The first chapter of this book described how private commercial bankers came to provide almost all of the money supply in the West. The second described how this process has affected who is rich and who is poor, culminating in the extremes of wealth and poverty we experience today. This chapter looks at banking in relation to law.
A system of law can be anything from a concerted effort to establish justice in our human world, to a system of robbery and murder (Nazi law is an extreme example). When a banking lawyer described modern banking as ‘the greatest system of kleptocracy foisted upon the human race’ he was agreeing with many previous eminent and knowledgeable commentators. The American Founding Fathers were particularly vocal on the subject: banking is the enrichment of ‘swindlers at the expense of the honest and industrious part of the nation’ (Thomas Jefferson, 1813). ‘Every dollar of a bank bill that is issued beyond the quantity of gold and silver in the vaults represents nothing, and is therefore a cheat upon somebody’ (John Adams, 1809). Even more bluntly, the banking system supports a ‘tyranny of fraud’ (John Taylor, 1814).
Laws enabling bank-money to permeate the economy were passed at a time when ‘real money’ was gold and silver, whereas bank-money was claims written on paper or in ledgers. One justification for bank-money was that it replaced an expensive commodity with a cheap one. This justification no longer applies: today, all money (except coin) is produced very cheaply indeed; but the system authorising banks to create credit continues.
Only a few people, even among bankers and politicians, take the trouble to understand the simple reality of how bank-money is created. Powerful people must surely understand (or know intuitively) that money-creation is the source of their power, for it enables them to access huge amounts of money created on the spot on the prospect of a profitable return. At the present time (May 2015) wealthy speculators may, in theory, even be paid to borrow (the new phenomenon of negative interest rates), though the reality is somewhat different.
On the other hand, most ordinary people probably assume, in a trusting sort of way, that money is created impartially: that is, favouring no one group over any other. Readers of this book will probably understand that this assumption is wrong. Our modern system of money-creation was authorized precisely because it does favour some groups over others. Banking had already flourished for many years within trading and ruling circles, but to establish the legality of banking practice and to make it ubiquitous and pervasive, a simple change in the law was needed.
The change in law, first introduced in England in 1704, was to make the promises of bankers enforceable. In other words: if a banker issued a note promising to pay a certain sum of money (gold or silver) to whoever presented the note, the law would support the owner of the note when they went to claim the money. At first sight, this law seems to favour the customer; after all, if a bank promises to pay, it should be held to its word. But the real significance of the law – and this was obvious to everyone concerned when the law was introduced – was that it enabled the promises of bankers to become money: to ‘pass from Man to Man in Payment, which will be an Addition to the Cash of the Nation’ (John Cary, 1695.)
How can the promises of bankers become currency? For a customer, a banker’s promissory note is a claim on money belonging to the bank. How can a claim to money, itself become money? In his mighty History of Economic Analysis, economist Joseph Schumpeter observes: ‘You cannot ride a claim to a horse, but you can pay with a claim to money.’ He goes on to explain: if ownership of a claim can be legally transferred from one person to another, and everyone believes the bank will pay ‘real money’ when presented with the claim, then a claim to money can be as confidently received in payment as ‘real money’. Furthermore, a paper claim was an attractive form of payment, being more convenient and easier to manage than heavy gold-and-silver.
So ‘promises to pay’ became a kind of money, circulating from hand to hand in payment as ‘bank-credit’. Bankers have understood for a very long time that they can get away with creating ‘promises to pay’ far in excess of money they have in store, so the money supply grew with money created by the bankers.
The simple ‘widget’ of law authorising banks to create money, first introduced in England in 1704, and has since then been adopted in various forms all over the world, as countries have conformed to international standards of banking and commerce.
Before the Promissory Notes Act of 1704, bankers were writing ‘promises to pay’ and notes were passing from hand to hand, but no one could be certain that the law would enforce them. Some judges were ruling in their favour, and some against. The Lord Chief Justice of that time (Sir John Holt) had set his face against them. Sir John Holt was a man in advance of his time: he made rulings against slavery and the persecution of witches. His surviving remarks on promissory notes indicate that he thought it undesirable to make a special exception (‘specialty’) of promissory notes which would allow them to evade established rules and principles of law.[i]
What were these established rules and principles of law? They were fairly elaborate, reflecting the efforts of lawmakers to avoid supporting unjust claims and contracts.
One rule was that obligations arising from a contract should only be enforced if the person obligated had derived some previous benefit from the contract (rules and doctrines of ‘consideration’: ‘nudum pactum non parit actionem’ or ‘ex nudo pacto non oritur actio’). This would imply that a bank should only be obliged to pay on a note if it had received some sort of payment or benefit from the bearer.
Another was: if the law recognises that you have a right to something but you need a court order to take possession of it, you cannot transfer that right to someone else (the ‘non-assignability of choses in action’). An example: if you are owed money, you can’t sell the debt for someone else to collect. A bank-note represents a debt from a bank, its ownership passing from hand to hand.
A third was: you cannot give to someone else what you do not own yourself (‘nemo dat quod non habet’). For instance, you can’t sell Buckingham Palace unless you already happen to own it. This spelled trouble for bank-notes: if a promissory note gave no definite rights to its first owner, there was nothing to pass on to subsequent owners.
Yet another rule stated that obligations and rights arising from a contract should only be enforced between the original parties – i.e. not for a third party arriving late on the scene (a doctrine now known as ‘privity’). This would rule against bank-notes, which are an agreement between a bank and the anonymous and ever-changing ‘bearers’ of the note.
Yet another rule was: the law should not enforce obligations originating in an illegal act (for instance, a claim on the loot from a robbery, or payment for an assassination). This last is particularly interesting if bank-credit is, as Jefferson, Adams and so many others have claimed, a ‘swindle’, a ‘cheat’, or a ‘fraud’.
The complexity of these rules, and the fact that their histories and meanings are still controversial today, reflect the difficulties that law faces when dealing with claims. A claim is an odd kind of property. Most pieces of property are fairly definite and simple: a house, a piece of land or furniture, a vehicle. A claim is different: it often arises from a private contract and it must always involve risk: of what might happen between when it is created and when it is exercised. It can be on something that only partially exists (as with bank-credit); on something that might or might not exist (for instance, mineral rights); on something that might exist in the future (for instance, profit on an investment); or on something that exists today, but might not exist tomorrow (for instance, the assets of a debtor teetering on the edge of ruin). It can also be on something belonging to someone else – as when people invest in war, or piracy, in exchange for a claim on some of the profits.
So why did the English Parliament of 1704 authorise fictitious bank-credit to pass from hand to hand as currency, when the process transgressed so many rules and principles of law? The context of the decision reveals a lot about the nature of bank-money and its effects upon our world.
In 1704, banks were fairly new to England. They had emerged during the Civil War a half-century earlier as safe-deposits for gold and other valuables. Private bankers were making a great deal of money by issuing more ‘notes of receipt’ than they had gold in store, and these notes were circulating as ‘promises to pay’.
Parliament at that time consisted of rich males voted in by other rich males (‘forty shilling freeholders’). Members of Parliament were roughly of two types: landed gentry, and men rich from business and trade. Generally speaking, the landed gentry were anti-banking. Banks were a threat: they were creators of ‘fictitious credit’: ‘a sort of property, which was not known twenty years ago, is now increased to be almost equal to the terra firma of our island’ (Henry Bolingbroke, 1710). On the other hand, merchants and businessmen were generally pro-banking.
Successive English governments had become heavily dependent upon private bankers for supplying them with gold in return for the government’s own ‘promises to pay’, most of them in the form of wooden tally-sticks (sticks with cuts made in the full width signifying the debt; the sticks were then split so that the two portions held by creditor and debtor exactly matched. An interesting aside: when, in 1834, two cartloads of old tally-sticks were burned in the House of Commons, the fire went out of control and burnt down the whole building).
The unending problem was the English government’s need of money to go to war. ‘Real money’ – gold and silver – could not be conjured out of nothing: it had to be borrowed with the consent of its owners, or gained by taxation (which also required some sort of consent); and of course it could be stolen from foreigners if war was successful. Credit, on the other hand, was mere paper or wood. If ‘live now, pay later’ was the government’s motto, ‘get rich by creating credit’ was the bankers’.
‘All sorts of paper credit in Orders, Bills, Notes, Bonds, Assignments, etc, overflowed the kingdom,’ wrote an official in 1700. ‘All our wealth seemed to consist in a little gold and adulterated silver, a world of wooden scores and paper sums. Never was there known before such vast debts owing for Excise and Customs, upon Bills and Bonds unsatisfied. We had all the symptoms upon us of a Bankrupt State and an undone people.’ With so much credit-money augmenting the money supply, life had become hard for the working poor, who had to rely on debased and devalued coin to buy their bread: ‘a loaf which in the previous reign cost threepence rose to ninepence’ wrote the historian Lecky.
In order to decrease the government’s reliance on private bankers, the Bank of England – a corporate bank with privileges and monopolies – was founded by Act of Parliament in 1694. The Bank put investors’ money to use at least twice over, lending to the government and issuing promissory notes, on which (to begin with) it paid interest. Before the establishment of the Bank of England, King William had to send his ministers round the coffee-houses of the City of London to borrow to go to war. After it, the government was £1,200,000 richer and ‘the navy was able to take to the sea that summer’. William forged off to war and defeated the French at the siege of Namur (1695).
The foundation of the Bank of England ‘set a precedent for proposals to accord special privileges to those who lent their money to the State for the prosecution of war’ according to the economic historian Ephraim Lipson. But the Bank operated under strict limits, and after a run on the bank organised by London’s private bankers, the war-making King was once again in difficulty. According to one contemporary report, he was unable even to pay the travelling expenses of one of his agents. The government once again sought help from private bankers.
For most of history, private bankers had operated in a sort of legal ‘grey area’. After a large public bankruptcy, one of them might get into serious trouble, as when a banker was decapitated in front of his own bank (Barcelona, 1360). As a further restriction on their activities, for centuries bankers had to dodge laws forbidding the taking of interest. But banks were too useful, too necessary even, for States to actively suppress them for long, and they continued on as an activity between consenting adults – a sort of monetary equivalent of adultery – alongside the activities of moneylenders and pawnbrokers: but very different from these, because unlike moneylenders and pawnbrokers, banks were actually creating most of the money they lent. (The most authoritative history of early banking, Abbott Payson Usher’s The Early History of Deposit Banking in Mediterranean Europe, begins with the sentence: ‘The essential function of a banking system is the creation of credit’).
The English Parliament, its power greatly increased by the ‘Glorious Revolution’ of 1688, and provoked by the resistance of Sir John Holt, needed to establish once and for all that bankers’ money was legitimate, so that their activities, both as members of government and as individuals attempting to get very rich, could continue without challenge from pesky lawyers. And so the law was passed.
Attempts have been made over the years to assert that the Act of 1704 was not really necessary: that promissory notes emerged from the custom of merchants, and that the custom of merchants is, was, and ever must be an automatic part of law. In 1801 an American court took a vacation so that eminent judges could consider whether an action on a promissory note ‘could have been supported in England before the statute of Anne (i.e. before the Promissory Notes Act)’. Modern law is respectful of commercial practice, in particular of the ‘sanctity of contracts’. Things were not ever thus; even in the nineteenth century, judges were disputing the automatic right of commercial practice to be considered lawful. The simple fact is: the law of 1704, adopted in various guises across the world, put a stop to judges questioning the legality of circulating bank-credit.
Disgruntled landowners had opposed the passage of the Act in 1704: one grumbled that they ‘bore the greatest share’ of the burden of war, being ‘loaded with many taxes’ while the ‘Men of the City of London’ were ‘enabled to deck their wives in velvet and rich brocades’. But they found consolation in another form of robbery. The new supremacy of Parliament, unleashed from constitutional restraint by monarch, church or even most of the people (a majority had no right to vote) enabled landowners to pass over 3000 private Enclosure Acts depriving poor and independent country people of their rights of tenancy and rights in common land. Both main factions in Parliament were now engaged in dispossessing the poor: while England became the richest country in the world, its poor joined the desperate of the earth. A visiting slave-owner from Jamaica commented to an investigating committee in 1832: ‘I have always thought myself disgraced by being the owner of slaves, but we never in the West Indies thought it possible for any human being to be so cruel as to require a child of nine years old to work twelve and a half hours a day; and that, you acknowledge, is your regular practice’ (quoted by John and Barbara Hammond in The Town Labourer). The yeomen of the countryside, an ‘industrious, brave and independent class of men’, ‘once the pride of the country’, were ‘extinct’, their descendants ‘almost the paupers of the nation’ (Amasa Walker, 1867).
To check this concerted oppression from both sides of the political class, there soon emerged trades unions, socialism and communism. With them came a new ideology that would put all credit-creation in the hands of the State. Meanwhile, banking was largely removed from scrutiny by lawyers, judges, or even elected representatives, and given over to ‘regulators’ charged with keeping the system going. This meant that extraordinary developments, such as the replacement of gold-and-silver (as base-money for credit) with digits created by the State, occurred with little scrutiny or public debate. Lawmakers grew unfamiliar with the process of banking, and attempts to rein in the creation of credit by banks, such as the Bank Act of 1844, were undermined by their ignorance of the different guises that bank-credit can assume. Subsequent Acts were mostly concerned with adjustments to the regulatory framework to accommodate new commercial practice. Judges gave famous decisions based on commercial practice: such as Lord Cottenham’s of 1848: ‘Money, when paid into a bank, ceases altogether to be the money of the customer; it is then the money of the banker …’ and this insightful contribution from Lord Denning (1966):
‘When merchants have established a course of business which is running smoothly and well with no inconvenience or injustice, it is not for the judges to put a spoke in the wheel and bring it to a halt. Even if someone is able to point to a flaw, the courts should not seize on it so as to invalidate past transactions or produce confusion. …Communis error facit jus (common error makes law). … This applies with especial force to commercial practice. When it has grown up and become established, the courts will overlook suggested defects and support it rather than throw it down. Thus it will enforce commercial credits rather than hold them bad for want of consideration. It is a maxim of English law to give effect to everything which appears to have been established for a considerable course of time and to presume that what has been done was done of right, and not in wrong.’
When money-creation by banks was discussed in the UK Parliament in 2014, the majority of speakers began by admitting they had almost no idea of how money-creation actually works.
Now that money is mostly just digits in ledgers, our two-tier system of money-creation is the toxic residue of a primitive structure of exploitation. A later chapter will explore how the system could be reformed: the next chapter takes a look at how various economists, some well-known and some forgotten, have viewed (or ignored) the subject of bank-created money.
[i] The best discussion of Holt’s reasoning in the light of scant historical evidence is in Daniel Coquillette, The Civilian Writers of the Doctors’ Commons, London.