The Principles of Political Economy

Henry Sidgwick

Book III

Chapter IV

Section 8

§8. Paper Currency and Banking. The governmental monopoly of metallic currency has never, so far as I know, been advocated by theorists---though in earlier ages it has been extensively used---as a source of public revenue: in fact, as we have seen, the practical question is rather whether it should be a source of expense to the nation. It is universally admitted that the alarm and disturbance to trade that would be caused, if Government tried to gain by reducing the amount of metal in coins while keeping up their value by limitation of issue, would far more than outweigh any profit that might be made by the operation. It is agreed, therefore, that Government ought to coin metal into standard coins freely for all applicants, at a price---at least---not materially greater than the cost of coining. For similar reasons, it is agreed that the tempting source of gain offered by the power of issuing inconvertible notes should be at any rate reserved for an extreme crisis of national need. But it has often been maintained that the State ought to keep in its own hands the business of issuing notes convertible into coin on demand, with the view of deriving from it a valuable contribution to the national income. And it is certainly true that by monopolizing this part of the business of banking a Government can practically borrow a considerable amount of capital, at a very low rate: i.e. at the cost of making and circulating the notes, together with ordinary interest on the metal kept as a reserve in order to secure convertibility. This, however, does not prove that it is the interest of the community that such a monopoly should be exercised: there are many highly objectionable governmental monopolies which the State could easily carry on with considerable profit to the exchequer. What has to be shown is either (1) that governmental management has some special advantages as compared with individual or associative management in this business: or, at least (2) that, for some reason or other, the extra gain that bankers would make if free issue of bank-notes were allowed would not be transferred to the consumers, by a more abundant and cheap supply of the conveniences of banking. As regards (2) it is, as we have seen, theoretically possible that this transfer might not take place: the extra gains might (a) be retained by the banks so far as circumstances exempt them from competition, or (b) might be divided among an excessive number of competing businesses, so as to reduce average profits but not charges. I do not, however, know any adequate grounds for supposing that these effects would occur; or that competition would not operate in the normal way.

As regards point (1), it certainly seems that the business of issuing notes and giving coin for them on demand is of the routine character suited to governmental management; as admitting of being conducted safely under fixed rules, by which (e.g.) the amount of reserve to be kept is once for all determined: and a solvent Government seems to have an important advantage---as compared with private enterprise pure and simple---in being able to provide more complete security at a smaller expense of reserve: partly from the generally greater stability of Governments, partly because a Government, in the last resort, can suspend payment and yet keep its notes current. And this completer security is important not only because the greater confidence that a safe currency inspires is likely to increase its general use; but especially for the protection of the poor and ignorant persons who would be unable to inquire into the circumstances of the different banks whose notes they accept.

These reasons, I think, seem to me to weigh heavily against absolutely unregulated issue: it seems, however, that adequate security might be provided for the ordinary note-holder by merely placing private issues under strict governmental regulation, while still leaving to private enterprise the determination of the amount of notes and the proportion of reserve required from time to time. Thus---to adopt a suggestion made by Mr R. H. Patterson---bank-notes might be issued >by Government, but for any bank requiring them, without limit, but subject to the condition that their value should be covered by a deposit of Government securities exceeding the nominal value of the notes by an amount sufficient to obviate any danger of loss from depreciation of the securities. The bank for which such notes were issued should be solely responsible for the payment of gold for the notes; but they should be legal tender until the bank stopped payment. Whenever a bank stopped payment, its deposited securities would be at the disposal of the Government for the payment of the note-holders: the notes, in fact, would become practically a kind of exchequer bills; and they would probably continue to circulate in this condition. But even if they did not circulate the ordinary note-holder would at any rate suffer no serious loss from the collapse of the bank responsible for them.

Supposing the value of any note to be secured, either in this way or by full governmental responsibility, there would seem to be no ground for prohibiting the issue of notes below a certain amount; unless such issue should be found to carry with it inevitably a material increase of forgery, which the experience of Scotland does not lead me to anticipate. Apart from this latter danger, the issue of small notes is, of course, an economic advantage to the bankers directly, and indirectly---we may assume---to their customers; no less than the issue of notes for larger amounts is.

But although it seems manifestly possible, by such regulation as that above suggested, to protect the ordinary note-holder from material loss; I hardly think that this---or any other scheme for mere regulation of issues, as contrasted with absolute limitation through State monopoly---would adequately secure the result for which the commercial world is most keenly concerned, by providing a supply of good money in a financial crisis to fill the gap caused by a general collapse of credit. It may be urged that, as things are, the agony point of such a crisis in London is reached by the Bank of England declining to lend even on Government securities, and that the dread of this point has a certain tendency to realize itself, as it intensifies the earlier stages of the crisis: and it may be thought that such a scheme as the above would remove this dread, as it would enable any bank to obtain legal tender by depositing its own Government securities. And I should admit it to be quite possible that the pressure of a crisis might in this way receive timely relaxation, so that the crisis might pass off without reaching the worst stage; but I do not see how we can be assured that this would happen; while if the worst stage were reached, if the crisis became panic, the weak side of the proposed system of legal tender notes would become manifest. Every one would fear that the particular bank responsible for his notes might stop payment, and thereby reduce his notes to the condition of mere Government debts, not immediately and certainly available for meeting liabilities; there would therefore be a serious danger of a general run for gold, and general ruin. This danger is avoided under the existing system in England; since no one is afraid of the insolvency of the Issue Department of the Bank of England, even when the limitations on issue in the Bank Charter Act of 1844 are temporarily suspended---as has been the case in the three chief crises that have occurred since 1844. And it appears to me that only notes issued by Government, or by a bank which was understood to be practically secure of the support of Government in the ultimate resort, would have the unique quality required to resist the worst storms of distrust that experience shows to be possible.

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