[From The Theory of Money and Credit (1912)]
The events of recent years reopen questions that have long been regarded as closed. The question of the freedom of the banks is one of these. It is no longer possible to consider it completely settled as it must have been considered for decades now. Unfortunate experiences with banknotes that had become valueless because they were no longer actually redeemable led once to the restriction of the right of note issue to a few privileged institutions.
Yet experience of state regulation of banks of issue has been incomparably more unfavorable than experience of uncontrolled private enterprise. What do all the failures of banks of issue and clearing banks known to history matter in comparison with the complete collapse of the banking system in Germany?
Everything that has been said in favor of control of the banking system pales into insignificance beside the objections that can nowadays be advanced against state regulation of the issue of notes. The etatistic arguments, that were once brought forward against the freedom of the note issue, no longer carry conviction; in the sphere of banking, as everywhere else, etatism has been a failure.
The safeguards erected by the liberal legislation of the 19th century to protect the bank-of-issue system against abuse by the state have proved inadequate. Nothing has been easier than to treat with contempt all the legislative provisions for the protection of the monetary standard. All governments, even the weakest and most incapable, have managed it without difficulty. Their banking policies have enabled them to bring about the state of affairs that the gold standard was designed to prevent: subjection of the value of money to the influence of political forces. And, having arrogated this power to themselves, the governments have put it to the worst conceivable use. But, so long as the other political and ideological factors were what they were, we cannot conclude that the mere freedom of the banks would or could have made things different.
Let us suppose that freedom of banking had prevailed throughout Europe during the last two generations before the outbreak of the Great War; that banknotes had not become legal tender; that notes were always examined, not only with respect to their genuineness, but also with respect to their soundness, whenever they were tendered, and those issued by unknown banks rejected; but that the notes of large and well-known banking firms nevertheless were just as freely current as the notes of the great central banks of issue in the period when they were not legal tender. Let us further suppose that since there was no danger of a world banking cartel, the banks had been prevented, by the mere necessity for redeeming their notes in cash, from making immoderate endeavors to extend their issue by charging a low rate of interest; or at least, that the risk of this was no greater than under legislative regulation of the note system.
Let us suppose, in short, that up to the outbreak of the war, the system had worked no better and no worse than that which actually existed. But the question at issue is whether it would have held its own any better after July 28, 1914. The answer to this question seems to be that it would not have done so.
The governments of the belligerent — and neutral — states overthrew the whole system of bank legislation with a stroke of the pen, and they could have done just the same if the banks had been uncontrolled. There would have been no necessity at all for them to proceed to issue Treasury notes. They could simply have imposed on the banks the obligation to grant loans to the state and enabled them to fulfill this obligation by suspending their obligation to redeem their notes and making the notes legal tender. The solution of a few minor technical problems would have been different, but the effect would have been the same.
For what enabled the governments to destroy the banking system was not any technical, juristic, or economic shortcoming of the banking organization, but the power conferred on them by the general sentiment in favor of etatism and war. They were able to dominate the monetary system because public opinion gave them the moral right to do so. “Necessity knows no law” was the principle which served as an excuse for all the actions of all governments alike, and not only that of Germany, which was much blamed because of the candor with which it confessed its adherence to the maxim.
“Nothing has been easier than to treat with contempt all the legislative provisions for the protection of the monetary standard. All governments, even the weakest and most incapable, have managed it without difficulty.”At the most, as has been explained, an effective if limited protection against future etatistic abuse of the banking system might be secured by prohibiting the issue of notes of small denominations. That is to say, not by uncontrolled private enterprise in banking, but on the contrary by interference with the freedom of the note issue. Apart from this single prohibition, it would be quite possible to leave the note issue without any legislative restrictions and, of course, without any legislative privileges either, such as the granting of legal tender to the notes. Nevertheless, it is clear that banking freedom per se cannot be said to make a return to gross inflationary policy impossible.
Apart from the question of financial preparation for war, the arguments urged in favor of the centralization, monopolization, and state control of banks of issue in general and of credit-issuing banks in particular are thoroughly unsound. During the past 20 or 30 years, the literature of banking has got so thoroughly lost among the details of commercial technique, has so entirely abandoned the economic point of view, and so completely surrendered itself to the influence of the most undisguised kinds of etatistic argument, that in order to discover what the considerations are that are supposed to militate against the freedom of the banks it is necessary to go back to the ideas that dominated the banking literature and policy of two or three generations ago.
The bank-of-issue system was then supposed to be regulated in the interests of the poor and ignorant man in the street, so that bank failures might not inflict loss upon those who were unskilled and unpracticed in business matters — the laborer, the salaried employee, the civil servant, the farmer. The argument was that such private persons should not be obliged to accept notes whose value they were unable to test, an argument which only needs to be stated for its utter invalidity to be apparent. No banking policy could have been more injurious to the small man than recent etatism has been.
The argument, however, that was then supposed to be the decisive one was provided by the currency principle. From the point of view of this doctrine, any note issue that is not covered by gold is dangerous, and so, in order to obviate the recurrence of economic crises, such issues must be restricted. On the question of the theoretical importance of the currency principle, and on the question of whether the means proposed by the Currency School were effective, or could have been effective, or might still be effective, there is nothing that need be added to what has been said already. We have already shown that the dangers envisaged by the currency principle exist only when there is uniform procedure on the part of all the credit-issuing banks, not merely within a given country but throughout the world. Now the monopolization of the banks of issue in each separate country does not merely fail to oppose any hindrance to this uniformity of procedure; it materially facilitates it.
What was supposed to be the decisive argument against freedom of banking in the last generation before the war is just the opposite to that which was held by the Currency School. Before the war, state control of banking was desired with the very object of artificially depressing the domestic rate of interest below the level that considerations of the possibility of redemption would have dictated if the banks had been completely free. The attempt was made to render as nugatory as possible the obligations of cash redemption, which constitute the foundation stone of all credit-issuing bank systems.
“No banking policy could have been more injurious to the small man than recent etatism has been.”This was the intention of all the little expedients, individually unimportant but cumulatively of definite if temporary effect, which it was then customary to call banking policy. Their one intent may be summed up in the sentence: by hook or by crook to keep the rate of discount down. They have achieved the circumvention of all the natural and legal obstacles that hinder the reduction of the bank rate below the natural rate of interest. In fact, the object of all banking policy has been to escape the necessity for discount policy, an object, it is true, which it was unable to achieve until the outbreak of the war left the way free for inflation.
If the arguments for and against state regulation of the bank-of-issue system and of the whole system of fiduciary media are examined without the etatistic prejudice in favor of rules and prohibitions, they can lead to no other conclusion than that of one of the last of the defenders of banking freedom:
There is only one danger that is peculiar to the issue of notes; that of its being released from the common-law obligation under which everybody who enters into a commitment is strictly required to fulfill it at all times and in all places. This danger is infinitely greater and more threatening under a system of monopoly.
This article is excerpted from The Theory of Money and Credit.
