Thomas Tooke

Archive for the ‘Unreserved Banking’ Category

On the original purpose of banking from Elbridge Gerry Spaulding

In Unreserved Banking on August 14, 2012 at 2:06 am

Elbridge Gerry Spaulding is known for his “history of the legal tender paper money issued during the Great Rebellion being a loan without interest and a national currency”, and as a chief promoter of fiat money to finance the civil war. However there is a speech which is quite interesting called “One Hundred Years of Progress in the Business of Banking”, which Spaulding gave at the Meeting of the Bankers Association.

He wrote:

” In collecting historical facts I have frequently adopted the verbatim statements of those who have previously written upon the subject. The Bank of Venice, the first establishment of the kind in Europe, was established in 1171, and owed its existence of the Crusades, and the necessity of the government obtaining means for conducting these wars. It was originally a bank of deposit, and in the earlier days of the institution these deposits were not subject to draft, as is generally the case with banks of this kind. These deposits could, however, at the pleasure of the owner, be transferred on the books of the bank. This system was at a later period discontinued, and the deposits became subject to draft. This bank continued in existence without interruption until it was overthrown by the revolutionary army of France in 1797.

The Bank of Genoa was projected in the year 1345, but did not go into full operation till 1497. It was for centuries an important institution in that commercial city, but in 1800 it shared the same fate as the Bank of Venice, by being pillaged by the French army under Massena.

The Bank of Amsterdam was founded in 1609,  Holland being then possessed of a large foreign trade. This bank was only a bank of deposit, and the money in its possession was transferred on the books of the institution at the pleasure of its owner or owners. The primary object in the establishment of the bank was to give a standard of certain value to bills which might be drawn upon Amsterdam — rendered necessary by the depreciation of the coin owing to its having been worn or clipped. Here these coins were received on deposit, and had their value established by weight or fineness. It was not the design on founding the institution that the funds should at any time be lent out, but should remain in its vaults. However, the directors having lent to the governments of Holland and Friesland a large sum of money, the fact became known on the invasion of the French army, and produced the ruin of the institution. The Bank of Hamburg was established in the year 1619. This institution is a bank of deposit and circulation, which circulation was upon fine silver in bars.

Bank of England.

The Bank of England was established in 1694 — William and Mary then being on the Throne. To the war with France, and the extreme difficulty experience by the Government in raising funds for the war, is the institution of the monopoly due. Like the earliest of these institutions, the Bank of Venice, it owes its existence to the wants of the Government which gave it life. The idea first originated with Mr. William Patterson, a merchant of London, who readily saw that the Government, which had been paying interest at the rate of from 20 to 40 per cent. per annum, would, without much hesitation, grant exclusive and almost unlimited privileges to such parties as would in turn furnish it with a fixed and permanent loan at a reasonable rate of interest. The plan being brought to the attention of the King, was submitted to the Privy Council, where the details were completed, and it was laid before Parliament. There, however, it met the violent opposition of a formidable party. Nevertheless, the bill was carried by the Government, and on April 25th, 1694, became law. It was provided that the capital, ₤1,200,000 should be permanently lent to the Government at 8 per cent. per annum; and that in addition to the interest, an allowance of ₤4,000 per annum should be made by the Government for the management of the debt.

The capital has, at various periods, been as follows:

1694, ₤ 1,200,000

1697, ₤ 2,201,171

1708, ₤ 4,402,343

1709, ₤ 5,058,547

1710, ₤ 5,559,996

1722, ₤ 8,959,996

1742, ₤ 9,800,000

1746, ₤ 10,780,000

1782, ₤ 11,642,400

1816, ₤ 14,553,000

Since first this institution was founded, its capital and the loan to the Government have been nearly identical in amount. The following are the dates of the several renewals of the charter, with the amount of Government debt at each period, to wit:
1694, ₤ 1,200,000

1697, ₤ 1,200,000

1708, ₤ 3,375,027

1713, ₤ 3,375,027

1742, ₤ 10,700,000

1764, ₤ 11,686,800

1781, ₤ 11,686,800

1833, ₤ 11,015,100

1844, ₤ 11,015,100

The management of the entire public debt of Great Britain is placed in the hands of the Bank of England, for which service it has received compensation which has from time to time varied in amount, according to circumstances. During the year 1845 this compensation was ₤94,111 19s. 10d. The Bank of England is a striking example of the combined power of public authority and private influence in sustaining the Government of England, as well as the agricultural, manufacturing and commercial business of that empire. This bank has been the chief agent in sustaining the British Government in the long and exhausting wars in which she has been engaged. ”

” The bank of England is the fiscal agent of the Government”.

Well, this is unequivocal, central banks are a mean to an end, those are there to finance the government the trade was to grant a monopoly of issuing the currency which would be very lucrative to whomever that bank would belong to. In exchange for that monopoly the bank would fund the government. This is very clearly stated by one of the chief proponent of the Greenback during the civil war, Elbridge Gerry Spaulding.   It will become clear how it initially functioned from the account from E.G. Spaulding during the civil war. Before that banks were issuing private money, or bank notes backed by coins. So today, we still have a war currency and a central bank whose primary responsibility is to fund the Government debts, nothing more, nothing less. At least Spaulding is honest about the design of this system. As per the so called “central bank independence”, this probably the most silly joke that one could come up with, maybe to the exception of Germany´s bundesbank, since the very purpose of a central bank is to lower the cost of borrowing from the Government at the expense of the population.

How to finance the war bonds and destabilize the monetary system. Repression creating inflation.

In Unreserved Banking on May 19, 2012 at 9:42 pm

In 1920 Kemmerer wrote the following:

[…]

By maintaining official discount and loan rates at federal reserve banks below the market rates and by granting rediscounts liberally, we placed “the market in the federal reserve banks,” we encouraged a “borrow and buy” policy for war bonds and certificates of indebtedness, and made borrowing that resulted in a rapid expansion of our circulating bank credit — deposit-credit and federal reserve notes– appear to be both profitable and a matter of patriotic duty to all parties concerned. The fact that these two kinds of circulating credit were interchangeable to the public on demand, by the deposit of federal reserve notes or by the cashing of checks for notes, enabled the public to decide what proportion of this increased supply of circulating credit it should hold in the form of federal reserve notes. We inflated by expanding circulating credit. The public decided the form in which this newly created should circulate. Preferentially lower discount rates on war paper were an additional factor in this deposit and note expansion, and one that explains in part the large holdings of such paper by our banking institutions, holdings that are estimated to amount to something in the neighborhood of six billion dollars.

Now that the war is over this sort of expansion clearly should be stopped. War patriotism and progressive bank-credit expansion can no longer buoy up securities to artificially high levels. The real market rate of interest must now emerge and dominate the situation. There is no question but that the real rate is much higher than the camouflaged war rate. To an increasing degree Government war bonds and certificates of indebtedness must stand upon their own bottoms as investments.  The market should be “outside of the federal reserve banks. ” In other words, the federal reserve bank should rule as it did before our entrance into the war, and as does usually the Bank of England´s official rate, higher than the market so that recourse by banks to the discount and loan facilities of the federal reserve banks should be only an emergency recourse for temporary needs, not a recourse for permanent funds.

In the future preference should be shown to short-time loans of a self-liquidating character, as originally contemplated by the federal reserve system; and to an increasing degree, loans on the security of government debt should be discriminated against by federal reserve banks, both as to discount rates and in the matter of the banks´discretion, as to how much they shall loan and to whom.

Gradually but firmly government paper should be forced out of the federal reserve banks and out of the commercial member banks and into the strong boxes of the investing public, including the vaults of saving banks, insurance companies, and endowed institutions. To this end, in my judgment, the federal reserve banks should follow up their recent advances in discount rates, gradually raising the rates higher until they become effective in forcing a contraction.

The present preferentially low rate on loans secured by certificates of indebtedness should be discontinued. If an artificially and preferentially low re discount rate is necessary in order to enable the government to float these securities at their present low interest rate, then we are paying the price of further inflation for a low interest rate on the certificates. In that case why not frankly recognize the fact that in an unsupported market, the present rate is too low and should be raised, if further issues become necessary.

[…]

Kemmerer continues…

[…]

We should not be under the necessity of seriously impairing our banking system and of perpetuating highly inflated and unstable circulating media, with consequent high prices,in order to buoy up the market prices of bonds that were floated at abnormally low interest rates on waves of war patriotism.

[…]

A personal comment here: It seems that the same old tricks are being used to “stuff” the banks with government war bonds, expand the circulation and have the war bonds a source of debt-rehypothetication. The result is massive inflation between 1913 and 1920.

There is no manipulation of the Gold price! At least not before September 7th 1917. Or before 1873? Patrotism used again as the excuse.

In Inflationary Period of 1913-1920, Uncategorized, Unreserved Banking on April 29, 2012 at 3:19 pm

In the middle of 1830s, Gold was free to leave the Bank of England, and the bullion free to be exported. When over-expansion of paper money would occur, the result would prompt the speculators to lean against the tide by changing their Gold early in the process for Bullion and ship it overseas. This would lead to a contraction and at some point it would become interesting to bring bullion again in the UK.  However on September 7th, 1917 the United States government decided to monopolize money further (after the Fed layered the banking system with war bonds –treasuries–),  and declared an embargo on Gold shipments.

As Kemmerer writes:

[…]

The heavy drain of gold which such a condition of affairs would normally have brought about was prevented by the gold embargo, which was in effect from September 7th, 1917, to June 10th, 1919, by the government´s giving wide publicity to the doctrine that hte use of gold coin or gold certificates in circulation was an unpatriotic act, that all gold should be impounded in the federal reserve banks where it would serve the country with maximum efficiency, and by the further fact that most of the leading countries of the world were inflating their currency and bank credit at even more rapid rates than we were.

The result was an expansion of bank loans and, in consequence, of deposit currency such as this country and probably no other country ever saw before in an equal space of time. In the following table the expansion of bank deposits is shown. The figures cover individual and government deposits in commercial banks and government deposits in federal reserve banks.

[…]

Here we have within a period of six years an increase in our national bank deposits of approximately 118 per cent, or over seven billion dollars, and an increase of state bank and trust company deposits of over 121 per cent, or over six billion dollars. The two together represent and increase of over 120 per cent of our deposits in commercial banks since 1913, or an increase of over 13 billion dollars. Probably 80 to 85 per cent of the country´s business is concluded through the instrumentality of bank checks. It is through checks that deposits circulate and that the bank´s depositor gives expression to his demand for goods. The war period has been one in which deposits have circulated at a more rapid rate than usual and the doubling of deposits has therefore probably resulted in an even greater increase in the country´s deposit currency circulation.

This tremendous increase in bank deposits has resulted in a great decline in the average percentage of actual cash reserves held against deposits — namely the ratio of deposits (as above computer) to actual cash held by national banks, state banks, trust companies, and federal reserve banks (exclusive of reserves held against federal reserve notes). This average percentage for the country as a whole has varied as follows since 1913:


The hidden high interests to the government. War as a distorting mechanism to boost demand for capital.

In Inflationary Period of 1913-1920, Unreserved Banking on April 29, 2012 at 2:39 pm

Kemmerer makes an interesting argument that indeed high interests have to be paid one way or the other even if the nominal interest rates are low.

[…]

The Fundamental economic law which makes the interest rate the resultant of the interaction of the forces of demand and supply in the capital market was forcing up the real interest rate under the influences of a world wide destruction of capital and an unprecedented demand. “Present goods were at a large and ever-increasing premium over future goods.

The government, it is true, paid lower rates of interest on its bonds, but it was compelled to pay higher prices for the war supplies it bought, and was therefore compelled to float more bonds. It paid lower interest rates by reason of this policy, but it paid an dwill pay more interest.

[…]

Here I will interest some remarks. It sounds like the destruction of capital and manufacturing capacity, and probably the restriction of the flow of goods (which also a feature of the Napoleonic wars as noted by Tooke, has the real impact of forcing the demand for capital up. True the soldiers dead by millions reduce demand undeniably, but overall the destruction of capital is larger than the destruction of population.

[…]

Because of the observation that the more money and deposit credit an individual has the more goods he can buy, the inference was popularly drawn that the more money and deposit credit the government could get, the more war goods and services it could buy. The forces above described favored loan and deposit expansion. Such expansion was profitable to the banks and profitable to businessmen, while to the banker, the business man, and the ordinary citizen, the acts which were resulting in this expansion appeared to be acts of patriotic duty.

The unique purpose of low interest rates: Fund the government debts, concept of risk free upside down, usurpation of interest rates mechanism

In Inflationary Period of 1913-1920, Unreserved Banking on April 27, 2012 at 2:31 am

As Kemmerer further explains in 1920, the main purpose of low interest rates was to fund the government and it was dearly paid by the citizens of the United States through steep inflation.

[…]

In their laudable desire to keep interest rates low on bank loans to essential war industries, and more importantly, to make possible the floatation of large government war loans at excessively low rates of interest, the federal reserve authorities adopted a policy of low discount rates for the federal reserve banks and of preferential rates and great liberality for advances made on the security of government war obligations. Throughout the entire period of our belligerency the loan and discount rates of the federal reserve banks were below the market rates, and “the market was in the federal reserve banks.” Funds received by banks for the government through the sale of liberty bonds and short-time certificates were usually left for a time on deposit with these receiving banks at the low rate of 2 per cent interest and without reserve requirement. This policy greatly expanded deposit credit. When the deposits were called by the government the funds for meeting the calls could readily be obtained by the bank´s borrowing from its federal reserve bank either by the rediscount of war paper, or by a direct loan collateraled by government security; and the rates charged for these loans were usually enough lower than the rates paid to the banks by the customer for his advance used in buying the bonds to yield the bank at least a small net profit. The result was the piling up of many billions of dollars of liberty bonds and certificates of indebtedness in the commercial banks of the country and the federal banks, particularly the latter, in the form of collateral for loans.  Federal reserve banks loans so collateraled provided member banks with a continuously increasing supply of legal reserves for further loan and deposit expansion; and the expansion of federal reserve loans, with resulting increase in federal reserve deposits and issues of federal reserve notes was continually reducing the percentage of reserves held by federal banks. We bough our low interest rates on government paper at the price of very high prices for commodities. We kept interest rates down by a policy that kept pushing the price level up.

[…]

I will add a few personal comments here. This paragraph is important because a lot falsehood commonly held as “truth” are revealed here.

First on the issue of central bank as an independent entity. It appears that without re-discount from a federal system there would have been no demand for war bonds (treasuries), hence the conclusion is that the Federal Reserve was there to facilitate the low borrowing costs of the government.

Second the idea that the Fed must set interest rates is heavily fought by this author in 1920 as we will see later. He actually complains that “the market is in the Federal Reserve banks” instead of being in the real market.

The great fallacy of risk free rate on government bonds has the following origin. In order to maximize the flooding of government bonds in the banking system, the reserve requirements are 0. The legal requirement has nothing to do with the risk.  It is an upside down concept ignoring the agenda of the government.

The Federal System by treating government bonds very liberally without regards to the good bills doctrine but purely by political imperative, results in expansion of credit based on the re-hypothecation of government bonds with artificially low rates.

 

A convenient way to flood the banking system with government securities.

In Inflationary Period of 1913-1920, Unreserved Banking on April 27, 2012 at 1:55 am

As Kemmerer wrote, patriotism was quite convenient:

[…]

Much of this potential loan and deposit expansion appeared in the early years of the war, when the demands of European belligerents for our products assumed tremendous proportions and offered high profits to American producers of materials, so high as to call for a large expansion in the production of these materials. Labor was shifted from “non-essential industries” to “essential industries,” and while many of the former lagged, the latter were greatly stimulated. Here then was a great demand for increasing bank credit at just the time that the establishment of the federal reserve system, the reduced cash reserve requirements of commercial banks, and the heavy imports of Gold from Europe were making a larger loan and deposit expansion possible. The new federal reserve law and the  heavy gold imports created a potential supply of new circulating bank credit, the war stimulated the demand. It was the banker´s financial interest to expand credit, and to the interest of many groups of business men to seek these newly available funds.

As a matter of patriotic duty bankers were expected to expand their loans and deposits. Long before the United State entered the war, the sympathy to the Allies in this country became so pronounced and the conviction that they were fighting our battles became so strong, that production for the Allies and the granting of loans to finance such production were felt to be patriotic acts. After the United States entered the war, the extension of bank credit to the maximum limit consistent with safety to “essential industries,” and to the buyers of libery bonds was looked upon as the paramount duty of banks. “.

[…]

My comment here about how the Treasuries (war bonds) were initially inserted into the banking system with the incentive to let people borrow short term at low rates to buy liberty bonds and make a “spread”. Before that, without the generous  discount, it would be very difficult for the bank to have incentives to load up on government war bonds. This is how the Treasuries invade the banking system.

More from Kemmerer´s writings…

[…]

The demands of patriotism were looked upon as requiring the public to avail themselves to the limit of the liberal loan facilities made available by the banks. Nearly everywhere the belief prevailed that with the loans thus available, war industries should expand their production and the public should buy bonds to the maximum. “Borrow and buy”was a widely used slogan in the first three liberty loan campaigns, and was strongly, although more quietly, urged upon the public, in the fourth liberty loan and the victory loan campaigns.

[…]

The mechanics through which the Fed encouraged Malinvestment in 1913

In Unreserved Banking on April 27, 2012 at 12:53 am

In  a previous post we have discussed the level of unreserved banking which the Federal Reserve System brought about. Today I want to show how exactly the Malinvestment was encouraged by the Federal Reserve System.

As Kemmener discussed in 1920.

Take the case of a bank in a central reserve city which had been normally carrying a cash reserve in the neighborhood of say 25 per cent, because that was the minimum per-centage required by law, or because experience had shown that a reserve about that size was best suited to its particular type of business, or both of these reasons. Such a bank we will assume after the establishment of the federal reserve system, of which it became a member, found that the legal reserve requirement against demand deposits was cut to 13 per cent and that the greater liquidity of its assets brought about, through the facilities for rediscount and collateral loans offered by the federal loans offered by the federal reserve system would apparently make it safe for it to reduce its reserve to 17 per cent (namely, 13 per cent legal reserve in the form of a deposit with its federal reserve bank and 4 per cent cash in vault).

What would be such a bank´s probably course of action under these circumstance? The answer is obvious. It would reduce its normal reserve percentage from 25 to 17 because by so doing it would increase its profits without materially weakening its financial position or impairing its efficiency. The most likely method of doing this and the method that would probably be used, if possible, would be for the bank to extend its loan and deposit accounts. To do this it might well reduce its discount rates, extend the credit limits of its best customers, and possibly extend credit to others whom it had previously refused out of what might appear to it now to have been an excess of caution (emphasis added). In this way the loan account would be expanded, deposits would be increased, and the reserve percentage (legal plus till money) would be reduced from 25 per cent to the new norm of 17 per cent, the bank thereby probably realizing for its stockholders substantially increased profits.

[…]

So the leverage in the economy is actually not regulated by the Fed, but promoted by its existence, note the impact on lending to clients which were before denied credit for lack of credit quality.

[…]

If this reduced reserve requirement were limited to one bank, the possibility of deposit expansion thereby created would be small because the enlarged deposits resulting from the increased loans would tend to give the bank an unfavorable clearing house balance, and to draw quickly away thereby a part of its reserve money. Under the conditions, however existing during the war period this opportunity and this motive for reserve reduction, or in other words for loan and deposit expansion, were open to all of the national banks in the country and to large numbers of state banks and trust companies. It was but natural therefore that they should all endeavor to expand, in order to take advantage of the opportunity to increase their profits. The last few years have been highly profitable years for commercial banks.

[…]

The Fed encouraging un-reserved banking from the Start (1913-1919 account).

In Unreserved Banking on April 26, 2012 at 2:01 am

Kemmerer writes the following in his books in 1920:
[…]

State banks and trust companies entering the federal reserve system have generally experienced substantial reductions in legal requirements so far as actual cash reserves are concerned.  The reduction of legal reserve requirements was a statutory recognition of the fact that smaller cash reserves are needed under a banking system possessing a group of central banks of issue and rediscount than are needed under a highly decentralized system of banks like our American banking system prior to the federal reserve act. It was perfectly proper that with the establishment of the federal reserve system the legal reserve requirements of the banks should be reduced. Whether the reduction was too great or not, only experience will tell. […]

Well I let the readers make their own opinion about that. Kemmerer continues.

[…]

In the writer´s judgment the reduction was excessive, and it was a mistake to discontinue all-cash-in-vault legal reserve requirements of member banks. The important fact however, to note is, that the reduction of reserve is taking place at just the time when the country was being flooded with gold from the belligerent countries of Europe created the possibility of a tremendous loan and deposit expansion. This potential expansion was quickly turned into an actual expansion under the pressure of four important forces.

In fact from August 1st, 1914 to April 1917 (practically the period of the war prior to our entrance as a belligerent), our net importations of gold amounted to $1,109 millions and this enormous increase in our supply we maintained throughout the remainder of the war. We have most of it to this day, although there have been substantial losses since the armistice.

There four forces  were:

(1) the natural desire of bankers and business men for profit

(2) the patriotic impulses of bankers and business men to render the nation the best possible service in its time of emergency

(3) the desire of the Government to finance itself with the minimum disturbance to legitimate busines

(4) the desire of the Government to float its securities in large volume at the minimum possible rate of interest.

Reserve requirements reduction during 1913-1919. The Federal un-reserved system.

In Unreserved Banking on April 25, 2012 at 3:02 am

As Kemmener writes in March 1920:

[…]

The period of 1913 to 1919 was a period in which the country´s legal reserve requirements for bank deposits were enormously reduced. In 1913 national banks in central reserve cities, namely, New York, Chicago and St Louis, were required to keep on hand cash reserves equivalent to 25 per cent of their deposits, both demand deposits and time deposits. National banks in the 47 reserve cities were also required to maintain reserves of 25% per cent, but one-half of this could be maintain as an ordinary deposit with a national bank in a central reserve city. Other national banks, so called “country banks” were required to maintain against deposits reserves of 15 per cent of which three-fifths could be held as an ordinary deposit with a national bank in a reserve city or a central reserve city. For all banks the 5 per cent cash redemption bank notes was counted as part of the legal reserves against deposits.

At the present time (1920) all legal reserves of national banks consist of deposits with federal reserve banks consist of deposits with federal reserve banks against which deposits the federal reserve banks are required to maintain only 35 per cent lawful money reserve. Time deposits, namely deposits after notice of 30 days, which constitute about one-fourth of the total individual deposits of national banks, since 1913 have been treated separately as regards legal reserves and in all national banks are now subject to a reserve requirement of only 3 per cent. The 5 per cent bank note redemption fund can not longer be counted as legal reserve against deposits. Against demand deposits the present legal reserve requirement is 13 per cent for banks in central reserve cities, 10 per cent in reserve cities, and 7 per cent for banks in other cities.

An idea of the extent of the reductions in legal reserves of national banks since 1913 can be obtained by assuming three national banks, each having $1,200,000 demand deposits, $300,000 of times deposits, and $100,000 of national bank notes outstanding, one bank being in central reserve city, on in a reserve city, and one in a “country bank” city, and asking ourselves what ultimate legal cash reserves would have been held against theses deposits in 1913 and 1920 respectively. The answer is given in the following table.

[…]