from Michael Flürscheim
Clue to the Economic Labyrinth
CHAPTER VI – BANKING
“No banking system based upon gold can possibly meet the demands of expanding industry; it can never be other than a wrecker of industry.”
— W. A. Whittick.
This chapter will deal only with two branches of banking: with the credit business and the money issue. I purposely do not say the banknote issue, because, as I have shown in Chapter III., banknotes are mere money representatives, a form of credit, as long as they are not legal tender. Only when they are legal tender they are money, and need a special classification; ordinarily they are included in the bank’s credit business. To refer to other work performed by banks and bankers, such as money changing, purchase and sale of drafts, especially on foreign countries, stocks, bonds, etc., is unnecessary, as I can hardly say anything new in this respect, and as even the most radical State bank partisan would not care to forbid this trade to private banks. A chapter which is mostly concerned with the question whether the credit and money-issuing functions of our banks are not better monopolised by State banks can therefore leave this branch of the subject out of discussion.
State or Private Banks?
The dispute as to the relative advantages of the two systems of banking has advanced a stage through the consideration of the new system of issuing paper money here advocated, because the main objection hitherto brought forward against State banks of issue,
The Danger of Inflation,
in case the financial necessities of the public exchequer offer too strong a seduction for an appeal to the note press, can now be provided against by the limitations of the new system. Not that much importance need be attached to this ground of preference in favour of private banks; for experience has proved that such banks cannot resist the pressure put upon them by the needy treasury, and, in fact, most of the inflated note circulations known are those of private bank issues. I presume that it is unnecessary to explain that most of the so-called national banks are mere private banks—limited companies to which certain privileges have been given by the State—such as the Bank of England, the Banque de France, the Deutsche Reichsbank, the Bank of New Zealand, etc.
Minor reasons usually assigned for the preference of private banks to State banks have lost their importance through practical experience. So, for instance, the greater
Security in Times of War against Seizures
by an enemy. Napoleon the First, amongst others, proved by example that the money of a private bank is just as little exempt from seizure by victorious troops as that of the State treasury. The only difference may have been his passing through the formality of giving a receipt payable by the conquered State out of the imposed contribution levies. Another argument against State banks has always been the
Fear of State Administration;
but practically the national banks of Germany, Austria, and France, though they belong to shareholders, are to a certain extent administered by the State, or, to be more explicit, by State officials; and it is well known that their administrations are not inferior to those exercised by the appointees of shareholders. The fear that political influence might conduct to the patronising of favoured individuals has not, as a rule, been justified in the case of these institutions; whereas the same cannot be said of many a private bank administered by the nominees of the shareholders—as the scandals brought to light (1892) in the administration of the Banca Romana have sadly proved. Those who are familiar with the methods of our New Zealand banks well know that impartiality in the according of credits certainly does not belong to their prominent virtues; and that directors may sometimes decide regarding credits and discounts because of motives which render political influences pure and noble in any comparison with them. Methods may, and will, be devised to make political influence innocuous—the French, German, and Austrian administrations supply a precedent for this— whereas I cannot see what possible remedy there is against the abuses of the system at present prevailing in our country, unless it be State administration, which would give the shell to the State, and leave the kernel to the capitalists, I had no full idea what arbitrary power bank directors exercise and the menace this power is to the development of the country and its institutions, until my experiences as founder and managing director of the New Zealand Commercial Exchange Company, Ltd.—the so-called Exchange Bank—gave me the proof. I think I am fully justified in saying that one of the greatest obstacles in the way of this beneficent institution, of which Chapter IX. will say more, was the fear of business people to displease their bank manager and his directors—which might have meant a calling in of their overdrafts and consequent ruin. Those who style Mr. Seddon the despot of New Zealand ignore that whatever power our energetic premier may wield pales before that in the hands of our bank magnates.
When I said that State administration and private ownership would be the sacrifice of the kernel for the shell, I meant that the question of administration, weighty as it is, recedes into the background when we consider the immense value of the privileges which the State now squanders upon private capitalists—instead of making them a source of public revenue. Even the right of issuing notes, important as it will become under the changed conditions expected from the proposed reform, is not the most valuable and important of banking privileges; and besides, this right is not always given quite for nothing. In New Zealand the banks have to pay a yearly tax of 2% on their note issue. In Germany a tax of 5% is paid beyond a certain amount of note issue, and part of the bank’s profits belong to the State; in France a fixed amount is paid in as a stamp duty, and an income tax of 3% from the dividend. In Austria-Hungary a certain quota of the net profit is paid to the State. The Bank of England pays something over £200,000 a year into the treasury for the right of issuing notes. The principal source of profit made by banks is derived from the interest of current accounts—which means the interest profit made through lending to one set of people what the others deposit. Our New Zealand banks, for instance, gave the following statement for the quarter ending September 30, 1900:
Fixed deposits £7,944,i39
Free deposits £7,002,235
From these deposits they made advances to the amount of £11,262,204. This leaves out of sight the account with the Government and other investments made by the banks, from which they draw interest. On the other side, we have to take into account the coins and bullion kept in stock. This item amounted to £2,742,641, from which we have to deduct the note issue for which part of the coin is held liable, amounting to £1,269,002; so that only £l,473,639 have to be deducted from the amount of deposits. This leaves £13,472,735 upon which the banks obtained interest; which, on the average, did certainly not fall much short of 6%, if we have to judge by their gross profits. Taking as much as 3% as the rate paid for fixed deposits—though it is usually lower where these deposits are made for less than a year—and we find in round figures about;£600,000 gross profits made by lending the money of one set of men to another, minus expenses of administration. I do not include the 10 shillings a-year for eachaccount which the poor institutions found it necessary to charge because of their meagre profits, nor the profits made through the exchange charged on cheques payable in other towns, on drafts, etc. Let us figure only £400,000 net profits from this source, leaving the balance to come up for possible differences and for expenses not borne by the other profits. These £400,000 certainly could have been made by the people for themselves, if they had kept their accounts by the means of a State or co-operative bank.
Exploitation of the People’s Stupidity
The whole arrangements remind me very much of a story I once heard in America. The Mississippi had overflowed its banks. Hundreds of fine logs were rapidly drifting past a crowd of negroes who had gathered on the shore. They looked shiftlessly at the timber, when a white man, a stranger in those parts, addressed them.
“Boys,” he said, “I give every one of you one-half of the logs as salvage which he lands!”
With a will the men went into the water, and soon quite a number of valuable logs were piled on the shore. They took half of them for their labour, and the stranger took possession of his share and sold it to a neighbouring sawmill.
“Fools, those negroes!” the reader will say. “Nothing prevented them from securing the timber for themselves, without giving a share to a stranger who had not moved a finger, and who had not the least claim on the timber.”
Certainly; but, my dear friend, are you not acting in the same manner whenever you pay a bank for the right of an overdraft? The bank, in this case, only allows you to make use of your neighbour’s labour or its products, whom you finally repay by the products of your own labour. The bank only does the service of a clearing-house for you. It provides the tokens required for this mutual exchange, and for this service the banks of New Zealand, after paying all expenses, pocket at least £400,000 a-year. It is this price you pay for the permission to secure the logs, a permission enjoyed by you before it is generously given, after you begged hard for it; and besides, after you gave good security for your readiness to jump into the river to bring the logs ashore. Or, in other words, it is the price you pay for the use of tokens which you can just as well issue yourself. You can back them by something which is better than gold, and anyhow than no gold (only a small fraction of gold is held ready by the banks as a cover of their tokens)—your own valuable labour and its products. You do not need to pay for the permission of outsiders to let loose your productive power; you are entirely free to do so without their goodwill. However, the snug little tribute paid out so unnecessarily is the least item to be considered.
The Question of Security
comes in foremost. There is such a thing in this world as a broken bank. We in this country have a little tale to tell on this score. The Colonial Bank failure is still in sad remembrance, and the Bank of New Zealand would have gone the same way if the State had not stepped in to the amount of £2,000,000. A State bank would certainly offer a better security to depositors than most of the present private institutions. The so-called
National Banks of the United States
have to deposit Government bonds as collaterals, but this security only protects the note issue: the poor depositors have no protection whatever if the comparatively small capital of the banks and their deposits are lost through risky operations. Formerly, part of the collaterals deposited in the Treasury figured in the assets, as notes could be issued only up to 90% of the nominal value of the bonds; but now the law permits an issue of dollar for dollar. The following article from the Public (April 28, 1900) gives only the capitalistic feature of the new law, but even this is so highly interesting that I have thought it worth while to copy the article in extenso:
“When bankers want an Act of Congress facilitating the issue of banknotes, they assure the public that there is really no profit in the issue feature of banking, and that their sole purpose is to serve the people by furnishing them abundantly with currency. But when banks have got the Act about as they want it, indiscreet financiers sometimes ‘give the snap away.’ Here, for instance, is the firm of Price, M’Cormick & Co., of 71 Broadway, New York, which sends out a business circular full of enthusiastic praise of the National Bank Bunco Bill which has recently been enacted. A peculiarly interesting feature of this circular is a table which shows the profit a bank can make out of the issue privilege. It is not the work of some moon-eyed greenbacker, but has been put together in simple, though suggestive, form by a firm of financiers, in order to stimulate 2% bond purchases at a premium of 6% for the purpose of organising national banks.
“This table clearly shows, it will be observed, that under the new gold standard banking law a national bank can exchange $100,000 of its capital for $100,000 of its own notes, made universally current by Government endorsement, doing so at a cost of only $6,000, and net $1,293 a-year by the transaction. In what legitimate business could $6,000 be put to such safe and profitable use? ”
The article does not even mention the profits made by the banks out of the money of depositors, and the risk run by the latter, fully illustrated by the crisis of 1893.
To feed the financial cormorants who thus exploit the State and the public, the excellent greenbacks have to be retired, for the State’s paper has to suffer whenever the issue of national notes and greenbacks combined oversteps the amount which can be kept floating. Greenbacks are then presented at the United States Treasury for payment in gold; the gold is used to buy bonds from the State which she had to issue to obtain gold for the greenback-holders, and upon these bonds, whose interest goes into the pockets of the bank-owners, national banknotes are issued to them, which again drive a corresponding amount of greenbacks out of the market, with the same result. The game will be continued until all the greenbacks are replaced by national banknotes, until the bank-owners reap the whole interest profit from the nation’s paper money issue, which, as far as the greenback circulation was concerned, went into the public purse. Or, in other words, the State had to borrow, at not less than 2% interest, millions which she had free of interest from her greenback circulation, and these 2% (formerly more), minus a slight deduction, go into the pockets of private parties, besides giving their banks a semblance of solvency which they do not possess. The worst of it is that the State alone is practically responsible for the payment of the national bank notes in gold, for the banks can easily get out of their obligations to pay this gold, as long as greenbacks are obtainable. They simply exchange their notes for which gold has been demanded of them, against greenbacks, and by presenting these at the Treasury they get back their gold. To obtain this gold, new bonds have to be issued by the State, which enable the banks to increase their note circulation. When another crisis arrives, which breaks the banks, the State may have to sell the bonds deposited with her to obtain the cash demanded for the national banknotes; and if the bonds are not saleable at par, the loss will have to be made good by the tax-payer.
Law needed to prevent the Lending out of Free Deposits
There is no valid reason why the cheque circulation should be less protected than the banknote issue. If legal tender money has to be kept ready for the one, it should be held in reserve for the other, and a law which would force the banks to keep in stock, in their vaults or in those of the State, legal tender to the full amount of their free deposits, or deposits on call—as they are also called—would certainly be recommendable. Such a law would, anyhow, secure the depositors who left their money with the understanding that they can dispose of it from one day to another. Those who lend their money to the banks for certain periods, at interest, need as little protection as other parties who lend out money. Their position is entirely different from the free depositors who really only bring their money for safe keeping, and expect to find it when they want it. That this is a vain expectation has been shown already in Chapter III., where we saw that our banks, including the savings banks, owe on demand as much as 14 millions, for which about £2,700,000 in coin and bullion is on hand; for it is to be supposed that the savings institutions also deposit most of their cash with the banks, and that this money may therefore be considered as included in the £2,700,000. So, on an emergency, after one-fifth of this class of creditors have been paid, there is not a penny left for the other four-fifths; their deposits are gone, and whatever engagements they may have made on the expectation that the money deposited by them on call is always at their disposal cannot be met for the time. Even if there should be a settlement some day, irreparable loss may have been entailed. It is a strange latitude given by our laws to private bankers, and a remedy is urgently needed.
George Clare, in his Money Market Primer, says (p. 317): “The law takes no cognisance of a banker’s operations in accepting deposits. It leaves him to keep as much or as little legal tender as he pleases. It forbids him to put forth a single note beyond the amount assigned to him in 1844; but is silent on the subject of deposits, and while the State controlled liability to the public of all the banks in the United Kingdom (excluding the Bank of England) amounts on their authorised issue to £14,000,000, their uncontrolled liability on Current Deposit Accounts amounts to £650,000,000. Practically the whole of this vast sum is payable in gold on demand, but on the assumption that only a very small proportion will be asked for at any one time, bankers have locked up over 90%, and only the Bank of England pretends to keep up a large store of legal tender money. The 13 or 14 million pounds of notes and gold lying in its vaults are therefore the ultimate and sole cash reserve, in the whole country; and if the bank lost that reserve, neither the banks which depend on it, nor the customers who depend on the banks, would be able to keep their engagements. On it, in short, reposes the entire fabric of English credit.”
“Locked up” is a misleading expression. Mr. Clare means the money has been paid away, and is invested elsewhere. In fact, most of the money never existed, was only the ghost of money—credit money pure and simple. The law which does away with this dangerous state of things would only restore what once was considered a matter of course in the beginning of banking. Thus the Bank of Amsterdam in the seventeenth century was a bank of deposit pure and simple. The money was left there for safety’s sake, and was kept until called for. I suppose at that time it would have been a felony if the bank had dared to trade with such money entrusted to it for safe keeping. I quite admit that if other views had not obtained, our civilisation could never have reached its present development. Sir Walter Scott says of the
Scotch System of Banks of Issue:
“The facilities which it has afforded to the industrious and enterprising agriculturist or manufacturer, as well as to the trustees of the public, in executing national works, have converted Scotland from a poor, miserable, and barren country into one where, if Nature had done less, art and industry have done more than in, perhaps, any country in Europe, England not excepted. Through the means of credit which the system afforded, roads have been made, bridges built, and canals dug, opening up to reciprocal communication the most sequestered districts of the country; manufactures have been established, unequalled in extent or success; wastes have been converted into productive farms; the productions of the earth for human use have been multiplied twenty-fold,while the wealth of the rich and the comforts of the poor have been extended in the same proportion. And all this in a country where the rigour of the climate and the sterility of the soil seemed united to set improvements at defiance. Let those who remember forty years since bear witness if I speak truth or falsehood.” (Robert Ellis Thompson, Political Economy, p. 154.)
Without the high credit building erected on our scanty money stock, the immense extension of our modern trade could never have existed; production and distribution would have been cramped as they were in the Middle Ages.
Nor do I advocate that gold should be kept in stock by our banks. Government paper would be preferable, provided it were legal tender; and anyhow, it is better that the people’s hoardings should benefit the whole community instead of private institutions. Even if New Zealand did not adopt the reform currency here proposed, the Government ought, at the least, to pass a law forcing banks to keep treasury notes in stock, not only for the banknote issues, but also for the free deposits, which thus have the guarantee of the State behind them, while the State can make use of the money for her purposes. This does not apply to the savings banks, for these are not supposed to accept the money from their depositors in safe keeping, but to invest it for them as their trustees.
Advantage of such a Law to the Community
The sum thus put at the immediate service of the New Zealand Government would at present amount to about £8,700,000, minus the coin and bullion in the bank vaults of £2,700,000 = £6,000,000; which would be available for the completion of our railroad net, or advances to settlers. Lent out at the present rate of 4½% and deducting the present proceeds of the banknote tax, this would give an income of £240,000 a year, enough to double our old age pensions and still leave something for other purposes. The funds thus put at the disposal of the community will be much larger after the introduction of the reformed paper money, owing to the effects of this reform on our interest rate. In the chapter on “Interest” we shall see that in such a case this rate will go down considerably until it is lower than in Lombard Street. The lower the interest the more people will leave their deposits on call, the right of immediate disposal over the money, whenever a good chance of investment offers, becoming more important in the same measure in which the interest obtainable on fixed deposits is reduced. Though the interest profits of the State may not grow much through such an increase of the available funds due to free deposits, the uses it can put the capital to for public purposes may be productive of an amount of public good far exceeding any figures calculable in interest tables.
The same condition, a deposit of legal tender money, would apply to the note issue of our banks which would practically put an end to such issue, when the interest obtained for lending out the notes would have to be paid for the borrowing of the security. Much better save the trouble by making direct use of the Government notes. Such a law would do away with the most objectionable feature of the present banking system, and would make the demand for a State bank, which is gaining a growing support, less urgent. The new notes could just as well be issued by a department of the Treasury; and if the present banks abuse their remaining power, co-operative banks could make the people independent of them.
The People their own Bankers
We must not forget that most of the money power possessed by our present banks is not derived from their own capital, but from the deposits of the people; and if once the people come to understand that they do not need these arbitrary institutions, but can be their own bankers, the banks must liquidate their business. I quote a few passages from People’s Banks, by Henry W. Wolff (London, 1893), one of the best accounts given of those wonderful institutions, called the Raiffeisen Banks, after their German organiser.
” ‘Le plus grand banquier du monde est celui qui dispose de l’obole du prolétaire,’ says Jules Simon. (‘The greatest banker in the world is he who has the proletarian’s obolus at his disposal.’)
” ‘The only capital which will endure,’ says Professor Laurent, with the approval of Emil de Laveleye, ‘is the capital created by the working-man in himself. It would be idle to lend to him or to give to him the implements for his work. Such gifts, like an inheritance under the touch of a spendthrift heir, would be squandered in little time.’
“An ample and practically inexhaustible resource of productive power lies hidden in the labour, the frugality, the honesty of the nation’s workers, as materials for capitalisation; just as people who have not seen rivers like the Danube or the Rhine could not possibly estimate from the little driblets and rills which go to make them up what a vast volume of water may be collected from these insignificant sources.
“Dr. Johnson said that it takes 240 poor men’s pence to make one capitalist’s sovereign. But once a sovereign, put so together, it is a totally different sovereign from that taken out of the rich man’s safe. It has behind it 240 wills, 240 pairs of watchful eyes, 240 thinking brains. It has, so to speak, become an animate sovereign, with prudence, energy, vigilance diffused through all the parts.”
These theories have been practically realized in Germany and Italy since, in 1849, the first
was founded in the Westerwald, Germany—the mother of over a thousand offspring. These banks, together with another kind of people’s bank on the Schultze-Delitzsch system, and the different kinds of co-operative institutions organized by the people, possess, according to Wolff, a capital of 250 million pounds sterling. Though the Raiffeisen banks lend on personal security, the losses were only about 2s. 6d. per member in 1892, As they are based on an extensive or unlimited liability, each member watches his fellow-members; which is not difficult, as the members usually live close together.
“In Italy, 28,68% of the members are engaged in small industries and trades, 8,40% are artisans, 15,40% are school teachers, Government employees, etc., 19,08% are small cultivators, and 3,18°% are labourers. The balance are agriculturists, manufacturers, and traders, or persons without a calling.” One thousand societies exist with over 150 million lire capital (6 million pounds sterling). They lend out over 500 million lire, and have about 400,000 members. The losses in Milan, a society with £500,000 capital and reserve, have not reached ten cases in twelve years.
A leading feature of these banks has been the capitalization of profits, a principle especially to be recommended to the British co-operative societies. More will be said on this subject in Chapter IX, of this work.
State Bank and People’s Banks
The organisation of such banks must greatly facilitate the operations of a State bank by relieving it from the task of discriminating as to credits, a difficult and dangerous task—dangerous for the finances of the State and the political independence of the people. I would much rather see the State bank or Treasury lend its notes to the co-operative banks against their corporate guarantee, supported by the limited or unlimited liability of the members. I should prefer a limitation of the liability to an amount of, say, five times the share capital subscribed by the members. These banks would then attend to the according of credits. That such credits could be given much more freely, and still with much less risks under the new conditions, has already been specified in Chapter IV.
Our Banks a permanent Danger
Anyhow, it is of the greatest importance that the people be rendered independent of the present bank directorates and managers, whose decisions—even when there was no ill-will—have often been fatal to the welfare of their clients and to their own prosperity. R. H. Patterson, in his Economy of Capital, gives a very interesting experience made by the American banks in 1857:
“The banks broke many business firms by curtailing discounts, and the business people answered by breaking the banks through calling in their deposits. Then the banks saw their error and commenced liberal discounting, though they hardly had a dollar in their tills. At once the gold returned, and three months after the suspension, there were a million more in their vaults than before the crisis began. The notes had never been questioned.”
How different the record of the people’s banks in Germany! In 1866 and 1870, the two war years, when deposits were withdrawn wholesale from other banks, they were actually pressed upon the Raiffeisen banks, and for any length of time, as long as they proved trustworthy and used the money for productive purposes. The Rhineland law courts even allowed trust money to be lent them.
The Scotch banks could also be cited as exemplifying a good bank policy. I quote from Adam Smith:
“They invented another method of issuing their promissory notes: by granting what they called cash accounts; that is, by giving credit to the extent of a certain sum (two or three thousand pounds, for example) to any individual who could procure two persons of undoubted credit and good landed estate to become surety for him, that whatever money should be advanced to him, within the sum for which the credit had been given, should be repaid upon demand; together with the legal interest.”
I have already shown in Chapter IV. that security as good, or even better, will be supplied by the products of labour after the new currency has guaranteed an average stability of prices. I need hardly add that such strict terms as those mentioned by Smith, “payable on demand,” are totally out of place in the case of a currency which sees its quantity increased whenever an extraordinary demand is made. No more of the
“Stand and Surrender”
business practiced by our modern highway robbers, who first lock up the scarce money and then demand its immediate delivery or a sacrifice of property at ruinous terms; for the more money they will lock up under the new conditions the more will be forthcoming from the paper press of the State.
The officials of the issue department certainly will not wait until the periodical statistics indicate a fall of prices, but will at once issue more money whenever it becomes clear to the most superficial observer that a downward tendency of prices obtains for the time. Such downward tendency is the immediate result of a scarcity of money, and the periodical statistics will merely serve to adjust the issue more exactly and to prevent abuse.
The Methods of Issue
hardly require discussion, for they could closely follow those now in use. The minimum money issue required by trade will be used for public works, thus representing the 14 million pounds of notes issued by the Bank of England for money permanentlylent to the State; the balance is lent out to the people. Even here it will be best to follow precedents, and to lend partly on overdrafts, partly by means of bill discounting; the rate of interest being determined by supply and demand. We know that the Bank of England and the other European banks raise their discount rate for bills when their gold reserve goes down, and reduce the rate when the gold stock increases. There will be no gold stock to be maintained under the reformed paper currency; but still the rate of interest in discounting and lending will have to perform a similar purpose to the one it serves under the gold system. It will be the flood-gate whose opening and closing depends on market prices. When prices have a downward tendency, the rate of interest demanded by the bank or banks will go down, with the result that the issue flood-gate will go up, or vice versa. The lower rate will induce borrowing, and the buying of goods with the borrowed money, which has a strengthening effect on prices. On the other hand, when prices rise through a too great abundance of money, the raising of the interest rate will discourage discounting and lending. A number of bills will be paid without demand of renewal, and some of the overdrafts will be settled. In this way, part of the circulating money is withdrawn and prices fall until the normal equilibrium is re-established. In practice I hardly think that a restriction of the existing issue will often be found necessary, for trade, once freed from the dread of a crisis continually pending over it, will steadily expand with every new progress in the arts of production and distribution, as well as with the growth of population, and such extension may render a continuous increase of the currency imperative. Thus, a slight raising of the interest rate, just sufficient to prevent increased borrowing, without being considerable enough to cause repayments of past debts, will perhaps be sufficient. The task will probably not be to restrict the existing circulation but to prevent further issues for the time.
Currency Reform without a State Bank preferable to a State Bank without Currency Reform
I cannot close this chapter without addressing a note of warning to those zealous partisans to whom the creation of a State bank isthe one panacea for our financial difficulties, whose origin they see in our present system of private banking. If, as Mr. Miles Verall, one of these men, for instance, demands, the present currency system remained untouched, if gold continued to be the measure of value, our legal tender, a State bank would help very little. If, on the other hand, a currency reform on the lines here proposed is carried through, the institution of a State bank becomes only one of the instruments available for the purpose ofregulating the issue and circulation of the new money; perhaps the best of possible instruments, but by no means the only one. In other words: a reformed currency can be a success even without a State bank, whereas a State bank never would bring about a fundamental reform without a change in the currency.