Don't Comprehend "Real" Currency But Steady Yapping About Cryptocurrency

paecon |  Despite the fact that the goal of capitalists is to accumulate evermore money, the classical political economists largely took the analysis of money for granted.4 To be sure, from Adam Smith to Karl Marx, we can certainly find passages on money but two things are of general note. First, the classical political economists as well as Karl Marx thought gold and silver were “real” money. In other words, money was understood as “commodity money” and therefore to expand the money supply meant finding new mines, plundering it from others, or selling goods or services on the world market to obtain it from others who possessed it. Indeed, a considerable portion of the history of slavery and colonial violence can be traced back to the elite concern for acquiring gold and silver (Di Muzio and Robbins, 2016; Graeber, 2012; Kwarteng, 2014; Vilar, 1986). Second, because gold and silver were thought to be money, the classics failed to understand the scale or level of credit creation that began with the institutionalization of the Bank of England in 1694. Many argue that the Bank of England was inspired by the Bank of Amsterdam and the success of Dutch finance. But this is not the case. While the Bank of Amsterdam did make loans from time to time, its primary function was to maintain the quality of the paper notes in circulation that represented coin. Moreover, the bank was owned by the city, not private social forces as came to be the case with the Bank of England (Wennerlind, 2011: 69; Vilar, 1986: 206; Zarlenga, 2002: 238ff). Whereas the notes issued by the Bank of Amsterdam mostly reflected the exact value of gold and silver in the city’s vault, the Bank of England expanded the English money supply by extending paper notes as credit (Desan, 2014: 311ff). 

The Bank of England’s largest customer was the Crown in Parliament who used the initial loan of £1,200,000 to finance war with France. Indeed, the main reason why the Royal Charter was granted to the Bank of England’s 1509 investors was to provide the finance for organized violence against a dynastic rival (Davies, 2002: 261). The slave trade, colonization and continuous wars in the next two centuries lead to a mounting and unpayable “national” debt that solidified the Bank’s role as the government’s permanent debt manager. But the investors in the Bank of England did not only profit from war and debt, they also benefited from the interest received on loans to individuals and companies. As Wennerlind underscores, the Bank of England’s notes became “Europe’s first widely circulating credit currency” (2011: 109). Theoretically, however, the issued notes remained tethered to a metallic hoard of silver, and later only gold from 1861 (Davies, 2002: 315). No one knows for certain how much metal coin backed up the notes in circulation at any one time. In one study, Rubini argued that the Bank of England had a shifting reserve of silver for all notes in circulation of about 2.8 percent to 14.2 percent (1970: 696). Another study by Wennerlind argued that the founder of the Bank, William Paterson, proposed that 15 to 20 percent in silver for all notes outstanding would suffice to assure sufficient confidence in the Bank of England (2011: 128).5 This ambiguity and the fact that the Bank of England was privileged by the government, likely helped the Bank gain confidence among the users of its notes. As long as citizens thought they could eventually cash in their notes for silver/gold coins, faith in this system of money creation could continue (Kim, 2011). This uncertainty need not delay us, for what is definite is that the notes in circulation were of a far higher value than the actual metallic hoard at the Bank. To sum up this brief history of the world’s first widely circulating credit currency we can argue that new money was created as loans to customers – primarily to the British Crown in Parliament and primarily to finance an apparatus of international violence and Empire. 

By the early 19th century, the British politician, Samson Ricardo, realized the absurdity of granting private social forces the power to create money:

“It is evident therefore that if the Government itself were to be the sole issuer of paper money instead of borrowing it of the bank, the only difference would be with respect to interest: the Bank would no longer receive interest and the government would no longer pay it…It is said that Government could not with safety be entrusted with the power of issuing paper money – that it would most certainly abuse it... I propose to place this trust in the hands of three Commissioners” (Ricardo, 1838: 50). 

Ricardo’s proposal that the public take control of new money creation was ignored. In the 1844 Bank Charter Act, the Bank of England was given the exclusive right to issue banknotes in London. Country banks that were already issuing notes could continue to do so provided they were outside London (by a 65 mile radius) and backed their notes with some kind of credible security. Under this Act, the Bank of England was also divided into two distinct units, the Issue Department and the Banking Department. Davies highlights this important provision of the Act:

“The Issue Department was to receive from the Banking Department some £14 million of government securities to back its fiduciary issue of notes, any  issue above that [was] to be fully backed by gold and silver, the latter not to exceed one quarter of the gold” (2002: 315). 

Thus, while the Bank of England had the exclusive right to issue banknotes in London, its ability to create new money appeared to be circumscribed by the new laws. Existing banks outside of London were also seemingly bounded in their ability to create money. However, while official note issuance was restricted, this did not stop the Bank of England and other provincial banks from merely recording new loans on their balance sheets and issuing cheques to borrowers (Davies, 2002: 317). In other words, the bankers found a convenient way around the legislation and continued to expand the money supply regardless of gold reserves which were never publically known anyway. This changed the nature of banking in Britain and as we shall discuss, its legacy largely remains with us today. With this in mind, we now move to examine two theories of money creation: the heavily taught fractional reserve theory known popularly as the money multiplier model and the underappreciated credit creation theory.