Adam Smith's Simplified Wealth of Nations, Book 2, Chapter 2c: Bank operations
Chapter 2c: Bank Operations
49 Other than the common business expenses, such as the expence of house-rent, wages of servants, clerks, accountants, etc., a bank's expenses consist chiefly in:
The expence of keeping a large sum at all times in its coffers for answering the occasional demands of the holders of its notes.
This sum pays no interest.
The expence of replenishing those coffers as fast as they are emptied when answering those occasional demands.
50A bank which issues more paper than can be employed in the country, should increase the quantity of gold and silver kept at all times in their coffers.
Because the excess paper is continually returning to the bank for payment.
It should increase its gold and silver in a much greater proportion to this excessive paper circulation.
Because their notes will return to it much faster than the excess of their quantity.
Such a bank should increase their first expence in a much greater proportion to this forced increase of their business.
51 The coffers of such a bank should be filled much fuller because they will empty themselves much faster than if their business were confined within more reasonable bounds.
They must require a more violent, more constant and uninterrupted expence to replenish them.
The coin too is continually drawn in large quantities from their coffers
It cannot be employed in the country's circulation
The coin replaces paper which is over and above what can be employed
The coin is therefore over and above what can be employed in it too
But as that coin will not be allowed to lie idle, it must be sent abroad to find profitable employment that it cannot find at home
This continual exportation of gold and silver must further enhance the bank's expence in finding new gold and silver to replenish those rapidly emptying coffers.
Such a bank must increase the second article of their expence still more than the first, proportional to this forced increase of their business.
52 Let us say that all the paper of a bank which the national circulation can easily employ was exactly £40,000.
For answering occasional demands, it is obliged to keep £10,000 in gold and silver at all times.
Should this bank circulate £44,000, the £4,000 above the national circulation, will return to the bank as fast as they are issued.
For answering occasional demands, this bank should keep £14,000 at all times, not £11,000 only.
It will gain nothing by the interest of the £4,000 excessive circulation.
It will lose the expence of continually collecting £4,000 in gold and silver.
This £4,000 will be continually going out of its coffers as fast as it enters.
53 Had every bank always understood its own interest, the circulation could never have been overstocked with paper money.
But every bank has not always understood its own interest.
The circulation has frequently been overstocked with paper money.
54 By issuing too much paper, the excess continually returned to the bank to be exchanged for gold and silver.
For many years, the Bank of England was obliged to coin gold at an average of around £850,000 per year.
It was frequently obliged to buy gold bullion at the high price of 960 pence an ounce because of:
this great coinage, and
the degraded state of the gold coin a few years ago.
It then converted bullion into coin at 934.5 pence an ounce.
It lost between 2.5-3.0% on the coinage of such a large sum. [(960 - 934.5)/960]
The Bank of England paid no seignorage.
The government paid the coinage cost.
But this did not prevent the expence of the bank.
55 All the Scotch banks were also obliged to constantly employ agents in London to collect money at a cost seldom below 1.5-2%.
This money was sent by wagon and insured by the carriers at an additional cost of 0.75%.
Those agents were not always able to replenish the coffers of the Scotch banks as fast as they were emptied.
The banks had to draw bills of exchange on their London correspondents to the fill the discrepancy.
When those correspondents collected payment for those bills with interest and commission, some of the Scotch banks had to draw a second set of bills.
In this way, the bills for the same sum would make more than 2-3 journeys.
The debtor Scottish bank would always pay the interest and commission on the accumulated total.
Even more prudent Scotch banks were sometimes obliged to employ ruinous bills of exchange.
This distress was caused by the excessive circulation of Scottish bank notes.
56 The gold coin paid out by the Bank of England or the Scotch banks for their paper which was in excess of the circulation needed by the country, was also itself in excess of the national circulation.
It was sometimes sent abroad in coin or melted down and sent abroad as bullion.
It was sometimes melted down and sold to the Bank of England at the high price of 960 pence an ounce.
It was the newest, heaviest, and best pieces only which were carefully picked out of the coin and sent abroad or melted down.
While those heavy pieces remained in coin at home, they were of no more value than the light pieces.
They were more valuable abroad or when melted down into bullion at home.
The Bank of England found to their astonishment that every year had the same scarcity of coin as the year before, despite their great coinage.
They found every year the more degraded state of the coin despite the great amount of good new coins they issued.
Every year, they found themselves needing to coin nearly the same amount of gold as the year before.
Every year, they found the cost of coinage becoming higher due to the continual rise in the price of gold bullion.
This rise was due to the continual wearing and clipping of the coin.
By supplying its own coffers with coin, the Bank of England is indirectly obliged to supply the whole kingdom.
Its coin is continually flowing from its coffers in many ways.
The Bank of England was obliged to supply:
whatever coin was wanted to support this excessive circulation of Scotch and English paper money and
whatever lack this excessive circulation created in the kingdom's coin.
All the Scotch banks paid very dearly for their own imprudence and inattention.
But the Bank of England paid very dearly:
for its own imprudence and
for the much greater imprudence of almost all Scotch banks.