Sunday, March 29, 2009

Our Financial Troubles:The Government and the Panic in America 1873 (1)

From the London Economist, Nov. 1.

In one respect the panic in the United States brings out the relations of a Government to calamities of that kind in a form exceedingly simple. In most cases Governments must interfere; at a certain stage of the calamities, more or less advanced, they must give help for their own sakes. They have deposited the proceeds of taxation with some bank, and they must preserve that bank; they would be unable to defray their ordinary expenditure, and to pay the national creditor if that bank stops.Their money is part of the money market, and therefore they must support the money market. But the American Government is not thus in the money market; it keeps its funds in the Treasury, and does not deposit them in any bank. It can, therefore, consider without bias (which most Governments cannot) whether it ought to give or withhold help in panic; it can consider the permanent interest of the nation, and not its own momentary interest. In this respect the American panic is simpler than most panics, and in another, almost as important, it is also simpler. It is essentially a deposit panic; not a note panic. There is no doubt about the currency. Greenbacks, the inconvertible paper issued by Government, are not suspected, but hoarded; the national bank notes, being secured by the deposits of undoubted securities, are also in excellent credit. We have to consider only the duty of the Government to the banks, not its duty to the currency of the people. What, then, in such a panic, ought such a Government to do?

In England we have never had this precise problem to consider. Our Government has always been so placed that at last it must support the money market. Its money was deposited in the Bank of England, and it could not permit the Bank of England to fail. It is sometimes imagined that the necessity for the intervention of Government arises from the act of 1844. But this is a mistake. It had to interfere in one way or another years before the act of 1844 was heard of; in 1797 it helped the Bank of England by suspendi ng the specie payment of the bank notes, in 1793 it issued exchequer bills itself: in 1825 it was on the very verge of doing so again.

Our Government never could "let the money market take care of itself," for it would have lost its own money if it had. And behind the banking panic there has always been in England the possibility that the convertibility of the bank-note might be endangered. Since the act of 1844 this dread, no doubt irrational, is still , it is confessed;felt. The safety of the Banking Department of the Bank of England, and the safety of the bank note are not thoroughly distinguised. The public mind but vaguely apprehends the separation of the departments, and the simple case which the American Government is considering has never been before us. What, then, in such circumstances ought a government to do? In our judgment its duty is exceedingly easy to write on paper, and exceedingly hard to effect in practice. There is the gravest danger in its giving any kind of help; if possible, it ought to give no aid whatever. Banking is a trade just like any other: the lending of money is as purely mercantile a matter as cotton-spinning or match-making. In this case, as in others, help to the bad competitor is harm to the good competitor. If you want not to have good cotton factories you have only to subsidize the bad ones; you have only to say that the Government will pay the bills of insolvent cotton spinners, and solvent o nes will not exist any more. In the same way the greatest discouragement to sound banking is a help to unsound. If you always help bad banks out of the difficulties, you will hardly ever have banks which are not in difficulties. Failure is the penalty which nature imposes on bad banking; and failure gets rid of the bad bank. But if Government prevent the failure, it not only shares the penalty but continues the evil. The bad bank still exists, and is the more trusted because it has been helped.

As the Government has helped it once, the public expect that the Government will help it again. Probably the bank itself thinks so also; and having been saved once from the natural penalties of incaution it will not care much about being cautious again. Caution in banking, we must remember, means present low profit; rashness means present high profit. Banks helped by Government will always tend to be rash, and take the present high profit, because they are exempt from the only reason which would make them take the low profit they are certain not to fail.

To be continued: (2)

Source of this article will be given at the end of article.


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