.. ive years, continuously renewed, supported by a concept of property rights different from Roman law in that it defined not the owner’s rights but those of the tenant. Moreover, access to and use of water in the republic was controlled communally as early as the sixteenth century – like irrigation in Spain, and drainage boards in Britain and the United States in modern times. Private property yes, but allow for variation and exceptions. Free banking is a flag that many economists enlist under. Deregulate entirely. Abolish central banks.
Gresham’s law will work in reverse, good money driving out bad, as allegedly happened in Scotland between the failure of the Ayr Bank in 1772 and the Bank Act of 1845, when Scottish banks were brought under British legislation. A classic modern case is that of the Franklin National Bank, in which the other New York banks appealed to the Federal Reserve Bank of New York, and, when that was slow to act, brought the Franklin National to its knees by refusing to lend it overnight money or to accept its repossession offers. In the Scottish case, the three major joint-stock banks collected notes of the smaller, more adventurous competitors and presented them for collection when the lending of any one appeared reckless. But the proponents of Scottish bank history neglect the fact that the Scottish banks had reserves in London, too, and could adjust their positions by borrowing or depositing in London. The experience does not warrant the abolition of central banking and substituting a rigid rule of increasing the money supply on trend.
This is especially the case when money as a medium of exchange – though not as a unit of account – remains in Darwinian evolution: coin, banknotes, bank deposits, NOW accounts, checkbooks issued by thrift institutions, credit cards, and so on. I have discussed “Rules versus Men” on frequent earlier occasions. It is not clear to me on which side of this issue to find Heilbroner, but I suspect it would be a rather looser version of men than I would support, though I allow for men far more than many economists and economic historians. As in the past, I can cite hallowed authority – Walter Bagehot and Sir Robert Peel: Walter Bagehot: “In very important and very changeable business, rigid rules are apt to be dangerous. .
. The forces of the enemy being variable, those of the defense cannot always be the same. I admit this conclusion is very inconvenient.”(1) Sir Robert Peel: “My Confidence is unshaken that we have taken all the Precautions [in the Bank Act of 1844] which can prudently be taken against the Recurrency of a pecuniary Crisis. It may occur in spite of our Precautions; and if it be necessary to assume a grave Responsibility, I dare say Men will be found willing to assume such a Responsibility.”(2) Sir Robert was correct. The Chancellor of the Exchequer suspended the Bank Act in 1847, 1857, and 1866, issuing letters of indemnity to relieve the Bank of England of all loss for having violated the Act, in each case bringing the financial panic to an end.
Three other compelling cases come to mind: In 1925 the Bank of France violated legislative ceiling limits on its note issue and holdings of government securities. But it did so secretly rather than appealing to the public that the rules were crippling but not vital, as one economist, Pierre de Mouy; advised. In the Weimar Republic in Germany, Chancellor Heinrich Bruning deflated the economy strongly, against the economic and especially the political interest of the German people, after the failure of the Austrian Creditanstalt in May 1931. Wilhelm Lautenbach, an official of the Reich Economic Ministry who has since been characterized as a pre-Keynes Keynesian, recommended that Germany default on reparations and foreign credits, depart from gold, to which it was committed under the Dawes Act of 1924, and expand public works. There is a classic debate among economic historians in Germany whether Bruning had any real options. Knut Borchardt thinks he did not.
Carl-Ludwig Holtfrerich (and Lautenbach at the time) thinks he did. The third episode relates to U.S. free gold in the fall of 1931 after Britain had abandoned the gold standard. First Belgium, the Netherlands, and Switzerland – small countries with limited responsibility for the system – cashed their dollars for gold, and then the French, deliberately but inexorably, followed suit. There was abundant gold in Fort Knox, but it was not “free.” Foreign trade had declined, its financing had changed, and rediscounted paper, which counted with gold certificates against the Fed’s liabilities, was in short supply.
Milton Friedman and Anna Schwartz shrug off the free-gold issue; Elmus Wicker regards it as a serious constraint. But the answer for “Men” would have been for Herbert Hoover to call in congressional leaders, square it with them, and announce publicly that there was a crisis, that the Federal Reserve Act would be violated briefly until legislation could be enacted, allowing the substitution of government bonds for rediscounted trade paper, as was accomplished in February 1932. The law, as I understand it, has an excuse for breaking a contract or rule: force majeure, a major change of circumstances beyond the control of one side to the contract or the ruled body. In 1940, I used force majeure in resigning from the Bank of International Settlements, with which I had an understanding (not a contract) to work for three years – this because of war, especially after the fall of Paris on June 17. But Bagehot is certainly correct that it is inconvenient to break a rule; after fifty-eight years I still have a tiny twinge of conscience. Rules are mostly needed, and when broken they are hard to mend or replace. Violations create precedents.
One more example of Manichaeanism: In Britain, after parliamentary investigations in the nineteenth century, legislation was enacted requiring inspection of ships before they left port, checking their loading and general seaworthiness, as too many (though few) ship owners had sent fully insured vessels off with subsequent loss of ship, cargo, and crew. No legislation was needed in Norway (or earlier in Venice) because ship owners, as the Scottish bankers were alleged to do, regulated themselves to a high standard. Life is Manichaean. It has two rules: Look before you leap, and he who hesitates is lost. I do not know whether Bob looks or hesitates, but in his brilliant career he has never seemed lost. Bibliography 1.
Walter Bagehot, “Lombard Street,” in The Collected Works of Walter Bagehot, ed. N. St. John-Stevens (London: The Economist, 1978), vol. 9, pp.
207-8. 2. Great Britain, Parliamentary Papers, Monetary Policy, Commercial Distress (1857), (Shannon: Irish University Press, 1969), vol. 3, p. xxlx.
CHARLES KINDLEBERGER is Ford International Professor of Economics Emeritus, Massachusetts Institute of Technology. This article was originally presented as a speech in honor of Robert Heilbroner at the New School for Social Research, New York, November 12, 1998.