The Redemption of Paper Money

Excerpted from the book;
Individual Liberty: Selections From the Writings of Benjamin R. Tucker
Vanguard Press, New York, 1926
Kraus Reprint Co., Millwood, NY, 1973.

In a paper entitled "Banking and the State," read before the Single Tax Club of Chicago, Mr. A. W. Wright took the position, which he considered of the greatest importance, that paper money must always be subject to immediate redemption, the sole reason assigned for that contention being that nothing but public confidence can make paper money possible. The editor of Liberty took issue with him on that point:

It remains to be proved that immediate redemption is essential to public confidence. It is, of course, true that certainty of ultimate redemption is such an essential. But this is the most that can be claimed. A run on a bank of issue is caused by the fear of the note-holders that the notes will never be redeemed, and not because they desire them redeemed at once. On the contrary, if they felt sure of ultimate redemption, and felt sure that other people felt equally sure, they would go precisely contrary to their desire in presenting the notes for immediate redemption, for they are in need of the money for actual monetary use and in this respect find solvent paper preferable to gold. The pledge of immediate redemption, far from being essential to the usefulness of paper money, is one of the two things that in the past have done most to cripple it (the other being the restriction of its basis to one or two forms of wealth). Paper money, to attain its highest usefulness, must be issued in the form of notes either maturing at a definite date or else redeemable within a certain period following demand. There would be no lack of confidence in such money, if issued against specific and good security and under a system of banking furnishing all known means of safeguarding and informing the public. Mr. Wright's mistake probably arises from adherence to the old notion that a bank of issue needs capital of its own, and that this capital constitutes the security of the note-holders. The real fact is that the security and all the needful capital is that which the borrowers themselves furnish. There is no special reason why the State should not do a banking business, but only those general reasons which make it improper for the State to undertake any business. The fact that it has nothing of its own is no bar, for it is in the very essence of money-issuing that it is done on other people's property.

When banks cease promising to pay on demand, it will no longer be possible to precipitate a panic by cornering gold. But as long as demand notes alone are issued, banks will have to keep large quantities of coin in their vaults, and there will be a constant effort on the part of speculators to gain control of specie, success in which will cause a run on the banks and a general lack of confidence. The true way to maintain confidence is to refrain from making promises that cannot be kept. The fact that less than half the gold is coined proves nothing. Gold has other than monetary uses. It is needed in the arts; and in the worst panics, when money is so scarce that business men will pay enormous prices for it, but little of the uncoined gold finds its way into the market. The pressure upon the rich in times of panic is never great enough to cause them to melt their jewelry, carry their watch-cases to the mint, or have the fillings extracted from their own teeth and those of their dead ancestors to be turned into coin. To induce such a result money would have to command a much higher price than it ever does. And yet the high price of money proves its scarcity.

Mr. Wright further errs, it seems to me, in saying that "banks should be permitted to issue paper money equal to their unimpaired capital," implying thereby that they should not be permitted to issue more than this amount. This would be a virtual prohibition of mutual banks, which do not profess to have any capital and claim to need none. As Colonel Greene has pointed out, banks serve simply as clearing-houses for their customers' business paper running to maturity and no more need capital than does the central clearing-house which serves them in the same way. By what right does Mr. Wright pretend to say how many notes a bank shall issue to people who are willing to receive them? I ask him in his own words: Must the State afford holders of bank paper protection that is denied to holders of individual notes? "Can a note of issue justly be held more sacred than other promises to pay?" In putting a limit to paper issues Mr. Wright violates his principle of liberty in finance. And he does so again when he insists on unlimited liability. To deny the right of two parties to contract on a basis of limited liability is to abridge the freedom of contract. If unlimited liability is a better arrangement., those banks which offer it will survive, while the others will go down. Trust more to liberty, Mr. Wright, and less to law.

Erroneous also is the statement that "bills of issue should be a first lien upon the assets of the bank." But this I have no need to discuss, for I have received a letter from Mr. Wright in which he says that he has changed his opinion. I am convinced that further reflection will show him that prohibition of other than demand notes, restrictions upon the amount of issue, and invalidation of contracts specifying limited liability are, equally with his "first-lien" privilege, unwarrantable invasions of individual and associative liberty, and, as such, entirely at variance with the great doctrine of which his essay is, in the main, so excellent an exposition.

In a letter to the editor of Liberty Mr. Wright attempted to defend himself, and from his statements it became evident that he had not considered the use of anything but gold as a basis for banking. Mr. Tucker then went more deeply into that phase of the problem, as well as into other related aspects of mutual banking:

It now appears that the possibility of anything else than gold as adequate security for paper money is a conception which Mr. Wright's mind never before entertained. When I speak of paper money based upon adequate security and yet not upon gold, he opens wide his eyes and asks: What can you mean? Why, my dear Mr. Wright, the very keystone of Anarchistic economics, so far as finance is concerned, is the proposition to extend from gold to all other commodities that right of direct representation in the currency which gold now enjoys exclusively. The prohibition, or ruinous taxation, of money issued directly against miscellaneous securities is the chief denial of freedom of which the banking monopoly is guilty, and the right to so issue money is the chief liberty which freedom in banking will bestow upon us. How this right may be utilized and the tremendous changes that would follow its exercise are things not explained in "Social Statics." To understand them Mr. Wright must lay down his Spencer and pick up Colonel Greene, whose "Mutual Banking," though temporarily out of print, will probably be republished soon. If Mr. Wright will then read it carefully, our discussion will proceed more profitably. Meanwhile I will briefly examine the facts and arguments which he now offers.

For proof of the possibility of a solvent demand currency without a dollar-for-dollar coin reserve he advances the solvency of the Suffolk Bank and the Scotch banks. I answer that the case of the Suffolk Bank must be considered in connection with the history of the whole State system then prevailing. That history is one long succession of failures of banks intrinsically solvent but unable to meet sudden demands for gold. During such an experience everything does not fall; something has to stand, and people naturally reserve their confidence for the institution which has the greatest reputation. The Suffolk Bank stood, not because it was solvent while other banks were insolvent, but because the noteholders knew that the men at the back of it were men of great reputation and wealth who could and would supply it with coin in case of need. The illustration is really an unfortunate one for Mr. Wright, since by it he cites an entire banking system in which institution after institution, with assets far exceeding liabilities, were forced to suspend for lack of ready coin.

The solvency of the Scotch banks is due mainly to the following facts: first, that the stockholders in every bank except the three oldest of these institutions are liable to the whole exent of their personal fortunes for the bank's debts; secondly, that Scotch law enables property, both real and personal, to be attached with exceptional ease; third, that every note issued by a bank in excess of its average circulation for the year ending May 1, 1845, must be be represented by an equal amount of coin in its coffers; and, fourth, that all new banks of issue have been forbidden since 1845. I do not deny that under such conditions demand notes can hold their solvency without a full coin reserve; but certainly Mr. Wright must withdraw his assertion that free banking prevails in Scotland. It is surely an invasion to prohibit banks run on the plan of limited liability. But where these are not prohibited and where there is otherwise perfect freedom in banking, there will be no banks on the plan of unlimited liability, for they could get no business. Wealthy men will not jeopardize their entire fortunes without being roundly rewarded in the shape of dividends, and borrowers will not pay four, five, or six per cent. for the notes of an unlimited liability bank when they can get adequately-secured notes from a limited-liability bank for less than one per cent.

It should be added here that, however true the statement may have been when "Social Statics" was written, it is not true now that no Scotch bill has ever been discredited. Two of the largest Scotch banks suspended in 1857, and one of them, the Western Bank, went entirely to pieces; and, if my memory is correct, Scotland has known one or two serious bank failures within the last twenty years.

Mr. Wright is mistaken as to the necessary conditions of a "corner." A commodity may be cornered whether there are any promises to deliver it in existence or not. It can be cornered to induce a scarcity and consequent rise in price. Now, this rise in price would surely be much greater, and therefore also the incentive to create a corner, if the corner would give rise to a panic and thus cause a tremendous artificial demand. And it is precisely this that happens when gold is cornered and demand notes are in circulation. There is just as much incentive for the speculator when he knows that he can frighten people into calling for ten millions on a certain day as when he knows that some one has promised to pay ten millions on a certain day. Furthermore, the incentive in the former case would be very much greater than in the latter if the obligation to pay the ten millions were in the latter case contingent upon the happening of a very improbable thing. Now with mutual banking such would be the case. If the banks of New York held notes of borrowers to the amount of a million dollars and all maturing on the same day, and if the million dollars (or slightly less) which the banks had issued in their own notes to these borrowers were redeemable in gold at a later day if not presented on the earlier day for redemption by a re-exchange of notes, the borrowers, by turning in the bank-notes in fulfillment of their own obligations to the banks, would wipe out the banks' indebtedness of a million, with the exception of perhaps two or three thousand dollars, the percentage of bad debts being very small. Thus gold would be needed only to settle this trivial balance, and so slight a demand would furnish very little incentive for a corner.

I have now examined all the evidence adduced by Mr. Wright to show that demand notes can surely stand against a run (the only question that I am now discussing with him), and I claim, on the strength of this examination, that the evidence leads to precisely the opposite conclusion.

Mr. A. W. Wright has an interesting article in Electrical Engineering on "Governmentalism versus Individualism in Relation to Banking." It is thoroughly and avowedly Anarchistic, and is written in answer to criticism directed against Mr. Wright's financial views by the so-called Professor Gunton.

Mr. Wright's paper is admirably brave and earnest, and presents the case for liberty in banking with great force. Nevertheless, there are grave heresies in it, among them the assertions that it is impossible to get bank-bills into circulation without agreeing to redeem them on demand, and that an I0U cannot be made secure without totally destroying the economic reason for its existence." The reasons for the existence of an I0U are two in number: first, the desire of the giver of the I0U for an advance of capital; second, the generally-felt necessity of a circulating medium. Practically these two reasons are but one, since the desire of the giver of the I0U for an advance of capital is almost always a demand for that form of capital which will most readily buy all other forms, - that is, currency.

Now, to say that a man who needs more capital than he has, but who already has an amount of capital sufficient to enable him to secure his I0U by giving a mortgage, has therefore no reason to issue an I0U, or to say that such an I0U, when issued, will not be received by others in exchange for goods because it is secured, is to go to the extreme length of possible economic absurdity. Yet it is precisely what Mr. Wright has said. He should have said, on the contrary, that, unless liberty in banking will result in the issue of I0U's as secure as the best financial mechanism can make them, this liberty itself will lose much the weightier part of its reason for existence, becoming merely one of many petty liberties, - good enough in themselves, but not screaming necessities, or pregnant with great results. If financial liberty will not result in a secure currency, it will do nothing to lessen the exploitation of labor. But in Anarchistic eyes the destructive effect of liberty upon human exploitation constitutes ninety-nine per cent. of its value, and, if it will not have such effect, Mr. Wright is wasting his time in writing sixteen-page articles in its favor.

In all polemical writing there frequently occurs the necessity of interpreting the language or statements of an author. Such an occasion arose concerning a sentence in Col. William B. Greene's work on "Mutual Banking," which made necessary the following analysis by the editor of Liberty:

Some months ago Comrade Henry Cohen wrote a letter to the Conservator in which he declared that the ultimate of the mutual bank note is not redemption, but cancellation. He may not have used exactly these words, but they do not misrepresent the position that he took. The object of his letter was to show that the mutual bank note is not redeemable in specie by its issuer. In a later issue of the Conservator I undertook to correct Comrade Cohen, showing that, while cancellation by re-exchange for the borrower's note would be the usual mode of disposing of bank notes at maturity, their ultimate, properly speaking, is redemption in specie by the bank, since that would be the course adopted in case of a borrower's insolvency and consequent failure to take up his own note given to the bank; and I intimated that the author of "Mutual Banking" would not have died a peaceful death, could he have foreseen that some of his disciples would represent him as favoring an irredeemable currency.

When I said this, I was unaware that a single sentence could be quoted from "Mutual Banking" in support of Comrade Cohen's view. But Hugo Bilgram, seeing the letters in the Conservator, promptly wrote to me, calling my attention to the fact that, of the seven provisions constituting Greene's plan for a mutual bank, the seventh is that "the bank shall never redeem any of its notes in specie." Mr. Bilgram added that this sentence from "Mutual Banking" is obviously inconsistent with the rest of the work and seriously impairs its value, and, finally, he endorsed my position that a currency, to be reliable, must be ultimately redeemable in a fixed amount of a specific commodity. Soon came also a letter from Cohen, in which, fresh from his editing of "Mutual Banking," he desired to know how I explain the very sentence cited by Mr. Bilgram. I now answer unequivocally that I do not attempt to explain it, and that Cohen would have been justified in pointing to it with an air of triumph, instead of asking me his modest question. When I wrote to the Conservator, I had forgotten that this sentence occurs in "Mutual Banking." In fact, I never at any time could have been thoroughly aware of it. I first read the pamphlet in 1872. Possibly I read it again a year or two later. During the last twenty years or more, though I have often re-read single pages, I have not read it from end to end. In 1872 the subject was new to me. I was greatly interested in it, and the pamphlet made a deep impression on me, suggesting to me a thousand thoughts; but my boyish unfamiliarity with discussions of finance made it impossible for me to subject each and every one of its statements to that searching, criticism which such a book would now receive at my hands. The subsequent clarification of my thought was effected largely by personal intercourse with Colonel Greene himself. During the five years following 1872 which constituted the closing period of his life (he died at Tunbridge Wells, England, in 1877 or 1878) I had the privilege of his acquaintance, and enjoyed many a long talk with him on the subjects in which we were most interested. It should be remembered that even then "Mutual Banking" had been published almost a quarter of a century, and that in the meantime its author's thought, while not fundamentally changing, had undoubtedly matured, and his methods of presenting it had become more careful and precise. Now, in all our talks on finance, never once did he give expression to the doctrine laid down in the sentence cited by Bilgram and Cohen; on the contrary, all our arguments proceeded on the assumption that a mutual bank note would be a claim (though not a demand claim) on its issuer for specie to the amount of its face.

In determining, then, whether Cohen's interpretation of Greene or my own is the correct one, my testimony as to the conception of mutual banking which I derived from Greene personally must be considered, as well as the inconsistency between the sentence cited and Greene's proposal to have the notes secured by property salable under the hammer. This inconsistency is seen as soon as we ask ourselves in what form payment would be made for property sold under the hammer. It would have to be made either in specie or in bank notes. Now, we cannot assume that it would be made in bank notes, unless we also assume, first, that it is possible to float a large volume of mutual bank currency merely on the strength of members' agreement to receive it in trade in lieu of its face in specie, so that no one would ever present a note to the bank, even after maturity, for redemption in specie, and, second, that the insolvent borrower or his assignee would always consent to receive in bank notes so much of the proceeds of the sale as might remain to his credit after satisfaction of the bank's claim, - both of which, in my view, are assumptions of unwarrantable violence. The payment, then, would be made in specie, and this specie would have to be used partly in paying the balance due to the insolvent borrower and partly in calling in the bank notes which the insolvent borrower had failed to pay in at the maturity of his obligation. But such calling in would be specie redemption, which is forbidden in the sentence cited by Cohen.

It seems to me, then, that we are forced to the conclusion that this sentence was written carelessly by Colonel Greene, and that he really intended to say only that the bank shall never agree to redeem any of its notes in specie on demand.

This conclusion is further justified by Greene's provision for the acceptance of specie by the bank, at a slight discount, in payment of debts due the bank, and his failure to provide any means of disposing of the specie so accepted. The presumption is that he expected it to be used in redemption of notes. (Let me say, parenthetically, that I dissent from Greene's proposal to receive specie at a discount. Such discrimination might properly be made against bank bills redeemable on demand, but it would be absurd for a bank to discriminate against, and thus discredit, its own chosen standard of value.)

Another fact of significance in this connection is that, of the seven provisions laid down in the fourth chapter of "Mutual Banking" as constituting the author's plan for a mutual bank, every one except this questionable seventh is carefully embodied, almost word for word, in the petition for a general mutual-banking act which constitutes the fifth chapter, while this questionable seventh, though of the greatest importance if it means what Cohen thinks, is omitted altogether.

I maintain, then, for the various reasons urged, that Colonel Greene did not believe in an irredeemable currency, and I suggest that, in subsequent editions of "Mutual Banking," an editorial foot-note should adequately qualify the misleading sentence that has occasioned this discussion. Nevertheless, it clearly becomes me to apologize to Comrade Cohen for "calling him down" so abruptly, when he really had at his back evidence of seemingly considerable strength.

The question of the redemption of mutual bank notes in specie was still engaging the attention of some of the students of the problem, Mr. Cohen still contending that the author of "Mutual Banking" did not expect the mutual banks to handle specie at all; and Mr. Francis D. Tandy arguing that, even with definite maturity dates, a great many of the notes of the mutual bank would become payable in specie on demand, or else the bank would be compelled to accept from borrowers, in cancellation of loans, nothing but notes that have reached maturity, in which case the borrower might be obliged to pay a premium to obtain such notes. Mr. Tucker argued the matter still further with both his critics:

At the time when Colonel Greene wrote "Mutual Banking", the banks of issue in vogue were the old State banks professing to redeem their notes in specie on demand. It was this system which he had to combat, and the entire assault of "Mutual Banking" is upon a demand-note currency. There being no other currency in the people's mind, he had not to guard against other ideas. Consequently he declared the mutual bank-notes independence of hard money in language so absolute and unqualified as to give some color to the latter-day claim made by Henry Cohen that his plan excludes specie-redemption at any time and under all circumstances. If the passages which Mr. Cohen quotes in another column are to be construed with all the rigor that he seems to desire, they absolutely exclude the use of the specie dollar; but that Colonel Greene contemplated no such exclusion is undoubtedly shown by his declaration that no paper bill of less than five dollars should be issued, in which case disuse of the specie dollar would mean disuse of all dollars, for the specie dollar would be the only dollar in existence. The alternative, then, is to construe these passages liberally rather than literally, and in the light of the fact that an essential feature of the Mutual Banking plan is the provision of a collateral to serve for the redemption of notes not canceled in the ordinary fashion. Despite the keen intellectual quality shown in "Mutual Banking" as a whole, it contains here and there obviously inexact statements that will not bear analysis. There is, for instance, the declaration that the mutual bank is by its nature incapable of owing anything, clear absurdity if vigorously insisted upon instead of being interpreted by the context; for Colonel Greene elsewhere defines the issue of mutual money as an exchange of credits, an exchange inconceivable between two parties one of whom is by nature incapable of indebtedness. I might take up the cited passages seriatim, but it is needless, for my general answer covers the ground.

Possibly Mr. Cohen's suggestion that the security for uncancelled notes would be converted by sale partly into bank-notes and partly into gold, the former to satisfy the bank's claim and the latter to satisfy the borrower's equity, meets my argument that the collateral would have to be converted into gold because of the rights of the borrower, - though I have some doubts as to the practicability of the plan, - but my argument that the collateral could not be converted into bank-notes unless these bank-notes had first shown a greater power of general circulation than they would be likely to acquire by a mere agreement of members to receive them in trade regardless of redeemability in specie remains untouched. To be sure, Mr. Cohen urges that the notes will float if enough members join to insure their immediate convertibility into all marketable products; but to assume that a membership of this size and variety can be obtained, and that the non-enforcible agreement of the members to receive the notes in trade would inspire the same confidence in them that would be inspired by an enforcible agreement of the issuer to redeem them in specie, is to beg the question. It is this consideration - the necessity of inspiring confidence in the notes - that makes it desirable that the notes should mature, - that is, be made redeemable by the issuer under definitely-prescribed conditions.

Which brings me to Mr. Tandy's criticism. His error lies not in his logic, which is sound, but in his false premise, - namely, that the tendency of the matured note to flow back to the bank is no greater, and perhaps less, than the tendency of the unmatured note to so flow back. If this were true, then the conditions ultimately resulting would not differ materially from those obtaining under a demand-note currency. But it is not true. Most of the mutual banks would probably be banks of deposit as well as of issue, and large sums of circulating currency would be constantly passing through their hands, as a result of which they would be able, not only by their individual efforts, but by their associative efforts taking effect through the clearing-house, to call in matured notes, paying out in their stead unmatured notes previously paid in by borrowers in cancellation of loans. Mr. Tandy hints, to be sure, that there would be a counter-effort on the outside to corner matured notes in the hope of their going to a premium. I do not think this in the least likely, for people seldom execute movements which may be so simply and easily thwarted. It would not take a very expert financier to knock such a corner in the head. Suppose the bank notes were promises to pay in gold, dollar for dollar, thirty days after presentation at maturity or later, but subject to a proviso that all notes presented later than, say, ninety days after maturity should be liable, at the option of the bank, to a discount from the face value at a percentage rising in the ratio of the period of delay. How long, in Mr. Tandy's opinion, would a corner in matured notes last under such circumstances? He has discovered a mare's-nest.

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