George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue [1988] (1/11)

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1: Overview

The Historical Background

La sagesse conventionnelle veut que les banques centrales ont été établies, en majeure partie du moins, en réponse à des défauts de la déréglementation bancaire. De récentes études viennent contredire ce point de vue (le livre ayant été écrit en 1988).

Pour l’Angleterre :

The Bank of England was established by King William III in 1694. It was designed to secure “certain recompenses and advantages . . . to such persons as shall voluntarily advance the sum of fifteen hundred thousand pounds towards carrying on the war with France.” In the age of mercantilism the granting of special privileges to business firms in exchange for financial assistance to the state, especially during wartime, was common. Yet in banking this pattern continued even into the twentieth century. The Bank of England followed it faithfully until 1826, routinely securing for itself additional monopoly privileges in addition to extensions of its charter. In 1697, in exchange for a loan of £ 1,001,071, it was given a monopoly of chartered banking, limiting competition to private bankers. In 1708, in return for a loan of £ 2,500,000, the Bank’s owners were rewarded by an act prohibiting joint-stock banks (private banks of six partners or more) from issuing notes. To extend its privileges through the remainder of the century the Bank made further, large loans to the government in 1742, 1781, and 1799. In 1826 it suffered its first setback: a campaign led by Thomas Joplin gained for joint-stock banks the right to engage in note issue and redemption outside a circle with its radius extending 65 miles from the center of London, where the Bank of England was headquartered. But this threat of competition was made up for in 1833 by a law officially sanctioning the use of Bank of England notes by “country” banks as part of their legal reserves and for use instead of specie for redeeming their own notes. This encouraged country banks to use Bank of England notes as high-powered money (a role the notes were already playing to a limited extent as a result of the Bank’s monopoly of London circulation), expanding the Bank’s power to manipulate the English money supply.

In the meantime the reputation of all note-issuing banks suffered as a result of the suspension of 1797-1821. It was further eroded by a crisis in 1826. The authorities clamoured for restrictions upon note issue, making no effort to distinguish the powers of the Bank of England from those of other less privileged note-issuing banks. The country banks thus shared the blame for overissues that originated in the policies of the Bank of England. The consequence was Peel’s Bank Act of 1844, which prohibited further extension of country-bank note issues while placing a 100 percent marginal specie-reserve requirement on the note issues of the Bank of England. The Bank Act eventually gave the Bank of England a monopoly of note issue, as the Bank assumed the authorized circulation of country banks when they closed. It also added to the rigidity of the system by increasing the dependence of country banks on the Bank of England for meeting their depositors’ increased demands for currency. Since the Bank of England was itself restricted in its ability to issue notes, the system was incapable of meeting any substantial increase in demand for currency relative to the demand for checkable deposits. For this reason the Bank Act had to be repeatedly suspended until the desirability of having the Bank of England free to function as a “lender of last resort” during “internal drains” of currency was made conspicuous in Bagehot’s Lombard Street (1874). When it formally acknowledged its special responsibilities the Bank of England became the first true central bank, the prototype for other central banks that would be established in nearly every nation on the globe.

If England’s was a model central banking system, then Scotland’s was its antithesis. From 1792 to 1845, Scotland had no central bank, allowed unrestricted competition in the business of note issue, and imposed almost no regulations on its banking firms. Yet the Scottish system was thought to be superior by nearly everyone who was aware of it. Its decline after 1845 was caused, not by any shortcoming, but in consequence of the unprovoked extension of Peel’s Act, which ended new entry into the note issue business in Scotland as well as England.

Pour la Suède :

From 1831 to 1902 Sweden also had a nearly unregulated free banking system (Jonung 1985). At the end of this period there were 26 note issuing private banks with a total of 157 branches. […] One measure of the success of the Swedish private note-issuing banks is that, throughout their existence, none failed even though the government had an explicit policy of not assisting private banks in financial trouble. […] Still, despite its success, Swedish free banking was dismantled in stages beginning in 1901 when the government, resenting the loss of state revenue from reduced circulation of Riksbank notes, sought by means of regulations and offers of subsidies to restore to the Riksbank a monopoly of note issue. The private banks’ right to issue notes was formally abrogated in 1904.

Pour la Chine (lire aussi la note 7) :

Still another free-banking episode took place in Foochow, the capital of Fukien province, in mainland China. China went through numerous, disastrous experiences with reckless issues of government paper money, starting as early as the 9th century. At last the Ch’ing dynasty (1644-1911) decided to let note issue be an exclusively private undertaking, except for two brief, unsuccessful government issues during the 1650s and 1850s. In Foochow (and also in some other cities) local banks prospered under the Manchus, issuing paper notes redeemable (usually on demand) in copper cash and free from all government regulation. […]

The downfall of free banking in Foochow following the Republican revolution of 1911 was caused by the new central government’s restrictive regulations. These favored several very large, non-local or “modern style” banks which had given financial support to the revolutionaries. The Nationalists, when they gained power in 1927, were especially beholden to the modern banks (which issued silver-based monies) and favored them by prohibiting the issue of copper notes. At last, in 1935, the Nationalist government made notes of the three largest modern banks legal tender. The government eventually intended to give its greatest financial benefactor, the Central Bank of China, a monopoly of note issue. But its program was interrupted by the Japanese invasion of 1937, which caused it to concentrate on maximizing revenues from increased issues of legal tender. The consequence was yet another instance of paper money issued by the Chinese government becoming absolutely worthless.

Pour la France (lire également la note 8) :

In France merchants’ attempts to establish banking on a sound, competitive basis were repeatedly frustrated by the government’s desire to borrow money that it could not, or would not, repay. The spectacular failure of John Law’s Banque Royale in 1721, which had become a government bank three years before, prevented for half a century the establishment of any new bank of issue. In 1776 a new bank, the Caisse d’Escompte, was established to engage in commercial lending, but soon became involved in large loans to the state that caused it to suffer a liquidity crisis. The bank appealed to the Treasury to repay its most recent loan, but instead the government authorized a suspension of specie payments. The bank remained solvent, however, and when the government loan was repaid it resumed specie payments. After this, repeated forced loans to the state so entwined the bank with the government that it became, in effect, a branch of the Treasury. Its notes were made redeemable in Treasury assignats, which were made legal tender in 1790. The government soon sank into bankruptcy under a torrent of assignats, dragging the Caisse d’Escompte down with it.

Renewed attempts to establish banks of issue in the 1790s were defeated by Napoleon, who reacted to private banks’ refusal to discount government paper by establishing a rival institution, the Bank of France, in which he was also a shareholder. Support for the new bank, at first unimpressive, improved when one of the private banks decided to consolidate with it. Nonetheless Napoleon remained dissatisfied, and in 1803 he passed a law giving the Bank of France the exclusive privilege of issuing bank notes at Paris and forbidding the establishment of banks in other regions without official approval. This forced the Bank of France’s principal rival, the second Caisse d’Escompte, into merger with it. Finally, in 1806, the Bank of France was placed under formal government control, and in 1808 it was given an exclusive right of note issue in every town in which it established branches.

Pour l’Espagne :

Unlike France, Spain had a relatively liberal banking policy in the years just prior to 1873. It had many note-issuing banks, most of which were monopolies solely in their province of establishment. The exception was the Bank of Spain which, although begun as a financially conservative enterprise, became involved in large-scale loans to the government that eventually made it fiscal agent to the state. In return for this it was eventually given exclusive rights to interprovincial branching. Then, in 1874, six years after the overthrow of the Bourbon monarchy, in return for a loan of 125 million pesetas the new republican government gave the Bank a monopoly of note issue. The government also offered generous concessions to other banks in return for their becoming branches of the Bank of Spain. Most of the smaller banks accepted.

Pour l’Italie :

During the first decades of its independence, Italy, too, had a plurality of note-issuing banks. But the risorgimento left the new state with an immense debt, in which several of the banks, and the National Bank of the Kingdom in particular, were involved. As an alternative to retrenchment the Italian government sought further help from the note-issuing banks. It secured this help by allowing the notes of the Bank of the Kingdom issued in connection with loans to the state to pass as inconvertible (forced) currency, while at the same time awarding limited legal tender status to the notes of other issuing banks. This arrangement continued until 1874, when all Italian banks were placed on an equal footing, in that all were allowed to participate in the issue of irredeemable paper for the purpose of monetizing the national debt. This reform also prohibited further entry into the business of note issue. In consequence of these reforms the Italian money supply became extremely unstable. Its growth followed the growth of government expenditures. In 1883 gold convertibility was officially restored, but lack of strict enforcement, including severe limitations placed on the exchange of bank notes and settlement of clearings between competing banks, caused the system to remain in a state of de facto inconvertibility. Ten years later, a scandal erupted when several banks made unauthorized issues of legal tender notes. This gave rise to reforms leading to the establishment of the Bank of Italy, which had a monopoly of note issue conferred upon it in 1926.

Pour le Canada (lire aussi la note 14) :

During the 19th century Canada had a much more liberal banking policy than the US, and its banking system performed much better than the US banking system of the same era. Canadian laws allowed plural note issue, permitted branch banking, and encouraged the growth of an elaborate clearing system. After 1841 the only serious restrictions on banking freedom had to do with capital and note issue. To receive a charter and limited-liability status a bank had to have $500,000 (Canadian) or more of paid-in capital soon after opening. Note issue was limited to the amount of this paid-in capital, but this restriction had no effect until the severe currency drain of 1907. In 1908 the law was changed to allow an emergency circulation exceeding capital by 15 percent during crop moving season. The government also monopolized the issue of notes under five dollars, but government note issues were restricted by a 100 percent marginal reserve requirement modeled after Peel’s Act. For this reason government note issue did not become a source of inflation until World War I, when Canada joined Britain and the other Dominion nations in going off the gold standard. It was then that the government allowed, even pressured, the chartered banks to suspend payment, which they did. Meanwhile government (Dominion) notes were made legal tender and issued in large denominations to encourage their use for the settlement of clearings among the chartered banks. Since neither the government nor the banks were paying out gold, this was in effect a fiat-money central banking system, with the Treasury acting as the issuer of high-powered money. Though the war ended, the government did not retire the large Dominion notes, nor did it abolish the legal tender laws which made them high-powered money, and so the Treasury retained its power to manipulate the money supply.

Although Canada returned to the gold standard in the 1920s, it went off it again (once more in sympathy with Britain) in 1931. Canadian monetary experts soon became disenchanted with the “half-way house” measures affecting note issue, in which the Treasury was able to manipulate the money supply like a central bank but was not guided by any set policy. This fact, together with the desire of the government to escape permanently from the confines of private finance, led to demands for the creation of a true central bank. To satisfy these demands the Bank of Canada was established in 1935. It secured a monopoly in note issue shortly thereafter.

The U.S. Experience

On donne souvent l’exemple du système bancaire américain comme une preuve de l’échec de la banque libre. Selgin rappelle que ce système n’a jamais été réellement libre. Ou du moins, l’autonomie n’a pas été poussée jusqu’au bout; les réglementations ayant fragilisé les banques, les rendant dépendantes, et les poussant même à la spéculation.
D’abord, si l’émission monétaire était plus ou moins autorisée, les banques devaient pour ce faire acheter des obligations d’État. Concrètement, une banque désireuse de délivrer 90 dollars en billets devait en premier lieu acheter pour 100 dollars (valeur nominale) d’obligations d’État afin d’y être déposées auprès du contrôleur de l’État en échange de devises certifiés. En théorie, ce système de “bond-deposit” visait à garantir la sécurité des détenteurs de billets. Ça aurait peut-être pu se faire si les obligations “exigées” étaient plus liquides que les autres types d’actifs dans lesquels les banques auraient investi dans d’autres circonstances. Mais dans le cas présent, il s’est avéré que la seule, l’unique activité des banques fut de spéculer sur les obligations risquées, particulièrement sur les obligations d’État fortement décôtées : toute augmentation de la valeur de marché des obligations achetées représente un gain net pour le banquier, et toute baisse représentant une perte. Les billets obtenus servaient à financer d’autres tours de spéculation sur le même schéma.
Lorsque l’offre de ces titres obligataires a diminué, sa valeur de marché a augmenté, et les banques ont eu des difficultés à obtenir ces garanties collatérales nécessaires à l’émission monétaire.

The notes were then used to finance further rounds of bond speculation, with any increase in the market value of purchased bonds (which remained the property of their buyers) representing, along with interest earnings, a clear gain to the bankers. The infamous “wildcat” banks were mainly of this species, most of their issues being used to monetize state and local government debt.

Le défaut de ce système c’est d’avoir lié le potentiel de croissance de l’offre de billets à la valeur de la dette gouvernementale. Ce problème devenait encore plus évident avec l’imminence de la guerre civile et le fardeau financier qu’elle allait apporter. C’est alors que le gouvernement décide d’étendre le système à l’échelle nationale, créant par la suite le National Banking System, par lequel l’offre de billets fluctue en fonction du marché de la dette fédérale. Mais ce nouveau système montrait là toute son incompatibilité avec la “stabilité monétaire” établie dans les années qui suivirent 1865, année durant laquelle une loi imposa une taxe de 10 pour cent sur les billets de banques. (*)

After 1882, when surpluses began to be used to contract the federal debt, the system’s shortcomings were magnified: as the supply of federal securities declined, their market values increased. The national banks found it increasingly difficult and costly to acquire the collateral needed for note issue.

Ce qu’il s’est passé ensuite paraît évident : il y a eu pénurie de billets. Cela signifie que les augmentations cycliques dans la demande de billets par rapport à la demande totale de monnaie interne n’ont pu être satisfaites, si ce n’est en puisant dans ses réserves, asséchant le stock de monnaie de base. (voir chapitre 8 pour plus de détails)
Ces fuites de réserves ont ouvert la voie à toute une série de paniques bancaires : 1873, 1884, 1893 et 1907. Ces crises sont survenues durant la saison des récoltes, plus précisément en Octobre, lorsque les habituels retraits massifs de billets devaient servir à financer le transport des cultures. Tout le monde connaît la suite de l’histoire. Ces événements malencontreux ont servi de motif à la création de la Fed.

(*) “The Case for Free Banking: Then and Now” explique grosso modo la même chose, avec quelques détails supplémentaires.

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