Money and Banking (a short historical survey)

     For a short view of banks and money the city to visit is Amsterdam. It is associated with one or two of the great developments in their history.      In 1609, money – hard, coined money – was abundant in Amsterdam. But the problem was that most money was the coins of poor quality (after sweating and clipping). This problem worried the merchants of Amsterdam very much.. They created a bank owned by the city; the bank solved the problem of the coins by going back to the system that predated the invention of coinage. That was weighing. A merchant brought his coins to the bank, the bank weighed them, and the weight of the pure metal was then credited to his account. This deposit was a highly reliable form of money. A merchant could transfer it to the account of another merchant. The recipient knew that he was getting honest weight. Payments through

the bank commanded a premium.

Then came the second Amsterdam discovery. The deposits so created did not need to be left in the bank. They could be lent. The bank then got interest. The borrower then had a deposit that could be spent. But the original deposit still stood to the credit of the original depositor. That too could be spent. Money, spendable money had been created. But every monetary innovation or reform carried the seeds of some new abuse. So it was here. One of the important borrowers from the Bank was the Dutch East India Company. The members of the company were often the same men who ran the Bank. In the eighteen century the East India Company fell in hard times: there was war with England. Ships did not come back. It was slow pay at first, and then its loans went into default. As a result, suspicion spread among the original depositors, the weakness of this monetary innovation was affirmed: the depositors started coming, and they couldn’t be paid (couldn’t take money out of their bank accounts/withdraw their deposits from their bank accounts)

On the continent, John Law developed an idea for a new kind of bank the deposits of which would be secured by land rather than by silver or gold. In Paris in 1716, he got permission from the Regent to set up a bank, the Banque Royale. In 1717, Law organized the Company of the West, later the Mississippi Company. It became an absolute owner of all lands north from the Gulf of Mexico and east from the Rockies. Gold and silver were said to be in unlimited supply there. Maps of the period showed the mines, although no one has seen them since. The nonexistent metal in the

imaginary mines was the backing for the notes. Parisians, hearing of these conceptual riches, rushed to buy the stock of the Company of the West. The trading of stock boomed. By 1719, the boom had become wild speculation. The price of the stock went up, sometimes by the hour. Law's notes went out by the hundreds of millions. Government creditors who were paid off in the notes then rushed to buy stock in the Banque Royale or in the Mississippi Company. It was a complete closed-circle system for recycling worthless paper. In consequence, all involved were getting rich – on or in paper. It is to that year that we owe the useful French word "millionaire". In 1719, John Law was the most famous man in all France.

There was no way but go down, and presently this became evident. Doubts began to develop about the notes. So people started bringing them to the Banque Royale for the silver and gold that were still in Louisiana, and also not there. The Banque Royale went off the gold and silver standard. And, in a further, rather severe step, ownership of precious metals except in small quantities was made a crime. But nothing could disguise the elementary fact that the Banque Royale could not pay, that the notes were now worthless. Like the deposits in Amsterdam, Law's notes were money created by a bank. Issued in excess, the notes clearly were a disaster.

Another city to visit for a view of banks and money is London, The Bank of England was formed in 1694. Its founders subscribed the money the King needed. In return, they were given the right to make loans to others with newly issued notes backed by the King's promise to pay. The Bank regulated the creation of money by smaller banks. Placing limits on lending and consequent deposit expansion and note issue, it provided the restraint of money supply that, in its absence, had brought misfortune in Amsterdam and disaster in Paris.

In London in the eighteenth century the goldsmiths made loans in notes against the holdings of gold and silver coin. The Bank of England, when it received these notes, returned them for collection in gold and silver. This required the banks to maintain reasonable reserves of cash against their note issues. They could not be reckless in the issue of notes as was Law. Later the Bank acquired for itself a monopoly of note issue, first in

London then through out the country.

The commercial banks could still lend the funds of the depositors. This would mean money for those who borrowed. And this money creation could be carried to excess. That is why the Bank of England developed a method for preventing this. When the ordinary or common banks seemed too generous with their loans, the Bank allowed some of their loans to run out or it sold some of the securities it held. In repaying these loans or paying for their securities, customers of the commercial banks would transfer gold and silver from the vaults of the ordinary banks to the Bank of England. The reserves in gold and silver of the commercial banks, the protection in case depositors came for their money, would thus be depleted. Their lending and money-creation would then have to be curtailed. The commercial banks could replace their depleted reserves by borrowing from the Bank of England. But that could be restrained by raising the rate of interest. This charge by the Bank of England came to be called the Bank Rate, a mysterious and wonderful thing at that time. In the United Slates the Bank Rate is the rediscount rate or, nowadays, the discount rate. Such were the regulatory functions as developed by the Bank of England.

The Bank of England, we have seen, disciplined its subordinate banks by presenting their notes systematically for collection in silver or gold. Thus it required them to keep their loans and resulting deposits in some

reasonable safe relationship to their hard cash.

Sources: 1) www.en.wikipedia.org/

2) adapted from “The Age of Uncertainty”

by J. K. Galbright     

HISTORICAL NOTES

• The word “bank” comes from Old Italian banca (Middle French = banque) which meant bench. Benches were used as desks or exchange counters during the Renaissance by Florentine bankers.

• The Dutch East India Company was established in 1602 to carry   out colonial activities in Asia. It was the first multinational corporation in the world, the first company to issue stock, The company was dissolved when it became scandalously corrupt and nearly insolvent in the late 18th century.

• War with England - the rivalry between the two trading countries led to four wars that are known in English as the Anglo-Dutch wars. Trade conflicts and naval supremacy were at stake in these wars.

• The Regent – the Regency is the period in French history between 1715 and 1723, when King Louis XV was a minor (несовершеннолетний) and the land was governed by a Regent, Philippe d'Orléans, the nephew of Louis XIV of France.

• The Mississippi Company (of 1648) was bought by John Law and became a joint stock trading company. It was granted a trade monopoly of the West Indies and North America by the French   government.