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Chapter 4 (Read the Chapter 1, Chapter 2 and Chapter 3)
http://positivemoney.org/2015/07/bank-robbery-economists-banking-system-medieval-times-adam-smith/
1. From Medieval times to Adam Smith
Over the years, many economists have noticed how bank-created money
skews the economy, affecting distribution of power and wealth across
time and influencing what gets manufactured, built, destroyed. Their
observations – and often the economists too – have gone in and often out
again of what is ‘generally recognised and known’. This chapter and the
next will offer brief glimpses of how economists have noticed the
following facts – and how some have suggested reforms, so that money
might be created more equitably:
1. Bankers create more in ‘credit’ than they have in ‘cash’;
2. ‘Credit’ becomes money when it circulates in making payments;
3. When credit replaces cash, interest payments on the credit are effectively a ‘tax raised by the powerful on the productive’;
4. Large credit allocations by banks
increase the powers of government and concentrations of capital (i.e.
money intended for investment and speculation as opposed to spending).
5. Bank-credit feeds war, predatory nationalism and national debt.
6. Bank-credit allocates power in a way
destructive to the human and natural world: to the environment, freedom,
equality, and to other conditions that make human happiness a
widespread possibility.
For roughly two thousand years, from the days of Aristotle to the end
of the Middle Ages, economists (such as they existed) were not
scientists: first and foremost, they were moral philosophers. During the
Middle Ages they were employed by the Christian Church, which held a
great deal of worldly power. Sword-wielding bishops went into battle,
Popes led armies, papal territories grew and shrank: but mostly (and
more to the point) the Church’s authority relied on its assertion of a
moral order. The Church was made up of human beings so of course it was
open to the normal corruptions of greed, hypocrisy, ambition etcetera,
and in many respects its moral precepts differ from those we would live
by today. The authority of its pronouncements were backed up by a system
of Church Law capable of meting out punishment, and also by the threat
of damnation – which for many was a serious consideration.
In one of the great ironies of history, economists of the Christian
Church (the ‘Scholastics’) ignored Christ’s recommendation (in the
Parable of the Talents) that money SHOULD be lent at interest: in
keeping with more ancient Greek and Jewish traditions, they maintained
that taking interest (‘usury’) was sinful. Princes, merchants,
moneylenders and bankers found ways around these laws. Princes ignored
them. For investors, there were exemptions if the lender was to suffer
loss of some sort. As for bankers, they used falsified exchanged rates
and currency transactions to confuse the authorities.
At this point, it is worth emphasizing the differences between
moneylending and banking. Moneylending is the straightforward lending of
money already in existence. Banking creates new money, as claims on
money owned by the banker (nowadays we call these claims ‘credit’
although that word has actually a much wider meaning – as will be
explained later). In medieval times, moneylending was allowed by
Christian authorities to Jews under the authority of monarchs (who would
then habitually rob moneylenders of their accumulated wealth). Banking,
on the other hand, grew out of a practice (the Exchanges) which was
forbidden to Jews. It was ring-fenced not just by social and racial
prejudice, but also by the compulsory taking of Christian oaths. The
historical remnants of this separation linger today in the different
kinds of institution that call themselves ‘bank’. Commercial banks
(along with their governments) create money in a legally privileged and
protected procedure; ‘merchant banks’ lend it. The name ‘merchant bank’
is itself a misnomer, assumed by merchant moneylenders when the word
‘bank’ came to sound more respectable than the word ‘moneylender’. All
of which means that, looking at the present for a moment, extremist
agitators are being historically and conceptually illiterate (along with
whatever else) when they blame the systemic robbery of banking on ‘the
Jews’.
Preoccupied with their job of suppressing usury – the taking of interest – among Christians, Scholastic economists
‘paid scant attention to the operation of the economic system’
(de Roover). In other words, they did not fully analyse the process of
credit creation. Late Spanish Scholastics came closest to identifying
what was going on. Luis de Molina, (Tratado sobre los cambios, 1597)
recognised that bank-credit was in practice a way of making payment (and
therefore a form of money):
‘Though many transactions are conducted
in cash, most are carried out using documents which attest either that
the bank owes money to someone or that someone agrees to pay, and the
money stays in the bank.’[1]This comes close to the simple truth
stated publicly by the Venetian banker and Senator Tommaso Contarini in
1584, that a banker may create means of payment (money)
“by merely writing two lines in his books”.
Many economists today are in denial of this simple, long-established
truth, and insist that bankers are merely intermediaries between savers
and borrowers.
As medieval society diversified during the fifteenth, sixteenth and seventeenth centuries, from a society composed of
‘those who work, those who fight and those who pray’
to a more complex world centred on enterprise, trade and capital, so
people outside the Church began writing on economics: humanist
philosophers, public administrators, merchants and financiers. These
people, living in the practical worlds of administration and business,
were bound to notice that banks were creating lot of credit on rather
few assets.
Those practical economists are today known as ‘Mercantilists’.
Mercantilists disagreed with each other about most things, including the
desirability of banking, but they were agreed on one thing: a State
should maintain a healthy balance of trade in order to accumulate money
for emergencies such as wars, and also to avoid running out of
circulating coin. In an age when cash was gold-and-silver, bad decisions
by rulers could result in a kingdom being drained of coin. When there
was a shortage of coin, people had to resort to barter, improvised local
currencies – and to various forms of credit.
Money-creation by banks was a familiar fact. A sentence written in
the 1560’s (perhaps by Elizabeth I’s diplomat-financier Sir Thomas
Gresham) that bankers ‘
do greate feates having credit and yet be nothing worth’ was repeated almost word-for-word by the businessman Malynes in 1622: bankers
‘do great feats having credit and yet be nought worth’. Malynes went on to notice bank-credit rested on very little money.
‘What is this credit? – or, what are the payments of the Banks, but almost or rather altogether imaginative or figurative?’
He went on to explain in detail how payments are made in-bank, by
debiting and crediting from one account to another without involving the
transfer of hard cash, and how bankers quickly amass vast fortunes from
this practice:
‘without that any money is touched, but remaineth in
the bankers hands, which within a short time after the erection of the
Bank cometh to amount unto many millions.’
Malynes called banking the
‘Canker (cancer) of England’s Commonwealth’.
He listed some of the bad results of bank-created credit: it fuels
wars, it raises prices, allows bankers to engrosse (amass) commodities
and trade for their own benefit and to manipulate the exchanges for
their profit. A pro-banking opponent, Thomas Mun, replied (in another
pamphlet) that Malynes’ objections were mostly
‘all one matter in divers [different] forms’ and that every idiot knew them (
‘such froth also, that every Idiot knows them’).
Since anyone with good credit can borrow and do the same, Mun went on,
why pick on bankers? We see here the beginning of an argument that might
be had today – if the facts of banking were publicly and openly
acknowledged.
The Mercantilists were publishing their pamphlets around the time of
the birth of modern banking in seventeenth century England. It was a
time of wars: a Civil War at home, and wars with the Dutch abroad. For a
while (1649-60) England dispensed with kings and queens altogether and
found itself under a military dictator, Oliver Cromwell. Parliament sent
a deputation imploring him to take the Kingship because at least people
knew the limits of a King’s power: no one knew the limits of
Cromwell’s. Another ‘humble offering’ put to Cromwell was a proposal by
one ‘Samuel Lamb, merchant’ to set up a national bank. Cromwell’s
response is not known, but the proposal survives. A national bank, Lamb
said, was desirable for the same characteristics that foreign banks were
undesirable: to be able to monopolise and sell at a profit, to create
credit out of nothing, instead of having to pay for it; to finance war
by means of
‘imaginary money’; even, in what seems a very modern touch, to use bank-credit to purchase natural resources abroad to
‘save our own timber here until a time of need’. Fast-forward a few hundred years and we see Japan still heavily-forested, having stripped many Pacific Islands of their trees.
So banks, like weapons systems, were needed to counter foreign banks:
along with armies and navies, bank-credit was a weapon of predation.
For national self-defence,
‘what the neighbours have, we must have too’.
With the Mercantilists, the economics of nationalism were born, and
they are with us still. Later (1816) Thomas Jefferson would describe
banks as
‘more dangerous than standing armies’.
None of
these observers would be surprised to see, today, the peoples of
Mediterranean countries brought to their knees by predatory credit.
Before leaving the mercantilists, it’s worth mentioning an insight of
Josiah Child (1630-99). He chose to ignore the credit-creation aspect
of banking, but nevertheless warned of the destructive power of foreign
lending. It is sometimes forgotten how much wisdom was taken by
Christians from their Old Testament, the Jewish Bible. This observation
of Child’s rings true today and is worth quoting:
‘the Wisdom of God
Almighty did prohibit the Jews from lending upon Use one to another,
but allowed them to lend to Strangers for the Enriching of their own
(i.e. the Jewish) Nation and Improvement of their own Territory, and for
the Impoverishing of others, those to whom they were permitted to lend,
being such only whom they were commanded to destroy or at least to keep
Poor and Miserable, as the Gibeonites, etc., Hewers of Wood, and
Drawers of Water.’ Rich nations are today finding predatory credit as effective as war used to be, in the struggle to dominate and exploit.
The next character in economic history is an almost cartoon-style
foretaste of modern power. Sir William Petty is known as the founder of
modern statistical economics. Petty was a man of immense energy and
imagination, obsessed with mathematical calculations and schemes for the
general improvement of humanity, and he made an enormous fortune out of
what was perhaps the first modern genocide. By Petty’s own calculation,
504,000 people, more than a third of the people of Ireland,
‘perished
and were wasted by sword, plague, famine, hardship and banishment,
between the 23rd of October 1641, and the same day 1652’ – that is,
during Cromwell’s war of attrition and depredation in Ireland.[2] Petty
was on the spot: his job was surveying and allocating the newly-emptied
lands to Cromwell’s soldiers and ‘adventurers’ – people who had
invested in the ‘war’ to make a profit. Many of these people sold their
plots on cheap to Petty, not wanting to settle in a land far from home
where the few remaining natives hated them.[3]
With Petty, we emerge from economics as a branch of moral philosophy
into the economics of the modern world: control (and seizure) of
resources, maximised productivity and social engineering. Petty, at the
very outset of this development, expressed himself in an unusually
direct manner. The labouring class, being
‘licentious only to eat, or rather to drink,’
should be restricted in what they could consume. Surplus goods should
be put in storehouses rather than wasted in over-feeding the
‘vile and brutish part of mankind… and so indisposing them to their usual labour.’[4] Independence and freedom were for the higher orders; social management for the rest.
‘Supernumeraries’ – that is, humans not needed in Petty’s
system of maximised productivity – should be paid to do entirely useless
things like building pyramids: for
‘at worst this would keep their
minds to discipline and obedience, and their bodies to a patience of
more profitable labours when need shall require it’ (Keynes
repeated this suggestion in slightly different words in Book Three of
his 1936 General Theory). Maximization of productivity should be pursued
not to provide plenty for everyone, says Petty, but to increase the
wealth and strength of the nation. And once that is achieved, Petty asks
himself:
‘What then should we busy ourselves about? I answer, in ratiocinations upon the Works and Will of God.’[5] One wonders what sort of God was floating around in Petty’s mind.
Petty recognised that banking increased the money supply and he
recommended it for that reason. In a pamphlet titled Quantulumcunque he
asks himself:
‘What remedy is there, if we have too little money? –
We must erect a bank, which well computed, doth almost double the effect
of our coined money: and we have in England materials for a bank which
shall furnish stock enough to drive the trade of the whole Commercial
World.’ His ‘almost double’ was a low estimate, but his prediction
that English banking could ‘drive the trade of the whole commercial
world’ proved pretty much true. Three hundred years later, a banking
historian would write:
‘By 1914, the great loan-issuing houses could
not unjustly claim that it was largely by their efforts that Britain
held in fee not only the Gorgeous East, but the greater part of the rest
of the world as well.’[6]
Petty’s recommendation of banks included no assessment of how the new
money, its creation and allocation, might advantage some and
disadvantage others. His preoccupation was: will the new money be put to
productive use? (if so, good); or will it be frittered away in idle
consumption? (if so, bad). This way of thinking has come to dominate
economic thinking. A third possibility, not mentioned by Petty and often
ignored since, was that credit can be used in sheer speculation. This
potentiality would soon show its power in the Mississippi and South Sea
Bubbles (both of which burst in 1720).
Soon after Petty’s death (1687) came two developments, both central
to subsequent history and both remarked on in Chapter Three: the
establishment of the Bank of England (at that time a private bank) and
the Promissory Notes Act of 1704. The Bank of England (1694), according
to Thorold Rogers
‘put into circulation nearly 1.1 million of notes’ on
‘a reserve of less than £36,000 in cash’: i.e., it issued thirty times as much credit as it had cash to back it up.[7] It
‘invested nearly the whole of its funds in Government securities’
– i.e. in loans for war. Those who supplied the finance were making
large profits, and they were mostly of the ruling Whig party – so much
so that Bagehot and Holdsworth referred to it as a
‘Whig finance company’.[8]
The Bank of England came under repeated attacks from rival bankers
and political opponents. In 1696, when coin was scarce because of
re-coining, the Bank was almost driven under in a run organised by its
enemies. In 1705, there was a proposal to replace this private bank with
a public institution of National Credit, as explained in a pamphlet:
An Essay Upon the National Credit of England.
This remarkable proposal foreshadowed in many ways what Henry C.
Simons would propose more than three centuries later, during the Great
Depression. The idea was that the government should pay contractors and
suppliers with its own notes of credit, instead of borrowing expensively
from banks and private profiteers.[9] These credit notes would
circulate as money, on the security and surety of the assets and labour
of the English people – who would also be reaping the benefits.
‘It will certainly be an exact piece of justice,’ Broughton wrote,
‘to
make the credit of the public beneficial to the public, instead of its
being diverted into other methods for the benefit of private persons;
and that too, not without danger, as well as loss to the public.’
Here it is worth pointing out that our modern use of the word
‘credit’
is a narrow use of the word. ‘Credit’ is Latin for ‘believes’. Today,
‘credit’ means the belief of customers that a bank will pay out, on
demand, some of its own money either to themselves or to a third party.
In its wider meaning, ‘credit’ means any money that has value only
because others believe in it. Paper notes and figures in a bank account
are credit-money: without general credibility they are worthless. Gold
coin is not ‘credit’ because it can be melted down and sold if it’s no
longer wanted as money. Credit is money in its purest form: no more (nor
less) than the ability to purchase what is offered for sale.
How credit is created must be one of the most important factors in any economic system.
Broughton points out some differences in outcome between his National
Credit and government borrowing. The differences, if not exactly
‘froth known to any idiot’,
would have been quickly understood then by those in public life. In
both cases, the government is creating new money-assets. In the case of
National Credit, it is printing notes. In the case of borrowing, on the
other hand, gives the lender a government bond (of the same value as the
loan) that can be traded among merchants and financiers, and so is
effectively new money.[10] The most substantial difference between the
two outcomes is that in the second case, the government commits future
taxes to pay interest – a drain into perpetuity on the nation’s
resources into the pockets of lenders.[11]
Concerning over-issue and consequent inflation, Broughton relies on
Parliament to determine how much should be issued, to prevent the
executive from abusing its power. He contrasts this with the
‘boundless power of bankers’ to
‘extend the credit’.
Here the proposal differs from that of Henry Simons (referred to
above): during the intervening 250 years, legislatures had become less
trusted. Simons proposed an independent authority, governed by single
objective of keeping the value of currency steady, which would command
the government in how much to issue (or withdraw from circulation).
Broughton points out that the government, by issuing notes, will not be issuing credit
‘as a banker does’ but
‘as a merchant does, which is to extend his credit to serve his own occasions.’
Confidence in a merchant’s credit rests upon his trustworthiness and
solvency; the same would be true of National Credit, which must rest on
the honesty, solvency (and hard work) of
‘the Parliament and Estates of England’
– ‘Estates’ meaning people of all ranks and occupations.[12] National
Credit is suitable, he says, when governments are strong but limited,
and not
‘arbitrary’. His final words praise (flatter?) the government: it is
‘admirably qualified to assist, and equally restrained from oppressing, those under its happy influence.’
Broughton predicted that objectors in the main would be
‘people who have large incomes and make great gains by the present methods.’
Indeed! – And such people were the ruling party! How did he ever think
his proposal would be accepted? Lawmakers of the time were notoriously
concerned with their own interests: in the words of Sir Lewis Namier,
candidates for election
‘no more dreamt of a seat in the House in
order to benefit humanity than a child dreams of a birthday cake that
others may eat it.’[13] In retrospect, the plan’s rejection was
inevitable – and perhaps as great a missed opportunity as England’s
failure to develop institutions of local democracy (described by F.W.
Maitland as the
‘great blunder of English law’ and a
‘national misfortune’).
Similar plans to Broughton’s – governments should issue money not by borrowing, but as
‘national credit’
– have occasionally been put into operation elsewhere. This happened
usually in a time of war or revolution, when the special interests of
the governing class were temporarily forgotten or overruled by
necessity; or when the governing class itself was being replaced. In
such conditions, notes were usually issued in excess. Detailed studies
of responsible issues, however, show them to have been very successful:
of which, more in a subsequent chapter.[14]
How much notice was taken of Broughton’s suggestion at the time, and
how much did it become part of public discourse? His Essay was published
and re-published, and thirty years later the influential philosopher
and economist Bishop (George) Berkeley repeated the propositions in a
book consisting of a series of questions (The Querist, 1735, Questions
199-275). In a second edition of 1750, Berkeley omitted the questions
concerning Broughton: the public had lost interest. The new ruling class
of
‘capitalists’ was firmly established, and the new poor of
England were having a hard time making ends meet. As in England, so in
America: Thomas Jefferson (1725) noted
‘an aristocracy, founded on
banking institutions and moneyed incorporations under the guise and
cloak of their favored branches of manufactures, commerce and
navigation, riding and ruling over the plundered ploughman and beggared
yeomanry.’[15] Bishop Berkeley added, concerning his omission:
‘It may be Time enough to take again in Hand, when the Public shall seem disposed to make Use of such an Expedient.’ Perhaps now, some three hundred years later?
Broughton’s suggestion would have
eliminated at least three toxic outcomes of private commercial banks creating the money-supply:
1, the provision of currency at permanent and continual interest; 2,
new money provided in bulk to investors and speculators on prospect of
mere profit; 3, new money created for governments and capitalists at the
expense of the rest.
Consideration of justice in the matter of money-creation was now
taking a back seat. We see it already in Locke, the quintessentially
respectable
‘philosopher of government by the gentry’ (Acton).
Locke wrote a great deal on money. He recognised that inequality was a
threat to national happiness and even blamed it on money (gold and
silver); but he included no recognition of bank-credit’s special role in
enhancing it.
The second development referred to above was the Promissory Notes Act
of 1704, which authorised claims on imaginary assets as currency. This
excited the imaginations of speculators and ‘projectors’ – the word then
used for inventors of dubious schemes to benefit the human race and –
incidentally, of course – themselves.
One of these projectors was a Scotsman, John Law (1671-1729), a
professional gambler who escaped from an English prison after killing a
fellow gambler in a duel. Law had no trouble recognising that
‘credit is money’.[16] If bank-credit could circulate as money, why not claims on other things? In 1700, Law presented a plan for a
‘land bank’ (its notes to represent claims on land) to the Parliament of Scotland (known at the time as the ‘Parliament of Drunkards’).
His plan was rejected and he made his way to mainland Europe. In
France, Law directed his attention to two other kinds of paper claim
which could perhaps circulate and become currency, or at least the basis
for currency: certificates of government debt and shares in colonial
ventures licensed by the monarch. Why could not this kind of paper take
over, displacing gold and silver altogether? Charming his way round the
gambling salons of Paris, Law found a willing listener and
co-conspirator in the Regent (and effective ruler) of France: Philippe
D’Orléans, a man suspected of many crimes including incest with his
daughter and the murders of several close relations.
Together with the help of royal decrees, the two men merged a variety
of paper claims – government debt paper, bank-notes and share
certificates – into shares of a new French colonial monopoly, the
Mississippi Company. Shares could be purchased with small payments
upfront. More bank-paper was issued in extravagant quantities, and by
the time second payments were due, the value of the shares had already
soared. Speculation fever took hold: an immense financial bubble grew
and burst. The finances of France were plunged into disarray. The year
was 1720 – the same year as the South Sea Bubble burst in England.
A lesson was learned from these bubbles (temporarily at least):
the
engine of credit-creation would have to be managed with restraint,
otherwise it would run amok and shake down the whole edifice of property
and power.
Meanwhile the visible nature of bank-credit had changed: it was no
longer mostly numbers in deposit accounts, but promissory notes issued
by banks. Bank-notes were displacing coin as domestic currency; but they
were not acceptable for foreign payments. For the next hundred years,
the word
‘bank’ would tend to provoke discussion about whether
paper money issued by banks was a good thing for the internal economy of
a nation.
Discussion of the predatory nature of banking – Thomas Mun’s
‘froth known to every Idiot’ –
simply disappeared.
So – what of justice, in this new world of enterprise and money
created out of air? Justice in economic thinking was removed from the
arena of
‘what must be worked on by human effort and care’ and given over to a genuine piece of voodoo – an
‘invisible hand’. Curiously, perhaps, this piece of voodoo – and Adam Smith, its inventor – would inaugurate what is now called
‘scientific’ economics. Consideration of all that will have to wait for the next chapter.
[1] Huerta De Soto, Money, Bank Credit and Economic Cycles.
[2] Petty, Tracts, Chiefly Relating to Ireland. Petty published
his estimate to counter the opinion that ‘not one eighth of them (the
Irish) remained at the end of the wars.’
[3] Petty: Tracts, Chiefly Relating to Ireland, and The Life of Sir William Petty by Lord Edmond Fitzmaurice.
[4] Political Arithmetick.
[5] Verbum Sapienti.
[6] W.J. Thorne, Banking (1948).
[7] Thorold Rogers, The First Nine Years of the Bank of England.
[8] Bagehot, Lombard Street; and Holdsworth, A History of English Law.
[9] Downloadable at https://archive.org/details/essayuponnationa00daveuoft
[10] In the words of Adam Smith some sixty years later, ‘The
merchant or monied man makes money by lending money to government, and
instead of diminishing, increases his trading capital.’
[11] From an earlier, moral point of view, these interest
payments might have been justifiable if the lender was forgoing the use
of the money lent, as opposed to gaining an resource of equal value.
[12] When Maitland addressed this question two hundred years
later (from the point of view of creditors of the National Debt) he came
up with almost exactly the same answer: ‘the creditor has nothing to
trust but the honesty and solvency of that honest and solvent community
of which the King is the head and ‘Government’ and Parliament are
organs.’ The Crown as Corporation; also Moral Personality and Legal
Personality,
[13] Lewis Namier, The Structure of Politics at the Accession of George III.
[14] Consideration of these will have to wait for another
chapter. Some examples, and discussions of their later disparagement by
economic writers, can be found in Richard A. Lester, Monetary
Experiments and Bray Hammond, Banks and Politics in America from the
Revolution to the Civil War.
[15] Letter to William B. Giles, Dec. 1825.
[16] Money & Trade Considered.
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