WEBVTT NOTE Enter the Central Bank 1 00:00:00.000 --> 00:00:02.000 Enter the Central Bank. 2 00:00:02.000 --> 00:00:08.000 Central Banking began in England when the Bank of England was chartered in 1694. 3 00:00:08.000 --> 00:00:14.000 Other large nations copied this institution over the next two centuries, 4 00:00:14.000 --> 00:00:22.000 the role of the Central Bank reaching its now familiar form with the English Peel Act of 1844. 5 00:00:22.000 --> 00:00:29.000 The United States was the last major nation to enjoy the dubious blessings of Central Banking. 6 00:00:29.000 --> 00:00:34.120 Banking, Adopting the Federal Reserve System in 1913. 7 00:00:34.120 --> 00:00:39.440 The Central Bank was privately owned, at least until it was generally nationalized after 8 00:00:39.440 --> 00:00:41.800 the mid-20th century. 9 00:00:41.800 --> 00:00:45.980 But it has always been in close cahoots with the central government. 10 00:00:45.980 --> 00:00:51.720 The Central Bank has always had two major roles, one to help finance the government's 11 00:00:51.720 --> 00:01:13.720 and, two, to cartelize the private commercial banks in the country so as to help remove the too great market limits on their expansion of credit, on their propensity to counterfeit, a possible loss of confidence leading to bank runs and the loss of reserves should any one bank expand its own credit. 12 00:01:13.720 --> 00:01:24.720 For cartels on the market, even if they are to each firm's advantage, are very difficult to sustain unless government enforces the cartel. 13 00:01:24.720 --> 00:01:38.720 In the area of fractional reserve banking, the central bank can assist cartelization by removing or alleviating these two basic free market limits on banks' inflationary expansion credit. 14 00:01:38.720 --> 00:01:56.720 It is significant that the Bank of England was launched to help the English government finance a large deficit. Governments everywhere and at all times are short of money, and much more desperately so than individuals or business firms. 15 00:01:56.720 --> 00:02:12.720 The reason is simple. Unlike private persons or firms who obtain money by selling needed goods and services to others, governments produce nothing of value and therefore have nothing to sell. 16 00:02:12.720 --> 00:02:23.720 A minor exception, when admirably small governments such as Monaco or Liechtenstein issue beautiful stamps to be purchased by collectors. 17 00:02:23.720 --> 00:02:41.720 Sometimes, of course, governments will seize and monopolize a service or resource and sell their products, for example, a forest, or sell the monopoly rights to its production, but these are scarcely exceptions to the eternal coercive search for revenue by government. 18 00:02:41.720 --> 00:02:52.720 Governments can only obtain money by grabbing it from others, and therefore they are always on the lookout to find new and ingenious ways of doing the grabbing. 19 00:02:52.720 --> 00:03:09.720 Taxation is the standard method, but, at least until the 20th century, the people were very edgy about taxes, and any increase in a tax or imposition of a new tax was likely to land the government in revolutionary hot water. 20 00:03:09.720 --> 00:03:20.720 After the discovery of printing, it was only a matter of time until governments began to counterfeit or to issue paper money as a substitute for gold or silver. 21 00:03:20.720 --> 00:03:27.040 Originally, the paper was redeemable, or supposedly redeemable, in those metals, but 22 00:03:27.040 --> 00:03:32.840 eventually it was cut off from gold so that the currency unit, the dollar, pound, mark 23 00:03:32.840 --> 00:03:39.160 and so forth, became names for independent tickets or notes issued by government rather 24 00:03:39.160 --> 00:03:42.240 than units of weight of gold or silver. 25 00:03:42.240 --> 00:03:47.160 In the Western world, the first government paper money was issued by the British colony 26 00:03:47.160 --> 00:03:54.640 of Massachusetts in 1690. Printing was first developed in ancient China, and so it should 27 00:03:54.640 --> 00:04:00.600 come as no surprise that the first government paper money arrived in mid-eighth century 28 00:04:00.600 --> 00:04:08.320 China. The 1690s were a particularly difficult time for the English government. The country 29 00:04:08.320 --> 00:04:15.020 had just gone through four decades of revolution and civil war, in large part in opposition 30 00:04:15.020 --> 00:04:21.300 into high taxes, and the new government scarcely felt secure enough to impose a further bout 31 00:04:21.300 --> 00:04:28.300 of higher taxation. And yet, the government had many lands it wished to conquer, especially 32 00:04:28.300 --> 00:04:34.380 the mighty French Empire, a feat that would entail a vast increase in expenditures. The 33 00:04:34.380 --> 00:04:39.980 path of deficit spending seemed blocked for the English since the government had only 34 00:04:39.980 --> 00:04:46.740 recently destroyed its own credit by defaulting on over half of its debt, thereby bankrupting 35 00:04:46.740 --> 00:04:54.340 a large number of capitalists in the realm who had entrusted their savings to the government. 36 00:04:54.340 --> 00:04:58.620 Who then would lend any more money to the English state? 37 00:04:58.620 --> 00:05:03.540 At this difficult juncture, Parliament was approached by a syndicate headed by William 38 00:05:03.540 --> 00:05:06.660 Patterson, a Scottish promoter. 39 00:05:06.660 --> 00:05:12.700 The syndicate would establish a Bank of England, which would print enough bank notes, supposedly 40 00:05:12.700 --> 00:05:19.060 payable in gold or silver, to finance the government deficit. No need to rely on voluntary 41 00:05:19.060 --> 00:05:25.260 savings when the money tap could be turned on. In return, the government would keep all 42 00:05:25.260 --> 00:05:32.260 of its deposits at the new bank. Opening in July 1694, the Bank of England quickly issued 43 00:05:32.260 --> 00:05:42.260 issued the enormous sum of 760,000 pounds, most of which was used to purchase government debt. 44 00:05:42.260 --> 00:05:54.260 In less than two years' time, the bank's outstanding notes of 765,000 pounds were only backed by 36,000 pounds in cash. 45 00:05:54.260 --> 00:06:00.260 A run demanding specie smashed the bank, which was now out of business. 46 00:06:00.260 --> 00:06:21.260 But the English government, in the first of many such bailouts, rushed in to allow the Bank of England to suspend specie payments, that is, to cease its obligations to pay in specie, while yet being able to force its debtors to pay the bank in full. 47 00:06:21.260 --> 00:06:36.260 Specie Payments resumed two years later, but from then on, the government allowed the Bank of England to suspend Specie Payment while continuing in operation every time it got into financial difficulties. 48 00:06:36.260 --> 00:06:48.260 The year following the first suspension in 1697, the Bank of England induced Parliament to prohibit any new corporate bank from being established in England. 49 00:06:48.260 --> 00:06:55.260 In other words, no other incorporated bank could enter into competition with the bank. 50 00:06:55.260 --> 00:07:02.260 In addition, counterfeiting Bank of England notes was now made punishable by death. 51 00:07:02.260 --> 00:07:10.260 A decade later, the government moved to grant the Bank of England a virtual monopoly on the issue of banknotes. 52 00:07:10.260 --> 00:07:20.260 In particular, after 1708, it was unlawful for any corporation other than the Bank of England to issue paper money, 53 00:07:20.260 --> 00:07:27.260 and any note issued by bank partnerships of more than six persons was also prohibited. 54 00:07:27.260 --> 00:07:34.260 The modern form of central banking was established by the Peel Act of 1844. 55 00:07:34.260 --> 00:07:40.260 The Bank of England was granted an absolute monopoly on the issue of all bank notes in England. 56 00:07:40.260 --> 00:07:44.260 These notes, in turn, were redeemable in gold. 57 00:07:44.260 --> 00:07:49.260 Private commercial banks were only allowed to issue demand deposits. 58 00:07:49.260 --> 00:07:54.260 This meant that, in order to acquire cash demanded by the public, 59 00:07:54.260 --> 00:08:00.660 Similarly, the banks had to keep checking accounts at the Bank of England. In effect, 60 00:08:00.660 --> 00:08:06.940 bank demand deposits were redeemable in Bank of England notes, which in turn were redeemable 61 00:08:06.940 --> 00:08:14.660 in gold. There was a double inverted pyramid in the banking system. At the bottom pyramid, 62 00:08:14.660 --> 00:08:20.540 the Bank of England, engaging in fractional reserve banking, multiplied fake warehouse 63 00:08:20.540 --> 00:08:49.540 It is clear that once Britain went off the gold standard, first during World War I and 64 00:08:49.540 --> 00:08:57.380 And finally in 1931, the Bank of England notes could serve as the standard fiat money, and 65 00:08:57.380 --> 00:09:05.180 the private banks could still pyramid demand deposits on top of their Bank of England reserves. 66 00:09:05.180 --> 00:09:11.460 The big difference is that now the gold standard no longer served as any kind of check upon 67 00:09:11.460 --> 00:09:19.500 the central bank's expansion of its credit, that is, its counterfeiting of notes and deposits. 68 00:09:19.500 --> 00:09:33.500 Note 2, that with the prohibition of private bank issue of notes, in contrast to demand deposits, for the first time the form of warehouse receipt, whether notes or deposits, made a big difference. 69 00:09:33.500 --> 00:09:46.500 If bank customers wish to hold cash or paper notes, instead of intangible deposits, their banks have to go to the central bank and draw down their reserves. 70 00:09:46.500 --> 00:09:52.540 As we shall see later in analyzing the Federal Reserve, the result is that a change from 71 00:09:52.540 --> 00:10:00.460 demand deposit to note has a contractionary effect on the money supply, whereas a change 72 00:10:00.460 --> 00:10:05.620 Change from note to intangible deposit will have an inflationary effect.