# Central Banking ### Oft-omitted facts around the establishment of the [[Bank of France]] https://www.alt-m.org/2016/01/21/founding-bank-france/ By [[George Selgin]] Despite that PAs length, it also leaves much unsaid.  It says nothing at all, for example, about the seemingly innocuous sentence in chapter five of _America's Bank_ that reads: "The Bank of France was chartered in 1800 as an antidote to the financial turmoil of the French Revolution." It is but a passing statement, in a work concerning the founding, not of the Bank of France, but of the Fed; and it is of no importance to that work's thesis.  And yet…and yet that sentence says plenty, for it represents as well as any sentence in Lowenstein's book its author's inclination — a very common one, to be sure — to view even the earliest central banks as sources of financial order and stability, despite the fact that doing so often means overlooking oodles of inconvenient facts. In the case of the Bank of France, many of these inconvenient facts are, ironically enough, unabashedly set down in one of the volumes published by the National Monetary Commission — volumes that supposedly informed the Aldrich Plan and, indirectly, the Federal Reserve Act.  These volumes generally display a bias in favor of central banking, as their sponsors intended them to do. Were one looking for a rose-colored portrayal of the Bank of France's origins, one might expect to find it here. Nevertheless, according to this particular volume's author,  André Liesse, the Bank of France was conceived, not as a remedy for France's post-revolutionary financial turmoil, but as one for Napoleon's fiscal difficulties.  What's more, far from having represented an improvement upon the _status quo ante_, its establishment marked the end of a remarkable though short-lived period of relative financial stability. The disastrous failure, in 1721, of John  Law's _Banque Royale_, was, according to Liesse, entirely attributable to that bank's involvement with the financial operations of the French government, and to its having secured, in return for that involvement, an exclusive right to issue banknotes.  No wonder the bank's failure resulted in an edict establishing complete freedom of note issue.  Still, it was not until 1776 that the scars left by its collapse had healed sufficiently for another bank of issue to be established. The new bank, the first _Caisse d'Escompte_, also ran into trouble as a result of "repeated state loans and government interference," eventually leading to its becoming "nothing more than a branch of the public administration of finance."  The episode led the great economist (and Inspector General to Louis XVI) [Du Pont de Nemours](https://en.wikipedia.org/wiki/Pierre_Samuel_du_Pont_de_Nemours "Wikipedia: Pierre Samuel Du Pont de Nemours"), in Liesse's words, to defend the true principles of banks of issue, asserting that  a bank without a privilege, not involved in business relations with a debt-ridden and needy State, without the prerogative of forced currency, can not do otherwise than pay in coin on demand the value of every note issued. In 1793 what remained of the _Caisse d'Escompte_ succumbed to the financial "paroxysms" of the Revolution.  Once again, according to Liesse, an institution that "would have been of real service to commerce if it had not allowed itself to become the State's banker" instead found itself "lending money to the State without sufficient security, and receiving nothing in return but privileges which could not fail to be disastrous to it." But other banks of issue founded during the first _Caisse d'Escompte's_ lifetime managed to keep going despite the Revolutionary turmoil, including the "dangerous and ruinous flood of assignats" that was eventually to result in hyperinflation.  Their owners and managers, mostly Protestants whose families had fled from France to Switzerland after the Edict of Nantes was revoked, had managed, "even in dealing with Napoleon," to avoid being "cajoled into granting the State favors of credit which would cost them dear."  Their banks would soon be joined by other private institutions, including the _Caisse des Comptes Courants_, a central clearinghouse and bankers' bank (it issued only very large denomination notes, meant for interbank settlements) established in Paris in 1796, and the _Caisse d'Escompte du Commerce_ (or _Caisse du Commerce,_ for short) — organized in 1797. Thus began a brief but at least relatively glorious free banking interval. "It can not be denied," Liesse observes, that after the terrible years of the Revolution, in the midst of the confusion and anarchy of the Directory, these credit establishments, in spite of difficult conditions, survived, maintained their credit, and were of real services to the commerce and bankers of Paris.  They gave not the slightest occasion for complaint or interference on the part of the public authorities.  Without any sort of privilege, having no connection with the Government, they were able to meet their obligations even in the midst of serious panics. In short, freedom in banking worked just as Du Pont DeNemours said it would. Yet this success was not allowed to last.  As Charles Conant puts it (_History of Modern Banks of Issue_, p. 44), the established banks > were doing an active and safe banking business when a new turn was given to the economic history of France by the coup d'état of the Eighteenth Brumaire (November 9, 1799), which made Napoleon Bonaparte First Consul and virtually supreme ruler of France. Napoleon did not hesitate, despite the lessons of the past, to make plans for yet another government-controlled and privileged bank of issue, the Bank of France.   For Liesse this development, far from seeming perfectly sensible (as modern central bank enthusiasts would have it), was astonishing.  How could it happen, he wonders, that this most satisfactory state of freedom came to an end and that in the course of a few years there was organized in Paris a bank with the exclusive privilege of issue?  Is it due to a series of natural causes?  No.  Not one of the Caisses just described had occasioned disaster or invited suppression.3(https://www.alt-m.org/2016/01/21/founding-bank-france/#_ftn3)  The new state of things came from the idea of credit which existed in the mind of General Bonaparte, as well as from his tendency to centralize everything, and because the government at the moment was in great need of money. The "idea of credit which existed in the mind of General Bonaparte" boiled down to this: that he might have all the credit he wanted, if only he could establish a bank he could control, and award it a monopoly of currency extending throughout all of France. At very least, Napoleon could have a lot more credit for a lot less than France's then-existing banks were either willing, or even able, to supply.  According to notes left by a member of Napoleon's Council of State, to which Professor Liesse refers, the First Consul had "determined to lower" the interest rate at which the government could borrow to something less than the rate of 3 percent per_month_ banks were then demanding, thanks to the government's poor credit.  Napoleon "could not get what he wanted from the free banks.  On the other hand, he felt that the Treasury needed money, and wanted to have under his hand an establishment which he could compel to meet his wishes. …It would certainly seem that here originated the idea of creating a new bank of issue." Given the circumstances, raising capital for the new bank was no easy proposition. To address that difficulty, the government first persuaded the Caisse des Comptes Courants to merge with it. To make further shares attractive, the new bank secured the privilege of holding various government deposits. Still, less than 7500 of a requisite 15,000 shares (half of the Bank's stipulated capital stock) were taken, with Bonaparte's friends and relatives having pride of place among the subscribers. (Napoleon himself was the Bank's first subscriber, with 30 shares.) Further privileges were duly awarded it, until they sufficed to allow the remaining shares to be disposed of. At first, the Bank of France had to compete with other banks of issue, including the Caisse du Commerce. When attempts to persuade the older bank to merge with the Bank of France failed, and especially after the Caisse du Commerce refused the government a loan it sought, Napoleon resorted to coercion. The details remain obscure. According to one account (admittedly in an English newspaper) at first the Bank of France, with Napoleon's support, tried to bring its rival to submission by staging note-redemption raids. When that strategy failed, Napoleon simply had some of his troops shut the bank down. What's certain is that the law of 24 Germinal, An XI (April 14, 1803), against which the Caisse du Commerce protested vehemently, awarded the Bank of France the exclusive right to issue banknotes in Paris, compelling all other banks of issue to surrender their assets to it. "The Bank of France was chartered in 1800 as an antidote to the financial turmoil of the French Revolution." It is one of those sentences that exposes a dominating — but distorted — worldview no less effectively than it obscures aspects of reality itself. ## [[Walter Bagehot]], father of central banking and supporter of free banking https://www.alt-m.org/2011/08/19/walter-bagehot-father-of-central-banking-and-supporter-of-free-banking/ By [[George Selgin]] Walter Bagehot (1826-1877) was the most famous editor of The Economist. (His last name, by the way, is pronounced “BADGE-it.”) For his wisdom on financial matters, he was dubbed “the spare chancellor,” a reference to the Chancellor of the Exchequer, the British minister of finance. His book Lombard Street (1873), named after the English equivalent of Wall Street, criticized the Bank of England for not using its powers to alleviate financial crises. Bagehot argued that the Bank’s monopoly position gave it both the responsibility and the ability to do so, and that the Bank should not conduct itself as if it were an ordinary commercial bank. For its explanation of how the Bank of England should act, Lombard Street became the foundation document of modern central banking. As I explained in an earlier post, Henry Thornton had anticipated some of Bagehot’s ideas about 70 years earlier, but by the time of Lombard Street Thornton’s monetary thought had faded into obscurity, and would not be rediscovered for another half-century. The Bank of England followed Bagehot’s prescription during the worldwide financial crisis that occurred later in 1873, establishing a pattern that other central banks would imitate. It is worth recalling, though, that Bagehot did not view central banking as the natural monetary system. Here are his words: > ==We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size.== In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without. > > I shall be at once asked—Do you propose a revolution? Do you propose to abandon the one-reserve system, and create anew a many-reserve system? My plain answer is that I do not propose it. I know it would be childish. Credit in business is like loyalty in Government. You must take what you can find of it, and work with it if possible. A theorist may easily map out a scheme of Government in which Queen Victoria could be dispensed with. He may make a theory that, since we admit and we know that the House of Commons is the real sovereign, any other sovereign is superfluous; but for practical purposes, it is not even worth while to examine these arguments. Queen Victoria is loyally obeyed—without doubt, and without reasoning—by millions of human beings. If those millions began to argue, it would not be easy to persuade them to obey Queen Victoria, or anything else. Those who believe Bagehot thought that “there were responsibilities in emergent capitalism that only governments could assume, centralized control of the banking system chief among them” should be aware of this passage. And given that the Queen of England no longer reigns over millions of square miles teeming with hundreds of millions of subjects, but merely over the 80th largest country in the world plus some tiny outlying islands and a patch of frozen wasteland in Antarctica, we should consider that a return “the natural system” of free banking is likewise more possible than Bagehot imagined. ### Central Banks as Sources of Financial Instability By [[George Selgin]] ![[tir_14_04_01_selgin.pdf]]