Adam Smith's Simplified Wealth of Nations, Book 2, Chapter 2e: Bank collapse -- Ayr Bank & Mississippi Scheme
Chapter 2e: Bank Collapse -- Ayr Bank & Mississippi Scheme
In the midst of this clamour and distress, a new bank was established in Scotland to relieve the country's distress.
- "The design was generous but the execution was imprudent"
- It did not understand the nature and causes of the distress it meant to relieve.
- This bank was more liberal in granting cash accounts and in discounting bills of exchange than any other bank.
- It discounted all bills equally, including real and circulating bills.
- It chief purpose was to promote the improvements of land.
- It promised to advance, upon any reasonable security, the whole capital for land improvements (those with slow and distant returns).
- It issued many of its bank notes.
- But most of those bank notes were in excess of what the national circulation needed.
- The notes returned to be exchanged for gold and silver as fast as they were issued.
- Its coffers were never well filled.
- The capital which had been subscribed to this bank at two different subscriptions, amounted to £160,000, only 80% paid up.
- This sum should have been paid in at several different installments.
- Most of the proprietors opened a cash account with the bank when they paid their first installment
- The directors thought that they should treat their own proprietors with the same liberality as all other men.
- The directors allowed many proprietors to borrow on this cash account what they paid in on all their subsequent installments.
- Such payments only put into one coffer what was taken out of another.
- Even if its coffers were filled, its excessive circulation emptied them faster than they could have been replenished.
- The only way to keep it filled was to continually draw upon London with more bills of exchange.
- It was driven to this ruinous expedient a few months after opening, because its coffers were always ill-filled.
The estates of the bank's proprietors were worth several million pounds.
- Their estates were pledged for answering all its engagements.
- This great pledge enabled it to carry on business for more than two years despite its too liberal conduct.
- When it was obliged to stop, it had about £200,000 of bank notes in circulation.
- These notes were continually returning as fast they were issued.
- To support them, the bank constantly drew bills of exchange upon London which continually grew in value and number.
- In the end, the bills amounted to over £600,000 pounds.
- In a little more than two years, this bank advanced upwards of £800,000 at 5%.
- This 5% on the £200,000 which it circulated in bank notes might be considered as clear gain, deducting only management expences.
- But it was paying 8% in interest and commission on the £600,000 worth of bills of exchange upon London.
- It was consequently losing more than 3% on more than 3/4 of all its dealings.
This bank produced the opposite effects it intended.
- They intended to:
- support the spirited undertakings in the country.
- supplant all the other Scotch banks, particularly those in Edinburgh, by drawing the whole banking business to themselves.
- Those other Scotch banks offended this bank by being backward in discounting bills of exchange.
- This bank gave some temporary relief to those projectors.
- It enabled them to continue their projects for about two years longer.
- But it only caused them to get so much deeper into debt.
- When ruin came, it fell so much heavier on the projectors and their creditors.
- In the long-run, this bank aggravated the distress imposed by those projectors on themselves and their country.
- It would have been much better for themselves, their creditors, and their country, if most of them had stopped two years sooner.
- The temporary relief this bank gave to those projectors was a permanent relief for the other Scotch banks.
- All the bad bills of exchange which the Scotch banks were so backward in discounting, went to this new bank where they were received with open arms.
- Those other banks easily got out of that fatal circle which would have caused them loss and discredit.
In the long-run, the operations of this bank increased the real distress of the country it meant to relieve.
- It relieved its rivals from a very great distress.
Initially, people thought that its coffers could be easily replenished by raising money from its debtors' securities.
- They later realized that raising money by security was too slow to refill their coffers.
- They were forced to draw bills upon London.
- They paid these with other drafts with accumulated interest and commission.
- The bills let them raise money quickly, but it led to a loss each time.
- In the long-run, they ruined themselves as a mercantile company, though not as fast as by the more expensive practice of drawing and redrawing.
- They made nothing by the interest of the paper because it was in excess of what was needed by the national circulation.
- The paper returned to them to be exchanged for gold and silver as fast as they issued it.
- Their shortage of metal money continually obliged them to borrow metal money.
- They would have lost from the expence of:
- this method of borrowing, and
- employing agents:
- to look for and
- to negotiate with people who had money to lend, drawing the proper bond or assignment.
- Replenishing their coffers in this way may be compared to a man who employed people to go continually with buckets to a well to replenish a pond that was always losing water by a stream that was continually running out of it.
The country derived no benefit from this operation even if it was practicable and profitable to the bank as a mercantile company.
- On the contrary, the country must have suffered a very considerable loss by it.
- This operation could not augment the amount of money to be lent.
- This bank became a sort of general loan office for the whole country.
- Those who wanted to borrow applied to this bank, instead of applying to private persons.
- But a bank which lends money to 500 people is not likely to be more judicious than a private person who lends to a few people whom he knows.
- Most of the debtors of such a bank would likely be chimerical projectors.
- They would be the drawers and re-drawers of circulating bills of exchange.
- They would employ money in extravagant undertakings which they would probably never complete.
- Even if those undertakings were completed, would never repay their expence.
- Those undertakings would not afford a fund to maintain the labour employed to make them.
- On the contrary, the sober and frugal debtors of private persons would be more likely to employ the money borrowed in sober undertakings.
- Their undertakings would:
- be proportional to their capitals and
- be less marvelous but would be more solid and profitable.
- afford a fund to maintain more labour than that employed to make them.
- The success of this bank would not increase the country's capital.
- It would only have transferred most of the national capital from prudent and profitable, to imprudent and unprofitable undertakings.
Quantitative Easing: Mississippi Scheme
Mr. Law thought that Scotlan's industry languished for the lack of money to employ it.
- He proposed to remedy this lack by establishing a bank which would issue paper based on the whole value of all the lands in the country.
- The Parliament of Scotland rejected his proposal.
- The Duke of Orleans (Regent of France) adopted it with some variations.
The idea of multiplying paper to almost any extent was the real foundation of the Mississippi scheme.
- It was the most extravagant project of banking and stock-jobbing in the world.
- It is explained fully by Mr. du Verney in his Examination of the Political Reflections upon Commerce and Finances of Mr. du Tot that I shall not give any account of them.
- Its principles are explained in a discourse on money and trade by Mr. Law himself.
- He published it in Scotland when he first proposed his project.
- The splendid but visionary ideas on those principles still continue impress many people.
- It perhaps contributed to that excess of banking in Scotland and in other places.
Next: Chapter 2f: Central Banks