Monday, August 25, 2014

Henry Dunning Macleod on the History of Banking

Henry Dunning Macleod was a 19th century historian of banking in Great Britain, and this is a nice summary by him of the nature and history of banking:
“Here, again, great misconception prevails as to the meaning of the word banker and the nature of the business of banking. Gilbert says: ‘A banker is a dealer in capital; or, more properly, a dealer in money. He is an intermediate party between the borrower and the lender. He borrows of one party and lends to another; and the difference between the terms at which he borrows and those at which he lends forms the source of his profit.’ So a report of the House of Commons says: ‘The use of money, and that only, they regard as the province of a bank, whether of a private person or incorporation, or the banking department of the Bank of England.’ Notwithstanding the apparently high authority of these passages, which have misled so many unwary persons, these descriptions of the nature of the business of banking are entirely erroneous. In former times, there were many persons who acted as intermediaries between persons who wanted to lend and those who wanted to borrow. They were called ‘money scriveners.’ The father of John Milton was a money scrivener, but no one ever called a money scrivener a banker. At the present day, many firms of solicitors act as intermediaries between persons who wish to lend and others who wish to borrow. They may have some clients who wish to lend and other clients who want to borrow; and they act as agents between them. The first set of clients may entrust their money to the firm to lend to the second set, and the solicitors receive a commission on the sums which pass through their hands. But no one ever called a firm of solicitors who transact such business ‘bankers’; which shows that there is an essential distinction between the business of money scriveners and such a firm of solicitors and the business of ‘bankers.’ Solicitors who transact such agency business do not acquire any property in the money which passes through their hands. They receive it merely as a bailment or a depositum. They are only the custodians or the trustees of the money and it is only entrusted to their custody for the express purpose of being applied in a particular way. The actual property in the money passes directly from the lender to the borrower through the medium of the trustees or bailees, and if the latter appropriated the money in any way to their own purposes it would be a felony, and they would be liable to be punished for embezzlement. But the case of a banker is wholly different. When his customers pay in money to their account they cede the property in the money to the banker. The money placed with him is not a depositum or a bailment; it is a mutuum or creditum; it is a ‘loan’ or sale of the money directly to himself. The banker is not the bailee or trustee of the money, but its actual proprietor. He may trade with it or employ it in any way he pleases for his own profit or advantage. The banker buys the money from his customer, and in exchange for it he gives his customer a credit in his books, which is simply a right of action to demand back an equivalent amount of money from his banker at any time he pleases, and the customer may transfer this right of action to any one else he pleases, just like so much money.

When the client of a solicitor entrusts money to him, to lend to some one else, he retains the property in it until the arrangement with the borrower is completed; and then the property in the money is transferred directly from the lender to the borrower, without in any way vesting in the solicitor. But when a customer pays in money to his banker, the property in it instantly and, ipso facto, vests in the banker; and the customer has nothing but a right of action against the person of the banker to demand back an equivalent sum. So long as the money remains in the possession of the customer, it is a jus in rem; but when he has paid it into his account he has nothing but a jus in personam.

Galiani says (Delia Moneta, p. 325): ‘Banks began when men saw from experience that there was not sufficient money in specie for great commerce and great enterprises. The first banks were in the hands of private persons with whom persons deposited money; and from whom they received bills of credit (fedi di credito), and who were governed by the same rules as the public banks now are. And thus the Italians have been the fathers and the masters and the arbiters of commerce; so that in all Europe they have been the depositaries of money, and are called bankers.’ So Genovesi says (Delle deioni di Economia Civile, part II., ch. 5, § 5): ‘These monti (banks) were first administered with scrupulous fidelity, as were all human institutions made in the heat of virtue. From which it
came to pass that many placed their money on deposit, and as a security, received paper, which was called and is still called bills of credit. Thus private banks (banchi) were established among us, whose bills of credit acquired a great circulation, and increased the quantity of signs and the velocity of commerce.’ And this was always recognized as the essential feature of banking. Thus Marquardus says (Dejure Mercatorum, Lib. II., ch. 12, § 13): ‘And by “banking” is meant a certain species of trading in money, under the sanction of public authority, in which money is placed with bankers (who are also cashiers and depositaries of money) for the security of creditors and the convenience of debtors, in such a way that the property in the money passes to them; but always with the condition understood that any one who places his money with them may have it back whenever he pleases.’

A ‘banker’ is therefore a person who trades in the same way as the public banks did; they acquired the property in the money paid in; and in exchange for it they gave bills of credit; which circulated in commerce exactly like money and produced all the effects of money. And, moreover, when they bought or discounted bills of exchange, they did it exactly in the same way; they bought them by issuing their own credit, and not with money. And experience showed that they might multiply their bills of credit several times exceeding the quantity of money they held; and thus for all practical purposes multiply the quantity of money in circulation. This the essential business of a banker is to create and issue credit to circulate as money.”
(Macleod, in Macleod, Horn and Townsend 1896. 199–201).
The essence of banking as an institution of capitalism has always been the taking of money as a mutuum, often with the client having the right to demand repayment of the bank’s debt to him on demand.

And it was not 17th century English goldsmiths who were the first European bankers, but banking in the sense defined above predated them by many centuries, and certainly existed not only in Italy in the Middle Ages, but also in the ancient Roman Republic and Empire too.

The business of banking as described above is not fraudulent. Thus the vision of banking as held by many Rothbardian libertarians goes against over 2000 years of capitalism.

The callable mutuum loan is – and always has been – a fundamental private business practice and, with the use of fractional reserves, the basis of banking.

This is why in the end Rothbardians – by their own criterion of being vehemently against restrictions on free, voluntary, non-fraudulent private exchanges/contracts – are actually anti-capitalist.

Macleod, Henry Dunning, Horn, Antoine E. and John P. Townsend. 1896. A History of Banking in all the Leading Nations (vol. 2). Journal of Commerce and Commercial Bulletin, New York.


  1. “The business of banking as described above is not fraudulent.” Really?

    Over the last 5 years, “clients . . . right to demand repayment of the bank’s debt to him on demand” has turned out to be a complete farce. At least it would have been farcical and fraudulent were it not for the TRILLIONS of public money used to make good banks’ failure to make sure they can fulfil the above “right”.

    In short, and as I’ve pointed out before on this blog, the REALITY is that fractional reserve banking descends to fraud if banks are left to their own devices. In contrast, if decent capital ratios are imposed on them, then the extent of fraud declines.

    As to exactly what that ratio should be, Martin Wolf and Anat Admati want 25%. Personally I prefer 100%, i.e. full reserve banking.

    1. And as I argued before: you are deeply confused and mistaken about the nature of banking.

      You cannot distinguish between (1) breach of contract and (2) fraud.

      You mistakenly think that all FR banks will fail. This is nonsense. Many have existed and been solvent for hundreds of years and there is no reason why many of them will continue to as long as modern banking exists.

      And in point of fact the bailouts and QE programs over 2008-2009 still do not prove that FR banking is fraud.

    2. "if decent capital ratios are imposed on them, then the extent of fraud declines."

      Capital ratios are not the same thing as reserve ratios. A bank could have very few cash reserves relative to its demand deposits, and yet still have a high capital ratio.

  2. LK,

    the idea that banks could issue banknotes that are 100% backed by gold held in their vault doesn't make sense.

    Say you deposited $100 in gold coins at Good Bank, and they gave you a $100 Good Bank note, which said "This note represents $100 in gold coin currently held in the Good Bank vault, and may be exchanged for this gold coin by the bearer at any time during Good Bank opening hours".

    When you deposited your coins, you also agreed to pay a $10 monthly fee for the service.

    After 1 month, the bank debits $10 from your account.

    You, or someone else, then returns with the $100 Good Bank note, and you/they demand to withdraw the $100 in gold coin promised by the note.

    See, it doesn't work.

    1. what you think, LK?

    2. Yes, that could be one of the reasons why 100% reserve banks are problematic.

      Of course, they might write the note after they have deducted your fees, and make the note valid only for a year (during the time your fees are paid up), or something like that.

      But in general I would say 100% reserve "banks" are not even banks in the modern sense, just warehouses with maybe some strict time deposit loans being made.

      Virtually nobody wants such 100% reserve warehouses. It is a fantasy of libertarians.

    3. "make the note valid only for a year"

      then it would be very different to any privately-issued banknote that I've seen.

      Say you were to deposit $100 in coin and pay for a year of storage. Then you spent half the notes in the first couple of months. You'd still be paying for the storage of the associated coins for the rest of the year.

      Not to mention they'd have to print and issue new notes each time old ones reached their end date.

    4. Though I haven't studied him as much as I would like, note that Schumpeter called MacLeod the first person to really understand banking. Mitchell-Innes credited him with his credit theory of money, and Commons called him the founder of Institutional Economics.

  3. I have yet to understand the vicious opposition to my proposal that “fiduciary media” (bank deposits that are not covered by the underlying base money) contain express language on their face differentiating them from 100% reserve bank notes. Someone accepting such a note cannot later claim ignorance of the dangers (if any) or fraud. In fact, depending on the language, they might also be deemed to have assumed the risk of any loss of the deposit to which they hold a claim.
    I suspect the opposition comes from the likelihood that such clear language would impair the use of such notes making them far less “liquid” than otherwise.

    1. Actually nobody "opposes" it, idiot. If that is how you want things to be in your crazy libertarian fantasy world, so be it.

      The points made against you are:

      (1) that historically private banknotes were ALREADY differentiated from bailment receipts by words like "such-and-such a banker **promises to repay on demand** the sum of x dollars". That is the language of debts/IOUs, not bailment.

      (2) you still cannot understand that the banking contract is a callable loan, not a bailment.

      Therefore it makes no sense for a banknote to say that the client must bear "any loss of the deposit to which they hold a claim", because the account is NOT a "deposit". Of course, it might say "the banker might default on his debt, and you have the right to sue for recovery of your debt" or words to the effect. But you are too stupid to understand that.

      (3) but even if you were to use such warnings, it highly unlikely that anyone much would really want 100% reserve banks. The empirical evidence speaks against it: FR banking is a fundamental institution of modern capitalism.

      People like you are little more than delusional, ignorant anti-capitalists.

    2. "I have yet to understand the opposition to my proposal that “fiduciary media” (bank deposits that are not covered by the underlying base money) contain express language on their face differentiating them from 100% reserve bank notes"

      Commercial banks don't issue their own banknotes these days, bob. Notes issued by the government or central bank are base money. So your 'proposal' for banknotes obviously doesn't refer to the real world.

      Checking account terms and conditions usually state that the bank is a debtor and the depositor is a creditor. It's common knowledge that banks don't hold an amount of cash in reserve equal to the amount of customer deposits... It's also stated plainly that customer deposits are insured up to a certain amount. If checking account deposits below that amount were risky investments it would make sense to state this to customers, but they're not.

    3. "Commercial banks don't issue their own banknotes these days, bob. Notes issued by the government or central bank are base money. So your 'proposal' for banknotes obviously doesn't refer to the real world."

      Indeed!! Another stupid aspect of bob's idiot ramblings.

      Also, note that bank accounts these days are formally often not even called "deposits" but transactional accounts, current accounts, or checking accounts.

    4. Bob often seems to confuse reality and his own personal imaginary fantasy world.