Front Page Titles (by Subject) CHAP. II - An Enquiry into the Nature and Effects of the Paper Credit of Great Britain
Return to Title Page for An Enquiry into the Nature and Effects of the Paper Credit of Great Britain
The Online Library of Liberty
A project of Liberty Fund, Inc.
CHAP. II - Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain 
An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, edited and with an Introduction by F.A. Hayek (London: George Allen and Unwin, 1939).
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
This works appears online with the permission of the Estate of F.A. Hayek. A further annotated version of Hayek’s introduction appears as a chapter in volume 3 of the Collected Works of F.A. Hayek (University of Chicago Press, 1991).
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
Of Trade by Barter.—Of Money—Of Bills of Exchange and Notes.—Of Bills and Notes, considered as discountable Articles.—Of fictitious Bills, or Bills of Accommodation.
Society, in its rudest state, carries on its trade by the means only of barter. When most advanced, it still conducts its commerce on the same principle; for gold and silver coin, bankers’ notes, and bills of exchange, may be considered merely as instruments employed for the purpose of facilitating the barter. The object is to exchange such a quantity of one sort of goods for such a quantity of another, as may be deemed, under all circumstances, a suitable equivalent* .
Barter being soon felt to be inconvenient, the precious metals are resorted to as a measure of value, they being, at once, portable, steady in their price, and capable of subdivisions. The state fixes a stamp upon them, in order thus to certify the quantity and fineness of each piece.
The precious metals, when uncoined (or in the state of bullion) are themselves commodities; but when converted into money they are to be considered merely as a measure of the value of other articles. They may, indeed, be converted back into commodities; and it is one recommendation of their use as coin, that they are capable of this conversion.
We shall now advert to some of the simplest forms in which it may be supposed that paper credit will first exist.
To speak first of bills of exchange.
It is obvious, that, however portable gold may be in comparison of any other article which might be made a measure of value, to carry it in quantities to a great distance must prove incommodious. Let it be supposed, that there are in London ten manufacturers who sell their article to ten shopkeepers in York, by whom it is retailed; and that there are in York ten manufacturers of another commodity, who sell it to ten shopkeepers in London. There would be no occasion for the ten shopkeepers in London to send yearly as many guineas to London. It would only be necessary for the York manufacturers to receive from each of the shopkeepers, at their own door, the money in question (for we may assume a sufficient quantity to be usually circulating in the place): giving in return letters which should acknowledge the receipt of it; and which should also direct the money, lying ready in the hands of their debtors in London, to be paid to the London shopkeepers, so as to cancel the debt in London in the same manner as that at York. The expence and the risk of all transmission of money would thus be saved; and the traders in question would of course be, on the whole, enabled to sell their article at a price proportionably lower than that which they would otherwise require. Letters ordering the transfer of the debt, are termed, in the language of the present day, bills of exchange. They are bills by which the debt of one person is exchanged for the debt of another; and the debt, perhaps, which is due in one place for the debt due in another.
To speak next of Promissory Notes.
When goods are delivered in consideration of an equivalent in money to be received at a subsequent period, it becomes desirable that, for the sake of precisely recording the day on which payment is to be made, and the exact amount of the sum, a note, expressing each of these particulars, should be given. The term “value received” is introduced into the note, as also into every bill of exchange; that expression being deemed necessary in law to make the bill or the note binding.
Bills of exchange and notes have been hitherto considered as created only for those simple purposes for which they seem originally to have been drawn, and which are professed by the form always used in drawing them. Both these sorts of paper must now be spoken of as possessing an additional character, namely, that of being Discountable Articles, or articles which there is an opportunity of converting, at any time, into money; such a discount or deduction from the amount of the bill or note as is equal to the interest upon it, during the period for which it has to run, being paid as the price of the conversion. The bills of exchange, which were described as drawn from York on London, and as serving to transfer debts, would equally answer that purpose at whatever date they might be payable. It is customary, however, to make almost all bills payable at a period somewhat distant. Country bankers, for instance, and shopkeepers, who often act in this respect as bankers, indemnify themselves for the trouble and expence attending the drawing of bills, not by a commission, but by a protraction of the time at which the bills are to become payable. Thus is created a paper credit, which shall remain in existence for perhaps one or more months, and may serve, during any part of that time, as a discountable article.
Promissory notes were before represented as drawn on the occasion of the sale of goods, and made payable at a distant period. In returning to the more careful consideration of them, we shall discover the existence of the same disposition to multiply paper credit.
When a merchant in this country sells his goods on credit, it is, perhaps, not very important to him that he should receive from the buyer a promissory note (or an accepted bill, which is the same thing), if the only object of taking the note or bill is the ascertainment of the exact amount of the debt, and of the period of payment. It is true that the law gives superior facility to the recovery of debts for which promissory notes have been given. Nevertheless, if the sum be small, and the party in credit, all these advantages, in the present high state of confidence, would, in many cases, be thought scarcely to compensate even the trifling expence of the note stamp. The debt will be a book debt, if no note be taken; and, as such, may be sufficiently secure.
Notes, even for goods sold and delivered, are therefore to be considered as given chiefly for the sake of a convenience of another kind, which the seller finds in having them. The note, like the bill of exchange just spoken of, is a discountable article. It may be turned, if circumstances require, into money; or into bank notes, which answer the same purpose. It is not, perhaps, fully intended to turn the note or bill into money; they are taken rather as a provision against a contingency. The holder is rendered secure against the effect of disappointments in the receipt of cash. It is in this manner that his credit is fortified, and that he is enabled to fulfil with punctuality his pecuniary engagements; for there is a certain sort and quantity of bills and notes, on the turning of which into money, at the common rate of discount, the holder, if he be a man of credit, may almost as confidently rely on the changing of a bank note into guineas, or of a guinea into silver.
The interest which traders have in being always possessed of a number of notes and bills, has naturally led to a great multiplication of them; and not only to the multiplication of notes given for goods sold, or of regular bills of exchange, but to the creation of numerous other notes and bills. Of these, some are termed notes and bills of accommodation: and the term fictitious is often applied to them. It may be useful to describe them particularly.
It was before shewn, that the principal motive for fabricating what must here be called the real note, that is, the note drawn in consequence of a real sale of goods, is the wish to have the means of turning it into money. The seller, therefore, who desires to have a note for goods sold, may be considered as taking occasion to ingraft on the transaction of the sale, the convenient condition of receiving from the buyer a discountable note of the same amount with the value of the goods. A fictitious note, or note of accommodation, is a note drawn for the same purpose of being discounted, though it is not also sanctioned by the circumstance of having been drawn in consequence of an actual sale of goods. Notes of accommodation are, indeed, of various kinds. The following description of one may suffice.
A, being in want of 100l., requests B to accept a note or bill drawn at two months, which B, therefore, on the face of it, is bound to pay; it is understood, however, that A will take care either to discharge the bill himself, or to furnish B with the means of paying it. A obtains ready money for the bill on the joint credit of the two parties. A fulfills his promise of paying it when due, and thus concludes the transaction. This service rendered by B to A is, however, not unlikely to be requited at a more or less distant period by a similar acceptance of a bill on A, drawn and discounted for B’s convenience.
Let us now compare such a bill with a real bill. Let us consider in what points they differ, or seem to differ; and in what they agree.
They agree, inasmuch as each is a discountable article; each has also been created for the purpose of being discounted; and each is, perhaps, discounted in fact. Each, therefore, serves equally to supply means of speculation to the merchant. So far, moreover, as bills and notes constitute what is called the circulating medium, or paper currency, of the country (a topic which shall not be here anticipated), and prevent the use of guineas, the fictitious and the real bill are upon an equality; and if the price of commodities be raised in proportion to the quantity of paper currency, the one contributes to that rise exactly in the same manner as the other.
Before we come to the points in which they differ, let us advert to one point in which they are commonly supposed to be unlike; but in which they cannot be said always or necessarily to differ.
“Real notes,” it is sometimes said, “represent actual property. There are actual goods in existence, which are the counterpart to every real note. Notes which are not drawn, in consequence of a sale of goods, are a species of false wealth, by which a nation is deceived. These supply only an imaginary capital; the others indicate one that is real.”
In answer to this statement it may be observed, first, that the notes given in consequence of a real sale of goods cannot be considered as, on that account, certainly representing any actual property, Suppose that A sells one hundred pounds worth of goods to B at six months credit, and takes a bill at six months for it; and that B, within a month after, sells the same goods, at a like credit, to C, taking a like bill; and again, that C, after another month, sells them to D, taking a like bill, and so on. There may then, at the end of six months, be six bills of 100l. each existing at the same time; and every one of these may possibly have been discounted. Of all these bills, then, one only represents any actual property.
In the next place it is obvious, that the number of those bills which are given in consequence of sales of goods, and which, nevertheless, do not represent property, is liable to be encreased through the extension of the length of credit given on the sale of goods. If, for instance, we had supposed the credit given to be a credit of twelve months instead of six, 1,200l. instead of 600l. would have been the amount of the bills drawn on the occasion of the sale of goods; and 1,100l. would have been the amount of that part of these which would represent no property.
In order to justify the supposition that a real bill (as it is called) represents actual property, there ought to be some power in the bill-holder to prevent the property which the bill represents, from being turned to other purposes than that of paying the bill in question. No such power exists; neither the man who holds the real bill, nor the man who discounts it, has any property in the specific goods for which it was given: he as much trusts to the general ability to pay of the giver of the bill, as the holder of any fictitious bill does. The fictitious bill may, in many cases, be a bill given by a person having a large and known capital, a part of which the fictitious bill may be said, in that case, to represent. The supposition that real bills represent property, and that fictitious bills do not, seems, therefore, to be one by which more than justice is done to one of these species of bills, and something less than justice to the other.
We come next to some points in which they differ.
First, the fictitious note, or note of accommodation, is liable to the objection that it professes to be what it is not. This objection, however, lies only against those fictitious bills which are passed as real. In many cases, it is sufficiently obvious what they are. Secondly, the fictitious bill is, in general, less likely to be punctually paid than the real one. There is a general presumption, that the dealer in fictitious bills is a man who is a more adventurous speculator than he who carefully abstains from them. It follows, thirdly, that fictitious bills, besides being less safe, are less subject to limitation as to their quantity. The extent of a man’s actual sales form some limit to the amount of his real notes; and, as it is highly desirable in commerce that credit should be dealt out to all persons in some sort of regular and due proportion, the measure of a man’s actual sales, certified by the appearance of his bills drawn in virtue of those sales, is some rule in the case, though a very imperfect one in many respects.
A fictitious bill, or bill of accommodation, is evidently, in substance, the same as any common promissory note; and even better, in this respect,—that there is but one security to the promissory note, whereas, in the case of the bill of accommodation, there are two. So much jealousy subsists lest traders should push their means of raising money too far, that paper, the same in its general nature with that which is given, being the only paper which can be given, by men out of business, is deemed somewhat discreditable when coming from a merchant. And because such paper, when in the merchant’s hand, necessarily imitates the paper which passes on the occasion of a sale of goods, the epithet fictitious has been cast upon it; an epithet which has seemed to countenance the confused and mistaken notion, that there is something altogether false and delusive in the nature of a certain part both of the paper and of the apparent wealth of the country.
Bills of exchange are drawn upon London to a great amount, from all parts, not only of Great Britain, but of the world; and the grounds on which they have been drawn in a great degree elude observation. A large proportion of them, no doubt partakes of the nature of bills of accommodation. They have, however, in general, that shape communicated to them, whatever it may be, which is thought likely to render them discountable; and it is not difficult, as the preceding observations will have shewn, to make of some real, and, at the same time, of many seeming, transactions of commerce as a ground for drawing, and as a means of multiplying such bills.
The practice of creating a paper credit, by drawing and redrawing, has been particularly described by Dr. Adam Smith; and is stated by him to have a tendency which is very ruinous to the party resorting to it. This practice, however, is often carried on at much less expence to those engaged in it than Dr. Smith imagines. A, for instance, of London, draws a bill at two months on B, of Amsterdam, and receives immediate money for the bill. B enables himself to pay the bill by drawing, when it is nearly due, a bill at two months on A for the same sum, which bill he sells or discounts; and A again finds the means of payment by again drawing a bill, at two months, on B. The transaction is, in substance, obviously the same as if A and B had borrowed, on their joint security, the sum in question for six months. The ground on which transactions of this sort have been stated by Dr. Adam Smith to be ruinous is, that of the heavy expence of a commission on every bill drawn, which is paid by him who raises money in this manner. If, for instance, one-half per cent. is the commission, and the bills are drawn at two months, and a discount of five per cent. per annum is paid, the money is raised at an interest of eight per cent. Such transactions, however, are often carried on alternately for the benefit of each of the two parties; that is to say, at one time the transaction is on the account of A, who pays a commission to B, at another it is on the account of B, who pays a commission to A. Thus each party, on the whole, gains about as much as he pays in the shape of such commissions; and the discount in turning the bill into money, which is the same as that on any other bill, may, therefore, be considered as the whole expence incurred. Money may be raised in this manner at an interest of only five per cent. In the case recently proposed, the drawing and re-drawing were imagined to be only between A, of London, and B, of Amsterdam. This practice, however, is often carried on between three or more parties drawing from three or more places. In such case, the draft is drawn on the place on which the existing course of exchange shews that it will best answer to draw it. An operation of this sort may obviously be carried on partly for the purpose of raising money, and partly for that of profiting by a small turn in the exchange. Transactions which are the converse to this, are, on the other hand, entered into by those who happen to possess ready money. They remit, if the exchange seems to favour their remittance, and draw in consequence of having remitted. To determine what bills are fictitious, or bills of accommodation, and what are real, is often a point of difficulty. Even the drawers and remitters themselves frequently either do not know, or do not take the trouble to reflect, whether the bills ought more properly to be considered as of the one class or of the other; and the private discounter, or banker, to whom they are offered, still more frequently finds the credit of the bills to be the only rule which it is possible to follow in judging whether he ought to discount them.
[* ]By the term suitable equivalent, is not intended that equivalent which an impartial umpire, determining according to the strict rule of equity, might dictate. The equivalent obtained by men dealing in the way of barter is not exactly of this sort; for that power which the proprietors of a scarce and necessary commodity have over the consumers of it, will always lead them to demand a much higher price than the production of it may have cost.