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The Blessing and Curse of Banking

Mises Daily: Thursday, May 12, 2011 by

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It is of little importance to examine why the Bank of Venice and that of Amsterdam keep their books in moneys of account different from current (i.e., silver coin) money, and why there is always a fee for converting these book credits into currency. It is not a point of any usefulness for circulation. The Bank of London has not followed them in this regard. Its accounts, notes, and payments are made and are kept in current coins, which seem to me more uniform, more natural, and no less useful.

I have not been able to obtain accurate information about the quantities of money ordinarily brought to these banks, nor the amount of their notes and accounts, loans, and sums kept as reserve. Someone who is better informed on these points will be better able to discuss them.

However, I know fairly well that these sums are not as large as commonly assumed, so I will briefly discuss the subject.

Assume that the bills and notes of the Bank of London, which seems to me the most considerable, amount to a weekly average of four million ounces of silver, or about £1 million sterling. If they regularly keep a quarter (£250,000 sterling or one million ounces of silver in coins) in reserve, the utility of this bank to the circulation corresponds to an increase of the money of the state of three million ounces (or £750,000 sterling), which is without doubt a very large sum, and of very great utility for the circulation when it needs to be accelerated.

However, I have noted elsewhere that there are cases where it is better for the welfare of the state to slow down the circulation rather than to accelerate it. I have heard that the notes and bills of the Bank of London have risen in some cases to £2 million sterling, but it seems to me that this can only have been by extraordinary accident. And I think the utility of this bank corresponds in general to only about one-tenth of all the money in circulation in England.

If the general explanations I received in 1719 about the revenues of the Bank of Venice are correct, it may be said that the utility of national banks generally does not match one-tenth of the money circulating in a state. This is more or less what I've learned.

The revenues of the state in Venice may amount annually to 4,000,000 ounces of silver, which must be paid in banknotes, and the collectors hired for that purpose, who receive money at Bergamo and in the most distant places for taxes, have to change it into banknotes when they make the payments to the republic.

In Venice, all payments for contracts — purchases and sales above a certain modest sum — must, by law, be made in banknotes. Therefore, all the retailers who have collected money in their business are compelled to buy banknotes to make large payments. Those who need money for their expenses or retail purchases have to sell their banknotes for money.

The sellers and buyers of banknotes are usually equal when the total of all the credits or accounts on the bank's books do not exceed the value of approximately 800,000 ounces of silver.

Time and experience (according to my informant) provided this knowledge to the Venetians. When the bank was first set up, individuals brought their money there to have credit at the bank for the same value. The money that was deposited at the bank was later spent on the needs of the republic (i.e., the government), and yet, banknotes preserved their original value because there were as many people needing to buy them as those needing to sell them. Finally, the state — in need of money — gave credits to war contractors in banknotes instead of silver, doubling the amount of its credits.

Then with the number of sellers of banknotes being much greater than number of buyers, the notes began to lose value and fell 20 percent against silver. By this discredit, the revenue of the republic fell by one-fifth, and the only remedy found for this chaos was to pledge part of the state's revenues to borrow banknotes at interest. With these loans of banknotes, half of them were cancelled, and then with the sellers and buyers being about equal, the bank regained its original credit and the total of banknotes was brought back to 800,000 ounces of silver.

In this manner, it has been ascertained that the usefulness of the Bank of Venice, in terms of money in circulation, corresponds to about 800,000 ounces of silver. If we assume that all the money in the states of that republic amount to 8,000,000 ounces of silver, the usefulness of the bank corresponds to one-tenth of that silver.

A national bank in the capital of a great kingdom or state must, it seems, contribute less to the circulation than one in a small state because of its distance from the provinces. When money circulates in greater abundance than within neighboring countries, a national bank does more harm than good. An abundance of fictitious and imaginary money causes the same disadvantages as an increase of real money in circulation, by raising the price of land and labor, or by changing the value of money and goods only to cause subsequent losses. This furtive or unnatural abundance vanishes at the first gust of scandal and precipitates economic chaos.

Toward the middle of the reign of Louis XIV (1638-1715), there was more money in circulation in France than in neighboring countries, and the king's revenue was collected without the help of a bank, as easily and conveniently as it is collected today in England with the help of the Bank of London.

If exchanges in Lyons during one of its four trading fairs amounted to 80 million livres, and if they are begun and finished with one million in cash money, they are certainly of great convenience. Because everyone is in the same location, an infinite number of transactions can take place, and it saves the expense of transporting silver from one place to the other. Normally, it might take three months for this same million of cash to conduct 80 million in payments.

The Paris bankers have often observed that the same bag of money has come back to them four or five times in the same day when they had a good deal to pay out and receive.

I think that public banks are useful in small states and in those where silver is rather scarce, but of little utility in giving a solid advantage to a large state.

The emperor Tiberius, a strict and economical leader, saved 2.7 billion sesterces, equal to £25 million sterling, or 100 million ounces of silver in the imperial treasury. This was an enormous sum for those times, and even for today. It is true that in tying up so much money, he disturbed the circulation and silver became scarcer in Rome than it had ever been.

Tiberius, who attributed this scarcity to the monopoly of contractors and financiers who farmed the empire's revenues (i.e., private tax collectors), ordered by an edict that they should buy land with at least two-thirds of their capital. Instead of stimulating the circulation of money, his edict threw it completely into chaos. All the financiers hoarded and called in their capital under the pretext of putting themselves into a position to obey the edict by buying land, which, instead of rising in value, sunk to a much lower price owing to the scarcity of silver in circulation. Tiberius remedied this scarcity by lending to individuals on good security, but only 300 million sesterces, or one-ninth of the money he had in his treasury.

If the ninth part of the treasury sufficed in Rome to reestablish the circulation, it would seem that the establishment of a general bank in a great kingdom where its utility would never correspond to one-tenth of the money in circulation (when it is not hoarded) would be of no real and permanent advantage, and when considered for its intrinsic value, it can only be regarded as a means for saving time.

"As soon as the idea of great fortunes induced many individuals to increase their expenses, to buy carriages or foreign linen and silk, cash was needed for all that — i.e., for the spending of interest, and this broke all the systems up in pieces."

However, a real increase in the quantity of circulating money is of a different nature. We have covered this before, and Tiberius's treasury gives us another opportunity to touch the subject. This treasure of 2.7 billion of sesterces, left at the death of Tiberius, was squandered by his successor, emperor Caligula, in less than a year. Money was never seen so abundant in Rome.

What was the result? All this money plunged the Romans into luxury and into all sorts of crimes to pay for it. More than £600,000 sterling left the empire every year to buy merchandise from the Indies, and in less than 30 years, the empire grew poor and silver became very scarce, without the loss of a single province.

Though I consider that a general bank is not of great utility in a large state, I allow that there are circumstances in which a bank may have effects that seem astonishing.

In a city where there are public debts for considerable amounts, the presence of a bank enables one to buy and sell capital stock in an instant, and for enormous sums, without causing any disturbance in the circulation. In London, if a person sells his South Sea stock to buy stock in the bank[1] or in the East India Company, or hoping that in a short time he will be able to buy at a lower price stock in the same South Sea Company, he always takes banknotes, and will generally not ask for money in exchange for these notes, except for the value of the interest. Capital is hardly ever spent, so there is no need to change it into coins — but one does need to ask the bank for money to live on because cash is needed for small transactions.

If a property owner who has 1,000 ounces of silver pays 200 ounces for the ownership of public stock to earn interest and spends 800 ounces for himself, the thousand ounces will always require coins. This owner will spend 800 ounces and the owners of the stocks will spend 200 of them. But when these owners are in the habit of speculating — buying and selling public stocks — no silver is needed for these operations and banknotes suffice. If it were necessary to draw cash out of circulation to be used in these purchases and sales, it would amount to a great sum and would often impede the circulation, and if this were the case, stocks could not be sold and bought so often.

The origin of this capital is money that is deposited in the bank and is rarely drawn out, such as when an owner of capital engages in transactions and needs cash. This explains why the bank keeps in reserve only one-fourth or one-sixth of the silver against which it issues notes. If the bank did not have the funds of this type of capital, it would, in the ordinary course of circulation, find itself compelled, like private banks, to keep half its deposits on hand to be solvent.

It is true that we cannot determine from the bank books and from its operations the quantity of capital that passes through several hands in the sales and purchases made in Change Alley. These notes are often renewed at the bank and changed against others in purchases. But the experience of stock purchases and sales clearly shows that the quantity is considerable, and without these purchases and sales, the sums deposited at the bank would likely be smaller.

This means that when a state is not in debt, and has no need of purchases and sales of stock, the assistance of a bank will be less necessary and less important.

In 1720, the shares of public stock in private companies in London, which were bubbles and scams, rose to the value of £800 million sterling. But purchases and sales of such venomous stocks were carried out without difficulty by the quantity of notes of all kinds that were issued, and the same paper money was accepted in payment of interest. However, as soon as the idea of great fortunes induced many individuals to increase their expenses, to buy carriages or foreign linen and silk, cash was needed for all that — i.e., for the spending of interest, and this broke all the systems up in pieces.

This example shows that the paper and credit of public and private banks may cause surprising results in everything that does not concern ordinary expenditure for drink, food, clothing, and other family requirements. In the regular course of the circulation, the help of banks and credit of this kind is much smaller and less solid than is generally assumed. Silver alone is the true lifeblood of circulation (i.e., the economy).

Notes

[1] Cantillon is referring to the Bank of London, now the Bank of England.