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plaint of an institution which was the pride of the city and the
envy of Europe. When the French destroyed it, they found no
funds to reward them.

The Bank of Genoa originated in the same way, but differed
in some details of management, such as the issue of bank-notes.
The Bank of Stockholm owed its origin to the fact that copper
was the only coin in circulation in Sweden, and it was therefore
necessary to translate this into a more convenient form of money.
Hamburg and Amsterdam, the Genoa and Venice of the North
in the sixteenth century, were equally embarrassed by the various
weights and standards of the coin that flowed into their cities,
and established banks of deposit and transfer to translate these
into " money of account;" here also wholesale transactions were
required to be settled in the shape of transfer of bank credits.
As neither were based on government debts, and neither loaned
money, the expenses were defrayed by a slight charge to the
customers of the bank. Both cities reaped immense advantages
from the system, in the rapidity and ease with which money of
account passed from one person to another in effecting ex-
changes. The Bank of Amsterdam failed in 1790, as it was
found that the funds on which its credit rested had been in part
abstracted by the Dutch government. That of Hamburg still
exists.

§ 169. A bank in the modern sense is more than any of
these institutions was. It is a discount house, a firm for the
issue of paper-money, a place for deposit of money, a clearing-
house, and a branch of a larger clearing-house. It is the union
of all the earlier features of such institutions, with the addition
of others that grew out of the peculiar methods of modern
business.



FOUR FUNCTIONS OF A BANK. 171

First, its discount business. A bank is an institution that
deals in credits by buying up debts, — that may be said to turn
debts into credits for a consideration called discount. Except in
the retail trade, the larger part of modern business is transacted
by means of " mercantile paper." The buyer does not transfer
the amount due to the seller in coin or bank-notes. He gives him
a bill for the amount payable in (say) sixty or ninety days.
The seller cannot afford to do without the money for so long a
time. He wants to " turn over his capital " as fast as possible;
he would rather give up a percentage of his profits and get the
money at once. He takes it to bank to be discounted, after
making himself responsible for its payment by endorsing it.
If the directors are satisfied with the name of the endorser or
of the drawer,, or of both, they let him have the money, minus
the interest for the time specified. When the time is up the
drawer of the bill must pay it, or if he fail its endorser must.

Second, its issue business. A whole or a part of the money
advanced to the bank's customer may be needed in such shape
as will circulate among all classes. If he be a contractor or a
manufacturer he is dealing with people who keep no bank ac-
count. He must, therefore, have money that they can use, and
this the bank gives him, either in its own notes, or in those of
some other bank. In this way the banks put into circulation a
much larger sum in notes than their whole paid-up capital would
suffice to redeem, and this with perfect safety to themselves
and great benefit to the community.

Third, its business as a clearing-house, which is the most
important of its functions. In most cases a customer of the
bank who has had a note discounted would find it very incon-
venient to be paid in any form of money; he prefers a credit
to that amount on the books of the bank. That is, the bank
advances him a sum of money, and he at once "deposits" it
with the bank, and uses the credit thus obtained to pay his
debts by check, i. e., by the transfer of a portion of this credit
to the account of his creditors. A small percentage of checks
are drawn in money by their holders, but in most cases they



172 SOCIAL SCIENCE AND NATIONAL ECONOMY.

are paid simply by a transfer of credits. In this case the
" deposits " on the bank's books become virtually part of the
currency, and constitute a vast fund of "money of account"
for the discharge of indebtedness. These deposits far exceed in
amount all otber forms of money in circulation, and move with
greater rapidity and exhibit vaster utility in effecting exchanges.
The deposit fund continually tends, indeed, to diminish in volume
through the discounted notes maturing and being paid, as well
as through the payment of depositors' checks ; and it is only
kept up through fresh deposits of cash or fresh discounts. When
the demand for these discounts is not great, or the directors are
hopeful and confident, the rate of discount falls. When the con-
trary is the case, it rises and the best security is required.

This is particularly noticeable in countries where there is no legal limit
to the rate of interest, such as England. In the United States a bank
usually charges uniformly the rate fixed by law.

Fourth, to make the system more efficient and to give this
money of account yet wider currency, each bank in our great
cities is a branch of a larger clearing-house. When all the
business of a city was done at a single bank, the transfer of its
credits sufficed for all wholesale transactions. When several
took the place of one, very large sums of money passed between
them, as a check would not transfer credit unless both parties
kept accounts at the same bank. But now each bank makes its
statement in the clearing-house, of its claims against every other,
and on balancing the account of each, the net indebtedness to
(or from) it is ascertained, and paid from (or to) the clearing-
house. These balances are the merest fraction of the gross
amounts, and the system brings every bank, to a certain extent,
under the supervision of the rest.

This method of settlement was adopted by the dealers in the old
French fairs, and enabled the merchants to transact a great deal of
business with the exchange of very little money.

The Scotch banks first adopted it for the mutual supervision and con-
trol of their circulation. They met once a fortnight in Edinburgh to ex-
change notes, and paid the net balances in coin.



CAUSE AND CHARACTER OF PANICS. 173

§ 170. Note here that we must distinguish betweeu the true
character of money of account and the way in which it is mostly
created in modern times. The method of buying and selling
" on time " with which it is now associated is open to many ob-
jections; but if that method were utterly abolished, if the dis-
count system were to cease, and all purchases were to be paid in
cash, such a currency as this would be as necessary as ever for
the transaction of business. The credit-fund would then have
to be created entirely, as it now is in part, by the actual deposit
of money in some institution like the Bank of Hamburg. Its
volume would then be no longer liable to contraction or ex-
pansion with the hopefulness or distrust of bank directors.
Were a money of account based not on deposits of cash, but
on deposits of securities to a fixed amount, as in Venice, it would
retain its power of circulation, with no reduction of its volume,
in the worst seasons of panic, and would be continually available
for the transaction of legitimate business. The possession of
such a "money of account" was the secret of the mercantile
stability of Venice and Genoa, Hamburg and Amsterdam ; as
the complication of our " money of account" with the discount
system is a chief cause of our commercial fluctuations.

§ 1*71. No market is so sensitive as the money market. A
very slight reduction in the supply raises the price out of all
proportion, and leads to a rigid scrutiny of all securities offered
as the ground of a loan. The banks at such a period are sensi-
tive to the approaching stringency ; they refuse discounts that
they would else have granted ; they refuse new paper, and put
an artificial dam across the great stream of credit-payments, to
the ruin of those who must go on and who must have money.
In the fright that follows, as in all frights, men lose their wits ;
the business community is demoralized. Credit, faith in any-
body, in anything but visible and tangible money, disappears.
There is a general falling back upon the more primitive and
material methods of payment. The great credit-fund of money
of account loses its currency, or hold upon public confidence,
because created by discounts and bound up with the uncertain



174 SOCIAL SCIENCE AND NATIONAL ECONOMY.

fortunes of the discounting banks. Then begins a " run upon
the deposits." Those deposits were in great part created by
credits granted, and were never intended to be paid in money
of any sort. The banks should have the option of paying
them in legal tender, or in certificates of deposit, good at the
clearing-house; but they have none. They are demanded
in visible and current money. In spite of the reduction of dis-
counts, their amount is still too great to be thus disposed of,
and a suspension of the banks necessarily follows, upon which
the panic reaches its height. All exchange of services, except
the most necessary, ceases at once ; the community relapses into
the barbarism of mutual distrust. The history of banking,
since the establishment of the discount system, shows us the
necessity of such a reform as will sunder that system from bank-
ing proper, and secure the permanent currency and the free crea-
tion (under proper safeguards) of money of account.

No bank existed in England till 1694. During Common-
wealth times the London goldsmiths, whose fire-proof and thief-
proof vaults rendered them the natural custodians of large sums
of money, began to exercise some of the functions of modern
banking. They granted loans at high rates of interest, and is-
sued these in demand-notes. A little experience showed them
how much specie they must keep on hand to meet the possible
demand for it on any one day. They paid depositors six per
cent, interest for it. This continued till after the Revolution.

§ 172. It occurred to William Paterson, member of the Scotch
Parliament from Dumfries, that government could raise money
fur the war against France without paying the high rate of in-
terest exacted by the goldsmiths. He saw that a far larger sum
than they could command would be obtained, if the government
could give confidence to the multitudes who were hoarding sniall
sums, and make it worth their while to lend them. He pro-
posed a Bank of England, after the model of those of Italy and
Holland, — i. e., for the issue of circulating paper-money, secured
by the deposit of what we call government securities. After
much opposition, the plan was adopted with some modifications,



THE BANK OF ENGLAND. 175

and the Bank of England began its career January 1st 1694
by lending its whole paid-up capital of £1,200,000 to the gov-
ernment at 8 per cent, interest. At first its notes were gladly
taken in exchange for the light and defective silver currency of
that day ; but when the new coinage that was carried through
under Sir Isaac Newton came upon the market, the notes de-
clined in favor, although they bore interest and were much
needed for the business of the country. Iu 1096 their redemp-
tion in specie was suspended. The Tory party, mostly country
gentlemen, attempted to establish a land-bank as a rival. It
also was to loan money to the government and to discount bills
only on the credit of real estate. The plan failed utterly and
caused great loss to the nation.

■ The Bank of England grew slowly into favor, and lost its bit-
terest enemies as the old race of usurers died out and none filled
their places. It gradually perfected its methods; it established
the system of book credits, with payments by check. It substitu-
ted demand-notes bearing no interest for time-notes that bore
interest; these new notes passed quickly into the circulation, and
were rarely returned for redemption. It issued smaller and
therefore more useful notes, the first being never less than £20.
It secured in 1706 a virtual monopoly, not more than six per-
sons being allowed to unite their capital to establish any other
bank in England. (This lasted 120 years, and was then confined
to London and towns within 65 miles of it.) On the other
hand it upheld the public credit, and greatly simplified ques-
tions of finance, by furnishing a channel through which the
people could easily come to the support of the government in
time of need, and could always obtain either a profitable invest-
ment for capital or a loan of money on easy terms. The rate of
discount doivn to 18-14 varied between 4 and 5 per cent.,
save a rise to 5* and 6 in the last half of 1839. Other bank-
ing houses grew up in London and throughout the country, but
all subordinate to the great national concern in London.

§ 173. As a state bank it shared in the vicissitudes of the
government. It had to stand a run on its specie in 1745, when



176 SOCIAL SCIENCE AND NATIONAL ECONOMY.

the Pretender was on his way to London, but the city merchants
stopped this by publicly pledging themselves to stand by tbe
bank. In 1772 and 1783 panics were caused by " over-trad-
ing" in foreign goods; in the latter the ^bank for the first time
adopted the policy of cutting down its discounts, till the drain of
specie from the country should cease, — an effectual but rather
" heroic" remedy, as every reduction of the circulation intensi-
fies the panic.

In 1793 and 1797 panics recurred ; that of 1793 caused partly
by over-trading, partly by the political disturbances of the time;
that of 1797 entirely by the latter. In both cases the bank made
bad worse, by refusing discounts and thus allowing wealthy and
solvent firms to go down unaided. Happily tbe government re-
stored confidence by an issue of exchequer notes. In 1810 the
revolt of the Spanish-American colonies led to immense over-
trading and a consequent panic. Cargoes of skates had been
sent to cities where ice and snow were never seen, and others
had received Epsom salts enough to physic their entire popula-
tion once a week for fifty years. The bank having suspended
specie payments since 1797, came to the aid of solvent firms
with large amounts of notes, and the government ordered an
issue of £6,000.000 besides.

§ 174. In 1815 the bank began to get ready for a resumption
of specie payments by cutting down discounts and reducing cir-
culation. It thus reduced the currency by £12,000,000, a mere
trifle as compared with the money value of the nation's pro-
perty ; but the whole circulation for a time stopped and an arti-
ficial panic was produced. In 1819 it resumed specie payments,
after a suspension of twenty-five years, thus altering at once and
greatly the terms of all contracts made in the interval and not
yet executed. All who had land, labor or produce to sell, or
contracts to fill, were placed at great disadvantage. Creditors —
i. e., the wealthy, capital-holding class — gained greatly, except
where their debtors were absolutely ruined. Mills stopped, land
fell in price, labor was thrown idle, and in peace men suffered
more than the calamities of war.






peel's bank bill. 177

In 1S25, 1S37 and 1839 panics similar to that of 1793
occurred — i. e., they were caused by over-trading and intensified
by the selfish policy of the bank. In 1810 a parliamentary
commission began to investigate the reasons of these crises, and
in 1814 Sir Robert Peel's famous " Bank Act " was passed, with
a view to prevent their recurrence. Rejecting the opinion of
Adam Smith — that if bank-notes he issued only on the discount
of merchantable bills of undoubted character, and founded on a
real transaction, they cannot be excessive, — English financiers
had adopted the theory of over-issues as explaining the whole
matter. That theory grew very naturally out of their mechanical
theory of the effect of an increased supply of money (§ 161).

§ 175. The Act of 1811 was directed to the regulation of the
English currency through the Bank of England, to prevent a
fancied " depreciation." It severed the banking department
proper from the department of issues, and transferred to the
latter £11,000,000 in government obligations as security for bank-
notes of that amount. It required that, if the note circulation
exceeded that sum, the bank should have gold in its vaults equal
to the excess. At the same time it provided that the bank-note
circulation of the country banks should be limited and diminished,
never increased. In other words, it made the amount of paper-
money in circulation in England dependent upon the amount of
bullion in the vaults of the banks.

The measure betrayed a total want of apprehension of the true
nature of the discount and deposit system. It did not put the
vast currency created by the bank's advances and those of its
rivals, under any specific limitations. It allowed the bankers to
create currency ad libitum on the pages of their ledgers, pro-
vided they did not print it on bits of silk paper that passed from
hand to hand. In ordinary business times it could therefore put
no restraint upon the real circulation of the country. Rather it
set before the bank the strongest inducement to multiply that
currency and stimulate speculation when money was easy, that
it might " make hay while the sun shone " and get its super-
fluous issues into circulation. Heretofore the rate of discount
12



178 SOCIAL SCIENCE AND NATIONAL ECONOMY.

had ranged between 4 and 5 ; from this date the extremes are
2 and 10. The office of a regulator is to moderate extremes ;
but the bank has really intensified and exaggerated them.
And when we speak of the Bank of England, it must be re-
membered that it controls all the lesser banks. By its im-
mense size, its vast prestige, its special privileges, it is able to
fix the rate to be paid for money throughout the kingdom.

But in other than ordinary times, when this great credit-fund
loses its currency, when the business community is demoralized
by panic, and the demand for other and more tangible forms of
money recurs, the act becomes at once powerful for mischief. In
such a case the actual supply of notes and specie is manifestly
unequal to the vast demand made upon it by the business of a
great nation ; and not only the Bank of England, but all the
banks of the country are hand-tied so far as regards any help
they can give. Their notes may be as good as gold. Since
1823 they have always been so. But they can issue none until
the government step in and put an end to the panic by sus-
pending the act that was meant to prevent panics.

All these objections were very ably presented before the act was passed,
by Lord Ashburton (head of the house of Baring Bros.), T. Tooko,
(author of the History of Prices), John Fullarton {On the Regtdation of
the Currency), Charles Scott (a Montreal banker), and others ; but to no
purpose. The " sound views on currency " represented by Peel, Lord
Overstone (Mr. Jones Lloyd), Torrens, McCulloch, <fcc, carried the day.

Worse still, the act conduces to purely artificial panics. The
causes that lead to the diminution of bullion in the bank vaults
are various, and most, or indeed all of them, are without any signi-
ficance as to the general soundness of the English money market.
If a large amount of foreign stocks or government bonds have
been subscribed for, gold must go out to pay for them. If
schemes of improvement in India are on foot, English gold must
buy on the Continent the silver that is to pay the Hindoo work-
men. If any country has sold as much as usual to England, but
has bought less than usual, specie must be exported to pay the
balance, since bills of exchange are not to be had. If a failure



"putting on the bank screw." 179

of the English grain crop necessitates a larger import than usual
of Russian or American wheat, Mark Lane must pay for it partly
in gold, unless- the exports to Russia or America be unusually
great. Any one of these causes or a concurrence of several will
diminish the bullion in bank. Were there no Act of 1S44, aud
were the directors wise by past experience, the decrease would
Dot matter. It might be treated as a petty backset, that the
course of trade would speedily compensate for.

But as it is, the bank raises the rate and diminishes the
amount of discounts as the bullion diminishes, in order to keep
the circulation down to the level of the bullion, instead of
taking any steps to directly replace the loss. It does not go to
the Continent to buy or borrow bullion ; it throws the whole
pressure of the distress upon the business men of the nation.
Holders of stocks of domestic and even of foreign goods, who
arc in want of money, must throw them on the market at any sacri-
fice, and sell them at a bargain to some rich capitalist at home or on
the Continent who is on the outlook for such chances. English



o



stocks and foreign stocks held in England are sometimes sacrificed
to an extent that exceeds the maximum of bullion in the bank
vaults. In this way a purely artificial drain of specie home-
ward is produced, and the bank is satisfied. In the meantime
great establishments have broken down under the pressure, a
few because they ought to break, others in spite of their com-
plete solvency. In many cases, after the affairs of such houses
have been wound up by the costly processes of an English
bankruptcy, — which absorbs 45 per cent, of the estate, — every
creditor has been paid in full, and a handsome fortune left to
the partners.

§ 176. Three years after Peel's Bank Act was passed came
the crisis of 1847, occasioned partly by the drain of gold to
buy food abroad because of the failure of the potato crop, partly
by the great railway speculations of that period. The Bank Act
failed in its purpose, as even its author confessed ; the govern-
ment suspended its operations to allow the bank to come to the
assistance of business men. The same took place in the great



180 SOCIAL SCIENCE AND NATIONAL ECONOMY.

crises of 1857 and 1866, and in a less degree in 1874. In
1857 mercantile extravagance was not rife in England ; business
was quiet and moderate as compared with 1852, when the bank
stimulated speculation to the utmost by lowering the rate to
two per cent. But Peel's Act necessitates a crisis in England
whenever any of England's customers are in trouble. The
American crisis caused a drain of specie from Europe to the
United States, and all England was put " under the bank's
screw " to turn the tide of gold back to England ; prices were
forced down twenty-five per cent., and large amounts of the pro-
ducts of industry passed out of the hands of their rightful owners
into those of capitalists who could take advantage of their ne-
cessities. Every crisis takes from the poorer and more active to
give to the richer and idler classes, and adds to the inequality
of wealth that is so ominous a sign for the future of England.
It destroys also a part of the moral capital of the nation, — the
confidence and hopefulness of its captains of industry.

England possesses, therefore, a highly artificial banking system,
one which is nominally armed with great powers to protect the
industrial interests of the nation, but certain, if rigidly ad-
hered to, to use them to oppress and injure those interests.

§ m. In Scotland, on the other hand, we find an eminently
natural banking system, created not for the people, but hy them,
acting down to 1845 with the most perfect freedom in the exten-
sion of its operations, the increase of its credits and the amount
of its circulation. And the safety has been exactly proportional
to the freedom. Scottish bank-notes have been at par; the
people will take guineas instead, if they must, but they pass
the'm off as soon as possible as a pretentious, unthrifty, eminently
un-Scottish kind of money, much inferior to a native bank-note
issued in any corner of Scotland.

The business men of Edinburgh, having heard that their coun-
tryman (Paterson) was planning a bank for the English, and
that he had been successful in obtaining a hearing, asked an
Englishman named Holland to devise a Bank of Scotland. He
did so, and put his proposals before them. They knew nothing



THE SCOTCH METHOD OF BANKING. 181

of banking, but were willing to learn. They abounded in objec-
tions, but saw the point of his answers. And so, in 1695, the
new institution was launched, under a charter granted by the
Scottish Parliament, being the first private joint-stock bank that



Online LibraryRobert Ellis ThompsonSocial science and national economy → online text (page 16 of 38)