Denationalisation of Money: The Argument Refined

Some of the problems we are encountering were discussed extensively in the course of a great debate on Tree banking’ during the middle of the last century, mainly in France and Germany.1 This debate turned on the question whether commercial banks should have the right to issue bank notes redeemable in the established national gold or silver currency. Bank notes were then very much more important than the scarcely yet developed use of chequing accounts which became important only after (and in part perhaps because) the commercial banks were in the end definitely denied the right to issue bank notes. This outcome of the debate resulted in the establishment in all European countries of a single bank privileged by government to issue notes. (The United States followed only in 1914.)

A single national currency, not several competing currencies

It should be specially observed that the demand for free banking at that time was wholly a demand that the commercial banks should be allowed to issue notes in terms of the single established national currency. So far as I am aware, the possibility of competing banks issuing different currencies was never contemplated. That was of course a consequence of the view that only bank notes redeemable in gold or silver were practicable, and therefore that notes for other than the standard quantity of precious metal would seem to be merely inconvenient and not serve any useful purpose.

*

The older legitimate argument for freedom of the note issue by banks became, however, invalid once the notes they issued were no longer to be redeemed in gold or silver, for the supply of which each individual bank of issue was fully responsible, but in terms of a legal tender money provided by a privileged central bank of issue, which then was in effect under the necessity of supplying the cash needed for the redemption of the notes of the private banks of issue. That would have been a wholly indefensible system which was prevented (at least so far as the issue of notes, though not the issue of cheque deposits, was concerned) by the prohibition of private note issue. **

The demands for free banking (i.e. for the free issue of bank notes) were mostly based on the ground that banks would thereby be enabled to provide more and cheaper credit. They were for the same reason resisted by those who recognised that the effect would be inflationary—although at least one advocate of the freedom of note issue had supported it on the ground that

‘what is called freedom of banking would result in the total suppression of bank notes in France. I want to give everybody the right to issue bank notes so that nobody should take any bank notes any longer’.2

The idea was, of course, that the inevitable abuse of this right, i.e. the issue of an amount of notes which the banks could not redeem from their own reserves, would lead to their failure.

The ultimate victory of the advocates of the centralisation of the national note issue was, however, in effect softened by a concession to those who were mainly interested in the banks being able to provide cheap credit. It consisted in the acknowledgement of a duty of the privileged bank of issue to supply the commercial banks with any notes they needed in order to redeem their demand deposits—rapidly growing in importance. This decision, or rather recognition of a practice into which central banks had drifted, produced a most unfortunate hybrid system in which responsibility for the total quantity of money was divided in a fatal manner so that nobody was in a position to control it effectively.

Demand deposits are like bank notes or cheques

This unfortunate development came about because for a long time it was not generally understood that deposits subject to cheque played very much the same role, and could be created by the commercial banks in exactly the same manner, as bank notes. The consequent dilution of what was still believed to be a government monopoly of the issue of all money resulted in the control of the total circulation of money being divided between a central bank and a large number of commercial banks whose creation of credit it could influence only indirectly. Not till much later did it come to be understood that the ‘inherent instability of credit’3 under that system was a necessary outcome of this feature; that liquid means was mostly supplied by institutions which themselves had to keep liquid in terms of another form of money, so that they had to reduce their outstanding obligations precisely when everybody else also desired to be more liquid. By that time this kind of structure had become so firmly established that, in spite of the ‘perverse elasticity of the supply of credit’4 it produced, it came to be regarded as unalterable. Walter Bagehot had clearly seen this dilemma a hundred years ago but despaired of the possibility of remedying this defect of the firmly established banking structure.5 And Wicksell and later von Mises made it clear that this arrangement must lead to violent recurring fluctuations of business activity—the so-called ‘trade-cycle’.

New controls over currencies; new banking practices

Not the least advantage of the proposed abolition of the government monopoly of the issue of money is that it would provide an opportunity to extricate ourselves from the impasse into which this development had led. It would create the conditions in which responsibility for the control of the quantity of the currency is placed on agencies whose self-interest would make them control it in such a manner as to make it most acceptable to the users.

This also shows that the proposed reform requires a complete change in the practices not only of the banks which take up the business of issuing currency but also of those which do not. For the latter could no longer rely on being bailed out by a central bank if they could not meet from their own reserves their customers’ demands for cash—not even if they chose to keep their accounts in terms of the currency issued by a still existing governmental central bank which, to maintain its circulation, would have to adopt the practices of the other issuing banks with which it competed.

Opposition to new system from established bankers …

This necessity of all banks to develop wholly new practices will undoubtedly be the cause of strong opposition to the abolition of the government monopoly. It is unlikely that most of the older bankers, brought up in the prevailing routine of banking, will be capable of coping with those problems. I am certain that many of the present leaders of the profession will not be able to conceive how it could possibly work and therefore will describe the whole system as impracticable and impossible.

Especially in countries where competition among banks has for generations been restricted by cartel arrangements, usually tolerated and even encouraged by governments, the older generation of bankers would probably be completely unable even to imagine how the new system would operate and therefore be practically unanimous in rejecting it. But this foreseeable opposition of the established practitioners ought not to deter us. I am also convinced that if a new generation of young bankers were given the opportunity they would rapidly develop techniques to make the new forms of banking not only safe and profitable but also much more beneficial to the whole community than the existing one.

... and from banking cranks

Another curious source of opposition, at least once they had discovered that the effects of Tree banking’ would be exactly the opposite of those they expected, would be all the numerous cranks who had advocated Tree banking’ from inflationist motives.6 Once the public had an alternative, it would become impossible to induce it to hold cheap money, and the desire to get rid of currency that threatened to depreciate would indeed rapidly turn it into a dwindling money. The inflationists would protest because in the end only very ‘hard’ money would remain. Money is the one thing competition would not make cheap, because its attractiveness rests on it preserving its ‘dearness’

* The problem of a ‘dear’ (stable) money

A competition the chief merit of which is that it keeps the products of the competitors dear raises various interesting questions. In what will the suppliers compete once they have established somewhat similar reputations and trust for keeping their currencies stable? The profits from the issuing business (which amounts to borrowing at zero interest) will be very large and it does not seem probable that very many firms can succeed in it. For this reason services to the enterprises basing their accounting on a bank’s currency would be likely to become the chief weapon of competition, and I should not be surprised if the banks were practically to take over the accounting for their customers.

Though even very large profits of the successfully established issuers of currency would not be too high a price for a good money, they would inevitably create great political difficulties. Quite apart from the inevitable outcry against the profits of the money monopoly, the real threat to the system would be the cupidity of Ministers of Finance who would soon claim a share in them for the permission to allow a currency to circulate in their country, which would of course spoil everything. It might indeed prove to be nearly as impossible for a democratic government not to interfere with money as to regulate it sensibly.

The real danger is thus that, while today the people submissively put up with almost any abuse of the money prerogative by government, as soon as it will be possible to say that money is issued by ‘rich financial institutions’, the complaint about their abuse of the alleged monopoly will become incessant. To wring from the money power their alleged privilege will become the constant demand of demagogues. I trust the banks would be wise enough not to desire even a distant approach to a monopoly position, but to limit the volume of their business may become one of their most delicate problems. **

______________

7 A good survey of this discussion will be found in V. G. Smith [55].

8 H. Cernuschi [9], as quoted by L. v. Mises [47], p. 446; also V. C. Smith [55], p. 91.

9 The expression was originally coined by R. G. Hawtrey.

10 Cf. L. Currie [12].

11 W. Bagehot [3], p. 160: ‘I have tediously insisted that the natural system of banking is that of many banks keeping their own reserves, with the penalty of failure before them if they neglect it. I have shown that our system is that of a single bank keeping the whole reserve under no effectual penalty of failure. And yet I propose to retain that system and only attempt to mend and palliate it . . . because I am quite sure that it is of no manner of use proposing to alter it . . . there is no force to be found adequate to so vast a reconstruction, and so vast a destruction, and therefore it is useless proposing them.’ That was almost certainly true so long as the prevailing system worked tolerably, but not after it had broken down.

12 The list is very long and, apart from the well-known writers whose works are noted under numbers [13], [22], [44] and [51] in the Bibliography (pp. 140, 141, 143, and 144), the series of studies by Edward Clarence Riegel (1879-1953) published between 1929 and 1944 deserves special mention as an instance of how the results of acute insights and long reflection which seem to have gained the attention of an economist of the rank of Irving Fisher may be completely invalidated by an ignorance of elementary economics. A posthumous volume by Riegel, entitled Flight from Inflation. The Monetary Alternative, has been announced by the Hecthcr Foundation, San Pedro, California.

• 1Endemann [15], p. 172.
• 2Section VII, below, pp. 43-45.
• 3Herbert Spencer [57].
• 4On the Chinese events, see W. Vissering [61] and G. Tullock [58], who does not, however, allude to the often recounted story of the ‘final prohibition’.
• 5Vera C. Smith [55].
• 6F. A. Hayek [29], pp. 324 et seq.
• 7During the Middle Ages, however, the superstition arose that it was the act of government that conferred the value upon the money. Although experience always proved otherwise, this doctrine of the valor impositus was largely taken over by legal doctrine and served to some extent as justification of the constant vain attempts of the princes to impose the same value on coins containing a smaller amount of the precious metal. (In the early years of this century the medieval doctrine was revived by the German Professor G. F. Knapp; his State Theory of Money still seems to exercise some influence on contemporary legal theory.)
• 8It is probably impossible for pieces of paper or other tokens of a material itself of no significant market value to come to be gradually accepted and held as money unless they represent a claim on some valuable object. To be accepted as money they must at first derive their value from another source, such as their convertibility into another kind of money. In consequence, gold and silver, or claims for them, remained for a long time the only kinds of money between which there could be any competition; and, since the sharp fall in its value in the 19th century, even silver ceased to be a serious competitor to gold. (The possibilities of bimetallism are irrelevant for our present problems.)
• 9The value of paper money obviously can be regulated according to a variety of principles—even if it is more than doubtful that any democratic government with unlimited powers can ever manage it satisfactorily. Though historical experience would at first seem to justify the belief that only gold can provide a stable currency, and that all paper money is bound to depreciate sooner or later, all our insight into the processes determining the value of money tells us that this prejudice, though understandable, is unfounded. The political impossibility that governments will achieve it does not mean there is reason to doubt that it is technically possible to control the quantity of any kind of token money so that its value will behave in a desired manner, and that it will for this reason retain its acceptability and its value. It would therefore now be possible, if it were permitted, to have a variety of essentially different monies. They could represent not merely different quantities of the same metal, but also different abstract units fluctuating in their value relatively to one another. In the same way, we could have currencies circulating concurrently throughout many countries and offering the people a choice. This possibility appears, until recently, never to have been contemplated seriously. Even the most radical advocates of free enterprise, such as the philosopher Herbert Spencer or the French economist Joseph Garnier, seem to have advocated only private coinage, while the free banking movement of the mid-19th century agitated merely for the right to issue notes in terms of the standard currency.
• 10It is said that the Chinese had been driven by their experience with paper money to try to prohibit it for all time (of course unsuccessfully) before the Europeans ever invented it. Certainly European governments, once they knew about this possibility, began to exploit it ruthlessly, not to provide people with good money, but to gain as much as possible from it for their revenue. Ever since the British Government in 1694 sold the Bank of England a limited monopoly of the issue of bank notes, the chief concern of governments has been not to let slip from their hands the power over money, formerly based on the prerogative of coinage, to really independent banks. For a time the ascendancy of the gold standard and the consequent belief that to maintain it was an important matter of prestige, and to be driven off it a national disgrace, put an effective restraint on this power. It gave the world the one long period—200 years or more—of relative stability during which modern industrialism could develop, albeit suffering from periodic crises. But as soon as it was widely understood some 50 years ago that the convertibility into gold was merely a method of controlling the amount of a currency, which was the real factor determining its value, governments became only too anxious to escape that discipline, and money became more than ever before the plaything of politics. Only a few of the great powers preserved for a time tolerable monetary stability, and they brought it also to their colonial empires. But Eastern Europe and South America never knew a prolonged period of monetary stability.
• 11The value of paper money obviously can be regulated according to a variety of principles—even if it is more than doubtful that any democratic government with unlimited powers can ever manage it satisfactorily. Though historical experience would at first seem to justify the belief that only gold can provide a stable currency, and that all paper money is bound to depreciate sooner or later, all our insight into the processes determining the value of money tells us that this prejudice, though understandable, is unfounded. The political impossibility that governments will achieve it does not mean there is reason to doubt that it is technically possible to control the quantity of any kind of token money so that its value will behave in a desired manner, and that it will for this reason retain its acceptability and its value. It would therefore now be possible, if it were permitted, to have a variety of essentially different monies. They could represent not merely different quantities of the same metal, but also different abstract units fluctuating in their value relatively to one another. In the same way, we could have currencies circulating concurrently throughout many countries and offering the people a choice. This possibility appears, until recently, never to have been contemplated seriously. Even the most radical advocates of free enterprise, such as the philosopher Herbert Spencer or the French economist Joseph Garnier, seem to have advocated only private coinage, while the free banking movement of the mid-19th century agitated merely for the right to issue notes in terms of the standard currency.
• 12When one studies the history of money one cannot help wondering why people should have put up for so long with governments exercising an exclusive power over 2,000 years that was regularly used to exploit and defraud them. This can be explained only by the myth (that the government prerogative was necessary) becoming so firmly established that it did not occur even to the professional students of these matters (for a long time including the present writer) ever to question it. But once the validity of the established doctrine is doubted its foundation is rapidly seen to be fragile.