Monetary Tales from the Farthest Shore

The second bank by the sea

My music playlist has nearly stagnated for years and, depending on your age, maybe yours has too. Evidence suggests that (partly) because of mind shenanigans, our musical palette does not quite expand past the age of 30. I think that something similar goes for gaming. I am still fond of those (pc) games from my late teen – early adult years and stay happily ignorant about the newer ones. Those single player games immersed you through substance over eye-candies. Some in-game scenes remain pure gold after all these years. Like that dialogue, when one of my younger siblings was delving in a fictional setting resembling the Caribbean during the Golden Age of Piracy. (Escape from Monkey Island. I preferred RPGs. Nowadays, only books – like this one.)

At some point, the protagonist, a witty swashbuckler, visited the Second Bank of an island called Lucre. “What happened to the First Bank of Lucre?”, he inquired. “Nothing”, said the bank teller, “It was our public relations department’s idea. They felt that being called the ‘First’ bank didn’t project an image of experience”. At the time I thought it as just a funny anachronism. Later, I recognized a jab to brand marketing practices and the corporate-speak more generally. But it was also the scheme of a “fledgling” first banking institution versus a “trustworthy” second one that almost held a real-world analogy. 

Some kind of a theory

There is a rich discussion on the origins of money, its form and the proper control of it, as well as a few historical cases of either state or private currencies thriving – or failing. Hard. In the thick of it, we talk about two positions. From the one hand, the “economics textbook” approach proposes that money emerged in the realm of private economic relations, to minimize transaction costs and facilitate trade. (Francisco d’Anconia would approve.) Here be a decentralized, bottom-up acceptance of the medium of exchange. This view sits well with the classical liberal dichotomy between the civil and state spheres, which can be expanded to envision a very limited role for the state in monetary affairs. From the other hand, the “anthropological – historical” position articulates that trust on money comes mostly from the sovereign’s guarantee, marked by the sign of God and/ or Emperor. This top-down explanation is more receptive to the state control of money, rhyming with the monetary power as a prerogative of the ruler and an expression of sovereignty. 

Beginning with some important judicial decisions in the second half of 19th century, the official assertion of state power over money came in the 20th century. Per the Permanent Court of International Justice, in 1929, “it is indeed a generally accepted principle that a state is entitled to regulate its own currency”. You know, the norm of modern national monetary monopolies. There was a time though, when things were more colorful and less unambiguous. From the 13th century onward to the Golden Age of Piracy and beyond, it was only normal for different monies of various issuers to flow from one territory to the other. Reputable currencies required not only a resilient authority backing them, but also a nod by society and custom. This kind-of-synthesis of the two positions outlined above rung especially true in the case of the young Greek state in 1830s – 1840s. (For this section I draw from the comprehensive “History of the Greek State 1830 – 1920”, by George B. Dertilis [the 2017 Crete University Press edition, in Greek. An extended version, under a different title, is forthcoming in English in 2021/22]. Btw, on Mar. 25 we celebrate 200 years from the Declaration of the Greek Revolution versus the Ottoman rule, an [underrated?] event with connotations of nationalism and liberal constitutionalism.)

Over there at the (Balkan) shore

As the new state needed to break free from all the institutions of Ottoman Empire, its hastily assembled first Bank of Issue sought to introduce a new national currency (the Phoenix). The impoverished, ravaged and cut off from international debt markets nascent state reflected bad upon the Bank. The government tried to force public’s trust via legislation. By decree, payments from/ to the state coffers would include a mandatory percentage of the new banknotes (later the percentage was set at 100%). Revenue from state natural resources – present and future – would back the currency. The administrative magic did not do it. The public actively tried to avoid the Phoenix banknotes, in favor of traditional silver/ gold coins. Bank and currency failed to crowd out the foreign monies and ultimately went out of business. A few years later, the overall environment had improved somewhat and a more vigorous state established the second Bank of Issue. Another new national currency, the Drachma, was already circulating in – copper – coins along with the foreign ones. 

The second Bank received an exclusive charter of issue and undertook the task to roll-out the Drachma banknotes (silver/ gold coins would follow) and, in doing so, integrate the fragmented Greek countryside to a more cohesive national economy. Up until then, the local markets had operated as loosely hierarchical oligopolies. At the bottom of the chain, each small village or group of villages was dependent on a merchant-money lender who held monopsonistic power over the (tiny scale) agricultural production and, at the same time, monopolistic power in cash and credit. These rural businessmen depended on the respective merchant-money lender of the nearest town for brokerage. Next in line was the merchant-money lender of the nearest city, usually with access to international trade routes. You get the picture. These informal networks contained competition among neighboring lesser merchant-money lenders and promoted trade through a complex web of transactions (involving forward contracts, insurance premiums and bills of exchange, among others). (The official site for the anniversary features a fancy piece about the first attempts to establish a national bank as well. It includes a few names and dates, while noticing the “exploitative” networks and the “primitive” credit system .I find its lack of nuance disturbing somewhat misleading.)

Becoming one with the forces

The Bank opted to tap and complement the existing disjointed market forces, in order to gently nudge them. It channeled its primary tool, lending in banknotes, to the local money markets, firstly, to a limited number of large merchant-money lenders, later to the middle ones. (According to the Bank’s ledgers, these clients usually chose respectable job titles, such as “Banker” or “Broker”. Others, a bit blunter, went by the Greek equivalent of “Usurer”.) This lending – apart from being short-term, relatively safe and profitable – enabled the Bank to gradually assume a leading position, without the need to deep dive at the specifics of each end-user of the market. The soft, indirect entry in the century-old customary networks lowered the cost of money and contributed to the integration of the national economy. The transition was not always smooth, with the occasional episode (people switching from banknotes to metallic coins, the Bank returning the favor by aggressively cutting back lending, the government setting compulsory percentages etc  – you know the drill), but still, the stakeholders’ incentives aligned. Society at large recognized Bank and currency, with the system reaching a workable equilibrium

The merchant-money lender of old was finally phased-out by regular bank lending in the next decades. Further underpinned by a cozy relationship with the state (always a valuable client, usually a partner, sometimes even an opponent), the Bank acted as a quasi-central banking institution until 1928, when the charter was transferred to the newly found Bank of Greece. The Drachma continued as official legal tender (albeit with numerous conversions) until the end of 2001.

Elective Affinities in Institutional Design, 1951

[Note: this is a piece by Michalis Trepas, who you might recognize from the now-defunct NOL experiment “Be Our Guest.” Michalis is a newly-minted Notewriter, and this is the first of many more such pieces to come. -BC]

The Treasury and the Federal Reserve System have reached full accord with respect to debt-management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government’s requirements and, at the same time, to minimize monetization of the public debt.

– Joint announcement by the Secretary of the Treasury and the Chairman of the Board of Governors, and of the Federal Open Market Committee, of the Federal Reserve System, issued for release on Mar. 4, 1951

The Allied High Commission appreciates that these responsibilities [for the central bank] could not, without serious inconvenience, be given up so long as no legislation has been enacted establishing a competent Federal authority to assume them.

– Letter from the Allied High Commission to Chancellor Adenauer, Dated Mar. 6, 1951


A Financial Fable by Carl Barks, a short story starring Donald Duck and his duck-relatives, was published in Mar. 1951. It featured concepts like supply/ demand, money shocks, inflation and the ethics of productive labor, from a rather neoclassical perspective. Read today, it seems out of synch with the postwar paradigm of a subordinated monetary policy to the activist state and, more generally, with what came to be known as the Golden Age. As you have already probably noticed, this March also marks the 70th anniversary of two more instances against the currents of the time. It was back then that two main traditions of central bank independence – based on political consensus and judicial (“Chevron”) deference in the case of US, based on written law and judicial review in the case of Eurozone (read: Germany) – were (re)rooted. In the following lines, I offer an outline focused on institutional interplay, instead of then usual dramatis personae

The first instance is the well-known Treasury – FED Accord. Its importance warrants a mention in nearly every institutional discussion of modern central bank independence. The FED implemented an interest rates peg – kind of capping the yield curve – in 1942, to accommodate public debt management during World War II. The details were complicated, but we can still think of it as a convenient arrangement for the Executive. The policy continued into the early 50s, with the inflationary backdrop of the Korean War leading to tensions between a demanding Executive and an increasingly resistant central bank. Shortly after the dispute became more pronounced, reaching the media, the two institutions achieved a compromise. The austere paragraph cited above ended the interest rates peg and prompted a shift of thinking within – and without – the central bank, on monetary policy and its independence of fiscal needs.

The second one is definitely more obscure, and as such deserves a little more detail. The Bank deutscher Länder (BdL) was established in 1948, in the Allied territory of occupied Germany. It integrated central banking institutions, old and new, in a decentralized fashion á la US FED. Its creation underpinned the – generally successful – double reform of that year (a currency conversion with a simultaneous abolition of price controls), which reignited free market forces (and also initiated the de facto separation of the country). The Allied Banking Commission (ABC) supervised the BdL and retained the sole right to issue direct instructions, a choice more practical than doctrinal or ideological. As the ABC gradually allowed a greater leeway to the central bank, while fending off even indirect German political interventions, the resulting institutional setting provided for a relatively independent BdL. 

In late 1950, the Occupational Authority wanted out and an orderly transfer of powers required legislation from the Federal Government. Things deadlocked around the draft of the central bank law, the degrees of centralization and independence being the thorniest issues. The letter cited above, arriving after a few months of inertia, was the catalyst for action. The renewed negotiations concluded with the “Interim Law” of 10 Aug. 1951. The reformed BdL was made independent of instructions from the Federal Government, while at the same time assuming an obligation to support government’s general economic policy – without prejudice to its monetary duties. 

This institutional arrangement was akin to what the BdL itself had pushed for, a de jure formalization of its already de facto status. Keep in mind that the central bank enjoyed a head start in terms of reputation and experience versus the Federal Government, after all. But it can also be traced to the position articulated by the free market-oriented majority in the German quasi-governmental bodies back in 1948, a unique blend of explicit independence from/ cooperation with the government. The 1951 law effectively set the blueprint for the final central bank law, the Bundesbank Act of 1957. The underlying liberal creed echoed in the written report of the Chairman of the Committee for Money and Credit of the parliament:

The security of the currency… is the highest precondition for the retention of a market economy, and hence in the final analysis that of a free constitution for society and the state… [T]he note-issuing bank must be independent of these [political bodies] and subject only to the law.

The Financial Fable was the only story featuring Disney’s characters that made it to an important history of comics book, published in 1971. Around that time, the postwar consensus on macroeconomic stabilization policy was reaching its peak. A rethinking was already underway on the tools and goals of monetary policy, taking it away from the still garbled understanding of the period. It took another decade or so for both sides of the Atlantic to recalibrate their respective monetary policies. The accompanying modern central bank independence, with its foundations set in 1951, became a more salient – and popular – aspect a bit later.

Tuesday links

  1. Economics is [only] one way of reflecting on the times
  2. Those revenue-raising early central banks
  3. Trumpism after Trump (too much straw)
  4. Never reason from a fatality rate
  5. The collapse of the ancient Roman tax base
  6. Multilateralism is alive and well (in the Indo-Pacific)

Nightcap

  1. The challenges of lending to Main Street George Selgin, Alt-M
  2. What Sweden has done right on Coronavirus Joakim Book, AEIR
  3. The State Has Seized Many New Powers. It Won’t Let Go of Them Easily. Andrei Znamenski, Mises Wire
  4. When disease comes, rulers grab power Anne Applebaum, Atlantic

Nightcap

  1. Bernie, Cuba, literary, and ill-gotten gains Irfan Khawaja, Policy of Truth
  2. The weird global coronavirus data Scott Sumner, EconLog
  3. Why the Fed shouldn’t “Do Nothing” George Selgin, Alt-M
  4. Corporatism (“anarchy”) on the Indian subcontinent Priya Satia, LARB

Nightcap

  1. Goodbye, Neal Peart Suleman Khawaja, Policy of Truth
  2. Great economics, bad politics (Banerjee & Duflo) Chris Dillow, Stumbling & Mumbling
  3. The Golden Age of the Federal Reserve is here Scott Sumner, MoneyIllusion
  4. Randolph Borne and the Progressives Nikhil Pal Singh, New Statesman

Be Our Guest: “The U.S. Economy: A Fading Illusion?”

This essay, by longtime NOL reader and CPA Jack Curtis, is the first essay of 2020’s “Be Our Guest” feature. Here is a snippet:

This widespread financial vulnerability seems a natural result of government policies that minimize interest rates and support monetary inflation as the Federal Reserve and other central banks have continued to do in recent decades. There is little incentive to save money when it offers no significant return and its value is inflated away. Governments that cling to such policies are imposing dependence upon their citizens, forcing them in essence to live hand to mouth, deprived of the ability to provide for their own futures.

Jack paints a pretty gloom picture of the U.S. economy. Does this square with what economists have been telling us about the state of the world? Please, read the whole essay, and if you have been thinking about writing for the public in 2020, give us a holler. We’d be happy to put your thoughts up for the whole world to read.

Nightcap

  1. Who betrayed Syria’s Kurds? Amberin Zaman, Al-Monitor
  2. How the Physiocrats confronted France’s empire (Smithian-Misesian-Hayekian federation) Pernille Røge, Age of Revolutions
  3. Strange respect for central banks Scott Sumner, MoneyIllusion
  4. This is just the beginning of Brexit Tom McTague, the Atlantic

Nightcap

  1. Indigenous actors and International Relations Andrew Szarejko, Duck of Minerva
  2. You’re all a bunch of socialists Bryan Caplan, EconLog
  3. Doubting disaster capitalism Chris Dillow, Stumbling & Mumbling
  4. Inside America’s worst financial crisis Amanda Griffiths, Alt-M

Nightcap

  1. The threat of fanaticism Chris Dillow, Stumbling & Mumbling
  2. On targeting the price of gold George Selgin, Alt-M
  3. Reinventing language Catherine Charrett, Disorder of Things
  4. Geopolitics and Greenland Jon Rahbek-Clemmensen, War on the Rocks

Nightcap

  1. From Lahore to Lancashire: Untold stories from imperial Britain John Keay, Literary Review
  2. The younger sons in Jane Austen’s England had to work Richard Francis, Spectator
  3. How soon we forget Scott Sumner, EconLog
  4. Gin, sex, malaria, and American anthropology Charles King, Chronicle Review

Nightcap

  1. How to flip a yield curve George Selgin, Alt-M
  2. How ergodicity reimagines economics Mark Buchanan, Aeon
  3. How to think better about debt Lou Brown, Crooked Timber
  4. Why even have kids in today’s world? Bryan Caplan, EconLog

Nightcap

  1. Yield-curve inversion and the agony of central banking David Glasner, Uneasy Money
  2. Ossian’s Ride: wild Irish science fiction I’d never heard of Henry Farrell, Crooked Timber
  3. The pioneers of cultural relativism did a lot of good, too Patrick Iber, New Republic
  4. Umberto Eco: Champion of popular culture Paul Cobley, Footnotes to Plato

Those revenue-raising early central banks

In a piece on a rather different topic, George Selgin, director for the Center for Monetary and Financial Alternatives and editor-in-chief of the monetary blog Alt-M, gave a somewhat offhand comment about the origins of central banks:

For revenue-hungry governments to get central banks to fund their debts is itself nothing new, of course. The first central banks were set up with little else in mind. (emphasis added)

Writing about little else than (central) banks in history, you can imagine my surprise:

Reasoned response: Selgin ought to know better than buying into this simplified argument.

Less reasoned response, paraphrasing one of recent year’s most epic tweets: you come into MY house?! 

Alright, let’s make a quick run-through, then. Clearly, some simplification and lack of attention to nuances is permissible under the punchy poetic licenses of the economic blogosphere – especially so when the core of an argument lies elsewhere. But the conviction that early central banks

(a) were created as revenue-raising devices for their governments, or
(b) all central banks provided their governments with direct fiscal benefits,

is a gross simplification of a much broader and much more diverse history of early public banks. Additionally, the misconception entails what Italian banking scholar Curzio Giannini derisively referred to as overly-narrow “fiscal theor[ies] of central banks”. Since too many people believe some version of the argument, let’s showcase the plethora of early central banks and illustrate their diverse experiences.

Initially, the banks-as-fund-raisers argument may seem reasonable; a few proto-central banks definitely were set up with this purpose in mind, with the Bank of England’s series of monopoly charters beginning in 1694 as the prime example. David Kynaston, the great historian of the Bank, eloquently characterized the relation between the government and the Bank as a ‘ritualistic dance’ in light of the periodic renewals of its monopoly charter; the Bank provided the government with funds and in return received some new privilege in addition to lucrative interest payments.

Among the dozen or so other candidates reasonably fitting the description “first central banks”, we see a wide variety of purposes, not all of which were principally – or even at all – concerned with funding their governments.

Banco di San Giorgio (Genoa, 1407), was essentially a precursor of money market funds with investors holding the City state’s debt and receiving taxing rights. Here, as in many of the northern Italian city-state banks of the 14th and 15th century, the banks-as-fund-raisers argument seems applicable (we might mention others here too, like the Catalonian Taula de Canvi, 1401, that is often considered the first public bank). Whether or not these first generation banks may be counted as  “central banks” is much less doubtful, but a topic for another day.

Amsterdam Wisselbank (1609), a much-studied institution and a trailblazer in the history of central banking, was primarily set  up to facilitate payments, specifically to simplify the chaotic muddle of coins and payment methods that abounded in the Low Countries during the 1500s and 1600s. The Bank’s lending was circumscribed, and the lending that did take place often went to the Dutch East India Company – of course, we might argue that the Dutch East India Company, with its directors appointed by the Dutch provinces, actually constituted an arm of the government and so counting this lending as government financing. Besides, the City only began using the Wisselbank for financing purposes firstly through a loan in the 1650s and then more frequently towards the end of the 17th century. Regardless, those are (decades removed) outcomes – not initial purposes.

Hamburger Bank (1619) was similarly set up with monetary stabilization in mind and adopted many of the features of the Wisselbank. Contrary to the Wisselbank, it had a credit department that right away engaged in lending to private parties on collateral. However, it seems that most of its funds were lent to the Kämmerei (municipality treasury). In economists William Roberds and Francois Velde’s account, the

problems with circulating coinage in early seventeenth-century Hamburg were, if anything, worse than in Amsterdam.

A partial vindication, at best, for the banks-as-fund-raisers argument since the Hamburger Bank was clearly set up with monetary stabilization in mind rather than government financing. In practice, however, it did finance the city.

The Riksbank: (Stockholm, 1668). Picking up from its failed predecessor ‘Stockholms Banco’, what later became known as Sveriges Riksbank (frequently credited with being the first – surviving – central bank) was tasked with facilitating trade and upholding the value of the domestic currency. In practice, this meant influencing the foreign exchanges as they stood in Hamburg or Amsterdam. Initially, the bank was explicitly prohibited from extending funds to the crown (in early 2019 there has emerged a dispute over this point among some Swedish financial historians). What is clear is that for the first fifty years or so of the bank’s existence, the rule seems to have mostly held up; not until the Great Northern Wars in the early 1700s did the Riksbank to any meaningful extent advance funds to the government.

Bank of Scotland (1695) and the Royal Bank of Scotland (1727), were both – a bit like the Riksbank – chartered to advance and improve the functioning of the domestic economy, and they were prohibited from lending to the crown. Despite the well-known political conflicts leading to the chartering of the Royal Bank, the Scottish case of rivaling banks were clearly created to advance the North Sea trade, not to finance the government or manage its debt. The third chartered Scottish bank, the British Linen Company (1745) was formed in order “to carry on the linen manufactory”. As is often the case in banking history, the Scottish case might thus be the clearest counterpoint to an argument. Further, the Scottish banking historian Sydney Checkland pointed out that the Bank of Scotland was “solely dependent on private capital, and […] wholly unconnected with the state.”. Again, the No True Central Bank objection might be raised, but it would send us tumbling into a dark definitional hole that has to wait for another time.

Banco del Giro/Wiener Stadtbank (Vienna, 1703 and 1705) were both established as a result of “the poor state of Austrian public finance” Like in Venice and Genoa, the banks were meant to enhance the liquidity of the government’s debt, actively contributing to reducing the State’s and the City’s interest rates respectively – and then gradually pay back their debt. While both banks did accept private deposits, and like its Hamburg and Dutch predecessors facilitated payments through their ledgers, these operations were clearly not their prime purposes. Money-raising argument vindicated.

This brief overview of some early central banks illustrate the point: banking history contains much wider experiences than a simplified money-raising argument implies. Indeed, even the First Bank of the United States – clearly an aspiring candidate to the title of ‘first’ central banks’ – seems to primarily have had trade-enhancing and economic development purposes in mind. This I say much hesitantly, since early American banking is definitely not my forte and I fully expect Selgin (and others) to correct me here.

Regardless, to claim that early (central) banks were set up with government finance in mind, is clearly an overstatement.

___

The title is a play on my favorite of George Selgin’s many brilliant articles, ‘Those dishonest goldsmiths’.

For the record, George Selgin is well-versed in this literature, and I’m merely using his quote as a stand-in for a common conviction among the not-so-well informed academic crowd.

Nightcap

  1. Functional Illiteracy Stephen Cox, Liberty Unbound
  2. Hydraulic Monetarism Nick Rowe, Worthwhile Canadian Initiative
  3. The “New” Monopsony Argument and the Suppression of Wages Mario Rizzo, Think Markets
  4. The Computer-Glitch Argument for Central Bank eCash George Selgin, Alt-M