Front Page Titles (by Subject) CHAP. VII - 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. VII - 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 Country Banks—their Advantages and Disadvantages.
The country banks in Great Britain appear to have amounted, in the year 1797, to three hundred and fifty-three. By a numeration taken in 1799, they appear to have been three hundred and sixty-six. By a third numeration taken in 1800, they were three hundred and eight-six* . It seems, therefore, that no material addition to their number has arisen in these three years.
A great increase of country banks took place during the time which intervened between the American and the present war, and chiefly in the latter part of it; a period during which the trade, the agriculture, and the population of the country must have advanced very considerably. The circumstance of so many of our country banks having originated at such a time, affords a presumption that they are consequences and tokens of the prosperity, rather than indications of the declining state of the country. No banks have arisen in France during the period of its troubles, though several attempts to erect them have been made. It was with difficulty that any banks supported themselves in America during the war; but after the establishment of peace, banks were instituted in most of the American states. They seem naturally to belong to all commercial countries; but are more particularly likely to be multiplied in a state like ours, in which the mercantile transactions are extended, the population is great, and the expenditure of individuals considerable; and where also a principal bank exists, which, through the necessity imposed on it by its situation, undertakes the task of providing a constant reservoir of gold accessible to every smaller banking establishment. The creation of the large bank operates as a premium on the institution of the smaller.
A description of the origin of one of our smaller country banks may elucidate the subject before us. In every town, and in many villages, there existed, antecedently to the creation of what were afterwards termed banks, some trader, manufacturer, or shopkeeper, who acted, in many respects, as a banker to the neighbourhood. The shopkeeper, for example, being in the habit of drawing bills on London, and of remitting bills thither, for the purposes of his own trade, and receiving also much money at his shop, would occasionally give gold to his customers, taking in return their bills on the metropolis, which were mixed with his other bills, and sent to his London correspondent.
Persons who were not customers being also found to want either money for bills, or bills for money, the shopkeeper was led to charge something for his trouble on accommodating them: and the trade of taking and drawing bills being thus rendered profitable, it became an object to encrease it. For the sake of drawing custom to his house, the shopkeeper, having as yet possibly little or no view to the issuing of bank notes, printed “The Bank” over his door, and engraved these words on the checks on which he drew his bills.
It may be assumed, also, to have been not uncommon, before country banks were established, for the principal shopkeeper in a town to take at interest some of the money of his neighbours, on the condition, however, that he should not be required to pay it back without some notice. The money thus deposited with him, or borrowed by him (it is difficult to say which term is the more proper), might either be thrown into his trade, or employed in discounting bills soon to become due; but the latter would evidently be the more safe and prudent way of investing it.
All these parts of the banking business arose out of the situation and circumstances of the country; and existed in many places before the name of banker was assumed.
The practice of issuing country bank notes, that is to say, notes payable to the bearer on demand, may, undoubtedly, be considered as a separate branch of business. These notes, however, have been shown to be not so very different in their nature from other paper as is commonly imagined.
For the sake of more particularly proving this point, let us advert to the nature of interest notes, a species of paper which some country banks have issued to a great extent. Even the shopkeeper, it was lately observed, would take sums at interest. For each of these sums, especially if he became a banker, he would give out his note, in which would be expressed the sum lent or deposited, the rate of interest upon it, and the time which was to intervene before payment could be demanded. This note would be transferable to any third person. There would, however, be some impediments to its circulation. The interest must be calculated as often as it should change hands. Some of the persons to whom it was offered might not be disposed to accept it as a payment, especially if it had a long time to run. Although these notes might circulate, they would circulate heavily. In order to promote their circulation, and thus encrease the whole number of issuable notes, the banker would be inclined to lessen the time within which they should be payable; and he would find that, in proportion as he adopted this practice, a lower rate of interest on the notes would suffice to induce persons to take them. Notes carrying no interest would circulate, if due within a short time, better than notes bearing interest which should be due at a very distant period. But the only notes which would circulate freely would be those which should be payable, or at least paid, without any notice. Some banks wishing, on the one hand, to encourage the circulation of their paper, and, on the other, to avoid the inconvenience of a strict obligation to pay without notice have issued notes payable after a certain time, and yet have been in the regular practice of giving money for them whenever payment was demanded, and have taken no discount for the accommodation.
Thus, then, the shorter the notice is, the greater is the currency of the note; and, in proportion, therefore, as the circumstances of a country render it more safe for the banks to shorten their notice, in the same proportion it may be expected that notes to the bearer on demand will be issued, and gold displaced.
Some speculative persons have imagined, that the practice pursued by bankers of emitting notes payable on demand is founded on an altogether vicious and unwarrantable principle, inasmuch as such paper is issued with a view to a profit which is to be obtained only by lending out part of the sum necessary for the payment. A number of promises, it is said, are thus made, which the banker has evidently placed it out of his power to perform, supposing the fulfilment of them all to be required at the same time, an event by no means impossible. This objection implies that the banker ought not, after receiving the deposits left with him by his customers, to lend out part of the sum necessary for the payment of these deposits; for he is much bound to discharge demands for deposits without notice, as to pay without notice all his notes. The Bank of England, the London banker, the country banker, the merchant, and also the individual of every class, proceed, in respect to all their promises to pay money, not on any principle of moral certainty, but on that of reasonable and sufficient probability. The objection to bank notes, as such, if pushed to that extent to which, if it is at all just, it might be carried, would apply to all verbal promises to pay money, and, indeed, to almost all promises whatever; for there is scarcely any class of these for the performance of which a perfectly sure provision is always made at the time of giving the promise. The objection implies, therefore, that men ought to be prohibited from acting in their commercial concerns according to that rule of sufficient probability by which all the other affairs of human life are conducted* .
It is completely understood by the holders of notes, as well as by the customers of banks, that instant payment is provided for only a part of that sum which may, by possibility, be demanded; and the banker, therefore, seems fully justified if he makes such provision as the general and known usage of others in the same profession (for he is supposed, by those who trust him, to follow this usage), and a prudent regard to all the circumstances of his own case teach him to consider as sufficient.
The practice of issuing notes payable to bearer on demand became very common a few years antecedent to the present war, when various circumstances united to encourage this part of the country banker’s employment. Confidence was then high, the number of traders in the country had been greatly multiplied, the income and expenditure of individuals were much increased, and every branch, therefore, of the banking business had naturally enlarged itself. Some addition had been made to the number of London bankers; and a few of these took forward and active measures to encourage the formation even of very small banks in the country, with a view to the benefit expected from a connection with them. In many of our great towns a fair opening was afforded for the erection of additional banks. These new establishments having taken place, various country traders, who had before made use of their own correspondents in London, fell into the practice of transacting their business with the metropolis through the medium of the country banker with whom they kept their cash. The country banker drew largely on a London banker on the account of the country traders, and the London banker was willing to execute the extensive country business which he thus acquired, in consideration of a much lower commission than had before been paid by the several country traders to their separate correspondents in London, who had been, for the most part, London merchants. The reduction of the rate of commission arose from two causes: first, from the new security which was afforded to the transactions between the town and the country, by the interposition of the credit of rich and responsible country banks; and, secondly, from the transfer to one house of that labour of keeping accounts, writing letters, and receiving and paying bills, which had, before, been divided among many. The risk and trouble being diminished, a proportionate abatement in the rate of commission could be afforded.
The multiplication even of country banks, purposing to deal chiefly in bills, would tend, in many ways, to produce an encreased issue of notes on demand. Some deposit of gold would be kept by banks of every class, with the view of satisfying the demands of their customers; and the stock, maintained for this purpose, would would form a part of the necessary provision for the payment of notes payable on demand, and it would, therefore, become an encouragement to the issue of them. The multiplication of deposits of gold through the country would, moreover, furnish, in many cases, more prompt means of obtaining gold on any sudden emergency; since one country bank might often procure a supply from a neighbouring one, especially if a good understanding on this subject should subsist between them. The establishment of mail coaches afforded, at the same time, a more cheap and ready method than before, of bringing gold from London, as well as of transmitting thither any superfluity of it which might arise in the country. In proportion to the facility of obtaining gold, the unproductive stock of it kept in hand might be reduced; or, if the same stock should be maintained, the issue of notes payable on demand would be less hazardous. Indeed, a few old and respectable country banks had long been in the habit of emitting much paper of this sort, and had seldom experienced any inconvenience from doing it. The new ones, therefore, many of which were not at all inferior in property to the old, were led into the practice partly by example.
The circumstance which chiefly operated in procuring currency to the new circulating paper, was that participation of the benefit resulting from it which was enjoyed by the customers of the country banker; for he lent among them the capital which was acquired by the issue of his paper, and they became his instruments in sending it into circulation, by accepting it as a ready-money payment in return for bills discounted. In consideration of their obligations to the banker, and of the interest which they had in his stability, they were also forward, on most occasions, in the support of his credit. Such appear to have been the chief circumstances which led to that great encrease of our country banks, and to that substitution of paper in the place of gold, which have been, for some years past, so much the subject of complaint.
In order to assist the reader in judging whether a preponderance of good or of evil results from our numerous country banks, an endeavour shall now be made to enumerate the principal benefits as well as inconveniences of them.
That country banks have, in a variety of respects, been highly advantageous, can scarcely admit of a doubt. They have afforded an accommodation to many descriptions of persons; but more especially to those who are engaged in commerce. They may be regarded as an effect of that division of labour which naturally takes place in every opulent country. The receipts and the payments of money are now no longer conducted at home, even by the middling trader, but are become a separate branch of business in the hands of bankers. It was to be expected that they to whom this employment has been transferred would find means of abridging labour, and of sparing the use of coin, the most expensive circulating medium. By their skill in attaining these objects, they transact an important portion of the business of the trader at an expense far inferior to that which he must incur were he to conduct it by his own clerks; and they derive a profit to themselves, which, no less than the saving to the customer, may be regarded as clear gain to the kingdom.
Country banks are also useful by furnishing to many persons the means of laying out at interest, and in a safe manner, such money as they may have to spare. Those banks, in particular, which give interest notes for very small sums, afford to the middling and to the lower class of people an encouragement to begin to lay up property, and thus to make provision for the time of sickness or old age. Country banks also furnish a very convenient method of distributing to one class of men the superfluity of another. All who have money to spare know where they can place it, without expence or loss of time, not only in security, but often with pecuniary advantage: and all commercial persons of credit understand in what quarter they can obtain such sums, in the way of loan, as their circumstances will fairly warrant them in borrowing. While country banks thus render a benefit of the first magnitude to fair and prudent commerce, they are important barriers against rash speculation, though not unfrequently they are loudly accused of favouring it. However some few banks may have subjected themselves to this charge, banks in general, and particularly those which have been long established, take care to lend the sums which have been deposited in their hands, not to the imprudent speculator, or to the spendthrift, by whom they are in danger of suffering loss, but to those who, being known to possess some wealth and to manage their concerns with prudence, give proof that they are likely to repay the loan. Borrowers of this class are not apt to enter into very large and perilous undertakings; for they are unwilling to risk the loss of their own capital. Bankers, especially men of eminence, feel a special motive to circumspection, in addition to that which operates with other lenders. The banker always lends under an impression that, if he places in anyone a boundless or immoderate confidence, the imprudence will necessarily be known, in case the borrower should fail, as the affairs of every bankrupt are laid open to the body of creditors; and that his rashness is, therefore, liable to become the subject of conversation among his customers. Indiscretion of this kind, even if the particular instance be of no prominent magnitude, may thus prove an occasion of injuring the character and credit of the banking house, and of lessening the general profits of the business.
The banker also enjoys, from the nature of his situation, very superior means of distinguishing the careful trader from him who is improvident. The bill transactions of the neighbourhood pass under his view: the knowledge, thus obtained, aids his judgment; and confidence may, therefore, be measured out by him more nearly than by another person, in the proportion in which ground for it exists. Through the creation of banks, the appreciation of the credit of numberless persons engaged in commerce has become a science; and to the height to which this science is now carried in Great Britain we are in no small degree indebted for the flourishing state of our internal commerce, for the general reputation of our merchants abroad, and for the preference which in that respect they enjoy over the traders of all other nations. It is certainly the interest, and, I believe, it is also the general practice, of banks to limit not only the loan which any one trader shall obtain from themselves, but the total amount also, as far as they are able, of the sum which the same person shall borrow in different places; at the same time, reciprocally to communicate intelligence for their mutual assistance; and, above all, to discourage bills of accommodation. While the transactions of the surrounding traders are thus subject to the view of the country banks, those of the country banks themselves come under the eye of their respective correspondents, the London bankers; and, in some measure, likewise, of the Bank of England. The Bank of England restricts, according to its discretion, the credit given to the London banker. Thus a system of checks is established, which, though certainly very imperfect, answers many important purposes, and, in particular, opposes many impediments to wild speculation.
Country banks, also, as well as the Bank of England, have been highly beneficial, by adding, through the issue of their paper, to the productive capital of the country* . By this accession our manufactures, unquestionably, have been very much extended, our foreign trade has enlarged itself, and the landed interest of the country has had a share of the benefit. The common charge which is brought against country banks, of having raised up a fictitious capital in the country, admits of the following answer. They have substituted, it is true, much paper in the place of gold: but the gold which has gone abroad has brought back, as Dr. Smith observes, valuable commodities in return. The guinea spared from circulation has contributed to bring home the timber which has been used in building, the iron or the steel which has been instrumental to the purposes of machinery, and the cotton and the wool which the hand of the manufacturer has worked up. The paper has thus given to the country a bonâ fide capital which has been exactly equal to the gold which it has caused to go abroad; and this additional capital has contributed, just like any other part of the national stock, to give life to industry.
It has lately been objected to paper credit, that, by supplying the farmers with large loans, it has enabled them to keep back their corn from the market, and enhance the price. It is true, that farmers, both in the last and many preceding years, may have obtained larger loans than they would have procured if no country bank notes had existed. The capital so furnished to the farmers may possibly have induced some of them, at certain times, to keep in hand a larger quantity of grain than they would otherwise have found it convenient to hold. We know, however, that the general stock of grain in the autumn of 1800 was particularly low. Since, therefore, but a small part of the capital of the farmers, whether borrowed or their own, was then vested in grain, the principal share would probably be laid out on their land, and would encrease its produce; for, unquestionably, the value of a crop obtained from a farm depends chiefly on the sum employed in cultivation and improvement. Country bank notes have thus added to the general supply of grain; and, by doing so, have contributed to prevent a rise in its price: they have, probably, in this manner, afforded much more than a compensation for any temporary advance in price to which they may have given occasion by enabling farmers to keep a larger quantity in hand. The very possession of a large quantity in hand is to be considered as, in general, a benefit rather than a disadvantage; for it is our chief security against scarcity, and, consequently, also against dearness. To the want of a large surplus stock at the end of the years 1799 and 1800 is to be ascribed, in a great degree, the subsequent high price of provisions. The tendency, therefore, of country bank paper to encrease generally the stock of grain in the hands of the farmer is to be ranked among the advantages of country banks. The tendency to encrease it at the particular time of actual scarcity, is to be classed among the evils which they produce; and it is an inconsiderable evil, which is inseparable from a great and extensive good. To those who are disposed to magnify this occasional evil, it may be further observed, that the farmer is enabled to enlarge his stock by the encrease of his own as well as of the general wealth, much more, no doubt, than by the share which he obtains of that particular part of the new capital of the kingdom which is created through the substitution of country bank notes for gold; only a portion, therefore, of the mischief complained of is to be referred to country bank notes. It is principally to be ascribed to the growing riches and prosperity both of the farmers and other inhabitants of the country.
It is no small additional recommendation of the use of our paper, that the public draws a large yearly revenue from the tax imposed on bills and notes. If paper credit did not exist, a sum equal to that which is thus raised must be supplied by taxes either burthening the industry, or paid out of the property of the people. The public has, since the late additional tax, become a very considerable sharer in the profits of the country bankers’ business.
Since, therefore, a paper medium has served the purposes which have been described, and has been, generally speaking, quite as convenient an instrument in settling accounts as the gold which it has displaced, the presumption in favour of its utility seems to be very great; and, if it could be added, that no other effects than those which have as yet been stated have arisen or are likely to arise from it, the advantage of it would be beyond dispute. To reproach it with being a merely fictitious thing, because it possesses not the intrinsic value of gold, is to quarrel with it on account of that quality which is the very ground of its merit. Its merit consists in the circumstance of its costing almost nothing. By means of a very cheap article the country has been, for some years, transacting its money concerns, in which a very expensive material had previously been employed. If this were the whole question, the substitution of paper for gold would be as much to be approved as the introduction of any other efficacious and very cheap instrument in the place of a dear one. It would stand on the same footing with the substitution, for example, of cast iron for wrought iron or steel; of water carriage for land carriage; of a steam engine for the labour of men and horses; and might claim a high rank among that multitude of ingenious and economical contrivances to be found among us, by the aid of which we have attained to the present unrivalled state of our manufactures and commerce.
Some very solid objections, however, may be urged against the system of banking in the country.
The first which I shall mention, is, the tendency of country banks to produce, occasionally, that general failure of paper credit, and with it that derangement and suspension of commerce, as well as intermission of manufacturing labour, which have been already spoken of.
Country bank notes, and especially the smaller ones, circulate, in a great measure, among people out of trade, and pass occasionally into the hands of persons of the lower class; a great proportion, therefore, of the holders of them, have few means of judging of the comparative credit of the several issuers, and are commonly almost as ready to take the paper of any one house calling itself a bank as that of another. A certain degree of currency being thus given to inferior paper, even the man who doubts the ultimate solvency of the issuer is disposed to take it; for the time during which he intends to detain it is very short, and his responsibility will cease almost as soon as he shall have parted with it* . Moreover, the amount of each note is so small, that the risk seems, also, on that account, insignificant. The notes of the greater and of the smaller country banks, thus obtaining, in ordinary times, a nearly similar currency, they naturally fall at a season of alarm into almost equal discredit. If any one bank fails, a general run upon the neighbouring ones is apt to take place, which if not checked in the beginning by a pouring into the circulation a large quantity of gold, leads to very extensive mischief. Many country bankers, during a period of danger, prescribe to themselves a principle of more than ordinary reserve in the issue of their notes, because they consider these as the more vulnerable part of their credit. They know, that if the character of their house should be brought into question, through the fears or even the caprice of any of those strangers into whose hands their circulating paper passes, some distrust may be excited among their customers, the effect of which may be a sudden demand for the payment of large deposits. The amount, therefore, of the country bank notes circulating in the kingdom is liable to great fluctuation. The country banker, in case of an alarm, turns a part of the government securities, bills of exchange, or other property which he has in London, into Bank of England notes, and those notes into money; and thus discharges many of his own circulating notes, as well as enlarges the fund of gold in his coffers. The Bank of England has, therefore, to supply these occasional wants of the country banker; and, in order to be fully prepared to do this, it has, ordinarily, to keep a quantity of gold equal to that of the notes liable to be extinguished, as well as a quantity which shall satisfy the other extraordinary demands which may be made at the same season of consternation either by banking houses, or by individuals. Thus the country banker by no means bears his own burthen, while the Bank of England sustains a burthen which is not its own, and which we may naturally suppose that it does not very cheerfully endure* .
The national bank, indeed, may fairly be called upon, in consideration of the benefits enjoyed through its monopoly, to submit to a considerable expence in supplying gold for the country; but there must be some bounds to the claims which can equitably be made upon it: and, in estimating the benefit arising to the kingdom from the use of country bank notes, we have either to deduct the loss which the Bank of England incurs by maintaining an additional supply of gold sufficient to answer the demands which they occasion, or else we have to take into consideration the risk which the bank incurs by only keeping a fund of gold which is somewhat inadequate. The country banks may, perhaps, cause the bank in some measure to encrease its general fund of gold, though not to hold so much of this unproductive article as to afford a security equal to that which the bank would enjoy if no country bank notes existed.
It is obvious, that the additional capital given to the kingdom through the use of country bank notes must not be measured by the amount of those notes, but that a deduction must be made of the sum kept in gold in the coffers of the issuers, as their provision for the occasional payments to which their bank paper subjects them. The other deduction, which has been spoken of, is of the same nature. It is a second deduction, which must be made on account of a similar, and, perhaps, no less considerable provision for the payment of country bank notes, which is rendered necessary to be kept in the coffers of the Bank of England. In other words, the capital given to the country, through the use of country bank notes, is only equal (and it was so stated in speaking of that subject) to the amount of the gold which they cause to be exported.
I shall endeavour here to explain more particularly than has yet been done, some of those circumstances which cause a great diminution of country bank notes to bring distress on London, and to end in a general failure of commercial credit.
In a former chapter it was observed, that when that alarm among the common people, which produces an unwillingness to take country bank paper, and an eagerness for gold has risen to a considerable height, some distrust is apt to be excited among the higher class of traders; and that any great want of confidence in this quarter produces an encreased demand for that article, which is, among London bankers and merchants, in much the same credit as gold; I mean Bank of England notes, and which forms, at all times, the only circulating medium of the metropolis in all the larger transactions of its commerce. This more than usual demand for Bank of England notes the bank is at such a time particularly unwilling to satisfy, for reasons which I shall endeavour fully to detail. The reader will have been prepared to enter into them by the observations on the subject of the bank, introduced towards the close of the chapter which treated of that institution.
First, the bank may be supposed to be unwilling to satisfy that somewhat encreased demand for its notes which a season of consternation is apt to produce, because it is not unlikely to partake, in some degree, in the general alarm, especially since it must necessarily be supposed to have already suffered, and to be still experiencing a formidable reduction of the quantity of its gold. The natural operation of even this general sort of fear must be to incline it to contract its affairs, and to diminish rather than enlarge its notes.
But it must also be recollected, that the bank has necessarily been led already to encrease its loans in the same degree in which its gold has been reduced, provided it has maintained in circulation the accustomed quantity of notes. This point was explained in the chapter on the subject of the bank. The directors, therefore, must seem to themselves to act with extraordinary liberality towards those who apply to them for discounts, if they only go as far as to maintain the usual, or nearly the usual, quantity of notes. The liberality in lending which they must exercise, if, when the gold is low, they even augment their paper, must be very extended indeed.
In order to render this subject more clear, let us suppose that an extra demand on the Bank of England for three millions of gold has been made through the extinction of the paper of country banks, and through the slower circulation and hoarding of gold which have attended the general alarm. Let us assume, also, that the bank, during the time of its supplying this gold, has thought proper to reduce its notes one million. It will, in that case, have necessarily encreased its loans two millions. Let us further assume, as we not very unreasonably may, that the two millions of additional loans have been afforded, not to the government, who owe a large and standing sum to the bank (suppose eight or ten millions besides the bank capital), but exclusively to the merchants; and let the total amount of loans antecedently afforded to the merchants be reckoned at four millions. The bank, in this case, will have raised its discounts to the merchants from four millions to six; that is, it will have encreased them one half, even though it has diminished its notes one million. This extension of the accustomed accommodation to the mercantile world must appear to call for the thanks of that body, rather than to leave any room for complaint; and yet it is plain from reasoning, and, I believe, it might be also proved from experience, that it will not ease the pressure. The difficulties in London, notwithstanding this additional loan of two millions to the merchants will be somewhat encreased; for a sum in gold, amounting to three millions, has been drawn from the bank by the London agents of the country bankers and traders, and has been sent by those agents into the country. London, therefore, has furnished for the country circulation three millions of gold; and it has done this by getting discounted at the bank two additional millions of bills, for which it has received two of the millions of gold, and by sparing one million of its circulating notes as a means of obtaining the other million. This reduction of the usual quantity of notes is borne by the metropolis with peculiar difficulty at a time of general alarm. However liberally, therefore, the bankers and merchants may acknowledge themselves to have been already relieved by the bank, they will repeat, and will even urge more than ever, their application for discounts.
It may be observed, with a view to the further elucidation of this part of our subject, that both the bank, and they who borrow of it, are naturally led to fix their attention rather on the amount of the loans furnished than on that of the notes in circulation. The bank is used to allow to each borrower a sum bearing some proportion to his supposed credit; but seldom or never exceeding a certain amount. It is true, the various borrowers do not always in an equal degree avail themselves of their power of raising money at the bank; and, therefore, a material enlargement of the sum total of the bank loans may take place at a moment of difficulty, through the encreased use which some of the richer merchants then make of their credit, as well as through the creation of a few new borrowers at the bank. The directors also, in particular cases, may suffer their rule to be relaxed. The circumstance, however, of the general principle on which the bank ordinarily, and, indeed, naturally proceeds, being that of a limitation of the amount of each of its loans to individuals, must tend, as I conceive to place something like a general limit to the total sum lent. It must conduce to prevent the fluctuation in the bank loans from keeping pace with the variation in the necessities of the public, and must contribute to produce a reduction of notes at that season of extraordinary distrust, when the state of the metropolis, as was more fully remarked in a former part of this Work, calls rather for their encrease.
That the borrowers at the bank are likely to pay no attention to the subject of the total quantity of notes in circulation, is easily shewn. They have, indeed, no means of knowing their amount. They can only judge of the liberality of the bank by the extent of its loans; and of this they form an imperfect estimate by the sum which they or their connexions have been able to obtain. Scarcely any one reflects, that there may be a large encrease of the general loans of the bank, as well as possibly an extension of each loan to individuals, while there is a diminution of the number of bank notes; and that the amount of the notes, not that of the loans, is the object on which the eye should be fixed, in order to judge of the facility of effecting the payments of the metropolis.
It was remarked, in a former chapter, that the bank, at the time antecedent to the suspension of its cash payments, having diminished the sum lent by it to government, and enlarged, though not in an equal degree, that furnished to the merchants, the pressure on the merchants was not relieved, as was expected, by the encreased loan afforded them, but even grew more severe. It was also shewn, that this could not fail to be the case, since the bank notes necessary for effecting the current payments of the metropolis were then diminished, and since the additional loans afforded to the merchants only in part compensated for the new pressure which was created in the general money market of the kingdom, by the circumstance of the government being obliged to become a great borrower in that market. Whenever the bank materially lessens its paper, similar pressure is likely to be felt. Neither the transfer of the bank loans from the government to the merchants, nor even a large encrease of its loans, when that encrease is not carried so far as is necessary to the maintenance of the accustomed, or nearly the accustomed, quantity of bank paper, can prevent, as I apprehend, distress in the metropolis; and this distress soon communicates itself to all parts of the kingdom. The short explanation of the subject is this. Many country bank notes having disappeared, a quantity of gold is called for, which is so much new capital suddenly needed in the country. The only place in which any supply of gold exists is the Bank of England. Moreover, the only quarter from whence the loan of the new capital, under all the circumstances of the case, can come, is also the Bank of England; for the gold in the bank is the only dead or sleeping stock in the kingdom which is convertible into the new active capital which is wanted. The bank, therefore, must lend the gold which it furnishes; it must lend, that is to say, to some individuals a sum equal to the gold which other individuals have taken from it: otherwise it does not relieve the country.
If it should be asked, Why does not the bank in such case demand something intrinsically valuable, instead of contenting itself with mere paper in return?—the answer is, first, that if the bank were to receive goods in exchange for its gold, or, in other words, were to purchase goods, it would have afterwards to sell them; and it would then become a trading company, which it is forbid to be by its charter: it is allowed to traffic only in bullion. The answer is, secondly, that if it were to take goods as a mere security, and to detain them as such, it would then prevent their passing into consumption with the desirable expedition. By proceeding on either of these plans, it would also involve itself in a degree of trouble which would not be very consistent with the management of the business of a banking company* . It may be answered, thirdly, that the bills which the bank discounts, are, generally speaking, so safe, that the security either of goods, or stocks, or land, none of which are received in pledge by the directors, may be considered as nearly superfluous. A very small proportion of the five per cent discount, gained upon the bills turned into ready money at the bank, has compensated, as I believe, for the whole of the loss upon them, even in the years of the greatest commercial failures which have yet been known.
The observations which have now been made sufficiently shew what is the nature of that evil of which we are speaking. It is an evil which ought to be charged not to any fault in the mercantile body, but to the defects of the banking system. It is a privation which the merchants occasionally experience of a considerable part of that circulating medium which custom has rendered essential to the punctual fulfilment of their engagements. In good times, the country banks furnish this necessary article, which they are enabled to do through the confidence of the people in general; but when an alarm arises, the country banks cease to give it out, the people refusing what they had before received; and the Bank of England, the only body by whose interposition the distress can be relieved, is somewhat unwilling to exercise all the necessary liberality, for the reasons which have been so fully mentioned. The merchants are some of the chief sufferers, and they are generally, also, loaded with no inconsiderable share of censure; but the public, the country banks, and the Bank of England, may more properly divide the blame.
The mischief produced by a general failure of paper credit is very considerable. How much such a failure interrupts trade and manufacturing industry, and, therefore, ultimately also tends to carry gold out of the country, has been already stated at large. It also causes a great, though merely temporary, fall in the market price of many sorts of property; and thus inflicts a partial and very heavy loss on some traders, and throws extraordinary gain into the hands of others; into the hands, I mean, of those who happen to have superior powers of purchasing at the moment of difficulty. By giving to all banking, as well as mercantile, transactions the appearance of perilous undertakings, it deters men of large property, and of a cautious temper, from following the profession of bankers and merchants. It creates no small uneasiness of mind, even among traders who surmount the difficulties of the moment. Above all, it reduces many respectable, prudent, and, ultimately, very solvent persons to the mortifying necessity of stopping payment; thus obliging them to share in that discredit, in which, it is much to be desired, that traders of an opposite character only should be involved. If, indeed, we suppose, as we necessarily must, that, on account of the multitude of failures which happen at the same time, the discredit of them is much diminished, then another evil is produced, which, in a commercial country, is very great. Acts of insolvency, leaving less stigma on the character, become not so much dreaded as might be wished. The case of some, who bring difficulties on themselves, being almost unavoidably confounded with that of persons whose affairs have been involved through the entanglement of paper credit, to stop payment is considered too much as a misfortune or accident, and too little as a fault; and thus a principal incentive to punctuality in mercantile payments is weakened, and an important check to adventurous speculation is in some measure lost.
The observations which have been made will, however, shew that the tendency of country bank paper to produce a general failure of paper credit, is an evil which may be expected to diminish; for, first, if the Bank of England, in future seasons of alarm, should be disposed to extend its discounts in a greater degree than heretofore, then the threatened calamity may be averted through the generosity of that institution* . If, secondly, the country bankers should be taught (as, in some degree, unquestionably they must), by the difficulties which they have experienced, to provide themselves with a larger quantity of that sort of property which is quickly convertible into Bank of England notes, and, therefore, also, into gold, then the country bankers will have in their own hands a greater power of checking the progress of an alarm. Still, indeed, their resource will be the gold which is in the bank. The encreased promptitude, however, with which the greater convertibility of their funds will enable them to possess themselves of a part of the bank treasure, will render a smaller supply of it sufficient; and this smaller supply may be expected to be furnished, without difficulty, either by means of such a trifling addition to the bank loans as the bank will not refuse, or by sparing the necessary sum from the paper circulation of the metropolis, which, if commercial confidence is not impaired, will always admit of some slight and temporary reduction. The Bank of England will itself profit by the circumstance of its gold becoming more accessible to the country banks; for the untoward event of a general failure of paper credit will thus be rendered less probable, and, therefore, a smaller stock of gold will be an equally sufficient provision for the extraordinary demands at home to which the bank will be subject. Or if, thirdly, those among whom country bank notes circulate should learn to be less variable as to the confidence placed by them in country paper, or even to appreciate more justly the several degrees of credit due to the notes of different houses, then the evil which was before supposed to be obviated by the liberality of the Bank of England, or by the prudence of the country banker, will abate through the growth of confidence and the diffusion of commercial knowledge among the public. It seems likely that by each of these means, though especially in the second mode which was mentioned, the tendency of country bank notes to produce an occasional failure of commercial credit will be diminished. In time past, the mischief has been suffered to grow till it appeared too formidable to be encountered; and this has happened partly in consequence of our wanting that knowledge and experience which we now possess.
Another evil attending the present banking system in the country is the following.
The multiplication of country banks issuing small notes to bearer on demand, by occasioning a great and permanent diminution in our circulating coin, serves to encrease the danger, lest the standard by which the value of our paper is intended to be at all times regulated should occasionally not be maintained.
The evils of a great depreciation of paper currency are considerable. In proportion as the article which forms the current payment for goods drops in value, the current price of goods rises. If the labourer receives only the same nominal wages as before the depreciation took place, he is underpaid. Antecedent pecuniary contracts, though nominally, and, perhaps, legally fulfilled, are not performed with due equity. It is true, that the general stock of wealth in the country may remain nearly the same; and it is possible that the circulating paper may be restored to its full value when the period of the particular difficulty shall have passed by. Some degree, however, of unfairness and inequality will, in the mean time, have been produced, and much pressure may have been felt by the lower classes of people, whose wages are seldom raised until some time after the occasion for a rise has begun to exist.
In those countries in which the government is the chief banker or issuer of notes, a temptation arises, on the occasion of every public pressure, either to lessen the quantity of precious metal contained in the chief current coin, as one of the means of detaining it in the country, or to allow paper to pass at a considerable and professed discount, which is another mode of preventing the coin from being exported. These are evils from which we consider ourselves as happily secured by the established principles of good faith which prevail in Great Britain. Those principles, however, should, perhaps, lead us even to place ourselves at a distance from that temptation to depreciate coin, or to permit a discount on paper, to which so many other countries have yielded. The possession, in ordinary times, of a very considerable quantity of gold, either in the bank or in general circulation, or both, seems necessary for our complete security in this respect. The substitution of country bank notes for gold tends to lessen that security. The evil of them is not that they create any false and merely ideal riches, or that they do any constant prejudice to the country. They enable the trader to vest a capital in merchandize, which, without them, he would not possess, and thereby add to the annual income of the nation. In their immediate effect, therefore, they are beneficial; but they leave us more exposed to an occasional evil, against which it is prudent to guard, provided we can accomplish that purpose without too great a sacrifice of present advantages, It seems, on this account, as well as on some others, very undesirable to render permanent the temporary law passed some years since, and subsequently renewed, for the purpose of permitting the issue of English notes under five pounds. When it shall have expired, the power of re-enacting it, which we shall possess, will be a valuable resource. If, moreover, any measure can be devised, which, by encreasing the public confidence in good paper, will lessen the danger of a general failure of paper credit, and of a run upon the bank for gold, and which, also, by obstructing the issue of five and ten pound notes by smaller and less respectable banks, will somewhat extend the use of coin, on the whole, it will have a twofold argument to recommend it* .
The reader will observe, that even our circulating gold coin has here been considered in the light of a provision against an unfavourable balance of trade with foreign countries, and, therefore, as exportable. Part of our coin will, in fact, always be exported when the balance is very unfavourable, and the exportation, under such circumstances, is beneficial to the country. We are apt to think that it is the interchange of the usual gold coin for paper at home which alone maintains the value of our paper; and we are partly, on this account, much more anxious to detain our gold at home, than we are to discharge by means of it an unfavourable balance of trade, and thereby to improve our exchange with foreign countries. I apprehend, however, that an unfavourable course of exchange, which the export of our gold would cure, will, in many cases, tend much more to depreciate our paper, and to produce a rise in the nominal price of articles, than the want of the usual interchange of gold for paper at home. Our coin itself, as has been already remarked, when paper is depreciated, passes not for what the gold in it is worth, but at the paper price; though this is not generally observed to be the case. It is the maintenance of our general exchanges, or, in other words, it is the agreement of the mint price with the bullion price of gold which seems to be the true proof that the circulating paper is not depreciated.
[* ]This statement of the number of country banks is taken from three printed accounts of them, the first of which may not have been very accurate, but may be presumed to state them at too low rather than too high a number. The two later enumerations were made in a more careful manner.
[* ]In some of the democratic pamphlets of the present day, bank notes of every kind are spoken of not merely as liable to be carried to excess, or to be issued by irresponsible persons, or as producing particular evils, but as radically and incurably vicious; they are considered in the light of a complete fraud upon the public, which is practised by the rich, and connived at by the government; and the very issue of them has been stigmatized as equivalent to the crime of forgery. The resemblance of bank notes to other paper, and the resemblance of a promise on paper to any other promise, have been here touched upon with a view of exposing the absurdity of those doctrines.
[* ]Dr. Smith remarks, that it is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country. “Dead stock,” he observes, “is converted into active and productive stock.” Whether the introduction of the use of paper is spoken of as turning dead and unproductive stock into stock which is active and productive, or as adding to the stock of the country, is much the same thing. The less the stock of gold is, the greater will be the stock of other kinds; and if a less stock of gold will, through the aid of paper, equally well perform the work of a larger stock, it may be fairly said that the use of paper furnishes even additional stock to the country. Thus, for example, the use of a new sort of machinery which costs less in the erection than that which was employed before, and which just as effectually does the work required, since it enables the owner to have always more goods in the course of manufacture, while he has exactly the same means of manufacturing them, might not improperly be described as adding to the stock of the country.
[* ]I apprehend that, supposing a country bank to fail, the holder of one of its notes, who should have parted with it in sufficient time to afford to the next holder an opportunity of applying for the discharge of it before the day of failure, could not be called upon for the payment of the value of it. The responsibility therefore, of him who has been the holder of a country bank note commonly ceases in about one or two days after it has been parted with. That of the holder of a bill continues till after the bill is due, namely, for a period, perhaps, of one or two months.
[* ]At the time of the distress of 1793, some great and opulent country banks applied to the Bank of England for aid, in the shape of discount, which was refused on account of their not offering approved London securities: some immediate and important failures were the consequence. The Bank of England was indisposed to extend its aid to houses in the country. The event, however, shewed that the relief of the country was necessary to the solvency of the metropolis. A sense of the unfairness of the burthen cast on the bank by the large and sudden demands of the banking establishments in the country, probably contributed to produce an unwillingness to grant them relief.
[* ]Of the parliamentary loan of exchequer bills in 1793, which was directed to be granted on the security either of sufficient bondsmen, or of a deposit of goods, only a small proportion was taken on the latter principle, on account of the great obstruction to the sale of goods, which was thought to arise from warehousing them on the account of the commissioners appointed by parliament. It has been already remarked, that no part of the sum lent was lost.
[* ]It is by no means intended to imply, that it would become the Bank of England to relieve every distress which the rashness of country banks may bring upon them: the bank, by doing this, might encourage their improvidence. There seems to be a medium at which a public bank should aim in granting aid to inferior establishments, and which it must often find very difficult to be observed. The relief should neither be so prompt and liberal as to exempt those who misconduct their business from all the natural consequences of their fault, nor so scanty and slow as deeply to involve the general interests. These interests, nevertheless, are sure to be pleaded by every distressed person whose affairs are large, however indifferent or even ruinous may be their state.
[* ]Various objections, however, occur against almost every parliamentary measure for the regulation of country banks. Dr. Smith is of opinion, that a law prohibiting the issue of small notes is alone a sufficient remedy for the evils attending these institutions, and that the danger arising from banks is lessened by the multiplication of them. It is the object of this Work not so much to canvass any question respecting the particular means of regulating paper credit, as to lay down some general principles concerning it.