The Natural Law of Money
By William Brough
William Brough was born in 1826 in Kelso, Scotland. In his early childhood, the family moved first to Canada and then to Vermont. He began to study medicine but gave it up for business. He moved to New York in 1849 and then to Pennsylvania, where he was a pioneer in the development of the oil industry. He became the first president of the Oil Producer’s Association, and was involved in some important U.S.-Russian oil ventures. He retired in 1885, devoting his time to the study of social and economic subjects and to the writing of two books on money. A chaired professorship at Williams College is named in his honor.In
The Natural Law of Money, William Brough argues forcefully that privately-supplied money offers benefits not offered by government-supplied money.Brough’s analysis includes a discussion of Gresham’s Law. Gresham’s Law is commonly summarized by the catchy phrase “bad money drives out good.” It is just as commonly misunderstood. To understand Gresham’s Law, just remember this one simple requirement for it to hold: Fixed exchange rates.Historically, coins minted of valuable metals like gold or silver frequently became “bad” when they were clipped or shaved, making them weigh less. Coin-defacers could profit by shaving bits off of good coins and then reselling the metal clippings. Shop-owners, too busy to weigh coins for every transaction, were generally content to accept clipped coins at face value, so long as they could later spend those coins at that same face value. In daily transactions, the clipped coins were identical to the unclipped coins–they traded 1 : 1. Once this cycle got started for a currency, the bad coins quickly replaced the good ones, as coin-defacers snapped up and clipped any good coins in circulation. Thus, a gold coin stamped by the government with the value of one dollar might typically contain increasingly less than a dollar’s worth of gold over its lifetime. Eventually a critical point would occur, as the holders of bad coins became worried that other sellers would no longer accept their degraded coin at face value. Those left holding the bag stood to lose a great deal.In the modern world of fiat paper currency, the exact same effect occurs if a money’s quantity is relatively increased by its issuing Central Bank. Its value declines in principle, but it may temporarily be accepted at its stamped face value by those using it for daily transactions or to purchase other currencies, in the expectation that it will retain or return to that stamped value so it can be spent without loss. If the government further requires that the bad currency be exchangeable with another (good) currency at face value (i.e., at a fixed exchange rate), the bad currency will most certainly replace the good one in circulation. Why not accept a piece of paper worth less than a dollar if you can instantly buy with it another currency worth a full dollar? Why not keep any good pieces of paper under your mattress, and simply spend–recirculate–the bad ones? “Good” currencies are hoarded by the knowledgeable or used in illicit trade (because black market transactions typically involve large quantities of cash, which has to be accumulated and held by someone, risking an interim decline in confidence in its value), leaving the “bad” currencies in daily circulation.Gresham’s Law, so obvious and disturbingly critical to daily life that it was discussed in the streets for centuries, does not seem very relevant today. Why not? Gold coins of verified weight are good currency–why do they not drive paper monies out of existence? Because Gresham’s Law requires fixed exchange rates–exchange rates between the “bad” and “good” money that are fixed either by law, custom, or expectations. When coins are clipped but their stamped values trade 1 : 1 with unclipped coins–a fixed exchange rate–the bad coins soon drive out the good ones. When fiat money values are eroded by the increased supply of one relative to the other, but their relative legal values for transactions are mandated by government restrictions, the inflated currency drives out any available uninflated one. If gold or silver coins are required by law–fiat–to exchange with paper money at a fixed rate, and afterwards the quantity of paper money increases relative to that of the precious metal, the paper money will supplant the coin in daily transactions. Many other historical examples abound. The key factor in every case is fixed exchange rates between the bad and good currencies.But if the currencies’ values are instead determined by the market–that is, if they “float” relative to each other–then the clipped or overly-supplied money simply loses value (“depreciates”). Instead of the bad currency supplanting the good one, both currencies can exist side-by-side in circulation, trading at the market rate of exchange. The market participants have an incentive to keep tabs on the relative supplies or market exchange rates because no one wants to accept at face value money that will be worth much less when it comes time to spend it.Consequently, today, flexible exchange rates, supplied by nations implicitly competing in world money markets and simultaneously allowing their citizens access to those international money markets, enable people to substitute quickly their holdings of their domestic currencies for other currencies if they lose faith. The euro competes daily with the British pound, the U.S. dollar, and the currencies of Asia, Eastern Europe, and any other currency that gains a reputation for retaining its value–all of which helps keep values and monetary policies in line. Having suffered through enough fixed-exchange-rate tribulations and inflationary crises, many nations float their exchange rates and allow citizens to hold and use other currencies, at least to limited extents. Emigration allows further competition in money choices; and improved communication via computers allows instant access to information about international conditions affecting money supplies and demands. Thus, Gresham’s Law does not often rear its head in discussions. But Gresham’s Law still holds when rates of exchange are fixed; and it remains an Achilles’ Heel in discussions of returns to gold standards, unified currencies, or fixed (including managed) exchange rates. In money, as in all goods, market competition helps keep supply and demand in line.Does international competition in currencies effectively substitute for private competition? What conditions optimally determine the areas over which a single currency–the most extreme example of fixed exchange rates–can effectively operate? These questions excite international economists today.William Brough is one of only a few writers from the late 1800s who correctly explained Gresham’s Law, as well as many other matters concerning money supplies and these exciting matters of competitively supplied money. For more works on money supply from the late 1800s-early 1900s, see:Primary resources (historical order):
Bagehot, Walter,
Lombard Street (first published 1873)
Jevons, William Stanley,
Money and the Mechanism of Exchange (first published 1875). See, on Gresham’s Law,
Chapter 8, pars. 27-34.
Newcomb, Simon,
The ABC of Finance (first published 1877)
Laughlin, J. Laurence,
The History of Bimetallism in the United States (first published 1885). Empirical evidence on Gresham’s Law.
Brough, William,
The Natural Law of Money (first published 1896)
Fisher, Irving,
The Purchasing Power of Money (first published 1911). See, on Gresham’s Law,
Chapter 7.
Mises, Ludwig von,
The Theory of Money and Credit (first published 1912)
Cannan, Edwin,
“The Application of the Theoretical Apparatus of Supply and Demand to Units of Currency” (first published 1921)
Suggested Secondary Resources (alphabetical by author):
Mundell, Robert, Optimum currency areas. Online, see
International Economics, particularly Chapter 12,
A Theory of Optimum Currency Areas.
Timberlake, Richard H.,
“The Government’s License to Create Money” (
Cato Journal, The Cato Institute, Fall 1989). Online pdf file with helpful discussions of Brough, plus useful bibliography.
White, Lawrence H.,
“Competing Money Supplies,”The Concise Encyclopedia of Economics. Online at the Library of Economics and Liberty.
White, Lawrence H. and George Selgin,
“Why Private Banks and Not Central Banks Should Issue Currency, Especially in Less Developed Countries” Online at the Library of Economics and Liberty, April 19, 2000.
Lauren Landsburg
Editor, Library of Economics and Liberty
August, 2003Special thanks to George Selgin, Associate Professor of Economics at the Terry College of Business, University of Georgia, for biographical information on William Brough.
First Pub. Date
1896
Publisher
New York: G. P. Putnam's Sons
Pub. Date
1896
Copyright
The text of this edition is in the public domain.
CHAPTER VIII.
THE HOARDING PANIC OF JULY, 1893.
PROBABLY most persons who were in the United States in the summer of 1893 were conscious that a great commercial crisis had arrived, but many of them may not have realized that this crisis included two distinct panics referrible to quite different causes. The first of these occurred in May, the second in July. The May panic was the culmination of a long-continued drain upon the capital of the country by foreign investors who distrusted our ability, under existing legislation, to maintain the gold standard; there was no scarcity of money at the time. Gold had already disappeared from general circulation, and was paid out only at the United States Treasury; but, notwithstanding the withdrawal of gold, the money in circulation, had it possessed the requisite elasticity, would have been sufficient in quantity to effect all exchanges in all
parts of the country. The July panic was quite a different thing; it was occasioned by the hoarding of paper-money, which reduced the quantity in circulation far below the needs of the people. It is to this second panic that we wish to call special attention, because it furnishes, on the one hand, a practical illustration of the inability of a government to perform properly those functions of banking which our government has assumed in undertaking to supply the medium of exchange, and because, on the other hand, it illustrates the entire ability of the people to properly provide such a medium for themselves.
The withdrawal of capital from the country and of gold from the circulation, which preceded the May panic, were the acts of individuals who foresaw the disastrous consequences that would follow a suspension of gold payment; but that the hoarding of paper-money which brought on the panic of July was the work of individuals who were ignorant of monetary principles, is proved by the fact that the money they hoarded, like all the money in general circulation at the time, was liable to decline to the silver basis. Greenbacks are payable in coin, and coin means either silver or gold; silver certificates are payable in silver only; Treasury notes are pay
able in either silver or gold; and national-bank notes may be redeemed in either greenbacks or Treasury notes. These four kinds of paper-money, together with the silver coin in current use, constituted the entire circulating medium when the hoarding began, and the Secretary of the Treasury could at his discretion have lawfully reduced it all to a silver basis.
This entire volume of currency was substantially without elasticity; aside from the four and a half million dollars’ monthly output required by the Sherman Act, the paper-money could only be legally expanded by the issuance of notes, to the full amount of the authorized limit, by such national banks as had not already their full quota in circulation; but to so expand it involved a preliminary outlay of capital by these banks in the purchase of government bonds, as well as a delay of from twenty to thirty days before they could get their notes from the government; indeed, many of the applicants for notes did not receive them until after the need for them had passed. The only other available resource left open to the people in this extreme emergency was the importation of gold; to make any paper-money was a penal offence.
It should be borne in mind that there is, under existing laws, a tax of ten per cent. upon every
form of paper, excepting government notes and national-bank notes, that may be used as a common medium of exchange in any part of the country. This tax is not levied for revenue, but is intended to suppress the issuance of any and all paper-money not directly authorized by Congress; it is, therefore, in no proper sense a tax,—it is a fine.
In attributing the first panic to the withdrawal of capital from the country, and the second to the with-drawal of money from the circulation, it is understood that these withdrawals were but the logical sequences of that monetary legislation which was the primary and sole cause of both panics. The natural conditions were all favorable to industrial growth and prosperity.
The withdrawal of capital from the country had lowered prices, it had raised the normal interest rate, it had checked new industrial undertakings, it had, in short, lowered the productive powers of the nation, thus compelling individual economy and lessening the consumption of commodities: but although, in consequence of the loss of capital, the industry of the nation could move only on a lower plane of activity, the industrial organism itself was still intact. The hoarding of the currency, on the contrary, threatened a disruption of this industrial organism,
because any civilized community deprived of its medium of exchange, is thereby carried back to primitive barter. It is no more possible for a people to maintain their industrial activities without a medium of exchange, than it is for a farmer without farming implements to till the soil and produce crops.
The hoarding of paper-money doubtless began some time before its disturbing effects were seriously felt. Just before the July panic, it was noted by New York city bankers that the volume of current money in that city was shrinking at the rate of a million dollars a day, and this startling fact made it necessary for them to adopt measures to ward off the danger that threatened them; for although a bank may be ever so solvent, it must, under a strict ruling of our national banking laws, meet its demand obligations in lawful money, or close its doors. Consequently, although this hoarding originated with persons who were ignorant of monetary principles, it soon became necessary, as a matter of self-preservation, that banks and persons who perfectly understood these principles, should refrain, as far as possible, from paying out currency. The savings banks were not only admonished to increase their reserve money, but also to keep it in their own
vaults, thus withdrawing from current use the money usually kept by them in commercial banks.
The strain upon the industrial activities of the nation caused by the hoarding, reached its greatest tension in the third week of August. Congress had then been sitting in extra session for about two weeks, yet, notwithstanding the urgent appeals from all parts of the country, that body had done nothing to relieve the nation from its distress. The repeal, on the first of November, of the silver-purchase clause of the Sherman Act, served to allay the public fear of gold suspension, and doubtless somewhat checked the drain of capital from the country; but before this repeal was enacted, and while it was still the general belief that the clause would not be repealed, industries that had suspended in consequence of the hoarding, resumed operations solely through individual action, and without the least aid from Congress.
It may be doubted whether any people were ever placed in a more trying and critical position by false monetary legislation than were the people of the United States during the months of July and August, 1893, and no person at all conversant with monetary principles, noting what then took place, can fail to be impressed by the promptitude with which the
American people met the crisis and overcame it. Without any warning or previous indication, the mania for hoarding had broken out and had spread like an epidemic all over the country. Mills and factories with ample capital and in active operation, for lack of current money had to shut down and leave their work-people without employment; many perfectly solvent banks had to close their doors; railroad companies could not obtain the necessary money to pay the wages of their workmen.
Within four weeks after the July panic, the want of a medium of exchange had reduced the productive activities of the nation about thirty per cent. This was made evident by a thirty per cent. reduction in the sum-total of bank clearings in those cities which have the clearing-house system. There are eighty such cities in the United States, and the sum-total of the daily business transacted through the banks of each city is each day brought into one set of books, and the rise or fall of this sum-total, in all the cities, indicates from day to day, with measurable accuracy, the rise or decline of industrial activity in the nation at large.
The country was only saved from a much more serious crash by the action of the people who promptly took into their own hands the supplying
of a medium of exchange, ignoring the laws that make such action a penal offence. Before the hoarded money had returned to the circulation, mills and factories that had shut down, started up again with a money of their own making, which their employés were satisfied to take, and which the local store-keepers freely received at its full face value in exchange for goods. To relieve their need of currency, many banks imported gold at an extra cost; forty million dollars were thus imported in August. The bank clearing-houses in the different cities issued certificates which were used among themselves in lieu of legal money in making their exchanges. About forty million dollars, in certificates of five thousand dollars each, were issued by the New York Clearing-House; while in some other cities certificates for as small a sum as ten dollars were issued, and these passed into the current circulation of the localities where they were issued.
The individual bank-check was, however, the chief instrumentality of relief in this exigency; it became for a time the common medium of exchange, as was shown by the fact that legal money was bought and sold as any commodity might be. As much as four and a half per cent. premium was paid in check-money for legal money. In these transactions, it
was noted that the government paper-money sometimes brought half per cent. more than gold coin, and this circumstance was interpreted by some as evidence that silver money was preferred to gold, but it had no significance beyond the fact that the silver money was paper and the gold was coin. The paper-money commanded the higher premium only because it is more convenient to handle than coin. The question of quality did not enter into these transactions. What the buyers wanted was anything that could legally perform the function of a medium of exchange, and they were obliged to pay a premium to obtain it because the government, in its capacity of banker-in-chief, had failed to supply this medium.
The hoarded currency began to return to the circulation in September, and in October the banks were amply supplied with legal money and were paying it out freely. We cannot know to what extent the extemporized money—such as bank-checks, clearing-house certificates, pay-roll checks, etc.—supplied the deficiency occasioned by the hoarding of the legal medium of exchange, but we do know that by the second week of October the industry of the nation was no longer restricted by the want of such a medium. The issuance of cer
tificates by the New York Clearing-House, which began in the third week of June, had reached the sum of $38,280,000 on August 29th, and this was the largest sum outstanding at any one time, although there had been a total issue of $41,490,000. The cancellation of these certificates began in the second week of September, and the last certificate was cancelled on the first day of November. The date of issuance of these certificates not only enables us to fix definitely the duration of the hoarding period, but also to fix the time at which the strain was greatest; this was in August, as is confirmed by the fact that the premium on legal money began to be paid in the second week of August and ceased with the first week of September.
Under a monetary system that would not interfere with the freedom of metallic money or with the freedom of banks in the exercise of their legitimate function of issuing paper-money, and with laws that would recognize the vital importance of personal supervision and individual responsibility, this hoarding panic would not have been possible; but under our present system of government money, we are constantly exposed to similar experiences. Nor would this risk be lessened by a change of standard. Whether silver or gold, or whether both these metals,
formed the standard, government paper-money would still have all its present defects; it would still have a tendency to desert the agricultural districts for the great cities, where it would stimulate unwholesome speculation; it would still be monopolistic, in the sense that it would confer upon wealth the power to create a monopoly in money. A few rich men, by withdrawing money from the circulation and locking it up, can break prices and embarrass legitimate trade, thus producing conditions in a given locality similar to those produced by the hoarder in the nation at large.
During the greenback period, this method of manipulating the New York stock market was so commonly practised that it came to be regarded almost as a legitimate occupation. A clique of moneyed men would sell a long line of securities, then put away the greenbacks received for them, and having by this means broken the market, they would buy back their securities at the reduced rates,—a transaction made possible by the lack of elasticity inherent in government paper-money.
Money is so important a factor in the creation of wealth that until we can have a paper currency with sufficient elasticity, not only to respond promptly to legitimate demands in every section of the country,
but to return to its issuers for redemption when that demand shall cease, we can neither know what the productive powers of the nation are, nor can they be developed to their fullest extent; but we shall never have such a currency so long as the national government continues to exercise the function it has assumed of supplying the common medium of exchange.
