Adam Smith's Support for Money and Banking Regulation: A Case of Inconsistency
West, Edwin G., Journal of Money, Credit & Banking
The Bank of England originated in a deal between monopoly-seeking
financiers and a revenue-hungry government with war-seeking propensities.
The ultimate payee of the loans that the government secured from the new
bank was, of course. the taxpayer, and it is surprising that Smith did not
focus more on this fact. Indeed, the actual regulation
of private banks of which Smith approved. appears to have aided and abetted
the further development of the government alliance with the monopolizing
bank. The suppression of small notes had the effect of reducing entry into
banking while the legal obligation of the option clauses, which Smith also
wanted, made private banks more vulnerable to runs on their liquidity.
The wealth of nations is commonly regarded as the primary locus of the classic attack on monopolies. It is remarkable, nevertheless, that its author Adam Smith appears deferential rather than hostile to the most effective banking monopoly of his time: the Bank of England. Describing it as "the greatest bank of circulation in Europe" (Smith, Wealth of Nations 1976, p. 318, hereafter W.N.), he also observes that "The stability of the Bank of England is equal to that of the British government" (W.N., p. 320). Smith seems to be particularly impressed with the special services of the bank in providing advances to the government for expected revenues from land and malt taxes and receiving and paying annuities that are due to the government's creditors. For such reasons, Smith continues, "It acts not only as an ordinary bank, but as a great engine of state" (W.N., p. 320).
THE ORIGIN OF THE BANK OF ENGLAND
When William III needed funds to pay for a war against France, and was faced with exceptionally high interest rates (due to the Government's low credit), he was keen for his government to accept a huge loan from a group of financiers in return for allowing them to establish a bank to print banknotes (as well as to issue loans). The Company of the Bank of England was accordingly set up in 1694. It loaned the government 1.2 million [pounds sterling] in return for the right to issue notes to the same amount. This amount was increased in 1697, and it was on that occasion that the financiers obtained the supreme political privilege: a monopoly of chartered banking in England together with the substantial advantage of limited liability for the shareholders. The monopoly power was extended in 1709 when further legislation limited competition in England to companies with less than six partners with unlimited liability.(1)
The account of the development of the Bank of England in W.N. is delivered in flat terms and with little indication of the extent of the monopolization that had occurred. This phenomenon is even more surprising considering that Smith was as vehement against public debts as he was against monopoly in general. The very last section in W.N. (viii) contends that "were the expense of war to be defrayed always by a revenue raised within the year . . . wars would in general be more speedily concluded and less wantonly undertaken" (pp. 925-26). Consistency required, therefore, that Smith should have been doubly offended by the late seventeenth-century legislation setting up the Bank of England because it enabled government both to escape the obligation to pay for its new war by taxes, and to do so by erecting a powerful statutory monopoly to boot.
While Smith acknowledges that "No other banking company in England can be established by act of parliament, or can consist of more than six members" (W.N., p. 320), he appears to have failed to grasp the full implications of this restriction on entry into banking. Freedom of entry, of course, is the most important condition for competition, and Smith himself insists that banking should be a fully competitive undertaking (W.N., par. …