ON CURRENCY AND BANKS.
It is not my intention to detain the reader by any long dissertation on
the subject of money. So much has already been written on currency, that
of those who give their attention to such subjects, none but the
prejudiced are ignorant of its true principles. I shall therefore take
only a brief survey of some of the general laws which regulate its
quantity and value.
Gold and silver, like all other commodities, are valuable only in
proportion to the quantity of labour necessary to produce them, and
bring them to market. Gold is about fifteen times dearer than silver,
not because there is a greater demand for it, nor because the supply of
silver is fifteen times greater than that of gold, but solely because
fifteen times the quantity of labour is necessary to procure a given
quantity of it.
The quantity of money that can be employed in a country must depend on
its value: if gold alone were employed for the circulation of
commodities, a quantity would be required, one fifteenth only of what
would be necessary, if silver were made use of for the same purpose.
A circulation can never be so abundant as to overflow; for by
diminishing its value, in the same proportion you will increase its
quantity, and by increasing its value, diminish its quantity.[45]
While the state coins money, and charges no seignorage, money will be
of the same value as any other piece of the same metal of equal weight
and fineness; but if the state charges a seignorage for coinage, the
coined piece of money will generally exceed the value of the uncoined
piece of metal by the whole seignorage charged, because it will require
a greater quantity of labour, or, which is the same thing, the value of
the produce of a greater quantity of labour, to procure it.
While the state alone coins, there can be no limit to this charge of
seignorage; for by limiting the quantity of coin, it can be raised to
any conceivable value.
It is on this principle that paper money circulates: the whole charge
for paper money may be considered as seignorage. Though it has no
intrinsic value, yet, by limiting its quantity, its value in exchange is
as great as an equal denomination of coin, or of bullion in that coin.
On the same principle too, namely, by a limitation of its quantity, a
debased coin would circulate at the value it should bear, if it were of
the legal weight and fineness, not at the value of the quantity of metal
which it actually contained. In the history of the British coinage, we
find accordingly that the currency was never depreciated in the same
proportion that it was debased; the reason of which was, that it never
was multiplied in proportion to its diminished value.[46]
After the establishment of banks, the state has not the sole power of
coining or issuing money. The currency may as effectually be increased
by paper as by coin; so that if a state were to debase its money, and
limit its quantity, it could not support its value, because the banks
would have an equal power of adding to the whole quantity of
circulation.
On these principles it will be seen, that it is not necessary that paper
money should be payable in specie to secure its value; it is only
necessary that its quantity should be regulated according to the value
of the metal which is declared to be the standard. If the standard were
gold of a given weight and fineness, paper might be increased with every
fall in the value of gold, or, which is the same thing in its effects,
with every rise in the price of goods.
"By issuing too great a quantity of paper," says Dr. Smith, "of which
the excess was continually returning, in order to be exchanged for gold
and silver, the Bank of England was, for many years together, obliged to
coin gold to the extent of between eight hundred thousand pounds and a
million a year, or at an average, about eight hundred and fifty thousand
pounds. For this great coinage the Bank, in consequence of the worn and
degraded state into which the gold coin had fallen a few years ago, was
frequently obliged to purchase bullion, at the high price of four pounds
an ounce, which it soon after issued in coin at 3_l._ 17_s._ 10-1/2_d._
an ounce, losing in this manner between two and a half and three per
cent. upon the coinage of so very large a sum. Though the Bank therefore
paid no seignorage, though the Government was properly at the expense of
the coinage, this liberality of Government did not prevent altogether
the expense of the Bank."
On the principle above stated, it appears to me most clear, that by not
re-issuing the paper thus brought in, the value of the whole currency,
of the degraded as well as the new gold coin, would have been raised;
when all demands on the Bank would have ceased.
Mr. Buchanan, however, is not of this opinion, for he says, "that the
great expense to which the Bank was at this time exposed, was
occasioned, not, as Dr. Smith seems to imagine, by any imprudent issue
of paper, but by the debased state of the currency, and the consequent
high price of bullion. The Bank, it will be observed, having no other
way of procuring[47] guineas but by sending bullion to the mint to be
coined, was always forced to issue new coined guineas, in exchange for
its returned notes; and when the currency was generally deficient in
weight, and the price of bullion high in proportion, it became
profitable to draw these heavy guineas from the Bank in exchange for its
paper; to convert them into bullion, and to sell them with a profit for
bank paper, to be again returned to the Bank for a new supply of
guineas, which were again melted and sold. To this drain of specie, the
Bank must always be exposed while the currency is deficient in weight,
as both an easy and a certain profit then arises from the constant
interchange of paper for specie. It may be remarked, however, that to
whatever inconvenience and expense the Bank was then exposed by the
drain of its specie, it never was imagined necessary to rescind the
obligation to pay money for its notes."
Mr. Buchanan evidently thinks that the whole currency must, necessarily,
be brought down to the level of the value of the debased pieces; but
surely by a diminution of the quantity of the currency, the whole that
remains can be elevated to the value of the best pieces.
Dr. Smith appears to have forgotten his own principle, in his argument
on colony currency. Instead of ascribing the depreciation of that paper
to its too great abundance, he asks whether, allowing the colony
security to be perfectly good, a hundred pounds, payable fifteen years
hence, would be equally valuable with a hundred pounds to be paid
immediately? I answer yes, if it be not too abundant.
Experience however shews, that neither a state nor a bank ever have had
the unrestricted power of issuing paper money, without abusing that
power: in all states, therefore, the issue of paper money ought to be
under some check and control; and none seems so proper for that purpose,
as that of subjecting the issuers of paper money to the obligation of
paying their notes, either in gold coin or bullion.
A currency is in its most perfect state when it consists wholly of paper
money, but of paper money of an equal value with the gold which it
professes to represent. The use of paper instead of gold substitutes the
cheapest in place of the most expensive medium, and enables the country,
without loss to any individual, to exchange all the gold which it before
used for this purpose, for raw materials, utensils, and food, by the use
of which both its wealth and its enjoyments are increased.
In a national point of view it is of no importance whether the issuers
of this well regulated paper money, be the government or a bank, it will
on the whole be equally productive of riches, whether it be issued by
one or by the other; but it is not so with respect to the interest of
individuals. In a country where the market rate of interest is 7 per
cent., and where the state requires for a particular expense 70,000_l._
per annum, it is a question of importance to the individuals of that
country, whether they must be taxed to pay this 70,000_l._ per annum, or
whether they could raise it without taxes. Suppose that a million of
money should be required to fit out an expedition. If the state issued a
million of paper, and displaced a million of coin, the expedition would
be fitted out without any charge to the people; but if a bank issued a
million of paper, and lent it to Government at 7 per cent., thereby
displacing a million of coin, the country would be charged with a
continual tax of 70,000_l._ per annum: the people would pay the tax, the
bank would receive it, and the society would in either case be as
wealthy as before; the expedition would have been really fitted out by
the improvement of our system, by rendering capital, of the value of a
million, productive in the form of commodities, instead of letting it
remain unproductive in the form of coin; but the advantage would always
be in favour of the issuers of paper; and as the state represents the
people, the people would have saved the tax, if they, and not the bank,
had issued this million.
I have already observed, that if there were perfect security that the
power of issuing paper money would not be abused, it would be of no
importance with respect to the riches of the country collectively, by
whom it was issued; and I have now shewn that the public would have a
direct interest that the issuers should be the state, and not a company
of merchants or bankers. The danger, however, is, that this power would
be more likely to be abused, if in the hands of Government, than if in
the hands of a banking company. A company would, it is said, be more
under the control of law, and although it might be their interest to
extend their issues beyond the bounds of discretion, they would be
limited and checked by the power which individuals would have of calling
for bullion or specie. It is argued that the same check would not be
long respected, if Government had the privilege of issuing money; that
they would be too apt to consider present convenience, rather than
future security, and might, therefore, on the alleged grounds of
expediency, be too much inclined to remove the checks, by which the
amount of their issues was controlled.
Under an arbitrary government this objection would have great force, but
in a free country, with an enlightened legislature, the power of issuing
paper money, under the requisite checks of convertibility at the will of
the holder, might be safely lodged in the hands of commissioners
appointed for that special purpose, and they might be made totally
independent of the control of ministers.
The sinking fund is managed by commissioners, responsible only to
parliament, and the investment of the money entrusted to their charge,
proceeds with the utmost regularity; what reason can there be to doubt
that the issues of paper money might be regulated with equal fidelity,
if placed under similar management?
It may be said, that although the advantage accruing to the state, and,
therefore, to the public, from issuing paper money, is sufficiently
manifest, as it would exchange a portion of the national debt, on which
interest is paid by the public, into a debt bearing no interest, yet it
would be disadvantageous to commerce, as it would preclude the
merchants from borrowing money, and getting their bills discounted, the
method in which bank paper is partly issued.
This, however, is to suppose that money could not be borrowed, if the
Bank did not lend it, and that the market rate of interest and profit
depends on the amounts of the issues of money, and on the channel
through which it is issued. But as a country would have no deficiency of
cloth, of wine, or any other commodity, if they had the means of paying
for it, in the same manner neither would there be any deficiency of
money to be lent, if the borrowers offered good security, and were
willing to pay the market rate of interest for it.
In another part of this work, I have endeavoured to shew, that the real
value of a commodity is regulated, not by the accidental advantages
which may be enjoyed by some of its producers, but by the real
difficulties encountered by that producer who is least favoured. It is
so with respect to the interest for money; it is not regulated by the
rate at which the Bank will lend, whether it be 5, 4, or 3 per cent.,
but by the rate of profits, which can be made by the employment of
capital, and which is totally independent of the quantity, or of the
value of money. Whether a bank lent one million, ten millions, or a
hundred millions, they would not permanently alter the market rate of
interest; they would alter only the value of the money which they thus
issued. In one case 10 or 20 times more money might be required to carry
on the same business, than what might be required in the other. The
applications to the Bank for money, then, depend on the comparison
between the rate of profits that may be made by the employment of it,
and the rate at which they are willing to lend it. If they charge less
than the market rate of interest, there is no amount of money which they
might not lend,--if they charge more than that rate, none but
spendthrifts and prodigals would be found to borrow of them. We
accordingly find, that when the market rate of interest exceeds the rate
of 5 per cent. at which the Bank uniformly lend, the discount office is
besieged with applicants for money; and, on the contrary, when the
market rate is even temporarily under 5 per cent. the clerks of that
office have no employment.
The reason then why for the last twenty years, the Bank is said to have
given so much aid to commerce, by assisting the merchants with money,
is, because they have, during that whole period, lent money below the
market rate of interest; below that rate at which the merchants could
have borrowed elsewhere; but I confess that to me this seems rather an
objection to their establishment, than an argument in favour of it.
What should we say of an establishment which should regularly supply
half the clothiers with their wool under the market price? Of what
benefit would it be to the community? It would not extend our trade,
because the wool would equally have been bought, if they had charged the
market price for it. It would not lower the price of cloth to the
consumer, because the price, as I have said before, would be regulated
by the cost of its production to those who were the least favoured. Its
sole effect then, would be to swell the profits of a part of the
clothiers beyond the general and common rate of profits. The
establishment would be deprived of its fair profits, and another part of
the community would be in the same degree benefited. Now this is
precisely the effect of our banking establishments; a rate of interest
is fixed by the law below that at which it can be borrowed in the
market, and at this rate the Bank are required to lend, or not to lend
at all. From the nature of their establishment, they have large funds
which they can only dispose of in this way; and a part of the traders of
the country are unfairly, and for the country unprofitably, benefited by
being enabled to supply themselves with an instrument of trade, at a
less charge than those who must be influenced only by market price.
The whole business, which the whole community can carry on, depends on
the quantity of capital, that is, of its raw material, machinery, food,
vessels, &c., employed in production. After a well regulated paper money
is established, these can neither be increased nor diminished by the
operations of banking. If then the state were to issue the paper money
of the country, although it should never discount a bill, or lend one
shilling to the public, there would be no alteration in the amount of
trade; for we should have the same quantity of raw materials, of
machinery, food, and ships; and it is probable too, that the same amount
of money might be lent, not at 5 per cent. indeed, a rate fixed by law,
but at 6, 7, or 8 per cent., the result of the fair competition in the
market between the lenders and the borrowers.
Adam Smith speaks of the advantages derived by merchants from the
superiority of the Scotch mode of affording accommodation to trade, over
the English mode, by means of cash accounts. These cash accounts are
credits given by the Scotch banker to his customers, in addition to the
bills which he discounts for them; but as the banker, in proportion as
he advances money, and sends it into circulation in one way, is debarred
from issuing so much in the other, it is difficult to perceive in what
the advantage consists. If the whole circulation will bear only one
million of paper, one million only will be circulated; and it can be of
no real importance either to the Banker or merchant, whether the whole
be issued in discounting bills, or a part be so issued, and the
remainder be issued by means of these cash accounts.
It may perhaps be necessary to say a few words on the subject of the two
metals, gold and silver, which are employed in currency, particularly as
this question appears to perplex, in many people's minds, the plain and
simple principles of currency. "In England," says Dr. Smith, "gold was
not considered as a legal tender for a long time after it was coined
into money. The proportion between the values of gold and silver money
was not fixed by any public law or proclamation; but was left to be
settled by the market. If a debtor offered payment in gold, the creditor
might either reject such payment altogether, or accept of it at such a
valuation of the gold, as he and his debtor could agree upon."
In this state of things it is evident that a guinea might sometimes
pass for 22_s._ or more, and sometimes for 18_s._ or less, depending
entirely on the alteration in the relative market value of gold and
silver. All the variations too in the value of gold, as well as in the
value of silver, would be rated in the gold coin,--it would appear as if
silver was invariable, and that gold only was subject to rise or fall.
Thus, although a guinea passed for 22_s._ instead of 18_s._ gold might
not have varied in value, the variation might have been wholly confined
to the silver, and therefore 22_s._ might have been of no more value
than 18_s._ were before. And on the contrary, the whole variation might
have been in the gold: a guinea, which was worth 18_s._ might have risen
to the value of 22_s._
If now we suppose this silver currency to be debased by clipping, and
also increased in quantity, a guinea might pass for 30_s._; for the
silver in 30_s._ of such debased money might be of no more value than
the gold in one guinea. By restoring the silver currency to its mint
value, silver money would rise; but it would appear as if gold fell, for
a guinea would probably be of no more value than 21 of such good
shillings.
If now gold be also made a legal tender, and every debtor be at liberty
to discharge a debt by the payment of 420 shillings, or twenty guineas,
for every 21_l._ that he owes, he will pay in one or the other according
as he can most cheaply discharge his debt. If with five quarters of
wheat he can procure as much gold bullion as the mint will coin into
twenty guineas, and for the same wheat as much silver bullion as the
mint will coin for him into 430 shillings, he will prefer paying in
silver, because he would be a gainer of ten shillings by so paying his
debt. But if on the contrary he could obtain with this wheat as much
gold as would be coined into twenty guineas and a half, and as much
silver only as would coin into 420 shillings, he would naturally prefer
paying his debt in gold. If the quantity of gold which he could procure
could be coined only into twenty guineas, and the quantity of silver
into 420 shillings, it would be a matter of perfect indifference to him
in which money, silver or gold, it was that he paid his debt. It is not
then a matter of chance; it is not because gold is better fitted for
carrying on the circulation of a rich country, that gold is ever
preferred for the purpose of paying debts; but simply because it is the
interest of the debtor so to pay them.
During a long period previous to 1797, the year of the restriction on
the Bank payments in coin, gold was so cheap, compared with silver, that
it suited the Bank of England, and all other debtors, to purchase gold
in the market, and not silver, for the purpose of carrying it to the
mint to be coined, as they could in that coined metal more cheaply
discharge their debts. The silver currency was during a great part of
this period very much debased, but it existed in a degree of scarcity,
and therefore on the principle which I have before explained, it never
sunk in its current value. Though so debased, it was still the interest
of debtors to pay in the gold coin. If indeed the quantity of this
debased silver coin had been enormously great, or if the mint had issued
such debased pieces, it might have been the interest of debtors to pay
in this debased money; but its quantity was limited and it sustained its
value, and therefore gold was in practice the real standard of
currency.
That it was so, is no where denied; but it has been contended that it
was made so by the law which declared that silver should not be a legal
tender for any debt exceeding 25_l._, unless by weight, according to the
mint standard.
But this law did not prevent any debtor from paying any debt, however
large its amount, in silver currency fresh from the mint; that the
debtor did not pay in this metal, was not a matter of chance, nor a
matter of compulsion, but wholly the effect of choice; it did not suit
him to take silver to the mint, it did suit him to take gold thither. It
is probable that if the quantity of this debased silver in circulation
had been enormously great, and also a legal tender, that a guinea would
have been again worth thirty shillings; but it would have been the
debased shilling that would have fallen in value, and not the guinea
that had risen.
It appears then, that whilst each of the two metals was equally a legal
tender for debts of any amount, we were subject to a constant change in
the principal standard measure of value. It would sometimes be gold,
sometimes silver, depending entirely on the variations in the relative
value of the two metals, and at such times the metal, which was not the
standard, would be melted, and withdrawn from circulation, as its value
would be greater in bullion than in coin. This was an inconvenience
which it was highly desirable should be remedied, but so slow is the
progress of improvement, that although it had been unanswerably
demonstrated by Mr. Locke, and had been noticed by all writers on the
subject of money since his day, a better system was never adopted till
the last session of Parliament, when it was enacted that gold only
should be a legal tender for any sum exceeding forty-two shillings.
Dr. Smith does not appear to have been quite aware of the effect of
employing two metals as currency, and both a legal tender for debts of
any amount; for he says that "in reality, during the continuance of any
one regulated proportion between the respective values of the different
metals in coin, the value of the most precious metal regulates the value
of the whole coin." Because gold was in his day the medium in which it
suited debtors to pay their debts, he thought that it had some inherent
quality by which it did then, and always would regulate the value of
silver coin.
On the reformation of the gold coin in 1774 a new guinea fresh from the
mint would exchange for only twenty-one debased shillings; but in the
reign of King William, when the silver coin was in precisely the same
condition, a guinea also new and fresh from the mint would exchange for
thirty shillings. On this Mr. Buchanan observes, "here, then, is a most
singular fact, of which the common theories of currency offer no
account; the guinea exchanging at one time for thirty shillings, its
intrinsic worth in a debased silver currency, and afterwards the same
guinea exchanged for only twenty-one of those debased shillings. It is
clear that some great change must have intervened in the state of the
currency between these two different periods, of which Dr. Smith's
hypothesis offers no explanation."
It appears to me, that the difficulty may be very simply solved, by
referring this different state of the value of the guinea at the two
periods mentioned, to the different _quantities_ of debased silver
currency in circulation. In King William's reign gold was not a legal
tender, it passed only at a conventional value. All the large payments
were probably made in silver, particularly as paper currency, and the
operations of banking, were then little understood. The quantity of this
debased silver money exceeded the quantity of silver money, which would
have been maintained in circulation, if nothing but undebased money had
been in use; and consequently it was depreciated as well as debased. But
in the succeeding period when gold was a legal tender, when bank-notes
also were used in effecting payments, the quantity of debased silver
money did not exceed the quantity of silver coin fresh from the mint,
which would have circulated if there had been no debased silver money;
hence though the money was debased, it was not depreciated. Mr.
Buchanan's explanation is somewhat different, he thinks that a
subsidiary currency is not liable to depreciation, but that the main
currency is. In King William's reign silver was the main currency, and
hence was liable to depreciation. In 1774 it was a subsidiary currency,
and therefore maintained its value. Depreciation, however, does not
depend on a currency being the subsidiary or the main currency, it
depends wholly on its being in excess of quantity.
To a moderate seignorage on the coinage of money there cannot be much
objection, particularly on that currency which is to effect the smaller
payments. Money is generally enhanced in value to the full amount of the
seignorage, and therefore it is a tax which in no way affects those who
pay it, while the quantity of money is not in excess. It must, however,
be remarked, that in a country where a paper currency is established,
although the issuers of such paper should be liable to pay it in specie
on the demand of the holder, still, both their notes and the coin might
be depreciated to the full amount of the seignorage on that coin, which
is alone the legal tender, before the check, which limits the
circulation of paper, would operate. If the seignorage on gold coin were
5 per cent., for instance, the currency, by an abundant issue of
bank-notes, might be really depreciated 5 per cent. before it would be
the interest of the holders to demand coin for the purpose of melting it
into bullion; a depreciation to which we should never be exposed, if
either there was no seignorage on the gold coin; or, if a seignorage
were allowed, the holders of bank-notes might demand bullion, and not
coin, in exchange for them, at the mint price of 3_l._ 17_s._ 10-1/2_d._
Unless then the bank should be obliged to pay their notes in bullion or
coin, at the will of the holder, the late law which allows a seignorage
of 6 per cent., or four pence per oz., on the silver coin, but which
directs that gold shall be coined by the mint without any charge
whatever, is perhaps the most proper, as it will more effectually
prevent any unnecessary variation of the currency.[48]