1 Introduction
Commercial banking developed in Italy by the fifteenth century. The public banks of Naples were in the forefront of that development. Since then, they, and the practice of banking worldwide, have been undergoing a continuous process of development, partly in response to the changing structure and needs of the macro-economy and partly in response to crises, some manmade, e.g. in the guise of wars and political disturbances, and some not, e.g. natural disasters such as plagues and earthquakes.
The early Italian banks introduced many crucial innovations, such as lending on the basis of collateral and the use of bills of exchange. The public banks of Naples had a special role in this regard, since they developed a flexible form of deposit certificate, the fedi di credito, based on currency, or other assets placed with them, that were flexible, redeemable and transferable, and, arguably, also the first recorded instances of cash credit overdraft facilities (see Chapter 2, Sect. 5 by Costabile and Nappi). These remarkable innovations are described at greater length in several of the subsequent chapters, notably Chapters 2â4, and their balance sheets (1587â1806) are reported in Chapter 5 (F. Balletta, L. Balletta and E. Nappi).
In particular, the paper by Avallone and Salvemini, Chapter 4, not only describes why the public banks in Naples, connected to large charities,1 became preferred to private bankers (mostly managed by foreigners, e.g. Genoese), but also records why the fedi di credito were so popular. Silver coins were subject to clipping and their other transactions costs, e.g. ensuring safety, weight, forgery, etc., were also greater than those of the fedi di credito. Such coins were also subject in many regions to periodic debasement, following by inflation, and then âcrying downâ to halt such inflation, all of which led to a greater demand for the paper of stable public banks (see Neal, Chapter 6). And, of course, there were usually many different coins in circulation at any time, whose value varied continuously against each other. One of the main roles of public banks, such as the Bank of Amsterdam (see Chapter 13 by Quinn and Roberds) was to provide a more stable and efficient medium of exchange, notably for bills of exchange, than could be obtained through the use of coins of shifting values.
Not all the developments that have occurred in the banking industry since then have been as beneficial as the fedi di credito. The charitable impulse that was associated both with the Neapolitan banks and with several other early Italian banks, such as the Monte de Paschi di Siena, is now somewhat conspicuous by its absence. Under the Amato-Carli Act of 1990, there was an attempt in Italy to restore the role of non-profit organisations, in the guise of Banking Foundations, in the governance of the newly privatised banks, as recorded by Giannola, Chapter 16; but this model has not been entirely successful. Many would argue, however, that the shift of investment banking in the USA from partnerships to limited liability companies and the switch of housing finance from mutual associations (S & Ls in the USA, Building Societies in the UK) to regular commercial banks have been deleterious in effect. Epstein and Dutt, Chapter 15, note that non-profit-maximising banks have not been as pro-cyclical as shareholder banks, and argue that a larger share of public sector or stakeholder banks would provide a beneficial diversification for the financial system.
Whereas bank intermediation has, on balance, been enormously beneficial, (lending to keen borrowers, providing a liquid and safe source of financial assets, running the main payment systems, smoothing out the jagged fluctuations of cash flow, etc.), there is one facet of its activities that remains of persistent concern, which is that bankers, being normal human beings, and their banks tend to amplify the inherent cyclical fluctuations of our economy. During good times, profits are high; asset prices rise; borrowing gets repaid; defaults are low; and bankers tend to lend more, thereby reinforcing the boom. And when the bust occurs, the amplification feedback mechanism goes into reverse.
Particularly during the boom period, this amplification process can threaten price stability and also the adherence of the local paper currency to an external standard of value, such as the gold standard or a pegged exchange rate. Although several of the early Central Banks, such as the Bank of England and Banque de France, were founded to help finance their countryâs war expenditure, a role that remained paramount during major wars, e.g. in the Napoleonic era, WWI and II, these nationally pre-eminent banks soon became accorded with the quasi-political task of managing the monetary and banking system as a whole, so as to maintain price stability.
The greater the power of the issuer of local currency, the less its value is needed to be strictly tied to its metallic content in gold, silver or copper, i.e. seigniorage will be greater. As Eichengreen shows in Chapter 14, the US dollar, the linchpin of the international monetary system, no longer has any firm link to a precious metal. He argues that, historically, the conditions supporting an international currency, besides its metallic content, were size, stability, liquidity and power. Several of the early Italian City StatesâGenoa, Florence, and Veniceâhad the attributes that made their currencies widely acceptable in international trade. The Neapolitan silver ducato was not so used; Eichengreen suggests that this may have been owing to some political limitations.
Just as the following Chapters record the evolving patterns of commercial banking in Naples, and more widely in Europe, so it is the purpose of this Chapter to analyse and record the changing pattern of Central Banking. The history of Central Banking, as I have outlined previously (Goodhart 2015), can be divided into periods of consensus about the roles and functions of Central Banks, interspersed with periods of uncertainty, often following a crisis, during which Central Banks (CBs) are searching for a new consensus. The timeline is roughly as follows (Table 1).
Table 1
History of CBs has swung between periods of Consensus and Uncertainty
Consensus | Uncertainty | |
|---|---|---|
1873â1914 | Gold standard Real Bills Doctrine Lender of Last Resort (LOLR) | |
1914â1933 | Break-down of GS Break-down of Real Bills Doctrine Unemployment and inflation | |
1934â1970 | Fiscal (Keynesian) dominance CB subject to Finance Ministry Financial repression Interest rates used for BoP, otherwise low | |
1971â1990 | Stagflation Monetarism vs Keynesianism Liberalisation and Financial Crises | |
1990â2007 | Independent CBs Inflation Targets Great Moderation | |
2008â | Great Financial Crisis Financial Instability Deflation |
Most monetary historians, and this book is about monetary history, will be familiar with these key aspects of CB history. It may, however, be worthwhile emphasising a couple of features from this history, which have become less familiar during recent decades. These are, first, the Real Bills Doctrine and the second is the conclusion of much analysis into the onset of the depression in the USA in 1929â1933, that this was largely caused by excessive competition in the banking and wider financial systems, since that lowered profit margins and encouraged a riskier reach for yield. Many of the more stable banking structures, including most likely the public banks of Naples, have been cartelised.
2 The Real Bills Doctrine
Prior to the twentieth century, most government deficits were incurred by the need to finance war. Almost by definition, war is not productive, so monetary finance of wartime expenditure was inherently inflationary. So, banks, and especially Central Banks, tried to avoid purchasing government paper, beyond the minimum necessary to satisfy politiciansâ willingness to extend their Charter. Moreover, until the middle of the nineteenth century, the rulers of many European states were either unwilling or unable to repay all the debts that occurred to finance their wars, employing various forms of default, either strategically or under duress. Consequently, the better established banks often had more credibility and a better record of repayment than their rulers. This was one reason why in several countries debt management was largely delegated to the Central Bank.
Larry Neal argues in Chapter 6 that Bartolomeo dâAquinoâs establishment of the final public bank, the Banco del Santissimo Salvatore in 1640, was motivated essentially by the need to manage the outstanding public debt (most of which he had purchased at fire sale prices in the previous years from the original holders). Thereafter, it became recognised as the governmentâs bank, but existed harmoniously with the original seven public banks, at least after the Masaniello revolt was repressed.
Moreover, absent wartime, rulers during these early centuries often ran a surplus, and there was not always a large stock of short-dated public sector debt, through which to operate in order to manage the money market. So, the preferred liquid asset for money market operations, and for Central Banksâ open market operations, became bills of exchange, short-dated credit instruments drawn by the borrower, and, when accepted, became a two-name bill. Here, the main distinction was between real bills, largely drawn by industry based on trade and inventory, and speculative bills, which were drawn largely for the purpose of purchasing assets, which were hoped to rise in price.
The basic idea was that the volume of real bills would rise and fall with the volume of output and trade, so that the monetarisation of real bills would not lead to inflation; according to the quantity theory of money, where MV = PY, the Real Bills Doctrine would bring about a close positive correlation between movements in M and Y, leaving P stable. Similarly, real bills would be self-liquidating, since, being based on trade and production, the borrower would always be able to repay the bill from the proceeds of the sales involved in the trade and sale of goods in process. In contrast, the repayment of speculative bills would depend on the course of asset prices, which, being uncertain, meant that they were much more subject to default.
One of the key founders of the Federal Reserve System, Pau...