Central banks are the supposed champions of
both price stability and financial stability.... But, have prices and finance really been very
stable? or was the world of money actually more stable before central banking was invented? Hi, I am Joeri and to find out,
I have collected the best works from economic historians and summarized them into what I
believe is the true origin story of central banking. And, to be honest, after doing the research,
I am no longer surprised about the popularity of central bank conspiracy theories
Okay, the scene is 13th century Europe, a golden era of rising trade. And to facilitate that trade, the various
princes, dukes, and kings each offered their own silver, gold, or other metallic coins. However, while the official prices of these
coins were based on their precious metal content, the actual metal content of these coins frequently
changed, making them not as pure as you might have
expected, and therefore not always reliable. This uncertainty, along with the difficulty
of carrying around heavy coins and the cost of protecting them, meant that merchants,
that needed to do larger or possibly even international transactions, relied on famous
European banking families such as the Bardi, Perruzi and Medici to transform their debts
into tradeable deposit money. However, the increasing reliance on private
deposit money brought with it another problem and that is that,
since money is kind off essential for any economy, if one of these banking houses went
out of business, it often took the economy down with it. For example, when both the Bardi and Peruzzi
family banks went belly up after King Edward the 3rd of England failed to repay his loans
in the 14th century, there were massive economic repercussions in Italy. In this light it is not surprising that the
first government owned deposit bank, the Casa di San Giorgio, was created in Italy (Genoa)
in 1407. So, was this the origin of central banking? Well the definition of central banking is
that of a: a national bank that provides financial and
banking services for its country's government and commercial banking system, as well as
implementing the government's monetary policy and issuing currency. where, banking means an institutions that
provides deposit and credit facilities. Now, this public bank Casa di San Giorgio
took in deposit but it did not yet provide loans or credit to the state. It just promised that for each deposit, there
would coin of equal value in the bank. In this way the Casa di San Giorgio along
with many of its contemporaries in 14th and 15th century Italy and Spain was a publicly
owned 100% reserve banks. It provided the important service of settlement
of large transactions by using a ledger rather than coins,
How would this work in practice though? Well, say that one prominent merchants wanted
to pay another. At least one of them would then have to go
to the bank to make their intentions known. Then, later they would both have to return
in person and make the payment via changes in their deposit accounts, with a notary there
to confirm it all. While, still quite a hassle, you can imagine
that for large transactions this deposit money was still a lot easier than using bags of
coins that all needed to be counted. Especially, since there were many coins in
circulation with different values. So, nothing wrong with these public deposit
banks and the honest people that ran them then... Well, not so fast
In the research I read, it states that in practice the full reserve rule was frequently
broken... especially when there was a public emergency... for example... When the Taula de Valancia was restructured
in 1613 it came to light that it had made several illegal advances to city officials
and even illegal loans to the city itself. So, then you could say that these Southern
European deposit banks were in fact the first central banks since they did two things that
define what a central bank is. They issued currency ... and ... even though
it was illegal ... they provided credit to the state... But, since this was on such a small scale,
and outside of their mandate, I consider them the ancestors of modern central banks... not
the first central banks themselves. No, for the next stage in the evolution of
central banking, we need to go to my home country.... the Netherlands. The year is 1609 ... roughly 30 years after
the founding of the Dutch Republic.... Dutch trade with the Baltic nations was flourishing
but cloth importers were demanding monetary reform... why? ...
well because there were 14 mints in the small republic all making their own coins... making
it extremely difficult to exchange them and to separate good from bad coins.... In response, the city of Amsterdam founded
a bank and named it ... de Amsterdamse Wisselbank.... which translates literally to the Exchange
Bank of Amsterdam, but is better known as the Bank of Amsterdam. Like its South European predecessors it was
known as a public deposit bank or full reserve bank. Here is what Adam Smith had to say about it
in his famous book the Wealth of Nations:
"At Amsterdam, however, no point of faith is better established than that for every
guilder, circulated as bank money, there is a correspondent guilder in gold or silver
to be found in the treasure of the bank." However, recent research of old ledgers of
the bank has revealed that in fact Adam Smith was wrong.... As you can see in this graph (graph1), from
very early on the Bank of Amsterdam did provide some credit to both the city of Amsterdam
and the Dutch East India Company. So, again, the bankers of Amsterdam were not
completely honest. Even, if, you can see that the Bank did basically
start out as a full-reserve bank whose primary function was to provide deposit money to merchants. And again, this type of deposit money was
primarily used for large transactions. This was desperately needed and highly valued
as we can see from the fact that Bank of Amsterdam deposit money typically traded at a 5% premium
over metallic coin money.... Meaning that you had to offer more money in
coins to the Bank of Amsterdam than you would get back as deposit money – and you would
be happy to do so, so popular was the deposit money. Of course, this led to more public city banks
being founded in the Netherlands. For example, the Bank of Middelburg was founded
in 1616, the bank of Delft in 1621, and the bank of Rotterdam in 1635. And these all weren't full reserve banks. They provided credit. We know this because in 1672 when the French,
English, and two German armies simultaneously invaded the Netherlands, a bank run occurred
and they couldn't repay all of their depositors. Meanwhile the Bank of Amsterdam could – apparently
it had enough coins, or could attract enough coins in time, to make the payments. The Economy of the Dutch republic never fully
recovered after the attack. But, the Bank of Amsterdam, with its proven
resilience, did not just survive, it became stronger than ever. In 1683, the bank had grown so strong that
it basically created an early European fiat currency when it changed its policies such
that not all deposits would be redeemable for coins anymore. This meant that those non-redeemable deposits
were purely based on the trust in the authority of the bank of Amsterdam. That being said, this non-redeemable deposit
money was still implicitly tied to metal because the people that accepted them did so knowing
that on the secondary market they could still trade them for metal coins, if need be. And that power came in handy when, in the
panic of 1763, at the end of the seven years’ war between France and England, the massively
overstretched Merchant banking house Gebroeders de Neufvill went bust, sending shockwaves
through the financial centres of Europe. While the crisis ravaged the banking houses
of Hamburg and Venice, the crisis was contained in Amsterdam thanks to the Bank of Amsterdam
stepping in as a lender of last resort, hence becoming a banker of the banking system as
well as of the city of Amsterdam. Furthermore, the Bank of Amsterdam started
increasing its credit services to both the city of Amsterdam and the Dutch East India
Company. This was fine at first, having almost no impact
on the Bank of Amsterdam deposit money premium. However, trust in the Bank of Amsterdam was
still largely based on its supposedly large reserves of metal because by now the bank
had grown so large that, even if the city of Amsterdam wanted to, it wouldn't be able
to bail it out in a crisis. And that crisis came in the form of the fourth
Anglo-Dutch war which broke out because the Dutch kept trading with the rebellious British
colonies of the United States. With the British attacking the Dutch East
India Company, souring those loans, and the city of Amsterdam demanding more and more
credit, trust in the Bank of Amsterdam quickly turned sour, a bank run occurred and while
the Bank of Amsterdam did technically survive, it was never able to return to its former
glory, and was ultimately dissolved in 1819 having become obsolete thanks to the establishment
of the Dutch Central Bank in 1814. So, was the Bank of Amsterdam it the first
central bank? No! it was definitely the next step in the
evolution towards central banking thanks to it providing credit somewhat more openly,
acting as a lender of last resort to the financial system, and introducing non-convertible deposit
money. However, what is keeping it back is that it
was not a national bank... it was a city bank... Sure, you could argue that that is a tiny
detail because the Netherlands was just more decentralised than it is today. But, it turned out to be detail of massive
importance since the Dutch republic might have been able to bail it out, whereas the
city of Amsterdam... was not. So, even though it was not the first central
bank, it did inspire a Latvian born citizen in Amsterdam for 'unknown reasons', and the
kind that moved abroad to Sweden immediately when he was released in 1646. And with him, he brought a suspicious wealth
of knowledge about economics, finance, and specifically the workings of the Bank of Amsterdam. The Swedes promptly appointed him head of
the Chamber of Commerce from where he was in the position to propose to King Karl Gustav
to establish for Sweden a bank that would provide both deposit (Wechselbank) and credit
(Lanebank) services for the Swedish state. Noticeably, this bank, named Stockholms Banco,
was established in 1656 as a privately owned bank with shareholders including the King,
the City of Stockholm, and, of course, none other than Johan Palmstruch himself. Now at the time in Sweden, a deposit bank
was sorely needed since the Swedes mainly used copper coins for trade, which are much
heavier and more cumbersome than silver or gold coins. And so, it is perhaps not surprising that
it was here in Sweden, in 1661, that Banco Stockholm premiered the use of a spectacularly
innovative slip of paper that allowed people to pay with deposit money without both parties
needing to go to the bank with a notary to verify a transaction..... Exactly, Palmstruch's Banco Stockhold issued
the first recorded bank notes... However, that is where his triumphant story
ends. Johan was a rooky central banker after all
and after having lent too much too quickly while trying to pay below market rates on
deposits, Johan found out the hard way the meaning of a bank run and Sweden experienced
its first banking crisis. Banco Stockholm promptly collapsed and poor
Johan again found himself charged for financial crimes by the state. However, having experienced the benefits of
both deposit money and not having to borrow from wealthy individuals, the Swedish state
took over the Banco Stockholm in 1668 and rebranded the Sveriges Riksbank (literaly
Swedish State Bank). A bank that provided financial and banking
services for the Swedish nation.... And that last part is why, technically the
Swedish and not the Dutch, invented central banking. But, did having a central bank bring price
and financial stability to Sweden? Well, that is not immediately clear, if we
look a historical time series of inflation in Sweden... we don't see a clear effect. You could even argue that prices got less
stable in spite of price stability being at the center of the Riksbank design right from
the start with its stated mission to "maintain the domestic coinage at its right and fair
value." One reason for this might have been that the
central bank was able to provide much cheaper credit to the state ... mainly used to Finance
some of Sweden's 17th, century wars. And while you could argue that this extended
the lifespan of the Swedish Empire which had already peaked before the establishment of
the Riksbank, the Riksbank was never able to rival the power of the Bank of Amsterdam
at the end of the 17th century Swedish bills of exchange were mainly cleared in Amsterdam
even though the bulk of Swedish exports went to England. So, while the Sveriges Riksbank is technically
the first central bank, we need to head to late 17th century England for the next evolution
in central banking. The year is 1688, and England has just been
invaded.... by the Dutch. That's right, the last successful invasion
of England was by a Dutch army, led by its ruler William of Orange the third. But, while it pains this Dutch economist to
admit it.... this was as much of a coup as it was an invasion since
the royal British army actually helped the Dutch invaders to overthrow the British Monarchy
and William of Orange to become King William the Third. What is more interesting for our financial
story though is that, in an ironic twist, economic historians believe that this invasion
ultimately created the central bank that would overtake the Bank of Amsterdam. You see, one of the first things that the
Dutch king William did was granting the Bank of England its charter in 1694. Notably, though, much like the Riksbank, it
had two departments right from the start, one for lending and another for deposit services. Another similarity was that it started as
a for profit enterprise owned by the crown and wealthy merchants- many of them happened
to be Dutch Yeah... there was a lot of corruption in Europe
back then... That being said, economists widely agree that
the primary reason for its establishment was to help England fight the Nine Year war with
France. One way it did this was by transmitting to
funds to troops on the continent via Amsterdam. But, more importantly, it funded the war through
the issuance of bank notes and ... because war is expensive... this quickly turned into
the excessive issuance of new notes... causing inflation... So again, did the Bank increase price stability? It seems that the opposite happened at first. Although, if we consider longer-term inflation,
inflation was lower the century after the inception of the Bank of England than in the
century before that. But, this might have a had little to do with
the central bank and more with the massive inflow of
Silver from the American continent and a spike in population driving up agricultural prices
in the 16th century. Okay, so, what about financial stability? Well, not long after the inception of the
Bank of England, the UK experienced its first massive bubble in the form of the South Sea
Bubble. However, this was not directly the fault of
the Bank of England. In fact the British South Sea company could
be seen as a competitor for the Bank of England because it was primarily used as a vehicle
to finance the British state and various agents of the state therefore had an interest in
this bubble. However, it should be noted that when the
bubble popped, its impact on the economy was limited. Possibly, thanks to emergency lending by the
Bank of England. And, as London's financial might grew, so
did the frequency of its financial crises. For example in in the crisis of 1793.... West India Merchants got into trouble due
to a war with France and went to the Bank of England.. for support ... which they got. But supporting the economy and government
while you are tied to gold is tricky. So, not surprisingly, when gold supplies got
low compared to issued notes, the Bank of England had to suspend convertibility to gold
in 1797. The suspension lasted almost 25 years and
so in practice the Bank of England, like the Bank of Amsterdam before it, now issued fiat
currency. This allowed it to further support first its
(slave trading) merchants in 1799, while slowly moving to a lender of last resort function
for banks during the early 19th century. Here it should be noted that not all banks
were to be saved whatever the cost, since for the longest time the Bank of England followed
the rule formulated by Bagehot: central banks should lend early and without limit, to solvent
banks, that were able to post good collateral, and at 'high rates.' And with that rule in place, it does appear
that financial crises became a thing of the past under the Bank of England. And actually right up to the second world
war.... British prices seemed to be more stable than
in the decade before the Bank of England. So, while the history of central banking is
one steeped in lies, crises, profiteering businessmen, corrupt politicians, and even
support of slave trading, it did seem to stabilise prices and finance. Not surprisingly, all of continental Europe
introduced their own central banks, and even in the USA, which had stumbled form one banking
crisis to another in the era of free banking came up with its own... and so all seemed
to be well in central banking land... up to the 1950s when central banks were still there,
but high economic growth along with inflation became the new norm, and then finally in the
90s and early 2000s when financial instability made a big come-back. So, what happened there? To find out, consider subscribing to the channel
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