7.10 Currency and banking school thought on the Continent

The flowering of the currency and banking school debates in Britain, coupled with the later burgeoning of central banking on the Continent, led to similar controversies in France and Germany in the 1850s and 1860s. Generally, the results were the same: pseudo-currency triumph in the sense that the central bank acquired a monopoly of note issue, and de facto banking school victory in elastic, fractional-reserve banking and repeated increases and declines in the supply of money.

In France, laissez-faire thought flowered among economists, who proved themselves the true heirs of J.B. Say. Professors, journalists, the long-lasting Société d'Économie Politique, the Société's Journal des Économistes, both launched in 1842, and several other scholarly and popular periodicals were dedicated to the free trade and laissez-faire cause. In that atmosphere, the French economists naturally plumped for free rather than central banking. Most of them, unfortunately, felt constrained to adopt banking school doctrine so as to maintain that freely competitive banking, like banks in general, can never issue excessive notes or bring about a business cycle. They were a far more genuine free banking group than the British who, as we have seen, were special pleaders for commercial banking interests rather than consistent advocates of free banking. Indeed, in this as in other areas, the French, in contrast to the hesitant, muddled and pragmatic British, were not afraid to be consistent, rigorous, militant, and therefore ‘extremist’ advocates of individual liberty and free exchange.

One of the leading, and one of the most interesting, of the French free banking theorists was Jean Gustave Courcelle-Seneuil (1813–92). Courcelle, as one historian writes: ‘was in favour of absolute freedom and unlimited competition and was the most uncompromising of all free bankers in France. The sole permissible regulation, in his view, was one aimed simply at the prevention of fraud’.⁴⁵

I. Edward Horn (1825–75) was another notable French free banking theorist. In his La Liberté des Banques (1866), Horn went so far as to challenge the idea that the state must have a monopoly on coinage. He pointed out that private investment bankers could easily gain as much public confidence in the circulation of their coins as has the state. Horn noted that the state is far more likely to suspend the obligation of a central bank to redeem in specie than grant such a boon to the smaller, individual banks. In the paraphrase of Vera Smith:

Horn called attention to the greater possibility that the liability of such a [Central] bank to pay out specie on demand would be revoked with its consequence of pure paper money in place of notes convertible into coin. A bank under State patronage always counted on the Government to relieve of its obligation to pay when nearing insolvency, and its bankruptcy became legalised instead of its having to go into liquidation and suffer the usual penalties of insolvency. This history of privileged banks had undeniably been full of bankruptcies.

Horn went on to insist that, under free banking, any refusal whatever to pay in specie on demand must mean instant liquidation for the errant bank. Only then could a free banking system work. Horn notes: ‘If banks of issue were given to understand, however, that they were positively and irremediably responsible for their acts, and had themselves to bear the consequences, they would be as prudent in their policy as any other business concern’.⁴⁶ The problem is how could government be trusted to enforce prompt specie payment on the banks, especially if many or most banks get into trouble at the same time?

Courcelle and Horn were both heavily influenced by James Wilson's circulation into fixed capital analysis of the boom. But both men, while stressing with the banking school that banks cannot over-issue their notes, did admit, in contrast to Wilson, that banks could and did err in fuelling over-investment in fixed capital during the boom. Interestingly enough, Horn, Courcelle, and many of the French free bankers felt they had to deny, by legalistic quibbles, that even bank notes were ‘money’, since money, in the legalistic though not economic sense, must be strictly confined to the standard specie in which notes were convertible.

But the most fascinating theorists were the tiny intrepid band of Frenchmen who believed in free banking and at the same time were rigorous currency school ultras, who despised as fraudulent and inflationary all fiduciary media, all bank liabilities beyond 100 per cent specie reserve. They believed, quite plausibly, that neither a monopoly privileged bank, nor the government that backed it, could be long trusted to maintain 100 per cent gold reserve banking. The leader of this little band was Henri Cernuschi, who, writing two tracts in 1865, declared that the important question was not monopoly note issue vs plural or free banking, but whether bank notes should be issued at all. His answer was no, since ‘they had the effect of despoiling the holders of metallic money by depreciating its value’. If they were at all useful, they should no more than represent metallic money by 100 per cent; any uncovered notes, any fiduciary media, should be ended totally. Cernuschi favoured free banking because he held that, lacking any special privilege, encouragement, or acceptance by the state, and forced to close the minute banks refused any payment of liabilities, nobody would wish to hold bank notes. As Ludwig von Mises approvingly quoted from Cernuschi: ‘I want to give everybody the right to issue banknotes so that nobody should take banknotes any longer’.⁴⁷

A follower of Cernuschi was Victor Modeste, whose policy conclusions were rather different, and brought him close to the hard-core Jacksonians in the United States. Modeste was a dedicated libertarian, who believed that the state is ‘the master..., the obstacle, the enemy’, and whose announced goal was to replace government by 'self-government’. Modeste agreed with Courcelle and the banking school free bankers that commerce and trade must remain free. He also agreed with them that central monopoly banking was far worse and more damaging than freely competitive banking, and was also opposed to administrative control or regulation of banks. On the other hand, what is to be done about bank notes? In this category, Modeste explicitly included demand deposits, which he saw to be illicit, fraudulent, inflationary, generators of the business cycle, and bearers of ‘false money’. His answer was to point out that ‘false’ demand liabilities which pretend to but cannot be converted into gold, since they go beyond the value of the gold stock, are in reality equivalent to fraud and theft. Modeste concluded that false titles and values are at all times ‘equivalent to theft; that theft in all its forms every-where deserves its penalties..., that every bank administrator... must be warned that to pass as value where there is no value,... to subscribe to an engagement that cannot be accomplished... are criminal acts which should be relieved under the criminal law’. The answer, then, is not administrative regulation but prohibition of tort and fraud under general law.⁴⁸

In Germany, there were few writers influenced by the banking school; most were currency men. In the rigorous currency tradition was Philip Joseph Geyer. Writing in his tract Banken und Krisen (Banks and Crises) in 1865, and in another book two years later, Geyer declared that ideally the amount of money in circulation should always remain constant. The money supply is not in fact constant largely because continuing issues of bank notes are not covered by specie. At this point, Geyer contributed one of the first outlines of the Austrian theory of the business cycle, as he pointed out that uncovered bank note issues inject an ‘artificial capital’ (kunstliches Kapital) into the economy, and when this artificial capital exceeds the amount of available ‘real’ (naturliches) capital, over-investment and over-production bring about a crisis. However, Geyer then blundered into an inconsistent underconsumption theory while trying to develop his analysis.

An academic hard-line currency man in Germany was Johann Louis Tellkampf (1808–76). A young Prussian with a doctorate from the University of Gottingen, Tellkampf emigrated to the United States, where he taught first at Union College in law and political economy, as well as history, German language and literature. Then, in 1843, he moved to Columbia College as professor of German language and literature. Three years later, Tellkampf returned to Prussia and became professor of political economy at the University of Breslau. He was later elected to the Prussian senate, where he took a leading part in bank legislation.

Tellkampf's observations on the problems of decentralized banking in the United States led him to argue for strict 100 per cent specie reserves to bank notes, and for one monopoly central bank to put this plan into effect. Tellkampf aided in disseminating the currency principle by co-translating McCulloch's defence of the principle into German in 1859. On the other hand, failing the adoption of his 100 per cent specie plan, Tellkampf was very willing to consider free banking as a second best.

The free bankers in Germany tended to be smaller in number than in France, and currency school rather than banking school men. A notable writer in this camp was Otto Hübner, a leader of the German Free Trade Party. His multi-volume work, Die Banken (1854), was largely an empirical survey of banks throughout the world, and argued that banks were soundest and least in danger where they were freest and least controlled. Privileged central banks tend to be wildly run and are in danger of insolvency, as note the suspension of specie payment of the Austrian national Bank, which had financed large deficits of the Austrian government. Hübner's goal, like Cernuschi's in France and like that of Geyer and Tellkampf in Germany, was 100 per cent specie reserve to bank notes. His ideal preference would have been for a state-run monopoly 100 per cent reserve in the bank, like the old banks of Amsterdam and Hamburg, but he recognized the problem of inherent mistrust of state banking. As Vera Smith paraphrases Hübner:

If it were true that the State could be trusted always only to issue notes to the amount of its specie holdings, a State-controlled note issue would be the best system, but as things were, a far nearer approach to the ideal system was to be expected from free banks, who for reasons of self-interest would aim at the fulfillment of their obligations.⁴⁹