Conspiracy theory to the contrary, central banks are not a plot by the bankers to conquer the world by controlling access to money and credit. Government got into central banking by an accident of history. King William III of England needed money and demanded a bribe in the form of the specie reserves of the newly organized Bank of England in exchange for “government stock” (i.e., government debt) for the bank to obtain a charter.
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| Jean-Baptiste Say |
As originally intended, central banks were, in a sense, designed to be commercial or mercantile banks for commercial or mercantile banks. To understand this, we need to know what it is commercial or mercantile banks do.
Consistent with Say’s Law of Markets and the real bills doctrine, commercial or mercantile banking can be considered a type of insurance for the money supply and the value of the currency. There are at least three reasons for this.
First, users of a commercial or mercantile bank’s promissory notes have more confidence in the promissory notes issued by an institution of known creditworthiness than in privately issued bills of exchange. Having a single financial institution substitute its good name for all the individual money creators in the area served by the bank by exchanging the bank’s promissory notes for the individually issued bills of exchange greatly minimizes the risk associated with market exchanges. As monetary and banking authority James W. Gilbart explained,
Another advantage of keeping a banker is that by this means you have a continual reference as to your respectability. If a mercantile house in the country writes to its agent to ascertain the respectability of a firm in London, the first inquiry is, ‘Who is the banker?’ And when this is ascertained, the banker is applied to through the proper channel, and he gives his testimony as to the respectability of his customer. When a trader gives his bill, it circulates through the hands of many individuals to whom he is personally unknown; but if the bill is made payable at a banking-house, it bears on its face a reference to a party to whom the accepter is known, and who must have some knowledge of his character as a tradesman. This may be an immense advantage to a man in business as a means of increasing his credit; and credit, Dr. Franklin says, is money. (James W. Gilbart, “The Various Services of Banks,” adapted from The History, Principles, and Practice of Banking, 1837, Michie’s revision. London: G. Bell & Sons, 1882, 213-222, quoted in Harold G. Moulton, ed., Principles of Money and Banking: A Series of Selected materials, with Explanatory Introductions. Chicago, Illinois: The University of Chicago Press, 1916, II.9.)
Second, promissory notes payable on demand to a holder in due course are more convenient than bills of exchange with a maturity date in the future, and thus usually preferred.
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| Harold G. Moulton |
There have been instances, however, in which small denomination bills of exchange circulated, whether by preference, as in Lancashire in the nineteenth century (Charles P. Kindleberger, Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books, 1989, 67), or out of necessity, in the form of personal checks or clearinghouse certificates, as was the case following the Panic of 1893 and the Panic of 1907 (Moulton, Principles of Money and Banking, op. cit., 188-196), as well as during Roosevelt’s “bank holiday” in the 1930s.
In addition, bills of exchange are typically issued in large denominations, and must be indorsed by each holder in due course, where a banknote or coin can be used without each holder in due course appending his or her indorsement. (Yes, in this context, “indorse” is preferred over “endorse” for historical reasons.)
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| Chopmarked U.S. Trade Dollar |
There are exceptions to this, as well. When China’s domestically issued currency consisted almost exclusively of “cash” coins worth approximately 1/10 of a cent, the demand for circulating media was met by importing foreign silver coins. It was the custom for each merchant who received a silver coin in trade to punch his “chop” or character on the coin, thereby attesting to the coin’s silver content. (C. C. Chamberlain and Fred Reinfeld, Coin Dictionary and Guide. New York: Bonanza Books, 1960; Clifford Mishler, Coins Questions and Answers. Iola, Wisconsin: Krause Publications, 1987, 89, 194.)
Third, a dollar or pound banknote issued by a particular bank is fungible, that is, legally the same as all other dollar or pound banknotes issued by that bank. Each note, despite its physical condition or the creditworthiness of the drawer of the bill of exchange for which the notes were originally traded, is legally identical to all other notes of the same denomination issued by that bank. “Those things one specimen of which is as good as another, as is the case with half-crowns, or pounds of rice of the same quality.” (“Fungible Things,” Black’s Law Dictionary)
Given these reasons, however, an individual commercial or mercantile bank still faces greater risk than several banks taken together. Risk is always greater for a single entity than when it is when spread among many.
There are other problems as well, which will be covered in the next posting on this subject.
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