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The Pamphlet Collection of Sir Robert Stout: Volume 81

Chapter V. — A State Bank

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Chapter V.

A State Bank.

There is a disposition on the part of a large body of men to ascribe the economic ills of society to the money question. We have ardent advocates of Bimetallism, and still more ardent believer, in a State Bank. The former are a negligible quantity in practical politics, the latter by their numbers and importunity command attention. The faith of the working classes in the efficacy of abundant money as a panacea is hard to shake. No topic is more beset with subtle and insidious delusions. "All the evils of the day," says Jevons—" slackness of trade, falling prices, declining revenue, poverty of the people, want of employment, political discontent bankruptcy, and panic—have been attributed to the want of money" The remedy formerly proposed was to set the Mint to work; that now suggested is to start a printing press for the issue of paper money.

A State Bank and paper money are indissolubly associated. Many conceive of such a Bank as an institution where money can be made without limit and without cost. The popular mind invariably connects with it a printing press turning bales of paper into bank notes. As money can always purchase things and employ labour, it is thought that the more money there is the more commodities can be obtained, and the more labour employed. Thus the State, by the issue of paper money, could construct its public works and carry on the administration of government without appreciable cost. An illustration of this belief is afforded in the annual discussions upon the subject of the New Zealand Trades and Labour Conferences. With unfailing regularity, the desirability of the Slate's monopolising the functions of banking; is affirmed. With the same regularity resolutions are passed that the State should build its railways by the inconvertible paper money of such State Bank.

If the Australasian States, by monopolising banking and reserving to themselves the sole right to issue paper money, can construct roads, bridges, and railways without the necessity of recourse to the British money-lender—without cost, in short—then it will be generally admitted they should assume the discharge of these functions without delay.

An analysis, therefore, into the operation of paper as money must precede any judgment upon the merits of State banking. For it is this which specially distinguishes State banking from any other form of State enterprise.

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History would seem to condemn the use of paper money unless it is convertible at will into coin. The dire calamities of the past have induced all civilised communities to adopt gold or silver as their standard currency. Paper is used, but always subject to the strictest regulation. "The Bank Charter Act "allows the Bank of England to issue against Government securities some £15,000,000 of bank notes without requiring any gold reserve for their redemption. After this limit is reached, the Bank must deposit, in its vaults gold equivalent to five sovereigns for every five-pound note it puts in circulation, so that at any time there is sufficient gold actually in the Bank to redeem all the notes in circulation in excess of £15,000,000. All the notes, however, are alike convertible into gold at the demand of their possessors.

But British internal trade is such that, under normal conditions, there will remain in circulation a minimum of Bank of England notes amounting in value to £15,000,000. Apart from finanacial panic, therefore, the Bank runs no risk of being unable to meet its obligation to give gold on demand for every note it issues.

The insistence upon the convertibility of bank notes, and the strict regulations which govern their issue, are in striking contrast to the conditions under which gold money is issued. For gold there is absolutely free and unlimited coinage. The Government make no charge for the cost of minting and impose no limit upon the quantity coined. Any man may take gold bullion to the Mint and have it coined into as many sovereigns as it will make. The State will give him back his bullion in the form of sovereigns, containing the same weight of fine gold as his bullion did, and charge him nothing for the labour involved.

From this it will appear that Britain has no fear of the over issue of gold. The State bears the expense even of coinage, that there might not be the slightest impediment to the increase of gold money. There is a total absence of those restrictions that encumber the issue of paper money. Seemingly there cannot be too much gold in circulation, but there is a danger of too much paper truth is, however, there may be an excess of gold as well as paper but the former is subject to natural causes of limitation which do not affect the latter. Let us briefly recapitulate here the argument used in a previous chapter in elucidation of the law governing the value of money generally. It is necessary to a proper understanding of the peculiar dangers incident to paper money.

Money is not wealth, but it is the power to procure wealth It is now generally recognised that money is the medium of exchange and that a country is not enriched by the mere possession of gold or silver or paper. If the worlds supply of the precious metals were doubled to-morrow, there would be no more bread to satisfy the hungry, no more clothing, no more houses—in short, no more com- page 41 modities capable of satisfying human wants. The possession of gold enriches only so far as the gold can be exchanged for consumable goods. Robinson Crusoe would have been poor indeed if he had been wrecked on an island whose racks were of gold and whose sands were of silver, but whose soil could not support vegetation.

The leading idea of the Mercantile Theory, however, was that of all forms of wealth gold was the most useful to a nation. The pre-dominance of this idea led Spain. France, and Britain to adopt every conceivable expedient, to increase the quantity of gold and silver in their countries. Governments generally, indeed, gave bounties on the export of home manufactures, placed heavy duties on the import of foreign goods, and forbade the export of the precious metals. By this means each country strove to robits neighbours of their money. When commodities were being exported, and no commodities were being imported, the exported commodities had to be paid for in coin. The benefits of foreign trade to a country were measured by the amount of money such trade brought into it. A nation was said to have a favorable balance of trade when exports exceeded imports, leaving a balance to be paid for by money. It was the empire of this belief in the pre-eminent preciousness of gold and silver which dictated the early colonial policy of Britain and Spain. The colonies of both countries were considered valuable only in so far as they furnished the mother country with abundant quantities of the precious metals. To this end they were uniformly prohibited from trading with any but the mother country, and their trade was restricted to supplying her with the raw produce of manufactures or with precious metal. When Columbus discovered America he was impressed not so much with the wide stretches of fertile soil as with the indications of rich mines of gold and silver. What excursions he made on that vast continent were made in pursuit of gold. To him the grand advantage of America to Spain was its capacity of pouring into her the inexhaustible supplies of its natural storehouse of gold and silver. For many years Spanish galleons plied the Atlantic carrying wares and trinkets to the aborigines, and returning freighted with the spoil of the mines. In many cases whole villages of natives were reduced to slavery and compelled to work in the mines that the stream of gold and silver into Spam might be swelled.

All the time the Spaniards thought they were growing rich. They held on to their treasure with amazing tenacity. They prohibited under severe penalties, the export of' any of the gold and silver and in order that still more might flow in they encouraged in every way conceivable home manufacturers to export their goods. The producer who sent his goods to the foreign market for sale instead of to the home market received a bounty. In this way the nation confidently expected to get rich beyond all others. It was sending away from it, shores the goods by which its people page 42 could be fed and clad, and taking in return precious metals, which in themselves could satisfy no human want.

Disaster followed. The more that gold streamed in, the more that money circulated, the more that precious metals accumulated the more aggravated became the poverty of the inhabitants. If money was wealth, the country was fabulously wealthy. Unfortunately, however, the process of filling the country with gold had emptied it of those consumable goods, the abundance of which alone constitutes a people's well-being. The gold was there, but there was a lamentable shortage of commodities to be purchased by the gold. Spain became poor through having too much money From a position of pre-eminence she sank into the second rank among European nations, and has remained there ever since. No doubt many causes contributed to the decline of the once formidable power of Spain, but the excess of money was by no means one of the least. Spain suffered more than any other from the Mercantile system, because she carried it out to the most extreme degree, and because of the fatal ease with which she obtained supplies of the precious metals from America.

No better example could be furnished of the possibility of a glut of money and of the evils arising therefrom. The superfluity of over-issue of money of any kind leads to depreciation of its value, and all the collapse of credit and depression of trade which such depreciation entails.

Let us indicate again with precision what determines the value of money. Competent authorities tell us that the value of money varies inversely with its quantity. In other words, the more money there is in circulation the less will be its purchasing power or value. Each coin will exchange for a less quantity of goods. The grand purpose of money is to act as a medium for effecting transferences of commodities from one person to another. The number of exchange that require to he made at any time is limited. If the money which is the medium of these exchanges be doubled in quantity each individual coin or bank note will purchase only half as much as formerly.

An illustration may help to elucidate the truth. Suppose that next pay day every wage earner in the Dominion of New Zealand finds his wages increased twofold. There are then twice as many sovereigns or twice as many bank notes being offered in purchase of goods as there were on the previous pay day there are no more commodities in existence. There are no more But boots to buy, no more clothes for sale. What happens then Prices rise. Every piece of money in circulation represents a demand for some article of consumption or for some service. To double the number of pieces is to double the demand. But this increase in money has in no way increased the supply of the goods page 43 demanded. The retailers will be quick to discern this, and will lift their priaccute;ces in response. There are two conditions under which prices always rise. The price of a commodity rises when the demand is stationary and the supply is diminished; it rises also when the supply is Constant and the demand increases. The practical effect of doubling the money the money in circulation will be to bring two purchasers to a shop for every one that formerly came, Where formerly there was £1 being offered for drapery or groceries, there will now be £2.

But will this be a hardship? Will not shopkeepers quickly dispose of their present stock and create a demand for more goods, which will stiaccute;mulate production in all industriaccute;es? Would not this increase of money give a tremendous fillip to industry, relieving the glut of the labour market, raising wages, and conferring innumerable other benefits.

Undoubtedly the immediate effect of an increase of money would be to give buoyancy to trade. It would lead to quickened industrial activity for the time being. But the sudden increase in the demand would bring about a sudden increase in the price, as retailers would find themselves temporarily short of supplies. The supplies which merchants keep are determined on calculations of normal demand. Consequently they would be unready to meet the suddenly enhanced demand. This unreadiness would manifest itself in rising prices. The iaccute;ncreased price, however, which they would secure for what stocks they had would induce them to make every effort to replenish their stock. To increase their stock they would compete with each other vigorously in the wholesale markets, and wholesale prices would go up. Wholesale prices going up the profits of wholesale dealers would be enhanced, providing a strong incentive for them in their turn to increase their stocks. This would lead them to compete with each other with added energy for the purchase of commodities from the producers. Thus the producers would be able to obtain an increased price for the products of their industry. But when these went to spend their increased earnings they would find that the price of everything they wished to purchase had risen, and that although they had more money than formerly they could not obtain more articles for consumption.

The ultimate effect, then, of the increase of money is simply to increase prices more money has to be given for the same satisfaction. Wage earners find themselves in possession of a greater amount of money, from which they undoubtedly derive some temporary advantage, for wages don't rise uniformly all at once, but the larger portion of the benefit of the increased wages is taken away by the upward movement of prices which quickly asserts itself. The benefit, again which the rise in prices gives to the retailer is largely taken away by the increased price he has to pay to replenish his stock. The benefit of this to the wholesale dealer is taken away page 44 by the increased prices he is obliged to pay the producer. This last, in his turn, loses the benefit of the increased price by finding that the purchasing power of his larger quantity of money has per unit diminished.

In the process of this diffusion of enhanced prices individual fortunes may be made, and trade will be brisk. Indeed, production may in some degree be stimulated, and the advance in prices slightly checked. There can be no doubt that a gradual increase is the volume of the circulating medium has a distinct tendency to impart vigour to industry for a time; but depreciation, with all its evils, cannot be long held back. When the process of diffusion is complete industry will settle down to its normal condition, with prices at a permanently higher level. Everybody will receive more money, but everybody will have to give more money for everything purchased.

If, now, the country with the level of prices thus raised is engaged in commerce with other countries, the high prices will attract foreign commodities. The outcome of this attraction has already been indicated, but its relevancy here makes a passing note advisable.

Exceptionally high prices in a country invariably encourage imports and discourage exports. Local producers will not send their goods to foreign countries if the home market offers higher prices. The necessary result is obvious. Goods will come in but goods will not go out, consequently money must go out in payment for the goods imported. In that way the country with high prices will have its money drained away until prices are reduced to the same level as in other countries, making allowance for cost of freight, etc. Thus, if one country has an excess of money, as shown by excessive prices, foreign trade will draw away the excess and distribute it over the world.

But what, it may be asked, has this to do with a State Bank and paper money? A moment's reflection will show its close relation. The advocates of a State Bank, or many of them, draw their enthusiasm from their belief in its efficacy to manufacture paper money without cost, and thereby increase the community's wealth. They believe that the railways of New Zealand could be built for nothing if only the Government would pay the men's wages in bits of inconvertible paper, and compel storekeepers landlords, etc., to take them in payment for groceries and rent The Government would then be independent of the British money lender, public works would be constructed, and nobody would pay for them.

The foregoing argument, however, indicates clearly the effect of such a course. Instead of paying in money already in circulation the Government would pay in new additional money issued for page 45 the purpose. The amount of money in circulation would thus be increased and prices would commensurately be increased. The position would be: all the money that was formerly in existence would be offered in purchase of goods, and, in addition the money which the Government had paid away in wages to workmen engaged on railway construction would be offered for goods. But the work of building a railway would not increase the supply of articles ready for consumption. The supply of these articles would have remained the same, but the demand for them would have increased. Hence the price of them would increase If then, as the result of the Government's action, the general level of prices was raised, the artisan would find that his weekly wage would not purchase as much as formerly. He would discover that the building of the railways for nothing involved the curtailment of his purchasing power." The effect would be exactly the same as though the Government had levied a tax on him to provide for railway construction. If it had taxed the commodities he consumed it would have had precisely the same effect in increasing their price.

The impossibility of constructing public works in some magic way by the multiplication of money appears from another consideration. Whilst the work of construction is in progress, those engaged upon it are not producing anything which can be con-Mimed or can satisfy any immediate want. They must be fed and clothed and housed by the labour of others. All the time the railway is in building, the workers are being sustained by the consumption of the products of the efforts of other men. In order that the railway may be built, those engaged in producing the food and clothing for the community must produce an extra quantity for the railway workers. The mere fact of giving to the latter bits of paper does not give them anything whereby they can support life whilst constructing the railway. What it does is, by increasing prices, to force all persons with fixed money incomes or wages to forego a portion of their consumption for the benefit of those employed on the railway. It is tantamount to a forced loan. There is in short, no royal road to wealth.

This conclusion finds abundant confirmation from history. The United States provides many examples. Massachusetts was the first State to try the expedient of meeting financial embarrassment by the issue of a paper money. In 1690 she embarked upon an expedition against the French in Canada, and, being in straits for money she paid her soldiers in paper. The amount not being excessive, the effect on prices was not very marked. The apparent success of the device of Massachusetts emboldened Connecticut to adopt the same course. She disdained, however, all restraints upon the issue of her paper. Whenever she wanted to make a payment, she printed a piece of paper and made her creditor accept it. Issue after issue followed in quick succession. In consequence, prices rose, or money depreciated, more and more. page 46 In 1710 an ounce of silver was worth 8s in paper, in 1724 it was worth 15s, in 1739 26s, in 1744 32s, in 1749 60s, in 1755 88s Trade was embarrassed and the utmost confusion prevailed. Credit was almost at an end. No guide remained for estimating the future value of goods.

The experience of Rhode Island was still worse. In 1766 £185 of paper money in the State was worth £100 in London. In 1749, after enormous issues of paper, £100 in London would purchase as much as £1,000 of paper money in the State. The disasters which fell upon the American States through the issue of inconvertible paper money were so great, that, under the Constitution of the United States, the issue of paper money of any kind by the individual States is prohibited.

The calamities which follow over-issue of money were still more marked in the case of the French assignats. These pieces of paper actually represented property. They were issued against ecclesiastical property which the Government had confiscated The property was assigned as security for the notes. But it makes no difference whether notes have property behind them or not. In either case over-issue will bring about the same result. As the millions of notes were poured into circulation, the depreciation went on apace, although the money was based "unshakeably" on the only real property, the "sole source of production, the soil on which we tread." The factories of the country were closed, vast numbers of workmen were thrown out of employment, yet hundreds of millions of pounds of money were put in circulation yearly. The trouble was capitalists dared not embark in industry; the changes in prices were so sudden and extreme. "Commerce was dead, betting took its place." An assignat professed to be worth £4. At the last it would not purchase as much as could be purchased by 3d before assignats were issued. The truth stands out unmistakably—by increasing money wealth is not created mere jugglery with money can't create wealth. It may transfer wealth from the pockets of one man to the pockets of another, but, it has no power to make an addition to the world's stock of goods that can be consumed and enjoyed. Nothing but the expenditure of human energy on the resources of nature can promote the lasting prosperity of a people. The belief in the efficacy of inconvertible bank notes, issued by the State, to perform what their advocates claim for them is a delusion finding no support from the first principles of banking or from the experiences of the past.

Indeed, the statement once made by a great financier hardly seems exaggerated: "That of all the contrivances for cheating the labouring classes of mankind, none has been more effectual than that which deluded them with paper money. It was the most effectual of inventions to fertilise the rich man's fields by the sweat of the poor man's brow."

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It is not difficult to see that an over-issue of paper bringing about depreciation of its value, and a consequent rise of prices, is detrimental to the working classes. It lessen, their purchasing power. It is extremely unsettling to business generally. In a time of rapid depreciation capitalists are loath to advance money on industrial enterprises. A man loses all security for adequate purchasing power a week later. A depreciating currency enables borrowers to pay back their loans with less purchasing power than they received. Vice versa, the lenders receive less than they parted with.

But why is paper more liable to depreciation than gold? There are two reasons. The world's supply of gold can only be increased by the expenditure of labour in the mines. Gold is the product of toil like any other commodity. The difficulty of getting it imposes a real limit upon its over-abundance in circulation. Besides, if gold were to depreciate greatly as money, it would be used more extensively in the arts for ornamental and manufacturing purposes. This alone would absorb surplus quantities, and prevent serious depreciation. Paper money, on the other hand, can be increased in quantity without any increase in cost.

The second reason is found in the non-exportability of paper. This is the vital characteristic of an inconvertible currency. International trade distributes metallic money evenly over the world. No country can retain a quantity of metallic money greater than its commerce entitles it to. As the general level of prices is determined by the quantity of money (qualified of course, by the rapidity of its circulation and the extent to which credit prevails), if one country, considering the number of its exchanges, has more than other countries, prices in that country will be higher than they are in other countries. The high prices will attract goods of other countries, and will discourage the export of goods to those other countries, for goods will not leave a country where prices are higher to go to countries where prices are lower. The effect will be that the country with high prices will have to send its gold out to pay for the goods imported. This export of gold will continue until the level of prices is reduced to that in other countries, after making allowance for freight, charges, etc. Thus the excess of metallic money will be drawn away by the action of commerce.

But such a process is impossible with paper money. Its amount is not subject to regulation by the law which distributes metallic money over the world. Its essential feature is limitation of circulation. The paper money of one country is absolutely use-less in another country. It cannot circulate beyond the boundaries of the country issuing it. Possessing no intrinsic value, foreigners will not accept it in payment for goods or in discharge of obligations. Consequently an excess of issue cannot be cured by foreign page 48 trade. Where a country has superseded gold by inconvertible paper, and issued it excessively, there is no remedy whereby the inflation of prices may be checked. Here lies the peculiar defect of an inconvertible currency. It is useless in effecting international exchanges. As prices become inflated exports of goods stop, and imports are encouraged. But the latter, too, must soon stop because there is no gold with which to pay for them, and goods will not be exported, seeing that merchant never pass a market where high prices prevail for one where prices are low. Hence foreign trade, which under a metallic currency redresses the evils of a redundancy of money, is impotent in this case.

It is true that trade between nations is essentially that of barter. Nevertheless, gold is in constant use for the adjustment of balances. It is universally acceptable, because of its intrinsic value because of its preciousness as a commodity apart from its use as currency. So that a country with a relative scarcity of metallic money will, by its low prices, stimulate export and discourage imports, thus drawing upon the world's supply of money to meet its deficiency. The monetary crisis through which the United States is now passing is an illustration of this. The phenomena are there observable of falling prices in the home market and inflowing gold from abroad. So a country with a relative abundance of money will not send goods out in payment for imports, but money. In the light of this effect of the operation of trade, it is not difficult to understand how a country with a metallic currency is immune from the calamities which so often befall the country with inconvertible paper.

For this reason it has become an orthordox article of faith in banking that paper should always be convertible into gold. When a person can at will take a bank note to the issuing bank and demand gold to the amount of its face value, it cannot possibly depreciate more than gold. Convertibility is the safeguard against depreciation.

Nevertheless, the advocates of a State Bank have solid ground to stand on. As is often the case, the intuition of the messes on this question is right, although the reasoning by which they affect to support it is unsound. A State Bank with the prerogative of issue of inconvertible notes will not perform miracles; but it will enable gold, the costliest of money, to be supplanted in the internal commerce of a country by paper, the cheapest of money. This process of displacement, by driving the gold abroad in purchses of foreign goods, will indirectly enrich the country. Indeed while this movement is in progress, the State is practically obtaining loans free of interest. When a country like New Zealand borrows £1,000,000 for railways in London the loan arrives mostly in the shape of railway material or other commodities ready for consumption. On this loan she has to pay interest and underwriters page 49 charges. If, instead of raising such a loan, she issued £1,000,000 of bank notes local prices would be raised, foreign goods would be attracted, and local gold would emigrate in payment. In short, the issue of £1,000,000 of bank notes would drive £1,000,000 of gold coin abroad, which would purchase the goods for which the loan was raised. This result arises from Gresham's law, which has been so often adverted to and illustrated, although not before named The saving of interest is obvious, and it is equally obvious that no serious damage to industry will take place so long as gold is going out of circulation as paper is coming in.

The export of gold prevents any pronounced depreciation of the currency. The evils of a paper currency arise when further issue are made without any corresponding displacement of metallic coin. Then every successive issue brings aggravated distress.

The dangers, then, incident to incontrovertible paper money may be conceded, and yet a strong ease made out for its use. It satisfies the needs of internal trade as well as coin. Why, then, should we go to the infinite trouble of digging gold and silver out of the mines to be used in effecting domestic exchanges when bits of stamped paper will serve the purpose with equal efficiency? There is really no reason at all apart from the fear of over-issue. If a sufficient gold reserve were kept for the purpose of adjusting balances in the commence of foreign countriaccute;es, and if the issue of paper were strictly limited to the needs of a country, we could dispense with gold for internal commerce not only without loss, but with gain. The cardinal objection to an incontrovertible currency lies in the unreliability of Governments. If they could be trusted, under all circumstances to resist the temptation to overcome temporary financial embarrassment by excessive, issue of paper, an inconvertible currency for internal exchanges would be ideal. It would be so cheap. But, as Walker says, viaccute;gilance must never be relaxed. "The prudence and self-restraint of years count for nothing, or count for but little, against any new onset of popular passion or in the face of a sudden exigency of the Government. A single weak or reckless Administration, one day of commercial panic, a mere rumor of invasion, may hurl trade and production down the abyss."

The substitution of £1,000,000 worth of bank notes for £1,000,000 worth of coin to be used in internal trade would augment a country's riches or store of consumable articles. Paper that cost nothing would do the work of the gold, and the gold would purchase commodities abroad. The practical question, however always forces itself forward: Will Governments ever exist which are proof under all emergencies, against the temptation of overissue of this money which is so easy of multiplication?

This is the only danger. If adequate provision can be made for it the ease for a State Bank stands triumphant. It must be page 50 admitted the functions of banking have a peculiar fitness for exercise by the State. They are of such a kind as to necessiaccute;tate, under all conditions, the intervention of Government control. The issue of bank notes is everywhere subjected to rigorous regulation. Indeed, there is a growing body of opinion amongst competent authorities that the issue of paper, whether convertible or inconvertible, should be as much the prerogative of the Crown as the minting of coins. When, in addition to this, account is taken of the fact that banking partakes largely of the nature of a monopoly that a metallic currency is costly and not inherently necessary for home commerce, the advocacy of a State Bank is shown to have a rational basis. If it is right that the State should entrench upon the domain of private enterprise at all, banking might well be among the first undertakings to engage its energy.

But let it never be forgotten that, in taking over banking, the State is not getting control of machinery which will construct its public works or discharge its obligations for nothing. No miraculous way is opened of growing rich without effort. Money cannot be increased ad infinitum without burden to the community A certain amount of money is needed for effecting exchanges with ease and rapidity. Any amount in excess, by increasing prices lessens the purchasing power of money. It partakes, in short, of the nature of a forced loan. A recognition of this limitation will save the zealots for a State Bank from pursuing it as a solutions of the problem of poverty, unemployment, and insufficiency of wages It does not touch these problems at any vital point. It is not a radical reform; established, the roots of social difficulties would remain unaffected. It has no more potency to redress the inequalities of society than the regulation of industry. Come it must and with benefit to the State; but if progress does not run along other lines, as well, our economic and social problems will stand as gigantic, as importunate, as puzzling as ever. Having exploded the belief in the infinite capacity of a bank to create money our way is clear of another obstruction.