[First published in The Westminster Review for January 1858.]
Among unmitigated rogues, mutual trust is impossible. Among people of absolute integrity, mutual trust would be unlimited. These are truisms. Given a nation made up of liars and thieves, and all trade among its members must be carried on either by barter or by a 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 others’ rights as of their own—and nearly all trade among its members may be carried on by memoranda of debts and claims, eventually written off against one another 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 as a measure of value, and to facilitate those small transactions for which it is physically the most convenient. These we take to be self-evident truths.
From them follows the corollary that in a nation neither wholly honest nor wholly dishonest, there may, and eventually will, be established a mixed currency—a currency partly of intrinsic value and partly of credit-value. The ratio between the quantities of these two kinds of currency, will be determined by a combination of several causes.
Supposing that there is no legislative meddling to disturb the natural balance, it is clear from what has already been said, that, fundamentally, the proportion of coin to paper will depend on the average conscientiousness of the people. Daily experience must ever be teaching each citizen, 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. From personal experiment, and from current opinion, which results from the experiments of others, every one 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 be great, if all find that the fulfilment of trading engagements is tolerably certain. The degree of honesty characterizing a community, being 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 are respectively rash and circumspect. And two nations thus contrasted in prudence, will be similarly contrasted in the relative quantities of notes and bills in circulation among them. Nay, they will be more than similarly contrasted in this respect; seeing that the prevailing incautiousness, besides making each citizen unduly ready to give credit, will also produce in him an undue readiness to risk his own capital in speculations, and a consequent undue demand for credit from other citizens. There will be both an increased 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 prudence of any people is liable to more or less fluctuation. In railway-manias and the like, we see that irrational expectations may spread through a whole nation, and lead its members to give and take credit almost recklessly. But the chief causes of temporary variations are those which directly affect the quantity of available capital. Wars, deficient harvests, or losses consequent 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 disabled by such causes from meeting his engagements?—the shopkeeper whose custom has fallen off in consequence of the high price of bread; or the manufacturer whose goods lie in his ware-rooms unsaleable; or the merchant whose foreign correspondents fail him? As the proceeds of his business do not suffice to liquidate the claims on 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 furnish 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 to. 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 payments in circulation.
Reduce this proposition to its most general terms, and it becomes self-evident. Thus:—All bank-notes, cheques, bills of exchange, etc., are so many memoranda of claims. No matter what may be the technical distinctions among them, on which upholders of the “currency principle” seek to establish their dogma, they all come within this definition. Under the ordinary state of things, the amount of available wealth in the hands, or at the command, of those concerned, suffices to meet these claims as they are severally presented for payment; and they are paid either by equivalents of intrinsic value, as coin, or by giving in place of them other memoranda of claims on some body of undoubted solvency. 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 of coin, which is the most exchangeable equivalent of such necessaries, has been sent abroad to support an army, or to subsidize foreign states; or, suppose that there has been a failure in the crops of grain or potatoes. What follows? It follows that part of the claims cannot be liquidated. And what must happen from their non-liquidation? It must happen that those unable to liquidate them will either fail, or they will redeem them by directly or indirectly giving in exchange certain memoranda of claims on their stock-in-trade, houses, or land. That is, such of these claims as the deficient floating capital does not suffice to meet, are replaced by claims on fixed capital. The memoranda of claims which should have disappeared by liquidation, re-appear 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 of it, mortgage still further, and still further increase the promissory payments in circulation. Manifestly, if the members of a community whose annual returns but little more than suffice to meet their annual payments suddenly lose part of their annual returns, they must become proportionately in debt to one another; and the documents expressive of debt must be proportionately multiplied.
This a priori 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 Treasury 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 1796–7, there were failures of the provincial banks; a panic in London; a run on the nearly-exhausted Bank of England; and a suspension of cash-payments—a State-authorized refusal to redeem promises to pay. In 1800, the further impoverishment consequent on a bad harvest, joined with the legalized inconvertibility of bank-notes, entailed so great a multiplication of them as to cause their depreciation. During the temporary peace of 1802, 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 illustrations—illustrations of the sudden cessation of commercial distress and bankruptcy, resulting from a sudden increase of credit-circulation. When, in 1793, there came a general crash, mainly due to an unsafe banking-system which had grown up in the provinces in consequence of the Bank of England monopoly—when the pressure, extending to London, became so great as to alarm the Bank-directors and to cause them suddenly to restrict their issues, thereby producing a frightful multiplication of bankruptcies; the Government (to mitigate an evil indirectly produced by legislation) determined to issue Exchequer-Bills to such as could give adequate security. That is, they allowed hard-pressed citizens to mortgage their fixed capitals for equivalents of State-promises to pay, with which to liquidate the demands on them. The effect was magical. £2,202,000 only of Exchequer-Bills were required. The consciousness that loans could be had, in many cases prevented them from being needed. The panic quickly subsided; and all the loans were very soon repaid. In 1825, again, when the Bank of England, after having intensified a panic by extreme restriction of its issues, suddenly changed its policy, and in four days advanced £5,000,000 notes on all sorts of securities, the panic at once ceased.
And now, mark two important truths. As just implied, those expansions of paper-circulation which naturally take place in times of impoverishment or commercial difficulty, are 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. The process amounts to a postponement of trading-engagements which cannot at once be met. And the alternative questions to be asked respecting it are—Shall all the merchants, manufacturers, shopkeepers, etc., who, by unwise investments, or 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? or, by being debarred from issuing memoranda of claims on their fixed capital, shall they be made bankrupts? On the one hand, if they are permitted to avail themselves of that credit which their fellow-citizens willingly give them on the strength of the proffered securities, most of them will tide over their difficulties; and in virtue of that accumulation of surplus capital ever going on, they will be able, by-and-by, to liquidate their debts in full. On the other hand, if they are forthwith bankrupted, carrying with them others, and these again others, there follows a 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 10s. in the pound. Added to which evil 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 either be in great measure eventually escaped, or will be spread little by little over a considerable period. Stop this remedial process, and the whole evil, falling at once on society, will bring wide-spread ruin and misery.
The second of these important truths is, that an expanded circulation of promises to pay, caused by absolute or relative impoverishment, contracts to its normal limits as fast as the need for expansion disappears. For the conditions of the case imply that all who have mortgaged their fixed capitals to obtain the means of meeting their engagements, have done so on unfavourable terms; and are therefore under a strong stimulus to pay off their mortgages as quickly as possible. Every one who, at a time of commercial pressure, gets a loan from a bank, has to give high interest. Hence, as fast as prosperity returns, and his profits accumulate, he gladly escapes this heavy tax by repaying the loan; in doing which he, directly or indirectly, takes back to the bank as large a number of its credit documents as he originally received, and so diminishes the credit-circulation as much as his original transaction had increased it. Considered apart from technical distinctions, a banker performs, in such case, the function of an agent in whose name traders issue negotiable memoranda of claims on their estates. The agent is already known to the public as one who issues memoranda of claims on capital that is partly floating and partly fixed—memoranda of claims that have an established character, and are convenient in their amounts. What the agent does under the circumstances specified, is to issue more such memoranda of claims, on the security of more fixed, and partially-fixed, capital put in his possession. His clients hypothecate their estates through the banker, instead of doing it in their own names, simply because of the facilities which he has and which they have not. And as the banker requires to be paid for his agency and his risk, his clients redeem their estates, and close these special transactions with him, as quickly as they can: thereby diminishing the amount of credit-currency.
Thus we see that the balance of a mixed currency of voluntary origin is, under all circumstances, self-adjusting. Supposing considerations of physical convenience 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 corresponding 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 one another, 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 stupid, will inevitably suffer the penalties of dishonesty, or rashness, or stupidity. If any think that by some patent legislative mechanism, a society 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 foresight, may be so regulated by cunningly-devised Acts of Parliament as to secure the effects of uprightness and foresight, we have nothing to say to them. Or if there are any (and we fear there are numbers) who think that in times of commercial difficulty, resulting from impoverishment or other natural causes, the evil can be staved-off by some ministerial sleight of hand, we despair of convincing them that the thing is impossible. See it or not, 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 justice. 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 in credit-documents—bills of exchange, cheques, bank-notes. If any one 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 protective capacity to obtain fulfilment of the promise, at whatever cost to the debtor, or such partial fulfilment of it as his effects suffice for. The State’s duty in the case of the currency, as in other cases, is sternly to threaten 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 State-favours 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 war—whether with adequate reason needs 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 durst 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; that is, cash-payments were suspended. Now for these results—for the national impoverishment and consequent abnormal condition of the 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 arose from the acts of the ruling power. When, again, in 1802, 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-by 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 every banker, “You shall not be called on to liquidate in coin the promises-to-pay which you issue;” the natural checks to the multiplication of promises-to-pay, disappeared. What followed? Banks being no longer required to cash their notes in coin; and easily obtaining from the 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 were fostered the wild speculations of 1809—speculations that were not only thus fostered, but were in great measure caused by the previous over-issue of notes; which, by further exaggerating 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 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 further 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 1814–15–16, when ninety provincial banks were broken and more 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 of Ireland, stated that before the passing of the Irish Bank-Restriction-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 rate of discount whenever the demand enabled them; and so, both increased their profits and warded-off the danger of bankruptcy. During this unregulated period their note-circulation was between £600,000 and £700,000. But as soon as they were guaranteed by law 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 a base coinage, adulterated to the extent of fifty per cent.; and elsewhere it was replaced by notes payable at twenty-one 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 of the silver coinage. For these disastrous effects, then, legislation 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 from the excessive issue of notes by the Bank of Ireland; and this excessive 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 actually blind enough to cite this multiplication of sixpenny promises-to-pay, as proving the evils of an unregulated currency!
Returning now to the case of the Bank of England, let us pass at once to the Act of 1844. While still a protectionist—while still a believer in the beneficence of law as a controller of commerce—Sir Robert Peel undertook to stop the recurrence of monetary crises, like those of 1825, 1836, and 1839. Overlooking the truth that, when not caused by the meddlings of legislators, a monetary crisis is due, either to an absolute impoverishment, or to a relative impoverishment consequent on speculative over-investment; and that for the bad season, or the imprudence, causing this, there is no remedy; he boldly proclaimed that “it is better to prevent the paroxysm than to excite it:” and he brought forward the Bank-Act of 1844 as the means of prevention. How merciless has been Nature’s criticism on this remnant of Protectionism, we all know. The monetary sliding-scale has been as great a failure as its prototype. Within three years arose one of these crises 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, every one might have seen that it is impossible, by 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 a superstitious faith in State-ordinances disregards 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 Hamburg, where the “currency principle” has been rigidly carried out to the very letter, there has been a worse crisis than anywhere else; yet there will remain 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 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 Hamburg. In that city, there are no notes in circulation but such as are represented by actual equivalents 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 Hamburg merchants, lacking their remittances from abroad, were suddenly deprived of the wherewith to meet their engagements; and were prevented by law from getting bank-promises-to-pay by pawning their estates; 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 for securities. That is, having first by its restrictive law ruined a host of merchants, the Government was obliged to legalize that postponement of payments which, but for its law, would have spontaneously taken place. With such further confirmation of an a priori conclusion, can it be doubted that our late commercial difficulties were intensified by the measure of 1844? Is it not, indeed, notorious in the City, 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 his neighbours who had bills coming due, and who saw that by the time they were due the Bank would discount only at still higher 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 thus 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 the Bank’s issues temporarily useless to the general public? Did it not happen in this 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 subsided 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 more 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 the 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 intensified the pressure, made bankrupt a great number of respectable firms which 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 delusion that, judging from 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 of gold diminish so greatly as to risk the convertibility of its notes? Shall it be enabled recklessly 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 which legislation has produced, 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-to-pay 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 foreign demand; there resulted an abnormal exportation of gold. By-and-by 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 having continued for a quarter of a century, the concomitant doctrine rooted itself in the general mind. And now mark one 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, during 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 bank-notes, but is determined by merely mercantile causes. And the truth is that far from being an evil, an efflux of gold thus brought about by mercantile causes, 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 cause of efflux is either an actual plethora of all commodities, gold included, which 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 efflux of gold indicates some absolute or relative impoverishment of the nation, it is a means of mitigating the bad consequences of that impoverishment. Consider the question as one of political economy, and this truth becomes obvious. Thus:—The nation habitually requires for use and consumption certain quantities 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 or 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 commodity 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 circumstances 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 State 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 has the folly to contend for the one, nearly all contend for the other. One would think that the banker acquired, in virtue of his occupation, 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 checks 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 induced 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 much in excess of his available means of paying them, he runs a great 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 by the history of both the Bank of England and the Bank of Ireland; 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 numbers as to cause their depreciation?” has, in effect, been answered in answering the first two. There can be no depreciation of notes so long as they are exchangeable for gold on demand. And so long as the State, in discharge of its duty, insists on the fulfilment of contracts, the alternative of bankruptcy must ever be a restraint on such over-issue of notes as endangers that exchangeability. 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 true, has allowed those to be mobbed who brought back far-wandering notes for payment. 35 In all other cases the sin has been a sin of 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, forced upon the Bank of England that excessive issue of notes which led to the suspension of cash-payments. It was the State which, in 1802, forbad the resumption of cash-payments, 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-warrant. Yet now the State affects a virtuous horror of the crime committed at its instigation! Having contrived to shuffle-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!
35 This was written in 1858; when “greenbacks” were unknown.
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 augment but cannot prevent. Let the Bank of England, in common with every 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 efflux of gold or the circulation of paper; and the only check that can be put on the doings of speculators. Whatever leads to unusual draughts on the resources of banks, immediately causes 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 checks undue expansion of the note-circulation; stops 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 give the rate of discount asked, save those in peril of stopping payment; the increase of the credit-currency ceases; and the efflux of gold, if it is going on, is arrested 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 course is justified by the necessities. 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. Moreover, during a crisis which thus runs its natural course, there will really occur that purification of the mercantile world which many think can be effected only by some Act-of-Parliament ordeal. Under the circumstances described, men who have adequate securities to offer will get bank-accommodation; but those who, having traded without capital or beyond their means, have not, will be denied it, and will fail. Under a free system the good will be sifted from the bad; 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 body-politic 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 rapid 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, finally, it grew notorious that in Scotland, where there had been no law limiting the number of partners, a whole century had passed with scarcely a single bank-failure; legislators at once decided to 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—Government, in 1826, conceded 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 protégé, 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—“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. Every one knows that these banks with State-constitutions have been especially characterized by instability. Every one knows that credulous citizens, with a faith in legislation which endless disappointments fail to diminish, have trusted implicitly in these law-devised securities; and, not exercising their own judgments, have been led into ruinous undertakings. 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 Times, 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 the 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 recognized, alike in Parliament and in the Press; and it is therefore needless further to elucidate it. We will simply add that as, if there had been no law of unlimited liability, the London houses would not have discounted these bad bills; and as, in that case, these provincial joint-stock-banks could 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-stock-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 bank-notes. 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 perennial 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 be 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 convertibility 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 more notes 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 warrant either for entering into larger speculations himself, or for allowing his customers to draw on 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 bankers are tempted into greater dangers under this protective system. They can and will hypothecate their capital in ways less direct 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 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.” Now, 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 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 roundabout ways of giving credit do take the place of the interdicted ways; and that they are more dangerous than the 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 the debates give daily proofs of this? And is not the process of causation obvious?
Indeed it might have been known, a 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 quantity of payments that are being made. It has been repeatedly testified before committees, that when any local banker contracts his issues, he simply causes an equivalent increase in the issues of neighbouring 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 inverse variation, 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, etc., which constitute nine-tenths of the paper-currency of the kingdom, the State exercises, and can exercise, no control. And the limit it puts on the remaining tenth vitiates the other nine-tenths, 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 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, there might grow up certain natural safeguards, which would really put a check on undue credit and abnormal speculation. Were it not for the attempts to insure 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 offered—would endeavour to outdo each other in the obtainment of a legitimate public confidence. Consider 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 is sure to be looked upon by the trading world with considerable distrust. The field is already occupied by old banks with established connexions and reputations. Out of a constituency satisfied with the present accommodation, it has to obtain supporters for a system which 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 £1000 the liberty of inspecting its books—of ascertaining from time to time its liabilities and its investments. Already this plan is frequently adopted 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 long and successful experience, as manager of a joint-stock-bank, and his reply is, that some such course would very probably be adopted: adding that, under this arrangement, a depositor would practically become a partner with limited liability.
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 enterprize. 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 concerned.
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 reply that they would 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 the substance of their homilies.
To speak 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 very opposite of an “empiric,” who holds that people’s characters and circumstances determine the quantity of 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 £14,000,000 on the credit of the State; but which is broken if the State-credit is mortgaged beyond this—a “principle” which implies that £14,000,000 of notes may be issued without gold to meet them, but insists on rigorous precautions for the convertibility of every pound more. We are 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, which has the avowed object of restricting 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 detail. Is that a Free-trade 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 on any further exchange of credit-documents? We wonder what would be said by two merchants, the one about to draw a bill on the other in return for goods sold, who should 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 bill, it would be unsafe for him to do so; and that the law, in pursuance of the principles of Free-trade, negatived the transaction! Yet for the 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 customer.
It is true that the “currency-theorists” have a colourable excuse in the fact, that among their opponents are the advocates of various visionary 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, whose “Regulation of Currencies” 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? 36 Do they not know, in short, that both the profoundest thinkers and the most patient inquirers are against them? If they do not know this, it is time they studied the subject on which they write with such an air of authority. If they do know it, a little more respect for their opponents would not be unbecoming.
36 See Mr. Tooke’s “Bank Charter Act of 1844,” etc.