The Law of Banking
By Melvin J. Howard
Having escaped from prison in London, where he was held after conviction of murder in his early twenties, he toured Europe, earning his living as a professional gambler, and then achieved the most amazing leap in history. From the gaming table to the highest office in France a country of which he was not a citizen and from which, a few years before, he had been ejected by the minister of police because of his suspiciously. And when he assumed the role of financial dictator of France he had the satisfaction of succeeding the very gentleman who as minister of police had invited him to clear out of Paris. Law discovered and perfected the device that has played, perhaps, the most important role in the growth of what we now call finance capitalism. Here is what he discovered. On the first day of January 1939, the banks in America had on deposit, guaranteed by the government, the money of their depositors to the extent of fifty billion dollars.
But the balance sheets of these banks showed only seventeen billion dollars in cash. A closer examination, however, reveals that not only was the fifty billion in deposits a myth, but the seventeen billions in cash was equally a fiction. There was not that much cash in America then. The actual amount of cash—currency—in the banks was less than a billion dollars. Law's famous Mississippi Bubble was something more than a mere get-rich-quick scheme. To understand it you must have a clear idea of the theory, which lay at its base.
This theory consisted in two propositions. One was that the world
had insufficient supplies of metal money to do business with. The other was
that, by means of a bank of discount, a nation could create all the money it
required, without depending on the inadequate metallic resources of the world.
The bank Law had in mind was nothing more or less than the kind of banks we now
do business with universally.
But this was a unique proposal back then. Law did not invent this idea. He found the germs of it in a bank then in existence—the Bank of Amsterdam. This Law got the opportunity to observe when he was a fugitive from England. The Bank of Amsterdam, established in 1609, was owned by the city. Amsterdam was the great port of the world. In its marts circulated the coins of innumerable states and cities. Every nation, many princes and lords, many trading cities minted their own coins. The merchant who sold a shipment of wool might get in payment a bag full of guilders, drachmas, gulden, marks, ducats, livres, pistoles, ducatoons, piscatoons, and a miscellany of coins he had never heard of. This is what made the business of the moneychanger so essential. Every moneychanger carried a manual kept up to date listing all these coins. The manual contained the names and valuations of 500 gold coins and 340 silver ones minted all over Europe. No man could know the value of these coins, for they were being devalued continually by princes and clipped by merchants. To remedy this situation, the Bank of Amsterdam was established. Here is how it worked. A merchant could bring his money to the bank.
The bank would weigh and assay all the coins and give him a credit on its books for the honest value in guilders. Thereafter that deposit remained steadfast in value. It was in fact a deposit. Checks were not in use. But it was treated as a loan by the bank with the coins as security. The bank loaned the merchant what it called bank credit. Thereafter if he wished to pay a bill he could transfer to his creditor a part of his bank credit. The creditor preferred this to money. He would rather have a payment in a medium the value of which was fixed and guaranteed than in a hatful of suspicious, fluctuating coins from a score of countries. So much was this true that a man who was willing to sell an article for a hundred guilders would take a hundred in bank credit but demand a hundred and five in cash. One effect of this was that once coin or bullion went into this bank it tended to remain there. All merchants, even foreigners, kept their cash there. When one merchant paid another, the transaction was effected by transfer on the books of the bank and the metal remained in its vaults. Why should a merchant withdraw cash when the cash would buy for him only 95 per cent of what he could purchase with the bank credit? And so in time most of the metal of Europe tended to flow into this bank. There was in Amsterdam another corporation—the East India Company.
A great trading corporation, it was considered of vital importance to the city's business. The city owned half its stock. The time came when the East India Company needed money to build ships. In the bank lay that great pool of cash. The trading company's managers itched to get hold of some of it. The mayor, who named the bank commissioners, put pressure on them to make loans to the company—loans without any deposit of money or bullion. It was done in absolute secrecy. It was against the law of the bank. But the bank was powerless to resist. The bank and the company did this surreptitiously. They did not realize the nature of the powerful instrument they had forged. They did not realize they were laying the foundations of modern finance called capitalism. It was Law who saw this. Law perceived with clarity that this bank, in its secret violation of its charter, had actually invented a method of creating money. He came to the conclusion that this was something, which should be not merely legalized, but put into general use to cure the ills of Europe.
He also saw clearly that this bank had brought into existence a great pool or reservoir of money and that he who controlled this supply could perform wonders. This was to be one of the most powerful weapons of the acquisitive man of the future—the collection of vast stores of other people's money into pools and the capture of control of those pools. Here is what Law saw. It is an operation that takes place in banks daily. Lets say The First National Bank of Middletown has on deposit a million dollars. Mr. Smith walks into the bank and asks for a loan of $10,000. The bank makes the loan. But it does not give him ten thousand in cash. Instead the cashier writes in his deposit book a record of a deposit of $10,000. Mr. Smith has not deposited ten thousand. The bank has loaned him a deposit. The cashier also writes upon the bank's books the record of this deposit of Mr. Smith. When Mr. Smith walks out of the bank he has a deposit of ten thousand that he did not have when he entered. The bank has deposits of a million dollars when Mr. Smith enters. When he leaves it has deposits of a million and ten thousand dollars. Its deposits have been increased ten thousand dollars by the mere act of making a loan to Mr. Smith. Mr. Smith uses this deposit as money.
It is bank money this bank money has been created not by depositing cash but by loans by the bank to depositors. This is what the Bank of Amsterdam did by its secret loans to the East India Company, which it hoped would never be found out. This is what Law saw, but more important, he saw the social uses of it. It became the foundation of our current banking System.
