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Sunday, November 25, 2018

Cooking the Books: The Bank Charter Act (2012)

The Cooking the Books column from the October 2012 issue of the Socialist Standard

The Bank Charter Act of 1844 is back in the news. An article in the Guardian (13 July) by Deborah Orr discussed its terms and stated that it “removed from banks their licence to print money.” It did remove the right of banks other than the Bank of England to issue their own bank notes, but gradually rather than immediately. Banks which had been issuing notes until 1844 were allowed to continue until they merged or were taken over, but not to increase the amount they had been issuing. Some banks continued to issue notes for the rest of the 19th century, the last continuing till 1921.

According to the wikipedia entry, “The Act exempted demand deposits from the legal requirement of a 100-percent reserve which it did demand with respect to the issuance of paper money.” The source for this claim is given as the Ludwig von Mises Institute, as if this could be regarded as a source of reliable information.

This claim is wrong on two counts. The Act does not mention “demand deposits” at all, let alone exempt them from anything. Nor did it require banks to hold an amount of cash (gold or Bank of England notes) in their vaults equal to the face-value of the notes they were allowed to continue to issue.

The basic aim of the Act was to regulate the issue of paper currency which its promoters thought would lead to inflation if too much were issued. This was based on the theories of the Currency School, but was challenged by the Banking School who argued that, as long as bank notes were convertible on demand into a fixed amount of gold, this would not happen. Marx agreed and a whole chapter of Volume 3 of Capital is devoted, with contributions from Engels, to “The Currency Principle and the English Bank Legislation of 1844.”

The Act was not concerned whether or not banks backed up their notes with an equivalent amount of cash in their vaults. How much cash to hold was left to banks’ judgement. Knowing that only a small percentage of the notes were likely to be presented at any one time for payment in cash, the banks would normally only keep that amount in their vaults.

Giving someone a wad of notes was just one way in which banks could then make a loan. Another was to grant the borrower an overdraft, which is presumably what the Mises Institute mean by “demand deposits”. But these did not need to be backed by “a 100-percent reserve” either. The amount of deposits that a bank would need to retain as cash would depend, once again, on the bank’s experience of how much their clients were likely to withdraw in this form. That you don’t have to retain as cash all the money deposited is the basic principle of banking. To have required all loans to be covered by an equivalent amount of cash in the banks’ vaults would have turned banks into safety deposits and rendered all lending by them impossible. The promoters of the 1844 Act did base it on a fallacy but they weren’t that stupid.

The Act didn’t even require the Bank of England to cover all the notes it issued by an equivalent amount of gold in its vaults. It was authorised to issue £14 million, known as the “fiduciary issue”, without this. This proved not enough during financial panics and the Act had to be suspended in those of 1847, 1857 and 1866, as Marx chronicled in detail in Volume 3 of Capital. His conclusion is as valid today as it was then: “Ignorant and confused bank laws, such as those of 1844-5, may intensify the monetary crisis. But no bank legislation can abolish crises themselves” (chapter 30).

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