be regulated, controlled, or influenced by the legislature. The astonishing extent to which the practice is carried of settling accounts and making payments, without the intervention of money, can hardly be known to the great majority of the community. In London there is a place called the Clearing House, at which the clerks of the different banking-houses meet at one specific time every day, to balance all accounts between these houses; and as almost all merchants and dealers of every description make all their payments by means of bills payable at some banker's, or by checks drawn on a banker; as they all have their money paid into a banker's, and as a considerable quantity of business originating in the country is transacted or settled for in town, not only by far the larger quantity of all the payments of every description arising from the trade of the metropolis, but also from the trade of a large part of the country) are made by the London bankers; the consequence is, that they have daily immense sums to

61

62

Free Banking I BUSINESS OF THE CLEARING HOUSE.

209

pay to each other. In 1810, according to evidence given before the Bullion Committee, the amount settled on ordinary days at the London Clearing House, between the different bankers, was at least five millions sterling; and 011 settling days, at the Stock Exchange, this amount was frequently fourteen millions. By means, however, of the clerks of the different banking-houses meeting at the Clearing house, and only paying the balance of their respective accounts, 220,000[. was the whole amount of money or hank notes required to pay the enormous sum of five millions sterling daily. The bankers of the metropolis are the agents for paying the greater part of the bills ill circulation; so that, ill fact, the chief money transactions of all England are settled by the insignificant sum' just mentioned. Even this, it is supposed on good grounds, may and will be dispensed with. Such is a specimen of the natural and vast system of cooperating production; which, unknown and unmarked by us, is continually extended, and continually simplified. So much nonsense is spoken in Parliament, and written in the world at large, about bankers and bank notes, that it is right to add, that this beneficial simplification is the result of banking, and of employing commercial paper-money. Briefly to enumerate the advantages of bank papermoney. It seems to me to be such a useful instrument for supplying the daily wants of those whose products require a long time to perfect them, that it can no more be dispensed with, as society advances., than weights and scales. It is cheaper than coin; and the profits made by bankers in the first instance, arose from their substituting a cheap for a dear instrument.

Free Banking I

210

ADVANTAGES OF BANK NOTES.

Such profit, however, can only be large while the process of getting rid of the coin is going forward, which must in its own nature ever be very gradual. By no possibility could paper be made all at once to supply the place of the precious metals among a people accustomed to the latter as coiu. Among a people once accustomed to paper-money, and who have again had a metallic currency forced on them, it may, if circumstances permit, be suddenly substituted for gold. This process of getting rid of the coin, and replacing it, our government has renewed almost lleriodically; at one moment ruining bankers, and at another tempting cupidity to turn banker, by the prospect of enormous profits; permitting the issue of country bank notes for small sums in 1822, and forbidding it in 1826; while before 18.16 it will most probably again be permitted. In the measures which have been adopted or recommended as to issuing bank notes, it would be difficult to find a single scientific principle. They are directly and completely adverse from the regular progressive and steady march of civilization. The quantity of money, it has been explained, required at any time in society, depends on the quantity of business. Now this necessarily varies with tIle seasons. To keep money as much as possible steady in its value, the quantity should vary with the business to be done. As the rule, bankers only issue their note!; by discounting bonafide commercial bills, which are the best possible data for judging of the quantity of business. The issue of bank notes varying with the amount of bills discounted, they being also in all cases returned to the banker, if he put too many in circulation, is, perhaps, the best method which can be imagined or devised

63

64

Free Banking I PREVENT FLUCTUATIONS IN VALUE.

211

to make the quantity of money in society vary with the quantity of business. Thus bank notes, when the issue of them is freely permitted, when no corporations are endowed by the legislature with exclusive privileges, when the issues of every banker are checked and controlled by the watchfulness of rival bankers, tend continually to prevent all those fluctuations in prices which are occasioned by alterations in the relation between the quantity of business to be transacted, and the quantity of money in circulation. If little or no coin be used, it forms a nominal standard not liable to deterioration from wear. Paper money supplying its place, and being continually renewed at the expense of those who issue it, suffers no deterioration. In this case coin becomes to paper what the imperial gallon deposited in the custody of the Speaker of the House of Commons is to all the measures of capacity in the kingdom,-an almost invariable standard, subject to none of the bruisings and batterings of daily use, by which they may be, but by which paper is, at any an'd all times corrected and reformed. Having such a nominal standard as long as the circulation of paper is entirely free) it seems to be a measure of value which would be liable neither to depreciation nor fluctuations. The characters on paper-money are legible, and every man capable of reading may tell its value; but to know whether coin be good or not, requires the skill of the assayist. Bank notes are on this account also hetter than coin. That they have been frequently forged seems to me, in almost all cases, the result of the Bank of England monopoly. Notes issued by private bankers, who control and check each other, are rarely or

Free Banking I

212

EVILS CAUSED OF LATE

never forged. Their circulation is so limited as to space, and they are, in the natural course of business, so frequently returned to the issuer, that to forge them, with any prospect of advantage, is almost impossible. Of the credit due to a country banker, whose notes supply the place of money only in his own immediate neighbourhood, almost every man in whose hands they fall can judge; so that it is hardly too much to suppose if the whole business of banking were left, like the business of making hats and clothes, perfectly free, if there were no government and national banks, that bank notes could neither be forged nor issued to excess.· I beg the reader will recollect that I have only endeavoured to ascertain the natural origin of commercial paper-money, and that I mean tlle above observations only to apply to that species of papermoney which grows up among tlle productive classes • If the statement in the text, as to the origin of paper-money, and the source of its utility, be correct, we cannot condemn every species of government paper-money too strongly; governments are not producers, they have no commoditiell on their road to the market, and can have no claim whatever to issue paper-money. Even exchequer bills are wrong, they represent a revenue hereafter to be received, but all the credit which can be reasonablyobtained on the commodities which will constitute that revenue, is obtained and used by bills and notes of one kind or another, while the merchants and manufacturers are preparing these commodities, or bringing them to market. All hills drawn and circulated on mere revenue by those who do not produce commodities, although they may hereafter be entitled to receive certain sums, are more than is required for the business of the country, and are always issued that the issuer may obtain a share of other men's produce before he has any legal claim to it.

65

66

Free Banking I BY PAPER MONEY.

213

of society from the division of labour. That both government and commercial paper-money have in our time been productive of incalculable mischief, it would be madness to deny. We have seen nominal prices rise and fall twenty per cent. within a few years,-the variations having been caused by an improper issue of paper-money. Whole hecatombs of unfortunate wretches have been sacrificed on the altars of the law for imitating the names of those who were abusing public confidence to a much greater degree than their victims who suffered the penalty of death for their guilty avarice. Debts have been augmented or lessened, and all money contracts substantially violated. One class has been defrauded to enrich another; and the whole course of business has been diverted from its usual channels. No man has in consequence been certain of the amount of his income for two successive years; and confusion, dismay, and terror, such, perhaps, as were never witnessed in any country not overrun by a victorious enemy, nor devastated by some great natural calamity, have been caused in this, year after year, by an alteration in the quantity and value of paper-money. If such evils were inseparable from the invention, whatever may be its natural advantages, they would be far outweighed by its social disadvantages, and it would be impossible to condemn paper-money too strongly. But the reader will find in the Wealth of Nations, in l\'lr. M'Culloch's admirable article entitled Money, in the Supplement to the Encyclopredia Britannica, and in lUr. Storch's book, numerous examples of governments having caused, by tampering with metallic coin, "a greater and more universal revolution in the fortunes of private persons," to use

Free Banking I

214

NOT NECESSARY CONSEQUENCES OF BA~K NOTES.

the language of Dr. Smith on this subject, "than could have been occasioned by a great public calamity." In consequence, however, of the present extended use of paper-money, governments have latterly, and since the publication of Dr. Smith's book, always effected the same unhallowed purposes, by tampering with paper-money; and the present generation feeling only present evils-regardless, apparently, or ignorant of the economical history of Europe-has attributed those fluctuations to the instrument itself, which have been caused by the manner in which it has been abused by the 'venerated governments of E~rope. Such fluctuations, caused by similar conduct, frequently occurred when the whole circulation of Europe consisted only of coin. If from the abuse of paper-money we are to condemn its use, nothing will escape our censure. What can he more lovely or consoling than religion, and what has been perverted to more detestable purposes? In its name are continually practised base hypocrisy, blasphemous iniquity, and shameless plunder. With the perversion of a beautiful natural contrivance, with the wrong-headed speculations of ignorant and designing men, with the gambling and fraud of scheming projectors, with the ignorant cupidity of kings and statesmen, the natural science of national wealth has nothing more to do than to point out in what manner their conduct is opposed to its principles; though we must all lament that infatuation in m!lnkind, which refuses to take counsel from experience, and continues, after repeated proofs of deceit, fraud, and treachery, to place confidence where confidence never was merited. Declining on all occasions to examine in detail the effects

67

68

Free Banking I LOCAL BANKERS THE BRST.

215

of social regulations, I cannot explain the circumstances which have led in this country to the perversion of paper-money. I agree, however, fully with Dr. Smith, " that private and local banks, and private and local bank notes, which may be called natural, as contra-distinguished from legislative paper-money, are attended with the most advantages, and the fewest dangers." From the conduct of the governments of England, Russia, Austria, France, Denmark, and Sweden, with respect to paper-money-of which an impartial and not unfavourable account is given in lVlr. Storch's book-it is plain, that national and government bank-paper, ought on no account to be tolerated. Governments have no commodities on the way to the market, which is the natural guarantee of all papermoney j they cannot be compelled to make payment, and they can know nothing of individuals, which knowledge is the only secure foundation for giving them credit. l\:f uch has of late been said against Country bankers, and I readily admit, they deserve censure; but whoever takes into due consideration the vast extension of business within the last fifty years, and the great demand for bank notes, in consequence of the political state of the country, giving immense profits to bankers, will find numberless excuses for their conduct, which cannot be made for other classes of tradesmen, who have effected equal mischief by the circulation of their papermoncy. Banking, or at least the issuing of bank notes, is, as it were, a new business, and while the temptations to engage in it have been very great, the correct methods for carrying it on have been imperfectly known. And after all that has been said against country bankers, their issues of late have been far from extravagant. It

Free Banking I

216

ISSUES OF COUNTRY BANKERS.

is proved, for example) by parliamentary documents, that the issues of the Bank of England have been trebled in amount since the year 1792, while the amount of the issues of Country bankers were less, immediately prior to the late revulsion in the latter end of 1825, by seven millions, than they were in 1814, and less by four millions than in 1807. * Nothing but colossal power can work colossal mischief, and if that revulsion and consequent distress were in any degree caused by paper-money, they were so vast and extensive, that nothing less than the immense power of the Bank of England, which did actually vary the amount of its issues one-sixth within a few short months, could have caused them. Whatever may have been the real object of the Acts of Parliament passed in the year 1826, to put a stop to the issuing of bank notes for one and two pounds, because Mr. Canning supposed, very ridiculously, that country bankers were usurping the king's prerogative of coining money, their effects have been to injure country and local banks, which are the best kind, and to augment the power of the Bank of England, which has already done inconceivable mischief. They are a direct violation cf the principles of free trade, which the ministers profess; but as the Bank of England is under the control of government, those Acts have added to the power which it before possessed over the currency of the country. By tampering with it, the government has already inflicted vast misery on us, and no man can expect, from this added power, any other result than increased mischief. t ... See Edinhurgh Review, No. 87. Article Commercial Revulsions. t The consequences of Messrs. Canning and Huskisson, dc-

69

70

Free Banking I BANKING REGULATED BY NATURAL LAWS.

217

That issuing bank notes and the business of banking, must be conducted on some settled principles to make them advantageous, is quite certain; but to expound those principles, is the duty of the persons who write on the art of banking. As both the value and quantity of metallic money are regulated by natural circumstances, as the quantity of paper-money necessary is determined by the number of exchanges to be made, there is reason to believe, that the whole business of issuing bank notes is subject in its minutest details, to controling natural circumstances, many of which, whether theoretically known or not, are already acted on. parting in this instance from the liberal principles of free trade, on which their popularity was founded, are now coming home to them. By destroying country bank notes, they added to the general distress, lowered prices, and increased the difficulties they must at any time have encountered in amending the corn laws, to whil'h they stand pledged. On the one hand they gave, hy increasing the distress, additional urgency to the claims of the manufacturing classes for the repeal of those laws; on the other, hy lessening the quantity of the circulating medium and thus lowering the price of corn, they alarmed all the agriculturists and all the landlords, who are under engagements to pay specific sums, and roused sllch opposition and such dread of the consequences of altering the corn laws, that it is doubtful if they can carry through their poor and spiritless measure; and it is certain they can accomplish hy it nothing Leneficial. To have oLtained a satisfactory modification of the corn laws from the landed gentry, it was necessary that prices should he high, that they should have Leen threatened with an inundation of foreign corn undel' the present law; hut this necessity, which Legan to exist, was in part removed hy the illiheral measure respecting eountry hankers, which thus sllpplied tho~e who predously hated hoth Mr. Canning and Mr. II uskissoll with arh'1lments against them, and has tended to destroy their popularity and ruin their reputation.

Free Banking I

218

OUGHT NOT TO BE CONTROLLED.

There can be no doubt, for example, that there is a point at which it becomes disadvantageous to substitute paper for coin. Some persons of good judgment have stated, that one pound is below this point; and this principle, though it has not been either scientifically or practically ascertained, has been made the basis uflegislation. Banking, however, let us never forget, with the issuing of bank notes, is altogether a private business, and no more needs to be regulated by meddling statesmen, than the business of paper making. In fact, the impertinent interference of law-makers, their pretended wise regulations, but in reality their tricks and frauds, with the currency, have been the causes of all the evils we have suffered within the last century from variations in the value of metallic and paper money; and nothing can rescue mankind from such desperate fluctuations in prices, as have of late afflicted all the countries of Europe, but allowing, both the coining of metallic and the issuing of paper money, to find, under the controlling influence of natural circumstances, their proper course and just level.

71

[3] Excerpt from G. Poulett Scrope, Quarterly Review, 439-57

For these reaSOIlR, we reject the proposal of a degradation of the standard established in 1819, as essentially unjust, inadequate for tlte )Iurpose, amI destructive of all credit, pulJlic as well as private, and of all reliance on the security of property, which it is the very oltiect of the remedy we are in search of to confirm and maintain. There remains anotller course for consilieration; one which we have urged for sometillle past on the public, as the true mode of relief from 0111" Illonetary dilliclIlLies; one which, if it cannot be expected to work a JIIiraele in the imlllediate restoration of the lIational industry to vigorous health, will at least bring about a gr:llitml Cllre, by givillg room mill play for the development of the vi.y 1I'!rciicafrix inherent in the patient's constitution; which, if it will not at alice relieve creditors from the burden of their eugagelllcllts, will at least put them in the way of paying them off by industry and exertion, without :lIIy additional incull1brance. We mcan the removal of the mischievolls restrictions which now fetter the circulation of credit through this country, and the concession of thc free right of cOlllmerce to provide itself with whatever instJ"llnwnls it lIlay J"<'c(uire for cikcting its exchanges, IIninterfered with lJy those ollicious legislative illtcrmeddlillgs which experience has sulliciently proved to lJe fatal to almost everything they touch, but to nothing so much as to the currency. It is physically impossible to carryon the commerce of the civili7.ed world by the aid of a purely metallic currency-no, not though our gold and silver coins were every tenth year dcbased to a tcnth ! Why, in London alone, five millions of money are daily exchanged at the Clearing-house, in the course of a few 1lOurs. We should like to see the attempt made to bring this infinity of transactions to a setllement in coined money. Credit money, in some shape or other, always has, and llIust have, performed the part of a circulating mediulll to a very consideralJle extcnt. And (by one of those wonderful compensatory processes which so frequently claim the admiration of e,·ery investigator of civil, as well as of physical economy) there is in the unture of credit an elnsticity which causes it, whcn left unshackled by law, to adapt itself to the necessities of commerce, and the legitimate demands of the market. Well may the pl"Oductive classes exclaim to th(}~e who persist in legislating on the subject, and are Ilot cOlltl'nt without determining who lJIuy, and \\,110 may not, give credit to another, what kind of mouied obligations shall, 01" shall

not,

73

Free Banking I

440

The Rights of Industry and the Banking System.

1101, be allowed to circulate-tllat is, to be taken in exchange for goods at thc option of the parties-well might they cxclaim, as the lllerclHlnts of !'uris did to the ministcr of LOllis. whcn hc askcd what his mastcr cOllld do for thclll-' Luisscz 1I0US fuire,'-' L('ave liS alonc, to SlllTOUlid ourselvcs wilh thosc prcculltions which cxpericncc will suggcst, und thc instinct of sclf-prcscrvation put in execution.' But tlrc simple principlcs of banking, as laid down by Adalll Smith /rail' a century ago, have uevcr been acted IIpon or rcgarded by the government of this country. Ami it will be of SOlllC servicc to take a brief rcview of thc successi vc interfcrenccs of our o\\'n legislature with the crcdit-currency of .England, anti bring into juxta-position with thcse scvcral measlII'cs thcir imlllcdiatc rcsults, as they showcd thcmselves in the gcncral priccs of produce, and the condition of the productivc classes. Thc first and Illost fatal error was thc concession, or at Icast thc continucd rcncwal of thc Bank chartcr, by which a JIIonopoly in the issuc of notcs within sixty-fi"e lIIiles or London, accompanicd by a prohihition on their"issuc by more than five partncrs in any part of England, was confirmed to a metropolitan banking COI11pany, undcr tllC IIIa1H1gement of a secret dircctory, whosc procccdings, uncheckcd by the WllOlcsolllc restraints of competition, responsibility to sharcholders, or public supervision, werc ncccssarily liable to crror am\ capriec, granting the abscnce of any intercsted motivcs. By their faulty management of this privileged monopoly, the valne of the entire currcncy has bccn often unrcasonably, amI without warning, deranged, and evils of the greatest magnitude inflicted on the tradc of thc coulltry. This mismanagemcnt led to thc next crror of the legislature, the act of 1797, for relieving this privilcgcd bank from tire liahility to pay its 1I0tes on dcmand. No govcl'lllllent, having sound notions on the nature of p:lpcr currcncy. would have tnken such a stcp, ' for 110 calamity that conld befall thc country from the vicissitudes of war, short of thc actual conqncst of it, could be more calc.ulatcd to expose it to immediate cmbarrassment, and ultimate ruin and bankruptcy, than thlls letting tIle llanks loosc upon the public, to issue whatever quantity of papcr they pleased.'* The Bank dircctors having no dcfinite rule for their guidance, and being hampercd moreover by thcir conncxion with govcrnment, at one timcenlarged, at anothcr diminishcd their issues, with little or 110 rcgard to the real demand for money; and thc flllctuations thus occasioncd in prices, brought ullavoiclnulc ruin on the heads of thousands, and converted trade into a mere gambling spcculation. Thus, ill 1801-12, Bank-notcs were at a discollnt, comparcd with gold, of sevcn or eight per '" Parnell on Banking, &c.

cent.,

74

Free Banking I

The Riglds of Industry and the Banking System.

441

cent" which ill the next year was reduced, by diminished issues, to two and a half per cent. But in 1sag, and the five following years, the lhnk poured forth such a profusion of paper as depressed its value from ten to twenty-five per cent. below that of bullion; while imlllediately after, in 1815-16, a sudden contraction of. the issues brought lip the notes to withill OIlC :1IIt1 a half per cent. of par with gold, and, as a Hatural consequence, 110 less than two hundred alld forty clllintry hanks stopped payment. The return to cash paymcnts in HllD was an attempt, on the part of government, to retrie\'e their prcvious error in the Bank restriction act, aud, we may add, by committing an equal or still greater error. For, in the first place, it was altogether overlooked by Mr. Hicnrrlo, Lord Liverpool, and the other advocates of the restoration of the slandard, thnt, under the restriction, gold, not having been walltcd for use as a medium of exchange throllgh the 13ritish elllpirc, was thereby lowered in value, but that the certaiu effect of a retllrn Lo specie payments IlIust be an advance in its valuc proportioned to the increased llcmand that would arise for it to be employed as coin; and that consequently the market price of bullion at that time could ue no measure of the value it would obtain after the passing of all aet which went to create a new demand for gold to the extent of perhaps thirty lIIillions. The secoud error of the bill of 181!), was, that not being accompanied by measures for repealing the llIonopolyof thc Balik of England, and putting the system of credit cUITency on a footing of freedom and security, it failed in its object of providing a steady ami uniform supply of money. Instead of any approach to freedom, indeed, new restrictions were imposed. A n act was passed prohibiting the issue of all notes under five pounds; the consequence of which, and of the obligation on banks to provide a reserve of gold, was an insufficient supply of money, alltl the fall of prices which brought on the severe distresses of 1821. .As a (em porary relief the small notes were again permitted to issue; bllt here the opposite error of the legislature (which, throughout the whole of this unhappy drama, invariably controlled what ought to be left free, and gave full license to what ought to he coutrolled) came into play. Whilst the law actually prohibited the formation of banks all the broad foundation of an extensive partnership, any illdi-viduul, though destitute of a shred of property, had liberty to issue !lotes wit,hout guarantee of any kind. The natllral consequence was, that at the iirst, favolll'abl~ J)rosp~ct of tl'3de, an, over-issue occurred fr?m parties who rmg Lt gatn, bllt '!ad nollul!g ,t,o lose, ~y fomentlllg the most extravagant speculatlOlls 011 fictitIOUS capital. Hence mose the lIlad excitemellt and delusivc prosperity of IH24-5; till, at

Free Banking I

442

The Rights of Industry and the Banlcing System.

at the dose of the latter year, the bubble hlll'st; the sudden withdrawal of the issues of the Bank of Ellgland, alarmed at lellgth (that is, six mOllths after it should have perceived the danger) at the state (If the exchanges, gave the signal of a general pallic; credit of every kiwI was paralyzed, and the ulliversalnation on the eve of h:mkruptcy. 'Vhat measures, after this severe lessoll, did the legislalnre adopt? Were they at length taught by experience the necessity of establishing a sOllnd banking system? 17m' from it. They left the coulltry b:lnks of England :IS unsafe- :11\(1, of course, after the failure of seventy, far more discredited than before; lll1d instead of giving freedom to the issue of paper by responsible parties under etlicient securities, they fettered the circulation with precisely the same trammels which had brought on the sufferings of 18£ I, and passed the bill of 182G, again prohibiting the issue of small notes. The result, of course, Ims been the same train of unhappy consequences as before, namely, the continued and increasing distress of every branch of industry. Dllrillg each of these successive phases, the changes ill the conditioll of the productive classes, alternately elev:lted allil depressed, stimulated by high prices and ruined by low, so illllllediately followed the corresponding alte\Oations of the cmrency-laws, as to leave no room for doubt on the conncxion of the two as cause alld effect. Whilst these sec-saws of general prosperity and adversity evince the dangerous and mischievous character of our uctllal monopoly-crippled banking system, under which every relaxation brings on over-issue. ovcr-speculation, and a crash-every contraction grinding und intolerable distress; they, at the sallie tillie, suffice to prove that the effeet produced 011 prices by the comparative scarcity of the predous metals, which, during ullthis period, were diminishing ill quantity, can be cOllnteracted by the operation of paper Illoney; and lead to the conclusion that we have only to build our system of IJaper currency on a ratioual foundation, to secure our pl"Odnctive classes from sllilering in any way through the increasing deficiency of gold aud silve.·. There are, we know, some statesmen who oppose allY reconsideration of om monetary system, crying, ' Let us meddle uo 1I10re with the currency; it IllIs never been tampered with, Imt evil has followed.' This would be nil very reasonable if the currency were not at this moment interfcred with by the existing laws, and prevented from estahlishing itself, as it would otherwise do, OJ: a sound basis. Instead of being" sellled, as sOllie imagine, it is, at this moment, ill the most vitiated, unsettled, and deranged condition, through the perverse cuntrol of the I:IW. That law, as we have said, gives unlimited

75

76

Free Banking I

1.7te Rights of Industry and the Ran/ring System.

443

mited license to cOlllltry ballks to issue notes without a farthing of property to back them, at the sallie time that it prohibits their issue by parties of slIch IlUtllUer and pledgcd capital as would offer an effectual guaralltee for their solvettcy. It follows, of course, that battks of this stamp, attd of which as matty as seventy uroke at ottce bttt the other day, cmlnol possess fit" ol1lfidel1ce of the 'filMic, who therefore, ill gelleral, prefer gold to their lIotes. The prohibiliott of Ilotes under five pottllds still further increases the lll1JOUltt of gold required for circttlatioll. The consequellce is the absorption of all itllmense allJottnt of sovereigns into active use, in additioll to the reserves of the ilallk of ElIglalld, nnd the numerous coulltry banks which, from the ticklish state of their credit, must keep by thelll a large stock of coin.* But a gold circulation is necessarily a dear and a cOlltracted one. Country battks will by no mealls :H:comllJodatc their customers with advances in gold to the samc (!xtCttt that thcy would in theit· own lIotes. Their httsiI1CSS Iltust clItirely change its nature if, ittslcad of leudittg their credit or responsibility, they arc to lend hard cash. Their advances in this case mllst be greatly limited, and they mnst also charge SHch an interest 011 thenl as will cover, Itot merely the risk and the expense of their establishment, but likewise a pro/it on their capital employed itt the purchase of gold. The cottseqllence mllst be, and is, a great limitatiolt ill the atltOllttt of country circulation, a s·carcity of tltottey, and a ruinous fall of prices. llut it is dcnied by some that there is UllY deficiency of mouey. On the contrary, ' the money-market,' they say, ' is glutted. In London loans of money are to be obtainctl at three or four per cent.' They do not perceive that the deficiency of the money in

* There call he no
Free Banking I

44·1,

The Rights of Industry and tlte JJa71l~ing8ystr1ll.

circulation through the cOllntr)" nnd its acculllulation ill the hands of c:1pitalists who can find no use for it, instead of being inconsistent with each other, are necessarily co-existent, and are both owing to the same cause, the weak, crippled, and uiscredited. :ltate of the eOl\ntry banks, whose peculiar provincc it is to facilitate thc circulation of money, to act as the intermediate party between those who wi~h to lend and those who wish to borrow. Werc the laws repealed which paralyze the eflicicncy of thesc establishments, ~llId a wcll-organized system of banking introduced, the capital which now stagnates in the metropolitan money-market woulu, by its agency, bc spread over the whole slIrface of the eountry, and employed in Slllall portions in prolllotillg the various operations of productive industry. There are, however, still we believe a (daily diminishing) llumber of persons, who consider that tile laws of 1810 and 182(j, though followed, tlley admit, by great temporary distress and t1iflieuity, have ,et alfonled us the' invaluable blessing' of a ' sound allll wholesome' cmrcncy. SOllnd and wholesome! A state of thc circulating mediulll which has turned the horn of peace illto a phial of wrath; which, after twelve years of ~lggravated sllirerings and IIlIexampled struggles, has draggcd the iuuustriollS por1ioll of tbe COlJllllllllity to the brillk of all abyss, alit! will illevitably, if eOIltilJlJed, preeipitate them illto litter destruction; which bas brought about a decreasillg revellue, a failiug COllllllerce, a ruilled lauded interest, starving mauufacturers, an ullcmployed, pauperized, tliscontented population-this, truly, is a s0ulld and wholcsome currency, and an invaluable blessing! Though the prejudiee which in 1S'2G ran so strongly in favour of a metallic CUlTcucy has been pretty wcll abated by the dearly bought experiellce of its' invaluable blessings,' yet the notion is still elltertailled b), SOll1e, that paper-money is a lictioll, an imposture,-' worthless rags,' as Cobbett calls them,-and metal the only safe eurrellcy. As to paper beillg fictitiou~, if hy this is lIIeHllt that it has 110 intrinsic value, that is precisely what constitLltes its peculiar merit, since it enables it, at 110 cost, to fullil the oflice of a capital which can be bctter cmployed in the production of consllmable cOllllllodities. But if uy lictitious is meant worthless, it call ollly refer to had paper, not to good; to the lIotes of rotten amI illsccme banks, not to those oi" ~ound and un'lllestiollaLle ones, for whose notes there can be 110 possible !loubt that gold IIwy be obtailled ·whenever it is required. The paper issued by ballks of the latter character, actually rrpresenflf, and is backed by a double c:lpital-that of the bankers themselves, and that upon the security which they have Jent their notes. The way, therefore,

or

77

78

Free Banking I

The Riglds of Industry awl tlte Banking System.

445

fore, to prevent the issue of a fldiliollS currency is to rcquire security from banks, 01' to allow of companies being formed with a paid-lip capital as a guarantee of their solrcncy. liut for those who refuse making this improvcment on Ollt' banking system to cry alit against paper as bcing fictitious, when it is the miscmblc system thcy pertinaciously adhere to which alone admits of uny bad paper being issued, is sOlllething too much. Two powerful 1Il0tives hare contributed to create and keep alive this prejudice among certain c1asscs. l~irst, the bias which the monied interest. natllrally feels ill favour of a state of the circlllation which is continually adding to thcir wealth at the expense of thc rest of the community. Thc cry of' worthlcss rags' ",ill bc fOllnd chieHy to proceed from that intercsted quarter.· It would 1I0t bc diflicult to point out among the most prominent bullionists Some who have illcreased the value ofthcir propcrty half a million 01' more by thc cnforcemcnt of our' sound and healthy' system of currcncy! Secondly, the vague drcad cntcrtained by thosc who havc uot the capacity or leisure to probc the qucstion to the bottom, of the renewal of the banltruptcies of 1825, from which many of them arc still smartillg. No person, however, of information does, or ever cOllld dispute the vast superiority of a paper currenc), Mer OIlC of coin ;-thc advantage of saving thc expcnse of a cnpital of thirty, forty, or lifty millions in this cOllntry, locked lip in an IInproductive form, alit! ellabling us to clllploy a grcat part of tbis dead stock in adding to our wealth and enjoyments. A metallic currcncy is merely a more convenient form of barter. It still retains many of the inhcrent and unavoidable faults of that method of exchangc, appropriate to all age of barbarislll, though modificd by thc peculiar qllalities of tile precious metals, which render thelll, as is universally ndmittcd, a less objectionable mediulIl than any other cOllllllodity of intrinsic worth. But it is only the wallt of intercoursc between parties, 311(\ the consequent limitation of credit-or, in an advanced state of society, thc perlIicious illterferencc of government~-which cau forcc COlllmercc to cmploy, to any considerablc extent, so clumsy and costly an instrumcnt of exchange. In order to illustrate thc simple character and practical advalltage of a paper currcncy, let liS supposc three parties, of whom A oIVes lOut. to B-B thc sallie to C-allli C to A. There are thollsands of snch circlllatillg cngagements alwap in cxistence, thollgh varied ill thc amollnt allll the nUlllber of parties through whom the chain of obligation passes. A, for instance, is a maltster, B II fanller, and C his landlord; or A lIIay be a tailor, B a clothier, alld C a capitalist who has lent B mOllcy Oil ll1ortgllge. COlild these parties meet allll becollle aware of their \"IJI.. XI.\"lI. NO. XCI\". ,~ II n:lati\'c

Free Banking I 44G

The Rights of lndustry and tlte Banking System.

relative position, they would only have to exchange acquittances, and settle their accollilts withollt the use of mOlley in any shape. But the transactions of actual business are too lIlultiplied and complex to arlinit of all debtors and creditors assemhling in a room together to balance their respecti\'e acconnts in this way. Therefore money, in some shape or other, IIIl1st be employed for the purpose. Where the currency is purely or principally metallic, it is clear one of these parties, at least, 1I1nst make a fresh sale of goods, probably at a considerable sacrifice, in order to procure ca.ih with \"hich to pay his creditor. Ullder the system of cre(lit-cnrrency ill lise tllroughollt Lancashire, A wOllld pay 13 by his bill at a fixer! date; B would transfer it to C, and Chand it back again to A. This is clearly an immense improvement over the mode of pa)'lTIellt in an article of intrinsic value. But there are Jet great disadvantages attelldllllt on the use of private bills as currcncy. Before 13 will accept A's bill, he \IIust be convinced of his solvency. But how is a man who wants to sell to make himself aC(lllainted with the circulllstances of a\l who wish to huy? Two strallgers, for illstallce, bargain ill a fair 01' market. The bllyer prodllces a hill indorscd with a whole strin~ of n:llllcs. They lIIay be all .. espoll~ible pcrsons, :Ind yet thc H"lIer kilO'" nothing of :lny of tllcnl. 11 e mllst therefore either risk the chance of the indorsers beillg all JIIell of straw, or lose the sale of his goods. It is cvidently a vast improvcment IIPOII this awkward systcllI for a company of well-known alld wealthy pers{lIls to set lip a bimlc, backed by a large paid up capital, amI lelld their credit ill the shape of notes as a circulating medium in lien of either coin or private bills. The supposed transactioll wOllld thcn assume this shape. Either A wOllld borrow the 1001. of the bank on his personal security, with which to pay 13, or pay him in his bill which would be discounted at the ballk. In either case B would pay C in the notes; which. tholigh the chain or accounts extellded through the whole alphabet, wOllld settle them all without fllrther expense to any of the parties than the interest 011 the period rcquired to complete the transadion. The notoriolls credit of one great establi~hlllent is in this way employed as a substitute for the IInccrtain and varying credit (If individuals, or the costly and awkward mediulII of coin; and thc fac;ililies llllls aflimlcd to the circlllation and exchan;;e of every artiele of production, and thc COIISe(l'lcnt inGl'case of the trade, indllstry, allll wcalth of the country, are beyond all calculation. , The inventioll of pnper-III
79

80

Free Banking I

The Rights of II/(lnsfry and the Banking System.

447

one of the main call~es, as effertive a canse as the steam.engine itself, of the rapiel improvement of Great Britain in procluction and wealth, and of the rate at which she bas outstripped the remainder of the world. Does anyone believe that if our commerce had been cramped ,by restriction to an exclusively metallic circillation, we should have made the progress we have made within the last finy years? Though one sovereign may not circulate in the cOlin try, a paper-pound, payable in demand fo\' gold, at a fixed standard, hy banks of unquestionable security, is as safe, ami a less variable, and a far more convenient medium of exchange, than gold itself.'-Credit Currency, 1830.

But then, it is said, paper-money has been productive of immcuse and extensive mischief. U IHluestionably it has. The l1istory of the paper-currency of England, for forty years past, displays a snccession of flnctuations in the value of 1110ney which have occasioned irreparable il~jllry to millions. But since during this time there has existed in Eugland a rigid mOllopoly in favour of a chartered banking company, is it 1I0t just possible that these misfortnnes arc owing rather to the dcfective system of banking cansed by that monopoly, than to any inherent mischief ill papermoney, which, as we have shown, is merely the substitution of credit for barter, of a cheap :tnd relined mediulll of exchange for all expcnsive and clulllsy olle? Tllis presumption is COIIsiderably strcngthened when, Oil tllruin~ our eyes to a neighbouring country, ill which no 1II0nopoly 01" restriction 011 banking exists, but which, iu every other circLulIstallce relating to trade, is on the same footing exactly with England, we find a pure papercurrency to have supported itself for nearly a century and a half, not simply without producing any il~ury worth speaking of, but acknowledged by all to have beell one of the most efficient callses of the prodigiolls strides which Scotland has made in wealth and improvement during that period. Those, indeed, who look a little more closely into the matter, are perfectly able to trace all the mischief occasioned hy the English paper-currency to its necessary source in our monopoly-crippled banking system; while the freedom which characterises that of Scotland is ill their eyes the allsuflicicnl explanation of the security ami eflectiveness which cxperiellcchas proved it to possess. • Thc case of Rcotch hunking,' says ~ir H. Parnell, 'is, perhaps, the most perfect and satisfactory illustration of a science that has ever existed. It leaves nothing to be desired, in order to establish, beyomlllisp1Jte, the conclusion, that if hankers are restrained from issuing notes for less than twenty shillingR, and are subjected to tho obligation of an immediate anel Ul1COllditiollUI payment of their notes, as soon as prescllted, the trade of bankillg may, with safety to the public, be rcndered, ill all other reRpects, free.'-Poper lIfoney, p. 151. ~ II ~

Wc

Free Banking I 44~

'1'11" Rigltfso/ InrIllsfry (/nd the Banking S!Jstem.

"'c will

not here go into the description of that system, eicellencies of wllich were miulltely pointed ont in a former p:Iper, to which we refer our realiers. * We shall content ourseh·cs with liu)"ing, that with slIch an example before liS of a system Qf ptlper-currency, not merely perfect in theor)" but which has stO()1l the tcst of a century's experience, lind that not ill China 01' Utopia, out ill this island itself,-ill a part of Britain ill no JIlrtterial cirr:lIl11stallce differing from Yorkshire or Cumberland, except :1S being :1 few miles farther from London,-in the teeth of this to ha\'!' gone on Iloullflering, as we h:1ve done, from bad to worse, patching :11H1 botching ollr currency with oue qnbckery after another, ami settling down at last in an aUempt to carryon the t:')IIHlIl'l"Ce of this gr{'at country hy imrle1', lIlay wi'll he a matter of a;;tonis\tment ev{'n to those who arc 1II0st deeply convinced of the writy of Oxcnsticrn's saddelling retlection. The B:1llk is about to he pllt upon its trial; and if it call be pro,r·.d, Ily r"ir evidence, to have worked ",PlI for tl)(~ natiou at 1:11)1:1\ alld to lie tlte most lilling in~lrnnlenl tllat can h(' provided for tlte important purpose of slIpplying a soulld, IIniform, and slIfl"ir:iPllt circlllating medilllll, ' always filII, Hever ill excess,' then we -shall 1II0st willillgly hnil its rc-establislllileni. But we do 1I0t conceal our opinioll that its defenders will have great diflicllily ill lIJ:1kilig out their case. ]'vIr. Tooke, Mr. 1\1 IIshet, Sir 11. Parnell, Mr •• Joplin,,\" a urI 111 any other writers of great authority, have, as We think, demollstrated, that in each of the occurrences of sudden fllletllatioll in the vallie of the circulating medium, whidl, withill thl~ Inst forty years, have destroyed so much capital, alJ(l caused the ruin of so many innocent illdividuals,-in 17~):J, lSI J, IS15, [81 S, alltl 18'24-5, the mischief originated in the miscondllct or illJprudence of the Bank of England. In every installce it was t1ll~

* No. 86, art. Ii. 111t;le this nrtidc i. going throll:.;h the prc"" we prrccivn this gcntleman hns T"hli
\r"

II"""

}.lint ". a ft:now-lttl'(llln~J.'

ill this

eaU!ic.

81

82

Free Banking I

The Rights of Indns'ry alld the Banking Sy~,tem.

~'19

thc state of the issues of that g(cat centl'al reservoir wllic:h enlUlHraged the iliad over-issue of the coulltry ballks; and it w:t!J tllc weldell nnd hlnly withdrawal of its accommodation that g:n'C the signal to the panics alld runs, before which those frail establi,~hlllellts-prevelltecl as they are by the law from haSj.l)g thelllselves O!l a foulldation sufliciclltly broad to sccure the (;ontrdellce of the public, except ill tillles of gencral excitement anll carelessness-gavc W;)y by scores. We have scen bllt one nttcllJpl at a defellce of the Balik, or plea for the rellewal of its exclusive privilcges,-thc pamphlet attributed to Mr. M 'Culloch, and entitled, ' 11 istorical Skctch of the Balik of Ellgland.' Of tlJC historical portion of this essay \ve have ollly to remark, tfr:lt it passes ill silencc over uearly all the successivc errors of the HUlIk I)irector~. Thus, whell the several IalllelltaLle revulsiolls uf credit frolll 17!J3 to 18Q5, arc under notice, the ackllowledged over-issuc of paper-Illollcy, in which they originated, is attrilmh:d to the ('oulltry UHlIks, alld llolhing is Bait! 0[" thc c:wllIple lIud eH(~ollrag(,llIellt alfordet! the III by the Balik of Ellgland. It \\'as impos~iule, howevcr, for thc writer not tl) adluit the flagrant instances of illl pmdellce on thc part of the Bank ill 1 i97 amI 1825; sO'the forlller i., excllsed Oil the grolllld of the ' prcssillg solicitations' l)f .M r. Pitt, alld the latler attributed to I a llIi~t:lke of tllC Directors.' lhit this elTor, it is said, ' frolll ",halc\'er C:lIISC it procecded, Wtls' lllOSt illjllrious 10 the Balik, which was urought illlo a ~talC of cOllsideraulc danger. We have, fb('niofe, the best of all S(!Cr!rities-the ollly one, indeed, 011 which the least stress can, hI" l;!r~l, -the plain alld oLviolls illterest of the parties concerned,thnt slich III istakes will not he offreq1/ellt OCCII'f'/"CTlCe.' (!) .May we not urgc against this, that ,we have the cvidcnccof,e'X.pe." ricncc-the Lest of all proofs,-that such l1Iistakcs will be, becmu.$(~ they hu\'c been, of frcqlleut OCCllrrCllcc? But placillg' evclI' orrl" expcrience out of view, that does lIOt slll'ely seem a very clefeusiIJle system, (L Jlrioti, which puts it in thc power of' a secl'et cOJUmittee of irresponsiLlc persons to bring the whole country to tllevcrge of gencral Lankmptcy by J a llIistake;' or an ' indiscre-· tion,' or at the' pressing solieitatioil' of a ministe!'. Having thus proved the advantage of giving to a pri'\'ilcged company the complete control over the "hole currency of the elllpirc~ by the slIpcrlatire argullIent that it is lIot probable this power would bc very /refjlU!1Iily, abused so far as to inl'oll'e thc whole commll.Jlity in rllin, the writer goes on to show, Hlat a systelll of freeumu. sllch as exists in Scotland, ofrers no silllilar security. To be !lUff: ~t was impossible for him to cieny thc stuLborn fact, thal HIe .Ellgli~hsy6tCIll, foullded on thc Bank mOllopoly, Iz(z.~ convulsc\i. ahe' Coulltry over allci o\'cr ngllin, whilc the free l'ystclll of Scotl:ul
pursued

Free Banking I

450

The Rights of Indll,yt1·y and the BlLllldng

83 ."'y,~te1n.

pursued the C\'CIl tCllor of its uscful course, wholly undisturbcd by panics or rlln5, ovcr-issues, 01' re-actions, The oilly rcsourec, therefore, of 0111' sage is to dcelare poitlt- bialik, that the systcm which is perfeelly safe iu Euinburgh would be destl'llctivc ill LondOIl! Alltl the I'eason, tllat one is a provineial, the uther a mctropolitan CUITeIlCY, und 'there is nu analogy bctween the two! ' This appears to liS It rlreum, The seclII'ity agaillst over-isslle, whieh proves practically effective in Edinburgh, is the knowledge that sllch over-issue must imlllediately depress the cxchange with Londlln, mill so crcate a delllllllli for gold 011 the ballks. Thc mallagcrs of the hauks on this uccollnt lIarrowly wateh the exehallgcs, alld elllarge or rcstriettheir isslies accordingly, The scclII'ity agaillst over-issue ill l ... ondoll, were banking as frce there us ill Edinburgh, would be the certuillty of its heilig, in like mallllcr, followcd by a fall of thc cxehallges with the c:olliillent, allll a drain of hull ion for cxportation, Whem is the real difl'crellce between the two cases '! Howcvcr, as if lIot relyillg IIIlIeh on this funeied distinction, 0111' author cOllfidently puts forward :mothcr objection as dccisivc of thc whole qucstion. AmI sincc there is some lIovelty ill his m'glllnellt, unt! tile case of the Balik is, by its ollly supporter, rested strictly UPOII it, we lIIust alroru sOlllcwlmt more space to its cxaminntioll thnll its substancc would otherwise merit. Thc objection is, that' how ndvalltngcous socver competition mny be in most cases, thc free competition of banks l1nL,~t occasion over-issue, beclmse it is in the power of anyone bank to render the whole currency redundant, allll it will be for its intcrest to do so in order to drive the others out of the field.' • As this,' writes our philosopher, , is a matter of vital importance in the discussion of this question, let us suppose that there are ten banks, all enjoying equal and unbounded credit, established in London for the: issue of notes, and that they have issued I,OOO,oool, each: suppose further, that 0110 of these establishments thinks proper, with a.view to some interest 01' }lurpose of its own, to increase its issues to 2,000,0001. : the curl'ency of the metropolis, assuming it to have been previously. at its proper level, will, of course, become redundant, and there will be a fall of the excha.nge, and a demand for gold, It is clear, however, from the fact of the over-issuing. hank being in quite as high crcdit as any of the others, that only tllC same lmrporlion, 01' ten pel' cellt" of its notes, will bc returned upon it for payment, that will he retul'lled upon the others, so that when the exchange has recovered itself, and the dl'llin lias ceased, it will have 1,tHR,000l, aOoat, mill the othel' banks !J09,oool, ench, 'J'hatsneh wonl,1 he the case 110 nne rau rensonahly douht, A merdmnt srI'S, from the deprcssion of thr r:o<ehnng(>. t.hat the cllrrcncy is redundant; nllfl as all notes urc, IIl1dl'l' the Cil'cuIIIstanecs snpposrd, .equally good ill his estimution, lie scmls those ill for payment which come first to hand, It is no busilless of his to inquire whether the redundancy

Free Banking I

84

The Riglds oj Illdu"~{ry and tlte Banking SY,'fiem.

451

dnllcl:lnC'Y of cnrrency he ocC'asioncd by the proceedings of the ,bank A 01' the bank B; neithcI', l'edIRI'R, eoulcl he ascertain the fact, though lie m're to .take the trouble of inquiring into it; and though he did, it would make no change in his conduct, So long as he believes the different notes to be alike good, he will show no preference to one more than to another, but will return them indiscriminately upon their issuers, while he can make a profit by doing so. 'rhus it appears, that wcre several lmnks fOl' the issue of notes established ill London, it would be in the power of anyone opulent hank to occasion a heavy drain for bullion, and great distress and emharrassment throughout the ('ollntl'y, (!) All that would he required to produce these results would he, that she should add considerably to the amount of her issues. Ami she might do this fOl' variolli'! ohjeC'ts, to realize an immediate lll'otit; to ohtain a great ultimate accession of husiness hy submitting to the risk of an immediate slIcI'ilict,; to weaken and embarrass her rivals, &c. It wou]el he to no ]Iurpose that all the other establishJl]cnts eonduetc'd theil' hnsilless ill the soberellt manner and 011 the l'oulldest principle!!; their foI"llCamnce could 110t prl!Vent them from hcing materially injured by the proceedings of this single establishment, and some of them would certainly be tempted to endeavour to repair the injury done them by aeting in the same way, It would therefore seem, that the free system, which we have been taught to consider as capable of eradicating all the evils that have been hitherto attached to banking, is one that, if intro
N ow the first and most obvious answer to this novel and elaborate argument is, tlmt it proves too much ;-it professes to demonstrate that the free com petition of bankS' must, everywhere and always, occasion over-issue, distress and embarrassment throughout the country. There are none of the circulllstances in the case assumed peculiar to London; they are common to rival banks in Scotland as well as everywhere else, Bllt it is afact, not denied even by the author, that, in Scotland, competition does not occasion over-issue; bllt, on the C01ltr31'y, completely prevents it: the experience of a hundred unci forty years might be appealed to as a sn/licient answer to our author's it priori argument to tire l~Oll­ trary; hnt the fallacy by which he is misled is easily seen through. His reasoning evidelltly proceeds on the assumption that the wh~le 'Illalltity of paper which a bank can oncl? push Ollt, by discounting at a lower rute, or on lighter security than its rivals, remains P1?771wTll?lllly on1, with the exception of its prop(lrtionate share of tfle entire o\"er-issue, But everyone knoll'S that, on the eCllltrar)" there is a eontinual and rapid return :Illd re-isslle of notes going 011 ;

85

Free Banking I

The Rights of Inclusf'l'Y wul the Banking System. on j so that to enable the o\'er-issuillg bank to keep al10at any lar
86

Free Banking I

The Rights nf Industry (/nrllhc Ban!til1g System.

oy

453

bullioll, rind t!leir profits being lessened this increase of thcir ullproductive stock,' they would be at lellgth drivell to imitate its example. Acclllllulate bullion! Why, in the first place there is a d1'Oiu. upon the banks for bullion supposed, by the ohject-or hilllself, to accompany this struggle; and we need lIot insist tllat there callnot be a ruillous draill and an illcomeniellt acculllulation in the bank reserves at tl:e sallie time. But, secoII(i1y, HllIst gold stick for eyel' in the collers of these ballks whell it ollce gets there? Can they uot sell it? Alld IIIlIst not the overissuing ballk buy the gold of them just as fast as they pour in its notes? aIHI, since they get the gold uf tllis bank at the Mint price, while the ballk lIIust buy it of thelll at the increased price \yhidl the over-issue has caused, is not the whole forcc of the drain throwlI upon the over-issuillg ballk alone by this combillatiull of the other ballks against it? A))(l is it lIot clear that, by occasionally resorting, 01' threatening to resurt, to this rcsource, the principal hanks llIay always prevent over-issue Oil the part of any individnal bank? And, inJacf, is not ove.,-i~stle uniformly so prevmfed -in Scolln.nd? And has it not constalltly operated so as to prevent it 'I Alld yet, on the stn~np;th of these shallow fallacies, our doglllatist declar('~ that the free co~lpetition of banks introdn~etl into t.()lItlOIl would ' a~gravate the over-isSllc of I Rq,~ It. flwnwwd-Ji,ld;' alltl , whclI die rCGoil did take place, as ill 18~5, the 0111)' ditl'crence would be that it would be a t!lot/sand timeg more Se1JC1"I?!' Pretty well this. In 1H£;, private and public credit were on the \'crge of extinction. IVlr. H IIskissoll declared the nation to ha\'c heclI witllin twenty-follr hours of a state of barter i-and the min aud billlkruptcies,-the snflerings alld lIIisery that were the actual results 01' that crisis, h:l\'C beelljustly described as unequalled since the breaking up uf the 1\1ississippi sche11le in l'rance. 1\nd Jet we arc told that the systell1 which gave rise to this crash is the best that can be devised; anti that another, which has been for a century in operation in Scotland \i'jth lllliforill s:ifety and success, wonld, if introduced illto Ellglantl, occ:lsion crashes IL fl101/,.l"lnd (imrs more srlJPrc! I f hardihood of assertii)JI were the only I'e(JlIisite in :1Il :Icivor.:tte, the BUllk directors, it rnll~t be owned, have seemed an able challlpion. 111 Iris remarks un the inipolicy of cstablisllillg It National bank, we nrc illclillcil to agree witli him; we ngree also ill Its beillg highly de~lrahle thnt whatever noteissuing Lank or b:ulks arc established ill Loudon shollid adopt the deposit and cash-credit system of Scotlalld, the benelits of which arc incaleulable, aud have been alreudy dwelt on in fOl'lller N limbersof this JOlll'llal. But as to engrafting this system Oll the Balik of Englalld, how is it to be accomplished? Once concene all exclusive

aCCitnwlu{c

Free Banking I

454

The Rights of Industry and the Banlcing System.

exclnsive privilrge to that or any other establishmellt, and 11.ley will act on the principle of all monopolists, namely, a narro\\"lng of the market, allll an enhancellJent of the terms. Competition alone can secure for the pnblic, in banking as in other things, the widest accommodation at the cheapest rate. On tllCse grollnds we d ifrcr wholly from the concluding assertion of ollr author, that the Bank of England ' answers, or lIlay casily be made to answer, every legitimate pnrpose that a bank ollght to serve, and that it would he IIlIwise to introduce new establishments in its stead, of wbich the results, in so far as they can be determined beforehand, may be Immo1!11ced il~urious alike to individllals and the public.' "\Ve :.tlinn, on the contrary, that dearly-bought eXjll!ri(!Ilce has determined the results of the present privileged estahlislJlnent to be 'injurious alike to individuals and the public ;'-that the same sure t~st has proved other establishments based on a system of freedom to be, 011 the contrary, productivc of security and un(!xceptionable ;)(Ivantages,-that the Balik of England, as at present constituted, scarcely answers anyone' of the legitimate purposes that a bank ought to scrve,' and that the ' crise with which it cOllld be made to do so' is an assnllJption unwarranted by fact or ar~ulllent.

Our own opinion, as at present advised, is decidedly in favour of the proposal of Sir H. Pamell, ill his valuable tract Oil Papermoney and Banking, published in Hl!27, hardly a word of which, we believe, it would be uccessary to alter ill reprillting it at present, so completely have its assertions and predictiolls been borne out by the experience of the last five years. We think, with him, that ' cOlllmercial credit, instead of beiug left to the mercy and discretion of twenty-four Balik of England directors, ought to be placed under the protection of a free system of banking: on the one hand, the principle of profit would lead the banks to extend credit at all times as far as it ought to be carried; while, on the other, the principle of competition would prevent them from going too far, aud forcing so much paper into circulation as would lower its value.' We think the influence of this overgrown establishment over the value of funded property is far too dangerOilS a power to be entrusted to auy private individllals, however lliglt and honourable their character. By the proceedings of the Dank, the stocks may at any time be elevated alii \ dcpressed again, by five or ten 1'('1' cent., and the property of otlwrs transfe ....ed into the hands of the operator with perfect s('curity frolll detection. ""Ve thillk the cxe\nsivc powcr posscssed hy the Balik of iSSllillO" notf's, alJd its ('IHlrIllOIiS capital, givc it all arbitrary and tynllllliclJ authority o\"c .. tlte whole COIIJllJerce of LOlldon, illcolI,istl'llt ",ilh the libel~ty of trad(~ alld the security of property. We think the COlnlCXlO1I

87

88

Free Banking J

The Rights of iltdustnj and tlLe Banldllg System.

455

c~nl1exion of a pri;ate and exclusively privileged bankillg company wIth govel'lllllent IlIlproper and dangerous, as tending to seduce the olle party into extravagance, the other into concessions inconsistent with the interests either of its shareholders or the public; -above all, we think that it will be impossible to prevent the recurrence of ruinolls fluctuations in the extent all(\ value of o lit' cUITenC}"-altel'llations of over-issue at one tillie, extreme parsimony at another-under any system but one of competition and publicity. That freedolll is the sole guarantee for safety, experience and reason combille to demonstrate. The ollly measures which appear to liS to be needed upon the expiration of the Balik charter are, 1st. That all banks be required to deposit secllrity in govel'lllllent stocle to the full alllount of the notes they iss lie. '2dly. That the law be repealed which prohibits the issuing of notcs under live pounds. 3dly. We would make the notes njmelropoZifan bUllks (July convertible into bars of bullion, on thl' plan of l\Ir. Hicardo, alld allow the notes of coulltry banks to be paid in those of metropolitan banks. This would relieve the country banks from the necessity of keeping a large dead stock of gold by them to provide against panics or maliciolls runs upon them, which, under a system of freedom, might probably never OCClll', out which yet the banks mllst be prepared for. "Ve need not repeat here the argllmellfs by which 1\1 r. Hicardo, and, after hilll other writers, have demonstrated that excessive issue by the provincial banks will be as readily checked by their liability to pay their notes on demand in Bank of Englalld notes as in gold; and the extension of the privilege to all metropolitan banks, as well as the Bank of England, can in no degree weaken the security-on the supposition that these and all banks are required to deposit government securities to the extent of their issues. If these measures were adopted, it may be asked, what shall we have gained? We answer, in the lirst place, the establishment of a perfect currency, cheap, secure, and not susceptible of sudden variations in its. amount, and consequently in its value. Such a banking system, by proportioning the supply of money to that of commodities, will act like a charm on the present depressed condition of the productive classes, among whom there is all almost total stagnation of credit, from the absence of a sufficient medium of exchange, and the consequent impossibility of obtaining remunerating prices in any bu~iness. To the want of such a system alone, by which the void occasioned through the deliciency of the preciolls metals would have been lilled up, is owing, as we have shown, the winotls decline in prices of the last fifteen years, during which industry has undergone 1II0re stlllcriligs in peace tllan she ever cntimed ill war; and which has placed England ill the anomalous

89

Free Banking I

456

The Rights of Ind1lstry and the Banking System.

anolllalollS, and otherwise inexplicable,

position

of a n;ltion

plunged deeper into distress vy every increase of its pronllctilJlI~, that is, of its real \ve:t1th ! But, secolldly, puttill~ out of sigl,t its sallative efrect 011 tlw present circlllIIst:tll('es of the cOllntry, the pr.1'11!{l'Ilcnt hellelits of a soulld paper circlllatioll will be iIlC:t!Clllab Ie. it will ohviate the n:ClIITellce of evils similal' to those we arc wfferillg IIl1der; it will prevent those fitflll alld ruinolls IIl1c:" tnatiolls ill the value of 1II0lley hy which trade has been alternately over-excited amI depressed dllrillg the presellt century ;-it ",iiI give a wholesome steadillcss to the currency, proportiolling its supply exactly to the wallts of the market. . :Moreover, the nation will ve saved the vast expense of a metallic circlllation; alld a largc portioll of its capital, 1I0W locked up uIIl'roductively in gold, will ve set free to ve elllployed ill the paYlllent. of lavollr and the creation of consumahle wealth. The productive capital, alld, COIISCI!IIClltly, the :l\Il1ual prodllction alld COIISUIllption of the COlllltry, ",ill be illcrrased bj' so Illlu.:h, provahly by forty or fifty milliolls. Lastly, tIle restoration of this lIlass of metal to the gelleral markd of the conlillcrcial world, frolll whence we have been drainillg it dnrillg thc last lirtcen years, will everywhere lower the v:lllle of tllc metals, alld witll thelll that of l1Ioney. Prices will rise ollce lIIore Oil the COlitilll'lIt as well as here, ~o tlHlt the 1,1'0Cess will be IIl1relL ill our cOIIIIIH'reial trallsactions, I'XCl'pt iJyth(~ gradually increasing retul'lls to illdnstry both ill the hOllle :\1ld the forcigll markets. j\ lid sillcc it is the pecnliar virtlle of a credit CIiITCIIC), to expand with the increase of productiolls, ollr COIl1merce will 110 10llger be crippled by a grtmillg dclicicllcy of the circulating mcdilllll, no longer forcell to reglilate its pace hy the slow alill ,ariahlc rate at ",hidl the reluctant earth can, by a lavish sacrilice of hlliliall life and happiness, be lIIade to give III' its ores -bllt will be flll'lIished with tlmt grand desideratullJ, (which itis at once the first duty alit! the sOllndest policy of the go\'el'lllllent of a' conllllen;ial COlllltl-y to provide,) (t ctrrre.nc.'l thllt will (JpJlTooch uS' lwa'l'l.'l as l'ossibZ(: to cOllslww!J ill v(ll,/.(', r.xlwll.diny (/1Id cmLiracfiJl(T in (J.1/t()l(.Jli with Ute rcul 'lVI'HUh (if which it is tlte in.l'fTlllllcnt exchange,. therehy keeping the aggregate of prices 011 a par with

(1

the aggregate costs of productioll; givillg the lIIerchant, the lIIanufacturer, the fanner; :lIIn thc tradesman, some gccllrity thnt prtllIenee, skill, :tud illtillstl'y willlllcct with 1'cnwnrrntion,. that their ClIlclilutions Oil the provable demalld and supply of the markets :-:hall 1I0t at I('a~t V(~ o\'(:rthrowli hy an nllforcseen :111(1 treacherolls variatiol\ in the vallie of lIIoney. Industry C:11I110t bill thrive IIllder such a system; l\1ld ",hat allglJlI~lIts the wealth of the nation lIIust increase the rcsomCl'S its goverlllllt'nt, and the average enjoyments of every class of society. Productioll ",ill be restored to its

or

90

Free Banking I

The Riglds of Indusfrt and the Banki.ng System.

457

its wonted health and vigour; the misery, and with it the discolltent of the working classes will. disappenr; and encouragement will be again atforded to that spirit of ellterprise, persever.ance, and acculllulation, which has alrcady carried this country to so high a position among nations-and, if fair scope be but given it, will ·continue to urge her forward in an ullbounded career of improvement, prosperity, and geueral happiness. We cOllJmenced by showing, that the first and most indispensable of the BIGHTS OF INDIISTHY is the security of the property ac,]uircd by industry. We have since shown, that the existing state of the currency, as brought about by ullwise interfeh~nce aurl the establishlllcnt of exdusive privileges, is completely destructive of that security,-that it has occasioned, and cOlltinues to occasion, an Ill~just and treacherous transfer of the earnings of the illdustriolls to the idle,-of the property of the producillg to the 1I01l-producillg class. In the nallle of the industry of the country we eiaillJ, then, as the furl'lIlost of its rights, a revisal of this fraudulent alld jnggling system, and the estabJisiJmcntof a free, sound, aIHI equitable. currency. If the refusal be persisted in,-if the rights of industry arc dellied, CIIII we expect that allY other rights ",ill be IOllg respected? If the property of the industrious is lIot protected, how lIluch lungel' will other property r(,Jllaill inviolate '? I I ow IIllldl 100l~(!r ought. it to J"(!lIWill ~o-thc foundatioll of all rigbt to properly lying solely ill the right of indnstry to its earnings?

[4] Excerpt from Samuel Bailey, A Defence of faint-Stock Banks. and Country Issues, 1-100

ON .JOINT-STOCK BANKS, AND COUNTRY ISSUES.

PART I.

A MIDST the discordant opinions and multitudinous discussions to be heard on all sides upon the subject of Joint-Stock Banks, it is not easy to discern the real merits of the several questions at issue. We shall hardly see our way clearly throug'h the confusion unless we set out from some plain and acknowledged principles, and steadily pursue them to their legitimate consequences. If this could be accomplished, the controversy (amongst men of sense, at least) would soon be at an end. It is obvious that the great point to be determined is, how far the State can heneficially interfere in the business of banking. The fundamental principle in the general policy of interference is, that the state should not interpose in any case where private interest and exertions are adequate to accomplish an affair without it. The supreme authority should limit itself to those matters which private efforts are incompetent to deal with. It is no,,,, uni\'ersally admitted that amongst B

92

Free Banking I

the things which are thus ou t of the province of go· ,"ernment, the various trades in which men engage may be rightly classed. After much dear-bought experience, we have at length arrived at a drgl'ce of knowledg'e sufficient at least to teach us that the business of production and interchange requires no aid from the law; that a man may be left to gro,~ wheat and barley, to manufacture cloth, to deal in hats and hosiery, as he pleases, and to sell them at what prices he can obtain, without the necessity of the governing power watching his steps to prevent him from sacrificing his interest, or from reaping extraordinary profits in consequence of the supineness of his fellow men. The only purpose for which the State can interfere in these matters with advantage, is to uphold good faith and protect him and those with whom he deals from mutual injury. For this end, payments, contracts, and promises are enforced. There are certain prescribed modes in which he can extort the money that is wrongfully withheld, and compel the fulfilment of the bargain which anyone endeavours to evade. But there are no laws to save him from imprudence, none prescribing what capital he shall have, or what proportion it shall bear to the amount of business transacted, or what profits he shall make; none limiting the number of his offices and warehouses and factories, or fixing the towns and seaports where they shall be situated. Regulations of this sort would be manifestly ill-judged, burdeu-

Free Banking I

3

some, and unnecessary. Such poinb are to be determined by the vigilance of the party concerned -requiring minute knowledge of a thousand particulars which will be learned by nobody but him who has an interest in knowing them; and, although they are not invariably decided with perfect wisdom, they are determined more wisely on this plan than they could be on any other. There is, however, still one trade in which govel'11ments distrust the sagacity of self-interest, and deem that the vigilance and discretion of persons at a distance, and imperfectly acquainted with the circumstances of a contract, will be superior to those of the parties who are on the spot, and al'e immediately concerned. Dealing in money is imagined to have something so peculiar about it, that Legislators cannot forego the fond fancy that there is a necessity for their interposition. Allowing a merchant to load other commodities with a pront of fifty per cent. for six months, if he can find any body to take them at that rate, they will not permit him to charge a profit of six per cent. for twelve months, should his commodity be gold, although thousands may be willing to pay it. In imposing this restriction, the law, however, is now admitted, by all who have studied the subject, to do mischief. The restraint is justly regarded as the lingering relic of past ignorance, preserved by prejudice and sinister policy. No reason can be adduced why the trade in money should not be left Il 2

93

94

Free Banking I

4 as free as any other trade. Thl' law itself docs not aspire to direct a man from whom he shall borrow, or how much he shall lend. It pretends only to limit him iu the remuneration to be received for the lise of his money, and cannot really effect what it aims to accomplish. If we omit all reference to taxation or police regulations, the effects of which on commerce ought to be merely incidental; there appear to be only t\\'o cases of importance in whieh the State can properly interfere with allY trade or branch of production, for any other purpose than doing justice hetween man and man; or, at least, ollly two cases that can affect the question before us. l. One of these is when an undertaking is of so peculiar a nature, that it cannot be entered upon witllOut special powers and privileges. Canals and railroads, in the execution of which it becomes needful to trespass on the property of reluctant parties, may be cited as instances. In sanctioning such undertakings, the State is ohliged to grant a sort of monopoly, and having withdrawn the check of competition, it may with propriety interfere in various ways, according to the circumstances of each case; sometimes prescribing the maximum of profit-sometimes the rate of charge--and sometimes particular modes of proceeding. 2. The other case is where tIle prosecution of illdividual intcrcsts would interfere with branches of industry, or departments of excrtion, which the

Free Banking I ;)

State itself 11:15 thought propel' tu aSSUllle, Thus, in our country, the Government has undertaken the convcyanec of letters, antI the coinage of money ; and ill order to facilitate 01' insure the accomplishment of its purposes, private persons may be very properly restrained from any proceedings which would tend to defeat them. Now, it appears, that in pursuing the trade of' a dealer in money, the transactions of an individual could come only within the latter reason fur restraint. By issuing billil or notes, wbich he mllst unavoidably do, in some shape or other, he might be neutralizing the proceedings of the Mint. It is now beyond dispute that coin and notes of the same denomination will not long' circulate together. Individuals, therefore, 1Iy issuing such notes, might drive away the specie which the State had provided, and intendeu to form part of the currency. then, Government has determined, for any reason, to have a metallic currency, consisting of certain coins, here would be a plain grounu fur restricting the dealer in muncy from such issues of paper as would uefeat the design; but that object having been secured, there woultl be no reason left for extending the prohibition to the issue uf notes of higher denominatiolls. On the supposition, indeed, that he enjoyeu the sole privilege of issuing notes in a given district, his case wou lu fall under the first head; amI as he wuuld have a monopoly from Govemment, the

It:

95

96

Free Banking I

6 consequences of that monopoly might be properly limiteu by special checks on his issues. But if he had no monopoly of the sort, but was exposeu to the operation of free competition, he could not be reasonably subjected to restraint, in regard to the hills or notes which he might find it convenient to issue, except for the purpose already mentioned, of maintaining the circulation of coin. This is, in fact, the precise situation ill which an individual is placed in this country. He may deal in money aa he likes; he may draw bills; he may issue promissory notes, above a certain sum; he may lend at pleasure and borrow as he can, with the single restriction on the rate of interest. Alive to his own advantage, he will engage in t.hese transactions so far as he finus them profitable: subject to competition from rivals pursuing the same course, and tlependiug ill every step on the voluntary co-operation of others, he will Snu the transactions which he can carryon to a profit, whether borrowing or lenuing, or issuing notes, rigorously limited by the interests of those with whom he has to do. Thus, apart from the interference of the State, arises that combination of incitements anu checks which spontaneously insures that, in the long run, the business of dealing in money, like all other trades, shall be carried to an adequate, but not to an excessive extent. What iii tl'lle policy in regard to all individual ctll'J'ying on a t nulf', i~ tl'lll'1wiicy whell judividual~

Free Banking I

7

combine in partnershIp. When they unite in this way, there can be no more ground for interference with them as traders than when they were separate. The union may create a necessity for additional regulation to secure the performance of engagements between the partners themselves, and between them and the public, or otherwise to prevent wrong, but it can occasion no call for interference in the management of their trade. The proper and profitable management of it will be secured in as high a degree as is practicable by the same play of interests which we see so effectual in the case of individual traders. The number of partners can obviously make no difference in the matter, whether two or two thousand. In the latter case, a few still further laws might be necessary than in the former, for the sake of convenience in adjusting any points of right and wrong which might arise between the partners themselves, and between the partnership and other persons: but a multiplicity of partners would still form no ground for interfering in the management of the business. Nor could there be any just or adequate reason for limiting the number of partners by law. Private interest would determine the beneficial number with a precision unattainable by legislative regulations. Two would not unite unless they found it their interest to do so; and if a thousand found it their interest to unite, no reason can be shown why they should be prevented. The

97

98

Free Banking I

8 principle here insisted on is admitted with regard to other trades-but again it has been fancied that in this respect the trade in money may be shackled and hampered to the advantage of the community; and our legislators, in the plenitude of their wisdom, formerly restricted the number of partners in the business of banking to six. Not only was there no rational end to be answered by this, but mischief, deep and extensive, was sure to ensue. If there is any trade in the world in which a large number of partners is peculiarly desirable, or ill which, at least, the number should not be arbitrarily abridged, it is the very olle selected for this limitation; because it is the trade of all others in which the undoubted stability of the companies engaged in it is of the highest importance. The consequence of the restriction in England may be seen in the columns of the Gazette. It was under the impression of similar views to these that the British Government withdrew the restriction in question, and threw open the banking trade to large as well as small partnerships. In doing so, it very wisely abstained from attempting to regulate such points as the interest of the parties concerned would spontaneously provide for. The provisions of the law were almost exclusi vel y di rected to facili tate the formation of large partnerships, and to remove obstacles to the fI'n!1\' a!'s('rtioll I)f J'ight alld redress of wrong,

Free Banking I

9 arising out of circumstances peculiar to them. As the customary modes of joining anu retiring from a partner!'lhip would have been t.roublesome and expensive, where a considerable number were united, the law prescribed easier modes of accomplishing these acts. And inasmuch as, from the number of partners, there would be difficulties in suits at law, conducted in the same way as suits relating to ordinary partnerships, the legislature obviated these difficulties by introducing the appointment of public officers, to sue and be sued for the whole company. Further, as the list of partners would be continually liable to variation, it became requisite to provide, that the creditors of the Bank should have it in their power to ascertain at any time the actual shareholders; and the law very properly directs how this is to be effected. All these are regulations springing out of the manifest differences between large and small trading companies; they were designed to obviate the peculiar inconveniences of the latter, in points of formation and legal redress; they conferred no exclusive privileges, and were not at all intended to interfere with the management of the business. The same checks were left to operate on this, as on the affairs of individuals. The responsibility of partners was wisely retained in all its force. No attempt was made to prescribe points of conduct which there were ,u]cquatc motives to regulate.

99

100

Free Banking 1

lO

On the whole, the Act, although in some respects faulty, appears to have been judiciously framed, and to have limited the interposition of authority to its proper objects. Its principal feature, in fact, consisted in withdrawing an interference which ought never to have had place, and making a few provisions to regulate the new state of affairs, which might be expected to arise in consequence of that withdra wal. If the Legislature had simply taken off the restriction formerly existing in regard to the number of partners, it would have effected a great improvement in the character of Banks; but, by introducing also a few regulations, founded on the peculiar characteristics of large companies, it secured still more effectually t.he formation of solid establishments, adequate to the business of the country. All this, it may be said, is very plausible "in theory," but has the Act . answered its purpose? Has the system of Banking called into existence, and fostered by it, proved beneficial to the country 1 Have not evils ensued, requiring the interposition of the legislature 1 To the first question, we unhesitatingly answer in the affirmative. The law on the subject has provided the country with a considerable number of sound establishments. Up to the present moment, although pecuniary difficulties in the commercial world have reached an

Free Banking [

11

almost unparalleled height, none of the depositor!:; of money in Joint- Stock Banks, and none of the holders of their notes, have lost a shilling. To the second question we reply;-It is true that there has been mismanagement-it is true that there has been embarrassment in some of these establishments; but all this equally occurs in private business, and was what every man of sense expected at the outset of a new system, or rather an attempt to reform an old one. Both in private concerns, and in Joint-Stock associations, such evils, it may be added, unfailingly lead to their own rectification. To prove what is here asserted, let us examine in detail the principal charges brought against the system itself, as well as against the mode in which it has been carried into effect, and which are put forth as grounds for the interference of the legislature. 1. It is in the first place alleged that the law has led to the undue, and therefore mischievous, multiplication of Banking Companies. 2. It is further alleged, that there has been a great deal of mismanagement in conducting the affairs of these companies. 3. It is more especially charged against them that they have unduly swelled the currency of the country, by a great over issue of their notes. 1. As to the first charge, it may be admitted as probable that too great a number of banking com-

1O[

102

Free Banking I

12

panics have been formed, and too many banking offices, principal and subordinate, opened: but to complain of this, is to complain of the inevitable movements of the mechanism of society. If any one inquire how it is that any town is supplied in such nice adjustment with the number of drapers, tailors, hatters, and saddlers, which its wealth and population require, varying as these vary, he will find that this is not done by the wisdom of government, but is the result of certain tentative steps taken by private individuals, who are induced to set up in these several branches of business by the hope of gaining a livelihood, or bettering their condition. If they find room enough amongst their competitors, they do well; if they find the ground preoccupied, they attempt perhaps to gain custom by underselling their neighbours; the latter are forced to resort in self-defence to the same means; a reduction of profit ensues; the trade becomes a losing one from being overdone, till the superfluous traders are thrown out, and remove from the town, or appear in the gazette. So it has been, and will be, with banking companies. The same tentative steps have been taken with the same hopes of success; and by the same process-the disappointment of those hopes-will the redundancy, if it really exist, be corrected. The incitements and checks are the same in one case as in the other. No wisdom, short of omniscience, could so well proportion the number and extent of these establishments to

Free Banking I

]3 the wants of the community, as those principles of human nature which spontaneously work out the result. Admitting, then, for argument's sake, the alleged evil to its utmost extent, we cannot admit that it furnishes any ground for legislative interposition-because the same evil occurs in every trade-because there are always principles in operation adequate to correct it-and because needless interference is not only useless but mischievous. 2. It may be also allowed that there have been in some of these Companies very striking instances of mismanagement and overtrading j but no instances surely more striking than we witness in other branches of business. It was just what was to be expected from the opening of a new department of commerce, or rather of one from which the people had been shut out, and the nature of which they did not sufficiently understand. Besides, in 1835 and 1836, an inordinate spirit of speculation seems to have spread over the country, and a passion for Joint-Stock Companies of all sorts, set prudence and reason aside. This mania, although it manifested itself in the multiplication of banking companies, and the manner in which they were conducted, could not obviously be owing to them. It had a much deeper source, and this was only one of the forms in which it appeared. Thus, two different causes were in operation at the same time, to swell the amount of business transacted by the Banks. In the first place, some

103

104

Free Banking 1

14 of these establishments being newly formed, deficient in experience, and having a business to acquire in the face of rival companies, were led to push their transactions in the spirit of competition or avidity, or from ignorance of conse· quences, beyond safe and proper limits. In the second place, they were affected by the general spirit of speculation and overtrading which prevailed in the community, and would have been almost forced into overtrading themselves, or at least into a large extension of business, had they not already had a predisposition to pursue that course. In all this, however, there is nothing but what is temporary, nothing which will not correct itself, nothing peculiar to banks or banking companies, large or small. Other commercial establishments are constantly exhibiting the same phenomena. Open in any direction a new prospect of gain, or let an increase of demand for any important commodities arise, and you will soon see the same sort of rivalry, the same undue extension of business, and the same dereliction of the strict line of prudence. Looking at the worst instance that has occurred of mismanagement in large banking companies, the instance in which a Joint-Stock Bank was under the necessity of applying to the Bank of England for assistance to a very large amountwe may point to parallel cases in the large mercantile houses of London and Liverpool. These

Free Banking I

15

houses have evidently pushed their business far beyond the limits of discretion, have exposed themselves to the chance of accidents beyond their own control, and have been saved from ruin like the banking company alluded to, by an arm on whose aid they had no right to calculate. That such houses should be led into the error of overtrading, is no doubt greatly to be lamented; the mischief they may produce by it, is scarcely to be conceived; and the advantage of preventing it would of course be commensurate. But in such cases, who ever dreams of legislative interposition? of limiting their sphere of exertion? of enacting that they shall do business only in a certain ratio to their actual capital? of prescribing how many warehouses they shall establish, how many ships they shall charter, how many bills of exchange they shall draw, and what amount of drafts they shall honour? When the markets have been inundated with raw materials or manufactured goods, has Parliament interfered to prevent subsequent importations? When South America was opened to British enterprise, and the eagerness of speculation madly shipped cargo after cargo without bounds or discrimination; when coffin furniture was exported to nations who buried their dead in winding'-sheets, and skates to countries ignorant of ice; was an Act passed or even dreamed of, to restrain the folly? The case of Banking Companies is just the same

105

106

Free Banking I

16

as that of mercantile companies, or individual mer· chants. N a reasons exist, why the former should be placed under supervision and restrictions from which the latter are exempt. All the reasons on which the latter are exempt apply to the former. Both are subject to that eagerness after extending a profitable business which, salutary as it is on the whole, is so apt to outstrip discretion; both are alive to the contingency of loss, and interested in listening to the voice of experience; while they are also alike in being more intimately acquainted than any other party can be with the thousand consider· ations on which the prudence or imprudence of any of their steps depend. And, lastly, the errors of both can be corrected by nothing but ampler expe· rience, sounder views, and superior knowledgeacquisitions not to be forced upon them by Acts of Parliament. And, after all, what are the evils hitherto pro· duced by Joint-Stock Banks, and who are the sufferers? The holders of notes and the depositors, or,in other words, those persons who have trusted the Banks 1 No. Who then 1 The partners themselves. If there has been any loss, it has evidently fallen ill the right place, on the proper parties. With views of profit they have become partners in establish· ments not adapted to realize it, or they have neg. lected to exercise that control and vigilance over the management, without which the desired result ~ould not be attained. They ha,-e made erroneous

Free Banking I

17

calculations, 01' trusted the issue to chance, or COIlfided where confidence was not due, and they have no right to complain of any body in the world but those individuals who may have deceived them. If they had become partners in any mercantile concern, and been equally supine or misjudging, they would probably have encountered a similar disaster. Men who grasp at profit must run the risk ofloss. Thus, the mismanagement and over-trading of Joint-Stock Banks, even if the charge8 could be substantiated more generally than they can be, afford no more ground for interference than similar faults in other commercial establishments. This conclusion, indeed, is, I believe, not disputed in regard to those banking companies who are coutent to trade in gold and Bank of England paper, and do not issue notes of their own. "Mismanage and over-trade as you like," say these objectors, "so long as you refrain from circulating your promissory notes; but if you choose to deluge the country with your paper it is necessary that you should be placed under the salutary control of the state." This brings us to the consideration of charge the third. 3. The allegation that the Joint-Stock Banks have unduly and mischievously swelled the currency of the country by over-issues of their own paper, is, in fact, the grand charge of all. Even the friends of these establishments shake their heads at so grave a fault. c

107

108

Free Banking 1

18 This point, nevertheless, has been much misconceived and misrepresented. It is surprising, indeed, to see how little the real state of the case is understood. The generality of writers on the subject appear to fall into one common mistake-the mistake of conceiving that the Bank of England and the Country Banks are analogous in their character as banks of issue, and possess a similar control over the currency. A close examination, nevertheless, will show that there is scarcely a point of resemblance between them. As banks of issue, they are in a totally different situation. While the Bank of England has a power of issue not limited by the existence of rival establishments possessed of equal privileges, and without any check but the necessity of paying her notes in gold when demanded---a check which may be disregarded, as every body is aware, for a long period-the Country Banks, rivals to each other, act under circumstances which immediately and effectually limit the amount of their circulation. It is scarcely possible, indeed, that there should be a more complete system of checks on the issues of Country Banks than that which actually exists, and which either prevents overissues or almost instantly repres eh em. In comparing the two parties in question, there can be no doubt that they are alike in one respect: both the Bank of England and the Country Banks are equally liable to pay their notes in specie: for the recent alteration in the law, which gives the

Free Banking I

19

latter the option of paying them iu Bank of England paper, amounts to no more than a permission to pay the gold in London, instead of paying it on the spot. Both the Bank of Eng1and and the Country Banks have, therefore, to keep a reserve of money to meet the notes which may be brought in for payment. The only difference is that the latter may keep it either in gold, or in paper which has cost them gold. Here the similarity in the position of the two parties compared ends. While the Bank of England makes her advances on commercial bills, and her investments in public securities entirely by means of her own notes, Country Banks are under the necessity of making the principal part oftheir advances in gold or Bank of England paper; that is to say (for to them it is the same thing), in solid property. For every five pound note which they issue on commercial bil1s, or credit accounts, they must probably advance ten, fifteen, or twenty pounds in gold, or other real capital;· and it is plain that they can become possessed of no public securities by means of their own paper, but must pay down every shilling of the purchase money in specie. That this is a true representation everyone must

* Of course, Country Banks vary very much in this respect. The author is acquainted with one banking establishment, whose advances to its customers are five or six times greater than the amount of its circulation; and with another ",here they are only about three times greater. c 2

/09

Free Banking I

110

20 ~ee,

even if personally unacquainted with the subject, when he learns the mode in which Country Banks make their advances. In the first place, they are obliged to furnish to their customers. along with their notes, a certain quantity of gold for those transactions, such as retail purchases or the payment of wages, which although separately small, are great in the aggregate. What proportion of gold may be required to accompany the paper, must depend on the nature of the occupations carried on in the district. * If a bank should attempt to force more than the proper proportion of notes on its customers, the paper would be "returned upon it, probably the same day, for specie or London notes. But the main point to be attended to is, that a considerable part of the advances which Country Banks make to their customers are made in London, and in these their own notes are of course entirely unavailing. A merchant or manufacturer has a remittance to send to some other town, or he has an acceptance to provide for in the metropolis, or he has occasion for a letter of credit on some other Bank-transactions which all terminate in payments in London, without the intervention of a single note of the Bank which furnishes the required amount. In some Banks the proportion of receipts

* Mr. Beckett, of Leeds, stated before the Committee of 1832, that his bank issued to the manufacturers for wages, two-thirds or three-quarters in gold, and the rest in its own notes.-Minutes, page 95.

Free Banking I (t)

and payments in London, to their other business, is very large. In these two circumstances, which render the issues of their own paper a subordinate part of their advances, there would be a sufficient preventive check on the over-issue of Country Bank notes, were there no external and repressive checks. But if, in misconception of their real interests, any of these Banks should attempt to extend their cir,. eulation, and should succeed by some means or other in getting afloat a greater amount of their notes than would be issued without any direct effort in the regular course of their business; the extenial and repressive checks would instantly eome into operation. Should they have forced out a greater proportion of paper to specie, than the nature of the business carried on in the neighbourhood can do with, the surplus notes are instantly sent in for gold. Should they have compelled or induced their customers to take out. notes for large payments, which must after all be finally made in London, the paper in a few days finds its way back to the Bank that has had the folly to issue it, probably through the weekly exchanges which are established with its neighbours in the same trade, and the amount has to be liquidated by a draft on London, to the loss of the issuer. Hence, when a Country Bank agrees to make any advances to a customer, it usually imposes no restriction as to the sort of money he shall draw

III

112

Free Banking I

22 out. It would be indeed not only useless to do so· but impolitic, the real interest of the Bank being to facilitate his transactions. He receives local notes, or Bank of England paper, or gold on the spot, or a draft on London, just according to his own convenience. If he is in the practice of using local paper at all, he is of course expected to use that of the Bank which grants him the loan; but as he can have no obvious interest to do otherwise, the matter is commonly left to his own discretion. Another circumstance is constantly instrumental in returning their notes on Country Banks,-their practice of allowing interest to their customers on all sums paid in. Hence arises an alacrity in sending in superfluous cash of all kinds, never witnessed by those Banks of Deposit, where interest accounts are not customary. From this representation, everyone must see that the extension of their issues can never really be the primary object of Provincial Banks. Their principal business does not consist, like that of the Bank of England, in lending their own notes, but in lending real capital, belonging either to themselves or their depositors; and so long as their own paper bears so small a proportion to their loans, their chief concern must be to make advances to their customers safely and profitably, with little or 110 reference to the effect which such advances may produce on their circulation. Everyone must also see that the absolute

Free Banking I

23 amount of notes which they can keep out, besides forming so inconsiderable a proportion of their advances, is a matter over which they have very little direct control, and they have none whatever over the ratio which their notes bear to their whole payments. It may 'be usually presumed that the amount which any Bank can keep out, will correspond to the extent of its business, and, therefore, by doing all the good business offered to it, so far as its resources will permit, it will probably extend its circulation. But this is an incidental eH'ect-a collateral consequence, which mayor may not take place, and which is seldom adverted to in de· termining whether a loan shall be granted or refused. I am not aware of any mode of increasing their circulation which can be legitimately resorted to by Country Bankers with that single end in view, and certainly none can be adopted which would have the effect of swelling the currency. Some Country Banks have indeed been known to make it an object to circulate their notes as extensively as possible, by having recourse to means not of the most creditable kind, such as employing agents in various parts of the country to exchange their own notes for those of other Banks at fairs and markets, and in public-houses. A Bank which betakes itself to such expedients always suffers in reputation, and seldom reaps any benefit from them, even in a pecuniary point of view. Should it, however, be successful in keeping afloat

113

114

Free Banking I

24 a larger amount of paper, this additional quantity is obviously not to be regarded as so much added to the circulation, but is in fact kept out by displacing the notes of other Banks. The result is not an enlargement of the mass, but a change in the component parts. These considerations are surely sufficient to prove that there are abundant checks already existing on the issues of Country Banks, and that legislative interference is perfectly superfluous-a needless attempt to do what is already accomplished. Here again, an objector may say, "This is all very plausible, but nevertheless, look to the facts. Within little more than two years, from the spring of 1834 to the summer of 1836, there has been an increase in the country circulation of upwards of two millions." But what does this prove? an overissue? An answer may be fairly returned in the negative. The fact itself really proves nothing. Who shall say what is the precise amonnt of provincial paper requisite in any given state of trade? And if any person had sagacity enough to discover this point, how shall he be able to tell the alteration proper to be made in that amount when the state of trade has undergone a change? \Vhen the business of the country is prosperous, the demand for goods enhanced, industry quickened, and the transactions of the community multiplied, more money will be required than in the opposite condition, and a larger amount of pro-

Free Banking I

25 \Tincial notes will be issued and retained in circulation. A Bank has, of course, a certain number of customers, such as merchants, manufacturers, farmers, and shopkeepers, who require and keep in circulation a certain number of notes~ bearing some proportion to their trading transactions: when their business decreases, they require fewer notes; when it increases, they require more. In the instance of an individual Bank, an augmentation of its paper may be owing either to an increase of its business at the expense of other Banks, or to an absolute increase in the trade of the country. When the former happens, there is no addition to the currency; when the latter, the addition which is made is made because it is needed. With respect to the expansion which appears from the returns to have taken place in the circulation of the Country Banks, including private and Joint-Stock Banks, it is probable that part of it was owing to the substitution of their paper for that of the Bank of England in places where provincial notes had not before circulated (as Lancashire, for example,) part of it to an augmentation of the legitimate trade of the country, especially in the manufacturing districts, and part of it to general over-trading. Under such circumstances, if not a single Country or Bank of England note had been in circulation (to suppose an extreme case), an expansion of the means of interchange must have ensued, either by bills of various kinds, checks, transfers, book-credits, and otherexpedients, or by

115

116

Free Banking I

26

the importation of more bullion, or, as IS most probable, by both. An attempt to stop this process would be as futile as an attempt to prevent the expansion of iron when heated. We shall be prepared, by the foregoing review of the proceedings of Country Banks, to appreciate the injunction of the Parliamentary Committee of 1836, "that those who assume the responsibility of issuing notes payable on demand, should feel it their pressing duty to examine the state of the exchanges and the proceedings of the Bank of England in reference to its issues, and thus guard against the dangerous error of an imprudent extension either of credit or of circulation, when an opposite course is rendered necessary." The meaning of this is evidently that the JointStock Banks should govern themselves, not by a knowledge of the business of their several districts and of their own resources (which would seem to be the best guard against imprudence of any kind), but by the state of the exchanges and the proceedings of the Bank of England, with the express view of producing a general effect on the circulation of the country. Not to insist on the difficulty of extracting from the two data here recommended for simultaneous examination, any harmonious result, it may be observed, in the first place, that this is one of those injunctions, which being addressed to a number of parties standing in the position of rivals to each

Free Banking I

27 other, and proposing to them a public object attainable only by their general concurrence in doing what it is their individual interest to neglect, are in their own nature perfectly null. It is like a recommendation to the holders of wheat to charge a low price for their commodity, lest they raise it so high as to admit foreign grain-a recommendation which it might be advantageous to follow, if aU would combine, but which it is their interest to neglect, because no such combination can take place. Under these circumstances, the best thing for each of them to do is to obtain the highest price he can. It would be foolish for him individually to act on the general view of depressing prices-of keeping down what it was the interest of each to raise. Banks enjoying no monopoly are in the same position. The only proper principle on which any Bank, subject to the competition of rivals possessing the same powers as itself, can conduct its proceedings, is a very simple one and common to every trade. It is to do as much safe and profitable business as its resources will allow, and no more. All that it has immediately to look to when any transaction is offered to it, are the considerations whether the transaction will be safe and profitable, and whether the funds of the establishment are adequate to it. If these points are satisfactorily made out, there could be no more reason in the Bank declining the business thus offered to it, from an apprehension

117

118

Free Banking I

28 that credit and circulation might be unduly extended through the country, than in a draper refusing to sell a piece of cloth to a ready-money customer, from a fear that society might fall into the unlucky predicament of being over-dressed. If, attempting to act on the recommendation of the committee, it should wave legitimate business because the exchanges were unfavourable, or the Bank of England appeared to be contracting her issues (events by no means always contemporaneous), the consequence would be, that the rejected business would go to some other Bank. It would be an instance of self-sacrifice, without the possibility of effecting the desired result or accomplishing any public end. If a Bank looks at all at the state of the exchanges and the proceedings of the Bank of England, as it may very properly do, it will be only for the purpose of considering them in their probable effects on commercial affairs, on the money market, and thence on its own resources. But there are circumstances in which it might with the utmost prudence disregard these prognostications. While the exchanges were unfavourable, and the chartered Bank was contracting its issues, it might happen that the trade in the district where the Country Bank was situated was flourishing, its own resources ample, and safe and profitable banking business increasing. On no sound principle could it, under these circumstances, forego the opportunity of employing its capital to advantage.

Free Banking I

29 So far with regard to the" imprudent extension of credit" spoken of by the committee. On the other dangerous error of which the Joint-Stock Banks are warned, "the imprudent extension of their circulation," it is scarcely necessary to dwell, after having already shown that the issues of their own notes by these establishments are only incidental to their main business of lending real capital, and are subject to effectual checks, which relieve the banker from the necessity of attending to the amount. Suppose, however, that a Country Bank in compliance with the advice given, attempted to diminish its circulation a~ distinct from its credits, when it observed an unfavourable state of the exchanges, or an efflux of gold from the coffers of the Bank of England. We have already seen that it might prudent1y act in opposition to this advice with regard to its credits or advances; but nevertheless it might be wi1ling to follow the counsel, so far at least as to reduce its circulation. Suppose, then, it attempts to effect the reduction without reference to the advances; how shall it proceed in the matter? It cannot achieve the object by selling its public securities in London, for that would produce only Bank of England paper; and could not withdraw a single note of its own from circulation. It cannot reduce its credits, for by the hypothesis it is judicious to increase them. The only possible means to which it could have

119

Free Banking I

120

30

recourse would be to supply its customers with gold and Bank of England paper, instead of its own notes, as heretofore. Such a proceeding, however, would be quite ineffectual towards the object contemplated in the recommendation of the committee -the reduction of the country circulation. The sole effect would be, that neighbouring Banks would get hold of the specie or London paper, and substitute their own notes in its stead. Here again the self-denying Bank would be merely playing into the hands of others, without a step of advance to the proposed end. We will suppose, nevertheless, that all the Country Banks, instead of acting on their separate interests, . unite in following the Parliamentary recommendation; from a speculative dread of a redundant currency, or a chivalrous resolution to turn the exchanges; it is very much to be questioned, whether an intentional contraction of their Issues, in reference to the state of the Bank of England, would be proper and desirable. That establishment professes to let the public act on the amount of her circulation, by bringing in gold for paper, or paper for gold, and to be herself passive in the matter. - From this, one would think it to be the natural conclusion, that the Country Banks should pursue the same course; and we have seen that this is in fact the case,-they cannot indeed * See

Mr. Horsley Palmer's evidence before the _Committee of

1832: Report, p. 14, et seq.

Free Banking I

31

help doing it. But the Parliamentary advice would have them to be by no means content with this action of the public on their circulation and their gold; but to regulate their circulation by the demand~ made-not on themselves, but on the Bank of England. Thus, Bank A. in the country, is to contract its issues when no call is made upon it to do so by the holders of its notes, or the state of its business, merely because Bank B., in London, is sustaining a demand for specie. Let us see what would be the effect of this double contraction-first, from necessity, and next from (I presume) what philosophers have named sympathetic imitation. Assuming Bank of England paper to be in excess two millions, the consequence is that this amount is brought to the Bank to be exchanged for specie, and the excess is at an end; the req uired effect is produced ;-the error of an over-issue is rectified. But if Country Banks, catching the infection, or taking the alarm at second hand, as prescribed by the committee, attempted to contract their issues also, merely on the ground of an efflux of gold from the coffers of the chartered Bank, while the state of their own business prescribed a contrary course, and should unhappily succeed in the attempt to draw in two millions of their own paper, (as to the degree of contraction they would be completely at sea without chart or compass) there would be a reduction in the currency to the extent of four millions-that

121

122

Free &nIcing I

32 is to say, double the desired effect. The result would be mischievous. It is not difficult to discern that, if the course of proceeding thus recommended were harmless, still it would be unnecessary. A contraction of the metropolitan currency is not wholly sustained by the district in which it circulates without a rival, but is diffused throughout the country, ultimately, if not immediately. The comparative scarcity of money, and the rise in the rate of interest draw a greater number of payments to London. A larger amount of gold and Bank of England paper is sent from the country to London, and a smaller quantity from London to the country.· Country Bankers consequently find their resources diminished; their notes are brought in for drafts on London, or deposits are drawn out in Bank of England paper to send thither, and their issues are thus gradually contracted without any direct effort of their own with that view. Hence, instead of two millions being abstracted from the country circulation, in consequence of a contraction to the same amount in the metropolis, making together a diminution of four millions, the probability is, that if the matter were allowed to regulate itself and no alarm excited, one half, or some other considerable portion of the original decrease, would be borne by the country, and the other half (or the residue, whatever it was) by the metropolitan circulation. * In a panic this is partially counteracted.

Free Banking I

That a reduction in the amount of Bank of England paper operates in this way will scarcely be uenied. It must be recollected, however, both that the result is not contemporaneous with the reduction, but requires time to bring it about, and that in the interval it may be counteracted, and even overcome, by opposite circumstances. The tendency, nevertheless, of a contraction in the issues of the Chartered Bank is always to draw money from the country to the metropolis. That this must be so, everyone who is not yet convinced of it will probably perceive, when he considers that a Country Bank is a constant dealer in gold and Bank of England paper, partly at its own bankinghouse, and partly in London, undertaking to receive and pay these commodities at either station; and whenever they become of higher value in London, it is there that the Country Bank will have to provide them in greater comparative abundance. If any validity belongs to the preceding arguments, it will appear manifest to every reader, that the interference of the legislature with the management of Joint-stock Banks is wholly uncalled for, and cannot fail to be mischievous. There are the same propensities of human nature at work to regulate the trade in money, which rcgulate the trade in hardware or calico; and in regard to the issuing of'promissory notes, which has becn treateu as a sort of usurpation of the functions D

123

124

Free Banking I

34 of government, constituting a necessity and warrant for interposition, it is in truth a natural growth of commerce, not to be suppressed by any thing but despotic violence, but necessarily kept within due bounds, where there is free scope for competition, by the operation of the very principles to which it owes its rise. It will be hereafter thought a singular instance of the propensity to meddle which distinguishes legislative bodies, that a parliamentary inquiry should be instituted into the management of trading associations, in which all the usual motives are at work that incite and govern other parties engaged in business; assoeiations to which no peculiar privileges have been granted, and which, consequently, are exposed to the salutary action of competition; while other partnerships embarked in the same trade, placed in precisely the same circumstances, and differing only in the number of the partners associated, are exempt from scrutiny; and, above all, while the greatest establishment in the country, the "chartered libertine," enjoying a monopoly which places her above all rivalry, and gi ves her a power of affecting the property of the whole community, is protected from the parliamentary question, and even in the person of one of her officers seated in the inquisitor's chair. The inquiry, nevertheless, will not be without its use; it will be the means of bringing together a great deal of valuable information, otherwise diffi-

Free Banking I

cult to reach, and will throw light on the true principles of Banking, to the instruction of many parties engaged in the trade; and if Parliament were an institution designed for the special purpose of gathering statistical facts, and illustrating economical principles for the guidance of commercial associations, it could not perhaps have employed a portion of its time more suitably than in the examination of the directors and managers of Banks: but if, on the other hand, it is to be regarded as an institution designed for making good laws in those matters which private interests are incompetent to regulate, and if it has already more to do in this way than it can properly accomplish, then the attention which it has bestowed on the details of a particular trade, always, like all trades, best "let alone," can be considered in no other light than as a waste of legislative power which ought to have been devoted to objects within its legitimate province. The management of the Bank of England, as exhibited in the acconnts and statements of the directors, and in its whole history for the last fifty years, furnishes a remarkable illustration of the difficulties which follow a departure from the principle of leaving trade to the free operation of competition. Had no monopoly been granted to a single bank, a number of such establishments would doubtless have arisen in London, abounding in capital, with D2

125

126

Free Banking I

36 managers of ability sharpened by the competitiou of rivals, and adapted to all the emergencies which could call for its exercise. No redundant circulation would have ever made its appearance, or, if it had, the instant repression which it was destined to encounter, would have saved the community from the repetition of the mistake. No suspension of cash payments would have been dreamed of by government, because the healthy state of the Banks would never have required it. We should have seen, at the present time, sound establishments in the metropolis, furnishing all needful assistance to the commercial community, acting as the receivers of unemployed capital, and the distributors of the property so entrusted to them amongst those who wanted it, and issuing for public convenience a paper currency subject to the check of instant convertibility into gold, enforced with unremitting constancy by the watchful competition of rivals. Instead of all this, we see one huge establishment with an exclusive privilege of issuing promissory notes in a district extending sixty-five miles round the metropolis; and using that privilege (according, at least, to almost all writers who have touched on the subject) in the most inconsistent and mischievous manner; '" expanding the currency when it ought to be contracted, and contracting it when

* " Their conduct in 1824 and 1825, [i. e. the conduct of the directors] was directly oppositc to every sound prillciple."-Macculoch. Noie on Money.

Free Banking I

it ought to be expanded;* professing to act on rules which are habitually infringed;t publishing unsatisfactory accounts from which no certain COllclusions can be drawn;t mixing together in hurtful confusion the duties of a manager of the currency under a monopoly with the functions of an ordinary banker;§ and, what is not to be wondered at, hesitating in the midst of these complicated movements as to the soundness of the principle on which the most important part of the business is conducted. II Without entering into an examination of the just-

*"

Precisely at the time at which there ought to have been contraction, there was an extension of the Bank of England issues."-

the Cu/Teney, page 66. Now, the charge which I bring against the directors of the Bank of England is, that instead of conforming to the sound principle by which they profess to be guided, they art in systematic violation of it." -Colonel Torrens' Letter to Lord Melbourne, Tooke

01'

t "

page 23.

t

"But we are told in a pamphlet explanatory of the action of the Bank, and written by one of the most influential of the directors of that establishment, that upon the data furnished by the accounts as published, no safe conclusions can be founded."-Refleetions

suggested by Mr. Horsley Palmer's Pamphlet, by Samuel Jones Loyd, page 6.

§ Ibid. page 10. II "If there exist

any well-founded reasons for supposing that

the principle acted upon by the Bank is not sound, or that the proportion of one third of bullion with reference to thl) liabilities of the Bank at the period of a full currcncy be not sufficient, it mcrely remaills for Parliament to cxprcss all opinion upon either of those poillts, and thert· can be 110 question but that the Balik will imme-

diately rcglllHtl' its course ac('or
127

128

Free Banking I

38 ness of these allegations, it may be presumed that when such charges can be made with plausibility by experienced bankers and enlightened economists, they cannot be utterly without foundation. They prove, at all events, the difficulty of arriving at any satisfactory system of regulating the currency under quences oj the Pressure upon the Money Market, hy J. Horsley Palmer, Esq. " If the principle be unsound, then let it be changed."-Reply to Mr. Samuel Jones Loyd, by .T. Horsley Palmer. Similar charges against the Bank, to those above quoted, may be found in the pages of Mushet, Drummond, and a host of other writers on the currency. Having alluded to some of the pamphlets of the day on the present subject, the author cannot refrain from acknowledging the gratificatioll and instruction he has derived from the talent and intelligence which have been brought to bear upon it during the last six months.* Besides the able tracts already quoted, those of Vindex, Sir Francis Knowles, Mr. S. Ricardo, Mr. Salomons, and Mr. Bennison, have all their respective merits. Mr. Joplin has analysed the report of the Parliamentary Committee with great acuteness and knowledge of the subject; and there is an anonymous pamphlet published by Ridgway, entitled "Thoughts upon the Principles of Banks, and the Wisdom of Legislative Interference," which goes deeper into the philosophy of the question than any of the rest. Mr. Gilbart's Treatise on American and English Banking, which the author has recdved while correcting the proofs of this Postscript, abounds in useful matter and judicious comments. Mr. H. S. Chapman, in his Tract on Partnerships en Commandite, has very clearly explained a species of Commercial Associat;on foreign to our notions and practice, but well deserving attentive consideration. With writers like the~e in the field thc subject cannot fail to be thoroughly examined and more generally understood-to the infinite bencfit of the community ot large. * Written in May, 1837.

Free Banking I

a monopoly: and it may be doubted whether this difficulty, so long as the monopoly lasts, can ever be overcome; inasmuch as, whatever system is adopted, the necessity will exist of having recourse to arbitrary assumptions and empirical expedients. If the excellent suggestion, for example, thrown out by two very able writers, Col. Torrens and Mr. Lloyd, in regard to separating the two functions of the Bank of England, were adopted, and if, in the circulation department, the securities were maintained at one invariable amount, how is the right amount to be ascertained? On what principle is it to be determined? And if this could be done with exactness in any given state of affairs, on what principle could an amount of securities suitable for one condition of commerce, continue to be the proper amount when another widely different condition had supervened? It seems obvious that, unless one fixed amount of such investments were adapted alike to every state of commerce, it would not be sufficient on the part of the managers of the currency to suffer the public alone to regulate the circulation, by bringing in and drawing out gold, but that they would at intervals have to regulate it themselves by an alteration in the amount of securities, to an extent which must alwa~s be more or less a matter of conjecture. As far as I am able to judge, the elements necessary for the precise determination of such a point are within no man's reach.

129

130

Free Banking I

40 It is an almost inevitable conclusion, that the longer the monopoly is persisted in, the more complicated will be the difficulties in which commercial affairs will be liable to fall. Every year seems to urge us to pass from a system of artificial restraints to the simple and easy movements of unfettered trade. The great desideratum is to have a currency convertible into gold, and capable of adapting itself by those insensible contractions and expansions which no human sagacity can ever effect, to the perpetually varying wants of the community. Break up the monopoly, open the trade of Banking in all its departments to free competition, let it be unshackled by restrictions, and the obj ect, as far as attainable by human regulations, would be at once accomplished. We should soon sec a sufficient number of wealthy banking companies established, capable of doing all that the Bank of England now does, and deprived of the power of inflicting those evils which have been laid to her charge. That they would be equally capable with her of receiving deposits, and discounting bills, or making advances on other securities, seems plain. Ten or twenty establishments, with capitals of two or three millions each, or less, would have it in their power to grant every accommodation to commerce that could possibly be required. That they would lIot, as hanks of isslle, have the same power of arbitrarily expanding and contracting' the cir-

Free Banking I

41 culation of the whole empire, seems also manifest. They would, in this respect, be as passive as the Country Banks now are. Im.tead of their promissory notes being subject to no check but the irregular and desultory demand for gold by individuals, each Bank would be exposed to that organized system of checks, which is necessarily constituted by the existence of other similar banks of issue, and the operation of which would be daily felt. This systematic action, so constant and instantaneous, would proportion with exact precision the amount of the paper currency to the state of commerce, or, at least, with a precision more exact than could result fl'om the most vigilant attention of any board which attempted to accomplish the same object by watching the signs of the times. We might surely trust to the spontaneous operation of private interests for the supply of the metropolis with the requisite quantity of currency with as much confidence as we trust to it for the supply of the same vast community with food. The only valid objection to this arrangement appears to be that the Banks would need a common medium in which to settle their differences, less ponderous and inconvenient than gold, and that the country generally would want, in aid of their local notes, a paper currency. which, like that of the Bank of England at present, would be received every where without douut or tlemur,* .~

ill

See thi" ohjection stated at length by ;\Jr Samuel JOlles Loyd, Evidellce hefore the Committee on the Rank Charter, 1R:.l'.?,

hi~

131

132

Free Banking I 4~

This want (it appears to me) might be easily supplied, without the slightest infringement on the freedom of trade, or foregoing any of the benefits of competition, by the formation of a National Institution, specifically adapted to meet it. A National Bank might be established for the sole purpose of issuing note::! on deposit of specie or bullion, and returning specie or bullion in exchange for its notes; so that no note should be in circulation which was not the representative of a quantity of gold actually existing in the coffers of the Bank. These notes should be made a legal tender, and, of course, every other Bank, both country and metropolitan, should have the option of paying its own paper either in the notes of the National Bank or in gold. The advantages of such a currency-not to supplant, but in aid of the notes of all the other Banks -would be numerous and considerable. These National notes would obviously furnish the required medium in which Bankers might settle their differences, and form a universal currency throughout the British dominions, as Bank of England paper does at present. They would have no tendency to swell the circulation, but would simply substitute a currency easily passed from party to party, at whatever distance and for any sum~ in the place of one that is page '23'2 of the Minutes.

No other objection of the least weight

seems to have beell urged by any of the witnesses, although most of hem expressed opiniolls in favour of the present syskm of monopoly.

Free Banking I

43 necessarily cumbrous and inconvenient, except ill small payments, and amongst immediate neighbours. There never could be a greater demand on the National Bank than it was prepared to answer. A panic, in regard to such an establishment, would be almost impossible. Should there, nevertheless, be a drain on its resources, its liabilities would all be tlischarged the moment its coffers were exhausted. A limited amount of notes under five pounds might be issued for the purpose of facilitating small remittances-or even, if it were thought expedient, an unlimited amount, -- without t.he slightest danger of driving a single sovereign out of the country. An establishment so conducted, could not, I am aware, defray its own expenses: as its only source of profit would be the accidental destruction of its notes. But the expenses would not by any means be formidable, and might be discharged by a very small additional duty on the issues of all other Banks for whose convenience this would be in a great measure instituted. From a return by the Bank of England, inserted in the Report of the Committee of 1832, the expenses attending the circulation of the Bank for the twelve months enrling the 29th of February of that year, amount.ed to £106,OD2, a mere trifle for securing the object in VJeW. A much smaller sum than this would probably he adeqllate to the purpose.

133

134

Free Banking 1

44 Such an institution, as it could not at all interfere with the quantity and value of money, and would leave the freedom of issuing promissory notes untouched, would be altogether unlike the National Bank proposed by the late Mr. Ricardo, the establishment of which, as far as the metropolis is concerned, would perhaps be the next best course to a perfectly free trade. It would approach nearer to the celebrated Bank of Amsterdam, of which the reader may see an account in Adam Smith's Wealth of Nations, but would be on a simpler construction, inasmuch as the whole of its operations would consist in receiving and paying gold in exchange for notes, thus dispensing altogether with personal accounts. Without any confident assurance of the value of the suggestion, the author throws it out for the consideration of others, and especially of those who, like himself, have not acquired their experience in Banking without concurrent speculations upon the various phenomena presented to them, and upon the improvements of which this important department of commerce is still susceptible.

Free Banking I 4;)

PART II. Since the preceding tract appeared, new events have arisen to draw the attention of thoughtful minds to the topics of which it treats, and additional experience has been accumulated to guide the judgment of all who are conversant with the subject. Within the last few months, several able pamphlets on the currency have deservedly excited public interest. Amongst these may be particularly mentioned a tract by Mr. Jones Loyd, the Report of the Manchester Chamber of Commerce, and several Letters which have passed between Mr. Loyd and the President of that body. To enter into the general merits of the controversy between these gentlemen, forms no part of my design, non nostrum tantas componere lites; but some opinions have been thrown out by the firstnamed writer in the course of it, on the conduct, nature and position of Country Banks of issue, so much at variance with the views maintained in the preceding pages, that an examination of them will constitute a proper sequel to what has already been urged, and furnish an opportunity of insisting on some points not hitherto sufficiently explained, and on others not before at all adverted to. No one can dissent from the opinions of a gentleman who is understood to be practically con-

135

136

Free Banking I

46 versant with topics of this nature, and who at the same time evidently looks at them from the elevated ground of an enlightened philosophy, without naturally feeling some diffidence and mistrust of his own conclusions. An impression of this kind, nevertheless, ought not to operate further than to lead the individual who feels it, to a careful review of the arguments on both sides, and it has had its due influence, in that respect, on the author of the following observations. The principal points on which I purpose to tOllch are the following: 1. The rules proposed from various quarters as proper to be observed by Banks in the regulation of their issues, and the observance or non-obsen ance of which is to be regarded as the criterion of good and bad management; and particularly the rule advocated by Mr. Loyd. 2. How far the Bank of England and the Country Banks have observed this rule. 3. How far it is practicable and desirable that the Country Banks should vary their issues in conformity with the fluctuations of the b~llion in the Bank of England. 4. What variations are really beneficial in the circulation of the Country Banks, and the causes which produce them. 5. The effects of such variations on the Bank of England in regard to her circlliation and bullion. r•

Free Banking I J"" - I

G. \Vhat are the advantages and disadvantages of a paper currency, and the institutions best adapted to deal with them, and in particular, whether it is desirable that country notes should be suppressed, and the privilege of issuing bank notes confined to one establishment in the metropolis. 1. The rule which ought to be observed by Ban ks in the regulation of their issues is a matter far from being settled, and must, indeed, partly depend on the peculiar character and circulllstances of each establishment. Perhaps no more definite maxim for their guidance universally can be laid down than that they should always have ample resources at command to meet their engagements. It has been contended by some very able men that every Bank of issue ought to maintain a uniform proportion between the paper it has in circulation and the bullion in its coffers. If the bullion is less in quantity than the proper proportion, the Bank is to that extent deficient in resources to meet its engagements; if it is more, the Bank is needlessly losing interest on dead stock. This opinion is maintained, for example, by an eminent American Statesman in a passage which Mr. Loyd quotes with approbation for " the intrinsic soundness of the views" contained in it. " In England," says Mr. Webster, " the Bank of England, and in the United States all the Banks expand or contract the amount of circulation, of course, as they increase or curtail the general

137

138

Free Banking I

48 amount of their own paper. And this renders it necessary that they should be regulated and controlled. The question is by what rule? To this I allswer, by subjecting all Banks to the rule which the most discreet of them always follow, by compelling them to maintain a certain fixed proportion between specie and circulation, without regarding deposits on the one hand or notes payable on the other." According to this rule. supposing the proportion fixed upon to be one of bullion to two of paper, it is obvious that whenever an increase or a decrease of the former took place there must be an augmentation or a diminution to double the amount in the latter. A variation of a million in the bullion must be followed by a variation of two millions in the paper. If the proportion were one of bullion to three of paper, then a variation of a million in the former must be followed by a variation of three millions in the latter. A rule of this kind would obviously occasion very extreme and violent vicissitudes in the currency, and in an establishment holding a position like that of the Bank of England would be utterly impracticable. The principle on which the directors of that Bank have professed to be guided is, as is well known, very different. That principle is to invest in securities bearing interest two-thirds of the amount of deposits and notes in circulation, and to hold one-third ill

Free Banking I

49

bullion. Starting with these proportions in a time of full currency, their professed scheme has been to retain the amount of securities undisturbed and to abandon the fluctuations of both paper and bullion to the action of the public. It is needless to dwell on a plan the defects of which have been so frequently exposed and an adherence to which is, in fact, impracticable. Could it be enforced the con seq uences would be continual fluctuations in the paper and the bullion, without any constant or definable relation to each other of any kind, and it would afford as wide a scope for violent vicissitudes as the rule insisted upon by the American Statesman. The rule proposed by Mr. Loyd is different from both: it is "that the variations in the amount of circulation shall correspond to the variations in the amount of bullion, and the adherence of the Bank to this rule," (he goes on to say) " ought to be obvious on the face of the published accounts." In his letter to Mr. Smith, he thus insists upon the observance of this principle: "What is the test of mismanagement of the circulation? I presume the answer will not be disputed. Fluctuations in the amount of paper issues not corresponding to those of the bullion."· And in his second letter to that gentleman, he contends, in the following terms, that the rule is equally applicable to country issuers and to the Bank of England. • Page 11. E

/39

140

Free Banking I

50 " Management of the currency means regulating the fluctuations of the paper issues by the fluctuatiom: of the bullion; and mismanagement consists either in putting out large quantities of papermoney and rapidly calling them in again, when there is 110 corresponding increase or diminution of the bullion; or in taking in large quantities of bullion and not putting forth notes against it. By this rule I contend that all issuers of paper-money, whether Bank of England or country issuers ought to he judged, and that their measures must in every instance be condemned or approved, in proportion as they conform to or violate it."· This in its obvious sense means that the paper money of any Bank ~ctually in circulation and the gold in its coffers shall increase and decrease together by an equal amount. For the sake of brevity and explicitness it may be called the rule of equal increments and decrements, as contrasted with the rule (enforced by Mr. Webster) of proportional increments and decrements. The reason assigned for the rule is that by a strict observance of it the currency of the country would fluctuate in amount exactly as it would fluctlmte if it were purely metallic. This canon is not quite so unquestionable as Mr. Loyd assumes it to be. Some considerations might easily he urged both against the reason on which it * Second letter to J. B. Smith, Esq., page 20.

Free Banking I

51

is grounded and against its aptness for attaining the proposed end. Nor is it at all self-evident that it will suit all Banks, however constituted, or however varying in their positions and privileges. It may be suitable enough for a Bank placed in the peculiar situation of the Bank of England, but it is not in its strict interpretation applicable to establishments so wholly different in character and position as the Country Banks, which have no similar power over the currency, and are differently circumstanced with respect to the resources they have at command for meeting their notes. For the sake of argument, however, let us for the present concede the propriety of the rule. Whatever may be its defects, its superiority to the other two can scarcely be questioned. II. Having acquiesced in the rule then, our next subject of inquiry is, how far the Bank of England and the Country Banks have severally acted in conformity with it. With regard to the Bank of England, there is little need in this place to adduce instances of almost perpetual deviation from it. The returns for the year 1839, present, nevertheless, wider departures from the prescribed course than we have been lately accustomed to see. This may be at once shown without any great array of figures. Were the rule adhered to, the difference between the circulation and the bullion would be afixed quantity, or in other words E 2

141

142

Free Banking I

52 constantly the same: the following are some of the actual differences. 1839, Jan. 10. Sept. 19. Oct. 18.

difference do. do.

8,865,000 15,144,000 15,090,000

Here, instead of the difference between the notes in circulation and the bullion being a fixed quantity, it has varied above six millions. The circulation on the 19th Sept. was in excess (according to the rule) by the sum of 6,279,000, compared with the circulation on the 10th January preceding. If we turn even to the year 1838, we shall find considerable deviations. One example will be sufficient. On the 8th March, the difference between the circulation and bullion was 8,585,000 On the 21st September, it was . 10,050,000 The amount of variation from rule was 1,465,000, by which amount the circulation was in excess on the 21st September, 1838, compared with the 8th March. It is surprising, therefore, to find the following assertion in Mr. Loyd's letter to Mr. Smith.· "Tried by this test, and I know of no other which admits of clear definition or of strict application, the measures of the Bank during the year 18a8, are clear from blame. The relative • Page 11.

Free Banking I

53 condition of the cir0ulation and the bullion at the beginning and at the end of 1838 is the same." Surely a comparison of merely the beginning and end of the year, would be any thing but a strict application of the test. It would be transforming the rule into one of a totally different nature, admitting the most extravagant fluctuations, provided the returns about the middle of January and the middle of December following were brought to tally. Let us next proceed to try the conduct of the Country Banks by their observance or non-observance of the same rule. Here we are unfortunately met at the outset by a deficiency of evidence. We have returns showing the amount of the circulation of the Country Banks, but we have no returns of the bullion in their coffers. Give us the amount of their issues and the amount of their gold and we can then judge whether their conduct has been in conformity with the rule. We shall then be able to apply the same test to the Country Banks that we apply to the Bank of England, but not otherwise. As all this is very obvious, we begin to discover that when Mr. Loyd contends that all issuers of paper-money, whether the Bank of England or the Country Banks, should be subject to the same rule, he does not apply it to both parties in the same sense. He tries the conduct of the Bank of England by comparing her circulation with the bullion in her own coffers,

143

144

Free Banking I

54 while he tries the conduct of the Country Banks by comparing the increase and decrease of their circulation, not with their own reserve of specie, but with the increase and decrease of gold in the vaults of Threadneedle-street. This, however, is palpably and entirely changing the criterion employed. All thfl.t is required by the rule is obviously done when each Bank looks to its own resources and takes care that its circulation varies accordingly. If it can be proved that the Country Issuers have at any time put forth additional paper, without any increase in their resources, they are manifestly proper objects of reprehension on the principle before us, but it is equally manifest that on the same principle they cannot be justly blamed for not governing their conduct by fluctuations in the resources of another Bank. Mr. Loyd, in fact, as I have already observed, entirely changes the criterion of good and bad management when he quits the conduct of the Bank of England, and proceeds to scrutinize that of the Country Banks. III. Let us, however, follow him, and examine this new canon, the observance or non-observance of which is set up as the test of right and wrong in the conduct of provincial issuers. It may be a good rule, although it cannot be brought with the other under one general expression. 1. At the very outset we are encountered by the fact, that the new rule possesses none of t.hat pre-

145

Free Banking I

55

cision which characterises the other. We canllot extol it in the language of Mr. Loyd as furnishing a test which" admits of clear definition and strict application." Wheu we speak of the Bank of England, or any other Bank, and insist that its circulation and its bullion shall vary by equal increments and decrements, we lay down a precise and unambiguous principle, the observance and neglect of which, whether it is in itself just or not., are easily perceived and exactly measurable; but when we insist that the Country Banks shall make their issues vary with the variations in the quantity of bullion held by a Bank in London, we prescribe a rule to which no definite meaning can be affixed, and of which no ingenuity can prove that one interpretation ought to be followed rather than another. For example, take the following position of affairs : 1839.

Dank Circulation.

Jan. 10.

18,201,000 18,252,000

Feb. 7

Decrease.

Dulll on.

1838.

9,336,000 Dec. 31 8,919,000

Country Circulation.

12,225,488

. 417,000

About the middle of February the Country Banks might have learned that the Bank of England had lost £417,000. of her bullion, and had enlarged her circulation. Now what diminution, according to the rule, ought they to have set. about making in their issues? Is it a diminution of £417,000. which is the decrement that ought to have been made by

146

Free Banking I

56 the Bank herself from her own circulation of £18,201,000.? If so, the reduction of the Country Circulation would have been greater in pToportion than that of the Bank Circulation. Or is it a decrease bearing the same ratio to £ 12,225,488., as £417,000 bears to £18,201,000.? If so, the rille for the Country Banks is no longer one of equal increments and decrements like that for the Bank of England. Nor can any satisfactory reason be assigned why either of these sums shoulU be the particular decrement in the case, rather than twenty others which may be selected. It is needless to pursue the perplexities of such a rule farther: if anyone chooses to do so, he will find that they reducp. it to a very simple, although not a very available max~m, that when the bullion in the Bank varies, the Country Issues ought to vary somewhat in the same direction, the extent of the variation being an unassignable quantity. 2. The next consideration that presents itself is, that the new canon propounded for the guidance of the Country Issuers, cannot possibly be acted upon in the same wayas the rule laid down for the Bank of England. A Bank regulating its issues by its own bullion, has constantly the grounds of action before it, and can make the variations in both proceed passibus mquis; hut if it has to regulate its issues by the specie in the coffers of another establishment, it is dependent on external information, which may be defert'ed till it is of no avail. And

Free Banking I

57 this is the predicament of the Country Banks under the existing arrangements. If it were not impossible for them on grounds already stated to control their issues at will, yet a conformity with the rule would be impracticable from the circumstance, that the information on which they would have to proceed, comes to them too late for the object in view. When it reaches them they can tell indeed what has been the average amount of bullion during a past period, (which is anything rather than that sort of pre~ise information they ought to be furnished with) but not whether it is at the moment actually increasing or diminishing; and thus if they had the power to act upon the intelligence, they and the Bank of England would inevitably be often playing a game at cross-purposes. 3. Perhaps the most important consideration, however, yet remains. The rule for the Bank of England, and the unparallel rule, as it may be termed, propounded for the Country Banks, are both insisted upon by Mr. Loyd on the same ground, viz. on the principle that a paper currency ought to vary in amount precisely as a purely metallic currency would vary; which desirable object would be effected if both the parties in question strictly observ~d the rules laid down for them. Mr. Loyd, therefore, maintains the proposition, that if the Bank herself and the Country Banks were bot.h to make their issues increase and de-

147

148

Free Banking I

58

crease with the bullion in the Bank of England, the whole currency of the country would vary as if it consisted entirely of the precious metals. This branch of the que8tion has already been partially examined in the preceding tract, where it has been shewn that this double expansion and contraction would be mischievous. It will not require much ingenuity to shew further, that it would be a violation of the very principle on which it is advocated. Under a system of purely metallic currency, it would of course occasionally happen that the fo. reign exchanges would be unfavourahle, and part of the coin in circulation would be withdrawn for exportation. Suppose that on some occasion, one million pounds sterling of gold were abstracted for this purpose, the consequence would be a correction of the exchanges, and a lowering of prices commensurate in some degree with the loss. If a similar exportation of gold were made during our actual system of currency, by drawing' specie from the Bank of England, and if she acted on the rule of equal increments and decrements, she would contract her circulation in a corresponding degree. Under these conditions, the effect on prices and on the foreign exchanges would be the same, on Mr. Loyd's theory, as in the first case, where the currency by supposition was purely metallic. Now when the Bank had thus diminished her

Free Banking I

59 circulation by a million, it is quite ohvious that all would have been done that the case required. The wished-for effect would have been attained, and attained precisely to the same extent as if the currency had consisted entirely of the precious metals. But according to the requirement that the Country Issues should also vary with the bullion in the Bank of England, this is not sufficient. Not only must the circulation of the Bank be reduced by a million, but the circulation of the Country Banks must be diminished by an equal or proportional Thus this doctrine demands, that decrement. under our present system of paper currency an effect should be produced which would not take place if the currency were purely metallic, in diametrical opposition to the end and aim of the rule laid down. Suppose for a moment nothing but Bank of England paper to be in circulation, and no Banks to exist in the country but her own branches. When a million of her notes had been brought in to her metropolitan establishment in exchange for gold, would she immediately command her branches to curtail their circulation by the like sum, or by some decrement proportional to the amount of their issues? If her London circulation amounted to 18,000,000 l. and her country circulation to 1~,OOO,OOOl. would she order her branches to reduce their issues by a million, or at least two-thirds of a million? If she oid this she would depart

149

150

Free Banking 1

60

from the rule of equal increments and decrements; she would violate the principle on which it is founded; her bullion would be reduced by 1,000,0001. and her paper by 2,000,0001. or at all events by 1,666,666l. Suppose again that the whole currency consisted of Bank paper, to the amount of 30,000,0001, but instead of being supplied to the country districts through her own branches, it was supplied through the existing Banks. A demand arises from abroad in consequence of importations of corn, or other produce, for five millions of bullion; that amount is accordingly withdrawn from the Bank, in exchange for notes, and the circulation commensurably reduced, viz.:-to 25,000,0001. Now the Bank being by ths supposition, sole manager of the circulation, what further measures would she, or could she, take? Evidently none. She would have conformed to the prescribed course, and, according to the test, rigorously performed her duty. If she attempted any further contraction, it would be trespassing against the rule. What measures then would the Country Banks adopt? Again the answer must be-evidently none, with a view of diminishing the circulation. They would have nothing to do with regulating the currency, they would have been relieved from all participation in that task, and would have simply to go on dealing with their resources like other traders, as they best could.

Free Banking I

61

The country districts would doubtless feel the contraction, just as they would under a metallic circulation; they would be gradually brought to yield up part of their currency, to supply the loss in the metropolis, and if no counteracting causes sprung up, the proportions of the currency previous] y held by the metropolitan and the provincial districts would be restored. If we suppose the former to have been originally 18,000,000l, and the latter 12,000,000l, then the metropolitan circulation, although sustaining at first a loss of five millions, would have two of them restored toit, and ultimately stand at fifteen millions, while the country circulation would be reduced to ten millions. Such at least would be the tendency of the circumstances described, which is all that can be predicated. But this equalization of the 10s8, this yielding up a portion of their currency by the provinces, is a very different thing from the double contraction, which would result from Mr. Loyd's rule. In the latter case if the rule were carried out to its greatest possible perfection, the London circulation would be diminished five millions, and the Country circulation undergo a similar diminution of five millions, or, at least, of some 3i millions more, and to the latter extent would the professed principle of the rule be violated. Now, as any degree of contraction beyond what is absolutely necessary is injurious, and this would be a very great contraction, in direct violation of the principle on which the

151

152

Free Banking 1

62 rule is founded, we can scarcely conceive a more fatal error. I have taken the case of contraction, partly because the evils of a fluctuation on that side are more manifest than those of a fluctuation on the other. But the case of an expansion would equally well illustrate the erroneousness of the unparalle1 rule, were it necessary to task the patience of the reader by entering into the detail. It is easy for every one to conceive for himself, not only how the principle of the rule would be violated, but the other curious results which would ensue, if every time the Bank added to her circulation, by the issue of notes in exchange for bullion, the Country Banks should instantly put out a corresponding amount of their paper. The issues of a Country Bank we must recollect, form but a minor part of its means for making advances or loans to its customers; and in order to circulate a given amount of its notes, it must make advances in real capital to three, or four, or five times that sum. To effect an expansion therefore, of its issues, to the extent, for example, of 50001, it must enlarge its loans to the extent of 15,000l, or 20,0001. This would be to force it into overbanking with a vengeance. We have here an instance ofthe error continually committed, of assuming the Bank of England, and the Country Banks to be similar in character and position. The former, in order to put out an additional quantity of paper, has merely to purchase securities to that amount, while the latter have no

Free Banking I

63

oirect means whatever of effecting an expansion, and could effect it indirectly (if they attempted to comply with the rule) only by a forced ano ruinous extension of their loans. After this review of the character of the rule, it may be instructive to see what results we should . obtain, by applying it to the transactions of the last year; what would have been the consequences, had the Country Banks been both able, and resolute to observe it? It is obviolls that as the information which they must take as their guide, does not reach the Country Banks till some time after the facts have happened, their issues could not exhibit a contemporaneous conformity with the variations of the bullion. For example, the Country Banks about the middle of January, 1839, might have learnt that the bullion in the ret.urns on the 10th of that month, was 26,000l. less than it had been stated in the returns, on the 13th December preceding: and about the middle of February, they might have learnt that on the 7th of this latter month, the returns showed a further decrease, compared with January, of 417 ,000l. but it could not be expected that they would instantly have the power of making corresponding reductions in their own issues. We will therefore grant them a few weeks, or a month on each occasion, in which to effect the contraction. With this allowance, the following Table shows what would have been the state of the Country

153

Free Banking I

154

64

circulation at the periods named, if the rule of' equal increments and decrements, corresponding with those of the bullion, had been strictly observed; and for the sake of exhibiting the contrast there is also inserted a column, showing what would have been the Country circulation, had it conformed, not to the bullion but to the circulation of the Bank. Whal it would

What it would Actual Country C ireulatlon.

have been if

reli'lated by ullion.

Aelu.l ExcelS.

Dee. 31, 1838 12,225,000 Mar. 30,1839 12,259,000 10,969,000 1,290,000 7,982,000 4,293,000 June 30, 1839 12,275,000 Sep.30,1839 11,084,000 5,679,000 5,405.000

have been if re..

by the nank Cireula-

~ulaled

lion.

Actual Exee,,+ &

Defi·

ciellcy.-

--

12,054,000 +205,000 11,970,000 +305,000 11,716,000 -632,000

Of course, the required reduction in the Conntry Issues would not appear so great, if the rule were construed to mean proportional conformity; but it would still be enormous, and a rule, the observance of which, on either interpretation, would lead to such results, needs no further condemnation. I am aware, that it may he said by Mr. Loyd, that if the contraction had been made at the earliest possible period, the drain on the Bank coffers would have been greatly diminished or even stopped. This might possibly be a good answer to those who should object to the observance of Mr. Loyd's rule by the Bank herself, on the ground that an adherence to it would have occasioned in nine months a reduction of her circulation from eighteen to eleven millions; against such an objection he might perhaps with a good show of reason contend

Free Banking I

that if the Bank issues, instead of being augmented for some months after the commencement of the drain, had been diminished according to the rule, the efHux would have much sooner ceased, and the enormous reduction of the circulation alleged by the objection, could never have been required. It is indeed not quite clear that any measures would have stopped the drain, but waiving that consideration, this answer, however good in its place, will not serve, when the country circulation is in question. To give it validity here, it must be shown that a reduction in the country issues alone would have had a material effect in stopping the drain, while the Bank herself made no c.orresponding reduction,-no reduction that could be of any avail,-in her own issues. And if a commensurate reduction in both branches of the circulation is required when the bullion is flowing out, (as Mr. Loyd maintains), then the diminution of the inferior alone would not only have been inefficient, but an observance of the rule by the Country Banks exclusively, would have forced them to a reduction far beyond what an observance of it would have demanded, if the Bank of England herself had rigidly adjusted her paper to her bullion. Thus regarding the matter even in this light, a most extensive and injurious reduction must have taken place in the country circulation against all principle, if the Country Banks had pursued the impolitic course prescribed for them. The argument then stands thus :--A rule is proF

155

156

Free Banking I

66 pounded for the guidance of Banks of issue, by their observance or non-observance of which all issuers of paper money, whether Bank of England or country issuers, are to be judged. The rule is, that the fluctuations of the paper issues should be regulated by the fluctuations in the bullion; or more precisely, that the paper money in circulation should be made to increase and decrease by equal increments and decrements with the bullion held in reserve. This rule applied to the proceedings of the Bank of England is precise enough, and from the returns we may at once see whether (comparing any two or more periods) it has been observed. When, however, it is applied to the case of Country Hanks of issue, it becomes ambiguous: it may mean that their issues ought to vary with the quantity of bullion in their own coffers, or it may mean that their issues ou~ht to vary with the quantity of bullion held by the Bank of England. If we take it in the first sense it is intelligible and precise, but we have no evidence before us to show whether the Country Banks have observed it or not. H we take it in the second sense, which Mr. Loyd insists upon, there are numerous objections to it. ]. It is deficient in fulness and precision, leaving us at a loss to tell the exact law of variation intended; whether the country issues are to be increased and diminished by the same amount as the bullion in the Bank of England, or in some

Free Banking I

67 othel' ratio not indicated. 2. The rule is impracticable from the time at which the directive information reaches the parties required to act upon it, as well as from the vagueness of the statements furnished. 3. If it were observed both by the Bank of England and the Country Banks, the consequence would be a double effect in palpable violation of the very principle on which it is professedly founded. 4. If it had been acted upon during the past year it would have subjected the country issues to all the vicissitudes of the bullion in the Bank of England, which in about ten months ranged from £9,336,000 to £2,522,000. After this exposition of the unsoundness of the rule, it is perhaps scarcely worth while to scrutinize the particular instances adduced by Mr. Loyd, to prove the repl'ehensible conduct of the Country Banks. It might of course be expected, that if they were tried by a criterion so unreasonable in itself, and which they fortunately have never acknowledged and submitted to, the result would turn out to their disadvantage. The surprising part of the affair is that Mr. Loyd, not always having the merit of his own test before his eyes, sometimes condemns them on grounds inconsistent with it. An example of this kind occurs in a passage of his second letter to Mr. Smith, where he charges the Country Banks with a sudden contraction of their issues. .. 2

157

158

Free Banking 1

68 "For examples," he says,· "of sudden contractions of issues, I think that reference may be made to the returns of the country issues; look at the contraction which took place in these in the first quarter of 1837, and again between June and Septern ber 1839. " Country circulation wasIn December 1836 In April 1837

12,011,000 11,031,000

Decrease

£980,000

In June 1839 In September 1839

12,275,000 11,084,000

Decrease

£1,191,000"

These are, doubtless, instances of great and sudden decrease, but we must recollect that it is neither the greatness nor the suddenness of any variation which is reprehensible according to Mr. Loyd's canon, but its disconformity with the variations of the bullion. Mr. Loyd must permit us to hold him to his own test. Now the bullion in the Bank was In December 1836 In April 1837

4,545,000 4,071,000

Decrease

474,000 4,344,000 2,816,000

In June 1839 In September 1839 DecreaRt'

*

£

Page 39.

£ 1,528,000

159

Free Banking I

6U

In the first case the decrease in the bullion was considerably more per cent. than the decrease in the country issues: in the second case, it was more absolutely and relatively in any way the reader chooses to reckon. Contrast now the circulation of the Bank at these periods. It was In December 1836 In April 1837 lncreae.e In June 1839 In September 1839 Decrease

17,361,000 18,432,000

£ 1,071,000 18,101,000 17,960,000 £

141,000

Here we haye ill the one case a departure from the rule on the side of excess to an extent of more than 1,500,000, in the other a short coming in contraction to an almost equal amount. In some other cases too the Country Banks have a right to recall Mr. Loyd to his own criterion when he abandons it to bring accusations against them. In charging mismanagement on the country issners he adduces several instances of disconformity not between the fluctuations of their issues. and the fluctuations of the bullion in the Bank, but between the former and variations in the amount of the Bank notes in circulation."" • The following extract shows how quietly and easily on occasion Mr. Loyd drops his favourite test and passes to another, as if no great difference existed betweell them : .. The conduct of the couutry issuers has not been of that un·

160

Free Banking 1

70

Thus in another passage of his second letter to Mr. Smith, t he contrasts the country issues and those of the Bank of England for the purpose of proving an excess in the former-an excess which he considers as one of the three main causes of the commercial pressure in 1837. The Country Issues were in Sept. 1835 in June 1836 Increase The Bank of England in Sept. 1835 in June 1836 Decrease

10,420,000 12,202,000 1,782,000 18,240,000 17,899,000 341,000

By this test, therefore. the country issues are evidently excessive. If, however, we try them by the amount of bullion in the Bank, we shall obtain a very different result. Bullion in the Bank, Sept. 1835 . June 1836 . Increase

6,261,000 7,362,000 1,101,000

Hence it appears that the country issues did actually make some approach to conformity with .. exceptionable character which will exempt them from censure and II leave it to fall exclusively on the Bank of England. Neither " party has conformed in the regulation of its issues to the state of " the bullion-nor, omitting that consideration, have the fluctu-

" atiolls of the country issuers conformed to those of the central ., issller."-Remarks on the Ci"culution, page 77.

t Page 13.

161

Free Banking I

71 Mr. Loyd's rule, increasing about one-sixth, while the bullion in the Bank of England increased in about the same ratio, whereas the Bank herself widely departed from it by contracting her circulation. According to the rule her circulation in the month of June 1836, ought to have been at least £19,341,000, whereas it was only £17,899,000. It is really rather hard upon the Country Banks, in this the day of their trial before the grand inquest of the Legislature, to anaign their conduct for discongruity with two inconsistent and contradictory rules, against one or other of which they are sure to be caught sinning. This is truly launching them into the strait between Scylla and Charybdis; or if I may change the figure, it is insisting that their line of conduct shall be uniformly parallel to two other lines which are themselves frequently at right angles with each other. But there is another curious point to be observed with regard to this last instance. Mr. Loyd, in blaming the Country Banks for increasing their issues while the Bank of England was diminishing hers, overlooks the fact, that the latter was absolutely augmenting her branch circulation. Branch Circulation, Sept. 1835 June l836 Increase

. •

3,300,000 3,700,000 400,000

When the Country Banks are blamed for not forcing their circulation into a confol'mity with

162

Free Banking 1

72 that of the Bank of England, they may be indulged with the liberty of asking whether it is the metropolitan or the country issues of that establishment they are to conform to. Passing from these instances of what appears to me inconsistent censure, let us proceed with what is of more importance-the consideration of principles. IV. It may probably be asked, "If it is not desirable that the country issues should fluctuate with the bullion, in what way is it desirable that they should fluctuate, and how are the proper fluctuations to be brought about ?" The answers to these questions are not difficult. It is desirable that the amount of the country circulation should vary with the business it has to perform, and this is secured, as far as human regulations can secure it, by the present system. The checks upon over-issues are so complete, and so immediately operative, that the circulation cannot be forced for any period sufficient to affect prices, and whatever amount is afloat is kept out, because it is required by the actual wants of the community. The absolute amount, therefore, of the country circulation at any time, the fluctuations which it mdel'goes, and the want of conformity between meh fluctuations, and those of the notes or the bullion of the Bank of England, severally prove nothing- with 1'f'g'rtJ'rl to pithel' (,X ('PBS or orfirieney.

Free Banking 1

73 The country circulation is affected not only by the issues of the Bank of England, but by independent causes, belonging to the country itself, which have nothing to do directly with the business or the circulation of London. In proof of this, it may be observed, that there is always a remarkable decrease in the notes of the country Banks, in the quarter ending Sept. 30, compared with the preceding quarter, as is shewn during six years, by the following table. Country notes in circulation in the quarters ending June 30, and September 30. Decrease. Sept. 30. June 30. £364,5iO £10,154,112 £10,518,6ti2 1834 519,li8 10,420,623 10,939,801 1835 468,251 II,i33,945 12,202,196 1836 i29,951 10,142,049 1O,8i2,000 1837 380,541 11,364,962 II,i45,503 1838 1,191,818 11,084,000 12,275,818 1839

Some other regular phenomena may be observed. There is always, for instance, a tendency to an increase in the quarter ending Dec. 31, beyond the amount of any of the preceding quarters. In 1834, 1835, and 1838, the circulation uf the December quarter was higher than any other; in 1836, it was next to the highest,; in 1837, March was the highest, and June and Dec. nearly equal. As these phenomena are not exhibited at corresponding periods by the issues of the Bank of Eng-laud, they are l)I'oofs that the country circula-

163

164

Free Banking I

74 tion varies from independent causes, connected with the regular business of the provinces. There is one sense indeed, in which the country circulation may be said, although incorrectly, to be sometimes excessive. Although it can never be more than the business of the country requires, and can be augmented only by uemands made for it by actual transactions, yet the business of the country may itself be carried to excess. It cannot certainly be doubted, that the country circulation is increased by any augmentation of business, whether good or bad, prudent or imprudent. For a time, the sound or unsound character of the transactions can make no difference: a mercantile or manufactural concern may be carried on during even a considerable period without any proper foundation, and as long as it continues its operations, it will employ as much of the currency as if no disastrous termination were to follow, and may thus extenu the circulation. But this is a circuDlstance which must happen under any system of currency whatever; nor is th~ imprudent assistance which such undertakings sometimes receive from Banks, at all peculiar to Banks of issue, or mainly furnished by means of their own notes. A remarkable instance in point was cited by Mr. Gisborne in the House of Commons, on the 10th of March last. He stated that a large banking es-

Free Banking I

75 tablishment, which did not issue its own notes, and in which he (Mr. Gisborne) was a shareholder, had lost not less than half a million of money by bad debts. It had advanced to one firm above £350,000. -a firm which had never possessed more than £40,000. or £50,000. With regard to the effects produced on the country issues by fluctuations in the circulation of the Bank of England, it may be observed, that such effects are mainly brought about through the influence of those fluctuations on the London money-market. It may be stated as a general law, that whatever raises or lowers the rate of interest in the moneymarket in London, whether it is a variation in the amount of Bank issues or any other cause, has a tendency to affect the country circulation, because such changes enlarge or contract the resources and the business of the Banks. It is not at all surprising, therefore, that the quarter of the year ending September 30, 1839, exhibits a great reduction in the country issues compared with the preceding quarter; for besides the falling off already shown to be usual at that season ofthe year from a variation in business, which will account for nearly one half of the reduction, the Bank had raised the rate of discount first to 5 per cent in May, then in June to 5i, and on the I st of August to 6 per cent. Mr. Loyd terms this decreasc suddcn and violent,

165

166

Free Banking I

76 out whatever there was in it of sudden and violent, may be assuredly ascribed to the measures of the metropolitan Bank. V. Another consideration, however, remains; "granting," (it may be said), "the arguments against Mr. Loyd's rule as applied to the Country Banks to be conclusive, they show only that the provincial issues ought not to be forced to increase and decrease with the bullion in the Bank of England; granting that a double expansion and contraction would be mischievous, this implies, indeed, that the country circulation should remain without corresponding increase or decrease, but the arguments reach no further; they have no tendency to show that variations in a contrary direction from those of the London circulation are not detrimental. Now it is charged against Country Hanks that they frequently increase their issues, at a time when the Bank of England is lessening hers, and thus counteract the effect of her operations on the exchanges.' . This resolves itself into the general question, what effect is produced on the condition of the Bank in London, as respects her gold and circulation by fluctuations in the amount of country paper? After having given the subject much consideration, I cannot perceive that they produce any direct effect whatever on the bullion, or the circulation of the Bank, but 011 turnillg to the pages of Mr. Loyd, I find great consequences al:!cribed to them.

Free Banking I

77 In his third chapter "on the effect of the Country Banks and Scotch Banks as Banks of Issue," he partially discusses the subject, but scarcely perhaps succeeds in keeping distinctly apart the question respecting the effects of variations in the condition of the Bank on the conn try issues, and the converse question respecting the effects of variations in the Country Issues on the condition of the Bank. However this may be, the first two or three pages of the chapter are employed in describing effects produced, not by the country issues but upon them: the unfavourable state of the exchanges, indicated by a continuous decrease of bullion, is alleged to augment the country issues, the successive advances of the rate of interest to decrease them, and to decrease them violently. The evil effects therefore imputed to the country issues, consist in their forming a bad and unmanageable subject to act upon; in their want on the one hand of pliability and due conformity with the Bank circulation or Bank bullion: and on the other hand, in their undue sensitiveness and precipitate recoil as the Bank rate of interest advances. But the only dist.inct kind of re-action alleged by Mr. Loyd to be exerted by the country issues on the metropolitan establishment itself is this, that by expanding during an efflux of bullion, they retard the stopping of the drain on the Bank coffers. Mr. Loyd goes even so far to say, that if instead

167

168

Free Banking 1

78 of enlarging their issues the Country Banks had contracted them in due season, the serious danger to which the monetary system of the country has been exposed might very possibly have been altogether avoided. The way in which the Country Banks, according to Mr. Loyd, retard the stopping of the drain is by purposely increasing their issues in order to l'elieve themsel ves and their customers from the II tightness of money," produced by a contraction of the circulation on the part of the central issuer, and in order to outbank or outflank their rivals. But I will quote his own words:"The desire to extend his own issue," says Mr. Loyd, "is the motive of each issuer; this motive " will lead each party to meet an expansion of issue " on the part of others by a corresponding expansion " on his own part, but it will also lead him to look "upon contraction in any quarter as a favourable "opportunity, not for contracting but for expand" ing his own issues, with the view and in the hope "of possessing himself of the ground from which "his rival has receded. When the central issuer "contracts his issue, the effect is felt, principally, " perhaps, but not exclusively, in the circle which " immediately surrounds that centre; a scarcity of " money and a pressure upon trade is felt through"out the country. The local issuer, in the first " instance, meets this, not by a corresponding con"t.raction. but by an increase of his issues. He is

Free Banking 1

79 "induced to resort to this course by several consi" derations; first, such increase of his issues is a "ready relief to himself, under the tightness of " money (to use the common expression) which the " action of the central issuer has produced; second, " it enables him to extend his accommodation to his "customers, at a time when it is most wanted and " the tender of it is most valued; third, it affords "him some probability that he may be enabled to "occupy permanently with his issue, that portion " of the circulation, at least in his immediate neigh"bourhood, which has hitherto been filled by the " notes of the central issuer."· If, however, the representation which has been gi ven in the preceding part of this tract, of the passiveness of the Country Banks in regard to their issues, is correct, (and the testimony of all experienced country bankers, as far as I have had the means of gathering it, confirms that representation) this minute and lively description in Mr. Loyd's pages of their motives and conduct at such a crisis, must be little more than a fancy-piece. It is impossible that they could purposely expand their circulation in the way described, and under the inducements assigned. It is incompatible with their powers and position. There can be little question that if the central issuer raised the rate of interest in the money-market, or in other

*

Remarks on the Management of the Circulation during 1839, p. 66.

169

170

Free Banking I

80

wordR, occasioned "a tight.ness of money," the country circulation, instead of expanding, would contract of itself, although the consequence would be retarded, and for the country most beneficially retarded, by the independent resources of the provincial Banks. But allowing that the country issues were augmented, not in what I must regard the imaginary way represented by Mr. Loyd, but as they might be. by an increase in the real business of the country, how could such an expansion possibly counteract the measures adopted by the Bank to stop the drain? There are reasons even for supposing that in such a state of things a contrary result would ensue; that an expansion and contraction of the country issues, immediately on the expansion and contraction of the London circulation, would be attended by cir. cumstances which would rather counteract than promote the measures of the Bank. Take the case of a contraction of the circulation by a demand for bullion. This contraction, according to the theory on the subject, lowers the price of importable and exportable commodities, so as to discourage importation, and encourage exportation, and thus eventually our engagements to foreign countries are discharged in part by exported commodities, and the efflux of bullion ceases. Now, it follows from this, that any thing which keeps up the London circulation, or otherwise

Free Banking I

81

prevents the uemand on the Bank-coffers for bullion from reducing prices, tends to prolong the drain. Such a cause, for instance, is the withdrawal of deposits, if not countervailed on the part of the Bank, by selling a portion of her securities, or by other measures; such a cause is any expedient for economising the use of Bank-notes, as substituting bills, and buying and selling on credit, where cash had been employed before. These are all expedients which relieve the community indeed from the effect of the contraction, but, as far as they go, counteract the measures of the Bank. A similar effect is produced by that increase in remittances of funds from the country to London, which is the natural consequence of a contraction in the London circulation, and a rise in the money-market there; whenever this flow of money to the metropolis takes place, it causes the country circulation, as well as country business, to contract: and thus a diminution of the country issues, and a counteraction of the causes operating to stop the drain of bullion, immediately follow each other. In different words, the diminution in the country issues is attended with an enlargement of the London circulation by remittances from the country, which enlargement, as far as it goes, must counteract that withdrawal of Bank-paper, which is to stop the efflux of bullion. Now, supposing this increase of remittances from G

171

172

Free Banking I

82 the country to be prevented by such a flourishing state of business there, as renders it more profitable to employ the money at home, the described enlargement of the metropolitan circulation from this tributary stream would not take place, and the drain on the bullion would remain unaffected, while the country circulation would be expanded. Thus, an expam;ion of the latter would be, not the cause, indeed, but one of the phenomena of a state of things, which would favour rather than impede the stopping of the drain, by preventing the pressure in London from being relieved hy remittances from the country. But laying aside any inter-action of thi!'; sort between the conntry and London, which, whether allowed or not, is of no great importance in the discussion, let us inquire whether an increase of the country issues is not itself one of those causes which tend to keep up prices, and thus directly to prolong the efflux of specie? It is not to be cuncealed that this is a prevalent, perhaps an almost universal opinion; but I should be glad to have it fairly explained how any increase of provincial issues, under the strict system of convertibility and checks to excess now existing -an increase which must therefore be the consequence of an augmentation of business, not the cause-can have any effect on prices. To affect prices, such an expansion must affect

Free Banking I

83

the value of the whole circulation of the kingdom. But this is manifestly impossible. Fluctuations in the amount of paper, put forth by the Country Banks, cannot produce any change of purchasing power in that of the Bank of England, although fluctuations in the latter may alter the value of the whole currency, including country paper. The reason that provincial paper cannot affect that of the Bank of England is, that it cannot do the work of her paper. The fields of operation for these two currencies are not co-extensive. The latter can perform every office of the former, but the former is excluded frem the most important offices of the latter. Country paper cannot circulate in London, and cannot therefore by its abundance, or its scarcity, produce any effect on the prices of commodities there, or on the prices of public securities; and being at all times instantly convertible into Bank of England notes, it cannot by its quantity produce any effect on prices in the country. It is justly remarked by Mr. Loyd, "That in the case of the contraction of the paper circulation of any given country, the void created by that contraction cannot be filled up by a corresponding increase of the paper issues of any other country; the contracted circulation must produce its legitimate effects in enhancing the value of money, and lowering prices in the country in which it takes place. But the case is different," he continues, G2

173

174

Free Banking 1

H4

"with respect to a l'ontractioll of issues, by one among many issuers in the same country. Here the void created by the contraction of one, may be simultt'tneollsly filled up by the expansion of another; and the alteration in the value of money and in prices be prevented, or at all events materially delayed." The latter part of this representation is quite true in regard to issuers who are placed on the same footing: it is true of the country circulation, including that of the Bank branches; but applied as it is intended to be to the inter-action between the Bank of England's London circulation, and the issues of the Country Banks, it overlooks the distinction which I have just pointed out. The metropolit.an sphere of her circulation is as effectually cut off from the interference of the country issues, as the paper currency of one country is from the influence of that of another; and the void created by a contraction on her part, "cannot be filled up by a corresponding increase," on the part of the Country Banks. If we were to suppose Bank of England paper to circulate freely in France, while French notes, although strictly convertible in France, would not circulate in England, it would present a pretty just picture of the relative position of our metropolitan and provincial currencies. In this case it is obvious that any void arising from a contraction in England, could never he filled up by an enlarge-

Free Banking I ~5

ment of French issues. France, III consequence of the nltered relation of her currency to that of England, might yield up some of the English paper circulating amongst her people, and thus delay the effect of the measures taken for a specific contraction by the Bank of England, but the most profuse multiplication of French notes could have no direct influence whatever, and any circumstances which detained the English paper abroad. would prevent the supposed specific contraction from being counteracted from that source. The difference of the positions in which the two branches of our English circulation are placed has been too little adverted to, and it has been perpetually assumed that they must affect each other, precisely as if they were on an equal footing, and perfectly interchangeable, whereas, to make use of a jocular and expressive, although somewhat paradoxical phrase frequently heard, "t.he reciprocity is all on one side." For the reasons here assigned, the imputations of Mr. Loyd against the Country Banks of issue, whether they are considered as levelled at the mode in which their circulation has been managed, or regarded as cast upon the necessary and uncontrollable working af the system of country issues itself, must, in my opinion, fall to the ground. If the Country Banks have erred at all, it has not been in their conduct as banks of issue, but in their ('ondllct as banks for discounts and loans; a

175

176

Free Banking I

8()

matter altogether different and distinct, witl! which the legislature has no more to do than with rash speculations in corn or cotton, or improvident. shipments to China or Australia. These two things are often confounded, and many of the evils which have been attributed to mis-management of the circulation, to improper and excessive expansions and contractions, have in reality proceeded from improper discounts and loans,-transactions which would take place under any system whatever, and the evils of which can be remedied only by a progress in intelligence. On this distinction, indeed, being properly understood and kept in view, will depend, in a great measure, the wisdom of any decision which may be come to relative to the great question of a single Bank, or a multiplicity of Banks of issue. No one would be mad enough to attempt to interfere in any way with the management of establishments for borrowing and lending money, and yet it is not too much to say, that in that character Banks are of far greater importance to the community than the other; that they produce far more extensive consequences by the regulation of their loans than they can produce by any fluctuations which they have the power of effecting as Banks of issue, so long as their paper is convertible. Whatever arrangements consequently arc adopted in regard to the currency, the principal sources of good and evil in the system of banking will continue.

Free Banking I

8i Supposillg country issues to be suppressed, and no paper but that of one single issuer to be allowed, the Banks would still be at liberty to make any loans they might think proper. All the effects, whether good or bad, produced on the commerce of the country by banking institutions would remain, except those which are specifically occasioned by local paper. Banks properly conducted would then be of the highest service to commerce as they are now, while Banks improperly conducted, making immoderate and unwarrantable advances for improvident undertakings, and risking their money on hazardous or worthless securities, would bring great evils both on themselves and on the community, just like any other mercantile establishments in the hands of bad managers. It is necessary, therefore, in order to arrive at sound conclusions on the questions before us, not to mix up the benefits and evils of the trade of borrowing and lending capital, with the specific effects of issuing promissory notes. If we would form a proper judgment of the competency of any Banks of issue whatever, to perform their functions, we must endeavour to attain definite views of the peculiar advantages and disadvantages of that sort of currency which they circulate. VI. What then are the specific effects of a paper currency? What are the resulting advantages and disadvantages to the community, and what are the institutions best adapted to secure and properly distribute the one, and to avoid the other '!

177

178

Free Banking 1

8R

A few brief hints in answel' to these question;; are all that can be here offered to the reader. Everyone must see on reflection that there are two advantages resulting from wllat may be termed a Credit-note currency such as ours-the con· venience arising from its form and the sa\'ing of capital. The former advantage would be as effectually attained if every note were the representative of an actual quantity of gold in deposit; or in other words, if notes were not issued to a greater amount than the coin or bullion lodged in the Bank which issued them. For the sake of distinctness in the present discussion, let these be called bullion-notes. The latter advantage, viz. the saving of capital, depends on notes being issued to a greater amount than the bullion held in deposit, and it is important to remark that it is the sole peculiar advantage necessarily attending such a currency. I say necessarily attending it, because there is another effect flowing from it which may be either an advantage or disadvantage according to circumstances, viz. the depression of the value of the precious metals arising from their being extensively superseded in use as money by the substitution of paper. In the case of a great falling off in the produce of the mineR, while the world was becoming more populous, this would be an undoubted benefit; in the case of a great increase in th.eir fertility, it might possibly be a disadvantage Hitherto, perhaps, all the expedients of interchange

Free Banking I

89 by which the use of metallic money has been economized have operated beneficially in counteracting the enhanced demand for the precious metals accruing from the increase of population and luxury. We may for the present set aside this effect, which would not perhaps be sensibly different under any two possible systems of convertible paper, and consider the sole benefit peculiar to a credit-note currency, which it is necessary to take into view, to consist in the sa ,-iug of capital. In reference to this benefit, the questions which present themselves arc as to the amount and the distribution of it. It is desirable that it should be enjoyed to the greatest extent, and that it should be distributed 011 some just principle. The extent to which the benefit can be enjoyed, will be found to be limited by the disadvantages incident to such a currency which will be hereafter considered; the principle on which it should be distributed is obviously that of equal diffusion, as nearly as attainable, throughout the community. No reason presents itself why any part of the community should derive the advantage of this saving of capital more than any other part. If the benefit were to be monopolized by a few, the nation might as well have a bullion-note currency at once, by which we should obtain every possible convenience arising from the form without being subject to any of the disadvantages of a credit-note circulation.

179

180

Free Banking 1

90 The disadvantages of' a credit-note currency may be stated to be as follows. 1. It is liable to be expanded and cODtracted more frequently, more suddenly, and to a greater extent than a metallic or bullion-note currency, and also at inappropriate seasons. 2. It is liable to become inconvertible from the inability of the issuers to furnish gold at all times for the notes which may be presented for payment. 3. It is liable to lose its value and to entail ultimate loss on the community from the insolvency of the issuers. A brief consideration of these disadvantages will show how they are to be guarded against. If we inquire why a credit-note currency is more subject to fluctuation than a bullion-note currency, we ehall find the reason in this one circumstance, that the latter could not be expanded or contracted at the will of the issuer. Unless notes were wanted by external parties, bullion would not be brought into the issuing Bank; unless bullion were wanted by external parties notes would not be brought in. In the case of a creditnote currency, on the other hand, besides the operation of such external parties. there may be an operation from within the Bank itself. Unless it is placed under the control of proper checks, it may multiply or lessen its circulation at pleasure. Under a system of bullion-notes such an arbitrary expansion or contraction is not possible; under a

Free Banking I

HI

system of credit-notes it is, and thel'efore to be provided against. It is then in liability to arbitrary regulation by the issuers that the first disadvantage consists. If you can take away the dependance of the issues on the will of the issuer and leave the amount to be determined by the wants of the parties who use t.he currency, as would be the case under the system of bullion-notes, the first disadvantage of a creditnote currency will he obviated. The second disadvantage of such a currencythe danger of inconvertibility-arises from its very essence, from its exceeding in amount the bullion held against it in reserve, and the only principle on which the disadvantage can be obviated is to take care that the excess of paper beyond the reserve of bullion is not too great. There is a certain range in the call for gold, varying doubtless with the circumstances of different Banks, which is ascertainable by experience, and a sufficient stock of bullion ought to be held to leave an ample residuum after the utmost call has been answered. The third disadvantage-the danger of loss from insolvency-is to be provided against by a system of solid establishments. Let us proceed to try the present system of country issues by these principles. How far is it calculated to yield the benefit and avoid the disadvantages incident to a credit-currency? The only question that requires to be considered

181

182

Free Banking I

92

with this view, respecting the single advantage of a credit-note currency is, how far the present system of country issues properly distributes it. The advantage (it may be repeated) consists entirely in the saving of capital, and no reason can be alleged why it should not be as equally distributed through the community as may be practicable, in proportion to the business of each district. This proper distribution seems to be made by the present system of country issues, as far as it extends, with as much nicety as can well be conceived. Of the nine or ten millions of capital, rescued by the country circulation from being sunk in the mere machinery of interchange, each district where it prevails obtains a share in proportion to the extent of its business: if it does not, the non-participation in the advantage is clearly its own fault. It is commonly supposed that it is the banker alone who derives the advantage of this rescued capital, and hence it has been contended that a National Bank should be established in order to divert the profit into the State Treasury. But it must be manifest on reflection, that where there is a competition of Banks of issue and where no exclusive privileges exist, the advantage will accrue to the parties who have to avail themselves of the assistance of the Banks, and through them to the corn. munity at large, just as by any improvement in the machinery of making silks and cottons when it is open to eve),y manufacturer who chooses to adopt it.,

Free Banking I

93

tile we:tl'('I'S of those al tides are ulti matel y lwnefitted, and a gellcral incl'easc of employment is crcated. If it were not for this command of capital confen'cd by the power of issuing notes, the banking business of the country could not be transacted at so low a rate, nor the advantages of Banks extended to so many persons. Next, as to the disadvantages incident to a creditcurrency, and the efficiency of the country Banks to obviatc them. In the first place, the Banks, as alrcady cxplained with sufficient copiousness, are destitute of the power of arbitrarily expanding and contracting their issues. They could scarcely be more passive, if for every note they circulated, they had to hold in deposit an equal amount of gold. The fluctuations, thcrefore, in their circulation are only such as are the natural conscquences of variations in the busincss of the country. In the second place, they are so little subject to demands for payment of their notes, except for ordinary purposes, in the usual course of their business, and the resources which they have to provide for other purposes in the general conduct of their affairs, are so immediately applicable to this, that the danger of not being able to pay their notes on demand is reduced to a minimum. In the third place, the ultimate security, as well as the immediate convertibility of the notes, is provided for by the property or real capital which the

183

184

Free Banking I

94

law now allows to be freely applieu (in the greater part of the country at least) to the trade of banking. The only weak part of the system occasioned by the ullwise restriction on the number of partners in Country Banks (still continued as to Banks of issue within sixty-five miles of London) is yearly contracted within smaller dimensions; and it may be justly said that England never possessed Banks equal in solidity to those which are now in existence, nor a paper-currency received with snch universal and merited confidence. In what respect then would the proposed substitution of the issues of a single Bank improve upon the present system of a multiplicity of issuers? 1. In the equal distribution of the sole advantag'e of a credit-currency, no system whatever could surpass the present one, as far as the provincial districts are concerned. A single Bank of issue 011 any plan that I have ever heard of, or am able to conceive, could not approach the same degree of excellence in this principal point. Important as it is, this consideration has of late been almost altogether overlooked, and the attention has been absorbed by the evils to which such a currency is liable. The single advantage for which the danger of these evils is encountered, has been left out of the account; and yet it is obvious that if any system should fail to secure and to distribute this advantage to the parties who ought to enjoy it, no success which it might have in obviating the evils

Free Banking I

95

inci
185

186

Free Banking I

un its constitution ;lIld management. A perfect Rank would doubtless he superior in this point to the Conntry Banks, which as a body may be allowed to have considerable defectt', but a single establishment of a contJ'ary character wOllld be fraught with danger in proportion to its imperfections. The Country Banks for many yean: have maintained the convertibility of their paper, and inspired a confidence which has exempted them from the cOlltingency of panics; and even if any of their number should be occasionally reduced to a suspension of payment, the evil would be partial and limited, while the consequences of a disaster of this kind happening to the sole Bank of issue would be extensively calamitous. The career of the Rank of England afford~ no encouragement to trust so yaluable a freight to a single vessel, at least of a similar ~onstruction. The instance, I am aware, of the American Banks may be alleged on the opposite side. The subject is too extensive and complicated to be entered upon here, but a close and minute investigation of the facts would not in my opinion justify the unfavourable conclusions which have been drawn from them against a multiplicity of issuers. The admirable working of some of the American Banks for a long series of years furnishes a very different inference. It is sufficient, however, on the present occasion to say, that the English Country Banks are placed in so dissimilar a position from that of the Banks

Free Banking I

97 in America, and arp so differently constituted, that no inferences deduced from the history of one can he applied to the other without a comprehensive survey not only of the peculiarities of these establishments, but uf the commercial condition of both communities. In our own country, since the great extension of the system of Joint-Stock Banks, the convertibility of the provincial currency has been practically complete. 4. In regard to ultimate sol vency nearly the same remarks are applicable. A single Bank might be so constituted as to possess a superiority in this respect over the Country Banks, amongst which there are doubtless a few of precarious resources and little solidity. But the number of these is small, and they are gradually disappearing. The constitution of the Joint-Stock Banks with their unlimited liability and their capitals publicly proclaimed, affords all but perfect security to t.he holders of their notes. This comparison presents on the whole no grounds for placing the currency of the country in the hands of one establishment, even if the field of legislation were clear of existing institutions. But as this is not the case, the legislator in making any new arrangements has to deal with established habits and interests, which must unavoidably be taken into account.. The effect of taking away the puwer of issuing promissory note:-o from the COlllltry Banks, would H

187

188

Free Banking I

98 be to deprive the districts in which they are situated, not only of a species of currency to which they are attached, but of the command of capital to nearly the amount of their pt'esent circulation. By the use of local notes these districts are now in the enjoyment of at least nine millions sterling, which would then be withdrawn from them: they are just as fully in the enjoyment of this capital as if, under a metallic currency, the amount were lent in specie to the Country Banks without security and without interest. Withdraw it and one of the immediate consequences of the measure would be a check to industry, a loss of confidence, and a fall of prices highly detrimental to the community. It must be some very great and indisputably prepond~rant benefit, indeed, which could justify any attempt to deprive the provinces of such an ad vantag'e and to inflict upon them such evils. No preponderant benefit of this nature is presented by any suggestion which has yet been made. The consignment of the whole circulation of the country to the Bank of England, or any other body associated together for lucrative objects, would not for a moment be listened to by the nation. To a National Bank of issue, if intended to engross the whole circulation, there would be the same main objections, although unaccompanied by some of the grounds of rf'sistance to conferring a similar monopoly upon the Bank of England. The desirf' of som£' such change seems to proceed

Free Banking I

Y9 from a hypotheticaillotion that there is a necessity for subjecting the amount or quantity of the currency to regulation,-a notion engendered probably by long habit and imperfect institutions. The more the subject is considered, the more clearly I am inclined to believe it will be discovered, that any system which involves the necessity of any arbitrary, speculative, or deliberate adjustment of the sum total of a credit-note currency to the supposed commercial condition of the country is essentially wrong; on the same grounds that it would be a mischievous arrangement which imJ:>osed on any Government or assigned to any Board of Commissioners the task. of regulating the quantity of a currency which wholly consisted of the precious metals. No principle can be depended upon for the nice adjustment of the currency to the wants of the people, but that play of interests in which we unhesitatingly confide for the adequate supply of all the other necessaries, comforts, and conveniences of

life. With regard to any change at the expiration of the present charter in the power of issuing notes within the circle now exclusively supplied by the Bank of England, it scarcely comes within the object of these pages to discuss it. I see little reason, however, to modify the opinion already expressed in the preceding part of these observations. Many of the commercial embarrassments

189

190

Free Banking I

100

of the country seem to me to be aggravated hy the irregular action of an immense establishment artificially forced into its present magnitude and importance by exclusive privileges. Whether the times are ripe for adopting the salutary principles of free trade or (if that phrase be objected to) of free action in this important department of economical policy, is a question which requires for its decision a more familiar acquaintance with the commercial spi~it of the metropolis than the author of these pages can boast. In the adoption of any course on the expiration of the charter, a certain degree of regard is doubtless due to established habits, and to the general principle of gradual c'hanges. It would be unwise, nevertheless, in our statesmen to suffer the approaching opportunity of' improv-ement to pass by, without some attempt to get rid of an irregular and defective system; and no change I am persuaded can be an improvement unless it be made on the side of free action as contrllsted with exclusi ve plivilege, and on the side of simplicity as contrasted with complexity of means.

THE END.

_-

_.- -- .._._---" -"- ..... --.- ... NO/UlAN lND BKEEN, PRINTERS, MAIDEN LA.'NE, COVENT UA.RDII Ii

[5] Excerpt from James William Gilbart, Westminster Review, 89-131

ART. IV.-l. Report oj tlte Select Committee to illquire into tlte Effects produced on tI,e Circulation of tile COlllltry by tIle various Banking Establishmellts issuing Notes pa.ya/;{e on demalld, and to whom the Petitiolls presented this Sessiolt relative to CUl'renc.'1 and Ballking amI tlte Report qf fanner Committees on Blmking were referred. 2. Tile Speeclt of Joseph Hume, Esq., M. P., in the House oj Commons on tlte 8th July, 1839, on a MOli(mfor iliquir.1J into tke Pecuniary T1'Unsactiolls of ti,e Bank of Englaml since ti,e llesumption of Cash Payments ill 1821. 3. Remarks on the Mallagement of the Circalalioll alld 011 tlte Condition and Conduct of tlte Balik of Ellgland and of tlte Country Issues, during the year 1839. By Samuel Jones

Loyd. Richardson. 4. An Inquiry illto the Causes of tlte Pressure 011 tlte MOlle!} Marl,et during tile year 1839. By James William Gilbart.

Longman. 5. A History qf Prices, and of tIle State of tlte Circulation in 1838 alld 1839, with Remarks Oil the Com Laws allll Oil some of the Alterations proposed ill our Banking System. By Thomas

'tooke, Esq., F. R.S.

Longman.

6. A Letter to Thomas Tooke, Esq., in Reply to his O~jectio1/s against tlte Separatiolt of tlte Business of the BallI. into a Departmellt qf Issue and a Department of Deposit alld Discoullt, with a Plan of .Banle Reform. By R. Torrens,

Esq., F.R.S.

Longman.

7. A Letter to James William Gilbart, Esq., General Manager of tlte London and Westminster Bank, on the Regulation of the Currency by the Poreign Exchanges, and 011 the Appointment of the Ba"k of Ellglal/d to be the sole Bank oj Issue throughout Great Britain. By Robert Bell. Richardson. 8. A Defence of Joint Siock Ballks alld Country Issues. By

the Author of ,. Money and its Vicissitudes in Value," .. Essays on the Formation of Opinions," &c. &c. Ridgway. THE subjects of currency and banking have recently been so much discussed, that their introduction to the notice of our readers will require no prefatory observations. \Ve shall therefore proceed. in the first place, to review those principles of the currency which are advanced in the works before us, and then consider those plans that are proposed for its administration. Among the principles of the currency we shall select, as the

Free Banking I

192

90

THE CURRENCY:

subject of investigation, a few of the most prominent. shall inquire,

We

I. What effect have fluctuations in the currency upon the prices of cOllimodities? II. How do flucluations in the currency influence the foreign exchanges? Ill. What effects are produced by the substitution of papermoney for coin 1 IV. Ought bank deposits to be regarded as currency 1 and V. Ought bills of exchanges to be regarded as currency 1 I. We inq uire, What effect is p"oduced on tile prices of commodities by fluctuations ill the currenc,y ? As the {'rice of a commodity is the quantity of money for which it will exchange, it seems reasonable to suppose that an increase in the quantity of money will tend to advance prices. The doctrines put forth by the Manchester Chamber of Commerce were,-that great changes had taken place within a few years in the prices of commodities-that these changes had been produced by fluctuations in the currency-and these fluctuations in the cUlTency had arisen from the conduct of the Bank of England: these opinions were maintained by Mr Smith· and Mr Cobden, two directors of the Chamber, in their evidence before the committee. Mr Norman thinks that the Manchester statements are exaggerated, but admits that the effect of a contraction of the currency will be to reduce prices. " 2198. A real effect upon the exchanges could not be prodllced without a fall of prices; do you concur in that 1-1 conceive that the effect of a contraction is to discourage importation and to encoura~e exportation; and that plices are the medium through which thlS effect is produced. "2199. That fall of prices must operate as a loss upon the llOlders of goods?-Yes." Mr Horsley Palmer gave the following evidence before the committee of 1832 : " 679 •. Then the object 6f reducing the cil'culation is the reduction of prices 1-1t is the natural consequence of an unfavourable exchange. . "683. Could a redu,ction take place here without a great reduction of prices 7-1 think eventually prices must fall." • See Mi' Smith's Evidence, Questions G-IO.

193

Free Banking I :BAN k.IN~.

91

In the pamphlet before U8, Mr Samuel Jones Loyd uses similar language" The connexion between fluctuations in prices and variations in the amount of the circulating medium is a question of extremely difficult solution in its detail: and, probably, after the most laborious investil5ation of it, we can only come to the conclusion, that the immedIate effect upon prices of any variation in the amount of the circulation may be over-estimated, whilst there undoubtedly exists a very intimate connexion between them. Indeed, unless this be admitted, the whole doctrine of regulating the circulation by reference to the state of the exchanges falls to the ground, and we are len without any principle upon which the management of the circulation can rest." The Speech of Mr Hume is founded upon the same principles; and he has collected from public documents a vast number of' facts, showing the correspondences that have existed between fluctuations in the currency and fluctuations in prices, chiefly with relerence to the public securities. " He complained that the Bank ot England, by lending money at times at low interest, often lower than the market price, on stock and other securities, did, in reality, urge to over-speculation by merchants, and to over-issues of paper by joint-stock banks; and, having got the country into great excitement of high prices and apparent p\'o~perity, altered their plan when their coffers were emptying, reduced their discounts, raised the interest, and, to prevent the exhau!>tion of their bullion, suddenly cramped the whole of the commercial transactions of the country." Mr Tooke is the only witness who questions this doctrine; and he makes aamissions which, we think, completely overthrow his own opinions. In answer to the question No. 3297, proposed by Mr Burne, " What is it then that does affect prices 1" he answers, " The cost of production limiting the Bupply on the one hand, and the pecuniary means of the conBurner limiting the demand on the other." We should infer from this, that the increase of the currency would give increased pecuniary means to the purchasers, and hence cause an increased demand that would tend to advance prices. Again, in reply to No. 3300. proposed by Mr Warburton," Suppose the supply of the precious metals in the world to be increased, and to go on doublin~ and trebling, and so on, would not the prices of commodities estImated on the precious metals go on doubling and trebling, and so on, in proportion to the increase of the precious metals '/ -Yes, they will, undoubtedly; and I took for granted that we were speaking of alterations in prices as distinct from those of bullion value in the commercial world."

194

Free Banking I

92

THE CURRENCY:

Now, if an increase in the quantity of money in the whole wol'ld would cause an advance or prices in the whole world, then we sill)lIid infer that an increase in the quantity of money in any pa-rtlcuial' countt'y would cause an advance in the prices of commodities in that country. It matters not, as far as regards the objects of this inquit'y, whether commodities are said to get dearer or money to get cheaper. If the same commodity will exchange for a greater quantity of money, the price is advanced. . In these replies Mr Tooke seems to have intimated the way ill which an increase of money tends to advance prices; that is, by increasing the demand, an increase of money ~ive9 men the means and the inclination of purchasing an additIOnal quant.ity, either for consumption or speculation, and the increased demand advances the price. It is no objection to this doctrine to say, that prices may advance from other causes than an increase of the currency; no doubt they may. But this is not the question. The question is, whether the abllndance of money is not one cause. It should be recollected, too, that money always acts intermediately. When money is abundant, people me more disposed to make purchases or engage ill speculation; but the particular direction in which the money may be employed, depends upon a variety of circumstances. Thus, Mr Tooke states, that the fall of prices which took place in the latter end of 1836, arose from large importations; but WE' may ask, was not the previolls abundance of money the cause of those large importations? Again, it has been maintained that the panic of 1836 arose from the expansion of American credit; but, we may ask, was not the abundance and cheapne~s of money one cause of that e.lCpansion of credit 1 Money always operat.es, in the first instance, by producing a moral effect; by a moral effect, we mean an effect upon the minds of men. Mr Norman says, he thinks very little of the moral effect of an increase in the quantity of money; and yet, in a subsequent part of his examination, he admits that a contraction of the currency produces caution, and this incrt'ases the tightness in the money market. Now, what is caution bula moral effect 1 and, if a moral effect be produced bv the scarcity of money, why not by its abundance 1 In fact, fluctuations in the currency can produce no physical effects without, in the first place, producing a moral effect. Abundance of money makes men buoyant, sanguine and enterprizing, and hence they go into.speculation. The feeling becomes contagious, and sOllletimes a whole nation goes mad. On the other hand, a scarcity of money tnakes men cautious, timid and apprehensive,

Free Banking 1 BANKING.

195

93

and hence they prepare for the worst that can come upon them. In consequence of these mental afiections, fluctuations in the currency.often produce greater eH'ects than the mere amount of the fluctuation would lead us to expect. We conclude, then, than an abllndance of money has a tcndency to raise the prices of commodities; and we think it 110 objection to this doctrine to say, that, in some cases, there have been increased issues of money without a general advance of prices; for sometimes these increased issues may not be employed in commerce, but be employed in domestic investments or foreign securities, Nor do we think it any objection to this doctrine to prove, that the advance ill the price of any particular commodity may sometimes be accounted to I' by somc peculiar circumstances connected with that commodity. We believe this is gcnerally the fact. Speculators and merchants have always some peculiar reason fOl'dealing in onc commodity rathel' than another; but the facility of obtaining the money is the moving cause of the speculation, and the price of each commodity will advance according to the quantity of money that is brought to bear on that particular market. But when we contend that an increase in the quantity of money has a tendency to raise the prices of commodities, we must be understood to mean that the quantity of commodities remain the same as before. If there be an increased quantity of commodities brought to market, and money is drawn out from the banks to circulate these additional commodities, it will not cause any advance in price. We cannot better explain our meaning than by referring to the case of Ireland. The evidence given before the Parliamental'Y Committee of 1826 fully explains the state of trade in that country. The corn trade and the bacon trade commence in the months of t:>eptember and October. FrOID these months, until the following January, the notes in circulation continue to increase, and from that period they gradually diminish. This process is as follows :-A person goes from London with 1,0001. to engage in the Irish corn trade. He may obtain from the Provincial Bank, in Broad-street, a letter of credit upon one ofits branches (say COl'k) for 1,000/.: he will receive it at the branch in provincial bank notes, which he will distribute among the farmers in the purchase of corn. The farmers will keep these notes in their possession until the end of the year, when they have to pay their rent. The dealer having shipped his 1,0001. worth of corn, may draw a bill upon London for the amount, which he may discount at the brunch, and thus obtain another J,OOO/.

Free Banking 1

196

94

THE CURRENCY:

with which he may purchase another supply of corn, and he may repeat this operation as often as he pleases. The farmers will keep these notes in their possession until January, when the agents came round to collect the rents. The agents will receive these notes from the farmers, and take them to the bank for a letter of credit on London or Dublin, which they will remit to the landlord. Thus we find there is a large increase in the circulation; but as this is caused by the increased qliantities of commodities brought to market, it has no effect upon prices. The price of corn in Ireland is governed by the price at which it can be sold in England. If the price be high, a larger amount of notes will be drawn out of the bank: but the increased issue of notes is not the cause of the high price, but the high price is the cause of the increase of the notes. Confirmatory of this statement, we have extracted from the returns attached to the evidence an account of the circulation of notes in Ireland on the first week in September and in the last week in December for the years 1837, 1838, and 1839. Circulation of the Bank of Ireland, of the Bank of Ireland branches, and of the joint-stock banks in Ireland, in the fi1'8t week of September and the last week in December of the years 1837, 1838, and 1839. Total Bank of Ireland Circulation of Branche•• Bank of Ireland.

September Decpmber September December September December

-

1837 1837 1838 1838 1839 1839

2,940,400 3,265,700 3,067,900 3,474,500 2,980,700 3,192,200

Joint-stock Banks.

1,066,600 1,342,300 1,275,600 1,695,600 1,217,400 1,464,000

1,524,476 2,204,286 1,881,085 2,972,034 1,987,068 2,629,205

-

We observe, too, by these returns, that the circulation of Scotla~d i~ uniformly at its lowest point in March, and its highest pomt m November. The country circulation of England is usually the highest in April and the lowest in August. It cannot ~e supposed that t~e prices of all commodities vary every year III the s~me proportIOn. The circulation of the English country banks, Itke those of Irl;lland nnd of Scotland, is operated upon by local demands; and hence the issues of country banks have no effect upon prices. While, on the other hand, ihe notes of the Bank of England, being issued against deposits of gold, or in

197

Free Banking I BA.NKING.

95

purchase of Government Stock or Exchequer Bills, must have a tendency, by increasing the demand, to cause an advance in the lrices of commodities. I . Our next inquiry is-In what way does an extension or contraction f!ftlte CU1'1'ency operate upon tile Foreign Exchange$. The foreign exchanges are regulated mainly by the balance of trade. Ifwe import more commodities than we export, we must pay the balance in the precious metals. Money may aho be exported for other purposes than as payment for commodities imported; such as for subsidies to other powers, as rents to absentee landlords, or for permanent investment in foreign securities. Now, then, in what way can an expansion of the currency render the exchanges unfavourable? If this extension of the currency raise the prices of' commodities, as we have seen it will, its tendeucy will be to encourage importation, as 10reigners will find this a good mal'ket for their goods. It will at the same time check exportation, as foreigners will not be disposed to purchase our commodities at an advanced price. ThIS will cause the balance of payments to be against us. Besides, the increased quantity of money put into circulation will lower the rate of interest, and hence many parties may send money abroad to be invested in the foreign funds, in order to obtain a higher rate of interest than can be obtained at home. There are many other indirect ways in which an alteration in the amount of the currency affects the foreign exchanges. "3769. Mr. lVar/Ju1'ton. Would the raising of the rate of interest produce any effect upon the exchanges, unless it occasioned a diminution in the application for discounts, and therefore in the amount of the circulation 7-It would produce a decided effect upon the ex.. ohanges, at the same time that there would in all probability be an increase ill the amount of the issues through the medium of discounts; the effect upon the exchanges of a rise in the rate of interest would be that of inducing foreign capitalists to abstain from callin~ for their funds from this country, to the same extent as they otherWise might dQ, and it would operate at the same time in diminishing the inducements to caritalists in this country to invest in foreign securities, or to hold foreign securities, and it might induce them to part with foreign securities, in order to make investments in British stocks or shares. It would likewise operate in restraining credits from the merchants in this country by advances on shipments outwards, and it would have the effect of causing a larger proportion of the importations into this country to be carried on upon foreign capital.Tooke:'

We see, then, that an alteration in the quantity of the, cur-

Free Banking 1

198

96

THE CURIlENCY:

renr.y will affect the foreign exchanges in two ways. An increase in the quantity will tend to advance the prices of commodities, and thus check exportation, and encourage importation; and it will lower the rate of interest, and thus cause a transfer of capital for investment in foreign securities. Seeing, then, that we have the power of thus influencing the exchanges, the question arises, ought we, as a general principle of action, to make use of this power? It strikes us at once that this is an operation altogether at variance with the ordinary functions of money. The design of money is to effect the exchanges of commoditIes-to operate as a measure of value between different commodities, and thus to show their relative values. And it ought not only to show the relative value of different commodities at the s.amc time, but also the value of the same commodity at different times. All writers on monetary science have hdd that the measure of value ought to be free from change; and they state that the precious metals were originally selected for this reason, because they possessed more than any other commodity the quality of permanency. It seems as necessary to have a standard of value as a standard of weight or of measure. And were the yard measure or the bushel measure to be perpetually changing, it could not produce greater confusion or injustice than if the standard of value were perpetually changing. On this ground it has been contended that corn would be n very improper standard of value; for as, annually, the crops vary very much, an arlic.le that is worth one bushel of corn this year may be worth two bushels the next. But if the quantity of money were to be increased or diminished from year to year, with the view of influencing the exchanges, then it would become as improper a standard of value as corn. Indeed, during the last few yeats, the quantity of gold in the Bank of England has fluctuated more than the produce of the harvests. There are various cir;' cumstances that influence the prices of commodities; such as an increase Ol' a diminution 01' the supply-a state of peace or war-the opening of new markets-the discovery of cheaper modes of production, or the substitution of a scarce commodity. Now it seems proper that these legitimate causes of an alteration of prices should not be counteracted by an artificial operation on the currency: the natural price of a commodity is an indication of the relative quantity in the market; and when the price a,dvances, it is notice, to the consumers to reduce their consumptIon. Suppose, for 1I1stance, we had a scanty harvest, the price of corn would of course advance i this advance of price would

199

Free Banking I

97

BANKING.

induce many people, from motives of economy, to diminish their consumption, and to use instead cheaper kinds of food; and thus the quantity on hand would be eked out to the next harvest. But suppose the quantity of money were to be forcibly contracted, and corn kept as cheap in this season of scarcity as it had been in the pl'evious year, then consumption would not be diminished; the whole stock might soon be exhausted, and, before the next harvest, the nation might starve. Thus, artificial operations on the currency might contract the effect of the natural causes of alteration in prices, and also, by operating unequally on different commodities. might derange their relative values. III. Our next inquiry is- What ejJect is p7'oduced on tlte curre1lc!} by tile substitution of" paper money? The following question was put to Mr. Loyd:"2654, What, in your opinion, is the sound principle according to which the circulation should be re~ulated ?-A metallic currency, I conceive, by virtue of its own intrmsic value, will regulate itself; but a paper cunency, having no intrinsic value, requires to be Bubjected to some artificial regulation respecting its amount. The use of paper currency is resorted to on account of its greater economy and convenience, but it is important that that paper currency should be made to conform to what a metallic currency would be, and especially that it should be kept of the same value with the metallic currency, by being kept at all times of the same amount. Now, the influx and efRux of gold is the only sUl'e test of what would have been the variations of a metallic currency, and, therefore, I conceive that that constitute! the only proper rule by which to regulate the fluctuations of a paper currency." It is assumed in this reply that paper is a substitute for coin; that the forty millions of bank notes now circulating in England, Scotland and Ireland· represent forty millions of sovereigns; and that were the notes abolished, their place would be supplied by an importation of forty millions of gold. These points remain to be proved. We are inclined to believe with Sir Robert Peel, that were these notes abolished, theil' place would be supplied chiefly by bills of exchange, or some other description of paper money. Secondly, it is assumed that a purely metalhc circulation would perpetually vary in amount, according to the fluctuations in the foreign exchanges; that were six millions of gold imported. it would add six millions to the amount of the currency; and, on the other hand. if six millions of gold were exported, it would lessen the VOL,

XXXV. No, I.

H

Free Banking I

200

98

THE CURRENCY:

currency by six millions; this, too, remains to be proved. Even if gold bullion were used as currency, we see no reason why all the O"old bullion in the country should be used as money. Gold is an ~ticle of trade, and why, therefore, should every additional quantity imported be added to the quantity used as money. Hut we do not lise bullion as money, but coin; and it is cleal' that bullion cannot be used as money until it is coined. The privilege of coining money belongs to the sovereign. France has a silver currency; does this increase or diminish in quantity according to the exportation or importation of silver'l So far from this being the case, Fmnce has been adduced as a proof of the permanency attending a metallic currency. What proof thcn havc we that, were our currency purely metallic, it would increase and diminish in quantity according to the fluctuations of the exchanges? Thirdly, it is next assumed that a paper currency ought to be so regulated as to make it correspond ill quantity with the assumed fluctuations in a metallic currency. If it could be proved that a purely metallic currency would perpetually fluctuate with the foreign exchanges, so far from regarding such a state of things as a state of perfection to which the nation ought to aspire, we should regard it as a calamity that would call loudly for legislative remedy. Granting, however, that this would be the case, are we bound to make the paper currency correspond exactly to the supposed changes of a metallic clilTency? It seems a great advantage to have a currency that is capable of expanding and contracting in all the localities throughout the kingdom, exactly as the wants of trade may require. And why should we forego these advantages merely to make our paper currency correspond with the supposed changes of a metallic currency. without any satisfactory proof that the paper currency supplies the place of a. metallic currency, 01' that a metallic currency would undergo these changes?

IV. Ought Deposits ill tlte Bank

of England to he regarded as

MOlley?-

In discllssing this question it will be necessary to inquire, 1st. Whether deposits. perform the office of currency. and to what extent? 2nd. Whether there is any difference between the deposits in the Bank of England and those in other banks? 3rd. Whether the fluctuations in the deposits in the Bank of England are a fair criterion by which to judge of her

Free Banking I llANKING.

201

99

previous issues? 4th. Whether the Bank of England is justified in employing her deposits? 5th. What is the influence of deposits u pall the prices of commodities? 1st. Do Deposits IJerj'arm thejilllctiolls a[Currellcy, and to what ertellt?-We use the word currency as synonymous with the word money, ami including only coin and notes payable on demand. The ambiguity of the· word currency is perhaps the main cause of the difference of opinions that have been expressed on this subject. If the word currency include only bank notes and coin, then deposits are not currency j but if the word be extended so as to include deposits, then the word currency becomes a generic term, and includes various species of currency, as a coin-currency, a note-currency, and a deposit-currency. But this alteration in the meaning of the word would not make any alteration in the question, whether the deposits performed the same functions as bank notes? Mr Loyd says that deposits are not currency. "Money," says Mr Loyd, "is marked by certain distinguishing characteristics which deposits do not possess." The question is not, whether deposits and circulation are, in their own nature, in every respect alike, but whether they do not perform the same functions? Now it is undeniable that in some respects they uo. If two persons keep an account at the same bank, a debt due from one to the other may be discharged by a transfer in the banker's books. And when a number of bankers meet together and settle their accounts at the clearing-house, this amounts to nearly the same thing, as fiU' as regards their transactions with each other, as ifall these bankers formed only one bank, for the amount of bank notes with which they settle their balances must be small as compared with the total amount of the payments. But are we justified by this in considering the whole amount of deposits in the Bank of England as so much currency? We think not. .. Circulation," it has been said, ., are notes out of the Bank, and deposits are notes in the Bank, and, therefore, they are both currency." This is sheer mystification. A deposit is a loan. We do not deposit money in a bank in the same way as we would deposit a horse in a livery stable, with the expectation of receiving the same again when we call for it. A Bank deposit is a loan to the Bank, but as this loan is transferable, it ruay in this way perform some of the functions of money. But the extent to which this is done must be measured, not by the amount of the deposits, but by the amount of the transfers. 2nd. The next inquiry is, Whetller there is any differenc,

Free Banking I

202

100

TIlE CURRENCY:

between the Deposits ill the Bank of Englalld (lnd those in ollter Ba1lks, with regard to their etficiellcy ill performing thefu1Icliolls '!f Currency?-We think not. It seems to us that the deposits in all banks, whether issuing or non-issuing, are upon the snme level in this respect. Some of the witnesses contended that when deposits are made in a banker's own notes they nre then currency. but not otherwise. There appears to be 110 foundation for this distinction. Deposits, under whatever circumstances they may have originated, must all ha\'e the same characteristics and capabilities. The extent to which they perform the functions of currency depends upon the extent of the sums that are transferred from one class of depositors to another. Those deposits only are thus transferred which arc payable on demand. This class of deposits, therefore, can only be considered as currency, and that not to t.he extent they are capable of being employed, hut to which they are actually employed. One class of the deposits in the Bank of England consist of the Bank notes lodged by the London bankers in the evening and drawn out the following morning. These nre clearly circulation, and classing them with deposits at all is a mere matter of book keeping. Mr Horsley Palmer considered that nearly a third or a fourth of the deposits in the Bank might be regarded as circulation. 3rd. A third inquiry is, Whether the rise or fall of the Deposits is any criterion b,lJ which to judge of the increased or diminished issues of the Bank?-This is, in fact, the practical applicatlon of the doctrine respecting the identity of deposits and circulation. Those who accuse the Bank of England of excessive issue in the year 1835 contend that the deposits should be taken into account and regarded as money. On the other hand, the defenders Of the Bank of England say, look at the circulation-there is a positive diminution-and you have no right to look at the deposits. Now we contend that deposits are not money, though some portion of them may perform the functions of money. But, nevertheless, we feel constrained to admit that the deposits are a means of measuring the liberality of the Bank of England with regard to her issues. All the deposits must consist of gold or Bank notes. Now if we take any two periods, and find that at each of those periods the amount of the circulation and of the bullion are the same, but that the deposits have increased, it is an undeniable evidence that between those periods the Bank must have increased her issues. It is a mere subterfuge to say that deposits may arise from loans or from the discount of bills. Granting the loan

Free Banking I DANKING.

203

101

01' the discount was, 011 the part of the Bank, an act of issue for notes to that amount. If the Bank grant loans or discount hills, the party may do what he pleases with the notes he thus obtains. If he lodge them on deposit, it is a voluntary act. ~n increase of deposits, cateris paribus, shows an increase of Issue. A diminution of deposits, catel'is parious, shows a diminution of issue. 4th. Another inguiry is, Whet Iter tile Balik of ElI u!a"d ouu/lt to make lise of Iter Deposits ?-We reply yes, provid~d the demand be made by the public; but the Bank ought not to anticipate the demand or to issue hel' notes merely because she ant!cipates or fears that the circulation may become too much contracted. It is not likely that deposits will ever be lodged to the extent of causing an undue contraction of the currency. But should this be the case, the increased value of money would immediately cause the deposits to be again withdrawn, or else would increase the demand for discounts. In the questions refening to the advances on the West India Loan it is presumed that the deposits were made in the first inst&nce, and that afterwards the Bank invested this money in securities. The facL is the reverse. The Bank issued her notes on securities in the first instance, and then these notes were lodged on deposits. Where the Bank made the payment on the loan the increase of securities and of deposits was of course simultaneous. It appeared that these advances were made chiefly on bills of exchange. Had the Bank 1I0t made her advances at a low rate of interest these bills would lui.ve been discounted. But no one would discount a bill at four per cent. if they could obtain a loan upon it until it became due at three and a half per cent. Had the Bank not made these advances at all, the increase of deposits by the earlier payments on the loan might have been re-Issued before the later payments became due, and thus all the payments might have been made without causing an undue contl'action of the cUJ'J'ency. 5th. A further inquiry is, What e.ffect the Deposits in tIle Bank of England have upon the prices of commodities ?-Mr Hume asked Mr Loyd, "Is it your opinion that it is the circulation alone that affects the prices of commodities and the rate of interest, and that the deposits have no influence whatever upon them 1" Mr Loyd replied, .. It is not my opinion that the circulation is the only thing that affects the prices of commodities and the rate of interest." This reply leaves that portion of the question which refers to the influence of deposits wholly unanswered. Subsequently, in reply to a question from the

204

Free Banking I

102

'l'HE CURRENCY:

chairman, he states, " I conceive that f1 uctuations in the amount of the deposits will not necessarily produce corresponding fluctuations in the prices of articles." It may be observed that Mr Loyd does not say that fluctuations in deposits will not produce fluctuations In prices, nor that they wi\1 not produce corresponding fluctuations in prices, but that they do not necessarily produce corresponding fluctuations. We leave our readers to conjecture what are Mr Loyd's opinions on the subject. It seems to us quite obvious that when the deposits are increased by the overflowing of the circulation, those deposits must have a very considerable influence upon prices. We have stated that an increased circulation affects prices by occasioning an increased demand. Now if a party lodges his notes in the Bank on deposit, with a view of employing them as soon as he can find a profitable investment, they will clearly have the same effect upon prices as though he retained them in his own possession. The extent to which prices may thus be effected will depend upon the amount which the depositors have the power and the inclination to employ in the purchase of commodities, and also upon the exertions they may make to obtain suitable investments. To illustrate these propositions, let it be supposed that a man sells 1,000/. stock, and receives for it a 1,0001. Bank of England note; this gives him a power of rurcha~e to the extent of 1,000/. He may buy cotton or tea, or American bonds, or anything he likes, to the extent of 1,000/. If he is anxious to layout his 1,0001., and goes about in•. quiring the prices of these commodities, and making biddings for them, that will tend to advance the prices of these things, even though he makes no purchase. The more biddings for an article at an auction, the higher the price will advance, though there can be but one purchaser. But if he is not anxious to spend his 1,000/., and makes no effort to do so, he will not advance prices; and this will be equally the case, whether he keep the I,OOOl. in his pocket or lodge it in the Bank of England; but, in the former case, it will be called "circulation:' and in the latter case, it will be called" deposits." When he has made a purchase, of course he draws out his "deposit" (if he had lodged it in the Bank), and then his 1,000l. again becomes" circulation." But suppose that, instead of lodging it in the Bank of England, he lodged his 1,0001. with a private banker; in this case, as in the former, he would retain the power of purchase to the extent of 1,0001., and the 1,000l. note would, in the

Free Banking I BANKING.

205

103

returns of the Bank of England, be called .e circulation." But the banker would not lock up the 1,0001. in his till. He would keep, perhaps, 2001. in his till, and invest the remaining 8001. in discounting bills, or in some other securitiei>. Here we immediately see a difference. When he lodged his 1,0001. in the Bank of England, it increased the deposits to that extent, and he had a power of purchase to the amount of 1,000l.; when he took it from the Bank of England, and lodged it in a private bank, he still retained the same power of purchase; but, in addition to this power, 800l. of the money went into active circulation as currency, and 2001. remained as dead circulation in the banker's till. But the Bank of England may employ these deposits as well as the private banker, and will not be under the necessity of keeping any reserve in her till, as she can payoff the deposit in her own notes. In this case, the depositor will have the power of purchase to the extent of 1,0001., and the Bank will have increased her circulation as well as her deposits by 1,000/. Again, suppose the circulation is at its proper amount, and the Dank should purchase a million of Exchequer bills, the notes thus put in circulation not finding immediate employment, might be returned to the Bank, and be lodged on deposit. Here there woultl be no increase in the circulation, but an increase of a million in the deposits. A power of purchase, to the extent of a million sterling, would have been created by the Bank, and the efforts of the depositors to make the most advunta~eous investments would have the effect of advancing the prices of commodities and of stimulating a spirit of speculation ; and should the Bank consider this increase in the deposits a sufficient reason for adding another million to the circulation, this additional million might also come back and be added to the deposits; thus a power of purchase to the extent of two millions would be created, and a spirit of speculation would be still further promoted, without any addition ill the monthly returns to the amount of the circulation.

V. Ought Bills of Exelwuge to be regarded as Cun'eney? With regard to bills of exchange, we hold the same opinion as with regard to deposits; we think they perform the functions of currency to the extent of the actual transfers. The one case is the transfer of a loan-the other is the transfer of a debt, and either one 01' the other may be employed to make a purchase. or discharge an obligation. It is sllrprising to us that any gentleman connected with Manchester can express any

206

Free Banking I

104

THE

CU~nENCY:

doubt as to the power of hills of exchange to disch~rge the functions of cUl'rency. Only a few years ago, about ninetenths of the transactions at Manchester were settled by bills of exchange. It was stated by Mr Lewis Loyd, in 1826, that the circulating medium of Manchester consisted of nine-tenths bills of exchange, and one-tenth Bank notes and gold; at present the circulation of the Manchester branch of the Bank of England is above 1,500,000l. As the bills of exchange have diminished, the Bank notes have increased. We shall, perhaps, be told that it bill of exchange is not a Bank note. We know that; but it is notorious to every merchant and tradesman in the kingdom that a bill of exchange often performs the same functions as a Bank note, and at the clearing house every day a large amount of bills arc discharged by being exchanged against othet' bills, Mr Attwood seemed desirous to show that bills of exchange bave a very extensive influence upon prices. We doubt the soundness of this sentiment. Legitimate bills do not precede but follow the transactions on which they arc based, and have no more effect on prices than the notes issued by the country banks; but kites, Ot' accommodation bills, drawn for the purpose of raising capital, have the same effect upon prices as an Issue of notes by the Bank of England for the purchase of stock or bullion; they increase the demand for those commodities in the purchase of which this capital is employed, and hence raise the price; these accommodation bills are most numerous when money is abundant, as they can then be most readily discounted, and there is then afloat a greater spirit of speculation. Mr Leatham has attempted to calculate the amount of bills in circulation, or more properly speaking, in existence, during each year. He, through I.ord Morpeth, obtained a return of the number of stamps issued from 1835 to 1839 inclusive, and based his calculations on the supposition that each bill was circulated for half the amount which the stamps would cover, which was considerably under the amount. From the experience of his own bank, compared with that of the principal discount offices in London, he found, that the average date of bills, including foreign and inland, was three months. He then took the whole stamps for a year, and divided them by four, which gave the amount circulating at one time. By a similar induction, he estimat~d foreign bills at one-sixth of the English, though the pro}>ortlon was rather greater; and he took the same average for bish bills in the years where no official returns had been made.

The following is his Statement of the Bill circulation of Great Britain and Ireland, during the years under-mentioned : 1815.

-

Bill Stamjs for Great Britain, creating the sum Estimate Irish Bills _ _ _ _ _ Foreign Bills - - - -

-

-

-

Total

-

-

Average amount in circulation at one time

-

I

1824.

I

1825.

1826-7.

-

£.

£.

£.

232,429,800 38,738,300 45,194,683

£.

477,493,100 79,582,183 92,845,880

260,379,400 43,396,566 50,629,327

207,347,400 34,557,833 40,317,072

649,921,163

316,362,783

354,405,293

282,222,305

-

162,480,290

79,090,695

88,601,323

70,555,576

----

~

Z

~

~

;;

The following is a similar return for the last five years:

~

1835.

--

British Bills - - - - - Irish Bills - - - - Estimated amount of Foreign Bills _ _ Bills created by Bankers compounding for Stamps

-

Total

-

-

Average amount in circulation at one time

-

-

I

1836.

1837.

1838.

£.

£.

£.

£.

355,288,900 59,155,607 69,420,406 2,078,560

333,268,600 54,179,165 6/5,012,080 2,624,600

341,947,400 54,359,464 66,500,577 2,696,600

394,203,000 55,615,722 75,479,120 3,196,000

405,403,051

485,943,473

455,084,445

465,504,041

528,493,842

101,350,7621121,485,868

113,771,111

116,376,010

132,123,460

£.

~

~.

.......

1839.

294,775,269 51,109,061 57,914,721 1,604,000

~

b:!

>

.... o

C•.-,

~

'-l

Free Banking I

208

106

THE CURRENCY:

This table, even if correct, which we very much doubt, gives us bllt little informatiol\ as to the extent to which these hills A large portion of them, perform the functions of currency. probably, are drawn hy tradesmen on their customers, and discounted with a bankel', in whose hands they remain till they become due. Here there is only one transfer. Few bills in the present day have more than three or four indorsements. Ml' Lewis Loyd stated, in 1826, that he had seen bills with 120 indorsements. We qUt'stion if such a bill could now be found, even in Manchester. The extent tQ which bills of exchange perform the functions of currency depends not merely upon the amount of the bills in existence, but also upon the number of times they are transferred.'*' We now proceed to the second part of our subject: to in£) uire. What plans Itave been proposed for tlte administration of tlte currency?

I. In the first place we must notice that of Mr Horllley Palmer. I t is thus described by himself:" The principle, with reference to t.he period of a full cUl'rency, and consequently par of exchange, by which the Bank has been guided in the regulation of its issues, always exccptin~ special circumstances, has been to retain an investment in securitIes, bearing interest, to the extent of two-thirds of their liabilities, the remaining one-third being held in bullion and coin; the reduction of the circulation, so far as may be dependent upon the Dank, being' subsequently solely affected by the foreign exchange!:! or by internal extra demand. Mr Horsley Palmer's plan seems to us to be liable to several objections. First, It is founded on the principle that the amonnt of money in a country ought to be increased or diminished according as the foreign exchanges happen to be favourable or unravourable. Thus, all the gold and silver imported is to have the same effect as though it were instantaneously converted into coin and circulated throughout the country. Against these importations of bullion the Bank of England is to issue her notes, and th us for awhile we are to have all the prar.tical evils that would result fl"Ol1l an inconvertible paper currency. The prices of commodities will risespeculations will abound- foreign investments take placeand the exchanges become unfavourable again when gold is required for exportation-t.he coffers of the Bank of England are exhau~ted, and convulsion ensues. This plan. therefore. most effectually ensures a frequent recurrence of pressures and • See Mr Tooke's evidence, No. 3278-3280.

209

Free Banking I BANKING.

107

panics. We may find SOlUe proof of this in the fact, that we have had two panics of no short duration within the eight years that have elapsed since the plan was first announced. Secondly, Supposing the plan were good in principle, the stock of gold is very inadequate. It requires, that at the time of t\ full currency, that is, when the exchanges have been for a 10llg time favourable, and are just ahout to turn, the Bank shall have treasure to the extent of one-third of her liabilities. This is the largest amount she is expected to hold, and to this amount she is expected to attain only after treasure has been flowing into her coffers for a period so long as to be about to cease. Of the total inadequacy of' such an amount to meet the drain that is sure to take place on the return of the tide, we have had abundant proof. MI' Palmer himself seems to acknowledge that the amount of gold is too small, though he modestly intimates, that if the Bank should keep a larger amount of treasure, it ought to be at the expense of other parties. Severa) of the witnesses accused the Bank of having departed from the rule laid down in 1832; but Mr Palmer contends that the rule has been observed, "taking into account the extraordinary circulUstances that have intervened." Indeed, as Mr Palmer, in laying down the rule, introduced the clause, " always excepting special circumstances," and as the Bank herself is the judge of those special circumstances, it would be difficult to convict her of any violation of the rule. The conduct of the Bank, however, in regard to the East India deposits, the West India Loan, and the sending of gold to America, are acknowledged to be departures from the rule, and seem to be impelled by no necessity, and wholly unwarranted by any consideration connected with the public good. 1st. Ea,~t iitdia LOlllI.-The East India Company had a 1llr~e sum of money as a depollit in the Bank of England. ThlH money the Company was about to withdraw, and lend· in the London money market. To prevent this, the Bank of England engaged to allow two per cent. on the deposit, and then lent the money to the bill-brokers at three per cent. The Bank Directors contend that this was a proper transaction, for, had they not increased the circulation by this amount, the East India Company would have done so. This, however, is no justification. If the East India Company, by withdrawing tile deposit, had unduly increased the circulation, and redueed the market rate of interest, it would have been the duty of the Bank Directors to have counteracted this operation. But so far from doing this, they themselves, for the sake of one per cent. profit, became the agents for this undne expansion

Free Banking I

210

lOB

TIlE CURRENCY:

of the cil'culation, although it was contrary to their rules of business, and in violation of the principles by which they professed to be governed," 2nd. The West India Loan.-The conduct of the Dllnk with regard to the 'Vest India Loan is alleged to be one cause of the crisis of 1836-7. This was a loan of' fifteen millions, raised for the purpooe of indemnifying the holdel's of slaves in the West Indies. We think that under any circumstances, the taking of fifteen millions from the accustomed channels of circulation, and distributing it in masses to persons who would naturally seek other modes of investment, would have a tendency to produce a speculative feeling in the public mind, and to raise 'the prices of shares in joint-stock and othel' companies. So far, therefore, as this feeling arose fr0111 the circumstances of the loan, no blame is chargeable on the Bank of' England; but the charge against the Bank is, that, instead of repressing, she assisted this speculative feeling, by makin{?: advances: not ~nly upon a ~eposit of the scrip, but upon stock and all other kmds of secul'ltlCs, and that these advances were made at unusual times, continued for a long period, and at a reduced rate of interest. That the Bank did mal,e advances of this kind, and was opened to applications for further advanceR, are facts that cannot be questioned. The only question is, as to the effect which they produced; and when we find that a rage for speculation seized the public mind immediately after these liberal advanceR, we seem justified in supposing that this spirit of speculation \Vas the effect of these liberal advances. 'Ve think it no refutation of this charge to say that the circulation of notes was not increased, for in the first place the notes that were advanced were· returned immediately in payments on the loans, and hence they became public deposits. And, secondly, the fact that the Bank was open to application for advances, would of itself have the effect of sti mutating speculation. Every person who held stock, Exchequer bills, &c. knew that he could get advances from the Bank of England whenever he required them. Hence he llli~ht take shares in new companies, or engage in new undertakings with confidence. The money required for these pl'ojects, in the first instance, is always small, as' the capital is paid up by instalments, and hence no great advances were required from the Dank. The spirit of' speculation, when once excited, is always contagious, and ultimately becomes uncontl'ollable. The causes to which the panic of 1836-7 ha.ve been ascribed • See Ml' Page's Evidence, No. 916-919.

Free Banking I DANKING.

211

109

by the advocates of the Bank of England, were themselves, as we cOJlceive, the effects of those facilities of obtaining money which thc Balik harl afforded. It has been ascribed to the investments in forcign loans; but if money had not been rendered EO plelltifu I, would those investments have taken place? It has been ascribed to the credits granted by the American llOlIsesj but was it not the abundance of money that gave the American bills so much currency among the bankers and London hill-brokers? It has been ascribed to the formation of new joint-stock banks. But the joint-stock banks were themselves an effect (and, as we think, a beneficial effect) of the spirit of speculation which then prevailed. As a proof of this, the drain for gold commenced in April, 1836, at which period only two of' the new joint-stock banks of issue had come into operat ion.· 3rd. The sendillg of goM to America.-The next departure from 1\11' Palmer's principle was the sending of a million of gold to ,\merica in t.he year 1838. This is confessedly a departure from the principle which permitted the public to act upon the gold. But like all other departures from principle, it is said to be justified by the peculiar circumstances of the case. America wanted gold, and we had an abundance; and while we were sending gold to America we were receiving it from France, so, according to Mr Norman, OUl' stock was not diminished. But mark the effect on our circulation. For the million of gold we sent to America we had previously issued a million of Bank notes. Hence was an increase to our circulation. Having sent this gold to America, the Bank replaced it by taking another million frol11 France, for which anothel" million of BUlIk notes was issued, and thus the circulation was still further increased. For the million exported to America the Bank would receive bills, falling due at probably about four months from the time the gold was exported. During this interval the increased circulation was operating most injuriously by stimulating to foreign investments, and thus laying the foundation for the pressure of 1839. In the year 1835 the Bank of E\1gland made money cheap, in opposition to the plan of Mr Horsley Palme.". The Bank Directors, therefore, and not M r Palmer's plan, must be considered responsible for the pressure that occurred in 1836. But in 1837 and 1838 money was made cheap, in conformity with the plan; and by the end of the latter year the stock of gold was about the third of the liabilities. In this case the • See Mr Page's evidence, No. 929-943.

212

Free Banking I

110

THE CURRENCY:

plan was acted npon, and the consequence was, that it produced the pressure of 1839. In both these cases the cause of the evil was cheap money. The only facts adduced in favour of Mr Palmer's system are taken from t.he history of the currency from 1830 to 1832. Mr Loyd has adduced the same facts in support of his own system. It is curious that these facts should be adduced to prove the truth of two contradictory systems. And it is still more singular, that the facts themselves should be matter of dispute. The evidence of Mr Tooke has taken from both Mr Palmer and Mr Loyd-every advantage they may claim from this period in behalf of' their respective systems.

I I. 1'he plan of making the amount qf the circulation fluctuate in exact correspondellce wittt tlte amount of gold in tlte Balik qf England. This rule does not differ from Mr Palmer's in regard to the expansion of the circulation, but only in regard to the contraction. Mr Palmer's rule allows the g'old to diminish as the liabilities of the Bank, including notes and deposits together, shall diminish-but this rule requires that the diminution of gold shall be in exact proportion to the circulation alone. This rule was first announced to the public by Colonel Torrens, in his letter to Lord Melbourne, published in the early part of 1837, but its more prominent advocate recently has been M1' Loyd. The advocates of this system say it is better than that of Mr Horsley Palmer'lS. This, if correct, is not much in its favour. It has this evil, in common with Mr Palmer's, that it not only admits, but insllres on expansion of the currency to any extent that gold may be imported. Mr Loyd contends that a contraction of the currency, immediately on the commencement of a drain, would check the drain, and consequently the contraction would not be so severe as if it .were longer delayed. No one has ever denied that a contractlOn of the currenoy has a tendency to check an un· favourable course of exchange; but a contraction of the currency is always an evil, and upon this system it would become an evil that must periodically and necessarily occur. The currency ought to be so regulated as to prevent a drain. The causes of a drain may arise either from a depreciation of the currency, that is to say, from a general rise in the prices of commodities, arising from an excessive issue of' money, or from an unfavourable balance of trade. The latter cause cannot at all times be guarded against, but the former may. The plan now proposed, however, so far from guarding against this evil,

213

Free Banking I BANKING.

III

ensures its frequent recurrence. Mr Loyd states, that the highest point of high prices and speculation is always subsequent to the highest point of the expansion of the currency. There is no doubt of that. In the order of time an effect. must always follow the cause. llut why permit this expansion 1 Had this expansion been prevented, consequent excitement would have been prevented. But this system, by making the circulation expand or contract, as the gold may ebb or flow, ensures an expansion of the currency every time the course of the exchange may cause a flowing in of gold. When a drain of gold a\'lses frolll an unfavourable balance of trade, without any depreciation of the currency, then the drain will stop when the balance is paid. In this case Colonel Torrens seems willing, for awhile, " to suspend his obedience to principle," but MI· Loyd is inexorable.'" This plan is thus open to the following objections: 1. Upon this plan there must be a perpetual increase and diminution in the stock of gold, consequently a perpetual increase [Iud diminution in the amount of the currency. The increase in the alllount of the currency would raise prices and stimulate speculation. The diminution in the amount of the currency would reduce prices and produce distress. And thus there must be a constant alteration from high prices to low prices-and again from low prices to high prices-from specuculation to distress-and from distress to speculation. We have stated that the objections against both Mr Palmer and Colonel Torrens's plan is, that, during a favourable course of exchange, the currency will be unduly expanded, and hence prices will advance, interest fall, and speculations abound. The committee do not appear to have directed their inquiries to this part of the subject; and even some of the questions put by the chairman seem to recognize the principle that the Bank is justified in extending her circulation when the exchange is favourable. We consider this pl·inciple to be the main cause of the recent panics; and even the advocates of the system seem to shirk the defence of this part of its operation. They appear anxious to discuss only the beneficial effects of a contraction of the circulation. And even on this part of the sYlltem they seem to shrink from a defence of its necessary effects. According to the quotation we have made from Mr Loyd's pamphlet, the whole of this system must fall to the ground, unless it be true that fluctuations in the currency have an effect upon prices, and yet in his evidence he hesitates .. See Mr Loyd's evidence, No. 2751-2752.

Free Banking I

214

112

TilE CUnnENCY:

to admit that a contraction of the currency will produce a fall prices. "2755. A contraction in the currency operates by checking the export of bullion, and encouraging the export of goods?-Yes, certamly. . . "2756. Then that which precedes this. state of thin~s is II. rcduction of prices ?-That is true, certainly, upon princIple; it is the necessary effect of the contraction of circulation in ultimately reducin~ prices that constitutes the certainty with which we rely upon the pI'mciple; but at the same time, practically speaking, I think it is very possible that that effect may be anticipated by a speculative action upon the exchanges; and I think it not at all improbable that you migllt have an effect produced upon the exchanges without a preceding effect upon prices." We should gather from this answer that the doctrine is true lIpon principle. but not true in fact. It must. however, either be true or not true. If it be not true, then, according to Mr Loyd, fluctuations in the currency can produce no effect 011 the foreign exchange. If the doctrine be true. then alternate expansions and contractions of the currency, muat produce alternate rise and fall of prices. We should like to see how Mr Loyd and Colonel Torrens would extricate themselves from the horns of this dilemma.· 2. But depression of prices and their attendant miseries may not be experienced only when the foreign exchanges are unfavourable. Excessive caution, an apprehension of war, or political feeling may cause a domestic demand for gold. and this would cause for a while a contractiop of the currency as severe as that which would arise from an unfavourable exchange, and as the Bank Directors would have no discretionary power. but would be required" to adhere to principle" by giving gold for notes or notes for gold. they could do nothing to assuage these calamities. According to Mr Loyd, a drain, from whatever cause it may arise, must be met by a contraction of the currency. Mr Palmer, in laying down his rule, put in a saving clause-It except under special circumstances," but Mr Loyd makes no exceptions. . 3. To carry this system into operation, would require a separation of the issuing department from the other der.artments of the business of the Bank, and this would cause stIlt further inconveniences. The management of the issuing department would be exceedingly simple. The office of the directors would be a complete sinecure, and for any thing they would have to III

• See Mr Gilbart's ' Inquiry,' page ]9-22,

215

Free Banking I

113

13ANKIN<J.

do, their places might be as well supplied by four-and-twenty broomsticks. A few cashiers to exchange gold for notes, or lIotes for gold, would be all the establishment required j and, could M I' Babbage be induced to construct a " self-acting" machine to perform these operations, the whole business of the cnrrency department might be carried on without human agency. But the deposit department would req uire more attention. "It is in the nature of banking business," says M I' Loyd, " that the amount of its deposits should vary with a variety of circumstances, and as the amount of deposits varies, the amount of that in which those deposits are invested (viz. the securities) must vary also. It is therefore quite absurd to talk of the Bank, in its character of a bunking concern, keeping the amount of its securities invariable." As, therefore, the deposits might vary, the Bank would be a buyer or a seller of government securities, and as these variations are sometimes to a very large amount, th~ fluctuations in the price of the public funds and of Exchequer Bills would be very considerable. Thus the property of those who held these securities would be always changing. Ap;ain, the deposits would be withdrawn chiefly ill seasons of pressure, and the Bank would then be compelled to sell her securities. But suppose the scarcity of money should be so great that the securities would be unsaleable even at a reduced price, how then could the Bank payoff her deposits 1* Supposing, however. this functional separation to be established, what security we ask is there for its continuance? 'Vonld it not, like Mr Horsley Palmer's system, be considel'ed very beautiful until it should be tried, and then be immed iately abandoned? Should the directors of the deposit department be unable to sell their securities, and consequently unable to payoff thei'r deposits, is it likely that the directors of the currency departmellt would let the deposit department stop payment, and thus bring immediately a universal panic, and consequentlya domf'stic demand for gold upon themselves 1 4.• If the currency were administered upon this principle, the Bank would be unable to grant assistance to the commercial and manufacturing classes in seasons of calamity. Mr Loyd exclaims, " Let not the borrowers of money, government, and COlllmerce, approach, with theil' dangerous and seductive influences, the creatol' of money." nut with all deference to Mr Loyd, we contend that it is the province of a bank to afford assistance to trade and commerce in seasons of pressure. Mr Loyd, as a. practical bankel', would no doubt afford assistance • Sec the evidellce of 1\11' Tooke, No, :1813. VOl .. XXXV. No, I,

I

216

Free Banking 1

114

'rHE CURRENCY:

to his own customers in such seasons; and if this be the province and duty of a private banker, the duty is more imperative on a public banking company, and more imperative still on a bank, invested by the Legislature with peculiar privileges for the public good. Mr Loyd says, ., Let the Bank afford this assistance out of her own funds." But under Mr Loyd's system, she could grant assistance only by selling securities; and what relief would she aHord by selling securities with one hand, and lending out .the money with the other? Besides, is it certain that, under such a pressure as Mr Loyd's system must occasionally produce, these securities would be saleable at even any price? "But," says Ml' Loyd, "individuals may afford this assistance." In seasons of pressure few individuals have more ample funds than what are necessary for the supply of their own wants. The case. of the loan of MOO,OOOI. to the bank of the United States last year proves nothing. The parties had discounted bills which could not be paid when due, and they had the choice of holding these unpaid biIls or of taking bonds with additional security and a higher tate of interest for the amonnt. But this was no proof of the abundance of capital, nor of the capability of individuals to support public credit in all cases, without the assistance of the Bank of England. When the distress is caused by a contraction of the currency, it can only be removed by an increased issue of notet!. And there are many cast's, such for instance as that of the Northern and Central Bank, in which assistance can only be effectually rendered in this manner. We Were sorry to observe that some members of the committee uttered, and the witnesses admitted, the sentiment, that under any circumstances, the Bank was bound to take care of herself, and to secure the convertibility of her notes, whatever distress it might produce in the country. We are no advocates for an inconvertible paper currency, but we can easily conceive national calamities much greater than a suspension of cash payments On the part of the Bank. And we must deliberately condemn the principle, that when the Bank has brought herself into difficulties by her own mismanagement she has a right to extricate herself by ruining the country. We consider that any system of administering the currency, which prohIbits the banking institutions of the country from granting relief to the commercial and manufacturing classes, must be unsound. We should condemn such 8. system at once, even if we could not detect the fallacies on which it W8S founded. In political economy we can judge of principles only by their practical effects-and any system which produces

Free Banking I BANKING.

217

115

these effects lllllst be unsound. When seasons of c!llamity occur, it is not for the national bank to exclaim sauve qui peut. They ought to co-operate with the Government in attempting to relieve the distress and to preserve the tranquillity of the country. Ill. The next plan is that of Mr Loyd. This is an addition to that of Colonel Torrens; the lutter plan merely requires that the Bank of England shall make her circulation correspond with her stock of gold. and presumes that this contraction on the part of the Bank of England will cause a similar contractioll on the part of the country banks. But Mr Loyd's plan is the abolition of all the country issues, and the establishment of one bank of issue. not only ill England. but also in Scotland and Ireland. We have called this plan .vIr Loyd's; but it was first announced to the public by Mr Norman, in a pamphlet he published in the beginning of 1~38; but the proposition attracted little notice until it was adopted and advocated by Mr Loyd. This plan is of course liable to all the objections that may be advanced rlgainst the plan of Colonel Torrens, and also to additional objections, from the greater extension of its field of operation, and from its interference with existing institutions. 1. Although the whole tenor of i\h Loyd's pamphlet is in favour of one bank of issue. yet in his examination he seems to avoid the question: indeed, we may observe in general that Ml' Loyd is by no means l'emarkable for giving direct answel'S to the questions put by the committee. "29'28. YOII\, principles would lead to the establishment of a single issuing body if you thought the country prepared for it; is that the view that the Committee are to understand you to entel·tain? -In endeavo\ll'illg to come to a clear understanding of a difficult and compJicalcn sllhject, I upprellelltl that the true course always is, fir!;t, c1eal'Iy to lIIulcl'stauu and asccrtain what it is that principle in its pure alld austl'uct form I'equil'es; secondly, haviug formed a distinct view upon that point, then to consider what qualifications a regard to eXisting illtel'ests, or to other considCl'utions of expediency, may require; awl thirdly, to consider how fal' the principle 011 thp. one haud, and the considerations of expediency on the other hand, can be reconciled with each otller; 01' if they cannot be altogether reconciled, what tolel'ably satisfactory compromise can be proposed."

We differ entirely fro111 Mr Loyd as to the mode of conducting this investigation. Political Economy has no abstract principles. It is not a mathematical but a moral science. All its doctrines are deductions from f~\Cts, and the only evidence by which they can be supported is derived f!'Om observation. experiencel and analogy. To assume a priQri the existence of

Free Banking I

218

116

TilE CURRENCY:

an abstract, self-evident principle, and then to )'equire all the lll'actical measures to conform to this principle, is to adopt a course of investigation wholly at variance with the nature of the science. Aud here we may remark; that some of the members of the Committee seem to have entertained no very COHeet ideas of the nature of the evidence adapted to the investigation in which they were engaged, and hence the cross-examination of some of the witnesses parl.ook more of a legal than of a philosophic charactel'. '1'0 prove that two historical events sustain the relation of cause and effect, all that can be done is to show that the two events occlII'red ·in due order of time, and that there was a natural adaptation in the one to.produce the other. 'Chus if the Bank of England be charged with pl'oducin~ the panic of 1836, it will be necessary to prove, first, that the bank granted unusual facilities to the borrowers of money in 1835; second, that n. pressure occurred in 1836; third, that there was a natural adaptation in the facilities granted by the bunk in ] 835 to produce such a pressure as that which occllrred ill 1836, I f these thl'ee points are established, the charge must be considered as proved. Should an honourable member be unconvinced by this evidence he IHllst remain Ilncollvinced, for the case admits of no highel' pl'oof. 2. Mr Loyd states that he is not prepared to propound any plan for carrying his own principles into effect. He stated this several times in the course of his examination, and Mr Norman made statements to the same efIect.."" Thus we find that 1\'h Loyd and IVh Norman gi\'c to their own theories the name of .. principles," and assume that these principles al'e unquestionably" sound;" and that all other opiuions are to be condemned or approved according to the degree in which they conform to these "sound pl'iuciples." But when askE'd to show how these sound principles can be applied so as to pl'oduce any practical good, they tell us that they have never considered the subject, and that they have no plan to propose. Were n. mechanical philosopher to advise us to destroy all the steam engines througllout the country, nnd to erect a " self-acting" machme in the centre of London fOl' the }Hll'pOSe of performing in a bettel' llIanllel' all those scrvices which are llOW effecting by a valiety of machines, he would be expected to show how such a machine could be constructcd; how its power could be extended throllO'hout the country, and under what regulations its operations ~ould be applied to the • See Mr Norman's evidence, No, 2002·2008,

219

Free Banking I DANKING.

117

variolls districts so as to perform the work of the numel'OllS local engines: and if he were to reply, that he had paid no attention to these points, and had no plan to propose, he would excite but little disposition to destl'OY the existing machinery, however eloquently he might descant upon th-e soundness of his principles. 3. In order to pl'ove the propriety of establishing one bank of !ssue, it became necessary to bring chargcs against the existmg country banks. l\h Loyd, therefore, accuses the country hanks of not regulating their issues 80 as to make theil' circulation correspond with the stock of gold in the Bank of England. The rule thus laid down for their government is ably exposed in the 'Defence of Joint Stock Banks and Country Issues.' " 1. It is deficient in fulncsf! and }H'eCISlou, leaving ns at Il. 103s to tell the exact law of variatIOn intended; whethel' the country issues are to be increased and diminished by the same amonnt as the bullion in the Bank of England, 01' in some othel' ratio not indicated, 2, 'l'he rule is impracticable from the time at wllich the diI'ective information reaches the parties rcquired to act upon it, as wcll as fl'om the vagueness of the statements fUI'nished. 3. If it were observed both by the Bank of England and the country banks, the consequence would pe a double cffect in palpable violation of the very principle on which it is professedly founded. 4. If it had been acted upon during the past yeal' it would have subjected the eountJ'y issues to aU the vicissitudes of the bullion in the Bank of England, which in about ten monthil ranged fJ'om 9,336,OOOl. to 2,522,0001." Mr Loyd states, that olle evil of the principle of competition is, that when one bankCl' contracts his circulation, the neighbouring bankers increase theil' issue, in ol'der to fill up the vacuum which is thus Cl'catcll. If this were the fact, it is difficult to conceive how the total cil'culation of the country could evel' be reduced. Uut, nevertheless the fact is, that the total circulation docs Val'Y, not only from year to year, but fi'om month to month. The chal'ge of excessive competition has been more directly brought against the joint stock banks. If, thel'efore, the private bankers reduced theil' circulation, the joint slock banks would, of course, seize the opportunity of extending theirs. Now, how stands the fact? The avel'Uge circulation of the private bankers in March, 1839, was 7,340,7931., and, bv March, 1842, it was reduced to 6,190,3061. Now, upon Mr Loyd's pl'inciple, a large increase should have taken place in the issues of the joint stock banks; and had we not the returns of the actual amount, we cO\lld not disprove

Free Banking I

220

118

THE CUIUtENC"lI':

Mr Loyd's opinion; but, on refening to these returns, we find that the joint stock circulation in March, ] 839, wae 4,617,ti061., and in March, ] 840, it was 3,89&,748/. So far from an increase, here is a reduction, and that, too, in nearly the same pl'oportion as that of the private bankers. 4. The principal obstacles to the establishment of one bank of issue are thus enumerated by Mr Gilbart. : " We think the country banks of issue will bavc no difficulty in showing that numerous issuel's are a check upon each other by the system of exchanges, which cannot apply to a single issuer-that, were there a single issuel', there woulll bc 110 greatel' security against undue fluctuations in the amount of currency than in thc case of numerous issuers-that a currency conducted on the principle of being regulated by the foreign cxchanges is wholly unsuitable to om' agricultural, manufacturing, and mining operations-that a currency administered by one bank of issue could not be distributed a!l at present, in a manner adapted to the local circumstances and districts of the country-that the assistance no\v ~iven to trade and industry by countJ'y bankers would be much curtailed 01' attended with heavier charges to the parties, operating as a tax upon the middle classes of the community-and that in some district" bank", 01' branches of banks, would be discontinued from inability to pay their expenscs in case they had no longel' the profit upon the issue of notes, and 11lOse districts would thus be deprived of all banking accommodation. It may also bc maintained that a sole bank of issuc wou1<1 soon become more powerful than the government, and might be abused to the worst purposes of either tyranny 01' faction." The political evils that may result from a sole bank of issue have been too much overlooked. Were the whole currency issued by a government bank, or by a bank closely connected with the government, might not a foreign power, by gettin~ possession of a few million of ollr notes, pamlyze the national energies at a moment when the exercise of those energies would be most required 1 Or might not a political party attemr.t to embarrass the government by making a run of gold 1 fhis 'Would be no new event. A run for gold on the Irish banks took place in 1831, when the government ,commenced a pl'Osecution against Mr O'Connell; and another in 1833, during the passing of Earl Grey's Coercion Bill. A run was made on the Bank of England in 1832, during the passing of the Reform Bill; and large sums were drawn m gold from the Savings Banks in 1838 by the Chartists, actuated solely by political motives. A COlltrac~ion of the currency. o~casioned by these means would admIt of no remedy, for It IS a part of the system that the bank shall issue no notes except upon a deposit of gold. An-

Free Banking I

221 119

BANKING.

other evil would be, that whenever distress was produced by a contraction of the currency, it would be ascribed directly to the ~overnmellt, and hence would ensue pOpUIUl' discontent and Insubordination. Sir Rouert Peel seemed alive to these dangers. He wished to ascertain if Mr Loyd were friendly to a government currency. convertible into gold upon demand. Mr Loyd answered with his usual wariness. Sir Robert was baffled, and gave up the pursuit.* 5. We have shown that the circulation of the Irish hanks always increases from the month of October to the following January. whatever lIlay be the state of the Bank of England with regard to her stock of gold. We shall now lay before our readers a table referring to the circulation of Scotland. Circulation in Scotland on the last Saturday in March, July, and Nl)vember, in the years 1834., IB35, 1836,1837, 1838, and 183~).

I 1834 1835 1836 1837 1838 1839

--

,

Number of Danks.

March.

£

£

21 21 21 22 23-4 24 to 28

2,834,627 2,822,417 2,934,292 2,875,404 2,811,377 3,041,545

3,094,468 3,097,947

July.

3,22'l,142

2,962,673 3,060,199 3,120,183

November.

£

3,497,795 3,457,899 3,657,431 3,560,242 3,688,410 3,559,599

This table shows us first, that the circulation of Scotland is at its lowest point in the month of March, is higher in July, and reaches its highest point in November. Secondly, in the corresponding months of different years there is but little difference in the amount of the circulation. We find that during a course of six: rears the difference between the lowest and the highest circulatIOn is very trifling. Thirdly, the increase in the number of banks does not produce a corresponding increase in the amount of notes in circulation. In November 1834, the number of banks of issue was twenty-one; by N 0vember 1839, they had increased to twenty-eight; yet the circulation at the former period was 3,497, 79f>I., and in the latter 3,559,599l. Fourthly, these facts prove that the ei\culation of Scotland does not produce any effect upon prices, nor consequently upon the foreign exchanges. It is hardly necessary to ad• See Mr Loyd'lj evidence, No. 2761-2763.

Free Banking I

222 120

TUE CURRENCY:

duce evidence in proof of' the fact that the prices of commodities do 110t go on increasing fl"Olll March to November in every year, and if they do not, they cannot be regulated by the currency. Fifthly, this regularity in the circulation shows that it must be governed by some uniform laws arising from the local circumstances or habits of the country, and this we think will always be the case where the banks are passive, and permit themselves to be acted upon by the operations of the trade and commerce carried on in their respective dir,;tricts. Now Mr Loyd's system would destroy all this beautiful regularity. In some years the circulation would advance from March to November, and in other years it would retrograde. The corresponding months would sometimes agree and sometimes differ. The issues of notes would be restrairied or increased according to the caprice of the Directors of the Bank of England, or the fitful operations of the foreign exchange. How, then, must the new principle be adapted to the variolls districts of England, Scotland, and Ireland? Mllst all the local causes of fluctuation in the currency be controlled? Must the rates of exchange be posted up weekly at the entrance of evel'y market town, to regulate the prices at which commodities are to be sold? Are the people of Scotland to strike out of all existing contracts the clauses which fix the periods at which rents, &c, are paid, and stipulate that these payments shall be Illade when the foreign exchanges are favourable? And must the people of Ireland he taught to produce corn and bacon at such seasons only when there is a large stock of gold in the Bank of England? 6. The case of America has been so often adduced by Mr Loyd, Mr Norman, and others, as exhibiting the evils of a free system of banking, that it seems to req uire a special consideration. It strikes us as extraordinary that, to prove the evils of free trade in banking, we are directed to a country in which free trade in bankill!! has never existed. Neither an individual nor a company can carryon banking in America without the permission of the state. All the banks in America are chartered banks, and differ from om'joint stock hanks in many particulars, and especially in the limitation of the liabilityofthe shareholders. Now admitting that the system of chartered banks has failed in America, it seems very iilogical to infer that consequently a system of unchartered joint stock banks must fail in England. But it is contended that t.he history of banking in America shows the evil of having numerOllS hanks, and hence similar evils must arise from having numerous banks in England. To

223

Free Banking I BANKING.

121

maintain this argument, it should be shown that the banks in the two countries are of the same kind, and that the circumstances of the two countries, as fur as they bear upon banking', are similar. But is this the case 1 Besides, we may ask what evils have heen produced ill America by a number of chartered ban\(s which have nut heretofore been produced in. England by one chartered bank? Are they char~ed with issuing theil' notes to excess? Have not similar charges been made against the Bank of Ensland even by those who al'e now most clamorous for the extensIOn of her monopoly 1 Have the American banks suspended payment? And. did not the Bank of England suspend payment, and was not her suspension COIltinued for a much longer period? Although it is clear that the American system of chartered banks is inferiol' to the Scotch system of joint stock banks, yet it is not so evident that numerous chartered banks are a less evil than one chartered bank. The argument presumes too, that in case of free banking the number of' banks would be very great. Are we justified in supposing that this would be the case 1 Theory exclaims" yes ;" experience whispers "no." The numerous banks in Amp-rica are not the result of free trade, but are' the result of the acts of the Legislature. The State Legislatures have thought proper to give a large number of eharters, and of course there is a large numbel' of banks. Had the charters been fewer, the banks would have been larger and more respectable. The number of banks in England, too, have been the result of the interference of the Legislature. In the renewal of the charter of the Bank of England in 1708 it waR enacted, that no other bank having more than six partners should have the privilege of issuing notes. As the growing trade and wealth of the country required banks of some sort, and as banks havi'ng more than six partners could not be formed, a great numbel' of banks, each not having more than six partnel's, rose into existence as they were required by the increasing trade and wealth of' the country. Hence, instead of having a smull number of large banks, we have had a large number of small banks. If' we look to Scotland, where banking hall been free, we find that the total number of private and jomt stock banks is only twenty-eight. Banking has been free beyond fifty miles from Dublin for the last fifteen years, yet throughout that district there are only five banks of issue, with the ('xceptiol1 of the Bank of Ireland. In England, where there has been, as we are told, a frenzy in their favour, the joint stock banks of issue a.re only ninety-one, and probably they would have been less

224

Free Banking I

122

THE CURRENCY!

numerous had not the law excluded them from London. The capital which has been embarked in a number of small local banks would have been invested in large London establishments, and the place of the local banks would have been occupied by branches of the London bank~. From these facts it seems fair to infer that some of the small joint stock banks and many of the private banks will, in the course of the next twenty years, be merged in larger establishments. The supposition that unlimited freedom of banking would lead to the establishment of an inconvenient multitude of banks, is wholly unsupported by the testimony of experience. In adducing in~tances from the history of banking in Ame)'ica, some of the witnesses are guilty of another fallacy. When they wi!lh to prove the expediency of a sole bank of issue in England, they adduce the instance of the fOl'lner Bank of the United States. Readers unacquainted with the subject are led t.o suppose that the Bank of the United States was the sole bank of issue in America. Had this been the fact, it would have been, as the lawyers say, a case in point. But how stands the fact? This bank had no more exclusive privileges than the Bank of Scotland. It was merely the government bank, and it had the power of opening a branch in every state of the union. 'Vith regard to the issue of notes, it had no exclusi"e privileges. but was exposed to fair competition with the other banks. That the Bank of the United States conferred Ilumerous advantages upon the country cannot be doubted by reasonable men; and the destruction of that institution may fairly be adduced as an example of the mischiefs that may be inflicted on a country by a meddling spirit of legislation with I'egard to ballking. Had the law in America been the same as in Scotland, instead of one Bank of the United States, a dozen establishments of equal respectability would probably have been formed, extending their branches throughout the Union, and those mushroom banks, that have obtained charters from the State Legislatures, \\'ould have had no existence. Experience teaches us that whenever banking is free, the result is the formation of a few large banks, each having llumerous branches. Local banks having their head-quarters in the smaller towns, nre always of subsequent growth, and are kept from adopting a wrong course of action by the system of surveillance arlopted towards them by the larger establishments. Besides the fnet of the American banks being chartered banks, and the shareholders being exempt from liability, the American system is practically defective, 10 being without that

225

Free Banking I BANKING.

128

Bystem of exchanges between the banks which exists so beneficially in Scotland and England, and which Mr Loyd and 1\'11' Norman have attempted to disparage. However extraordinary it may appear to English and Scotch hankers, it is a fact that the American banks do not periodically exchange their notes with each other, and pay the diflerence in gold. When one bank in the course of its business receives the notes of another bank, they are merely carried to account against the bank that issued them. Hence in all balance sheets of American banks that we see in the newspapers, we find that "debts due to other banks," and ., debts owing by other banks," are two very considerable items. M. Gallatin informs U8 that the Bank of the United States acquired the ill-will of the States by insisting on frequent exchanges. He says, .. The mannel' in which the bank checks the issue of the State banks is equally simple and obvious. It consists in receiving the notes of all those which are solvent, and requiring payment from time to time, without suffering the balance due by any to become too large. We think we may say that on this operation, which. requires particulal' attention and vigilance, and mllst be carried on with great firmness and due forbearance, depends almost exclusively the stability of the currency of the country." Language such as this from a man so eminent as M r Gallatin, shows how very far the Americans are behind the English in the practical knowledge of banking. The exchanges of notes which is represented by M. Gallatin as being peculiar to one bank in America, is common to every bank of England and Scotland; and the operation is performed not merely from " time to time," but at least twice a week; and it is so much a matter of routine that we were totally unconscious of the particular attention and vigilance, the firmness and forbearance, which this process displays. A nd the effect of these exchanges to secure prudent management on the part of the banks, and to check an excessive issue of notes, is not with us a doubtful matter of opinion, hut a doctrine that we consider most firmly established. In his anxiety to support his own view, Mr Loyd has quoted the authority of Mr Webster, " one of the most enlightened and talented members of the AmericRll senate," as favourable to one bank of issue. The quotatioll made by Mr Loyd from a speech of Mr Webster expresses no such opinion. Mr Webster says he is in favour of a national bank, by which he meant probably such a bank as was the former Bank of the United States. 'fhat he did not mean his national bank to be the sole bank of issue is evident from his stating, as one of its advantages, that ~t

Free Banking I

226

12·1·

'l'IIg CUnrmNCY:

would restrain the excessive issue of the State bank,;. If he intended his national bank to be the sole bank of issue, thi"l language would have been absurd. The case of America suggests to us a striking difference between theory and experience. The theory of American banking appears very rational. There we behold the State with maternal care watching over the intercflts of her banking institlltion, prohibiting all except those to which she herself may give birth; to those she gives a charter as a special mark of hel' affection, prescribing the amonnt of the capital, the extent of theil' issne, the sums of gold to be kept in reserve; and to ensure obedience to her orders, she requires ample returns, and sends her officers at stuted periods to examine the amount of their treasure. 'Vhat a beautiful theory. lIad it never been tried, how loudly would it be applauded. Let us look at another theory. Suppose it were now proposed for the first time to pass a law permitting anyone individual to set up a bank and issue as many notes as he pleased, would not the plan be condemned as absurd? Should we not be told that banks would become as numerous as gin-shops, and that every pauper and swindler in the community would be issuing- " promises to pay," which would never be fulfilled? Yet tillS is the case in London at the present time. Any individual, 0\' any number of individuals not exceeding six, may take out a licence, and issue as many notes as they please, even in London. Yet where are the practical evils of this state of the law? Some people assert that no evils have arisen becau<;e the numbel' of partners is limited to six; but if this privilege were extended to pal'tnerships of more than six persons, then dreadful indeed would be the evils that would come upon the community. When people cease to reason, and begin to prophesy, they ml1st be left to themselves. We may rebut an argument, but we cannot refute a prediction. IV. We like the plan of Mr Tooke better than either Mr Palmer's, Colonel Torrens's, or Mr Loyd's,''' The practical working would appear to be this :-If the Bank had 10,000,0001. ofgold, and the foreign exchanges brought in 5,000,0001., the Bank would sell securities to the extent of 5,000,0001.; thus the notes issued against the gold would be brought back by the sale of securities. Bllt if a further amount of gold should be brought to the Bank after it had accumulated 15,000,000/.,. then the Bank would not sell securities, and the • See tIle plan fully explained in Mr Tooke's work and his evidence, and the animadversions of Colonel Torrens in his letter to l\fr Tooke.

227

Free Banking I JUNKING.

125

currency would be increased to the extent of this further amount. On the othel' hand, suppose the Bank had 15,000,000l., and a drain for gold commenced, the Bank would payout gold without reducing her securities or bel' circulation until her stock of gold should be reduced to 10,000,0001. But if the drain should still continue aftel' the stock ot' gold had been reduced to this amount, the Bank would then take steps for reducing the circulation. Thus, Juring the period that the stock of' gold in the Bunk of England is bet.ween ten and fifteen millions, the currency will be unafIecled by the fluctuations in the foreign exchanges. The Bank will not inflate the currency until the gold has reached 15,000,000l., and she will not contt'act the currency until the gold is reduced to 10,000,0001. While the gold relllaills between these two points, the circulation would remain tratHluil, and the Bank of England would do nothing either to stimulate speculation 01' promote distress. Mr Tooke is entitled to the praise of having directed the attention of the committee to the course to be pursued when the exchanges are favourable, while the other witnesses dwell only on the course to be pursued when the exchanges are unfavourable. Mr Tooke has also the merit of judging of' measures by their practical effects, and not by reference to any ideal standard of per~ fection pompously dignified by the name of" sound principle." V. Mr Gilburl's • Inquiry into the Causes of the Pressure on the Money Market during the Year 1839,' consists of an argument against the doctrine of regulating the currency by the foreign exchanO'cs. \Vhile Mr Tooke would exclude the foreign exchanges fro~l exercising any influence on the cunency when the stock of ~old in the Bank of England ranges from 10,000,0001. to 15,000,000/., Mr Gilbart would exclude them altogether. " We must 1I0t suppose that all the writers who contend that the currency ollght to be ~overned by the foreign exchanges, entertain precisely the same opinions as to the rules by which this principle ought to he applied, or the means by which it should be brought into operation. They all, however, agree in this-that when the foreign exchanges are favourable, the circulation of notes ought on that account to he increased; and when the exchanges are unfavourable, the cit'culatiol1 ought, 011 that account, to be diminished. We question the soundness of both these propositions. For the arguments on which these opinions are founded, and the practical'way in whieh they are proposed to be carried into operation, we must refer our readers to the work itself.

228

Free Banking I

126

'l'HE CURRENCY:

We have never seen any foundation for the censure cast upon the Bank of England for her recent engagements with the Bank of France. If it lessened the confidence of foreigners, that was merely because the measure was unusual, and therefore regarded as symptomatic of distress. 'Vere it a permanent regulaiion, it would excite no alarm, and might be so employed as to be highly beneficial. These credits, however, might be interrupted by war; and, perhaps, it would be desirable that the Bank should at all times hold a certain amount of foreign securl~les. The beneficial effects of this may be illustrated by a reference to the Bank of Ireland. That bank holds in all seasons several millions of public securities, whi(~h are of course saleable in London, and the proceeds may be remitted in gold. If the Bank of Ireland held securities saleable only in Dublin, she would be in precisely the same state as the Bank of England; she would then meet a drain for gold only by contracting her ci.rculation; whereas now, a drain for ~old, either foreign or domestic, could be met by a sale of securities, and the circulation would not be disturbed. Now what prevents the Bank of England holding securities saleable in France, and thus obtaining gold from France when necessary. with as much facility as the Bank of Ireland can obtain gold from England? Th~ efficiency of such a measure is explicitly stated by Mr Norman, and Mr Loyd admits that the plan is unobjectionable upon principle."" It is a frequent remark, that the Bank has to find gold not only for her own notes, but also for the notes of all other banks. This language is ambiguous. It is not intended to mean, that should the Bank of England payoff all her own noles, she would afterwards ha\'e to find gold to payoff the notes of all the other banks; it means only, that all the other banks, by holding Government securities saleable in London, are able to sell those securities for Bank of England notes, and by demanding payment of these 11otes, to get possession of her gold. If the Bank of England had securities saleable in France, the Bank of France mi~ht, with equal propriety, complain that she was obliged to find gold, not only for ber own notes, but also for those of the Bank of England; .and the Bank of England would Ilave all the advantages lyhich are now supposed to belong to our country banks. VI. The' Defence of Joint Stock Banks and Country Issues' is a very able work. It is divided into two parts; the first • See the evidence of Mr Norman and Mr Loyd, No. 1941-1947, and 2847-2848.

229

Free Banking I llANKING.

127

of which was originally published as a postscript to a work published by the author, Mr Bailey. in 1837, under the title of , Money and its Vicissitudes in Value;' the second part refers to facts and opinions ora more recent date, and includes a triumphant reply to the accusations brought by Mr Loyd against the country banks. \Ve are glad to observe, that while the author defends the joint stock banks, he makes no attack upon the private bunkers. With regard to the currency, it does not seem necessary to make any defence of the joint stock banks apart from those of the private bankers. No)' does Mr Loyd, or the writer before us, make any distinction between them, but both are referred to under the title of 'The Country Issues.' Indeed, since the beginning of the year 1837, the proportion of the countI'y circulation possessed by these two classes of banks has remained nearly the same. This proves that the charge of reckless issue brought against the joint stock banks cannot be founded in fact, or, if founded in fact, that a reckless issue of notes cannot permanently increase the circulation, even of those banks by whom it is practised; those who advance this charge must, therefore, be wrong, either in fact or in principle. We believe them to be wrong in both. The means Mr Bailey suggests for the improvement of the currency is the establishment of free trade, or, as he would call it, free action in banking. not merely in the country, but also in London. "The management of the Bank of England, as exhibited in the accounts and statements of the directors, and its whole history for the last fifty years, furnishes a remarkable illustration of the difficulties which follow a departure from the principle of leaving trade to the free operation of competition. " Had no monopoly been granted to a single balik, a number of such estahlitlhmcllts would douhtless have arisen in London, abounding in capital, with managers of ability sharpened by the competition of rivals, and adapted to all the emergencies which could call for its cxel'cise. No redundant circulation would have ever made its appearance, 01' if it had, the instant repression which it was destined to encounter, would have saved the community from the repetition of the mistake. No suspension of cash payment would have been dreamed ofbygovcrnment, because the healthy state of the banks would never have required it. We should have seen, at the prescnt time, sound establishments in the metropolis, furnishing all needful assistance to the commercial community, acting as the receivers of unemployed capital, and the distributors of the property so entrusted to them amongst those who wanted it, and issumg for public convenience n papel' currcncy, subject to the check of instant convertibility into

Free Banking I

230

128

TIlE CURRENCY:

gold, enforced with lllll'cmitting constancy by thc watchful competition of rivals. Instead of all this we see onc huge establishment with an cxclusive privilege of issuing pr011lissory notes in a district extending· sixty-five miles round the metropolis; and using that privilege (according, at least, to almost all thc writcrs who have touched on the subject) in the most inconsistent and mischievous mauner; expanding the currency when it ought to be contracted, and contracting it whcn it ought to be expanded; professing to act on rules which are habitually infl'inged; publishing unsatisfactory accounts from whieh no certain conclusions can be drawn; mixing together in hurtful confusion the duties of a manager of the curr!'Tlcy under a monopoly with the functions of an ordinary banker; and, what is not to be wondered at, hesitating in the midst of these complicated movemcnts as to the soundnm;s of' the principle on which the most important part of the businc~s is couductcd. " It is almost an incv itable conclusion, that the longer the monopoly is persisted in, the more complicated will be thc difficulties illto which commercial affairs will be liable to fall. Every year seems to urge us to pass from a system of artificial. re3traints to the simple and easy movements of unfettered trade. "The great desideralum is to have a currency convertible intogold, and capable of adapting itself, by those insensible contractions and expansions which no human sagacity can ever effect, to the perpetually varying wants of the community. Brcak up the monopoly, open the trade of banking in all its departments to fl'ee competition, let it be unshackled by restrictions, and the object, as far as attainable by humall rcgulations, would be at once accomplished. We should soon see a sufficien t number of wealthy banking companies establhlhed, capable of doing all that the Bank of England now does, amI deprived of the powcr of inflicting those evils which have been laid to her charge. "That they would be equally capable with her of receiving deposits and discounting bills, or making advances on othe1' secUl'ihe8, seems plain. Ten or twenty establishments, with capitals of two or three millions each, or less, would have it in their power to g1'8ut every accommodation to commerce that could possibly be required. That they would not, as banks of issue, have the same powel' of arbitrarily expanding and contracting the circulation of the wholf! empire, seems also manifest. They would, in this respect, be as passive as the country banks now are. Instead of theil' promissory notes being subject to no check but the irregular anll desultory demand for gold by individuals, each bank would be exposetl to that ol'~anised system of checks, whiah is necessadly constituted by the eXistence of other similar banks of issue, and the operation of which would be daily felt. This sy~tematie action, so constant and instantaneous, would proportion with exact precision the 0I110unt of the paper currency to the state of commerce, 01', at least, with a PI'Ccision more exact than could result from the most vigilant ottcntion

231

Free Banking I

129

llANKING.

of any boal'd which attempted to accomplish the 8ame object by watching the signs of the time... We might surely trust to the spontaneous operation of private interests for the supply of the metropolis with the requisite quantity of curl'ency with as much confidence as we trust to it for the supply of the same vast community with food. ·Whatever effects might have been produced from the establishment of several banks of issue in London a century ago, we do not think that their introduction at the present time would, for a considerable period, seriously affect the circulation of the Bank of England. So long as the Banl{ of England shall be the Government BanI" and have, besides, a large deposit and discount business-remain the centre of a dozen branches, some of which are the largest banks in the countryand issue thirty millions a-year in the payment of the public dividends, she must continue in possession of nearly the whole circulation of London. The great advantage of a few more banks of issue in London would be the check they would exercise upon the management of the Bank of England. She would not issue notes against gold bullion if she had to pay those notes in gold coin in her exchanges with the other banks on the following day. She would not act illiberally or capriciously towards her customers if there were other powerful banks to whom they might resort. She would not stand aloof in seasons of public calamity, and declare it would be a departure from sound principle to afford any relief, if she saw other powerful banks ready to perform the duty which she declined. Several other advantages would result from numerous banks. If the circulation now exclusively possessed by one bank was divided between several banks, it is probable that they would altogether be in possession of a much greater amount of gold. and they would be better able to meet an adverse exchange. Their united capital, too, would probably be greater than that of the Bank of England ; hence there would be greater security to the public, independently of the liability of all the partners. This capital would 110t be locked up in loans to Government, but employed in granting facilities to the trade and commerce of the country. The Government, too, would get the public business tranRacted on better terms, as the rivalry between the banks would induce them to outbid each other; while, at the same time, such abuses as have resulted from the connexion between the Government and the Bunk would be altogether nvoided. Mr Bell observes," With no hostile feeling towards tIle Bank of England, but, on the contl'ary, wit.h ("'CI'Y WiR!) to s('c it n pow(,l'flll nnd successful VOL. XXXV. No, I.

K

232

Free Banking I

130

'1'HE CURRENCY:

establishment, I woulcl earnestly recommcnd that it should lose nO time in I'elinquishing its exclusive privileges, which, besides throw. ing upon it the now unpJ'ofitable burden of managing the financial affairs of the govel'llment, necessarily entail on it beavy losses, and even a struggle for its very solvency on the recurrence of any monetary pressure. At least these privileges have been admitted at the last general meetinO' not to be profitable, while they unquestionably retard and obstruct improvement in the system of banking in England. W ere the~e privile~es relinquished, the Bank would be speedily surrounded by a powerful confederacy of joint stock banks, of which the great private banks of London would form the germ, which would be willing and able to afford the commerce of the country evel'y accommodation, and to ~ust!lin it under every emergency, whether ~rising from adverse foreIgn exchanges, or from any gl'eat absorption of national capital. Like the Bank of Scotland and Royal Bank of Scotland, having a community of interest with all the banks in the country, the Bank of England would become the centre and regulator of the whole banking interest in England, ,vhile the competition for circulation under a stringent system of exchanges, and for deposit!l, by allowing a liberal rate of interest, would lead, as it has led in Scotland, to the concentration of national capital in their hands, and afford a protection against those fast-recurring seasons of monetary distress, which have of late proved so disastrous as to shake public confidence in the stability of every great interest of the country. But if, on the contrary, the leO'islature shall persist in directing its exclusive attention to theoretical notion!l respecting the currency, and fails to establish a sound system of banking in the country, I feel convinced that these fast-recurrillg seasons of monetary pressure will sooner or later rouse the country, and the government will find it no lon~el' practicable to sacrifice the welfare of the empire in ordel' to facilitate the financial arrangements of the Chancellor of the Exchequer." We have not been able to discover that a single advantage has yet been gained by the evidence taken before the committee. The accusations and the defence of the Bank of England had been long ago before the pUblic in the city articles of the morning papers. The various theories as to the administration of the currency remain in the same state, and the causes of the recent pressures will now be as much a matter of debate as before the committee was appointed. No ~round has been furnished for any new act of the Legislature. ~The Bank direc.. tors have at present the power of actinG' upon the systems of Mr,Palmer or of C.olonel Torrens, just as they please. To estabhsh one bank of Issue would req une an Act of Parliament; but no gov~rnment woul.d Bupport a m,easure so des.tructive to the prospenty of the nation. To estabhsh free trade III banking

Free Banking J COMPARA'I'IVE PROSPECTS 0l.1' OUR NEW COLON lES.

233 131

in London would l'equire the sanction of the Legislature; but it Olav be questioned whether the nation has yet undergone a sufficient quantity of' suffering to induce our statellme.n to adopt !l0 simple a remedy, To this, however, they will come at last. Wisdom," says 1\11' Loyd, "is best learned in the school of adversity." When a few more theories have been tried-a few more" pressures" have been experienced~a few millions more of opulent families have been reduced to beggary, and our Union workhouses are thronged with stal'Ving artisans-then we may discover that all our attempts to regulate the currency have been pl"Oductive of mischief, and we shall be willing to let the currency regulate itself.~ J. W. G. I<

• Our readers will probably remark a difference between the opinions advanccd in thc above article and those on the same subject in former numbers of the Review. The question of the currency, however, is not one on which we are pledged to particular views. Upon this and other 8ubjects requiring discussion, our object will be to present the reader with Buch papers, whether fiwoul'able 01' not to received opinions, as in our judgment are entitled to a perusal; uud the present, both from the ability and the position of the writer, belongs eminently to that elass.-ED,

V.-I. England alld America. A comparison of the Social and Political State of both Nati()ns. 2 vols. Bentley. 2. Three Expeditions into the Interior of Eastern Allstralia, wW, a Description of tile Recellt(y Explored Regio" of Australia F,lix (Port Philip), and tlte present CoiollY of New South. Wales. Dy IVlajol' Mitchell, F. G. S. 2 vols. 8vo. T. alld \-\T. DOOlle. 3. Histo7"!! of the Rise and Progress of the new British Pro,!,!nce qf'South A uslralia, tc. Dy Jno. :;tevellS. Second EdltlOn. Smith and Elder. 4. Western Australia; comprisillg a Description of the Vicinity of Auslralia alld Port Leschenault. By T. J. BucktOll, Esq. JM. Ollivier. 5. Information relative to New ZealaTld; compiled for the Use of Colonists. By Jno. Ward, Esq. Parker, West Strand. 6. The New Zealand Journal. Nos. 1 to 23."" Chambers, 866 Strand. ART.

• A newspaper exclusively devoted to N e;v Zealand.

Part II American Free Banking Thought

[6] Excerpt from Richard Hildreth, Banks, Banking, and Paper Currencies, 109-13, 117-99

CHAPTER XXV. Present state of public opinion in America on the subject of Banks and Banking. The New York Free Banking Law. THREE opposite and hostile systems of opinion prevail at the present time in the United States, on the subject of Banks and Banking. One 'Party is opposed to all banks whatever j a second party IS in favor of the existing system of a monopoly of banking privileges j while a third party desire to throw open the business of banking, like all other mercantile business, to free competition. The first party, or that which is hostile to the whole banking system, and which desires to return to a currency exclusively metallic, is very numerous, and has received great encouragement of late from the course of policy in relation to banks, which the general government has seen fit to adopt. The existence and strength of such a party is not remarkable. Several of the most popular statesmen of the country, at the time the banking system was introduced, denounced it as a contrivance for fleecing the public for the benefit of a few. Mr. Jefferson, who had learned his political economy in the school of the French economists, who never had much knowledge of commerce, and who always regarded it with suspicion if not with contempt, was extremely violent in his denunciations of the banking system; and his opinions upon this subject, as upon others, have had a great influence. This prejudice, previons to the war of 1812, had considerably abateu; hut it was revived in full force by the mismanagements and misfortunes attendant npon the suspension and resumption of specie payments, as already narrateu. This prejudice again having subsided, it was again called into activity for party ~ur­ poses, during the contest for the recharter of the Uruted 10

Free Banking I

238

110

BANKS, BANKING,

States Bank; and the late suspension of the banks, together with the new policy of the federal administration, has inspired it with fresh vigor. This popular dislike to banks has been also inflamed from time to time by a variety of other causes. Many of those who have first introduced the banking system into the new states, have been speculating politicians, wholly unacquainted with the proper business of banking, who have obtained their charters by art and intrigue, and have then proceeded to act upon the monopoly they had secured, with very little regard to the rules of prudence; so that between their ignorance and their greediness of gain, they have soon involved themselves in distress, and have been reduced perhaps to the necessity of a failure. 'l'he friends of the existing monopoly system have put many arguments into the mouths of those who are hostile to all banks. The friends of monopoly have been accustomed to ascribe all the fluctuations in business, and all the calamities of commerce, to a multiplication of banks, and a consequent redundancy of paper. The opponents of all banks have caught at this admission, and have shrewdly argued, that if the multiplication of banks is attended with these evils, the existence of any banks at all must be an evil, since it is just as easy for a few banks as for many to issne a redundancy of paper. It has indeed been nsnal, both among the friends and the enemies of banks, to ascribe to those institutions a power over the currency, commerce and industry of the country, which they do not in fact possess. According to the vulgar way of stating the case, every thing is supposed to depend upon the plenty or scarcity of moTte1j, and the banks, since the currency consists in their notes, are supposed to have this plenty or scarcity entirely in their power, and to be the efficient cause of it. No derangement can take place in any part of the business of the country, that is not laid to the door of the banks, which are thus held responsible for the consequences of bad seasons, bad

239

Free Banking I AND PAPER CURRENCIES.

111

crops, unwise investments, unexpected changes of polIcy at home or abroad, unprofitable speculations, and all the uncertainties and bad luck with which human operations are ever apt to be attended. Mr. Gouge has written a very ingenious book, in which, with remarkable industry, he has collected all the complaints of hard times, unprofitable business, and commercial disasters which the history of the last forty years aifords,-and having taken it for granted that all these calamities were caused by the banking system, he concludes therefore that the banks Ilre a terrible evil. This book is well calculated to make a deep impression upon the generality of readers; and indeed its fundamental fallacy of ascribing much more to the banks than they ever were the cause of, is deeply interwoven with the current opinions of the day, and has received much countenance from those who have been regarded as high authority on the subject. How far the banks are actually the causes of fluctuations in trade, will be the subject of inquiry in a subsequent chapter. 'Vhat forms a most serious objection to the existing banking system, in the minds of many, is, that monopoly of the business) which is alleged to be essential to its safety. All monopolies are totally abhorrent to the ideas of the people ofthe United States, and this feeling extends so far, that even though a particular monopoly should be proved to be highly beneficial, not only to those immediately interested, but to the public at large, yet the circumstance that it atforded a peculiar profit to a few, in which others had no chance to share, would condemn it in the minds of a great majority. This is the true secret of the strong hostility to a National Bank, which has ever been displayed, notwithstanding the many apparent benefits which, in their practical administration, the two successive national banks conferred upon the country. 1'he second party to which we have above referred, or that in favor of the existing system of monopoly banking, consists not only of the stockholders and

Free Banking I

240

112

BANKS, BANKING,

directors of existing banks, who are naturally inclined to sustain a monopoly beneficial, or apparently so, to themselves, however injuriolls to the public, but of all that numerous party who maintain that" whatever is, is right," and who seem to make it a sort of religion to sllstain all sorts of existing institutions. The third party, or that in favor of free competition in banking, was, till recently, very inconsiderable. But of late it has received a strong impulse in the passage of a law by the Legislature of New York, on the 13th of April, 1838, entitled an "Act to authorize the business of Banking," by which, upon certain conditions, that business is thrown open to free competition. A law of a similar character had been previously passed by the Legislature of Michigan. It was however defective in its details, and, unfortunately, the institutions organized under it, commenced their operations just abont the time of the suspension of specie payments. They were thus enabled to get on at first without any solid capital, merely by lending notes which they were not obliged to redeem. But they soon got in to difficulties; many of them were obliged to wind up their affairs; and the experiment was regarded as by no means a favorable one. 'J'he Michigan ac t has since been repealed. The New York law seems in many respects to be very judicionsly drawn,* and several associations with a solid capital, and under able management, have already been established according to its provisions. It introduces a feature wholly new into the business of banking, by requiring the institutions formed under it, to lodge with the state comptroller, as a security for the payment of all the circulating notes issned by them, an amonnt of stocks, or of stocks and mortgages, equivalent to the amount of notes issued by each. This idea of requiring banks to give security for the redemption of their issues, seems to have been • See Appendix for a copy of this act.

Free Banking I AND PAPER CURRENCIES.

241

113

first started by Mr. Ricardo, some twenty years ago. It was derived from the way in which the capital of the Bank of England is invested, the public stocks in which that capital consists serving as a pledge, in addition to all the other means of the Bank, for the ultimate redemption of its notes. This subject is treated at length in a subsequent chapter. The passage of this law by the Legislature of New York has ensured for the system of free banking a fair trial. Nor does its success, or its speedy introduction into the other states, appear to be doubtful. That the system of free banking will at once put an end to all frand or mismanagements, that it will prevent fluctuations in trade, or will introduce a mercantile millennium, it would be ridiculous to imagine. Fraud, mismanagement and fluctuation are incidental to all business transactions. But as free competition in every other branch of trade has been found beneficial, and has afforded a certain degree of protection against these evils, so free competition in banking must and will be attended with the same results. To point out the advantages which free competition has over the existing monopoly system, is the object of the second part of this treatise.

242

Free Banking I

PAR T SECOND. ARGUMENT FOR OPEN COMPETITION IN BANKING. CHAPTER I.

Origin of the Monopoly of Banking. THERE is and always has been a strong tendency on the part of the first adventurers in any new branch of traffic to secure a monopoly of it to themselves. Hence the origin of the English East India Company, and of a hundred other similar associations, which in different countries have obtained the exclusive enjoyment of different branches of trade. Plausible arguments in favor of the creation of those monopolies have never been wanting. It is suggested, for instance, that the trade of which a monopoly is sought, is dangerous and delicate, and can only be conducted to advantage by persons of great probity, skill or experience; or it has been said that the wants of the public could only be well provided for by an exclusive company, which would adapt the supply exactly to the demand j and that to open the business to general competition would be ruinous to those who would rush into it without the requisite knowledge or capital; and by producing an irregularity of prices, would prove in the end highly disadvantageous to the public. In spite, however, of these arguments, experience has fully demonstrated that open competition is the

Free Banking I

118

BANKS BANKING,

life of trade, and that although it may lead occasionally to unwise and unprofitable investments and speculations, it is absolutely essential to any thing like commercial prosperity. When the issue of bank notes was first introduced into practice, that too, like other branches of trade, claimed the benefit of being erected into a monopoly; and the Bank of England, more fortunate than most of its sister companies, has succeeded in preserving to the present day its exclusive privileges comparatively unimpaired,-though of late some serious inroads have been made upon them. The whole system of banking in America has been formed upon the model afforded by the Bank of England,-the system of private banking which prevails in Great Britain never having been introduced into this country, and being even prohibited by statute in many of the States i-an enactment procured by the chartered banks, as a support to their monopoly. The Bank of England being the model, a monopoly or exclusive right to issue notes formed a part of it, an idea which was readily received by those who, having already obtained charters, would naturally be desirous of prohibiting any body else from sharing in the profits of the business. In this country, however, this idea of monopoly was never carried to its full extent; indeed the nature of our institutions would not admit of it. The National Banks enjoyed it in the highest degree, obtaining the sole and exclusive possession of all the privileges in the power of Congress to grant. The state legislatures have never been persuaded, unless it may have been in one or two recent instances, to confer the monopoly of banking upon any single company. They have chosen to retain the power of granting this privilege to new institutions, so that, although the privilege of banking has been confined to chartered companies, new charters have been gra.nted from time to time, according to the prevailing humor or policy of the several state legislatures.

243

244

Free Banking I AND PAPER CURRENCIES.

119

According to this system, the banks are privileged companies, enjoying certain peculiar rights, by the special grace of the legislature; a system which had a necessary tendency to mix up politics with the business of banking,-an intermixture from which have arisen most of the great disasters to the bankin~ business, and which forms a great and serious obJection to the whole monopoly system.

CHAPTER II.

Of the Intermixture of Politics with Banking. THE direct int.erference of government with any branch of trade has generally proved very disadvantageous to it. This has been the case especially with respect to the business of banking. It is proper to mention in the first place, that all those issues of paper, originally irredeemable on demand, whether called bills of credit, assignats, treasury notes, or by whatever other name,-issnes which have been the origin of so mnch of the prejudice felt against a paper currency, and of so much of the distrust with which it is regarded,-have all originated, not with bankers or merchants, but with governments. They have been speculations of finance for which, or for any of the consequences of which, neither the banking system nor the credit system is in any way to be held responsible. In the second place, those great disasters which have from time to time overtaken the banks, resulting in a general suspension of specie payments, by which the notes of the banks were converted into a currency precisely similar to the irredeemable government issues above mentioned,-these great disasters are directly traceable in their origin, and in their continnance, to an unfortunate and impolitic connection between the banks and the government. Thus the great run upon the Bank of England in

Free Banking I

120

BANKS, BANKING,

1796, which resulted in the stoppage of specie payments, and a long series of irredeemable issnes, originated in the idea, which was well founded, that the bank was so closely connected with the government, that in case of an invasion and the defeat of the government forces, it must certainly be ruined. Private individuals, it was supposed, might remain solvent even though the government were overturned; and hence, during that panic, the notes of private bankers were freely received by many, who refused the notes of the national bank. The long continuance of that suspension was also caused by the close intimacy between the bank and the government. The suspension was found so convenient to the government, by enabling it to obtain larger accommodations from the bank than otherwise it conld have done, that although at divers times the bank showed a strong disposition to resume, the government constantly interfered to prevent it. The sllspension of the American banks in 1814, grew in like manner out of extravagant loans to the general government, and the banks were enabled to continue that suspension solely by the countenance and connivance of the federal administration. The suspension of 1837 would never have taken place but for an attempt on the part of the federal administration to use a part of the banks not merely as banking, but as political agents. A vast snm of money was suffered, for political purposes, to accumulate in the hands of these banks, which they were first encouraged to loan liberally, as a means of conciliating the good will of the puhlic towards the administration; and then, by a sudden change of policy, they were obliged to call in those loans with a haste disastrous to their debtors, and distressing in its consequences to the whole country. Add to this, that the great importation of gold, which alarmed the Bank of England, and led to consequences heretofore pointed out, was principally caused by the policy, and indeed by the express instructions, of the federal government.

245

246

Free Banking I AND PAPER CURRENCIES.

121

Not only have these great revulsions in banking affairs grown out of a too close connection between governments and banks, but the system of bank charters has been attended by other serious dangers. The very circumstance that a legislature confers by charter the special privilege of issuing circulating notes, is naturally regarded by the people as a sort of guarantee on the part of the government that the institution it has specially authorized is a sound institution, and that its notes are worthy of credit. It thus happens that a bank, by the mere circumstance of being a chartered institution, and without any regard to its actual capital, or to those circumstances on which alone its credit ought to be founded, has been able to push a large amount of notes into circulation; and all the worst banl{ failures on record have been occasioned by the very circumstance, that the possession of a legislative charter enabled the banks to get into a credit which was never deserved, and which was founded not upon a real but on a mere nominal capital. Again, the circumstance that banks are created by special legislative acts, causes them to be regarded, to a certain extent, as public institutions, upon which the public has a right to call for succor and relief. The consequence is, that whenever the banks are not willing to loan as much as the public are desirous to borrow,-and any number of persons from three upwards are accustomed to assume the appellation of the public,-a hue and cry is raised against them, as if they did not sufficiently fulfil the end of their creation, namely, the accommodation of the public; and thus assailed, the banks are Jed into unsafe and injudicious extensions of their business, at times when prudence would rather demand a contraction of it. The circumstance, too, that bank charters have heen granted by sp~cial legislative favor, has been the occasion of banking institutions being too often set on foot, not by men who had a solid capital and a knowledge of the business, but by speculative politi11

Free Banking I

122

BANKS, BANKING,

cians, who have first availed themselves of their political influence to get a charter, and have then resorted to the most unsafe and unjustifiable means to make the most they could out of it. A very striking instance of this sort of procedure is afforded by the history of the early operations of the second Bank of the United States. When it is contended that banks ought to be totally independent of the government, and disconnected with it, all that is meant is, that the right to establish a bank ought to be a common right, open to all who will comply with such regulations for the public security as may be established by a general law. It is not intended that the government should refuse to have any dealings with banks in any shape. If the government has money to be kept or transferred, or other banking business to be transacted, it is as proper for it to employ a banker for that purpose, as to employ carpenters for the construction of its vessels, or sailors to navigate them. rfhis use of banking institutions by the government is altogether a different thing, from that intimate and dangerous association which has too often grown out of the system of monopoly.

CHAPTER III.

Practical operation of the Monopoly System. WITH respect to the business of banking there are two inquiries of principal interest and importance. First. What system is most advantageous to the public 1 Second. How can banks be rendered most profitable to the stockholders 1 Those who have been the first to establish banks, have been guided, like adventurers in all other branches of business, not so much by any concern for the public good, as by a regard to their own private gain j

247

248

Free Banking I AND PAPER CURRENCIES.

123

and hence it has happened that the second of the above questions has been studied with infinitely more zeal and assiduity than the first. One great secret of making banks profitable was soon discovered to be, the keeping competitors ont of the business. Thus originated that monopoly of bank charters, which afterwards was defended by arguments drawn from the public good, but with the origin of which the public good had nothing at all to do. To discover how far the public good is actually promoted by such a monopoly, it will be well to trace, with some minuteness, the practical operation of the system of monopoly banking. The first thing is, to get a charter. One from the General Government, with exclusive privileges, and a clause prohibiting the grant of any other bank, is esteemed best of all. But such a charter is a nonsuch not easy to be got. Next best is a State Bank, in which the state government takes a portion of the stock, with a clause, if possible, prohibiting the grant of any other bank within the state. But if such a bank is not to be had, a bare charter, without any exclusive privileges, should be thankfully accepted. It is very desirable, however, that no other bank should be permitted in the county, city, town or village, in which the new bank is established; and all existing banks are to join together, upon all occasions, in a solemn protest against the creation of any new banks, declaring, with one voice, that the multiplication of small banks,-which, by way of emphasis, may be denounced as "little peddling shaving shops,"is ruinous to the currency, causes fluctnations in trade, produces a scarcity of money, &C. &c. &c. In order to obtain a charter, it is necessary to be on good terms with the legislature applied to. Obstinate opposers may be silenced by the promise of a certain Humber of shares in the stock,--which shares. if very obstinate, they must be allowed to keep without paying for.

Free Banking I

124

BANKS, BANKING,

Things being properly prepared, a petition is to be presented to the legislature, representing that in the town of Blank, the public good requires the establishment of a bank; and to prove it, there should be annexed to the petition as long a list as possible of the shops, manufactories, shipping, &c., and the petition may wiud up with a grand flourish about the growing business and importance of the place. The bank is to be asked for solely on public grounds; not a whisper about the profits the petitioners expect to make by it. If the petition is coolly received, it may be well to revise the private list. of stockholders, and to add the names of several of the legislators. If the bank still rubs, it is a good plan to form a combination with the friends and advocates of some other proposed banks, and to push the whole through in succession, by that ingenious contrivance commonly known by the name of log-rolling. If nothing better can be done, employ some influential politician to procure a charter for you, and buy him out at a premium. Let ns now snppose that a charter is obtained j and the capital fairly paid, in specie, or the bills of speciepaying ballks. That capital, say, is one million of dollars. Problem. Having a capital of one million, how shall the bank be able to lend two millions and upwards, so as to make dividends of twelve or fifteen per rent 1 Solution. Get a million of notes or upwards into circulation. The bank can then lend one million in coin or the notes of other banks, and one million or upwards in its own notes. 1'0 redeem those notes when presented, it is necessary to keep on hand a certain amonnt of specie; but as the interest on this specie is a dead loss to the bank, the smaller the sum kept, the better. Now it is obvious that the fewer banks there are in existence, the greater amount of notes each existing bank will be able to circulate. Por, as has

249

250

Free Banking I AND PAPER CURRENCIES.

125

been explained in the first part of this treatise, the total circulation of all the banks is limited by the amount of circulating medium which the country requires. Suppose the total circulation of the United States to amount to two hundred millions; suppose a national bank with a capital of ten millions, and no other banks allowed in the country. This one bank could lend and circulate two hundred millions of its notes; and suppose it to keep on hand even so much as fifty millions of specie, still it could make dividends of from eighty to one hundred per cent. What a charming business! If another bank were chartered, it would probably divide the circulation about equally, and diminish the profits of the first bank ner.rly one half. A third bank would diminish the proti ts of the other two; so of a fourth, a fifth, &c. This statement makes it very clear, how it comes to be considered a sacred duty on the part of all existing banks to oppose, by all ways and means whatever, the creation of any new banks, which, in fact, are only rivals, eager to share, and certain to diminish, the profits of banking. -We now sllppose our bank in "the full tide of successful experiment." Capital, one million; loans, two and It half millions; circulation, one million; deposits, six hundred thousand; specie, one hundred thousand; dividend, ten per cent; stock, fifty per cent above pal". In this state of things, money begins to grow tight. Business perhaps has been unprofitable and confidence is shaken; the harvest has failed, or some particular branch of manufacture has been unsuccessful; a war or an embargo threatens to illtermpt business, and impede commercial intercourse; perhaps some bank or some political party have found it expedient, for purposes of their own, to get up a panic; or there merel y arises an accidental and transient demand for specie for exportation i-for some canse or other, and such callses are constantly occurring, onr notes come in, the specie is demanded, and something like a run 11*

Free Banking I

126

BANKS, BANKING,

begins, or threatens to begin. Directors meet in great alarm. What is to be done? The case is clear. All discounts must be steadily refused; such of our own notes as are paid into the bank must not be reissued; the notes of other ballks must be sent off as fast as received and the specie demanded, that we may have the wherewithal to replenish our empty vaults. Our circulation must be diminished one tenth, one quarter, one third, one half, according to circumstances; and this can only be accomplished by still refusing all discounts. If the run continues, we must keep on refusing discounts till our circulation is reduced almost to nothing. That point attained, and the bank is out of danger. Let us now look to the effects of this operation upon the customers of the bank. A, B, C, D, and others had obtained accommodations, upon the strength of which they bOllght goods, set up factories, built ships, and entered into diverse speculations. These accommodations were renewed from time to time, as a matter of course; and the borrowers went on, as they imagined, doing well and making money. But the sudden and unexpected stoppage of their discounts involves them in the greatest embarrassments. They find it impossible to meet their engagements. They fail. Their failure causes other failures; these failures give a shock to public cOllfidence; business is interrupted; prices fall; property is sacrificed; bankruptcies are multiplied. But no matter. We have saved the bank; and we, the directors, though we ha ve refused every body else, have been induced, now and then, to discount notes for each other. With the money thus obtained, we have bought up property at the low prices; and as business revives, our pockets begin to grow heavy. And before long, bnsiness does revive. The failing being over, confidence is presently restored. The low prices are a temptation to pnrchase. Capital is needed for these and other purposes, alld fresh applications are made for discounts. Discounts are granted; our

251

252

Free Banking I AND PAPER CtTRRENCIF.S.

127

circulation, loans, dividends, and the premium on our stock, return to the old limit, or perhaps go beyond it. But sooner or later, a demand for specie, or an apprehended demand for it, returns to vex us. The same system of contractions is resorted to; and the same ruin to individuals attends it. But the bank is saved as before. Should it happen, however, that we have a board of directors especially greedy of gain, or especially confident in their own good fortune, especially in need of discounts themselves, or especially tender-hearted towards the customers of the bank; or who, for any other reason, neglect an immediate resort, in cases of danger, to the orthodox remedy of sudden curtailment, the fate of the bank is certain. A run, under the circumstances supposed, is one of those galloping disorders, which require the application of an instant remedy. The delay of a single week, or a single day, may be fatal. The specie is exhausted; the bank stops payment. Upon the final settlement of its affairs, it. may turn out to be perfectly solvent; but many of those who depended upon it for loans are ruined by its stoppage; and the holders of the notes, unable or too impatient to wait: are generally obliged, or induced, to dispose of them at a great discount. Perhaps they are bought up by the very agents of the bank. Such: in general terms, is apt to be the history of every bank which enjoys a very extensive monopoly, and is enabled thereby to obtain a very extensive circulation. Thus far we have considered the operation of our supposed monopoly bank, principally as relates to its own profits. But the public is apt to imagine that it too has some interest in this bl1siness, and to ask, with some little eagerness, out of whose pockets come these great dividends? Why shonld a few favored individuals be permitted to grow rich by the privilege of lending the same money twice over, once in the shape of coin, and again in the shape of notes?

Free Banking I

128

BANKS, BANKING,

The bank directors, being thus put to the question, proceed to state the following apology and defence. It is most true, they say, that we make money by the bank j more money than we could make by any other investment of the same capital. But the advantage is not confined to us. It extends to the borrowers as well as to the lenders. By the contrivance of bank notes, we are enabled to lend twice as much money as we otherwise could. It is the same to the country as an actnal creation of capital j it is, in fact, calling into activity a capital which before was dormant. Where the circulation consists solely in bank notes, there is a net addition to the capital of the conntry, nearly equal to the entire amount of those notes. Suppose the bank-note circulation of the United States to amount to one hundred millions. 'rhen the banking system makes a net addition to the active capital of the country, equal to one hundred millions, deducting the amount of specie kept ou hand by the banks. For the gold and silver otherwise necessary to serve as coin, so soon as its place is supplied by notes, becomes an article of merchandise, and may be exported like an equivalent value in wheat or tobacco. This is the advantage which the public derives from banks. It will be observed that this statement is far from being a full answer to the two questions above proposed i-but so far as it goes, it is satisfactory and solid. It is, in fact, that same argument in favor of bank notes, so clearly explained, and so fully illustrated, ill the" Wealth of Nations." It cannot be refuted j and notwithstanding all the frauds of which banks have been the fruitful occasion; notwithstanding the bad purposes to which they have sometimes been prostituted j notwithstanding the serious calamities they have often inflicted; notwithstanding their confessedly delicate and necessarily dangerolls nature,delicate and dangerous, that is, according to the practice of banking now under consideration,-it is the experimental perception of this fact, on the part of the

253

254

Free Banking I AND PAPER CURRJ.:NCIES.

129

community, which has enabled the banks to bear up against all the real, and all the fanciful objections which have been urged against them. A, B, 0, and D, enterprising people, but without capital, have always been ready and eager to borrow. They are willing to pay for the use of capital, and, provided they can have it, they care not whence it comes, or who receives the interest. It is also for the public advantage that A, B, 0, and D should be able to borrow; and if they can get the money at home, instead of going abroad for it, the country is not only a gainer by their share of the profits made fwm its use, but it also retains that share which would otherwise go abroad in payment of interest. And perhaps these people, being persons of little property, would not have been able to borrow abroad; and for want of the means of working, would have been condemned to a state of idleness, irksome to themselves, and dangerous to the community. Now if this process for the creation and loaning of capital went on as securely for the borrowers, as it does profitably for the lenders, there would seem to be no very reasonable objections to it; for however a spirit of vulgar envy might declaim against the excessive gains of the banks, it might be answered, that the honest gains of individuals are gains to the community; and if only some are the gainers, that is better than to have no gain at all. But it is obvious that, according to the practice of banking at present under consideration, the borrowers are placed in a very awkward predicament. The gains of the bank are tolerably certain; but the customers, a far more nnmerolls body, and one in whose welfare the public have a much deeper stake, are kept in a constant state of the most harassing and servile dependence. The bank may be obliged suddenly to contract its discounts, at any moment. The 9ay and the hour no man knoweth; and business done upon the strength of loans so uncertain, becomes a mere gambling business, the success of which depends

Free Banking I

130

RANKS, BANKING,

entirely upon the fact, whether or not the bank will continue its accommodations, tm the business reaches a conclusion j a contingency as to which it is impossible to form even the shadow of a guess. Trade is uncertain enough at the best j but trade resting upon ban]dng accommodations, granted in accordance with this system of banking, ceases to be an art. Shrewdness, calculation, knowledge, prudence, good sense, become of little or no avail,-for the wisest plans, and the most judicious arrangements, may be defeated by an unexpected contraction of bank loans, which no one could foresee, and against which it is impossible to guard. These respectable qualities lose the estimation to which they are entitled. Trade comes to be looked upon as a lottery j the merchants are infected with a mere spirit of gambling: and it is not industry, it is not sagacity, it is not economy, which ensure commercial success j it is chance, it is good luck. It is obvious that, according to the practice under consideration, the more prosperous a bank is, the more delicate and dangerous a machine it becomes. There is required in its management a constant watchfulness and care, to guard not only against a run, but against the probabilities of a run. In times when confidence is shaken, and the customers of a bank look to it as a friend who will support and back them up, just in proportion to the prosperity of the bank, or, in other words, to the extension of its business, it becomes their most dangerous enemy j for just in proportion to its prosperity, the necessity of contracting its loans becomes the more imperious. 'I'he safety of the bank requires it sternly to close its ears against the distress and piteous lamentations of its customers. It must refuse accommodations,-and just in proportion to the extent of its business must be the extent of its refusals. However harsh the remedy, it is absolutely necessary; and if, through an ill-jlldged pity or a false confidence in its own good fort line, this remedy is omitted, and accommodations are continued, the relief is only

255

256

Free Banking I AND PAPER CURRENCIES.

131

momentary; for the bank, if it continues to discount, must presently stop payment; and that stoppage not only puts a sudden period to its accommodations, but it in vol ves the holders of its notes in the common misfortune. It is to be recollected, also, that this harsh remedy is applied not only to cases of real, but to those of merely suspected danger. Not only the actual fluctuations of trade, but a false alarm, a rumor, a panic, got up for stock-johbing or political effect; the humor, fancy, or caprice of a board of directors; the low spirits or imaginary terrors of an influential memher; the most trifling causes, acting upon machines so delicate, may produce the most serious consequences to individual borrowers. Thus far, it has been all along supposed that the getters-up and managers of the bank were men of honesty and honor; and that its capital was actually paid, before commencing opel'ations, in specie, or its equivalent. But suppose, what sad experience teaches to be but too likely to happen,-snppose that the getters-up of the bank are not honest. Suppose that the nominal capital, instead of being actually paid in, is made up of the promissory notes of the stockholders j so that the bank commences operations with little or no solid capital. Laws have heen enacted in several Stales to prevent such proceedings; but wherever it is an object to evade them, the dishonest easily find the means of aoing so. In the case now supposed, the loans of the bank are fOllnded solely upon its circulation; and any thing which drives its notes home, puts a total stop to its business. But with such banks the stoekholders are al ways the principal customers. The harsh remedy of contraction might save the bank, but it would ruin them. Of course it is generally judged more expedient for the bank to fail; and though the notes should ultimately be paid in full, the stockholders are enabled, in the mean time, to levy npon the public a forced loan without interest, for their own private benefit.

Free Banking I

132

BANKS, BANKING,

These very serious objections to the practice of monopoly banking, lead to the important and interesting inquiry, whether, taking for our sole guide the advantage of tlte publici-which in this case may be considered as nearly coincident with the interest of the borrowers,-it is not possi ble to propose a theory of banking, and a practice founded upon that theory, to which these objections shall not apply.

CHAPTER IV. Theory of Paper Currency. THE reasons which have caused the precio11s metals to be so generally adopted as money, that is, 1st: as a measure of value, 2d, as a medium of excltange, are mentioned in every treatise npon political economy. It is to be observed, however, that notwithstanding these two offices are jumbled together under the single name of money, they are perfectly distinct in their nature, and, as will presently appear, in some respects incompatible. 'rhe reason why the precious metals have been adopted as a measure of value, may be thus explained. Fluctuations of value, that is of price,-for in matters of trade these two words are synonymous,-depend, 1st, upon supply, 2d, upon demand. While supply remains perfectly steady, it has a tendency to keep the demand steady also; and though the independent fluctuations of demand produce considerable effects upon price: yet, in general, the price or value of things is not affected by those fluctuations at all to the same degree as hy fluctuations of snpply; for experience shows that the supply of most things is much more liable to vary than the demand for them. The wants of man, growing ont of his constitntion, are regular and constant. The supply of natnre is apt to vary. Effective demand, it is true, depends not only upon the

257

258

Free Banking I AND PAPER CURRENCJF.S.

133

desire to possess, but also upon the ability to purchase. But variations in that ability are apt to be less sudden and violent than variations in the supply. Indeed it is by variations of supply, operating to enhance or reduce the price, that variations in the capacity to pmchase are often principally caused. Now the supply of the precious metals seems much less liable to sudden fluctuations, than that of any other thing which is an article of trade. This steadiness of supply is principally owing to the durability of the precious metals; for it must be recollected that we understand by supply, the whole quantity of the article in question, in existence and circulation, at any given point of time. In the case of the precious metals, the supply, that is, the total available amount on hand, cannot be materially affected by the annual production or the annual consumption, at least, not till the end of a con~ siderable series of years. Whereas in the case of most articles of daily use, the supply on hand is wholly dependent upon the proportion which the annual production bears to the annual consumption. 'rhe supply of the precious metals being thus comparatively steady, produces a comparative steadiness or uniformity in their value; and this steadiness or uniformity of value adapts them to serve as a measure of value.; for it is obviol1s, that the less liable the measure is to vary, the more correct will be the measurements. Though a very incorrect measure, when the values to be measured are separated by a great distance of time,-and in somp, cases, even by great distance of space,still it answers sufficiently well for the temporary transactions of ordinary trade; and as a measure of value adapted to that purpose, no substitute has ever yet been proposed, which is worthy of a second thought. The other service performed by the precious metals, in their character of money, is to answer as a medium of exchange. For this purpose they are adapted by their capability of being subdivided to almost any degree, without loss; by their small comparative bulk,

12

Free Banking I

]34

BANKS, BANKING,

which enables a large comparative value to be easily carried about and transported from place to place j and by their capability of receiving a permanent imprint, expressive of their weight and fineness. Still, their employment for this purpose is subject to some very serious difficulties. 1. Notwithstanding the small ratio which the bulk of the precious metals bears to their value, yet, where sales and purchases are large, the bulk of metallic money, the trouble of counting it, and the expense of transporting it from place to place, become a great inconvenience. We now use copper only for the smallest coins, and the most trifling exchanges. It once formed the entire circulating medium of whole nations. But the increase of trade, and the increasing amount and value of sales and purchases, made its bulkiness intolerable, and silver, as comprising a much greater vallie in a smaller bulk, was substituted in its place, as the principal medium of exchange. But trade and wealth continued to increase; and the bulkiness of silver coin began to be complained of. Gold offered a new medium; and by its greater value in a smaller bulk, consoled the toiling brains and cracking sinews of the merchants and money dealers. But gold was only a palliation of the difficulty. A Venetian merchant wished to purchase wool in England to the value of 1O,OOOl. sterling. The transportation of such a bulk in coin, for such a distance, was attended with great expense, anxiety and danger; and mercantile sagacity soon hit upon a much more convenient medium for exchanges of that nature. One Venetian merchant wished to transport coin into England to buy wool; another Venetian merchant had lately sold broadcloths in England, and wished to transport his coin to Venice. In this state of things, it occurred to these two merchants that it would be possible to get along without any transportation at all. Gi ve me au order on your English agent for your coin there, and you shall have my coin heff~. Such was the origin of Bills of Exchange, the convenience of

259

260

Free Banking J AND PAPER CURRENCIES.

135

which soon appeared so palpable, as to lead to their general use; and they presently became, and still are, almost the sole medium for the great transactions of international trade. An American who goes to England to purchase goods, instead of incumbering himself with several bags or boxes of coin, takes bills of exchange on London in his pocket-book; or more likely, a simple authority to draw; and with this medium, he effects his purchases exactly as well as if he had the coin. A bill of exchange may be described as a title deed to a certain amount of coin, at a certain place, and in the hands of a certain banker or merchant, or to be there at a certain time mentioned in the bill. For example, a bill on London for a hundred pounds is a title deed to one hundred sovereigns, at London, in the hands of a certain person on whom the bill is drawn, and who is mentioned and described in it, or to be there, at the time the bill becomes due. As the bill passes from hand to hand, the title and property in the coin which it describes, passes with it. It is a maxim of the common law, that delivery is essential to a sale; but as it is not easy to take up a ship, a warehouse, or a farm, and deliver it over bodily to the purchaser, especially if the ship, farm or warehouse is some thousand miles distant from the place of sale, it has therefore been held that the delivery of the title deeds, or bill of sale in the name of the article sold, satisfies the law, and conveys the property. Precisely so, a bill of exchange, which is exactly a title deed or bill of sale of a certain amount of coin in a certain place, being endorsed and delivered, transfers, as it passes from hand to hand, the property and title in the coin which it describes. London being the centre of modern commerce, a place where goods are purchased and sold to be sent to all parts of the world, there is always a vast amount of money wanted at London to effect these purchases. On that account, bills on London are generally in demand, and often at a premium. They form a univer-

Free Banking 1

136

BANKS, BANKING,

sal currency in all those parts of the world to which commerce penetrates; and a man who has bills on London in his pocket, or authority to draw bills on good houses there, wherever he may be, whether on the frozen shore of Kamtchatka, in the heart Qf the African desert, or among the distant islands of the ocean, will find no difficulty in purchasing with those bills whatever products the country affords. 2. It is further to be observed, that this international medium of bills of exchange has a great advantage over coin, not only in convenience, but in economy. Gold is an expensive medium. If it perishes by the way, it is a dead loss, both to the individual and to the world; whereas, in most cases, the shipwreck of a bill of exchange is no loss to any body. Nothing is lost to the world, but a small piece of paper; and as to the individual owner, though the first of a set perish, the second may come safe to hand, and fulfil its office. Besides, though the transportation of gold were subject to no danger, still, during the time of transportation, the gold remains idle. The value of its use, or what is the same thing, the interest upon it, is lost to the owner and to the world. By the employment of bills of exchange, this loss is avoided. The gold mentioned in the bill is all the time performing its office and producing an interest, while the bill is on its travels, or lying idle in the pocket of its holder. But it is not only the interest which is saved. Gold perishes by use; a certain imperceptible part is taken away every time it is touched. Hence it gradually decays hyexposure to the weather, and by repeated handlings and recountings at every transfer. By the aid of hills of exchange all these causes of waste are avoided; and though the amount thus saved at any individual time can hardly be appreciated without the help of the infinitesimal calculus, yet the sum of all these atoms makes up at last the total substance of the thing.

261

262

Free Banking I ANn PAPER CURRENCIES.

137

3. It has been shown in the preceding part of this treatise, that metallic currencies are liable to a certain degree of depreciat.ion, by reason of the very waste just now spoken of; to which, fraudulent abstractions in the way of clipping are to be added. Bills of exchange are totally free from this source of depreciation. The coins therein mentioned are supposed to be perfect coins, fresh from the mint, of standard weight and fineness. No door is left open to the petty trickeries and little frauds, the misunderstandings and disputes, of which a depreciated currency is so fruitful an occasion. 4. It is also easy to show, that the use of bills of exchange as an international medium of trade, decidedly improves the quality of the precious metals as a measure of value; and thus gives additional steadiness and certainty to the transactions of commerce. Supply remaining the same, value depends upon demand. Now it is a well-known fact that the extent of trade, particularly of international trade, is subject to constant fluctuation. It depends upon the crops; upon the sncce::;s of the different branches of manufacture; upon peace and war; upon the political condition of nations; upon many other circumstances, all of a very variable character. As the amount of trade varies, there varies with it the demand for a medium with which to carry it on. Trade, this year, is in a certain condition; and if we suppose no other medium of exchange but coin, coin assumes a certain relative value exactly proportioned to the demand for it. Next year, trade falls off one half, but the quantity of coin remains about the same; therefore its relative value must fall. Coin being worth relatively less, prices rise-a good thing while it lasts; but this very rise in prices gives a new stimulus to trade, and the following year, it returns to its old amount. Trade increasing, the demand for a circulating medium increases with it; but the supply of that medinm,-which we suppose all this time to be only coin,-remaining about the same, of course it becomes relatively more 12*

Free Banking I

138

BA.NKS, BANKING,

valuable, and prices fall. 'rhis fall proves a source of loss to the merchants, an embarrassment to business, and a public calamity. All this difficulty is avoided by the use of bills of exchange for an international medium. Their quantity increases or diminishes exactly with the wants of trade j and that increase or diminution produces little or no effect upon prices. Not only are universal fluctuations in the relative value of the precious metals prevented, to a good degree, by the use of bills of exchange j but they are the means of avoiding local fluctuations of a no less serious charaeter. Suppose no other medium but coin, and snppose twenty millions in coin suddenly taken out of the United States to pay for foreign goods. But the demand for a circulating medium remains the same as before. The supply being diminished, the relative value rises, and all prices must fall. A similar influx of gold would produce a corresponding fall in its local value, and a corresponding rise in prices. By means of bills of exchange all these local fluctuations are avoided j and it never becomes necessary to take coin out of a country or to bring it in, except for the purpose of settling the inconsiderable balance between the total value of its sales and its purchases, whereby the local value of the precious metals preserves a certain degree of steadiness and uniformity. Let it be recollected, however, that bills of exchange are enabled to perform the office of a circulating medium only by virtue of the express reference which they constantly carryon their face, to a certain sum of coin, at a certain place described in the bill, to the possession of which coin the holder of the bill is entitled. In itself a bill of exchange is nothing but a piece of paper j it owes all its value to the coin to the possession of which it conveys a title j and if there is any rflasonable doubt whether the bill will command the possession of that coin, its value is at once destroyed. it is obvious, therefore, that if bills of exchange have

263

264

Free Banking I AND PAPER CURRENCIES.

139

several other advantages over a metallic medium, in point of security they fall below it. With the gold in my hand, I am absolutely certain that I have got a positive value for my goods; but when I take a bill of exchange in payment, I remain exposed to a degree of uncertainty,-for perhaps the bill will never be paid. But experience has proved that this objection to an international currency of bills of exchange, is of very trifling consequence, compared with the reasons in its favor. These bills have been established by the common consent of merchants, for the last five centuries, as the chief medium of foreign traffic; and they have even been introduced, with equal advantage, into the commercial intercourse between the different trading towns of the same country. Now a currency of bank notes, redeemable in specie, on demand, is nothing but an application to the domestic, local, and retail trade, and to the money transactions of the whole community, of an idea and practice, which the use of bills of exchange long ago made familiar to all engaged in wholesale mercantile transactions. A bank note is a bill of exchange, pa yahle to the bearer at sight. It is a title deed to a certain amount of coin, at a certain place mentioned and described in the note, the possession of which coin may be had, whenever it is demanded. Bnt instead of demanding the coin, and carrying it about in a bag, I find it more expedient to carry the note in my pocket. In Boston, a Boston bank note passes in all commercial transactions the same as coin, because every body knows that should the holder of the note happen to want the coin, he has only to step into State street, present his note at the bank, and carry the coin off at his leisure. But a Philadelphia bank note does not pass in Boston, in the same way. Few people in Boston want coin in Philadelphia; and nobody wants the trouble of going to Philadelphia to get the coin described in the note, and the additional trouble of bringing it to Bos-

Free Banking I

140

BANKS, BANKING,

ton. But if a Boston man happens to have money to pay in Philadelphia, or wishes to purchase goods there, he will not only cheerfully receive the Philadelphia note, but if he cannot otherwise get it, he will pay a premium for it; for a note is much more convenient to send or carry than coin to the same value. 1. Though the contrast is not so striking as in the case of foreign bills of exchange, the convenience of bank notes over coin is not less real. A decisive proof of this fact may be drawn from the universal currency which bank notes have always obtained wherever they have been introduced. For the same reason that silver is preferred to copper, and gold to silver, bank notes are preferred to gold. They always have been; they always will be. 2. Of all kinds of property, coin is most exposed to the depredation of thieves. Its great value in a small bulk, the fact that it is money which serves at once, and without any further trouble, as a means of obtaining all other kinds of property, and its destitution of those ear marks, or particular tokens of recognition, which in the case of other kinds of property are apt to lead to detection, hold out peculiar temptations to the plunderer. Hence the great advantage of being able to carry a large sum of circulating medium about the persoll, and to carry it too incognito, so as not to attract that attention from the depredator in which the danger principally consists. A moderate sum in gold, and qnite a small sum in silver, form a bulk and weight not conveniently or securely to be attached to one's person. To carry the money about in a bag is troublesome and dangerous; and if left at home it becomes a constant source of anxiety and alarm. From all these inconveniences, bank notes are in a great measure free. 3. The facility of sending bank noles from one place to another by mail, or otherwise, enclosed in letters or small packages, is also a very great convenience, not to be enjoyed in the case of metallic money. 4. The same advantage over coin, in point of econ-

265

266

Free Banking I AND PAPER CURRENCIES.

141

omy, which bills of exchange possess, is enjoyed by bank notes; and for precisely the same reasons. I have explained, in the preceding chapter, how a circulation of bank notes makes a net addition to the active capital of the country in which they circulate, nearly equivalent to the total value of the gold and silver which they displace. When to this saving of interest is added the saving in wear and tear, and the freedom from all those consumptive causes which are ever acting upon a metallic currency, it is evident that the annual gain to the community from a circulation of bank notes, will exceed, rather than fall short of, the annual interest upon the whole amount of the circulating medium. 5. Bank notes, like bills of exchange, are free from that depreciation which arises from the wear and clipping of the current coin. The coins described in a bank note are understood to be perfect coins, of full weight; and were it otherwise, so long as the coin of a country is kept quietly in banks, and its place supplied, and more than supplied, by bank notes, the exposure to wear and tear, and to fraudulent diminution, is greatly reduced. 6. It is equally plain that bank notes, like bills of exchange, greatly improve the quality of the precious metals as a measure of value; a circumstance in their favor, which appears to have been quite overlooked, but which is of the greatest importance. Every body knows the fluctuations to which trade is necessarily liable; and every body knows that these fluctuations must be constantly increasing with the increase of trade. As the supply of all articles of trade is naturally uncertain, so the extent of the exchanges of those articles must be equally uncertain; and equally uncertain must be the demand for a medium whereby to make those exchanges; and if the supply of that medium remains the same,-which to a great extent it must do, so long as it consists only of coin,-then the relative value of that medium must be constantly fluctuating; and this fluctuation will produce a constant

Free Banking I

142

BANKS, BANKING,

fluctuation in prices, quite independent of that natural fluctuation, growing out of supply and demand, on which alone prices should depend. The more commercial a nation grows, the greater this evil becomes; and the attempt to make the precious metals the sole medium of exchange,-for which purpose a superior substitute has already been invented,-is highly injurious to their quality for performing that other office of a measure of value, for which it is impossible to offer any tolerable substitute. Bank notes, on the other hand, increase, or diminish, just as they are needed, without any effect upon prices; or so they would do, if they were left to regulate themselves. The agricultural and other products, and also the mercantile transactions of a certain year, are of a certain amount. The next year, they may be double the amount of the year preceding, and the third year, they may subside again to the level of the first. Now it is evident, that ifthe same quantity of specie be employed in each of these three years as the medium of exchanges, that prices the second year must be much lower than in the first,-because, to enable the same quantity of specie to effect double the amount of exchanges, the quantity employed in each exchange must be diminished i-and the third year there must be a rise of prices, the same quantity of specie being employed to effect half the number of exchanges, thereby affording a larger quantity to each exchange. No doubt the fall and rise of prices, thus produced, would lead in the first case to an exportation, and in the second case to an importation of the precious metals, whereby this inequality of prices would be prevented from reaching its utmost limit; but the cure would only come after the disorder had wrought the greater part of its effect. On the other hand, the employment of a paper currency would prevent the disorder altogether. With the demand of trade for a greater circulating medium the currency would expand; with the diminution of that demand it would contract again, preserving all the while the same relative value.

267

268

Free Banking I AND PAPER CURRENCIES.

143

But while bank notes possess, as a local currency, all the advantages which recommend bills of exchange for a medium of international trade, they are also subject to the same disadvantage. In point of security, bank notes are not equal to coin. With the dollars in my pocket, my wealth is unquestionable j but if I have only bank. notes, the bank may fail, and the notes become worthless. But here, as in the case of bills of exchange, the risk is so small, that it is not possible to calculate it; and therefore it does not produce any effect, that can be appreciated, upon the value of bank notes as a circulating medium. Thus far we observe a perfect correspondency, in character and effects, between the international currency of bills of exchange, and a local currency of bank notes. Let us now turn our attention to a point wherein we shall observe a most singular and remarkable difference. Banks and bank notes are an everlasting subject of political controversy and dispute. They are also a constant subject of murmurs and complaints on the part of the public and the merchants. Now, the issues are said to be unreasonable; now the contractions are complained of. In the preceding chapter, the great distresses among mercantile men, which banks, according to the monopoly system of management, are constantly liable to produce, have been stated at length. It has even been seriously doubted, whether these ill effects are not, on the whole, more than an overbalance for all the advantages to be derived from a circulation of bank notes. With respect to bills of exchange, we never hear any such complaints. They are not charged, nor are they chargeable, with producing any such bad effects. Their use is a pure good; without any mixture of those very serious evils, which have attended the use of bank notes. How explain this remarkable difference" The effects of a thing depend upon two circumstances: first, the inherent nature of the thing; second, the mode of its operation.

Free Banking I

144

BANKS, BANKING,

Now it has been already proved that the inherent nature of bills of exchange and of bank notes is precisely identical j therefore we must look to some difference in the mode of their operation for this difference in their effects. Turning our attention that way, we discover at once a most striking difference in their respective methods of operation. The issue of bills of exchange is left perfectly open to the free competition of all the world. Any capitalist, of any country, is any where at perfect liberty to enter into it. The consequence is, that the amount of accommodation in the way of exchange, furnished by anyone house, is always limited, and the mischief which is or can be caused by a refusal to sell bills, or a neglect to pay them, on the part of any single dealer, is so very trifling as to be quite imperceptible. But suppose a single institution in any country, for instance a state or national bank, or some great incorporated company, representing that the greater part of the merchants are men of small capital and less knowledge, wholly incompetent to have any thing to do with so grave a matter as furnishing an international currency, and that it would be far better to entrust this important affair to the sole management and control of an institution, whose amount of capital, great credit, respectability of character and extent ofinformation, give it every advantagej-suppose that, upon the strength of these reasons, or any others, the business of drawing and accepting foreign bills of exchange shonld be solely entrusted to such an institution,-what would be likely to be the result 1 Would it add any new advantages or any new security to the use of bills of exchange 1 ,V ould it give any new stability to prices 1 Would it benefit the foreign trade 1 But this course of proceeding, which, as it respects the international currency of bills of exchange, all would acknowledge to be absurd and fatal, is the very method of operation it has been thought proper to adopt for the domestic currency of bank notes. According to the theory of monopoly banking, the

269

270

Free Banking I AND PAPER CURRENCIES.

145

perfection of the banking system is, to have only one single institution, to which the whole business shall be entrusted. Every additional bank, if we believe this doctrine, tends to destroy the perfection of the system; and the high priests of our banking hierarchy solemnly assure us, that all the evils of the present system of banking, against which complaints are so grievous, are solely produced by the multiplication of banks. But it has been shown, in the preceding chapter, that the whole evils of the present banking system grow out of the single fact, that the banks lend a great deal more money than they have got. They lend money to a great amount that does not belong to them; they are the greatest debtors among us; of course, they are the first to feel a pressure in the money market, and they must save themselves let who will suffer. How does it happen that the banks get so much into debt 1 Plainly because they possess the exclusive privilege of circulating their own notes as money. How shall we limit the indebtedness of the banks 1 Not by prohibitory statutes, which are always evaded when it is an object to evade them, but by opening the business of issuing bank notes to a free competition. What would be the effects of such a competition 1 As every new bank comes in for a share of the circulation, it necessarily diminishes the circulation of all the previously existing banks; and just as their circulation is diminished, in the same proportion is diminished the possible fluctuation of their loans. Suppose the circulation of Massachusetts to amount to ten miUions, and suppose this circulation wholly supplied by a single bank with a capital of ten millions. rrhis bank could ordin~rily lend about twenty millions, of which amount one half would be credit. A sudden run or panic might compel the bank to reduce its circulation, say one half; and this whole unexpected, unforeseen curtailment of five millions, falling, in the first instance, upon a limited num ber of individuals, the customers of the bank, would greatly distress them, and cause several of them to fail. 13

Free Banking 1

146

BANKS, BANKING,

Suppose now that in place of this one bank we have one thousand banks, with a capital of one hundred thousand dollars each. If the business were equally divided, and to that point it would constantly tend, each bank might ordinarily lend one hundred and ten thousand dollars, being the amount of its capital and ten thousand dollars in addition, for its share of the circulation. The whole loan would be one hundred and ten millions of dollars, of which only one eleventh would be on credit; and a pressure corresponding to that above supposed would require a reduction of loans at each bank of only five thousand dollars; nor could it be possible for anyone of them to be obliged to curtail more than ten thousand dollars; and the whole curtailment of five millions, instead of tumbling in a mass upon the few customers of one bank, would be divided in the very first instance into fragments, and being distributed among the numerous customers of one thousand banks, would hardly be felt by any body. By continuing to multiply the number of banks, the circulation of each individual bank would presently be reduced to such a trifle, that such a thing as a run, and a consequent reduction of leans, would be almost un known. If specie were needed for exportation, it would necessarily be collected in small sums from many contributors; and the amount demanded from any single bank would be too trifling to produce any serious alarm. The loans of the banks being mainly founded upon capital, would be free from those fluctuations necessarily incident to a business carried on chiefly upon credit, for, in fact, a bank of which the loans are founded to a great extent upon its credit, that is, upon the amount of its circulation and deposits, stands in a much more delicate position than is incident to ordinary credit transactions. Its notes and its deposits, instead of being payable on some fixed future day, are payable any time, at the pleasure of the holders or depositors. Where a bank possesses the monopoly of the circulation for a large tract of

271

272

Free Banking I AND PAPER CURRENCIES.

147

country, it is able to extend its credit very far. It lacks that constant and salutary check which would be furnished by the establishment of several other banks in its neighborhood, which would be constantly returning its bills, contracting the extent of its credit, and reminding it of the necessity of being always prepared to redeem its paper on presentation. It is in this way that banks, the more numerous they become, act constantly with still greater effect to check each other's operations, and to confine them within narrow and safe limits. They become the most watchful guardians over each other, and while each struggles to obtain for itself the largest possible share of the circulation, none is able to engross a dangerous amount of it. It is very true that, according to the system here proposed, bank dividends could never much exceed the ordinary profits upon capital; and bank stock would be seldom above par. But though the gain made by a currency of bank notes would not be so obvious, still it would not be the less real. Instead of being engrossed by a few favored individuals, it would be spread abroad among the community; and though not so evidently seen, it would be more generally felt. Moreover, it would become almost impossible for a bank to fail, however great the fraud or folly of its managers; and so far as the public is concerned, it would be of comparatively trifling consequence whether it failed or not. The amount of notes which any one bank could get into circulation, would be too small to make its failure any object to the stockholders. The forced loan they would thus be able to levy on the public, would be a mere trifle; and almost the whole loss and trouble which the failure of the bank would occasion, would fall where it properly belongs, namely, upon the stockholders. It is evident then that a free competition in the business of banking would be attended with the two folJowing effects.

Free Banking I

148

BANKS, BANKING,

First· It would operate to prevent that frequent, su,ddell ~nd extensive fluctuation in the amount of the loans of individual banks, which is the great misery of the present system of banking. Second' It would be an additional security to the bank-note 'circulation,. since every new bank is equivalent to a new endorsement upon the mass of the circulating currency. Reference to facts will make this matter clear. On the 1st of January, 1830, there were in Virginia four banks, with an aggregate capital of $5,571,100 j loans $7,698,900; circulation $3,857,900. Suppose such a run as to oblige them to withdraw half their notes from circulation; they must have diminished their loans upwards of one quarter. On the same day, there were in Massachusetts sixty-six banks, with an aggregate capital of $20,420,000; loans $28,590,000 ; circulation $4,747,000. A similar run in Massachusetts would have obliged the banks there to have diminished their loans one twelfth, which makes a vast difference for the customers, especially when we consider that the whole contraction, instead of falling in the first instance upon the few customers of four banks, would be divided, from the very first, among the many customers of sixty-six banks. But in Rhode Island, the smallest State in the Union, and inferior in extent and population to some single counties of Massachusetts, there were, on the same day, forty-seven banks, with an aggregate capital of $6,118,900; loans $6,909,000; circulation $673,000. The same run in Rhode Island would have compelled the banks there to diminish their accommodations only one twentieth,. and the interruption to business would have been hardly perceptible. It is to be observed that in all three of these cases, the specie on hand was not half equal tp the amount of deposits, for which the banks were as liable to be called upon as for their own notes. Now as to the security of these several currencies. In Virginia, for a circulation of $3,857,900, there was

273

274

Free Banking I AND PAPER CURRENCIES.

149

the responsibility of four banks, and a pledge of capital to the amount of $5,571,100, or less than a dollar and a half of capital for each dollar of circulation. In Massachusetts, for a circulation of $4,447,000, there was the responsibility of sixty-six banks, and a pledge of capital to the amount of $20,420,000, or upwards of four dollars and a half of capital for each dollar of circulation. In Rhode Island, for a circulation of $673,000, there was the responsibility of forty-seven banks, and a pledge of capital to the amount of $6,148,000, or upwards of ten dollars of capital for each dollar of circulation. Which of these currencies was the most secure 1 It is precisely in Massachusetts and Rhode Island, the best peopled, and, for extent, the wealthiest, the best cultivated, the most manufacturing, the most commercial, the most intelligent, industrious and enterprising of all the States, that the monopoly of bank charters has been most broken in upon. But the good work is not yet completed. The monopoly of bank charters must be abolished altogether j and not in one or two States only, but in all; otherwise the best-conditioned of the States will be constantly liable to suffer sympathetically, from the numerous disorders of their ricketty sisters. Capitalists must be left as much at liberty to invest their money in a bank as in a cotton mill. This work is going on, by the almost daily creation of new banks; and notwithstanding the croakings of those who repeat, parrot-like, the one lesson their teachers have taught them; notwithstanding the angryarguments of those who will not see because they think it their interest to remain blindfold; notwithstanding the doubts and apprehensions of a public not well informed, and purposely misled; yet it is clear as the noon-day sun, that every new bank which has a solid capital and is well managed, every step towards the destruction of the monopoly of bank charters, is a gain to the community. 13*

Free Banking I

150

BANKS, BANKING,

A bank, whether great or small, naturally and necessarily falls under the influence and control of a few individuals. If there is but one great bank, bank accommodations will be limited, for the most part, to the friends, favorites, proteges and toad-eaters of the few great capitalists who will usurp its management; and the monopoly of banking will tend necessarily to produce a monopoly of business,-for those possess a monopoly of business who enjoy a monopoly of the means necessary to carry it on. But let a bank be planted in every village, and let those who are dissatisfied with the conduct of existing banks be at liberty to establish new ones, and the convenience and aid of these institutions will be generally dispensed, like the refreshing dew, to every nook and corner of the country. It is objected that new banks cannot be of any great use, for they do not create or bring into activity any new capital. It is true they do not; but they greatly economize and facilitate the use of existing capital. Ina11 sorts of business, especially trade, there is required, first, a certain fixed and constant capital always invested, second, a certain floating capital, sometimes employed and sometimes idle. Now if a number of business men can club together their floating capitals and invest them in a bank, they find it, in many respects, exceedingly convenient and advantageous. That convenience and advantage consist in this. When they need, in the course of their business, the use of the floating capital which they have invested in the bank, they can borrow of the bank to the amount of their stock, and perhaps more. When they have no call for this money, it can be lent to others of the stockholders who need it; or if none need it, it is lent to any body who wishes to borrow. It is quite clear that when a number of business men can combine their floating capitals in this way, the same amount of capital may be made to go much further than when each operates by himself, and upon

275

276

Free Banking I

AND PAPER CURRENCIES.

151

his individual means. When money is in great demand, and each wants all he can get, each stockholder receives his just share of accommodation. But it will generally happen, that while some are pressed for money, others will have little occasion for it; and the funds of the bank can be appropriated in turn to the relief and aid of all. In the mean time all these floating capitals are securely invested, paying a moderate interest, and capable of being brought into action at a moment's warning. Many of the Massachusetts and Rhode Island banks are constituted and managed much upon this principle. The stock is chiefly held by business men, who hold it, not for the sake of the dividends, which in these States are always moderate, but on account of the business facilities they derive from their concern in the bank. This system of banking is a decided improvement upon the system of cash accounts which has given such just celebrity to the Scotch banks. By the system of cash accounts, the customers are allowed an interest upon their deposits; but by the system I am now explaining, they arc allowed to participate in all the profits of the bank. It is precisely the principle of the savings-banks carried into the operations of business. This matter is not theoretically understood by om husiness men; but they have a confused perception of the fact; and hence those annual and urgent applications for the grant of hank charters, which, upon the principles of free competition, ought to be as freely granted, as so many applications for the charter of manufacturing companies. Some cautious persons are terribly alarmed at the idea of this illimitable creation of banks; and at the liberty thus given to any body and every body to run in debt to the public. If these good people could be induced to reflect for two seconds, it would be easy to show them how groundless are their fears. Every new bank with a capital of $100,000, chartered by

Free Banking I

152

BANKS, BANKING,

the Massachusetts Legislature, will be able to circulate from twenty to sixty thousand dollars of its notes, and this is the utmost sum in which it can he come indebted to the community, except under very peculiar circumstances; and as banks continue to increase in number, the amount of possible indebtedness upon the part of any single bank has a constant tendency to diminish. Every manufacturing company which shall be chartered with the same capital, has a freedom to contract debts without any definite limit; and if it does any thing of a business, will probably owe, at any given time, from fifty to two hundred thousand dollars,-a considerable proportion of which shall be due to girls, boys, laboring men, dependent on their weekly wages for their bread, the very people who are to be robbed and ruined, as we are told, by irresponsible banks. No man of common sense will undertake to deny this statement; yet shall it happen, that our respectable legislators will make a most alarming fuss about every bank that is chartered, while manufacturing companies shall pass muster by the dozen, without a single question being asked or answered. Those who strain at a gnat, are marvellously adroit at swallowing a camel. The objection founded upon the supposed danger that a host of irresponsible banks would spring up the moment that the circulation was opened to free competition, would be completely set aside, by requiring all banking institutions to give security for the redemption of their circulating notes, a subject which will be considered in the next chapter. Every branch of trade was once a monopoly. The progress of knowledge has banished that wretched system from every sort of business except the business of banking. Before long it will be obliged to surrender this, its last strong-hold. When the doctrine of free competition comes to be generally understood and generally admitted,-and that time is not far distant,-our legislators, instead of spending their time, and abusing the public pa-

277

278

Free Banking I AND PAPER CURRENCIES.

153

tience, with stupid and unintelligible debates about the state of the currency, in useless and frivolous disputes whether a bank be needed in this place or that, will have time to turn aside from these contemptible and hypocritical shufflings of personal interests, and to bestow some attention upon necessary amendments of the laws. Trade will no longer lie at the mercy of ignorant and reckless politicians, or at the mercy, no less to be deprecated, of a few purse-proud, domineerillg, dictatorial bank directors, who care not what mischief they do, if they can but perpetuate their own exclusive privileges. The sound condition of the currency, the prudent management of the banks, will not depend upon the discretion or honesty of any individual or body of individuals. Instead of being subjected to artificial regulations, the currency will be controlled and guided by its own necessary laws,-the Laws of Trade,-Iaws which do not act by jerks and starts, like the awkward and clumsy substitutes which have been foisted into their place, but by a constant, steady, gentle, yet inevitable pressure, which does better than set things to right,which prevents them from ever getting wrong.

CHAPTER V.

Of requiring Security from Banks for the Payment of their Circulating Notes. THE system of granting bank charters by the special grace of a legislature, to such applicants only as may seem meritorious and trustworthy, has been found, in its practical operation, to be so slight a guard against irresponsibility on the part of those chartered monopolies, that in most, if not in all the States, there have been enacted a great number of complicated provisions, specifying the way in which the capital shall be paid in, and the method in which the business

Free Banking I

154

BANKS, BANKING,

shall be conducted, regulating the quantity of specie to be kept, and limiting the amount of the loans and circulation. In some of the States, it. has even been deemed expedient to create certain public officers called Bank Commissioners, whose duty it is to look after the banks, and see that they conform to the statute regulations above mentioned. The policy of some of these regulations is exceedingly doubtful, and all of them are easily evaded; nor have they succeeded in accomplishing the object at which they aim, which is the security of the public against loss by the failure of banks to redeem their notes. There is an expedient, however, of a very simple kind, which leaves no room for evasion, and the adoption of which would enable us at once to dispense with all the complicated statute provisions designed to regulate the conduct of the banks, and all the machinery devised to enforce those regulations. Inasmuch as the citizens are exposed to suffer loss from receiving as money, notes which have been issued by a bank unable to pay them; and especially as these notes must be often received by persons who have no means of judging as to their actual value, it is certainly the duty of the legislature to guard against fraud or loss in this matter. Now any loss to the holders, arising out of the issue of bank notes, and any temptation to any person to set on foot such an issue with the design to defraud the public, may be effectually prevented, by allowing no notes to be issued which are not countersigned by some public officer, which notes are to be furnished to those who propose to issue them, only upon the deposit, with the officer who signs them, of securities equal in value to the notes furnished; which securities, in case of any failure on the part of the issuer to redeem the notes, are to be forthwith applied, under the direction of the same officer, to that purpose. The securities thus deposited may consist of stocks of settled and permanent value, or of bonds and

279

280

Free Banking J AND PAPEtt CURRENCIES.

155

mortgages, or of both. They will draw an interest for the benefit of the depositors, and will thus form a profitable investment, at the same time that they serve as a security for the circulating notes. Under this system, it will be impossible to set up the business of banking merely upon credit. Every banking institution must have an amount of capital, equal at least to the amount of its notes in circulation, and certainly applicable to their redemption. The payment of those notes being thus secured, this is all the interference with the management of the banking business which the public good either requires or authorizes. A legislature, when it permits the issue of circulating notes, is bound to provide for the security of the holders of those notes. But beyond this, it has no call to go. The stockholders should be left to take care of their own concerns; and as to the depositors, it is a voluntary thing with them to become such, and they may properly be left to select a depository for themselves, and to stand any loss which that voluntary selection may involve. It is perfectly clear that this simple contrivance of requiring security for all notes issued, would go infinitely fnrther than all the regulations hitherto invented, to guard against the insolvency of banks. At the same time it completely does away with that plausible argument in favor of monopoly, founded upon the apprehension that if the business of banking were open to all, many notes would be issued without any capital to sustain them. This apprehension, however, under any circumstances, is not very well founded. Under the monopoly system, a bank that has a charter derives a credit from that very circumstance; it is supposed to have capital from the fact that it has a charter and it is thus enabled to get its notes into circulation, capital or no capital. Under the system of free competition, every bank would be obliged to rely upon its own unassisted credit; and in order to obtain a circulation; it would be necessary either to have capital, or to have the reputation of it. Under

Free Banking 1

156

BANKS, BANKING,

the system of requiring security, an amount of capital sufficient for the protection of the note-holders would be certain in all cases, and it would be hardly possible for the holders of bank notes ever to suffer any considerable loss.

CHAPTER VI.

The Effect of Free Banking upon Fluctuations of Trade. IT has been a favorite argument against the multiplication of banks, that they are the causes of speculation, and lead to those commercial fluctuations, the results of which are often so distressing. This argument was first used against the increase of banks; but it has since been employed against the existence of any banks whatever; and if it be valid at all, it is certainly as valid against old banks as against new ones. Inasmuch as coin, or the bank notes which serve in its place, is the medium by which all commercial transactions are carried on, there has grown up a habit of ascribing to this medium a great deal more of importance than rightfully belongs to it. According to the mercantile theory of political economy, money was the only wealth; and though this extravagant doctrine has been long since exploded, a great many effects still continue to be ascribed to the state of the currency, which originate wholly in other causes. The fluctuations of trade, the spirit of speculation which from time to time appears, the rise of prices and the fall of prices, and all the consequences attendant upon that rise and fall,-all these results are generally ascribed to the condition of the currency,and the banks, as furnishing that currenoy, are held responsible for them.

281

282

Free Banking I AND PAPl!:R CURRENCIES.

157

'rhe account usually given of the matter is this,that the banks make an over-issue of notes, which produces a rise of pric.es and great speculations, and then, by. a contraction of that over-issue, prices fall, speculatIOns explode, and distress results. A bank no doubt may issue more of its notes than is safe or prudent; but though they may be issued, it is impossible for the bank to keep them in circulation except they are needed as a medium of trade; and unless kept in circulation it is impossible for them to do any harm except to the bank itself. The amount of notes, payable on demand, that can be kept in circulation, is and must be limited by the demand of the community for a circulating medium. It is no doubt true that every rise of prices, every unusual activity of trade, every outburst of speculation, is attended by an increase in the circulation of the banks. The reason of this is very obvious. The rise of prices, the activity of trade, the spirit of speculation, create a new use and a new demand for the circulating medium, the amount of which is increased accordingly. The increase of circulation did not cause the rise of prices, the trade and the speculation, but it was the trade, the speculation, and the rise of prices which caused the increase of circulation. So also a fall of prices, the decline of trade and the failure of speculation, is attended by a diminishing circulation, because the demand for a circulating medium is thereby diminished, and the excess returns to the banks which issued it. These fluctuations in the amount of the circulation are absolutely necessary to keep up a due proportion between the medium of trade and the amount of trade. The same thing takes place with a metallic as well as with a paper currency; though not so obviously, because the little trade that is possessed by countries where the only money consists in coin, can of course be liable only to little variations. The doctrine so confidently asserted, that speciepaying banks have the power so far to depreciate the currency by an over-issue of notes, as to cause a great

14

Free Banking I

158

BANKS, BANKING,

rise of prices, is wholly destitute of any foundation. It is plainly impossible that a currency of notes payable in specie on demand, can ever be depreciated to a greater amount than a currency consisting wholly of gold and silver. Suppose a sudden addition of ten millions to the present currency of that portion of the United States in which the banks pay specie. So far as respects the depreciation which such an increase would cause, it is a matter of entire indifference whether that increase consists wholly in bank notes, or wholly in coin. 'rhe amount to which that depreciation can attain, and its effect upon prices, is exceedingly limited. A very slight degree of depreciation in the value of gold or silver in one country, compared with its value in other countries, is sufficient to produce an exportation, which goes on till the equilibrium is restored. Not only is the degree of depreciation in the currency which can be produced by the over-issues of specie-paying banks, no greater than what the currency would be occasionally liable to, if it consisted wholly of specie; hut it is impossible for the banks to produce any depreciation whatever, unless they all join simultaneously in the operation. If a number of banks issue a quantity of notes beyond what are needed for the operations of trade, those notes soon come into the possession of other banks, and when they are presented for payment, unless those other banks have also issued an extra quantity of notes, which, having fallen into the hands of the first set of banks, will serve for the redemption of theirs,-the issuers will be obliged to redeem their excessive issue in specie, a process which will soon compel them to put a stop to that issue. With a single great bank, or a small number of banks, an excessive issue may easily happen; but with the increase of banks the improbability increases of any such concert of action as would make it possible. Under any circumstances, the direct power of banks to raise prices is very limited. They are able, however, to cause a great fall of prices. This fall they pro-

283

284

Free Banking I AND PAPER CURRENCIES.

159

duce, not, as is usually alleged, by contracting the currency,-for their ability to operate upon prices in that way is exceedingly limited,-but by creatillg alarm, and panic, and giving a general shock to credit by a sudden curta ihnent of their loans. Such panics and alarms, however, are always so directly opposed to the interests of the banks themselves, that they are not very likely to be wantonly produced. Even though the banks were deprived of their right to issue notes, their power to produce a fall in prices, in the way just described, would be but slightly diminished. By contracting the amount of their loans, or by refusing to discount particular kinds of paper, they could at any time give a shock to confidence, and produce then'by a fall in prices. In reality this is a power inherent in lenders of capital, who, by suddenly withdrawing that capital from business, can always interrupt and disturb the business dependent upon it, and it is a power which, if no banl{s existed, would be exercised much more extensively and capriciously by individual capitalists. It thus being obvious, that mere fluctuations in the amount of the currency cannot be the efficient causes of those alternations of commercial prosperity and of commercial embarrassment, which dllring the last quarter of a century have attracted so much of the public attention, and have been the subject of such warm discussions, it remains to inquire what the origin of those alternations actually is. 'rrade is from its very nature in a state of constant fluctuation. The annual amount of all kinds of productions is liable to be affected by several causes, of which the chief is, the temperature of the season. The same variety of causes affects the capacity to purchase, so that fluctuation may be said to be an incident inseparable from trade. Between trade and speculation it is not easy to draw any distinct line. Trade, however, used in contradistinction to speculation, is employed to signify old, established branches of business, carried on

Free Banking I

160

BANKS, BANKING,

in the old way,-while speculation implies either a new branch of business, or a departure from the accustomed routine of an old branch. When speculation proves successful, however wild it may have appeared in the beginning, it is looked upon as an excellent thing, and is commended as enterprise,. it is only when unsuccessful that it furnishes occasion for ridicule and complaint, and is stigmatized as a Now it is plain that in an bubble or a humbug. improving country, a certain spirit of speculation must at all times exist, otherwise there could be no improvement; for every improvement is in the beginning an experiment, that is, a speculation. The circumstance which distinguishes the people of Great Britain and of the United States from other nations is, their inclination to speculate, in other words, their disposition to try experiments, their spirit of enterprise; and what keeps a great part of the world in an inert and un improving state is, a destitution of that disposition and spirit. But thongh the disposition to speculate be the cause of all improvements, it often leads to considerable disasters. Persons are induced to engage heedlessly in speculations which prove unsuccessful. A speculation becomes fashionable, and the same apish folly which, under like circnmstances, is so often displayed in regard to other things, is then exhibited in matters of trade. Ignorance, want of discernment, want of reflection, and an eager, heedless haste to grow rich,-these are the true causes of those speculative fevers with which, from time to time, the public mind is seized. The South-Sea scheme is one of the most remarkable delusions of this kind, of which we have any knowledge, so mnch so that it has become proverbial. At the time of that speculation there were no bank notes issued in England under £20, and the amount of such notes in circulation formed but a very trifling part of the whole currency. In addition to the ordinary, or what may be called the annual fluctuations of trade, there are fluctuations

285

286

Free Banking I AND PAPER CURRENCIES.

161

of a more serious and permanent kind, which grow out of some great change in the relations of commerce and industry, and which are apt to produce what is called a commercial crisis. Changes from general peace to war, and from war again to peace, must necessarily be followed by a derangement of the previously existing state of business, by great fluctuations in commerce, and great changes in the value of property. The same effect is produced by civil disturbances; and sometimes even by revolutions taking place in foreign and distant countries. Of this character were the commercial shocks in England in the years 1810 and 1819; in the United States in 1819; and in France in 1805 and 1831. At the former period, France had no paper money at all ; at the latter, a very inconsiderable amount, and none under the denomination of 500 franks. The actual way in which banks operate to produce fluctuations in business, is, by fluctuation in the amount of their loans, that is, by increasing or diminishing the amonnt of capital in the hands of merchants and manufacturers. Though the amonnt of loans which the banks can make, is in some degree dependent upon the amount of their circulation, it is dependent still more upon the amonnt of their deposits, and should be dependent more yet, and would be, under a system of free competition, upon the amount of their capital. That portion of bank loans which is founded npon capital is not liable to fluctuate at all; that portion which is founded upon circulation, so long as the credit of a bank remains undoubted, is liable to fluctuate only to a certain extent. That portion which is founded upon deposits is most of all liable to fluctuate, because the amonnt of deposits which a bank may at any time have, is a much more uncertain thing than the amount of circnlation it may be able to maintain. The contraction of loans in 1834, by the Bank of the United States, was caused by the diminution of the amount of its deposits consequent upon the with14*

Free Banking I

162

BANKS, BANKING,

drawal of the public moneys from its custody. The contraction of loans so severely felt towards the end of1836, was occasioned by the prospective withdrawal of large amounts of public money from the banks which held it, to be distributed among the states; and the same effect would have been produced though the banks had been, like the London private banks, not banks of circulation, but banks of deposit and discount merely. The stable portion of the loans of a bank being those dependent upon its capital, and the fluctuating portion those dependent upon its circulation and deposits, it is obvious that the ratio which the stable portion bears to the fluctuating portion, will determine the stable or fluctuating character of the whole. Now it has already been shown how the increase of banks tends to diminish the circulation of each particular bank, and of course the amount of loans founded upon that circulation. The same operation takes place with respect to deposits; from all which it results, that the increase of banking capital consequent upon the multiplication of banks, tends to give a stability to the loans of each bank, by increasing the relative amount of that portion of its loans which is not subject to fluctuation. Thus the increase of bank capital attendant upon the multiplication of banks, by giving a stability to bank loans, tends at the same time to give a comparative stability to trade. If we snppose only one great bank of issue, similar, for instance, to the Bank of England, the amonnt of the loans of snch a bank founded upon its circulation and deposits, that is, the amount of its loans liable to fluctuation, must bear a very large proportion to the amount of its loans foullded on capital. Of course the entire loan of such a bank mllst be liable to vibrate through a great extent, a vibration which mllst be attended with great fluctuations in trade. With regard to the Bank of England, its capital, except the T'est or surplus, being invested in public stocks, almost the entire amount of its loans is founded upon

287

288

Free Banking I AND PAPER CURRENCIES.

163

its circulation and deposits, and of course is liable to great and sudden fluctuations. The rule adopted by the directors, of keeping the amount of secllfities, or, in other words, the loan, as far uniform as possible, is a good one, but under the circumstances the directors are not able to act upon it. It happens too, unfortunately for trade, that fluctuations in the amount of the loan of the bank, are generally made to fall almost exclusively upon that portion of it which is secured by mercantile paper. The influence of the bank is so great, that every contraction in the amount of its loan gives a certain shock to credit, and induces other lenders to draw in their loans also. The power which such an institution is able to exert over trade is enormous, and altogether too great to be entrusted to any twenty-four men, however respectable for talents or integrity. Its effects extend beyond the island of Great Britain. They have recently been felt with severity in the United States. Now if the circulation and deposits of the Ban k of England were divided among a large number of banks, the amount of loan which each bank would found upon its share of that circulation and those deposits, must be small. It would follow that the fluctuating portion of the loans of those banks must be in a small ratio to the stable portion, and of course the entire loan must acquire a character of comparative stability. Let ns now take an illustration from the banks of the United States. At the end of the year 1835, there were in the State of Mississippi jive banks, with a capital, paid up, of $8,764,000, circulation $4,490,000, deposits $6,400,000, specie $660,000. From this statement it is evident that more than half of the whole amount loaned by these banks, mnst have been founded on circulation and deposits, and must have partaken of their fluctuating character. About the same time, in Rhode Island, there were sixty-one banks, with a capital of $8,750,000, circulation $1,644,000, deposits $1,700,000, specie $566,000. Only about a quarter part of the loans of these banks could

Free Banking I

164

BANKS, BANKING,

have been founded upon circulation and deposits, and so have been exposed to fluctuation. But this arithmetical statement of the comparative stability of the loans of the Mississippi and Rhode Island hallks does not exhibit the whole extent of it,-for it is an unquestionable fact, that with the increase of the circulation and deposits of a bank, their liability to fluctuate increases in a much greater ratio. It therefore seems to be sufficiently evident that the increase of banks, so far from tending to increase fluctuations of trade, as has been so confidently alleged, must have a stl'ong tendency the other way; for it tends directly to give a stability to bank loans by increasing the relative amount of that portion of the loan not liable to fluctuation, and decreasing the relative amount of that portion of the loan liable to fluctuate. It is not to be supposed that, under any system that can be devised, fluctuations of trade can be entirely prevented. They are one of those evils which flesh is heir to; they may be alleviated, but cannot be radically cured. It is a sad thing, to be sure, to see vast numbers of persons, by a sudden commercial revolution, thrown out of lucl'ative employment and reduced to poverty and idleness. But we ought to recollect that it is only owing to commerce, and to that vivacity which banks, the credit system and the spirit of enterprise have imparted to trade and industry, that these persons ever had any lucrative employment out of which to be thrown. In countries where trade and manufactures are at a low ebb, the great mass of the people al ways remain in that state of destitution and idleness which is witnessed with us only at the moment of some great commercial crisis,-a crisis which soon passes by, and gives place to the state of prosperity by which it was preceded. '1'hose persons who are so excited at contemplating the effect of fluctuations in trade, that they are ready to do away with all trade,--which indeed must be the result, at least to a great extent, of destroying that machinery of credit

289

290

Free Banking I AND PAPER CURRENCIES.

165

~y which alone it can be prosperously carried on,-are Just as reasonable as the man who was so vexed to find that his clothes did not prevent him from suffering every now and then by the cold, that he resolved to wear no clothes whatever, but to go naked.

CHAPTER VII. The connection between the Currency and the Foreign Exchanges. THE connection, or supposed connection, between the currency of a country and the state of its foreign exchanges, has been made the foundation of a theory of banking which would break down all competition whatever, so far as the circulation is concerned, and would render the issue of circulating paper a perfect monopoly in the hands of a single issuer.'*' This subject therefore needs to be examined. It is alleged that whenever the foreign exchange is against a country, that very circumstance is a proof that the currency is redundant and needs contraction j that when the foreign exchange is in favor of a country, that fact indicates too great a contraction of the currency, which then needs to be expanded j that when the foreign exchange is at par, it is thereby indicated that the currency is exactly proportioned to the wants of the country. If this statement were in conformity to fact, it would certainly furnish a very convenient rule for the regulation of bank issues. It is obvious however, at a single glance, that such a rule is just as capable of regulating the management of five hundred banks, as of one bank. Were these five hundred banks satisfied that the state of the foreign exchanges afforded .. It is somewhat curious that Mr. McCulloch, the chief author of the articles on political economy in the Edinbul'g Review, and a most un· compromising, and sometimes extravagant advocate of free trade in every thing else, should have become a patron of this theory.

Free Banking 1

166

BANKS, BANKING,

them asure and certain guide by which to regulate their issues, their own interest would lead them to observe it; for as the banks furnish a large proportion of the capital by which trade is carried on, a certain portion of the losses arising from derangement of trade, is sure in the end to fall upon them. This doctrine therefore concerning the connection between the currency and the state of the foreign exchange does not furnish any valid argument in favor of a single source of issue. It seems certain, however, that the doctrine itself is not well founded. It must indeed be admitted that one effect of the depreciation of a currency produced by too great an increase of its amount, is, to give an unfavorable turn to the foreign exchanges; but it is equally certain that the exchanges may become unfavorable from a variety of causes wholly unconnected with the state of the currency. Thus it may happen, and often does happen, that the exchange as between England and the continent is in favor of England, at the very moment that the exchange as between England and the United States is in favor of the United States. Whether at any given moment the exchange as between two particular countries shall be in favor of one or the other, depends in general very much upon the fact against which country inclines the balance of debt immediately payable. Suppose that at any given period the exchange, as between England and the United States, is decidedly in favor of England, and suppose further that during this state of things a heavy loan is negotiated in England in favor of the United States, one of the individual states, or some great banking or railroad company, for the amount of which the borrower is at liberty to draw at once. It is plain that this new amount of exchange upon England brought suddenly into the market would have the effect to reduce the price and turn the exchanges in our favor. This change is certa.inly independent of the state of the currency in either country. Suppose again that there is lent out by English

291

292

Free Banking I AND PAPER CURRENCIES.

161

capitalists to American merchants some millions of pounds sterling payable at short dates, and suppose further that during this state of things the exchange is in our favor. If however from any circumstance the English capitalists were to resolve suddenly to withdraw their capital from this country, and were to refuse any renewal of their loans, such a determination, it is very certain, would have the effect to turn the exchanges against us, though in the mean time the amount of our currency might have been considerably diminished. It is not denied, that when the foreign exchanges are against a country, the banks have reason to be cautious how they extend their loans. The American banks however are far more apt to be too much than too little alarmed at such an event. On the other hand, to maintain that so long as the exchanges are in our favor, the banks are at liberty to go on increasing their liabilities, appears to be a doctrine, the practical application of which cannot fail to be attended with great danger to the banks. Whatever ma y be the state of the exchanges, there is a certain point beyond which their liabilities cannot be judiciously or safely extended. Upon this point no rule can be laid down applicable to all banks alike. Each bank must be regulated upon this point by the peculiar circumstances in which it is placed; and the particular bearing of those circumstances, in each particular case, can only be ascertained by cautious experiment.

CHAPTER VIII.

Effect of the Usury Laws upon Bank Loans and Commercial Fluctuations. THE attempt to regulate by law the price of labor, of provisions, and of many other articles, was formerly a favorite project with legislators. This attempt,

Free Banking I

168

BANKS j BANKINGI

with regard to every thing except the interest of money, has long since heen abandoned, as useless and pernicious. With respect to the usury laws, a very general opinion as to their impolicy prevails among all well-informed people, yet such is the power of habit and prejudice, that they still remain unrepealed. By individual money-lenders, these laws are for the most part totally disregarded j but with respect to the banks, the chief resources whence capital is obtained upon loan, these laws still have their full effect, because the forfeiture of charters might be the consequence of violating them. The rise in the market value of articles operates as a useful check upon consumption, whenever the supply falls short of the demand j and in like manner a rise in the rate of interest,-if that rate were not limited by law,-would act as a useful check upon all undertakings in which an outlay of borrowed capital is required. It would operate especially as a check upon specUlative undertakings. By increasing the rate of interest whenever they found themselves beset by a multiplicity of borrowers, the banks would check the disposition to borrow in a much less violent and a safer way, than by sudden and apparently capriciolls refusals to discount. As things now are, when speculations are entered uFon, it is always calculated that money can be had o the banks wherewith to sustain them, at six per cent interest. In point of fact, money cannot be had at that rate j for when trade or speculation reaches a high pitch, it creates a demand for capital greater than the banks can supply, and the speculators are driven to borrow of private lenders at high rates. This, however, is a result which is not anticipated. It is known that the banks cannot ask more than the rate established by law, and an expectation is always cherished that bank loans can be had to the extent desired. If the banks had the power, and were in the habit, as they would be if they had the power, of raising

293

294

Free Banking I AND PAPER CURRENCIES.

169

the rate of interest as the demand for capital mcreased, this probable rise in the rate of interest would always be taken into account, and would operate as an important check to undertakings founded solely, or principally, upon bank credits. Besides, the rate of interest as fixed by the banks, that is, as regulated by the demand for capital, would form a sort of mercantile barometer, by means of which it would be easy to foresee the approach of a pressure in the money market. Whenever the rate of interest was high, that high rate would be a perpetual warning against commencing new operations, the returns of which, however great they might promise ultimately to be, were yet distant and uncertain. Under the present law, persons are induced to go on involving themselves under the expectation of always being able to borrow at six per cent, an expectation which the present law is calculated to create, but which is both false and dangerous. From loaning freely at six per cent, the banks now pass, by a sudden and generally unexpected transition, to not loaning at all, or only in small amounts. 'rhis change is of so violent a character as often to prove exceedingly distressing, if not ruinous, to the borrower, whereas if the borrowing were checked by a gradual rise of the rate of interest, it would be much less disastrous in its operation, and might be foreseen and provided for. This necessity of paying a high rate of interest, when perceived at a distance, would prove a very great drawback to what is called overtrading. A man of ordinary prudence, who could plainly foresee this danger, would not fail to be greatly influenced by it. Under the present system, this check does not begin to operate till speculations are carried so far that the speculators must struggle on at whatever sacrifice; and even then it operates but feebly, because hopes are always entertained of borrowing to a certain extent of the banks, at the rate of interest fixed by law. This sul>ject might be illustrated at great length i nor would it be difficult to show that the usury laws

15

Free Banking I

170

BANKS, BANKING,

have had ten times the influence in promoting speculation and overtrading, that ever the excessive issue of bank notes has had; and indeed that this very excessive issue, whenever it has existed, has been principally produced by these very usury laws, the banks seeking to gain that profit by an extension of their loans which, but for the laws against usury, might be obtained more safely and beneficially, both for themselves and the public, by a rise in the rate of interest. But for this discussion we have not room in the present treatise.

CHAPTER IX.

Of a National Bank and a Uniform Currency. ACCORDING to strict propriety of phrase, by a National Bank we ought to understand an institution wholly or mainly under the control of the government. Such are the banks of France, Austria, Russia, Holland, and some others. Such an institution at the present day would find few advocates in this country. By a National Bank, according to the common use of that term in America, is intended an institution resembling in its essential features the Bank of England, or the late Bank of the United States. According to the doctrines maintained in the preceding chapters, such an institution is neither necessary nor useful. Such a bank has exclusive privileges, entirely inconsistent with freedom of competition. It always forms the strong-hold, the impregnable fortress, the pride and reliance of the monopolists. It is worthy of careful attention, what rapid strides the English jointstock banks have made since the Bank of England has been shorn of a part of its exclusive privileges. In like manner, the local banks of the United States

295

296

Free Banking I AND PAPER CURRENCIES.

171

have doubled in number and capital since Jackson's veto upon the recharter of the United States Bank' and that too notwithstanding the gold currency party have acted in the mean time in strict alliance with the monopolists of bank charters, and have most strenuously joined in the opposition to the creation of any new banks. These gold currency people bea.r a most desperate hatred to all monopolies,-and so far they are right. But they have suffered the common fate of fanatics j they have allowed themselves to be spellbound by words j and to be made instruments in the hands of the men they hate most, for promoting that very end to which they are most heartily opposed. It is said that a National Bank is necessary, First, To regulate the local banks and to keep them in order. Second, 'ro facilitate domestic exchanges. Third, To furnish a uniform currency. 1. The first of these reasons has been already disposed of in the preceding chapter. A free competition in banking will accomplish the end proposed, with much less trouble, and much greater certainty. This idea of creating one great bank to superintend and control all the other banks, rests upon no better foundat.ion than would the creation of one great firm, invested with peculiar privileges, for the purpose of regulating the foreign trade, and keeping in order the rest of the merchants engaged in it. It supposes a superior degree of knowledge and of disinterestedness on the part of the men who may happen to be chosen directors of the great bank, quite superhuman. Now, in point of fact, these directors are no more likely to be endowed with these superior gifts than the directors of any other respectable bank; and how they may be deluded, and how readily they may become the instruments to delude others, is evident, among other numerous instances, from the conduct and doctrines of the Bank of England during the suspension of specie payments; of the late Bank of the United States during the two first years of its existence j and

Free Banking I

172

BANKS, BANKING,

of the present Pennsylvania Bank of the United States, from the day it commenced operations down to the present moment. The trade or the currency of the country cannot safely be delivered over to the sole management of any single board of bank directors. This is the introduction of a sort of absolute monarchy into commercial affairs; a form of government which in theory, and supposing the despot to be eminently virtuous and wise, has a plausible appearance, but which in practice proves exceedingly pernicious. As open competition has been found to be the best and safest regulator of all other kinds of trade, so it will no dou bt prove the best and safest regulator of the trade of banking. 2. The business of domestic exchanges can be as well conducted by one bank as another. Free competition is as necessary here as elsewhere, and will soon reduce profits to their lowest level. Ever since 1834, the state of the domestic exchanges has formed a regular topic of newspaper declamation. Before the removal of the deposits, it is said, exchanges were at such and such low rates; since then, they have doubled, tripled, quadrupled; and this we are told is owing to the destruction of the United States Bank. Those who reason in this way do not seem to recollect that all the time that exchanges have been rising 80, the United States Bank has been going on, in full blast. To be sure, it has changed its character, in the mean time, from a national to a state bank; but that cannot have interfered to any great degree with its exchange business. It had the same capital, the same officers, the same credit, the same means. It is true that the diminution of its circulation had a tendency 10 diminish the total amount of its loans; but the close of its branches cut down its loans upon personal security, and tended to throw its whole capital into the business of domestic exchanges, and if it had

297

298

Free Banking I AND PAPER CURRENCIES.

173

lost the public deposits, it still retained a large amount of money belonging to the United States. 'rhe true cause of the derangement of the domestic exchanges is to be fonnd in the excessive indebtedness of several of the Southern and Western States to the commercial cities of the North. From 1823, when the Bank of the United States re-entered upon this business of domestic exchange, down to about the time of the removal of the deposits, the commercial balance between the cities of the North, and the Southern and Western States, remained about even, and of course the exchanges between them were nearly at par. Subsequently to the removal of the deposits, various circumstances inclined the commercial balance greatly against the South and West. Several of the Western States, to which a great tide of emigration was setting, imported much and exported little; while the cotton-growing States of the South, owing to the rise in the price of cotton, were enabled to obtain vast credits beyond the actual value of their produce remitted to the North. The South and West being thus brought greatly in debt to the commercial cities of the North, the exchange became unfavorable to them, and drafts upon those States could only be negotiated at a great discount. With or without a national bank, like causes will always produce the same results. When the commercial balance is greatly against any particular states or cities, it is impossible for any bank to collect or discount drafts upon them, except at a considerable premium. 3. With respect to the matter of a uniform currency, it cannot be denied that the late Bank of the United States supplied a paper generally current throughout the Union, and which was, in many cases, a matter of great convenience. The universal circulation of the paper of that bank was owing to two causes: first, its large capital and well-established credit, and secondly, the receivability of its notes in all payments made to the government. It is very possible, however, to carry the uniformity 15*

Free Banking I

174

BANKS, BANKING,

of the currency to a much greater extent than ever prevailed during the existence of a National Bank. The notes of that bank had a pretty uniform value in all parts of the country; but the local notes, which formed the great mass of the circulation, had bu.t a limited, local uniformity of value, and when carrIed to any considerable distance from the place of issue, not only they were not current, but heavy discounts had to be paicl to the broker who exchanged them for current notes. In England, all the country bankers have agents in London to redeem their notes there, and in many cases the notes, upon their face, are made payable in London as well as at the place of issue. By means of this system, no note of a banker in good credit can fall to any considerable discount. London, being the centre of trade, is the point towards which all the circulation constantly tends, and as the exchange, except under very peculiar circumstances, is always in favor of a place towards which trade concentrates, throughout the whole extent of the country to which it serves as a centre, notes which are redeemable in London preserve a pretty uniform value throughout the whole kingdom,-that is, if the issuer of the notes be known, and his credit be undoubted. A similar system has been adopted in New England with signal success. By the combined operations of a number of the Boston banks, all the country banks in New England have been obliged to keep funds in Boston for the redemption of their notes. The country banks did not come into this arrangement without some struggle against it, though it is, in fact, as much for their interest as it is for the public benefit. They found it, however, more safe and cOllvenient to keep funds in Boston for the redemption of their note~, than to expose themselves to have specie in large quantities demanded at their own counters, which was the alternative presented to their choice. The result of this arrangement is, that the note of any New England bank is at par any where in New Eng-

299

300

Free Banking I AND PAPER CURRENCIES.

175

Jand. It amounts to the same thing, so far as relates to the currency of their paper, as if all the banks redeemed each other's notes. The currency throughout New England is thus rendered perfectly uniform; each bank is constantly acting as a check upon all the others; and each is assured of its just share of the circulation. This same system has been adopted, to a certain extent, in some other parts of the country. To place the currency and the operations of the banks upon a basis of uniformity and solidity, it is necessary that this system should be so far extended, as that all the local banks should be obliged to redeem their notes at that commercial city towards which concentrates the business of the district in which they are situated; and in addition, the banks of these commercial centres should provide for the redemption of their notes in the city of New York, which has now become, beyond dispute, the commercial metropolis of the country. In this way the notes of every bank in the United States, of which the credit was unimpeached, would obtain the same uniformity of value which metallic coins, issued by different governments, possess. It is necessary to pay a certain premium in order to obtain the exchange of the gold coins of one country for the gold coins of another of equal weight and fineness; and a similar premium it would be necessary to pay to obtain the exchange of the local notes of one district for those of another. This however would not be the case with respect to the notes of the principal banks in the principal cities. These notes being all redeemable in New York, and being issued by banks of large capital and credit, and of general notoriety, would pass current in all parts of the Union. Such a scheme as this for the establishment and preservation of a uniform currency, though far superior to any thing which could be achieved by the sole agency of a national bank, cannot come into operation at oncc. It requires time for its maturity, and can only be introduced by degrees. In the mean time, and

Free Banking I

176

BANKS, BANKING,

during the state of t.ransition, some.incon!enience will be experienced, WhICh. however ~Ill be In. a great degree alleviated by vanous expedIents WhICh mercantile and banking ingenuity will suggest.

CHAPTER X. Of the duty of the Federal Government to regulate the Currency. IT seems to be sufficiently clear that the framers of the federal constitution intended to secure for the United States a currency of gold and silver coin, or of something equivalent to it, and exchangeable for it, at pleasure. This intention it is the duty of the federal government to carry into effect. We have seen, in the preceding chapters, that a currency of bank notes, so long as those notes retain their peculiar and characteristic quality of being exchangeable on demand for gold or silver, forms precisely the sort of currency which the framers of the constitution desired. Institutions have been established under state laws for furnishing this kind of currency, and so far, the federal government is saved from the necessity of intermeddling at all with the matter. Dut experience has shown that these state institutions are liable to a certain disorder called stoppage of specie payments, which unhanks them at orree, and changes them into mere machines for manufacturing paper money of no particular value,-a sort of commodity not a whit better than those bills of credit, of which the framers of the constitution had so wholesome an abhorrence. This unhappy disorder is apt occasionally to become epidemical; and what is still worse, the people, or some of them, have got into the habit of meeting together, and insisting that the banks shall stop payment whether they will or no, and then

301

302

Free Banking I AND PAPER CURRENCIES.

177

the state legislatures assemble and relieve the delinquent banks from all the penalties they have incurred by their stoppage. This is a sore evil. Banks that are banks, are excellent things, but non-specie-paying banks are the greatest nuisances with which a country can be cursed. This matter is wholly in the power of the federal government, and ought at once to be attended to. 1'he federal government possesses a sovereign medicine against this disorder, which it ought to apply at once. Let Congress enact a general bankrupt law, as it is specially authorized to do, including banks and other corporations, and placing them upon the same level with other bankrupts, and the thing is done. Such a suggestion was thrown out, accidentally perhaps, in Mr. Van Buren's message to Congress at the extra session of 1837. It was received with a general growl on the part of the suspended banks, and seems to have been since forgotten. That however is the thing. It is worth a dozen sub-treasuries, and is besides an act which the bitterest enemies and the best friends of the banking system might cordially unite in passing. Instead of wrangling about sub-treasuries, or independent treasuries; let the present Congress unite to pass such an act, and if it does nothing else it will deserve well of the country. If Mr. Van Buren is sincere, and if his party are sincere in their alleged good wishes towards the currency and the banks, here is the test.

CHAPTER XI. Of Banks OfDned in whole or in part by the State. IT has been a favorite notion with many persons, that the profits derived from using a paper currency instead of coin, ought properly to redound to the state, and not to be left to be engrossed by individuals. It

Free Banking I

]78

BANKS, BANKING,

is however a mistake to suppose that the profit derived from capital invested in the business of banking, differs in any respect from any other mercantile profit. There are expenses to be incurred, and, above all, a risk to be taken, and the profits derived from an issue of paper to circulate as currency, are, or at least would be under a system of open competition, no more than a fair compensation for this expense and risk. There is not in fact any reason why the state should attempt to engross the profits of banking any more than the profits of the foreign trade, or of any particular branch of manufactures. With the hope however of securing to the public the profits to be derived from the business of banking, banks have been at different times established in several of the states, owned wholly or in part by the state, or more or less under the management of the state government. Where the state merely takes a share of the stock, leaving the greater part of it in the hands of individuals, and leaving the bank to be managed principally by those individuals, no great harm results from this partnership. Indeed there may be very good reasons why a state should thus become partner in a bank. But whenever the state has been sole or principal owner, and has engrossed the entire or chief management of the bank, the consequences have uniformly been most disastrous. A state can only manage a bank by means of agents j and the agents elected to manage a state b~nk are, in general, politicians, who feel little or no interest in the ultimate success of the institution entrusted to their care, but who look upon it merely as a means, for the time being, of advantageous loans to themselves or their friends. It is a wellestablished mercantile maxim that no business is likely to flourish which is left entirely in the hands of hireling agents, who not only have no personal interest in its success, hut whose personal interest is, or may be, the other way. This maxim is quite as true in banking as in any thing else. Hence it has happened that all the American banks owned and controlled by states

303

304

Free Banking I AND PAPER CURRENCIES.

179

have had a very short career. The experiment was amply tried in Vermont, Kentucky, Tennessee, North Carolina, and perhaps some other of the states, a quarter of a century ago. Some of the South-western States have recently been trying new experiments of the same sort. There is every reason to believe that the result will be precisely the same now, that it was formerly. The only sure and reasonable means by which a state can participate in the profits of banking, seems to be, by means of a stamp duty upon circulating notes. A tax upon bank stock, such as is levied in Massachusetts and some other of the states, especially when such a tax is considered in connection with the usury laws, by which the banks are absolutely prohibited from charging a higher profit than six per cent, is one of the most unjust and unreasonable taxes that can possibly be imagined.

Free Banking I

PART THIRD. AN APOLOGY FOR ONE-DOLLAR NOTES. CHAPTER I. Origin of the prejudice against Small Notes. TRE Bank of England, for upwards of sixty years from the date of its incorporation, issued no notes of a smaller denomination than twenty pounds, or near one hundred dollars. In 1759, it commenced the issue of ten-pound notes, and in 1794, it began to issue notes of the denomination of five pounds. rrhe private bankers however, both of Scotland and England, had issued notes for much smaller sums. In Scotland, notes for five and ten shillings were in general circulation; and in Yorkshire some notes, it is said, were issued of no higher denomination than sixpence. Owing to certain abuses and evils which were alleged to attend upon the circulation of these small notes, the issue of any note in Scotland under twenty shillings was prohibited by act of Parliament. A similar act, but more restrictive, was enacted with respect to England, in consequence of which the English bankers ceased to issue any notes of a less denomination than five pounds. It appears that the Scotch small notes, above alluded to, customarily contained what was called an optional clause, by which the banker had the choice either of paying on demand, or in six months after demand, together with legal interest for the six months. The

305

306

Free Banking I PAPER CURRENCIES.

181

Yorkshire sixpenny notes contained a condition that they were not to be paid unless the holder would give change for a guinea to the person who issued them. Such conditions would be equally objectionable whatever might be the denomination of a note in which they were contained. Yet it seems probable that all the alleged evils of the small-note circulation, grew entirely out of these conditional clauses, which deprived the notes of the essential character of being payable on demand. After the stoppage of specie payments in 1794, and to supply the place of the gold circulation which began to leave the country, the Bank of England commenced the issue of one-pound notes, an example which was followed by all the private bankers. About the time of the resumption of specie payments, the notes of the Bank of England under five pounds were withdrawn from circulation, though the issue was still continued by the private bankers. During the crisis of 1826, the Bank of England re-issued about a million and a half of these small notes. Shortly after, an act was passed which prohibited altogether the circulation in England of notes under five pounds j it being alleged that the crisis and panic of 1825 had been caused, or aggravated, by the circulation of one-pound 110tes. The ministry were desirous of extending the same act to Scotland; but as soon as their intention was known, it aroused a determined spirit of resistance among the bankers and the people. ~ven ~he l?y:al Sir Walter Scott wrote a pamphlet agamst thIS mmlSterial project, and the ministers, with much reluctance and chagrin, found themselves obliged to abandon it. The prejudice against small notes which has been propagated from England to this country, has derived much support from the authority of Adam Smith. What he says upon this subject deserves therefore to be carefully examined; an:} llpon examination it will be found to be sufficiently meagre. It is as follows: "Paper money may be so regulated as either to confine itself very much to the circulation between the

16

Free Banking I

182

BANKS, BANKING,

different dealers, or to extend itself likewise to a great part of that between the dealers and the consumers. Where no bank notes are circulated under ten pounds' value'*' as in London, paper money confines itself very much' to the circulation between the dealers. When a ten-pound bank note comes into the hands of a consumer he is generally obliged to change it at the first shop ~here he has occasion to purchase five shillings' worth of goods, so that it often returns into the hands of a dealer before the consumer has spent the fortieth part of his money. When bank notes are issued for so small sums as twenty shillings, as in Scotland, paper money extends itself to a considerable part of the circulation between dealers and consumers. Before the act of Parliament which put a stop to the circulation of ten and five shilling notes, it filled a·still greater part of that circulation. In the currencies of North America, paper was commonly issued for so small a sum as a shilling, and filled almost the whole of that circulation. In some paper currencies of Yorkshire, it was issued for so small a sum as a sixpence. "When the issuing of bank notes for such very small sums is allowed and commonly practised, many mean people are both enabled and encouraged to become bankers. A person whose promissory note for five pounds, or even for twenty shillings, would be rejected by every body, will get it to be received without RCnlple when it is issued for so small a sum as a sixpence. But the frequent bankruptcies to which such beggarly bankers must be liable, may occasion a very considerable inconveniency, and sometimes even a very great calamity to many poor people who had received their notes in payment. "It were better perhaps that no notes were issued in any part of the kingdom for a smaller sum than five pounds. Paper money would then probably confine itself, in every part of the kingdom, to the circula• When this was written, the Bank of England had not commenced the issue of five-pound notes.

307

308

Free Banking I AND PAPER CURRENCIES.

183

tion between the different dealers, as much as it does at present in London, where no bank notes are issued under ten pounds' value; five pounds being in most parts of the kingdom a sum, which, though it will purchase perhaps little more than half the qnantity of goods, is as much considered, and is as seldom spent all at once, as ten pounds are amid the profuse expense of London. "When paper money, it is to be observed, is pretty much confined to the circulation between dealers and dealers, as at London, there is al ways plenty of gold and silver. When it extends itself to a considerable part of the circulation between dealers and consumers, as in Scotland, and still more in North America, it banishes gold and silver almost entirely from the country; almost all the ordinary transactions of its interior commerce being thus carried on by paper. The suppression of ten and five shilling bank notes somewhat relieved the scarcity of gold and silver in Scotland; and the suppression of twenty-shilling notes would probably relieve it still more. Those metals are said to have become more abundant in America, since the suppression of some of their paper currencies. They are said likewise to have been more abundant before the institution of those currencies."'*' It will be seen from the above quotation, that Smith advocates the prohibi lion of all notes under ten pounds in London, and of all notes under five pounds in the rest of the kingdom; and the reasons he gives are the two following: First, that when the issuing of notes for small sums is allowed, many mean people, who otherwise could not be able to get their notes into circulation, are encouraged and enabled to become bankers, and that inconvenience and calamity, especially to the poor, must result from the frequent bankruptcies to which such beggarly bankers are liable. Second, that if the circulation of bank paper is confined to the trade between dealers, that is, to the whole... Wealth of Nations, Book II. Chapter II.

Free Banking I

184

BANKS, BANKING,

sale trade, gold and silver will be plenty, whereas an extension of paper currency to the commerce between dealers and consumers, that is, to the retail trade, occasions a scarcity of gold and silver. With respect to the first of these reasons, it evidently is not applicable to the old system of banking in this country, which confines the issue of circulating notes to incorporated companies. A bank whose means or credit are such as to enable it to obtain a circulation for notes of a hundred or a thousand dollars, can be safely trusted to issue notes for one dollar. Or if these institutions are so destitute of means as to be unworthy of being trusted for the sum of one dollar, certainly they ought not to be allowed to obtain credit by means of notes for ten, twenty, a hundred, or a thousand dollars. Nor is this first reason any more applicable to the new system of banking, ill which New York has taken the lead, by which the right to issue notes is thrown open to every body, who will tirst lodge with the public authorities, security for the redemption of the notes issued. This security is as available for the small notes as for the large ones, and will be an effectual protection to the holders of the notes against loss by the" frequent bankruptcies of beggarly bankers." Smith's til'st objection being thus disposed of as inapplicable to this country, there remains only the second, which, as it is the argument principally relied upon by the American advocates for the suppression of small notes, will be examined at length in the next chapter. At the time of the passage of the English act of Parliament, in 1826, for the suppression of bank notes under five pounds, a new objection was brought forward against this kind of currency, which it will be well to mention. It was alleged that the one-pound notes were the cause, or one of the causes, of the panic and run of 1825, and that much of the alarm and confusion of that period, were caused by the demands

309

310

Free Banking 1 AND PAPER CURRENCIES.

185

made upon the bankers by the holders of these small notes. Now whatever may have been the case in England, the experience of Scotland, and of America, is quite different. No panic nor run, in either of those countries, was ever caused, or supposed to be caused, by the holders of the small notes. Upon the occasion of the late sllspension in the United States, it was not the holders of the small notes, or any demand for their redemption, that gave the bankers any trouble. It was the depositors whose calls were chiefly dreaded j any demand from the holders of the small notes only, the banks might have met without difficulty. But it is evident from the very facts of the crisis of 1825, that the small notes, merely as small notes, were in no respect the causes of the panic and the run; for in point of fact, at the very height of the run, the Bank of England re-issued a million and a half of its one-pound notes, which had been withdrawn from circulation two or three years before; and it was the finding of a chest containing these notes, which had accidentally escaped destruction, and their issue, which alone saved the bank from being drained of its specie, and compelled to sllspend. It is surely very strange, if small notes ha ve a natural tendency to produce runs and panics, that an issue of small notes, in the very height of a run, shonld have operated to put a stop to it. The trouble at that lime with the English country banks originated in the universal suspicion and distrust with which they were regarded i-a suspicion and distrnst which grew out of their limited capitals, the great extension of their loans, the want of publicity in their proceedings, and the fact that they were deeply entangled in the speculations of the day. The holders of the small notes demanded gold, because they doubted the solvency of the bankers. They were perfectly willing, however, to receive Bank-of-England one-poulld notes, becallse nobody doubted the solvency of that institution. It was the weakness of the English

16*

Free Banking I

186

BANKS, BANKING,

country banks that gave impnlse to the run, and it was that same weakness which obliged many of them to stop payment. The run upon the Bank of England was made by the country bankers, who drew out gold wherewith to redeem their own discredited notes. The mercantile pressure of that crisis was as severely felt in Scotland as in England; but Scotland escaped the run upon the banks, and all the disasters with which it was attended, because in Scotland the banks were strong, and their solvency undoubted.

CHAPTER II.

Answer to the Argument against Small Notes. THE notions prevalent in the United States upon matters of political economy, as well as upon a great variety of other subjects, are generally derived at second hand from England; and as happens in the case of the fashions, they often just begin to be adopted here, about the time they are beginning to be cast off at home. Deriving from England a prejudice against small notes, the majority of our political economists have pushed that prejudice to the extent of ascribing all the defects and evils, or supposed defects and evils, of our banking system and currency, to the circulation of onedollar bills. These ideas were by no means confined to any particular political party, nor to the sect in favor of an exclusive hard money currency. They were very generally adopted by men of all parties; the suppression of small notes was recommenderl as a remedy against panics, commercial fluctuations, and the inevitable disasters occasionally attendant upon trade and speculation; and the act of Congress, which provides for discarding by degrees from the pecuniary transactions of the Federal Government, the use of all notes under twenty dollars, received, at the time

3Il

312

Free Banking I AND PAPER CURRENCIES.

187

of its enactment, the general approbation of all parties. In several of the States, prohibitions against the issue of notes under five dollars had long existed. In several others, in consequence of the general attack upon this kind of currency, similar laws were enacted. The State of New York, however, has seen fit to retrace its steps in this matter, and other States will be likely to follow the example. The argument by which small notes have been assailed in this country, is in substance the same as the second argument cited in the preceding chapter from Adam Smith. It consists in the allegation that small notes tend to drive gold and silver out of the country, and to produce a scarcity of those metals, such as can only be relieved by the suppression of small notes. The assertion that the circulation of small notes tends to drive gold and silver ont of the country is unquestionably true; and it is precisely in that very way, to wit, by driving gold and silver out of the country, that they confer one of their chief benefits upon the community. When by means of the cheap substitute of paper, as a medium of trade, we are enabled to dispense with the expensive use of gold and silver, that gold and silver can he exported from the country, and being so exported, it adds just so much to our active capital; and this is one of the chief henefits derived from the use of bank paper. It is no doubt true, that small notes tend to banish gold and silver from the country; but it is just as true that large notes have that tendency in a much greater degree. A onedollar note, by supplying the place of a single silver dollar, tends to drive that silver dollar out of the country; but a twenty-dollar note, by taking the place of twenty silver dollars, tends to drive those twenty silver dollars out of the country. If, therefore, the object is, to keep gold and silver in the country, that object will be much more effectually accomplished by suppressing the large notes, and leaving the small ones

Free Banking I

188

BANKS, BANKING,

to circulate; by banishing the use of bank notes from wholesale transactions, and confining their use to retail dealings. For, as Adam Smith very justly observes, in the paragraph immediately preceding the qnotation given above, "The circulation between the dealers, as it is carried on by wholesale, requires generally a pretty large sum for each particular transaction. 'rhat between the dealers and the consumers, on the contrary, as it is generally carried on by retail, frequently requires but very small ones, a shilling, or even a halfpenny, being often sufficient. But small sums circulate much longer than large ones. A shilling changes masters more frequently than a guinea, and a halfpenny more frequently than a shilling. Though the annual purchases of all the consumers, therefore, are at least equal in value to those of all the dealers, they can generally be transacted with a much smaller quantity of money; the same pieces, by a more rapid circulation, serving as the instrument of many more purchases of the one kind than of the other." These statements are unquestionably true, and it unquestionably follows from them, that if the object is to keep the gold and silver in the country, that object will be more effectually accomplished by prohibiting large notes, than by prohibitillg small ones. It is most curious and instructive to observe how a prejudice long prevalent will continue to operate long after it has been fully exploded; and what is stranger yet, to operate even upon the minds of those who have had a principal hand in exploding it. ThIS dread of the expulsion of gold and silver from the country, which even Smith himself alleges as a valid argument against small notes, what is it but an idle fear growing out of the mercantile theory of political economy, according to which wealth consists, and consists only, in an abundance of the precious metals,-the groundlessness of which theory Adam Smith himself has so fully and clearly shown. There is another circumstance,-a sort of verbal error,-which no doubt has greatly contributed to

3/3

314

Free Banking I AND PAPER CURRENCIES.

189

give a seeming weight to this argument. People of little reflection are pretty apt to confound plenty of gold and silver with what, in mercantile phrase, is called plenty of money, and a scarcity of gold and silver with a scarcity of money. Whereas, in point of fact, a country,-such for instance as Spain or ~exico,-may contain a great abundance of gold and slIver, and yet money may be always scarce,-that is to say, there will always exist a great difficulty of borrowing money or of obtaining payment of debts j whereas in an other country,-Scotland or New England for example,-there may be a great scarcity of gold and silver, and yet money may, at times, be exceedingly plenty; and always far more so than in the countries with which they are here contrasted. In a country which is well supplied with a paper currency, issued by bankers of competent skill and competent capital, the only use of gold and silver is, to settle the balances between different parts of the country, and the balances with foreign nations. It has been imagined by some, that if small notes were banished from use, and their place supplied by a circulation of gold and silver, that this gold and silver would furnish a fund upon which the banks could draw, whenever the foreign exchanges turned against us; and thus might be avoided those contractions, and the consequent fluctuation of prices, with which a call upon the banks to furnish specie for exportation is commonly attended. This, however, is evidently and doubly a mistake. For, in the first place, the only possible way by which the banks could possess themselves of any of this circulating gold and silver, would be by a contraction of their loans; and in the second place, the country would suffer precisely the same, by the withdrawal from circulation of a part of this gold and silver, as it does by the withdrawal from circulation of an equal quantity of bank notes. The currency would thus suffer a double contraction. The banks, in the first place, would contract the currency by withdrawing

Free Banking I

190

BANKS, BANKING,

from circulation a quantity of their notes, in order by that means to get possession of a portion of the circulating gold and silver, and they would then contract the currency a second time, by sending that part of its metallic circulating medium which had thus fallen into their hands, out of the country, in payment of foreign debts. In truth, the idea that the metallic circulating medium, which begins where the paper circulating medium leaves off, whether that point be one dollar, five dollars, or twenty dollars, forms a fund upon which the banks can draw for the redemption of their paper, is to suppose that this gold and silver possesses the mirac.uIous power of being able to be in two places at the same time, of serving at one and the same moment as a medium for small transactions, and a medium for large ones. The gold and silver which is set apart to fill the smaller channels of circulation is as much appropriated to a specific purpose, as the gold and silver worked up into ear-rings and silver spoons; and in times of a demand for specie for exportation, the precious metals in the shape of ornaments and utensils, are just as much a resource, as the precious metals in the shape of circulating coin. The late suspension of specie payments, by exposing the circulating coin to be withdrawn from the channels in which it was employed, to be sold for a premium in order to be exported, furnished a striking proof of the inconveniences by which every snch withdrawal must be attended. Every body rec.ollects the trouble arising out of the scarcity of small change which for some time existed; an inconvenience which was felt in the highest degree in those states in which the circulation of notes under five dollars was prohibited, and in which, of course, the gap created by the withdrawal of the metallic currency was the widest. In several of these states, this incon venience was so severely felt, as to lead to the issue, on the part of corporations, companies, and individuals, of what were called shin plasters, that is, notes from the

315

316

Free Banking I AND PAPER. CURRENCIES.

191

denomination of three dollars down to five cents, a practice which, though it was in direct violation of the laws, was yet tolerated in consideration of its convenience. It is thus sufficiently evident that so far as regards a supply of specie, to satisfy any foreign demand that may arise, nothing is to be gained by the suppression of small notes. Nor is any relief to be thus obtained against a domestic pressure upon the banks. Such a pressure can only arise from the same causes which produce a pressure upon individuals,-that is, from severe and unexpected losses, from doubts, whether well or ill founded, of the solvency of the banks, or from too great an extension of their business; in other words, from getting too much into debt. Suppose a bank exposed to one or all of these causes of embarrassment,-can any relief be afforded by the fact that all the minor channels of circulation are filled with specie 1 Is it any aid to my difficulties that other people have an abundance of gold and silver 1 Will the coin in their pockets enable me to pay my debts 1 But it is said that prohibiting the circulation of small notes will have a tendency to diminish those sudden fluctuations in the amount of the currency, which are often attended with such disastrous consequences. It has been shown in a previous chapter, that effects generally ascribed to a fluctuation in the amount of the circulating medium, are chiefly produced by a fluctuation of bank loans,-fluctuations which may occur to a great extent, quite independently of the amonnt of circulating medium. But whether the effects of a fluctuation in the amount of the currency be greater or less, it is easy to show that the small-note portion of the currency, where small notes are allowed, is altogether the most stable portion of it, and snpposing the solvency of the banks to remain undoubted, that it is liable, in fact, to but very slight variations. Bearing in mind the distinction set up by Adam

Free Banking I

192

BANKS, BANKING,

Smith, in the passages above quoted, between the wholesale and the retail trade, it is clear, in the first place, that the small-note portion of the currency must at all times form but a small part of the total circulation. It is equally clear that the retail trade, to which the use of small notes is principally confined, is not at all liable to those speculative inflations, by which sudden expansions of the currency are chiefly caused. Speculation is confined to the wholesale trade, and as it prevails to a greater or less extent, it produces great, and frequently very sudden changes in the amount of currency which the wholesale trade requires, that is to say, in the circulating amount of large notes. As the small-note currency is free from this cause of expansion, it is of course free from the corresponding contractions growing out of the gradual decline, or sudden fall of speculative operations. '!'he retail trade, without doubt, is liable to fluctuate with the ability, or snpposed ability, of the consumers. But even the decline of that ability creates a new occasion for small notes, because they come to be substituted in many cases in the place of large ones, those who formerly purchased to the amount and with a note of ten or twenty dollars, being now reduced to employ a two or a five. The truth is, that in cases of a contraction of the paper currency, it is the large notes, the notes for a thollsand, five hundred or a hundred dollars, that first begin to disappear; and the contraction must be carried to a great extent before it reaches the twos and the ones. That this must be so, is clear from the well-known fact, that the average time which bank notes of different denominations remain in circulation, diminishes rapidly as the denomination of the notes increases. Hence the curtailment must principally fall upon the large notes, because they are the first to return to the possession of the issuer. As it is with contractions, so it is with expansions of the currency. The mcrease of speculative, that is of prospective operations,-operations carried on upon a

317

318

Free Banking I AND PAPER CURRENCIES.

193

large scale,-demands an increase o.f large notes, adapted to. the use o.f that so.rt o.f business. which increase takes place acco.rdingly, while the "amo.unt o.f the small no.tes remains co.mparatively steady. It thus appears that the suppression of small no.tes, so. far from giving a stability to the paper currency, acts directly to increase its tendency to. fluctuatio.n. The evils gro.wing out o.f commercial fluctuatio.ns have been felt with much greater severity in England than in Sco.tland. The former co.untry has suffered ten times as much from bank failures as ever did the latter; yet in Sco.tland twenty-shilling no.tes have always circulated, while in England five po.unds has generally fo.rmed the limit of the paper circulatio.n. So far as regards bank failures, this difference has been chiefly produced by the superiority o.f capital and means po.ssessed by the Sco.tch joint-stock banks. The weakness of the English private banks, caused by the limitatio.n in the number of their partners, and their peculiar liability, gro.wing Gut of their co.nstitution and management, to' be deeply invo.lved in every new speculation, has been the efficient cause o.f the frequent, extensive and disastro.us failures to' which they have been expo.sed. The banks o.f New England, tho.ugh they have always issued o.ne-do.llar no.tes, have been infinitely mo.re stable than the English private banks. It has been alleged as an evil growing out o.f the circulatio.n o.f small no.tes, that it banishes specie from the interio.r and co.ncentrates it in the large towns on the sea-board; so. that in case of a demand for specie for exportation, that demand falls wholly and at once on the sea-port banks. Now, in point o.f fact, this concentration o.f the specie o.f the c~>untry in the great commercial towns, so. far from bemg an evil, is so much a good, that it may be enumerated as o.ne of the principal benefits to be derived from the system of inducing all the co.untry banks to redeem their no.tes in that commercial town with which the section of the country to which they belong is princi.. pall y co.nnected. 17

Free Banking I

194

BANKS BANKING,

On this subject of specie and the demand on the banks for specie, a strange hallucination seems to prevail. The idea appears to be, that the proper duty of the specie fund of a bank is, to lie forever idle in the bank vaults j whereas, the entire utility of keeping a fund of specie on hand arises from the fact, that such a fund is occasionally needed for use. That use of it which is the most common, most extensive, and most important, is, to settle the halances with foreign countries j and to enable it to perform this office with the greatest promptitude and convenience, it is necessary that it should be concentrated ill those great commercial marts through which the intercourse with foreign countries is principally carried on. lt is the proper business of the banks of these great cities to attend to this matter of foreign balances, and they ought always to have the means on hand to meet any sudden demand from abroad. Instead of being taken by surprise by the turn of the exchanges against us, and overwhelmed with a panic, which they presently communicate to the rest of the country, that is a contingency which they ought always to bear in mind, and to be prepared for. Suppose, for instance, such a demand from abroad upon the New York banks for specie, as to diminish their stock on hand one half or three quarters,-it is certainly the duty of those banks so far to diminish their loans as to be enahled to replace the amount that has been withdrawn from their vaults. This however they ought to do gradually. It is not necessary that the specie should be replaced the very instant it is withdrawn j that indeed is in the nature of things impossible j nor is it either necessary or expedient for the bank to create a panic by a sudden and violent contraction, for such a panic, by causing a sudden fall of prices, and a sudden interruption to commercial transactions, makes unnecessary a portion of the currency. previously circulating. This currency, thus set free, mstantly tends to return to the source of its issue; so that the same process by which the banks

319

320

Free Banking I AND PAPER CURRENCIES.

195

suddenly withdraw a portion of their issues, creates the. ne~essity of withdrawing still another portion. ThIs dl~culty may be easily avoided by a gradual contractIOn. It is indeed commonly alleged that for every dollar withdrawn from the banks in coin, it becomes necessary for the banks to withdraw from circulation some five, six, or ten dollars of their paper, or to diminish their loans in that proportion. This notion is founded upon the idea, that the specie in the vaults of a bank forms the basis of its issues, and that each specie dollar in a bank vault supports the circulation of a certain number of paper dollars, determined by the ratio which the entire amount of the specie of a bank bears to the entire amount of its circulation, which basis being withdrawn, the quantity of paper which it supported, must be withdra wn also. This idea, however, is clearly erroneous. The amount of notes which a bank may be able to keep in circulation has nothing whatever to do with the amount of specie in its possession. It depends entirely upon the ex lent of the sphere through which the notes circulate, and upon the amount of the competition which they have to encounter. It is very plain that if a bank which has paid out from its vaults half a million of specie, instead of lending out upon interest the next half million which is paid into it,-whether that half million paid in consists of its own notes or the notes of other banks,--shall employ that sum in the purchase of specie, it can by that means, with a small deduction for premium and commission, replace all the specie it has lost. Diminishing the circulation of a bank has no tendency whatever to increase its specie, but only to decrease the likelihood of a call upon it for specie. As a general rule, it is better for a bank to protect itself by withdrawing its notes from circulation than by the purchase of gold and silver coin. The notes which it issues for snch purchases are liable to return upon it at once; whereas the notes withdrawn not only dimin-

Free Banking 1

196

BANKS, BANKING,

ish its liabilities by their own amount, but the withdrawal diminishes at the same time the likelihood of the return of any part of its remaining circulation. Some of the principal banks in New York and Philadelphia have adopted a judicious method of protecting themselves against runs for specie dra wn out for the purpose of paying foreign balances. They have opened accounts with English bankers, to whom they make remittances when the exchange is in their favor. When the exchange turns against them or is on the point of doing so, they draw against that fund, and by coming into the market at such times as sellers of exchange, they keep down the price of it, and thus prevent the exportation of specie. On the other hand, by coming into the market as purchasers when exchange is low, they tend to raise the price. Thus they operate in both ways, to prevent fluctuations in its value, and while protecting themselves, at the same time they confer a great benefit upon the merchants. These operations are as yet in their infancy. They admit of being extended much further.

CHAPTER III.

Advantages and D-isadvantages of a Small-Note Currency. HAVING shown the futility of all attempts to improve the currency, by prohibiting the circulation of small notes, the question, whether or not the circulation of such notes ought to be permitted, remains to be settled by a comparison of the advantages and disadvantages with which their use is attended. The benefits of a small-note circulation are the same in kind, though not so obvious and striking in their character, as those attendant upon a circulation of large notes. They enable us to dispense altogether with the use of gold, that most expensive of

321

322

Free Banking I AND PAPER CURRENCIES.

197

circulating mediums,-and they reduce the quantity of silver required for circulating uses within a very narrow limit. Three quarters, at least, of the gold and silver thus set free becomes a net addition to the capital of the country, and the disappearance of these precious metals from ordinary use, so far from being an evil, is only a sign that they have been converted from a dead, into an active capital. Under these circumstances, to complain that the paper has banished the specie, would be just as reasonable as to lament that the use of cheap cottons had banished the use of dear linens. The convenience afforded by the use of small notes, though not so obvious to the senses as that which arises from the use of large ones, is yet very considerable. A silver dollar is a cumbrous coin, and ten silver dollars in bulk and weight are more than any one desires to carry about him. Small notes possess besides the great ad vantage of being transmissible by the post; and though the remittance of five or ten dollars may seem a very tritling matter to some, it is an affair of no inconsiderable convenience to a large portion of the community. The convenience of small notes is sufficiently proved by the extreme reluctance of a community, which has once experienced their advantages, to give up the benefit of them. In some states so situated, severe laws have been enacted against their use; but those laws have never been enforced. It has been easy indeed for a state to prevent its own banks from issuing notes except of a certain denomination; but the gap thus created has been instantly filled by an influx of small notes from other states. It becomes a matter of speculation with banks or individuals of other states, to furnish a small-note currency for the citizens of the prohibiting state; and advantage has been taken of the withdrawal from circulation of the small notes of banks well known and entitled to confidence, to push into circulation the small notes of distant banks not possessed of any solid capital; so that the 17*

323

Free Banking I

198

BANKS, BANKING,

only effect of those laws has been to substitute doubtful notes in the place of good ones. Another advantage derived from the circulation of small notes, consists in the encouragement which it holds out for the establishment of small country banks. If the circulation of all notes under twenty dollars were prohibited, the greater part of the country banks of New England would have no circulation at all, nor would they be able to continue their business to advantage. 'l'he profits which the city banks derive from the use of deposits, is shared only in a trifling degree by the country banks. l,'or any thing beyond the bare interest on their capital, those banks are mainly dependent upon their circulation, and that circulation is mainly a small-note circulation; so that the prohibition of the issue of notes under twenty dollars, would cause the shutting up of the greater part of the country banks, and would deprive the country towns of the facilities and benefits which they confer. There seem to be only two cases in which any advantage can be derived from prohibiting the circulation of small notes. The first case is, when the whole banking system of a country is so destitute of a sufficient foundation of capital, or of sufficient judgment and skill in the employment of that capital, as to create a degree of unsoundness in the whole mass of the paper currency. In such a case, any thing which tends to increase the circulating proportion of the precious metals is a benefit; and the prohibition of small notes, so far as it goes, is a benefit. But it is sufficiently obviolls that the prohibition of large notes would be a still greater benefit, since, by the supposition, they do not possess those qualities which alone adapt them to serve as a substitute for the precious metals. The advocates of a purely metallic currency are therefore sufficiently consistent in advocating the nrohibition of smaU notes. They assume that every rency of bank paper is, and of necessity mnst be, unsafe and unsound. Tbeir objeet, therefore, is to abol-

cur-

324

Free Banking I AND PAPER CURRENCIES.

199

ish the use of paper entirely. Knowing, however, that such projects are best carried by degrees, they begin with the one-dollar notes; and their warfare against this description of currency is greatly assisted by the prevailing prejudice with regard to it, the explosion of which has been above attempted. From the onedollar notes, they proceed to the fives, the tens, the twenties. But having advanced thus far, they will not stop. Those same fluctuations of trade, that. same alternation of high and low prices, which have furnished the pretence for prohibiting notes under twenty dollars, will still continue to occur; and will form a reason quite as substantial for demanding the prohibition of all notes whatever. Gold is the panacea of these physicians; and if the patient fails to amend under their prescription, they will still declare that the only reason is, that he has not taken enough of the medicine. There is one other case in which the prohibition of small notes may be beneficial, and that is, where the mass of the inhabitants are unable to read. The value, and even the authenticity of a bank note, is to be judged of by the reading upon it; but if the mass of the inhabitants are unable to read, they will be unable to distinguish good notes from bad ones, and will be liable to gross impositions. In such a country, Adam Smith's doctrine of confiniug the use of bank pa.per to wholesale transactions, might perhaps be wisely adopted; for in this case, as in others, ignorance would be likely to turn into an evil what otherwise would be a benefit. These two cases seem to be t.he only ones in which the slightest advantage is derivable from that prohibition of small notes, to which such an undue importance has been given. If there is any portion of the Union to which these reasons are applicable, it is the Southern States, and perhaps in those states the prohibition of small notes' may be a wise enactment.

Part III Later British Writers

[7] Excerpt from Herbert Spencer, Westminster Review, 21(}-32

ART. VlII.-STATE-TAMPERINGS WITH MONEY

& BANKS.

1. Principles of Political Economy, with some of thei1' Applications to Social Philosophy. By John Stuart Mill. FourthEdition. London: John W. Parker and Son. 1857. 2. The Elements of Political Economy. By Henry Dunning Macleod. London: Longman and Co. 1857. 3. On the Bank Oharter Act of 1844, its Principles and Opera-

tion;. 1vith Suggestions for an Improved Administration of the Bank of England. By Thomas Tooke, F.R.S. London ~ Longman and Co~ 1856. 4. Oapital, OU'F'fency, and Banking. By: James Wilson, Esq., M.P..

A

MONG unmitigated rogues, mutual trust is impossible_ Among people of absolute integrity, mutual trust woulcl be unlimited. These are truisms. Given a nation made up entirely of liars and thieves, and all trade between its members must be carried on either by barter 01' by n currency of intrinsic value: nothing'in the shape of promises to pay can pass in place of actual payments; for, by the hypothesis, such promises being never fulfilled, will not be taken. On the other hand, given a nation of perfectly honest men-men as careful of the rights of others as of their oWD-and nearlv all trade between its members may be carried on by memoranda 'of debts and claims, eventually written off against each other in the books of bankers; seeing that as, by the hypothesis, no man will ever issue more memoranda of debts than his goods and his claims will liquidate, his paper will pass current for whatever it represents: coin- will be needed only to fumish a measure of value, and for those small transactions for which it is physically the most convenient. These we take to be self· evident truths. From them follows the obvious corollary, that, in a nation neither wholly honest nor wholly dishonest, there may, and eventually ,yiIl, be established a mixed currency-a currency partly of intrinsic value, and partly of credit·value. The ratio between the qnantities of these two kinds of currency ,vill be determinell by a combination of several causes. Supposing that there is no legislative meddling, which may of course disturb the natural balance, it is clear from. what has already been said, that, fundamentally, the proportion of coin to paper will depend upon the average conscientiousness of the people. Daily experience must ever be teaching each citizen

328

Free Banking I

Nat1wal Variations oj the Currency.

211

which other citizens he can put confidence in, and which not. Daily experience must also ever be teaching him how far this confidence may be carried. And thus, from personal experiment, and from current opinion which results from the experiments of others, everyone must learn, more or less truly, what credit may safely be given. If all find that their neighbours are little to be trusted, but few promises to pay will circulate. And the circulation of promises to pay will increase as fast as all find that the fulfilment of trading engagements becomes more certain'. The degree of honesty characterizing a community being thus the first regulator of a credit currency, the second is the degree of prudence. Other things equal, it is manifest that among a sanguine, speculative people, promissory payments will be taken more readily, and will therefore circulate more largely, than among a cautious people. Two men having exactly the same experiences of mercantile risks, will, under the same circumstances, respectively give credit and refuse it, if they be respectively rash and circumspect. And, manifestly, two nations thus contrasted in prudence will be similarly contrasted in the relative quantities of notes and bills in circulation among them: or, rather, they will not be similarly contrasted in this respect, but much more contrasted; seeing that the prevailing incautiousness will not only entail an undue readiness on the part of each citizen to give credit, but also an undue readiness to risk his own capital in speculations, and a consequent undue demand for credit from others. There will be both an inoreased pressure for credit, and a diminished resistance; and therefore a more than proportionate excess of paper currency; Of this national characteristic and its consequences, we have a conspicuous example in the United States. To these comparatively permanent moral causes, on which the ordinary ratio of hypothetical to real money in a community depends, have to be added certain temporary moral and physical causes which produce temporary variations in the ratio. The degree of prudence displayed by any people is liable to more or less fluctuation. In railway manias and the like, we see that irrational expectations, based upon inadequate evidence, may spread through a whole nation, and lead its members to give and take credit almost recklessly. But the chief causes of temporary variation are those which directly affect the quantity of available capital. Wars, deficient harvests, or losses nonsequent on the misfortunes of other nations, will, by impoverishing the community, inevitably lead to an increase in the ratio of promissory payments to actual payments. For what must be done by the citizen whose losses disable him from meeting his engagements? -the shopkeeper whose custom has greatly fallen off in consep2

Free Banking I

212

State-tamperings with Money and Bunks.

quence of the high price of bread; the manufacturer whose good::; lie in his warerooms unsaleable; the merchant whose foreign correspondents fail him? As the proceeds of his business do not suffice to liquidate the claims upon him that are falling due, he is compelled either to find other means of liquidating them, or to stop payment. Rather than stop payment, he will, of course, make temporary sacrifices-will give high terms to whoever will flirnish him with the desired means. If, by depositing securities with his banker, he can get a loan at an advanced rate of interest, well. If not, by offering an adequate temptation, he may mortgage his property to some one having good credit; who either gives bills, or draws on his banker for the sum agreed on. In either case, extra promises to pay are issued; or, if the difficulty is met by accommodation-bills, the same result follows. And in proportion to the number of citizens obliged to resort to one or other of these expedients, must be the increase of promissory paymeuts in circulation. Reduce the proposition to its most general terms, and it becomes self-evident. Thus :-All banknotes, C118(111eS, bills of exchange, &c., are so many memoranda oj claims: no matter what may be the technical distinctions among them on which upholders of the "currency principle" seek to establish their dogma, they every one of them come within this definition. Under ths ordinary state of tbings, the amount of available wealth in the hands, or at the command, of those concerned, 5uffices to meet these claims as they are severally presented for payment; and they are paid either by an equivalent of intrinsic yulue, as coin, or by giving in place of them other memoranda of claims on some body of undoubted solvency, as the Bank of England. But now let the amount of available wealth in the hands of the community be greatly diminished. Suppose a large portion of the necessaries of life, or coin, which is the most excltang.'nble equivalent of such necessaries, has been sent abroad to SnppGi"t an army, or to subsidize foreign states; or, suppose that the:";.? has been a failure in the crops of grain or potatoes; or, sappose that an extremely short supply of cotton has entailed ;1 gTeatly diminished produce of exportable manufactures, and therefore of the consumable articles we purchase with such mand·aetmcs. Suppose, in short, that, for the time being, the n<1tion is impoverished. What follows? It follows that a great proportion of the claims cannot be liquidated. And whltt must happ(m from their non-liquidation? It must happen that. those unable to liquidate them will either fail, or they will redeem them by direetly or indirectly giving in exchange certain memoranda of cbill13 upon their stock-in-trade, houses, or land. That is, such of these claims as the deficient floating capital does not suffice to m~et, are replaced by claims upon jixe(Z capital. The

329

330

Free Banking I

Increase of Notes in Times of Difficulty.

213

l1:emoranda of claims which should have disappeared by liquidatwn, reappear in a new form; and the quantity of paper currency is increased. If the war, famine, or other cause of impoverishment continues, the process is repeated. Those who have no further fixed capital to mortgage, become bankrupt; while those whose fixed capital admits, mortgage still further, and still further increase the promissory payments in circulation. 1tlanifestl y, if the members of a community whose annual returns but little more than suffice to meet their annual debts, suddenly lose part of their annual returns, they must become proportionately in debt to each other; and the documents expressive of debt must be proportionately multiplied. This it pri01'i conclusion is in perfect harmony with mercantile experience. The last hundred years have furnished repeated illustrations of its truth. After the enormous export of gold in 1795-6 for war loans to Germany, and to meet bills drawn on the Treasmy by British agents abroad; and after large advances made under a moral compulsion by the Bank of England to the Government; there followed an excessive issue of bank-notes. In 179U-7, there were failures of the provincial hanks, a panic in London, a run on the nearlv exhausted Bank of England, and a suspension of cash-puyment~-a State-authorized refu~al to redeem promises to pay. In 1800, the further impoverishment consequent on (\ bad han-est, joined with the legalized incoIlvertibility of bank-notes, entailed so great a multiplication of them as to cause their depreciation. During the tempol'llry peace of ] 802, the country partly recovered itself; and the Bank of England would have liquidated the claims on it, had the Government allowed. On the subsequent resumption of war, the phenomenon was repeated: as in later times it has been on each occasion when the community, carried away by irrational hopes, has locked up an undue proportion of its capital in permanent works. :Moreover, we have still more conclusive illustl'ationsillustrations of the sudden cessation of commercial distress and bankruptcy, resulting from a sudden increase of credit circulation. When, in 17D3, there came a general crash, mainly due to an unsafe banking system which had grown np in the provinces ,in consequence of the Bank of England monopoly-when the pressure, extending to London, had become so great as to alarm the Bank directors and cause them suddenly to restrict their issues, thereby producing a frightful multiplication of bankruptcies; the Government (to mitigate an e,-il indirectly produced by legis~a­ tion) determined to issue Exchequer Bills to such as could glve adequate seeurity. That is, they allowed hard-pressed citizens to mortgage their fixed capital for an equivalent of State promises to pay, with which to liquidate the demands on them. The effect

Free Banking I

214

State-tamperings with Money and Banks.

was magical. 2,202,000l. only of Exchequer Bills were required. The consciousness that loans would be had, in many cases prevented them from being needed. The panic quickly subsided. And the loans were all shortly repaid. In 1825, again, when the Bank of England, after having intensified a panic by t}xtreme restriction of its issues, suddenly changed its policy and in four days advanced 5,000,OOOl. notes on all sorts of securities, the panic at once ceased. Anel now, mark two important truths: one of them, indeed, already indicated in the foregoing paragraph. Observe, in the first place, that this expansion of paper circulation which naturally takes place in times of impoverishment or commercial difficulty, is highly salutary. This issuing of securities for future payment when there does not exist the wherewith for immediate payment is a means of mitigating national disasters that would else be far more severe. In few words, the process amounts to a. postponement of trading engagements that cannot at once be met. And the alternative questions to be asked respecting it are -Shall all the merchants, manufacturers, shopkeepers, &c., who, by unwise investments, 01' war, or famine, or great losses abroad, have been in part deprived of the means of meeting the claims upon them, be allowed to mortgage their fixed capital to a bank in return for promises to pay of equivalent value? or, by being debarred from so issuing memoranda of claims on their fixed capital, shall they be made bankrupt? On the one hand, if they are permitted to avail themselves of that credit which their fellowcitizens willingly give them on the strength of the proffered securities, most of them will tide over their difficulties: in virtue of that accumulation of surplus capital ever going on, they will be able, by-and-by, to lir!uidate their debts in full. On the other hand, if, as they must else be, they are forthwith made bankrupt, carrying with them others, and these again others, there follows, in the first place, a most disastrous loss to all the creditors: property to an immense amount being peremptorily sold at a time when there can be comparatively few able to buy, must go at a great sacrifice; and those who in a year or two would have been paid in full, must be content with lOs. in the pound. Added to which eyil comes the still greater one-an extensive damage to the organization of society. Numerous importing, producing, and distributing establishments are swept away; tens of thousands of their dependents are left without work; and before the industrial fabric can be repaired, a long time must elapse, much labour must lie idle, and great distress be borne. Between these alternatives who, then, can pause? Let this spontaneous remedial process follow its own course, and the evil will be either staved-off and in great measure eventually escaped, or will be spread little by

331

332

Free Banking I

A Note-circulation cont'J"acts when undue.

215

little over a considerable period. Stop this remedial process, and the whole evil, falling at once on society, will bring widespread ruin and misery. The se.concl of these important truths which we have to note, is that an expanded circulation of promises to pay, caused by abso. lute or relatiye impoverishment, contracts to its normal limits as fast as the need for expansion disappears. For the very conditions ofthe case imply, that all who have mortgaged their fixed capital to obtain the means of meeting their engagements, have done soon very unfavourable terms; and are therefore under a strong stimulus to redeem their mortgages as quickly as possible. Everyone who at a time of commercial pressure gets a loan from Q. bank, has to pay a high rate of interest. Hence, as fast as prosperity returns, ancl his profits accumulate, he is glad to escape this heavy tax by repaying the loan: in doing which he takes back to the bank as large a number of its promises to pay as he originally received; and' so diminishes the note-circulation as much as his original transaction had increased it. Thus we see that the balance of a mixed currency is, under all circumstances, self-adjusting. Supposing considerations of physical cOlwenience out of the question, the average ratio of paper to coin is primarily dependent on the average trustworthiness of' the people, and secondarily dependent on their average prudence. When, in consequence of unusual prosperity, there is an unusual increase in the number of mercantile transactions, there is a corresJlonding increase in.the quantity of currency, both metallic and paper, to meet the requirement. And when from war, famine, or over-investment, the available wealth in the hands of citizens is insufficient to pay their debts to each other, the memoranda of debts in circulation acquire an increased ratio to the quantity of gold; to decrease again as fast as the excess of debts can be liquidated. That these self-regulating processes act but imperfectly, is doubtless true. With an imperfect humanity, they cannot act otherwise than imperfectly. People who are dishonest, or rash, or stupicl, will inevitably suffer the penalties of dishonesty, or rashness, or stupidity. If any think that by some patent legislatiye mechanism a societv of bad citizens can be made to work together as well as a society of good ones, we shall not take pains to show them the contrary. If any think that the dealings of men deficient in uprightness and prudence, may be so regulated by cunningly-devised Acts of Parliament as to secure the effects of uprightness and prudence, we have nothing to say to them. 01' if there are any (and we fear .there are numbers) who think thut in times of commercial difficulty, resulting from impovedshment 01' other natural causes, the evil can be staved-off by some ministerial sleight of haud, we despair of convincing

Free Banking I

216

State-tamperings with Money and Banks.

them that the thing is impossible. See it or not, however, the truth is, that the State can do none of these things. As- we shall show, the State can, and sometimes does, produce commercial disasters. As we shall also show, it can, and sometimes does, exacerbate the commercial disasters otherwise produced. But while it can create and can make worse, it cannot prevent. All which the State has to do in the matter is to discharge its ordinary office-to administer justi.ce. The enforcement of contracts is one of the functions included in its general function of maintaining the rights of citizens. And among other contracts which it is called on to enforce, are the contracts expressed on credit-documents-bills of exchange, cheques, bank-notes. If anyone issues a promise to pay, either on demand or at specified date, and does not fulfil that promise, the State, when appealed to by the creditor, is bound in its pi'otective capacity to obtuin fulfilment of it, at whatever cost to the debtor; or such partial fulfilment of it as his effects suffice for. The State's dutv in the case of the cunency, as in other cases, is sternly to thre~ten the penalty of bankruptcy on all who make engagements which they cannot meet; and sternly to inflict the penalty when called on by those aggrieved. If it falls short of this, mischief ensues. If it exceeds this, mischief ensues. Let us glance at the facts. Had we space to trace in detail the history of the Bank of England-to show how the privileges contained in its first charter were bribes given by a distressed Government in want of a large loan-how, soon afterwards, the law which forbad a partnership of more than six persons from becoming bankers, was passed to prevent the issue of notes by the South-Sea Company, and so to preserve the Bank monopoly-how the continuance of Statefavours to the Bank corresponded with the continuance of the Bank's claims on the State; we should see that, from the first, banking legislation has been an organized injustice. But passing over earlier periods, let us begin with the events that closed the last century. Our rulers of that day had entered into a warwhether with adequate reason need not here be discussed. They had lent vast sums in gold to their allies. They had demanded large advances from the Bank of England, which the Bank dared not refuse. They had thus necessitated an excessive issue of notes by the Bank. That is, they had so greatly diminished the floating capital of the community, that engagements could not be met; and an immense number of promises to pay took the place of actual payments. Soon after, the fulfilment of these promises became so difficult that it was forbidden by law, amI cash-payments were suspended. Now for all these results-for the national impoverishment, and consequent abnormal state of the

333

334

Free Banking I

Law-produced Depreciations.

217

currency, the State was responsible. How much of the blame lay with the governing classes, and how much with the nation at large, we do not pretend to say. What it concerns us here to note is, that the calamity resulted from the acts of the ruling power. When again, in ] 802, after a short 'peace, the available capital of the community had so far increased that the redemption of promises to pay became possible, and the Bank of England was anxious to begin redeeming them, the legislature interposed its veto; and so continued the evils of an inconvertible paper currency after they would naturally have ceased. Still more disastrous, however, were the results that by-and-bye ensued from State-meddlings. Cash-payments having been suspended-the Government, instead of enforcing all contracts, having temporarily cancelled a great part of them, by saying to evel'Y banker, " You shall not be called upon to liquidate in coin the promises to pay your issue ;" the natural checks upon the multiplication of promises to pay disappeared. What resulted? Banks being no longer required to cash their notes in coin, and easily obtaining from tbe Bank of England supplies of its notes in exchange for fixed securities, were ready to make advances to almost any extent. Not being obliged to raise their rate of discount in consequence of the diminution of their available capital; and reaping a profit by every loan (of notes) made on fixed capital; there arose both an abnormal facility of borrowing, and an abnormal desire to lend. Thus there were fostered the wild speculations of 1809-speculations which were not only thus fostered, but were in great measure caused by the previous over-issue of notes; which, by fnrthel' exag gerating the natural rise of prices, increased the apparent profitableness of investments. And all this, be it remembered, took place at a time when there should have been a rigid economy-at a time of impoverishment consequent on continued war-at a time when, but for law·produced illusions, there would have been commercial straitness and a corresponding carefulness. Just when its indebtedness was unusually great, the community was induced still furtber to increase its indebtedness. Clearly, then, the progressive accumulation and depreciation of promises to pay, and the commercial disasters which finally resulted from it in 181415-16, when ninety provincial banks broke and as many more were dissolved, were State-produced evils; partly due to a war which, whether necessary or not, was carried on by the Government, and greatly exacerbated by the currency regulations which that Government had made. Before passing to more recent facts, let us parenthetically notice the similarly-caused degradation of the currency which had previously arisen in Ireland. When examined by a parliamentary committee in 1804, Mr. Colville, one of the directors of the Bank

Free Banking I

218

State-tarnperings with :Money and Banks.

of Ireland, stated that before the passing of the Irish BankRestriction Bill-the bill by which cash-payments were suspended -the directors habitually met any unusual demand for gold by diminishing their issues; that is to say, in the ordinary course of business, they raised their rute of discount whenever the demand enabled them, and so both increased their profits and warded-off the danger ofbankruptcv. During this unregulated period, their note-circulation was between .£600,000 and £700,000. But as soon as by la,v they were guaranteed against the danger of bankruptcy, their circulation began rapidly to increase; and very soon reached £3,000,000. The results, as proved before the committee, were these:-The exchange with England became greatly depressed; nearly all the good specie was exported to England; it was replaced in Dublin (where small notes could not be issued) by abase coinage, adulterated to the extent of fifty per cent.; and elsewhere it was replaced by notes payable at twentyone days' date, issued by all sorts of persons, for sums down even as low as sixpence. And this excessive multiplication of small notes was necessitated by the impossibility of otherwise carrying on retail trade after the disappearance ofthe silver coinage. For these disastrous results, then, legislatioll was responsible. The swarms of "silver-notes" resulted from the exportation of silver; the exportation of silver was due to the great depression .of the exchange with England; this great depression arose £rom the excessive issue of notes by the Bank of Ireland; and this excessi ve issue followed from their legalized inconvertibility. Yet, though these facts were long ago established by a Committee of the House of Commons, the defenders of the "currency-principle" are ac.tually blind enough to cite this multiplication of sixpenny promises to pay, as proving the evils of an 1mregulated c.urrency! Returning now to the case of the Bank of England, let us pass at once to the Act of 1844. While still 0. protectionist-while still a believer in the beneficence of law as a controller of commerce-Sir Robert Peel took upon himself to stop the recurrence of monetary crises like those of 1825, 183(j, and 1839. Overlooking the truth that, when not caused by the meddlings of legislators, these crises are either due to an absolute impoverishment, or else to a relative impoverishment consequent on speculative over-investment, and that for the impruuence causing this there is no remedy; he boldly proclaimed that" it is better to prevent the paroxys1n than to excite it:" and he brought forward the Bank Act of 1844 as the means of prevention. How merciless has been N ature's criticism on this remnant of Protectionism, we all know. The monetary sliding-scale has been as great a fuilure a.s its prototype. Within three years arose one of these crises

335

336

Free Banking I

Panics intensified by Restriction.

219

which were to have been prevented. Within another ten years has arisen a second of these crises. And on both occasions this intended safeguard has so intensified the evil, that a temporary repeal of it has been imperative. We should have thought that, even without facts, anyone with a modicum of sense must have s'een that it is impossible lly Act of Parliament to prevent imprudent people from doing imprudent things; and, if facts were needed, we should have thought that our commercial history up to 1844 supplied a sufficiency. But intellects paralysed by a superstitious faith in State-ordinances, cannot appreciate such facts. And we doubt not that even now, though there have been two glaring failures of this professed check on over-speculation-though the evidence conclusively shows that the late commercial catastrophes have had nothing whatever to do with the issue of bank-notes, but, as in the case of the Western Bank of Scotland, occurred along with diminished issues-and though in Hamburgh, where the" currency principle" has been -rigidly carried out to the very lette1', there has been a worse crisis than anywhere else; yet there will still be plenty of believers in the efficiency of Sir R. Peel's prophylactic. But, as already said, the measure has not only failed; it has made worse the panics it was to have warded off. And it was sure to do this. As shown at the outset, the multiplication of promises to pay that occurs at a period of impoverishment caused by war, famine, over-investment, or losses abroad, is a salutary process of mitigation-is a mode of postponing actual payments till actual payments are possible-is a preventive of wholesale bankruptcy - is a spontaneous act of self-preservation. We pointed out, not only that this is an a priori conclusion; but that many facts in our own mercantile history illustrate at once the naturalness, the benefits, the necessity of it. And if this conclusion needs enforcing by further evidence, we have it in the recent events at Hamhurgh. In that city, there are no notes in circulation but such as are represented by an actual eCluivalent of bullion or jewels in the bank: no one is allowed, as with us, to obtain bank promises to pay in return for securities. Hence it resulted that when the Hamburgh merchants, lacking their remittances from abroad, were suddenly deprived of the wherewith to llleet their engagements; and were prevented by law from getting bank promises to pay by pawning their property; bankruptcy swept them away wholesale. And what finally happened? To prevent universal ruin, the Government was obliged to decree that all bills of exchange coming due should have a month's grace; and that there should be immediately formed a State Discount Bank-an office for issuing State promises to pay in return

Free Banking I

220

State-tampering8 with Money and Banks.

for securities. That is, having first by its restrictive law ruined a host of merchants, the Govemment was obliged to legalize that postponement of payments, which, but for its law, would have spontaneously taken place. With such further confirmations of an apriori conclusion, can it be doubted that our late commercial difficulties were intensified by the measure of 1844? Is it not, indeed, notorious among all who know anything of City affairs, that the progressively increasing demand for accommodation, was in great part due to the conviction that, in consequence of the Bank Act, there would shortly be no accommodation at all ? Does not every London merchant know that hosts of his neighbours who had bills coming due, and who saw tbat by the time they were due the Bank would discount only at still higber rates, or not at all, decided to lay in beforehand the means of meeting those bills? Is it not an established fact, that the hoarding tbus induced not only rendered the pressure on the Bank greater than it would otherwise have been, but, by taking both gold and notes out of' circulation, made its issues temporarily useless to the general public? Did it not happen in tbis case, as in 1793 and 1825, that when at last restriction was removed, the mere consciousness that loans could be had, itself prevented them from being required? And, indeed, is not the simple fact that the panic quickly subsidecl when the Act was suspended, sufficient proof that the Act had, in great measure, produced it? See, then, for what we have to thank legislative meddling. During ordinary times Sir R. Peel's Act, by obliging the Bank of England, and occasionally provincial banks, to keep a larger stock of gold than they would otherwise have kept (and if it has not done this it has done nothing), has inflicted a tax on the nation to the extent of the interest on such portion of the gold currency as was in excess of the need: a tax which, in the course of tbe last thirteen years, has probably amounted to some millions. And then, on the two occasions when there have arisen the crises that were to have been prevented, the Act, after having exacerbated the pressure, made bankrupt a great number of respectable firms who would else have stood, and increased the distress not only of the trading but of' the working population, has been twice abandoned at the moment when its beneficence was to have been conspicuous. It has been a cost, a mischief, and a failure. Yet, such is the prevailing insanity, that, judging fram appearances, it will be maintained! " But," ask our opponents, "shall the Bank be allowed to let gold drain out of the country without check? Shall it have permission to let its reserve ot' gold diminish so greatly as to risk the convertibility of its notes? Shall it be enabled recklessly

337

338

Free Banking J

Fallacies respecting the Export of Gold.

221

to increase its issues, and so produce a depreciated paper currency?" Really, in these Free-trade days, it seems strange to have to answer questions like these; and, were it not for the confusion of facts and ideas that legislation has produc.ed, it would be inexcusable to ask them. In the first place, the common notion that the draining of gold out of the country is intrinsically, and in all cases, an evil, is nothing but a political superstition-a superstition in part descended from the antique fallacy that money is the only wealth, and in part from the maxims of an artificial, law-produced state of things, under which the exportation of gold really was a sign of a corrupted currency: we mean, during the suspension of cash payments. Law having cancelled millions of contracts which it was its duty to enforce-law having absolved bankers from liquidating their promises in coin, having rendered it needless to keep a stock of coin with which to liquidate them, and having thus taken away that natural check which prevents the over-issue and depreciation of notes-law having partly suspended that home demand for gold which ordinarily competes with and balances the fore·ign demand; there resulted an abnormal exportation of gold. By-and-bye, it was seen that this efflux of gold was a consequence of the over-issue of notes; and that the accompanying high price of gold, as paid for in notes, proved the depreciation of notes. And then it became an established doctrine, that an adverse state of the foreign exchanges, indicating a drain of gold, was significant of an excessive circulation of notes; and that the issue of notes should be regulated by the state of the exchanges. This unnatural condition of the currency, be it remembered, continuing for a quarter of a century, the cODcomitant doctrine rooted itself in the general mind. And now mark ODe of the multitudinous evils of legislative meddling. This artificial test, good only for an artificial state, has survived the return to a natural state; and men's ideas about currency have been reduced by it to chronic confusion. The truth is, that while, dUl'ing a legalized inconvertibility of bank-notes, an efflux of gold may, and often does, indicate an excessive issue of bank-notes; under ordinary circumstances, an efflux of gold has little or nothing to do with the issue of banknotes, but is determined by purely mercantile causes. And the truth is, that so far from an efflux of gold thus brought about by mercantile cl1.uses being an evil, it is a good. Leaving out of the question, as of course we must, such exportations of gold as take place for the support of armies abroad; the causes of efflux are either an actual plethora of all commodities, gold included, which

Free Banking I

222

State~ta-mpe'l'ings

with Money and Banks.

results in gold being sent out of the country for the purpose of foreign investment; or else an abundance of gold as compared with other leading commodities. And while, in this last case, the effiux of gold indicates some absolute or relative iJ:npoverishment of the nation, it is a means of mitigating the bad consequences of that impoverishment. Consider the question as one of political economy, and.thistruth becomes obvious. Thus:-The nation habitually requires for use and consumption certain que.ntities of commodities, of which gold is one. These commodities are severally and collectively liable to fall short; either from deficient harvests, from waste in war,. from losses abroad, or from too great a diversion of labour or capital in some special direction. When a scarcity of some chief commodity, some necessary, occurs, what is the remedy? The commodity of which there is an excess (or if none is in excess, then that which can best be spared) is exported in exchange for an additional supply of the deficient commodity. And, indeed, the whole of our foreign trade, alike in ordinary and extraordinary times, consists in this process. But when it happens either that the commodity which we can best spare is not wanted abroad; or (as recently) that a chief foreign customer is temporarily disabled from buying; or that the commoclity which we can best spare is gold; then gold itself is exported in exchange for the thing which we most want. Whatever form the transaction takes, it is nothing but bringing the supplies of various commodities into harmony with the demands for them. The fact that gold is exported, is simply a proof that the need for gold is less than the need for other things. Under such circum· stances an efflux of gold will continue, and ought to continue, until other things have become relatively so abundant, and gold relatively so scarce, that the demand for gold is equal to other demands. And he who would prevent this process, is about as wise as the miser, who, finding his house without food, chooses to starve rather than draw upon his purse. The second question,-" Shall the Bank have permission to let its reserve of gold diminish so greatly as to risk the convertibility of its notes ?" is not more profound than the first. It may fitly be answered by the more general question,-" Shall the merchant, the manufacturer; or the shopkeeper, be allowed so to invest his capital as to risk the fulfilment of his engagements?" If the answer to the first be "No," it must be "No" to the second; if to the second it be "Yes," it must be "Yes" to the first. Any one who proposed that the StlLte should oversee the transactions of every trader, so as to insure his ability to cash all demands as they fell due, might with consistency argue that bankers should be under like control. But while no one will, we presume, have the folly to contend for the one, nearly all contend for the other. One would think that the banker acquired, in virtue of his occu-

339

340

Free Banking I

nlusions respecting Over-issue$.

.223

pation, some abnormal desire to ruin himself-that while traders in other things are restrained by a wholesome dread of bankruptcy, traders in capital have a longing to appear in the Gazette, which law alone can prevent them from gratifying! Surely the moral checks which act on other men will act on bankers. And if these moral checks do not suffice to produce perfect security, we have ample proof that no cunning legislative check will supply their place. The current notion that bankers can, and will, if allowed, issue notes to any extent, is one of the absurdest illusions-an illusion, however, which would never have arisen but for the vicious over-issues ind'uced by law. The truth is, that in the first place, a banker cannot increase his issue of notes at will: it has been proved by the unanimous testimony of all bankers who have been examined before successive parliamentary committees, that "the amount of their issues is exclusively regulated by the extent of local dealings and expenditure in their respective districts;" and that any notes issued in excess of the demand are "immediately returned to them." And the truth is, in the second place, that a banker will not, on the average of cases, issue more notes than in his judgment it is safe to issue; seeing that if his promises to pay in circulation, are greatly in excess of his available means of paying them, he runs an imminent risk of having to stop payment,-a result of which he has no less a horror than other men. If facts are needed in proof of this, they are furnished alike by the history of the Bank of England and the Bank of Irelaud; which, before they were debauched by the State, habitually regulated their issues according to their stock of bullion, and would probably always have been still more careful but for the consciousness that there was the State-credit to fall back upon. The third question,-" Shall the Bank be allowed to issue notes in such number as to cause their depreciation ?" has, in effect, been answered in answering the first two. To every one not blinded by the mystifications of the currency-theorists, it must be obvious that there can be no depreciation of notes so long as they are exchangeable for gold on demand. And while the State, in discharge of its duty, insists on the fulfilment of contracts, the alternative of bankruptcy must ever be il restraint on such over-issue of notes as endangers that exchangeability. The truth is, that the bugbear of depreciation is one that would have been unknown but for the sins of governments. In the case of America, where there have been occasional depreciations, the sin has been a sin of omission: the State has not enforced the fulfilment of contracts-has not forthwith bankrupted those who failed to cash their notes; and, if accounts are tme, has allowed those to be mobbed who brought back far-wandering notes for payment. In all other cases the siu bas been a sin of

Free Banking I

224

State-tamperings with Money and Banks.

commission. The depreciated paper currency in France during the revolution was a State-currency. The depreciated paper currencies of Austria and Russia have been State-currencies. And the only depreciated paper currency we have known, has been to all intents and purposes a State-currency. It was the State which, in 1795-6,fo1'ced upon the Bank of England that excessive iRsue of notes which led to the suspension of cash-payments. It was the State which, in 1802, forbad the resumption of cashpayments when the Bank of England wished to resume them. It was the State which, during a quarter of a century, maintained that suspension of cash-payments from which the excessive multiplication and depreciation of notes resulted. The entire corruption was entailed by State-expenditure and established by State-walTlmt. Yet now, the State affects a virtuous horror of the crime committed at its instigation! Having contrived to shu:£He off the odium on to the shoulders of its tools, the State gravely lectures the banking community upon its guilt, and with sternest face passes measures to prevent it from sinning! We contend, then, that neither to restrain the efflux of gold, nor to guard against the over-issue of bank-notes, is legislative interference warranted. If Government will promptly execute the law against all defaulters, the self-interest of bankers and traders will do the rest: such evils as would still result from mercantile dishonesties and imprudences, being evils which legal regulation may exacerbate but cannot preyent. Let the Bank of England, in common with e-.;ery other bank, simply consult its own safety and its own profits, and there will result just as much check as should be put on the e:£Hux of gold or the circulation of paper; and the only check that can be put upon the doings of speculators. Whatever cause leads to unusual draughts on the resources of banks, immediately entails a rise in the rate of discount-a rise dictated both by the wish to make increased profits, and the wish to avoid a dangerous decrease of resources. This raised rate of discount prevents the demand from being so great as it would else have been-alike prevents undue expansion of the note-circulation; checks speculators from making further engagements; and if gold is being exported, diminishes the profit of exportation. Successive rises successively increase these effects; until eventually none will pay the rate of discount demanded, save those in peril of stopping payment; the increase of the credit currency ceases; and the e:£Hux of gold, if it is going on, is stopped by the home demand out-balancing the foreign demand. And if in times of great pressure, and under the temptation of high discounts, banks allow their circulation to expand to a somewhat dangerous extent; the cuurse is justified by the necessities.

341

342

Free Banking I Joint-Stock Bank Legislation.

225

As shown at the outset, the process is one by which banks, on the deposit of good securities, loan their credit to traders who but for loans would be bankrupt. And that banks should run some risks to save hosts of solvent men from inevitable ruin, few will deny. Add to which, that during a crisis which thus runs its natural course, there will really occur that purification of the mercantile world which many think can only be effected by some Act of Parliament ordeal: seeing that, while under the circumstances described, men who have adequate securities to offer will get bank accommodation; those who, having traded without capital or beyond their means, have not, will be denied it, and will fail; whereas the existing restrictions on bank accommodation tend to destroy good and bad together. Thus it is not true that there need special regulations to prevent the inconvertibility and depreciation of notes_ It is not true that but for legislative supervision bankers would let gold drain out of the country to an undue extent. It is not true that these " currency theorists" have discovered a place at which the bodypolitic would bleed to death but for a State styptic. What else we have to say on the general question, may best be joined with some commentaries on provincial and joint-stock banking; to which let us now turn. Government, to preserve the Bank of England monopoly, having enacted that no partnership exceeding six persons should become bankers; and the Bank of England having refused to establish branches in the provinces; it happened, during the latter half of the last century, when the industrial progress was rapicl and banks much needed, that numerous private traders, shopkeepers and others, began to issue notes payable on demand. And when, of the four hundred small banks which had thus grown up in less than fifty years, a great number gave way under the first pressure-when on several subsequent occasions like results occurred-when in Ireland, where the Bank of Ireland monopoly had been similarly guaranteed, it happened that out of fifty private provincial banks forty became bankrupt-and when, finnlly, it grew notorious that in Scotland, where there had been no law limiting the number of partners, a whole century hud passed with scarcely a single bank failure; legislators slowly arrived at the conclusion that they had better abolish the restriction which had entailed such mischiefs. Having, to use Mr. Mill's words, "actually made the formation of safe banking establishments a punishable offence"-having for one hundred and twenty years maintained a law which first caused great inconvenience and then extensive ruin, time after time repeated; [Vol. LXIX. No. CXXXV.J-NEW SERIES, Vol. XlII. No. I. Q

Free Banking I 226

StatertamperLJl[JB with

illoney and Banks.

Government in 1826 decided to concede the liberty of joint-stock banking: a liberty which the good easy public, not distinguishing between a right done and a wrong undone, regarded as a great boon. But the liberty was not without conditions. Having previously, in anxiety for its protege the Bank of England, been reckless of the banking security of the community at large, the State, like a repentant sinner rushing into asceticism, all at once became extremely solicitous on this point; and determined to put guarantees of its own devising, in place of the natural guarantee of mercantile judgment. To intending bank-shareholders it said-" You shall not unite on such publicly-understood conditions as you think fit, and get such confidence as will naturally come to you on those conditions." And to the public it said-I< You shall not put trust in this or that association in proportion as, from the character of its members and constitution, you judge it to be worthy of trust." But to both it said-" You shall the one give, and the other receive, my infallible safeguards." And now what have been the results? Every one knows that these safeguards have proved anything but infallible. Everyone knows that these banks with State-constitutions have been especially characterised by instability. Every one knows that credulous citizens, with a faith in legislation which endless disappointment fails to diminish, have trusted implicitly in these law· devised securities; and, not exercising their own judgments, have been led into ruinous undertakings. Everyone knows that the evils of substituting artificial guarantees for natural ones, which the clear-sighted long ago discerned, have, by the late catastrophes, been made conspicuous to all. When commencing this article we had intended to dwell on this point. For though the mode of business which brought about these joint-stock bank failures was, for weeks after their occurrence, time after time clearly described; yet nowhere did we see drawn the obvious corollary. Though in three separate City articles of the T·imes, it was explained that, "relying upon the ultimate liability of large bodies of infatuated shareholders, the discount houses supply these banks with unlimited means, looking not to the character of the bills sent up, but simply to the security afforded by tbe Bank endorsement;" yet. in none of them was it pointed out that but for the law of unlimited liability, this reckless trading would not have gone on. More recently, however, this truth has been duly recognised alike in Parliament and in the Press; and it is therefore needless further to elucidate it. All we will add is, that as, if there had been no law of unlimited liability, the London houses would not have discounted these bad bills; ;nd as in that case these provincial joint-stock banks could

343

344

Free Banking I

Restrictions on Provincial Issues.

227

not have given these enormous credits to insolvent speculators; and as, if they had not done this, they would not have been ruined; it follows, inevitably, that these joint-stook bank failures have been law-produced disasters. A measure for further increasing the safety of the provincial public, was that which limited the circulation of provincial banknotes. At the same time that it established a sliding· scale for the issues of the Bank of England, the Act of 1844 fixed the maximum circulation of every provincial bank of issue, and forbad any further banks of issue. We have not space to discuss at length the effects of this restriction: which must have fallen rather hardly on those especially careful bankers who had, during the twelve weeks preceding the 27th April, 1844., narrowed their issues to meet any incidental contingencies; while it gave a perennia.l license to such as had been incautious during that period. All which we can notice is, that this rigorous limitation of provincial issues to a low maximum (and a low maximum was purposely fixed) effectually prevents those local expansions of bank-note circulation, which, as we have shown, ought to take place in periods of commercial difficulty. And further, that by transferring all local demands to the Bank of England, as the only place from which extra accommodation can be had, the tendency is to concentrate a pressure which would else have been diffused; and so to create panic. Saying nothing more, however, respecting the impolicy of the measure, let us mark its futility. As a means of preserving the oonvertibility of the provincial bank-note, it is useless unless it acts as some safeguard against bank failures; and that it does not do this is demonstrable. While it diminishes the likelihood of failures caused by over-issue of notes, it increases the likelihood of failures from other causes. For what will be done by a provincial banker whose issues are restricted by the Act of 1844 to a level lower than that to which he would otherwise have let them rise? If he would, but for the law, have issued to a larger extent than he now does-if his reserve is greater than, in his judgment, is needful for the security of his notes; is it not clear that he will simply extend his operations in other directions? Will not the excess of his available capital be to him a wan-ant either for entering into larger speculations himself, or for allowing his customers to draw upon him beyond the limit he would else have fixed? If, in the absence of restriction, his rashness would have led him to risk bankruptcy by over-issue, will it not now equally lead him to risk bankruptcy by over-banking? And is not the one kind of bankruptcy as fatal to the convertibility of notes as the other? Nay, the case is even worse. There is reason to believe that

Q2

Free Banking I

228

State-tamperings with Jlfoney and Banks.

banI{ers are tempted into greater dangers under this protective system. They can amI will hypothecate their capital in ways more indirect than by notes; and may very likely be led, by the unobtrusiveness of the process, to commit themselves more than they would else do. A trader, applying to his banker in times of great commercial difficulty, will often be met by the reply"I cannot make you any direct advances, having already loaned as much as I can spare; but knowing you to be a safe man, I will lend you my name. Here is my acceptance for the sum you require: they will discount it for you in London." N ow, as loans thus made do not entail the same immediate responsibilities as when made in notes, (seeing that they are neither at once payable, nor do they add to the dangers of a possible run,) a banker is under a temptation to extend his liabilities in this way much further than he would have done, had not law forced him to discover a new channel through which to give credit. And does not the evidence that has lately transpired go to show that these more roundabout ways of giving credit do take the place of the interdicted ways; and that they are more dangerous than those interdicted ways? Is it not notorious that dangerous forms of paper-currency have had an unexampled development since the Act of 1844? Do not the newspapers and thtl debates give daily proofs of this? And is not the process of causation obvious? Indeed, it might have been known it priori that such a result was sure to take place. It has been shown conclusively that, when uninterfered with, the amount of note circulation at any given time is determined by the amount of trade going on-the qnantity of payments that are being made. It has been repeatedly testified before committee, that when any local banker contracts his issues he simply causes an equivalent increase in the issues of neigbbouring bankers. And in past times it has been more than once complained, that when from prudential motives the Bank of England withdrew part of its notes, the provincial bankers immediately multiplied their notes to a proportionate extent. Well, is it not manifest that this law, which holds between one class of bank-notes and another, also holds between bank-notes and other forms of paper-currency? Will it not happen that just as diminishing the note circulation of one bank, merely adds to the note circulation of other banks; so, an artificial restriction on the circulation of bank-notes in general, will simply cause an increased circulation of some substituted kind of promise to pay? And is not this substituted kind, in virtue of its novelty and irregularity, likely to be a more unsafe kind? See, then, the predicament. Over all the bills of exchange, cheques, &c., which constitute some nine-tenths of the paper-currency of the king-

345

346

Free Banking I

Natural Safeguards are prevented.

229

dom, tIle State exercises, and can exercise, no control. And the limit it puts on the remaining tenth, vitiates the other ninetenths by causing an abnormal growth of new forms of credit, which experience proves to be especially dangerous. Thus, all which the State does when it exceeds its true duty, is to hinder, to disturb, to corrupt. As already pointed out, the quantity of credit men will give each other is determined by natural causes, moral and physical-their average characters, their temporary states of feeling, their circumstances. If the Government forbids one mode of giving credit, they will find another, and probably a worse. Be the degree of mutual trust prudent or imprudent, it must take its course. The attempt to restrict it by law is nothing but a hundredth repetition of the old story of keeping out the sea with a fork. And now mark, that were it not for these worse than futile State-safeguards, it is not unlikely that there might grow up certain natural safeguards, which would really put a check upon uudue credit and abnormal speculation. Were it not for the attempts to ensure security by law, it is very possible that, under our high· pressure system of business, banks would compete with each other in respect of the degree of security they offeredwould endeavour to outdo each other in the obtainment of a legitimate public confidence. Oonsider the position of a new joint· stock bank with limited liability, and unchecked by legal regulations. It can do nothing until it has gained the general good opinion. In the way of this there stand great difficulties. Its constitution is untried, and sure to be looked upon by the trading world with considerable distrust. The field is already occupied by old banks with established connexions. Out of a constituency satisfied with the present accommodation, it has to obtain supporters for a system that is apparently less safe than the old. How shall it do this? Evidently it must find some unusual mode of assuring the community of its trustworthiness. And out of a number of new banks so circumstanced, it is not too much to suppose that ultimately one would hit on some mode. It might be, for instance, that such a bank would give to all who held deposits over 1000l. the liberty of inspecting its books-of ascertaining from time to time its liabilities and its investments. Already this plan is not unfrequently pursued by private traders as a means of assuring those who lend money to them; and this extension of it might naturally take place under the pressure of competition. We have put the question to a gentleman who has had loug and successful experience as manager of a joint-stock bank; and his reply is that some such comse would very prol)ably be adopted: adding, that under this arrangement a depo· sitor would practically become a partner with limited liability.

Free Banking I

230

State-tamperings with Money and Banks.

Were a system of this kind to establish itself, it would form a double check to unhealthy trading. Consciousness that its rashness would become known to its chief clients, would prevent the bank-management from being rash; and consciousness that his credit would be damaged when his large debt to the bank was whispered, would prevent the speculator from contracting so large a debt. Both lender and borrower would be restrained from reckless enterprise. Very little inspection would suffice to effect this end. One or two cautious depositors would be enough; seeing that the mere expectation of immediate disclosure, in case of misconduct, would mostly keep in order all those con· cerned. Should it however be contended, as by some it may, that this safeguard would be of no avail-should it be alleged that, having in their own hands the means of safety, citizens would not use them, but would still put blind faith in directors and give unlimited trust to respectable names; then we simply reply that they would fully deserve whatever bad consequences fell on them. If they did not take advantage of the proffered guarantee, the penalty be on their own. heads. We have no patience with the mawkish philanthropy which would ward off the punishment of stupidity. The ultimate result of shielding men from the effects of folly, is to fill the world with fools. A few words in conclusion respecting the attitude of our opponents. Leaving joint-stock bank legislation, on which the eyes of the public are happily becoming opened, and returning to the Bank Charter with its theory of currency regulation, we have to charge its supporters with gross, if not wilful, misrepresentation. Their established policy is to speak of all antagonism as identified with adhesion to the vulgarest fallacies. They daily present, as the only alternatives, their own dogma or some wild doctrine too absurd to be argued. "Side with us or choose anarchy," is practically the Sll bstance of their homilies. To speak more specifically:-They boldly assert, in the first place, that they are the upholders of "principle;" and on all opposition they seek to fasten the title of "empiricism." Now, we are at a loss to see what there is "empirical" in the position that a bank-note circulation will regulate itself in the same way that the circulation of other paper currency does. It seems to us anything but "empirical" to say that the natural check of prospective bankruptcy, which restrains the trader from issuing too many promises to pay at given dates, will similarly restrain the banker from issuing too many promises to pay on demand. We take him to be the opposite of an "empiric" who holds that people's characters and circumstances determine the quantity of

347

348

Free Banking I

Misrepresentations of the "Ourrency-theorists."

231

credit-memoranda in circulation; and that the monetary disorders which their imperfect characters and changing circumstances occasionally entail, can .be exacerbated, but cannot be prevented, by State-nostrums. On the other hand, we do not see in virtue of what "principle" it is that the contract expressed on the face of a bank-note must be dealt with differently from any other contract. We cannot understand the "principle" which requires the State to control the business of bankers so that they may not make engagements they cannot fulfil; but which does not require the State to do the like with other traders. To us it is a very incomprehensible" principle" which permits the Bank of England to issue 14,OOO,OOOl. on the credit of the State; but which is broken if the State credit is mortgaged beyond this-a "principle" which implies that 14,OOO,OOOl. of notes may be issued without gold to meet them, but insists on rigorous precautions for the convertibility of every pound more. Weare curious to learn how it was inferred from this" principle" that the average note circulation of each provincial bank, during certain twelve weeks in 1844, was exactly the note-circulation which its capital justified. So far from discerning a" principle," it seems to us that both the idea and its applications are as empirical as they can well be; Still more astounding, however, is the assumption of these " currency theorists," that their doctrines are those of Free-trade. In the Legislature Lord Overstone, and in the press the Saturday Review, have, among others, asserted this. To call that a. Free-trade measure, whose avowed object is to oversee and restrict certain voluntary acts of exchange, appears so manifest a contradiction in terms, that it is scarcely credible it should be made. The whole system of currency legislation is restrictionist from beginning to end: equally in spirit and in detail. Is that a Freetrade regulation which has all along forbidden banks of issue within sixty-five miles of London? Is that Free-trade which enacts that none but such as have now the State warrant, shall henceforth give promises to pay on demand? Is that Free-trade which at a certain point steps in between the banker and his customer, and puts a. veto upon any further exchange of credit-documents? We wonder what would be said by two merchants, the one just about to draw a bill on the other in return for goods sold, who should suddenly be stopped by a State-officer with the remark that, having examined the buyer's ledger, he was of opinion that ready as the seller might be to take the bilI it would be unsafe for him to do so; and that the law, in pursuance of the principles of Free-trade, negatived the transaction! Yetforthe promise to pay in six months, it needs but to substitute a promise to pay on demand, and the case becomes substantially that of banker and

Free Banking I

232

Siate-tamperings with Money and Banks.

customer. Really, to this preposterous assumption of the title of Free-traders, we can find no parallel but that supplied by the proslavery party of America; who, claiming for themselves all the honour, justice, humanity, and religion, charge the abolitionists with dishonesty, licentiousness, tyranny, and iniquity of every kind! It is true that the "currency theorists" have a colourable excuse in the fact, that among their opponents there are various advocates of visiouary schemes and propounders of regulations quite as protectionist in spirit as their own. It is true that there are some who contend for inconvertible "labour-notes;" and others who argue that in times of commercial pressure banks should not raise their rates of discount. But is this any justification for recklessly stigmatizing all antagonism as coming from these classes; in the face of the fact that the Bank Act has been protested against by the highest authorities in political economy? Do not the defenders of the "currency principle" know that among their opponents are Mr. Thornton, long known as an able writer on currency questions; Mr. Tooke and Mr. Newmarch, famed for their laborious and exhaustive researches respecting currency and prices; Mr. Fullarton, whoee "Regulation of Ourrencies" is a standard work; Mr. Macleod, whose just-issued book displays the endless injustices and stupidities of our monetary history; Mr. James Wilson, M.P., who, in detailed knowledge of commerce, currency, and banking, is probably unrivalled; and Mr. John Stuart Mill, who, both as logician and economist, stands in the first rank? Do they not know that the alleged distinction between bank-notes and other credit documents, which forms the professed basis of the Bank Act-and for which Sir R. Peel could quote only the one poor authority of Lord Liverpool-is denied, not only by the gentlemen above-named, but also by Mr. Huskisson, Professor Storch, Dr. Travers Twiss, and the distinguished French Professors, M. Joseph Garnier and M. Michel Chevalier?* Do they not know, in short, that both the profoundest thinkers and the most patient and elaborate inquirers are against them? If they do not know this, they stand convicted of writing with an air of authority on a topic which they have not studied. If they do know it, they have the audacity to speak of numerous distinguished men in terms of supreme contempt. • See Mr. Tooke's "Bank Charter Act of 1844," &c.

349

[8] Excerpt from O.E. Wesslau, Rational Banking (The Remedy for Depression in Trade) Versus Bank Monopoly,

37-64

YI. FREE XOTES THE

RATIO~AL

MEDIC)I OF EXCHAXGE.

IF we are to re-organize our system of co-operation in accordance with sound theory and reasonable principles, instead of blindly following the rules which our forefathers, in complete ignorance of the subject, laid down, we shall have to choose between two rational systems, namely, complete State management on the one hand and complete freedom of competition, regulated Ly supply and demand, on the other. Our present system is a blending, or rather confusion of these two, and like most hybrid systems, it has the faults of both with the advantages of neither. Any change beyond that of mere form must therefore take us nearer to one of the above two rational systems. Just now we are gravitating towards entire State management, or, to call it by its real name, socialism. We are urged from all sides to take deliberate steps down the inclined plane which leads to it. Now it is a well known fact that State interference is a remedy which has a strong tendency to be required in a larger measure the more it is applied. If, for instance, we were to try to mitigate one of the evils resulting from State interference with co-operation, viz., the bad housing of the poor, by more State interference, and build dwellings at the expense of the State, we should, firstly, check private building through State competition, and, secondly, Increase the number of houseless poor through augmented taxation, thus rendering the necessity for State bUIlding more urgent than before. Each change in the direction of increased State management is therefore a telling step towards Socialism. Though the economic circumstances of the country are such as to cause many sincere philanthropists to lean towards socialistic measures, we think that Englishmen in general are almost instinctively averse to the socialistic form of co-operation. We shall therefore not combat here arguments in favour of socialism, but content ourselves with pointing out that in economic respects socialism would be u. failure. It would deprive work, daring, invention, enterprise, and even self-control of their most powerful incite-

Free Banking I

38

Rational Banking versus Bank }'lo'nopoly.

ments j it would have many of the economic defects of slavery and des{lotism j and the absence of individual liberty which it mvolves would probably lead to loss of national independence. In spite, then, of the clamour of the moment, we may, for the above reasons, reject any reform in our system of cooperation which would take us nearer to entire State manaO'ement, as a step in the wrong direction. Any desirable improvement must therefore be found in the direction of free competition, with maintenance of individual property. Our task is thus reduced to stating the reply to the following question: What system of co-operatIOn is the best j general prosperity being the object, and respect for individual property and individual freedom being the condition? In replying to this question, it will be conducive to clearness to give the entire reasoning which leads to the conclusion that entirely free banking is the best and only rational mode of free (not State managed) co-operation. This cannot be done without a slight and partial recapitulation, for which no other apology will he required. Our globe :produces, or could easily be made to ,Produce, a thousand times more material for life's necessities, comforts, and even luxuries, than the human race now consume. Work is required to make this natural wealth available. Human beings can exist, and even enjoy life, by working isolated or associated only in families and tribes j but their work is hard, and their life rough and full of dangers. Co-operation on a wide scale is the indis{lensable condition for civilization, wealth, comfort, happmess, and progress. The greater and easier the co-operation, the greater the general wealth and happiness. When individual property is to be maintained, co-operation can be carried on only by exchange. Facility of exchange is therefore the first condition to the increase of wealth. Exchange necessarily implies valuation. Direct valuation of goods by any other goods is slow, difficult, and inexact. A general value measurer, such as gold is for us now, is therefore of the greatest importance. The value measurer is such only in that it is the most desirable and safest medium of exchange. But we have seen in Chapters I. and IV. that only a small part of the exchange of a busy place or country can

351

352

Free Banking I

Rational Banl.:ing versns Bank Monopoly.

39

be effected direetly by the medium of the value measurer, gold, and that its temporary presence in increased quantity has a destructive influence on production by raising cost. For extension of business other mediums of exchange must be found, which Cltn do the work of coin withollt limitation as to supply, and considerinp the state of society it is highly desirable that the work should be done in the same simple way as coin does it. Coin, the value nl'lasurer and the ideal medium of exchange, is in general demand, not because it is consumed, but because it can easily be exchanged for goods or services. Coin in a man's possession is then a power over a certain amount of goods or services, or in other words evidence of certain rights respected by all. It can therefore be superseded in its function by other evidence of rights, while it retains its function of value measurer in all exchanges. Such evidences of rights would then become mediums of exchange. For clearness' sake we will call such mediums of exchange as are not coin' instruments of credit.' We use here the word credit, of course, in its economic sense, meaning thereby not so much deferred payment as the power of purchasing goods and services, valued in coin, and proved by some stamped, written, printed, spoken, or understood evidence. It now has to be determined which of the known credit instruments is the most important as an auxiliary medium of exchange, or the one which is most suitable to replace coin and assist it in its function as a medium of exchango without interfering with its function as a yalue measurer. Coin being the ideal medium of exchange understood by ltDcl within the reach of all, and therefore of very extensive use in our productive trades, where want of commercial training and of sufficient means render many of the other credit instruments inapplicable, it i!; necessary that the credit instrument which we select as a substitute for coin should possess as many as possible of the advantages of coin without its disadvantages. To enable us to examine more easily the known instruments of credit, we arrange them in the following scale; l.

2.

Coin.

Btate banknotes.

3.

4.

State superFree intended notes. notes.

r>.

6.

Cheques.

Bills.

7. Accounts current.

Free Banking I

40

Rational Banking

verSU8

Bank },fonopoly.

They have been thus placed in order according to their flegree of similarity with coin. \Y e will exam~ne them, beginning with the last, viz., ~ o. 7, Accounts current. An amount credited in the ledger of a bank or good commercial firm will buy goods and services to the same amount in coin. Accounts current will then, where they exist, render the same services as coin. A very large business is daily transacted all over the world with no other medium than accounts. They have not the defects of coin, regarded as a medium of exchange, inasmuch as the increased use of them will not directly affect prices of goods as increased presence of coin does. Large amounts may be credited and debited in merchants' books any number of times without afiecting the value of coin. Also, for large businesses accounts current are a cheaper medium of exchange than coin, and the possible use of such a system may be called unlimited. Such are the advantages of accounts current over coin. These advantages are very important. But accounts can replace coin only in certain kinds of transactions between certain classes of people. They cannot be used as the general substitute for com which we are in want of; they are not a portable and easily transferable evidence of credit; they can be used only by people of a certain commercial standing; they can efiect exchanges only between people known to each other as solvent and honest; and they are not suitable for small transactions amongst the general public. Let us now examine Ko. 5, Cheques, and 1'0. 6, Bills. These have similar advantages, though to a less degree, to those we have described as belonging to accounts current, and are also free from the disadvantages attached to coin; besides which they are portable and transferable. But at the same time they have all the restrictions to their use that accounts have, and would therefore not well replace coin. K o. 4, Free notes, offer the same kind of facilities as accounts current. They are cheap, easily procurable in the exact amount wanted, and at the same time they can be handled in exactly the same way as coin. They can be used by all who can use coin; they are transferable by simple exchange, etc. If, besides, they are free from those disadvantages which coin has as a medium of exchangea fact which we shall prove in the following chapter-free notes have then similar advantages to those of all the other mediums of exchange without having any of their defects.

353

354

Free Banking I

Rrtfional Banking ver8U8 Bank

~},fonopoly.

41

That Xo. 3, State superintended notes, and No.2, State Hank notes, have all the disadvantages which coin has as a medium of exchange, we shall prove hereafter. If we now return to the scale on page 39, and read over the diftorent credit instruments from right to left, we find that the advantages fully present in No.7 are present in some form in Nos. 6, 5, and 4, but not at all in 3, 2, or 1. If we proceed from left to right we find that the advantages realized in No.1 (coin) are present in Nos. 2, 3, and 4-, but not in .5, 6, or 7, or, in other words, that the disadvantages of coin stop at No.3, and the disadvantages of accounts current stop at No..5. No.4 (Free notes) thus stands out prominently as possessing all the advantages and being free from the disadvantages of all other instruments of credit. 'Ve thus come to the conclusion that free notes are the perfection of all credit instruments, and the only one which can replace coin advantageously. The other credit instruments are good and useful in their places, but none of them can prove an adequate sole substitute for coin regarded as a medium of exchange. It remains yet to prove what we have so far presupposed -namely, that State Bank notes and State superintended notes are no improvement on coin, but have all its disadvantages, and that free notes have, as a medium of exchange, none of the disadvantages of coin. As these facts are very important links in the chain of our reasoning, and as they arc ignored by all who have legislated for banking, and, as far as we know, by all who have written on the subject, we shall devote a separate chapter to them.

VII. THE EFFECT OF STATE SUPERVISION OVER NOTE ISSUING. \VHEN redeemable State Bank notes are issued they do not increase the quantity of the circulating mediums of exchange in the country, for the reason that gold leaves the country in exact proportion to the issue of the notes, everything else remaming unchanged. There is no lack of proof drawn from experience, for this economic fact, and its explanation is as follows. A

Free Banking I

42

Rational Banking versus Bank Monopoly.

quantity of State Bank notes known to be safe and redeemable at sight would-being equivalent to coin-have the whole country for their market; when issued they would buy some kind of goods or services; a scarcity of this kind of goods or services would be caused, and would be filled from other places than that in which the notes were first issued. Capital employed in buying services having a tendency to become mvested in goods for immediate consumption, we need speak here only of goods. If the goods purchased for the new notes came from abroad, a quantity of gold corresponding to the issued notes would leave the country at once in payment for this extra import, as the notes could not be used for payments out of the country. We suppose here, of course, an isolated, ideal transaction; in reality the phenomenon would be complicated by variations in the rate of exchange, and a great number of other transactions; but the final result would always be that the issued notes would take the place of a corresponding quantity of g-old, which would remam abroad. If, on the other hand, the goods absorbed in the first instance were home products, the home production would first increase; everything else remaining the same, the consumption of raw materlal, provisions, etc., would increase and wages rise. The increased activity in one place would soon spread, and the advance in prices would permeate the whole country, if the first cause, that is, the quantity of issued State Bank notes, was sufficiently important. An advance in prices all over the country means necessarily less export, and more import: the difference would be paid in gold corresponding to the quantity of the issued notes. (In reality the gold might not actually be paid; it might be kept back from intended gold shipments to the country, etc., but the actual result would be so much less gold in the market than would have been there if the supposed extra issue of State Bank notes had not taken place.) We find, then, that the issue of State Bank notes affects the country in exactly the same way as imported gold, described in Chap. IV. The advantage from State Bank notes is then limited to the interest saved on the quantity of gold they replace-a very small advantage indeed, and more than counterbalanced by the deterioration of the ·value measurer, and the insecurity which results from increasing the promises to pay while still the gold is banished. Strange to say, this so-called advantage of saving the interest of the replaced gold is the only one mentioned by

355

356

Free Banking I

Rational Banking versus Banlc Monopoly.

43

most writers on banking as resulting from all kinds of notes. They are quite right so far as ~tate Bank notes are concerned, but it is strange that the effects of free banking in Scotland did not suggest to them the vital importance of free bank-notes. It has been said that State Bank notes have proved very useful, at least when first introduced, as may be gathered from the history of banking in several countries. But the fact is that it was not the notes which cauRed the noticed imI?rovement, but the simultaneous extension of banking, whICh could have been carried on very well without notes, and very much better with free notes. It may further be urged that when State Bank notes are issued they cause an increase in business, and thereby enable the market to carry increased mediums of exchange. Our reply to this is that the increase of activity is entirely temporary, and lasts only during the interval necessary to raise prices high enou~h to check production and export, and thus send the gold out. When the gold has left the country, and the corresponding capital is consumed, things turn out much the same as before, if not worse by reaction. Private notes supervised by the State are the worst kind of notes. The State supervision is either efficient enough to make the note safe in the estimation of the people, or it is insufficient, only lending an empty prestige to the notes, and giving the people a delusive guarantee. The latter kind of superviSIOn would be an act of deception on the part of the Government, and though it has been practised more than once, we may consider it obsolete. It remains to examine how the notes of private banks made, relatively speaking, safe by law would affect the trade of the country. In the first place they would affect the trade of the country as coin does, because the Government having undertaken to look after the security, the people would make no distinction between the notes of the different banks, but cause them to circulate indiscriminately all over the country. Excess of issue could only be discerned, therefore, when the reaction had fully developed, that is, after production and export had been seriously affected. Supermtended notes being equal to coin in their financial and economic effects would cause banking to take the objectionable form of coin lending, inducing none of the delicate and intelligent handling so conducive to prosperity, which results naturally from free banking, or even from the French banking method. Then we find that State super-

Free Banking I

44

Rational Banking versus Ban';, Monopoly.

vised banks cannot achieve the public o~iect for which they are established, namely, to augment the mediums of exchange. They cannot make any considerable use of their right of note issue except when they can secure a sufficient gold reserve, and when the general market of the country is in a condition to carry an increased quantity of notes. But these conditions are fulfilled only when business is flourishing, and when prices are favourable to production and export, or in other words, just when there is enough coin and coin notes in circulation, but not too much to send prices up and hamper export. Such periods are the opportunities of these banks, and they naturally take advantage of them to issue as much of their notes as they can force into the market. The notes drive the gold out of the country, and its scarcity soon becomes embarrassing, because it is wanted to pay for the increased import inflated by great consumption, unwise production, and artificial flush times. When the circulation of the notes is thus at its height, and a great need for them is developed, the banks find it absolutely necessary, in consequence of the increasing scarcity of gold, to withdraw their notes as quickly as possible, and a crisis is created which lasts until prices have again dropped sufficiently to tempt those who have means left to again start production and export. Thus these banks increase enormously the circulating mediums of exchange when such an increase is undesirable, and withdraw them when the demand for them is greatest. In countries where this absurd system is in vogue the people pay dearly for any short period of prosperity which they can snatch through exceptional favourable circumstances, and such periods are infrequent. The notes being taken indiscriminately all over the country, no supervised bank has any control over the surrounding market, or what ought to be its own market. Such banks do not care to have a merely local control, the whole country being their market. The interest of each is to circulate its notes as far from the bank as possible, and liberal terms are given to distant customers. A more efiE~ctive way of gorgin&" the country with notes could hardly be imagined, and the country is full of them to overflowing; the notes are always in excess of the quantity compatible with sound business. The result of course is that prices are kept as high as possible, production as dear and as small as possible, work scarce as possible, and business as unprofitable as possible.

357

358

Free Banking I

Rational Banking '1..'ersus BanT;: Monopoly.

45

Excessive import and a tendency towards forei8ll indebtedness are apt to become chronic amongst people who thus deliberately corrupt their value measurer, introduce base paper coinage, and bring on themselves all the evils of gold-producing countries without being able to produce an ounce of gold. Free notes have no such effects on the economy of the country where they are circulating. The fundamental reason for this is that, free from all State supervision, they never acquire the attributes of coin. In whatever form they may be issued, and in whatever way they may be handled, they always remain credit instruments, with no other effect on the market than cheques would have. While State supervised notes are coin-bad paper coinfree notes are cheques. They can be used as coin wheresoever coin can be used: they do not produce the effect of coin on production and export, but accomplish fully the objects of cheques in the same way as cheques. To well grasp this argument minute investigation is necessary. We must first inquire into the nature of free bank notes. The general impression is that as soon as everybody in this empire is permitted to issue notes payable to bearer on demand-or what is generally called bank notes-everybody would set about issuing notes, everybody would soon have too many notes out, everybody would stop payment, and everybody would be ruined. As a matter of fact, everybody would not, and could not, issue notes; because the followmg conditions are, by force of circumstances, attached to free note-issuing: First Condition.-1'he issuer of free notes m't~st be of good standing, and have ample means. When all State interference disappears, notes will have to circulate entirely on their own merIt. Who would, under such circumstances, take an unknown man's or a poor man's notes as cash? Just as many as would now take an unknown or poor man's IOU as cash. A man of small means would find note-issuin~ a most difficult, not to say impossible, way of raising capltal. He would gain his object much sooner, and with far less expense, tbrough bills or promissory notes at fixed due dates, or any other instrument of credit. And if a poor man, by some chance, did get some one to take his notes, would thbY not be presented for payment at once, and then where would the issuer's advantage be? It is, then, out of the

Free Banking I

46

Rational Banking ve1'SUS

Banl~

359

:!Jfonopoly.

question that anyone except firms and companies of good standing would ever attempt to issue notes? Secon(l Condition.-Notes can be issued only by ca1'rying on Ct b(t1l1.;illg business. The reasons for this are as simple as they are conclusive. If free notes were issued in any other way, they would be presenteel for payment at once. If notes are not lent nor used for discounting, they can only be given away as presents, or used as payment for goods or services. If a rich man were to issue notes for these two latter purposes, they would be taken out of politeness; but they would at once either be presented for payment, or passed throu~h banks and clearing-houses as cheques. No one would have any interest in circulating them, and everywhere they would be subject to a commisslOn, if they were received at all, which would be quite enough to send them home very soon. But even if a rich man not carrying on a banking business could succeed in circulating a quantlty of notes, it would be about the last thing he would desire to do. There is hardly any greater business nuisance imaginable for a rich man than to have small amounts coming dutl constantly and irregularly. Why should he expose himself to this, when he can buy largely on long, fixed credit, pay with cheques on his banker, or secure his supply in many other ways less expensive, troublesome, and annoying than note-issumg? Banking is therefore the only possible way, and the only advantageous way, of issuing notes. Thi1"(l Condition.-The issuing banker must issue his notes only thrOltgh customers carrying on business in the locality 1t"here the notes are issued. When banking is entirely free, notes will not circulate beyond the neighbourhood of the issuing office-that is, where the bank is well known. Banks being numerous, under a free system the people will have to look at the notes before they take them as cash, and they will very soon adopt the habit of refusing all notes they are not accustomed to. Every banker will, to defend his own market, treat other banks' notes as cheques, and charge a commission on them. These and many other circumstances will prevent the notes from leaving their natural market. Even in England, where note-issuing is monopolized by some few banks of unquestionable standing, where Government watches over a strictly limited issue, and where, consequently, there are fewer causes to keep the private notes within their respective markets, these notes circulate only

360

Free Banking I

Rational Banking '!.'e1'SUS Ban!.; Monopoly.

47

round the banks of issue. At some distance from the issuing office few of the notes are found, and many an Englishman has never seen an English private bank-note, although there are now in En~land fourteen note-issuing banks, besides the Bank of England. If, therefore, a free note-issumg banker were to lend his notes to people outside his own market, they would all come back at once, either to be exchanged for gold, or as J!ayments which would otherwise have brouO"ht him gold. Such a transaction would diminish the banker's metallic cash, and it would be useless to send away the notes at all. If a banker would lend capital to customers outside his natural market, he would not send his notes, as they might come back all in a lump, and cause him some inconvenience; he would send gold, a cheque, a draft on some other bank, or some such document. If he wants his notes to circulate, he must pay them out in the only place where they have a chance of staying-namely, his own market. It'ou·rth Condition.-The free issuing bankel' '1nust tuO?'I.; only with people whose business consists in fn1'thering P?'Oduction or expO?'t from the dist?'ict. If an issuing banker lends his notes to a customer, the latter will buy goods with them, and consume the O'oods; a scarcity of thIS kind of goods is thereby caused, and is filled from other markets, without countervailing export; the import must be paid for, but as the notes are not acceptable outside the market, they must be exchanged for gold or gold's equivalent (a draft on some one outside the market) before the payment can be made. Lending his notes to consumers amounts, then, for the issuing banker, to the same as lending his O'old. He might lend his gold to consumers, but he would not thereby circulate his notes. Fifth Condition.-The issuing banker must endeaVOU1' to worl~ only with people '!.vho have a p1'ofit on their business. If the producers or exporters to whom the free notes are lent spend more on their goods than they obtain for them when sent out of the market, they cause a deficiency of goods exactly as a consumer would do. A losing production IS, economically speaking, a consumption pure and simple. The issuing banker must avoid unsuccessful producers or exporters on the same grounds as he would consumers. ~uch are the chief conditions which the force of circumstances imposes on bankers who wish to create a note circulation. Anyone who takes the trouble to study tho

361

Free Banking 1

48

Rational

Banl~ing

versus

Banl~

l.fonopoly.

matter will find that these conditions are safer and much more to the purpose than any conditions or regulations which the Government could impose. Having now gained some insIght into the nature of free notes, it will be possible to grasp thoroughly the important fact that free notes, as we have described them, will not affect the country in the same way as the use of coin or State-supervised notes. Every issuing banker must keep a certain quantity of gold in stock to meet such quantitlCs of notes as are likely to be presented for payment. If a banker carries on his business in such a way as to leave himself short of coin, he may be obliged to stop payment, even though only temporarilyand though he be wealthy, and thereby lose his creait, his business, his connection, and the result of all his work. He must, therefore, carefully avoid over-issuing. But, on the other hand, the more notes he can keep in circulation, the larger is his profit through interest on the notes, and through the increased turn-over. Self-preservation on one side, and the desire for profit on the other, thus determine the limits of a banker's issue. Free notes produce-but, note it well, only within their own market-the same effect as coin would produce circulated through the same channels. It is the Important fact that the efiect of free notes is necessarily limited to their own market, which gives them, as a medium of exchange, the great superiority over coin. We have already given the reasons why the free notes do not leave their own market. If, therefore, the banker issues in excess, the notes do not spread further in the country, but come back to be exchanged for gold, which can and does leave the district. We shall explain why. An issuing banker works, as we have seen, only with producers or exporters (from the district). When the customer of the bank gets the notes, he spends them in raw material, tools, wages, etc.; an extra import into the district follows, and there is a balance against the market in which the bank works, which may be paid in gold, or left to be paid by the produced goods. The fact that the notes come into the market through the channel of production causes at once an increased activity; many people buy and sell more, many produce more, and many consume more, and more notes are therefore required. Thus the free notes improve their own market, and make it more fit for their own circulation. When the note-issuing

362

Free Banking I

Rational Banldng

verS1L8

Brmlc .Monopoly.

40

is extended, it tends to increase the import, but this import is paid for by the fresh products, and not in gold. As the producers and exporters have a profit on their goods, and the workpeople may save something out of their wages, the new products have a higher value than those which have been consumed in their production. Consequently, there remains a balance in favour of the market of the issuing bank, and gold has a tendency to flow into that market rather than to leave it. The balance will be added to the working capital of the district, and the prosperity will be permanently increased. Should the banker now send out too many notes, prices would advance, because too many would compete in buying the products of the district and the services of the people. Production would then have to stop, or be carried on at a loss. As we have seen, the result would in either case be the same-gold would leave the market. The chief gold stock is with the banker, and he has to part with it, obtaining his notes in return. A drain on the gold stock is a danger and great inconvenience to the banker, and he will, therefore, always avoid over-issuing. He can easily do this. His metallIc cash always tells hIm the exact state of the market, and with such a sure guide the banker soon learns to avoid not only runs, but all increase in the return of notes as compared with issue. He cannot help but find out by experience that any attempt to flood hIS market with notes is bound to bring a reaction which will reduce his circulation, and that his only way of increasing his note circulation is to improve the condition of his market; this he can do by choosing the best producers as his customers, by O'iving his support to all promising enterprises, and avoi~ing over-issumg. If the banker pays attention to the indication of his metallic cash, he can easily keep his market in a steady, progressive state. With coin and State supervised notes no such natural regulations exist. The whole country is always becoming over-supplied with coin-notes-we mean over-supplied in proportIOn to the business doing-and the whole market is constantly in a state which requires part of the circulating value-measurer to be withdrawn, and only issued gradually through the channels of production, in proportion to the imrrovement in the market. But there is no one to do this delIcate work. A State bank or any centre of issue or goldstoring, can only act when the gold begins to leave the country-that is, when the mischief is done, when produc. 4:

Free Banking I

50

Rntional

Banl~in[J '!)C1'SlLS

Banl.; Monopoly.

tion is checked, when foreicrn competition has prevailed, when time, capital, trade, and connection are lost. Besides, there may be cases when all the trades of the country are sufiering from over-inflation of prices through excess of issue while some political or some great external cause keeps up the gold-supply and still encourages a large issue. The state of the metallic cash of a national bank is not so true an indication of the condition of trade in the country as the private banker's metallic cash is of the state of his smaller market. The crisis towards which a country deprived of free banking is naturally drifting when no exceptional cause of prosperity is at work is m a free banking country prevented, all the causes of it being- carefully removed in detail by the bankers. The normal state of a free-banking country is, therefore, one of steady, uninterrupted progress; while the country with State-supervised notes has a'-tendency to drift towards economic crises, and experiences only short and infreguent periods of that kind of prosperity which, in reality, IS only the reaction from extreme depression, and is produced by enormous sacrifice of capital and' great sufiering amongst the people. Such is the difference between State-supervised notes, adopted by every civilized country and recommended by most writers on banking, and free notes, the use of which is forbidden by law all over the civilized world.

rIll. OBJECTIONS TO FHEE llAXKIXG REFL"TED.

OF all the prejudices in the commercial world, that acrainst free banking is probably the strongest and certainly the most general. The o~jections put forward against it are many and various. And yet these objections are all based on mere supposition, because no fact exists or has existed in any country at any time which can be cited in defence of them; and the prejudice is unreasonable and unreasoning. being at variance with all sound political economy. Almost every economic and commercial incident in the world directly or indirectly illustrates the correctness of the theories in favour of free banking, or the principles on which they are founded.

363

364

Free Banking I

Rntional

Ba1d.:~n!J Vel·8n.~ Banl~

:JIonopoly.

51

But, after all, the prejudice against free banking is both pardonable and easily explained. During hundreds of yea.rs bank-notes have been called 'money,' and the evils which have resulted from bad' money' have been very grea.t 1m!l very numerous. A safe 'currency,' or safe 'money,' is therefore considered as the first result which a bank law should attain. It is only natural that most people shoul!l feel frightened at the idea that everybody in this empire should be allowed to issue bank-notes, or, as it is generally put, to coin paper-money. With such superficial views of the question, it is no wonder that people should at first consiaer a great number of the objectlOns against free banking as both reasonable and weighty. But after having found in Chapter VI. what stringent conditions free banking imposes on the issuer of notes, and that only well managed banks can attempt such a business, we may dismiss all objections raised against note-issuing by other than bankers as entirely groundless, because it would never be attempted by such. It suffices then to meet the objections raised against free issuing banks or bankers. It is said that if bankm~ were free, dishonest men could take to banking, secure a large circulation for their notes, and when a large number were out, fail or decamp. Let us see if such a thing would be likely to occur. To begin with, it will be necessary for a dishonest banker to have a good name. His real character must remain a. secret to all, as a man whose dishonesty was known would find it impossible to circulate his notes. He must also have a considerable capit.al. We must also suppose that he has perseverance and intelligence enough to work up a considerable business of that sound and healthy kind which alone will circulate notes, because we know by experience that the note circulation is small compared with the business, and that in all banks the proportion of coin and notes to tho turn-over of the bank tends to diminish as the business grows. (A good London bank does about It per cent. of its business with ca.sh.) If we suppose all this, we arc still short of a very important factor, namely, a sensible motive for failing or running away. It would pay the dishonest man better to carryon a good business, or to sell it instead of ruining it. But let us, for argument's sake, suppose tha.t there was a motive for dishonesty, and let us see whether he could gain any adv~ntage at all by running away. or failin!{ fraudulently. Agamst the :lotes he issues he receIves no com, no goods4-2

Free &nking I

52

Rational Banking versus Bank Monopoly.

simply claims on his customers. He cannot work his business without a substantial metallic cash reserve, and a great part of that is also in his customers' hands. Thus his customers have more of his cash than he has of theirs. If he runs away he cannot take the claims with him. He might have rediscounted all bills and warrants; but we know that cash accounts are the best means of circulating notes, and he could not discount these. As under a free system the total of granted cash accounts will always exceed considerably the circulation of notes, we find that even if we suppose a number of highly improbable contingencies the fraud feared is simply impossible. It was not by chance that so few banks failed in Scotland during the 150 years of freedom which preceded the Bank Act of 1844. The almost complete absence of bank failures is the more conclusive if we consider that during this time the Government committed all sorts of financial absurdities, and caused fearful panics in England; that times were very troubled, and that the true theories of banking were unknown. It has further been objected that a banker might begin with an honest note-issuing business, gradually- go in for a deposit business, obtain a large amount of deposits, and then decamp. If such a thing did happen the loss would be caused by the deposit business, and not by the note-issuing. Deposit banks can easily ruin themselves and thousands of their customers (or shareholders, if they are unlimited), and they may now be carried on by anyone. Note-issuing, which cannot be put to any bad use, is forbidden by law. If the two branches were carried on by one bank, such bank would have to be far more cautious and more rational than a bank which does not issue notes. Note-issuing is therefore a most healthy check on a bank, and tends to keep it straight. A note circulation would hamper a dishonest or imprudent banker, and he would get rid of it before he took any undue advantage of deposits. Besides, it is evident that note circulation decreases as deposits increase. Deposit accounts make other and cheaper mstruments of credit possible than notes, such as cheques and bills. Notes are used in connection with cash accounts, and cheques with deposit accounts. If a bank doing an issuing business combined with other business were to go wrong, it would be found that the note-issuing had acted as a safeguard for the creditors and shareholders by enforcing moderation, and by precipitating an early disclosure of the true state of afiairs.

365

366

Free Banking I

But let us suppose what would not occur often, namely, that an issuing bank did fail, and even, what is highly improbable, that it failed with as many notes out as its market could carry. Would such a failure be very disastrous? 'Ve must, again, remember that under a free system the note circulation is small in proEortion to the turn-over of the bank, and that this proportion tends to diminish. At the end of the free period of Scotch banking, the aggregate note circulation of all the Scotch banks was below four millions, and in 1840-1841 it was as low as three millions, while the deposits reached forty millions. The amount which could be lost by note-holders would not only be small, but would be divided over a very great number. Few people now keep in their own hands a large amount of cash, and with more banks still fewer would do so. The amount lost by unpaid notes when an issuing bank failed would therefore be small for each holder; but when a deposit bank fails, thousands may lose their fortunes! Our wonderful Bank Law thus protects our purses; but our fortunes it not only leaves unprotected, out actually undermines. A great ar~ument of the opponents of free banking is that the working man might be the loser if a free bank failed. Should we then keep the working man in constant poverty in order to protect h.im against a remote chance of losing a few shillings throuO'h a bank failure? Compared with such reasoning it woul~ be wisdom to recommend the cessation of all railway traffic for fear of accidents. Such ar~uments do not require refutation. We may, however, pomt out that the working man has the right to refuse any note he may suspect, or he may have it endorsed by the person who pays it to him; that few working men would keep even a full week's wa~es in notes, as it is either consumed or placed in a savmgs bank; and, finally, that all the holders of cash accounts in the failing bank would be entitled to pay their debt to the bank in notes, and would therefore be able to cash the notes in 'the hands of others after the bank had failed. This they would probably be willing to do at a small discount. The risk of the working man would thus be imperceptibly small, or something like no small discount, or a few shillings once perhaps in a century. Another objection raised is that when many banks are allowed. to issue notes, ignorant people who cannot distinguish the notes of one bank ii'om those of another may be made to accept valueless paper in payment.

Free Banking I

54:

Rational Banking 'versus Bank },{onopoly.

Such a thing has happened, though seldom, in countries where the Government supervise the banks, and where all notes circulate indiscriminately, and where conse<}.uently no one notices what bank has issued the notes received; but in a country where it is generally known that the Government has nothing to do with the notes, only simpletons could be taken in by papers resembling notes. Even carefully-executed forged notes could have no chance of a circulation that would repay the forger. As the free notes do not circulate all over the country like Government notes, but have a limited market, run in fixed channels and reappear often in the banks, forged ones could more quickly be detected and traced to their origin than forged Government supervised notes. In any case it would always be easier to forge cheques and to deceive by cheques; but no one dreams of prohibiting cheques because not only stupid people but a great many clever people are taken in by them! It has been said that if an issuing bank were to stop payment, there would be a run on all the other issuing banks, and a general panic might follow. There is no experience to justify such fear, nor can a reasonable ground be given. Under a free system centralization disappears, and each bank stands more independently of other banks than under any other system. To arrive at having a good note-circulatiOn, a bank must be very useful to its market, and will therefore be popular. All who derive advantage from the bank will do their best to prevent a run, and all the cash-account customers will not only have a special reason for protecting the bank, but will have great power to do so, as they can without any risk to themselves cash notes up to the amount of their own balance. As note-issuing is not a business likely to bring about the failure of a bank with a large circulation, there would be a special reason for each failure, which would be generally known; and as each bank would be well known on its market, only those banks would be affected by a failure which had suffered from the same cause. Some people seem to fear that in case of complete absence of State regulation, a great quantity of very small notes would be issued, and that these would drive all the silver out of the country and generally prove a great nuisance. It must be remembered that the smaller the amount represented by each note, the smaller is the profit on the issue. It costs as much to print, number, check, and issuo

367

368

Free Banking I

Rational B(mldng

'L'CrS1(",'?

Bank Monopoly.

;);)

a. note for five shillings as one for a. hundred pounds. The issuing bank would, therefore, not send out more small notes than the market could hold regularly. Whether small notes would supersede silver or not would of course depend on the public. If there existed any dislike to notes under a certain amount, such notes would come back too frequently to give the bank any profit. They would obliB'e the banker to keep a. silver cash reserve as well as a gOld one, for if he at any time refused to oblige his customers or even outsiders with silver, his small notes would not circulate at all. Thus the public would have it in their power to decide the minimum amount at which a note becomes a nuisance. In busy centres no small notes would pay, an
IX. FORECAST OF RESULTS OF FREE BANKING IN ENGLAND.

IF free trade in bankin(f were introduced now throughout o . d the British Empire it would in a short time open a perlO of growing prosperity, a.nd close a term of tha~ ??rmal depression which is inseparable from hampered dl,vls.lOn of labour, and which becomes intense when, as now, It IS not counteracted by some special causes of activity in trade.

Free Banking I

56

Rational Bo/nl.:ing

ve1'SUS

Ban!.: :!fono]Joly.

The effects of free banking would bo groat and prompt, because it would enable us for tho first time to enjoy tho uenefit of all modern improvements, up to now neutralized by the absence of rational banking. Co-operation will, when free, benefit enormously from the last fifty years' progress in government, colonization, means of communication, and science. Free banking would, by supplying an unlimited wealth-producing medium of exchan~e, incapable of being abused, give for the first time to this widespread Empire the greatest development to co-operation compatible with our system of civilizatlOn. This is saying- much, but it may be interesting to point out here not all of these results -that would be impossible-but the most important of those which can be proved from experience or by deductions from the preceding chapters. Free banking would cause credit to be cheap and coin to retain its highest value; or, in other words, capital to be supplied to labour at a low rate of interest, and cost of production to remain low. The bulk of the capital of the nation would find its way into the channels of genuine I?roduction, in preference to those of consumption, speculatlOn, and spurious business. The intelligence existing amongst the lower middle and working classes, now often wasted, would be largely utilized, as the banks would derive more profit from intelligent customers than from rich ones. The cash credit system would be adopted, as it was in Scotland, by all the issuing banks wherever the presence of natural raw material, large population, or any other facilities for business might exist. The number of work givers would thereby he greatly increased, and a great man)' people would get a start in life. " ages would be high and living cheap, and the working elasses would be well off. Production would be large, cleverly managed, and profitaule. Consumption would be in proportion. Hence large import and corresponding export. Consequently Commerce would be flourishing and professions well paid. The complaint of 'no work to do' would cease. So long as there are men fond of luxuries, pleasure, or refinement, there will be more work in the world than can be done; only it must be allowed to fall into tho natural free division. The strifo botween capital and laLour would coase,

369

370

Free Banking I

Rational Banking

'L'Cl'8US Banl~

:Monoj)oly.

.,... vi

because no labour would be lost for want of capital. The despotism of capital would collapse, for the capitalist \Voul(l depend as much on the workers as the workers on the eapitalist. Capital would always be waiting on work, through the medium of the banks. An honest an(l capable man would easily find capital for any paying business, especially for one of production, as the banks would derive a double profit from any healthy increase of production in their markets. Capital, though no longer a despot, would find safer and more profitable investment, because the free banks would supply the long missing channels through which it can reach safe and paying production. And through noteissuing the banks could pay good dividends, allow goorl interest. on deposits at long and fixed periods, and still charge a moderate interest on advances, The great cause of stagnation in business-viz., the great increase of coin for a small increase in production-would disappear, as would consequently the tendency of the cost of production to exceed the prICe of sale, which tendency must prevail when we overloaa our own country, where our production is financed, with coin taken from countries which are our natural customers. 'Vith free banking no such tendency would exist; firstly, because gold would not be imported, but notes would be used, amI we consequently would not lower the price of sale abroad; secondly, because any over-issue would only affect the district of the overissuing bank, and would be speedily corrected; thirdly, because the notes would go direct to production, and create a demand or a market for themselves, failing which they would be retired before they could raise the cost of production too much for sale and export; fourthly, because with note-issuin~ bank inS' would pay, eyen on a small scale and with a small capital, in all places where there is an opening for it, and the humblest producers in even the remotest parts of the country would have the great benefit of banking, after a method superior to that which London has ever had, and would have the chance of carrying on their business as advantageously as the London firmsnamely, 98 per cent. by means of banking, and 2 per cent. with coin. The financial position of the nation would be safer. Instead of one single gold stock there would be manynamely, one in each bank. The quantity of gold in the country would be smaller than now, compared with the

Free Banking I

58

Rational Banldng verswi Bcmk :Monopoly.

business; but larger than the actual stock now in the country, the volume of business being so much greater. The gold supply would not fluctuate and produce sudden changes in the markets as it does now. It would grow steadily, but only in small proportion to the business. A gold panic could hardly be I?ossible, while now one might set in at the end of every period of depression. Honel'lty, thrift, sobriety, and other virtues would be greatly encouraged, as they would be indispensable conditions for a good cash account. The EnO'lisn would find, a.c; the Scotch found before 1844, a good character to be a discountable capital which would secure them cash for a start in life. When the supply of capital is decentralized, and independent business centres (banks) established all over the country, the tendency of labour to centralize in the large towns will be much less, if it does not disappear. Noone would lose by the free bankmg reform. The Bank of England would have to give ul? an absurd monopoly which even some of the directors, If we are well informed, consider of very questionable value. The Bank of England would give up the monopoly of note-issuino-, but keep all its other prIvileges, and certainly its worldwide prestige, and it would gain its freedom. Its notes would, of course, cease to be legal tenders. The value of freedom to a bank of such a position and such a prestige would be very great. The loss of the monopoly would not diminish but increase its circulation, and would be a gain in every way, because a monopoly which undermines the business of the whole empire must be very disadvantageous to its chief bank. The bank reform would therefore cause no loss to the Bank of England. N or would it in any way harm any other bank. The large banks would probably not try to circulate notes, as their connection is already above this primitive instrument of credit; but they would ~robably have many note-issuing branches for customers. fheir business would thereby extend considerably, and the extension would be very safe, as all papers coming through these banks would have the endorsements of the latter. The fact that no one would lose anything, and that most people would gain considerably by free banking, would soon induce other nations to follow England's example. They have not done so with regard to Free Trade, because the protected people are supposed to lose somethinothrough Free Trade, and because the reform has not freea

371

372

Free Banking J

Rational Banking

ve1'S1t8 Ba?ll~

lIfonolJOly.

59

Eng-land from periods of depression in trade. It will be eaSIer for AmerIca and the Continent to follow the lead of England in banking than in Free Trade. And those countries which adopt free banking will have taken an important step towards Free Trade, because the only sensible arguments in favour of Protection are based on two fallacies which free banking will expose-namely, that the various protected nations have no work to do and that they lack capital. Every country which adopts free banking will very much increase its prosperity, and consequently its trade with England. Should no country follow England's example, England would be the leading country in production, and have only a small and weak competition to contend with. Emigration would not require State assistance. The right people would go out with sufficient means, intelligent plans, and with a direct view to develop the business of their friends at home. The effects of free banking will be very striking in most of our colonies. In such as Canada, Australia, the Cape, and New Zealand, the immense store of natural wealth in virgin soil could be won freely, because the economic dead lock which is now established by law, and which tends to raise the cost of production above the price of sale, would disappear. As no reasons can be given why free banking should not do for Ireland what it did for Scotland, we shall here devote a page to free banking in Scotland and its efiect. The prejudice against free banking is so strong and so general that it would probably be useless for a long time yet to try to overcome it by logic alone. But a hundred and fifty years of experience with extraordinary success, which cannot be explained away, ou~ht to go a long way towards convincing a practical people like the English. All writers on the subject agree in upholding the Scotch before 1844 as the perfection of banking system as it banking, though they never recommend its acceptance except with such modifications as would change its nature altogether. During nearly a century and a half banking was free in Scotland, if we except some small prohibitions solicited by some of the large banks in a fit of Jealousy. Banking was free, not because the legislators understood the vital importance of such freedom, but because no one thought of making a Bank Law. When in 1844 rational banking was sacrificed in Scotland

was

373

Free Banking I

60

Rational Banking versus Bank

~Monopoly.

for uniformity's sake, no one had a word to say against the banks; on the contrary, only praise was heard. But unfortunately no one could defend the free system as it ought to have been defended, for the reason that the true theories of free banking were not known. The Government had theories, such as they were, but the friends of free banking had none, and were beaten. Walter Scott, though no economist, saw that an injustice wa.s beinO' done to Scotland, and wanted to know' why the Scotch should be forced to take the medicine when it was the En[lish who were sick l' The ~reat praise which so many ~nglish and foreign writers lavish on the Scotch system, and the glowing descriptions they give of its effects, are bY' no means exaggerated. When the first bank was started in Scotland the country was one of the wildest and least civilized in Europe, which is saying a good deal when speaking of the end of the seventeenth century. Manufacturing hardly extended beY'ond a meagre home sUJ?ply of the rudest wares, and agriculture was entirely primitlve; black-mailing and robbery must have been of almost daily occurrence, judging from the laws enacted in those days; security for life and property was small, and poverty was &{lpalling. If we compare the state of Scotland in 1690 wlth its condition in 1844, we attain an idea of the progress which had been accomplished. No European country can show such an extraordmary development during so short a period. This progress becomes more surprising when we ·consider that in Scotland at the beginning of that period almost everything except banking was obstructive to progress and prosperity, and that the effects of free banking were not accelerated by the great facilities for co-operation which modem progress has established. CommunicatlOn with other countries was slow and dangerous; there was very little shipping, no railways, no canals, only bad roads infested by robbers. There was no Free Trade, no schools, no police. The country was agitated by political and religious strife, and for want of anything better to do for a living many younO' Scotchmen hired themselves out as mercenaries on the Continent, distinguishing themselves through their fierceness and recklessness. AO'ainst all these difficulties free banking won for Scot~and the race of progress between the countries of' Europe. It gave Scotland its model farms, its large and varied manufactures, its fleets of ships, and forty millions

374

Free Banking I

Rational Banki11g versus Bank Monopoly.

61

of deposits in the banks. But it did for Scotland what is worth more than all this; it moulded and educated the Scotch into the best business-men in the world. To free banking they owe thrift, economy, good methods, foresight, and trust in hard work. And who dares to say that free banking would not produce the same results in Ireland? It certainly would, and in a very short time, because none of the obstacles to cooperation exist now which existed in Scotland then. Increasing prosperity and thrift will produce contentment. All the advantages the country can derive from its connection with a great, self-governmg, and free-trading Empire, will be made manifest to the Irish when they have free banking. But in no country would the effects of free banking be greater than in India, because in no country are the evils consequent on legally prohibited division of la.bour greater. The British Parliament has for a long time been legislating for India with a sincere desire to benefit its inhabitants, making its usefulness to England a secondary consideration; but increasing poverty has, so far, been the result, and will be the result so long as co-operation is not either entirely State managed or entirely free. The poverty of India under English rule threatens to become as proverbial as was its wealth before the conquest. If those foreigners who seem to envy England the possession of this 'bri~htest jewel of her crown,' and who fancy that the free and selfg-overning 20,000,000 of Englishmen derive untold riches irom wealthy India, and the 250,000,000 of conquered Indians, were to inspect our back streets and slums, they would be surprised to find how little the country of fabulous wealth has benefited its masters. They would certainly think there must be something very far wrong in our management of Indian affairs. And they would be right. Production of wealth is prohibited by the fact that co-operation is prohibited. The very improvements introduced in India have reduced the productive power of the country. We have abolished slavery, compulsory labour and despotism, and thereby removed important factors in the co-operation of the people, without replacing them by others. Such banking as we allow is of no use to the producers, and they have no medium of exchange but COIn. In countries where such an economy is established the money-lenders are sure to multiply. In India they are

Free Banking I

62

Rutional Banking versus Bank

375 ~1Ifonop()ly.

considered a time-honoured and indispensable institution, and we have not, in all these years durmg which they have oppressed the people. found the means to free the country from such a curse. The result is that about 40 per cent. of the ryots are paupers, and 20 per cent. more are insolvent, misery is on the increase, the beautiful and interesting industries of the country are dying out, and the hopelessness of the suffering people is becoming more and more intense. What a chanO'e we would create if we allowed free cooperation to do for these 250,000,000 of India what it did for Scotland; if we allowed entirely free organization of division of labour between all these people, and between them and the rest of the empire! The first result would be that the money-lenders would have to make room for free banks. The 'peculiar agrarian system of India would not present any serIOUS obstacles, as the reform would increase the revenue of the landowners, who, moreover, could take an interest in the banks. The people would obtain their capital at 5 per cent. interest mstead of 50 or 60 per cent., and would find their cost of production in more favourable proportion to the price of sale. The ryot is known to be a relIable payer, not only of his own debts, but also of those of his father and grandfather, and such customers are the right sort for cash accounts in free banks. In India none of those obstacles exist now which obstructed economic progress in Scotland. By all the improvements effected under the English rule the country is splendidly prepared to reap the greatest benefit ii'om free banking. Tlie great increase in production which free banking calls forth had, in Scotland, to be raised under a hard climate, in cheap and rough products, from meagre moorlands, as a new experience. In India free banking would simply have to revive an ancient prosperity, decayed through want of it, and to facilitate the growth and manufacture of the most valuable products in a warm climate, and from the most suitable soil. The new prosperity in India would totally eclipse the ancient one, because as a medium of co-operation free banking possesses such considerable ad.vantages over the anCIent one, the feudal system. I t is evident that from the very beginning of free banking a healthy change would set in. With ample mediums of exchanO'e, cheap capital, and naturally low cost of production, tho Indian farmer would easily supply bis wants and soon have products for sale. To easo the minds

376

Free Banking I

Rational Banking

vel'BUS Ban7~

Monopoly.

63

of those who are afflicted with the over-production theory, we may point out that as soon as increased production is in operation in India the consumption would necessarily increase; that as soon as the cultivator could sell produce he would increase his consumption further. This increased consumption, which increased production and increased wealth naturally and necessarily involve, would react on European markets; larger orders would come from India, trade would improve in countries which ship to India, and the consumption of Indian produce would increase. Thus, the improvement in India would improve the European markets, and then again react favourably on India. There would therefore be no overproduction, but an end to the under-consumption from which we now suffer, and which appears as over-production to superficial observers. Suoh reciprocal influences can be noticed arising out of even occasional and ephemeral causes of both good and bad trade. Improved, not to say permanently perfected, co-operation in such an important country as India, is therefore sure to react strongly all over the world, as she would draw her supply from many countries, send her produce in return, and thus increase activity everywhere. England, the great free-trading country, would, of course, obtain the bulk of the increased Indian trade. With sufficient capital (and with free banking every market would have sufficient capital) the products of India will not only increase in quantity, but also in number and variety. All the old industries will leap into fresh life, and, under the free division of labour and free exchange with Europe, prove themselves capable of great development and wide application. Irrigation will be easily and speedily established whereever it is likely to pay, because useful public enterprises arc greatly facilitated by free banking, not only indireetly, but also directly. The Scotch note-circulation facilitated and cheapened the construction of canals in Seotln.nd to a ye.ry great extent. The same work executed with imported coin would have increased the expenses and paralyzed industry in a great part of the country during a cunsiderable time after the construction, which is proved oy every great public enterprise undertaken with coin as the only medium of exchange. Prosperity in India would accelerate the civilization of all its races, amI the more civilization advances the greater will be the demand for European, and especially for English goods.

Free Banking I

G4

Rational Banking versus Bank j[onopoly.

Finally, we must express our firm belief that when banking has been allowed to establish itself on a truly economic basis, distrust of the truths of political economy will disappear, as the absence of true theories of banking has alone been the stumbling block of its votaries, and the cause of the sad mistakes and consequent misery which do so much to produce sceptical sneers against 'the dry bones of political economy.' True theones will then be established In perfect harmony with all experience, capable of explaining all the economic phenomena which now puzzle statesmen and business-men. The fundamental theories of political economy will, no doubt, be accepted without further discussion, as reliable facts, by the bulk of the masses in the same way as other scientific facts have been accepted. If, therefore, rational banking could be introduced throughout the empire, all States which form part of it would arrive at a perfect understanding on all economic questions, and have all their interests parallel. This would no doubt strengthen and perpetuate their bond of union, and give to our empire a hitherto unrivalled power and prosperity. With Western civilization flourishing in our country and our colonies as it never flourished in any country before, joined to the splendour of ancient empires revlved and exceeded in our -.Eastern possessions, we could prove to the world t.hat prosperity does not bring decay, when it springs, not from degrading slavery, but from a soul-ennobling system of economy in perfect harmony with the natural and moral laws of God.

E:liot Stock, P"t!ri1ostcr Roze, London.

377

Name Index Attwood 206 Babbage 215 Bailey 229 Bell, Robert 191,231 Burgess, Henry 55, 56 Canning 69 Chevalier, Michel 349 Cobbett 77 Cobden 192 Colville 334 Denham, Major 36 Fullarton 349 Gallatin 225 Genghis Khan 51 Gernier, Joseph 349 Gilbart, James William 191, 220, 227 Gisborne 164, 165 Gouge 239 Grey, Earl 220 Hume, Joseph 191, 193,203 Huskisson 86, 349 Jefferson, Thomas 237 Joplin 81 Kaigatou 51 Koblai 51, 52 Leatham 206 Liverpool, Lord 9, 74, 349 Lloyd, Lewis 206, 208 Loyd, Samuel Jones 129, 135-7, 139, 140, 142-5, 147, 148, 151, 154-9, 161, 165-70, 173, 175, 191, 193, 199,201,203,204, 212-19, 221, 222, 225, 226, 228, 229, 233

M'Culloch 36, 66, 82 Macleod, Henry Dunning 327, 349 Melbourne, Lord 212 Mill, John Stuart 327, 342, 349 Morpeth, Lord 206 Mushet 81 Newmarch 349 Norman 192, 194, 211, 217, 218, 222, 225, 228 O'Connell 220 Palmer, Horsley 192, 202, 208, 209, 211-15, 226,232 Parnell, Sir H. 81, 87 Peel, Sir Robert 221, 335-7, 349 Pitt, William 87 Ricardo 74, 88, 134, 241 Rose 9 Scott, Sir Walter 306 Smith, Adam 134, 139, 142, 157, 160, 192, 306,313,316,317 Smith, Dr 31,33,34,46,67,68 Storch 49,51, 66, 68, 349 Thornton 349 Tooke, Thomas 6,28,81, 191, 193, 194,212, 226, 227, 327, 349 Torrens, Col. 129,213,214,217,226,232 Turgot 37 Twiss, Travers 349 Van Buren 302 Warburton 193, 197 Webster 137, 140, 225 William the Conqueror 42 Wilson, James 327, 349