Free Banking: Theory, History and a Laissez-Faire Model by Larry J. Sechrest

Author:Larry J. Sechrest [Larry J. Sechrest]
Language: eng
Format: epub
ISBN: 978-1-61016-113-8
Publisher: The Ludwig von Mises Institute
Published: 1993-11-06T16:00:00+00:00

Small-Denomination Notes

In 1765, the British Parliament imposed on Scotland legislation that prohibited not only the option clause, but also the issue of notes smaller than one pound-sterling. The option clause has often been discussed—see Dowd (1991h), White (1984a), or Selgin (1988a), for example—but the prohibition of small-denomination notes seems to have received little attention.

Three aspects of this are of importance. First of all, one needs to realize that the one-pound note of 1765 had roughly the purchasing power of $180–$200 in the United States today.15 This figure may be achieved by discovering that British prices are presently ninety to 100 times the level of 1765 (Mitchell 1988, 719–34) and observing recent exchange rates of about $2.00 per pound. The implication is that after 1765 many day-to-day transactions could not be conducted in terms of banknotes; recourse to coins was necessary. Furthermore, the control of coinage rested with the Royal Mint and the Bank of England (Clapham 1958, Vol. II, 51–53). In other words, Scottish banks were systematically excluded from competition by means of notes for the business of those whose currency needs were relatively small in scale.

This restriction likely had two further effects. It may have served as a barrier to entry for small banks, since it could deny them the “niche strategy” of catering to small entrepreneurs and to the less wealthy consumers. Furthermore, since small-denomination notes always tend to circulate more rapidly than those of large denominations (White 1984a, 8), it would seem that the Act of 1765 must have reduced to some extent the effectiveness of the reflux process. That is, it may have raised the average period of circulation for Scottish banknotes and, thereby, increased the possibility of inflationary overissues. Consistent with this hypothesis, one finds Adam Smith’s observation in 1776 that in Scotland, “the circulation has frequently been over-stocked with paper money” (1937, 286). One may add to this the facts that (1) food prices fell from 1717 to 1750 but rose strongly in the latter part of the eighteenth century, as did coal, cattle, and grain prices, and (2) Scottish net exports declined after 1775 and were generally negative from 1780 to 1805 (Lythe and Butt 1975, 102, 103, 113, 116, 117, 162, 247). All of this suggests—but does not prove—the existence of an inflationary monetary expansion.

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