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In the Previous piece Monetary history dealt with the double standard of the nineteenth century, a system in which both gold and silver coins circulated. We also described how, for practical reasons, the Dutch Central Bank (DNB) opted for silver and not gold for a single standard. In the nineteenth century, in addition to a discussion about the correct money standard, there was also a discussion about the coverage of paper money. What was this discussion about and how was it conducted in the Netherlands?
The coverage of our money is a topic that often recurs. Critics of our monetary system often point to the violent fluctuations of the Business Cycles which are caused by the way our money is created. This also creates financial bubbles. On the other hand, proponents of an elastic money system point to the need for a money supply that can breathe with the economy and the danger of deflation if the economy grows faster than the money supply. In England in the nineteenth century, a similar discussion led to the formation of two schools; the British Currency School and the British Banking School.
It is important in this discussion to distinguish between the regulatory principle (Currency Theory) and the principle of freedom, (Banking principle). Proponents of the principle of regulation see the most benefit in a money circulation consisting of precious metals. Traditionally, they did not exclude the issuance of banknotes, but that issuance had to be backed by precious metals. A strict application prescribed full coverage, but more elastic forms of the principle have also been applied.
In England, there were strict rules for the issuance of banknotes. There, the Bank of England In the Peel Banking Act In 1844 it was authorized to issue as many banknotes as the amount of government debt held by the bank. If the bank issued more banknotes, these notes had to be fully backed by precious metals. In several crises, this law has been suspended in England in order to be able to provide the necessary loans. The coverage obligation did not apply to bank deposits, so these deposits could grow faster than the amount of precious metal that was in return.
Bank of England note of 1856 (Source: Historyextra)
Since, according to Dutch economists, the system in England was not elastic enough, other possibilities were sought in our country. For this reason, less strict rules were chosen for the coverage of bills. For example, we described in a Other article that the Dutch Central Bank had a more elastic application of the regulatory principle, with an initial funding ratio of 40 percent. Only the number of banknotes that exceeded a certain threshold had to be fully backed by precious metals.
A strict implementation of the regulatory principle is therefore best in line with a gold standard, in which money is fully backed by precious metals. In such a system, there is often only one dominant bank that issues notes. The advantage of the system is that money retains its value, while today's money loses value over the years. Inflation is now very high high But in previous years, too, the aim was to achieve 2 percent inflation on an annual basis. However, a money standard also requires that prices are flexible downwards and that the price of labor must therefore also be able to fall. That is hard to imagine today, since wages do not go down through the intervention of trade unions.
The principle of freedom is diametrically opposed to the principle of regulation. According to the principle of freedom, the money supply can grow a little faster and the strict rules of the regulatory principle are superfluous. The banker's school was of the opinion that too much money could not be created, since an excess of money would be would flow back to the bank that had issued it. According to supporters of the Banking School are exchangeable for precious metals. In this way, the money supply can naturally adapt to the needs of the public and the public also retains confidence in the banknotes issued.
Supporters of the principle of liberty considered it unlikely that banks would print money unrestrainedly. After all, banks themselves could suffer a lot of damage and therefore have an incentive to handle money creation carefully, or so the thinking goes. That is why several issuing banks are possible in this system. Competition between banks also forces sensible policies. Too much money creation leads to distrust in a healthy market, after which people will move their money to healthier banks. Sensible policies are thus rewarded, because healthy banks get more customers and therefore more capital.
The discussion about the coverage of money was held in several countries. In England, this led to the above-mentioned system in which the money supply was subject to strict standards. The United States, on the other hand, opted for the principle of freedom. In the U.S. there were Thousands of banks who issued banknotes, although there were certain rules that these banks had to comply with.
Banknote issued in the state of Louisiana in America (Source: Wikipedia)
The Netherlands also had several economists who were involved in this discussion. For example, DNB President Willem Mees opponent of the idea that banks should be released. He saw much more merit in strict rules for the coverage of banknotes. Mees thought the coverage of 40 percent up to a certain threshold was the best system; Not too elastic, but not too rigid either. Competition between different banks only led to uncontrolled money growth and could therefore fuel enormous inflation, according to the former president of DNB.
Former President of DNB Willem Mees (Source: Elsevier)
Mees also found his opponents, such as Professor Johannes Buys, who was a fervent proponent of a multi-bank system. On the contrary, he considered competition between banks to be particularly desirable, as DNB's track record was not very strong at that time. Fifty years after the bank was founded, the focus was still mainly on Amsterdam. Many people in the province had never held a DNB banknote in their hands. Despite this mediocre performance, the Dutch Central Bank did earn a lot of money through the monopoly on the issuance of money.
According to the professor, an issuing bank that also had the exclusive right to issue should have achieved much more than DNB had done. Buys wondered why there couldn't be more issuing banks besides DNB. The arrival of other banks would force DNB to innovate more. In addition, other banks should also be able to benefit from the issuance of banknotes. Any dangers that arose if several banks started issuing banknotes could easily be overcome with capital requirements and by the convertibility of the notes for precious metals, according to the professor.
The Banking Act of 1863 complied with the principle of freedom by keeping the possibility of multiple circulation banks open for the time being, although DNB's patent was extended by 25 years. It was not until 1948 that DNB would legally become the only institution allowed to issue banknotes.
As a result, the Dutch Central Bank was in a different position from other European national banks. In other countries, the national banks had to compete with other issuing banks, while DNB faced hardly any competition. In England around 1880 there were still 166 issuing banks, although the Bank of England After the Peel Banking act by far the most important. In France, the Banque de France up to 1848 it competed against seven competing institutions. In Germany, in addition to the Reichsbank 32 other issuing banks and in Italy the Banca d'Italia share the emission right with five other banks, according to the book De Nederlandsche Bank by Wim Vanthoor.
Eventually, in the course of the nineteenth or twentieth century, many of these banks were granted the exclusive right to issue banknotes. In fact, some countries received this before such a law was drafted. This was the case in the Netherlands, for example, because there were simply no other issuing banks. In other countries, the national banks did not acquire this position until the entry into force of a law. The fact that from then on only one bank was responsible for the issuance ensured that the money supply could be better regulated and that inflation could thus be fought more easily.
The influence of the government was also less felt, because the bank was better separated from the government. For example, from the Banking Act of 1863 onwards, the Dutch government had less and less influence on the appointment of bank directors. As a result, the road to monetary financing became increasingly difficult. Unfortunately, this would go wrong a few more times, such as in Germany during the interwar period. Nevertheless, an important step had been taken for the organization of central banks. In the next section, we will describe how the Dutch Central Bank operated during the period of the gold standard.
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