The Origins of Fraudulent Banking and Government Finance: The Bank of Amsterdam
Following up on the enthusiasm the Fool community showed for A History of Inflation in Rome, I would like to share another fun historical study I have come across. The following is an excerpt from chapter 2 of Money, Bank Credit, and Economic Cycles by Jesus Huerta De Soto. I apologize that I could only reproduce a portion of this chapter. Should you decide to read the entire chapter, you will be treated to a lengthy discourse on fraudulent banking in Ancient Greece, Egypt, Rome, the Middle Ages, the Bank of England, France, etc. all the way through to the present day. De Soto's entire treatise is over 700 pages long. After slogging through the chapters establishing the different constructs of bank contracts, legal history, arguments for and against fractional reserve, a history of credit cycles and more, you finally get to the meat and potatoes: a plan to reform our monetary system, taking us from here (corrupt fractional reserve banking and the Fed) to there (free market banking.) It is truly a masterpiece.
The entire book is available for free on pdf here.
I hope you enjoy the read.
David in Qatar
A NEW ATTEMPT AT LEGITIMATE BANKING: THE BANK OF AMSTERDAM
The last serious attempt to establish a bank based on the general legal principles governing the monetary irregular deposit and to set up an efficient system of government control to adequately define and defend depositors’ property rights took place with the creation of the Municipal Bank of Amsterdam in 1609. It was founded after a period of great monetary chaos and fraudulent (fractional-reserve) private banking. Intended to put an end to this state of affairs and restore order to financial relations, the Bank of Amsterdam began operating on January 31, 1609 and was called the Bank of Exchange.103 The hallmark of the Bank of Amsterdam was its commitment, from the time of its creation, to the universal legal principles governing the monetary irregular deposit. More specifically, it was founded upon the principle that the obligation of the depository bank in the monetary irregular deposit contract consists of maintaining the constant availability of the tantundem in favor of the depositor; that is, maintaining at all times a 100-percent reserve ratio with respect to “demand” deposits. This measure was intended to ensure legitimate banking and prevent the abuses and bank failures which had historically occurred in all countries where the state had not only not bothered to prohibit and declare illegal the misappropriation of money on demand deposit in banks, but on the contrary, had usually ended up granting bankers all sorts of privileges and licenses to allow their fraudulent operations, in exchange for the opportunity to take fiscal advantage of them.
For a very long time, over one hundred fifty years, the Bank of Amsterdam scrupulously fulfilled the commitment upon which it was founded. Evidence reflects that during the first years of its existence, between 1610 and 1616, both the bank’s deposits and its cash reserves came very close to one million florins. From 1619 to 1635, deposits amounted to nearly four million florins and cash reserves exceeded three million, five hundred thousand. After this slight imbalance, equilibrium was restored in 1645, when deposits equaled eleven million, two hundred eighty-eight thousand florins and cash reserves added up to eleven million, eight hundred thousand florins. Equilibrium and growth were more or less stable, and in the eighteenth century, between 1721 and 1722, the bank’s deposits totaled twenty-eight million florins and its stock of cash reached nearly that amount, twenty-seven million. This great increase in the deposits of the Bank of Amsterdam stemmed, among other causes, from its role as a refuge for capital fleeing the crazy inflationist speculation that the system of John Law produced in France in the 1720s. We will deal with this more in depth later. This continued until 1772, in which both deposits and cash reserves totaled twenty-eight to twenty-nine million florins. As is evident, during this entire period, to all intents and purposes the Bank of Amsterdam maintained a 100-percent cash reserve. This allowed it, in all crises, to satisfy each and every request for cash withdrawal of deposited florins. Such was true in 1672, when panic caused by the French threat gave rise to a massive withdrawal of money from Dutch banks, most of which were forced to suspend payments (as occurred with the Rotterdam and Middelburg banks). The Bank of Amsterdam was the exception, and it logically had no trouble returning deposits. Increasing and lasting confidence in its soundness resulted, and the Bank of Amsterdam became an object of admiration for the civilized economic world of the time. Pierre Vilar indicates that in 1699 the French ambassador wrote in a report to his king:
“Of all the towns of the United Provinces, Amsterdam is without any doubt the foremost in greatness, wealth and the extent of her trade. There are few cities even in Europe to equal her in the two latter respects; her commerce stretches over both halves of the globe, and her wealth is so great that during the war she supplied as much as fifty millions a year if not more.” 104
In 1802, when, as we will now see, the Bank of Amsterdam started to become corrupt and violate the principles on which it was founded, the bank still enjoyed enormous prestige, to the point that the French consul in Amsterdam noted:
“At the end of a maritime war which has kept the treasures of the mines pent up in the Spanish and Portuguese colonies, Europe is suddenly inundated with gold and silver in quantities far above what is needed, so that they would decline in value if they were put into circulation all at once. In such an eventuality, the people of Amsterdam deposited the metal in ingots in the Bank, where it was kept for them at a very low cost, and they took it out a little at a time to send to different countries as the increase in the rate warrants it. This money, then, which if allowed to flood in too rapidly would have driven up the prices of everything exceedingly, to the great loss of all who live on fixed and limited incomes, was gradually distributed through many channels, giving life to industry and encouraging trade. The Bank of Amsterdam, then, did not act only according to the special interests of the traders of this city; but the whole of Europe is in its debt for the greater stability of prices, equilibrium of exchange and a more constant ratio between the two metals of which coin is made; and if the bank is not reestablished, it could be said that the great system of the trade and political economy of the civilised world will be without an essential part of its machinery.” 105
Therefore, we see that the Bank of Amsterdam did not try to attain disproportionate profits through the fraudulent use of deposits. Instead, in keeping with the dictates of Saravia de la Calle and others we have mentioned, it contented itself with the modest benefits derived from fees for safeguarding deposits and with the small income obtained though the exchange of money and the sale of bars of stamped metal. Nevertheless, this income was more than sufficient to satisfy the bank’s operating and administration costs, to generate some profit and to maintain an honest institution that fulfilled all of its commitments.
The great prestige of the Bank of Amsterdam is also evidenced by a reference to it found in the incorporation charter of the Spanish Banco de San Carlos in 1782. Although this bank, from its very inception, lacked the guarantees of the Bank of Amsterdam, and it was created with the intention of using its deposits, authority, and clout to help finance the Treasury, it could not escape the immense influence of the Dutch bank. Thus, its article XLIV establishes that private individuals may hold deposits or
“equivalent funds in cash in the bank itself, and whoever wishes to make deposits shall be allowed to do so, either in order to draw bills on the money or to withdraw it gradually, and in this way they will be exempt from having to make payments themselves, their bills being accepted as payable at the bank. In their first meeting, the stockholders will determine the amount per thousand which merchants must pay the bank in relation to their deposits, as they do in Holland, and will establish all other provisions concerning the best dispatch of discounts and reductions.” 106
DAVID HUME AND THE BANK OF AMSTERDAM
A sign of the enormous prestige of the Bank of Amsterdam among scholars and intellectuals, as well as merchants, is the express mention David Hume makes of it in his essay Of Money. This essay first appeared, with others, in a book called Political Discourses, published in Edinburgh in 1752. In it David Hume voices his opposition to paper currency and argues that the only solvent financial policy is that which forces banks to maintain a 100-percent reserve ratio, in accordance with traditional legal principles governing the irregular deposit of money. David Hume concludes that
“to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities, and thereby heightening their price to the merchant manufacturer. And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce. A public bank, bythis expedient, might cut off much of the dealings of private bankers and money-jobbers; and though the state bore the charge of salaries to the directors and tellers of this bank (for, according to the preceding supposition, it would have no profit from its dealings), the national advantage, resulting from the low price of labour and the destruction of paper credit, would be a sufficient compensation.” 107
Hume is not completely correct when he claims the bank would not earn a profit, since its safekeeping fees would be sufficient to cover operating costs, and it might even generate modest profits, as in fact the Bank of Amsterdam did. However his analysis is categorical and reveals that, in defending the creation of a public bank with these characteristics, he had in mind the success of the Bank of Amsterdam and the example it had already set for over one hundred years. Furthermore the third edition of his Essays and Treatises on Several Subjects, published in four volumes in London and Edinburgh, 1753–1754, includes a note by Hume in reference to the phrase, “no bank could be more advantageous, than such a one as locked up all the money it received.” Footnote number four contains the following words: “This is the case with the Bank of Amsterdam.” It appears that Hume wrote this footnote with the intention of more clearly emphasizing his view that the Bank of Amsterdam was the ideal model for a bank. Hume was not the very first to propose a 100-percent reserve requirement in banking. He was preceded by Jacob Vanderlint (1734) and especially by the director of the Royal mint, Joseph Harris, for whom banks were useful as long as they “issued no bills without an equivalent in real treasure.”108
SIR JAMES STEUART, ADAM SMITH, AND THE BANK OF AMSTERDAM
Sir James Steuart offers us an important contemporary study of the Bank of Amsterdam’s operation in his treatise published in 1767 entitled, An Enquiry into the Principles of Political Oeconomy: Being an Essay on the Science of Domestic Policy in Free Nations. In chapter 39 of volume 2, Steuart presents an analysis of the “circulation of coin through the Bank of Amsterdam.” He maintains that “every shilling written in the books of the bank is actually locked up, in coin, in the bank repositories.” Still, he states,
“Although, by the regulations of the bank, no coin can be issued to any person who demands it in consequence of his credit in bank; yet I have not the least doubt, but that both the credit written in the books of the bank, and the cash in the repositories which balances it, may suffer alternate augmentations and diminutions, according to the greater or less demand for bank money.” 109
At any rate, Steuart indicates that the bank’s activities “are conducted with the greatest secrecy,” in keeping with the traditional lack of openness in banking and especially significant in the case of the Bank of Amsterdam, whose statutes and operation demanded the maintenance of a continuous 100-percent reserve ratio. If Steuart is correct and this ratio was at times violated, it is logical that at the time the Bank of Amsterdam tried to hide the fact at all costs. Although there are signs that at the end of the 1770s the Bank of Amsterdam began to violate the principles upon which it had been founded, in 1776 Adam Smith still affirmed in his book, An Inquiry into the Nature and Causes of the Wealth of Nations, that
“The Bank of Amsterdam professes to lend out no part of what is deposited with it, but, for every guilder for which it gives credit in its books, to keep in its repositories the value of a guilder either in money or bullion. That it keeps in its repositories all the money or bullion for which there are receipts in force, for which it is at all times liable to be called upon, and which, in reality, is continually going from it and returning to it again, cannot well be doubted. . . . At Amsterdam no point of faith is better established than that for every guilder, circulated as bank money, there is a correspondant guilder in gold or silver to be found in the treasure of the bank.” 110
Adam Smith goes on to say that the city itself guaranteed the operation of the Bank of Amsterdam as described above and that it was under the direction of four burgomasters who changed each year. Each burgomaster visited the vaults, compared their content in cash with deposit entries in the books and with great solemnity declared under oath that the two coincided. Adam Smith remarks, tongue-in-cheek, that “in that sober and religious country oaths are not yet disregarded.”111 He ends his commentary by adding that all of these practices were sufficient to guarantee the absolute safety of deposits in the bank, a fact which was demonstrated in various Dutch political revolutions. No political party was ever able to accuse the prior of disloyalty in the management of the bank. By way of example, Adam Smith mentions that even in 1672, when the king of France marched into Utrecht and Holland was in danger of being conquered by a foreign power, the Bank of Amsterdam satisfied every last request for repayment of demand deposits. As we stated before, this acted as an even more impressive reinforcement of the public’s confidence in the absolute solvency of the bank.
As additional evidence that the Bank of Amsterdam maintained a 100-percent reserve ratio, Adam Smith offers the anecdote that some coins removed from the bank appeared to have been damaged in the building fire that struck the bank soon after its creation in 1609, which shows those coins had been kept in the bank for over one hundred fifty years. Finally, Adam Smith, in strict keeping with the true legal nature of the irregular-deposit contract, which requires that it be the depositors who pay the bank, indicates that the bank’s income stemmed from safekeeping fees:
“The City of Amsterdam derives a considerable revenue from the bank, besides what may be called the warehouse-rent above mentioned, each person, upon first opening an account with the bank, pays a fee of ten guilders, and for every new account three guilders three stivers; for every transfer two stivers; and if the transfer is for less than three hundred guilders, six stivers, in order to discourage the multiplicity of small transactions.” 112
In addition, Adam Smith refers to other sources of income we have already mentioned, such as the exchange of money and the sale of gold and silver bars.
Unfortunately, in the 1780s the Bank of Amsterdam began to systematically violate the legal principles on which it had been founded, and evidence shows that from the time of the fourth Anglo-Dutch war, the reserve ratio decreased drastically, because the city of Amsterdam demanded the bank loan it a large portion of its deposits to cover growing public expenditures. Hence, deposits at that time amounted to twenty million florins, while there were only four million florins’ worth of precious metals in the vaults; which indicates that, not only did the bank violate the essential principle of safekeeping on which it had been founded and its existence based for over one hundred seventy years, but the reserve ratio had been cut from 100 percent to less than 25 percent. This meant the final loss of the Bank of Amsterdam’s long-standing reputation: deposits began to gradually decrease at that point, and in 1820 they had dwindled to less than one hundred forty thousand florins.113 The Bank of Amsterdam was the last bank in history to maintain a 100-percent reserve ratio, and its disappearance marked the end of the last attempts to found banks upon general legal principles. The financial predominance of Amsterdam was replaced by the financial system of the United Kingdom, a much less stable and less solvent system based on the expansion of credit, deposits and paper currency.