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A NEW ATTEMPT AT LEGITIMATE BANKING:
THE BANK OF AMSTERDAM. BANKING IN THE
SEVENTEENTH AND EIGHTEENTH CENTURIES
THE BANK OF AMSTERDAM
THE BANK OF AMSTERDAM. BANKING IN THE
SEVENTEENTH AND EIGHTEENTH CENTURIES
THE BANK OF AMSTERDAM
The last serious attempt to establish a bank based on the
general legal principles governing the monetary irregular
deposit and to set up an efficient system of government con-
trol to adequately define and defend depositors’ property
rights took place with the creation of the Municipal Bank of
Amsterdam in 1609. It was founded after a period of great
monetary chaos and fraudulent (fractional-reserve) private
banking. Intended to put an end to this state of affairs and
restore order to financial relations, the Bank of Amsterdam
began operating on January 31, 1609 and was called the Bank
of Exchange.103The hallmark of the Bank of Amsterdam was
its commitment, from the time of its creation, to the universal
legal principles governing the monetary irregular deposit.
More specifically, it was founded upon the principle that the
obligation of the depository bank in the monetary irregular-
deposit contract consists of maintaining the constant avail-
ability of the tantundem in favor of the depositor; that is,
maintaining at all times a 100-percent reserve ratio with
respect to “demand” deposits. This measure was intended to
ensure legitimate banking and prevent the abuses and bank
failures which had historically occurred in all countries
where the state had not only not bothered to prohibit and
declare illegal the misappropriation of money on demand
deposit in banks, but on the contrary, had usually ended up
granting bankers all sorts of privileges and licenses to allow
their fraudulent operations, in exchange for the opportunity
to take fiscal advantage of them.
98
Money, Bank Credit, and Economic Cycles
103As for the curious reference to the public banks of Seville (and
Venice) as models (!) for the Bank of Amsterdam, included in a petition
from leading Dutch merchants to the Council of Amsterdam, see José
Antonio Rubio Sacristán, “La fundación del Banco de Amsterdam (1609)
y la banca de Sevilla.”
For a very long time, over one hundred fifty years, the
Bank of Amsterdam scrupulously fulfilled the commitment
upon which it was founded. Evidence reflects that during the
first years of its existence, between 1610 and 1616, both the
bank’s deposits and its cash reserves came very close to one
million florins. From 1619 to 1635, deposits amounted to
nearly four million florins and cash reserves exceeded three
million, five hundred thousand. After this slight imbalance,
equilibrium was restored in 1645, when deposits equaled
eleven million, two hundred eighty-eight thousand florins and
cash reserves added up to eleven million, eight hundred thou-
sand florins. Equilibrium and growth were more or less stable,
and in the eighteenth century, between 1721 and 1722, the
bank’s deposits totaled twenty-eight million florins and its
stock of cash reached nearly that amount, twenty-seven mil-
lion. This great increase in the deposits of the Bank of Amster-
dam stemmed, among other causes, from its role as a refuge for
capital fleeing the crazy inflationist speculation that the system
of John Law produced in France in the 1720s. We will deal with
this more in depth later. This continued until 1772, in which
both deposits and cash reserves totaled twenty-eight to twenty-
nine million florins. As is evident, during this entire period, to
all intents and purposes the Bank of Amsterdam maintained a 100-
percent cash reserve. This allowed it, in all crises, to satisfy each
and every request for cash withdrawal of deposited florins.
Such was true in 1672, when panic caused by the French threat
gave rise to a massive withdrawal of money from Dutch
banks, most of which were forced to suspend payments (as
occurred with the Rotterdam and Middelburg banks). The
Bank of Amsterdam was the exception, and it logically had no
trouble returning deposits. Increasing and lasting confidence
in its soundness resulted, and the Bank of Amsterdam became
an object of admiration for the civilized economic world of the
time. Pierre Vilar indicates that in 1699 the French ambassador
wrote in a report to his king:
Of all the towns of the United Provinces, Amsterdam is
without any doubt the foremost in greatness, wealth and the
extent of her trade. There are few cities even in Europe to
equal her in the two latter respects; her commerce stretches
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 99
over both halves of the globe, and her wealth is so great that
during the war she supplied as much as fifty millions a year
if not more.104
In 1802, when, as we will now see, the Bank of Amsterdam
started to become corrupt and violate the principles on which
it was founded, the bank still enjoyed enormous prestige, to
the point that the French consul in Amsterdam noted:
At the end of a maritime war which has kept the treasures
of the mines pent up in the Spanish and Portuguese
colonies, Europe is suddenly inundated with gold and silver
in quantities far above what is needed, so that they would
decline in value if they were put into circulation all at once.
In such an eventuality, the people of Amsterdam deposited
the metal in ingots in the Bank, where it was kept for them
at a very low cost, and they took it out a little at a time to
send to different countries as the increase in the rate war-
rants it. This money, then, which if allowed to flood in too
rapidly would have driven up the prices of everything
exceedingly, to the great loss of all who live on fixed and
limited incomes, was gradually distributed through many
channels, giving life to industry and encouraging trade. The
Bank of Amsterdam, then, did not act only according to the
special interests of the traders of this city; but the whole of
Europe is in its debt for the greater stability of prices, equi-
librium of exchange and a more constant ratio between the
two metals of which coin is made; and if the bank is not re-
established, it could be said that the great system of the
trade and political economy of the civilised world will be
without an essential part of its machinery.105
100
Money, Bank Credit, and Economic Cycles
104Pierre Vilar, A History of Gold and Money, 1450–1920, Judith White,
trans. (London: NLB, 1976), p. 207. The deposit and reserve figures we
have cited in the text are also found here on pp. 208–09. Two other Euro-
pean banks modeled after the Bank of Amsterdam were the Bank of
Venice and the Bank of Hamburg. They were both founded in 1619.
Although the first eventually violated the strict safekeeping obligation
and disappeared in 1797, the Bank of Hamburg operated in a more con-
sistent manner and survived until merging with the Reichsbank in 1873.
J.K. Ingram, “Banks, Early European,” in Palgrave’s Dictionary of Political
Economy, Henry Higgs, ed. (London: Macmillan, 1926), vol. 1, pp. 103–06.
105Vilar, A History of Gold and Money, 1450–1920, p. 209.
Therefore, we see that the Bank of Amsterdam did not try
to attain disproportionate profits through the fraudulent use
of deposits. Instead, in keeping with the dictates of Saravia de
la Calle and others we have mentioned, it contented itself with
the modest benefits derived from fees for safeguarding
deposits and with the small income obtained though the
exchange of money and the sale of bars of stamped metal.
Nevertheless, this income was more than sufficient to satisfy
the bank’s operating and administration costs, to generate
some profit and to maintain an honest institution that fulfilled
all of its commitments.
The great prestige of the Bank of Amsterdam is also evi-
denced by a reference to it found in the incorporation charter
of the Spanish Banco de San Carlos in 1782. Although this
bank, from its very inception, lacked the guarantees of the
Bank of Amsterdam, and it was created with the intention of
using its deposits, authority, and clout to help finance the
Treasury, it could not escape the immense influence of the
Dutch bank. Thus, its article XLIV establishes that private
individuals may hold deposits or
equivalent funds in cash in the bank itself, and whoever
wishes to make deposits shall be allowed to do so, either in
order to draw bills on the money or to withdraw it gradu-
ally, and in this way they will be exempt from having to
make payments themselves, their bills being accepted as
payable at the bank. In their first meeting, the stockholders
will determine the amount per thousand which merchants
must pay the bank in relation to their deposits, as they do in
Holland, and will establish all other provisions concerning
the best dispatch of discounts and reductions.106
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 101
106We quote directly from a copy of the Real Cédula de S. M. y Señores del
Consejo, por la qual se crea, erige y autoriza un Banco nacional y general para
facilitar las operaciones del Comercio y el beneficio público de estos Reynos y
los de Indias, con la denominación de Banco de San Carlos baxo las reglas que
se expresan (Royal Charter of H.M. and Members of the Council, by
which a universal, national bank is created, erected and authorized, to
promote trade and the common good of these kingdoms and the New
World), printed by Pedro Marín (Madrid, 1782), pp. 31–32; italics added.
There is an excellent profile on the history of the Banco de San Carlos by
DAVID HUME AND THE BANK OF AMSTERDAM
Asign of the enormous prestige of the Bank of Amsterdam
among scholars and intellectuals, as well as merchants, is the
express mention David Hume makes of it in his essay Of
Money. This essay first appeared, with others, in a book called
Political Discourses, published in Edinburgh in 1752. In it
David Hume voices his opposition to paper currency and
argues that the only solvent financial policy is that which
forces banks to maintain a 100-percent reserve ratio, in accor-
dance with traditional legal principles governing the irregular
deposit of money. David Hume concludes that
to endeavour artificially to encrease such a credit, can never
be the interest of any trading nation; but must lay them
under disadvantages, by encreasing money beyond its nat-
ural proportion to labour and commodities, and thereby
heightening their price to the merchant manufacturer. And
in this view, it must be allowed, that no bank could be more
advantageous, than such a one as locked up all the money it
received, and never augmented the circulating coin, as is usual, by
returning part of its treasure into commerce. A public bank, by
this expedient, might cut off much of the dealings of private
bankers and money-jobbers; and though the state bore the charge
of salaries to the directors and tellers of this bank (for, according
to the preceding supposition, it would have no profit from its deal-
ings), the national advantage, resulting from the low price of
labour and the destruction of paper credit, would be a sufficient
compensation.107
Hume is not completely correct when he claims the bank
would not earn a profit, since its safekeeping fees would be
sufficient to cover operating costs, and it might even generate
modest profits, as in fact the Bank of Amsterdam did. How-
ever his analysis is categorical and reveals that, in defending
102
Money, Bank Credit, and Economic Cycles
Pedro Tedde de Lorca, entitled El banco de San Carlos, 1782–1829
(Madrid: Banco de España and Alianza Editorial, 1988).
107We quote from pp. 284–85 of the excellent reissue of David Hume’s
work, Essays: Moral, Political and Literary, edited by Eugene F. Miller and
published by Liberty Fund, Indianapolis 1985; italics added.
the creation of a public bank with these characteristics, he had
in mind the success of the Bank of Amsterdam and the exam-
ple it had already set for over one hundred years. Furthermore
the third edition of his Essays and Treatises on Several Subjects,
published in four volumes in London and Edinburgh,
1753–1754, includes a note by Hume in reference to the
phrase, “no bank could be more advantageous, than such a
one as locked up all the money it received.” Footnote number
four contains the following words: “This is the case with the
Bank of Amsterdam.” It appears that Hume wrote this foot-
note with the intention of more clearly emphasizing his view
that the Bank of Amsterdam was the ideal model for a bank.
Hume was not the very first to propose a 100-percent reserve
requirement in banking. He was preceded by Jacob Vanderlint
(1734) and especially by the director of the Royal mint, Joseph
Harris, for whom banks were useful as long as they “issued no
bills without an equivalent in real treasure.”108
SIR JAMES STEUART, ADAM SMITH,
AND THE BANK OF AMSTERDAM
Sir James Steuart offers us an important contemporary
study of the Bank of Amsterdam’s operation in his treatise
published in 1767 entitled, An Enquiry into the Principles of
Political Oeconomy: Being an Essay on the Science of Domestic
Policy in Free Nations. In chapter 39 of volume 2, Steuart pres-
ents an analysis of the “circulation of coin through the Bank of
Amsterdam.” He maintains that “every shilling written in the
books of the bank is actually locked up, in coin, in the bank
repositories.” Still, he states,
Although, by the regulations of the bank, no coin can be
issued to any person who demands it in consequence of his
credit in bank; yet I have not the least doubt, but that both the
credit written in the books of the bank, and the cash in the reposi-
tories which balances it, may suffer alternate augmentations and
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 103
108Quoted by Rothbard, Economic Thought Before Adam Smith, pp. 332–35
and 462.
diminutions, according to the greater or less demand for bank
money.109
At any rate, Steuart indicates that the bank’s activities “are
conducted with the greatest secrecy,” in keeping with the tra-
ditional lack of openness in banking and especially significant
in the case of the Bank of Amsterdam, whose statutes and
operation demanded the maintenance of a continuous 100-
percent reserve ratio. If Steuart is correct and this ratio was at
times violated, it is logical that at the time the Bank of Ams-
terdam tried to hide the fact at all costs.
Although there are signs that at the end of the 1770s the
Bank of Amsterdam began to violate the principles upon
which it had been founded, in 1776 Adam Smith still affirmed
in his book, An Inquiry into the Nature and Causes of the Wealth
of Nations, that
The Bank of Amsterdam professes to lend out no part of
what is deposited with it, but, for every guilder for which
it gives credit in its books, to keep in its repositories the
value of a guilder either in money or bullion. That it keeps
in its repositories all the money or bullion for which there
are receipts in force, for which it is at all times liable to be
called upon, and which, in reality, is continually going from
it and returning to it again, cannot well be doubted. . . . At
Amsterdam no point of faith is better established than that
for every guilder, circulated as bank money, there is a corre-
spondant guilder in gold or silver to be found in the treas-
ure of the bank.110
Adam Smith goes on to say that the city itself guaranteed
the operation of the Bank of Amsterdam as described above
104
Money, Bank Credit, and Economic Cycles
109We quote from the original edition, published by A. Miller and T.
Cadell in the Strand (London, 1767), vol. 2, p. 301; italics added. Prior to
Steuart’s analysis, we find a more superficial study of the Bank of Ams-
terdam’s operation in the Abbot Ferdinando Galiani’s famous book,
Della moneta. The original edition was published by Giuseppe Raimondi
(Naples, 1750), pp. 326–28.
110We quote directly from the original edition of Adam Smith, An
Inquiry into the Nature and Causes of the Wealth of Nations (London: W.
Strahan and T. Cadell in the Strand, 1776), vol. 2, pp. 72–73.
and that it was under the direction of four burgomasters
who changed each year. Each burgomaster visited the
vaults, compared their content in cash with deposit entries
in the books and with great solemnity declared under oath
that the two coincided. Adam Smith remarks, tongue-in-
cheek, that “in that sober and religious country oaths are not
yet disregarded.”111He ends his commentary by adding that
all of these practices were sufficient to guarantee the absolute
safety of deposits in the bank, a fact which was demonstrated
in various Dutch political revolutions. No political party was
ever able to accuse the prior of disloyalty in the management
of the bank. By way of example, Adam Smith mentions that
even in 1672, when the king of France marched into Utrecht
and Holland was in danger of being conquered by a foreign
power, the Bank of Amsterdam satisfied every last request for
repayment of demand deposits. As we stated before, this
acted as an even more impressive reinforcement of the pub-
lic’s confidence in the absolute solvency of the bank.
As additional evidence that the Bank of Amsterdam main-
tained a 100-percent reserve ratio, Adam Smith offers the
anecdote that some coins removed from the bank appeared to
have been damaged in the building fire that struck the bank
soon after its creation in 1609, which shows those coins had
been kept in the bank for over one hundred fifty years. Finally,
Adam Smith, in strict keeping with the true legal nature of the
irregular-deposit contract, which requires that it be the depos-
itors who pay the bank, indicates that the bank’s income
stemmed from safekeeping fees:
The City of Amsterdam derives a considerable revenue from
the bank, besides what may be called the warehouse-rent
above mentioned, each person, upon first opening an
account with the bank, pays a fee of ten guilders, and for
every new account three guilders three stivers; for every
transfer two stivers; and if the transfer is for less than three
hundred guilders, six stivers, in order to discourage the
multiplicity of small transactions.112
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 105
111Ibid., p. 73.
112Ibid., p. 74.
In addition, Adam Smith refers to other sources of income
we have already mentioned, such as the exchange of money
and the sale of gold and silver bars.
Unfortunately, in the 1780s the Bank of Amsterdam began
to systematically violate the legal principles on which it had
been founded, and evidence shows that from the time of the
fourth Anglo-Dutch war, the reserve ratio decreased drasti-
cally, because the city of Amsterdam demanded the bank loan
it a large portion of its deposits to cover growing public expen-
ditures. Hence, deposits at that time amounted to twenty mil-
lion florins, while there were only four million florins’ worth of
precious metals in the vaults; which indicates that, not only did
the bank violate the essential principle of safekeeping on
which it had been founded and its existence based for over one
hundred seventy years, but the reserve ratio had been cut from
100 percent to less than 25 percent. This meant the final loss of
the Bank of Amsterdam’s long-standing reputation: deposits
began to gradually decrease at that point, and in 1820 they had
dwindled to less than one hundred forty thousand florins.113
The Bank of Amsterdam was the last bank in history to main-
tain a 100-percent reserve ratio, and its disappearance marked
the end of the last attempts to found banks upon general legal
principles. The financial predominance of Amsterdam was
replaced by the financial system of the United Kingdom, a
much less stable and less solvent system based on the expan-
sion of credit, deposits and paper currency.
THE BANKS OF SWEDEN AND ENGLAND
The Bank of Amsterdam was a forerunner of the Bank of
Stockholm (Riksbank), which began operating in 1656 and
was divided into two departments: one responsible for the
safekeeping of deposits (using a 100-percent reserve ratio) and
modeled after the Bank of Amsterdam; and another devoted
to loans. Although the departments supposedly functioned
106
Money, Bank Credit, and Economic Cycles
113Vilar, AHistory of Gold and Money, 1450–1920, p. 208. On the operation
of the Bank of Amsterdam see also Wicksell, Lectures on Political Economy
vol. 2, pp. 75–76.
separately from one another, in practice they were separate
only on paper, and the Bank of Stockholm soon abandoned the
standards set by the Dutch bank.114The Swedish authorities
nationalized it in 1668, making it the first government bank of
the modern world.115Not only did it violate the traditional
principles which guided the Bank of Amsterdam, but it also
initiated a new fraudulent and systematic practice: the
issuance of banknotes or deposit receipts for a sum higher than
actual deposits received in cash. This is how banknotes were
born, along with the lucrative practice of issuing them for a
higher amount than the total of deposits. Over time, this activ-
ity would become the banking practice par excellence, especially
in the centuries that followed, during which it deceived schol-
ars, who failed to realize that the issuance of banknotes had the
same repercussions as artificial credit expansion and deposit
creation, two practices which, as A.P. Usher has noted, had
been at the core of the banking business from its origins.
The Bank of England was created in 1694 and was also pat-
terned after the Bank of Amsterdam, due to the considerable
influence Holland exerted on England following the accession
of the House of Orange to the English throne. However, the
bank was not constituted with the same legal guarantees of
safekeeping as the Bank of Amsterdam. Instead, one of its main
aims from the outset was to help finance public expenditures.
For this reason, although the Bank of England was intended to
stop the commonplace, systematic abuses committed by pri-
vate bankers and the government,116in practice this goal was
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 107
114In this sense, as Kindleberger perceptively points out in A Financial
History of Western Europe, pp. 52–53, the Riksbank’s system of organiza-
tion was a precursor to the structure which two centuries later the Peel
Act (Bank Charter Act) of 1844 assigned the Bank of England.
115In celebration of the tercentenary of the Bank of Stockholm in 1968,
an endowment was made to fund a yearly Nobel Prize in economics.
116For instance, in 1640, Charles I, echoing the policies pursued in Spain
a hundred years earlier by his namesake the emperor Charles V, seized
the gold and valuables deposited for safekeeping in the Tower of London
and in the process completely ruined the reputation of the mint as a safe
place for valuables. Thirty-two years later, Charles II also failed in his
duty, causing the royal treasury to suspend payments and precipitating
never achieved. In short, the Bank of England eventually
failed, despite its privileged role as the government’s banker,
its monopoly on limited liability in England and its exclusive
authorization to issue banknotes. As a result of its systematic
neglect of the safekeeping obligation and its practice of grant-
ing loans and advances to the Treasury against the bank’s
deposits, the Bank of England eventually suspended pay-
ments in 1797 after various colorful vicissitudes, including the
South Sea Bubble.117Also in 1797, the same year the Bank of
England was forbidden to return deposits in cash, it was
declared that taxes and debts were to be paid in bills issued by
108
Money, Bank Credit, and Economic Cycles
the bankruptcy of many private banks that had extended loans to the
crown or had directly bought treasury bonds with funds from demand
deposits. See Kindleberger, A Financial History of Western Europe, pp.
53–54.
117In 1720 the South Sea Company devised an ambitious plan to take
over Britain’s national debt for a sum of money. This company emerged
from the Tory party, just like the Bank of England, and was intended to
help finance the war. In return, the government granted privileges to
certain corporations. The actual aim of South Sea Company promoters
was to speculate with company stock, to the extent that government
debt obligations were accepted in payment for new stocks. During that
year the Bank of England extended loans on its own securities to facili-
tate their acquisition, just as the South Sea Company had done. This set
off an inflationary process in which the price of company and bank
stock was driven to great heights, generating huge profits. Specula-
tors, including many company officials, took advantage of these bene-
fits. A portion of profits was invested in land, the price of which also
rose significantly. All of this speculative and inflationist mania came to
an abrupt halt during the summer of 1720, at the same time John Law’s
network of speculation began to deteriorate in Paris. Once prices began
to fall it became virtually impossible to stop their plunge. South Sea
Company stock prices plummeted from 775 points in September to 170
in mid-October and Bank of England stocks dropped from 225 points to
135 in just one month. Parliament responded by passing the Bubble Act,
which from that time on severely limited the establishment of corpora-
tions. However, it was not until 1722, and after much difficult negotia-
tion, that the financial problem was alleviated. That year Parliament
approved an agreement between the Bank of England and the South Sea
Company, stipulating that the former was to receive four million
pounds of the latter’s capital through yearly payments of 5 percent,
guaranteed by the Treasury. See also the end of footnote 43 of chapter 7.
the bank, and an attempt was made to limit advances and
loans to the government.118This was the dawn of the modern
banking system, based on a fractional-reserve ratio and a cen-
tral bank as lender of last resort. In chapter 8 we will analyze
in detail the reasons central banks were created, their role and
theoretical incapability of fulfilling it, as well as the central
banking vs. free banking controversy and its influence on the
different theories of money, banking and economic cycles. The
current chapter would not be complete, however, without a
brief reference to the development of banking and paper
money in eighteenth-century France.
JOHN LAW AND EIGHTEENTH-CENTURY BANKING IN FRANCE
The history of money and banking in eighteenth-century
France is closely linked to the Scottish financier John Law and
the “system” he concocted and put into practice there. Law
persuaded the French regent, Philippe d’Orleans, that the
ideal bank was one that made use of the deposits it received,
since this increased the amount of money in circulation and
“stimulated” economic growth. Law’s system, like economic
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 109
118From this point on many theorists, especially in the United States,
proclaimed the great threat posed to individual liberty by an implicit or
explicit alliance between bankers and governments. This type of pact
was expressed through the continual, systematic granting of privileges
to allow banks to violate their legal commitments by suspending the
cash repayment of deposits. For example, John Taylor, an American sena-
tor from the second half of the eighteenth century, classified this practice
as true fraud, stating that “under our mild policy the banks’ crimes may
possibly be numbered, but no figures can record their punishments,
because they are never punished.” See John Taylor, Construction Construed
and Constitutions Vindicated (Richmond, Va.: Shepherd and Polland, 1820;
New York: Da Capa Press, 1970), pp. 182–83. Another very interesting
piece on this topic is James P. Philbin’s article entitled “An Austrian Per-
spective on Some Leading Jacksonian Monetary Theorists,” published in
Journal of Libertarian Studies 10, no. 1 (Fall, 1991): 83–95, esp. 89. Murray N.
Rothbard wrote a magnificent summary of the emergence of fractional-
reserve banking in the early United States: “Inflation and the Creation of
Paper Money,” chapter 26 of Conceived in Liberty, vol. 2: “Salutary
Neglect”: The American Colonies in the First Half of the 18th Century (New
York: Arlington House, 1975), pp. 123–40; 2nd ed. (Auburn, Ala.: Ludwig
von Mises Institute, 1999).
interventionism in general, arose from three different, though
interconnected factors. First, disregard for traditional legal
and moral principles, particularly the requirement for contin-
ual safekeeping of 100 percent of deposited money. Second, a
reasoning error that appears to justify violating legal princi-
ples to attain seemingly beneficial goals quickly. Third, the
fact that there will always be certain agents who view in pro-
posed reforms an opportunity to make huge profits. The com-
bination of these three factors allowed a political dreamer like
Law to launch his “banking system” in France at the begin-
ning of the eighteenth century. In fact, once the bank had
earned people’s trust, it began to issue banknotes far exceed-
ing deposits on hand and to extend loans against deposits.
The quantity of bills in circulation increased very rapidly, and
as is logical, a significant artificial economic boom resulted. In
1718 the bank was nationalized (becoming the royal bank) and
began churning out even more bills and granting more loans.
This encouraged stock market speculation in general, and in
particular speculative buying and selling of shares of Law’s
Compagnie de la Lousiane ou d’Occident or Mississippi Trading
Company, aimed at fostering trade and advancing coloniza-
tion of this French territory in America. By 1720 the absurd
proportions of the financial bubble had become clear. Law
tried desperately to stabilize the price of the company’s stock
and the value of his bank’s paper money: the bank and trad-
ing company were merged, company stock was declared legal
tender, coins lost part of their weight in an attempt to restore
their relationship to bills, etc. However, all was in vain and the
inflationary bubble burst, bringing financial ruin not only to
the bank but also to many French investors who had placed
their trust in it and in the trading company. The losses were so
heavy and the suffering so immense that for over a hundred
years it was even considered a faux pas in France to utter the
word “bank,” a term which for a time was synonymous with
“fraud.”119The ravages of inflation plagued France again a
110
Money, Bank Credit, and Economic Cycles
119A detailed account of Law’s notorious bank failure in France by a
scholar with first-hand knowledge of the events can be found in the
book Della moneta by Ferdinando Galiani, pp. 329–34; and in chapter
23 through 35 of volume 2 of An Enquiry into the Principles of Political
few decades later, as evidenced by the serious monetary chaos
during the revolutionary period and the uncontrolled
issuance of assignats at that time. All these phenomena made a
permanent impression on the collective psyche of the French,
who are still aware today of the grave dangers of paper
money inflation and preserve the custom of storing consider-
able amounts of gold coins and ingots. In fact, France,
together with India, is one of the countries whose people hold
the largest stock of gold on a private basis.
All of the above notwithstanding, and in spite of his ill-
fated banking experiment, John Law made some contribu-
tions to monetary theory. Although we cannot accept his infla-
tionist and proto-Keynesian views, we must acknowledge, as
Carl Menger did, that Law was the first to formulate a sound
theory on the spontaneous, evolutionary origins of money.
RICHARD CANTILLON AND THE FRAUDULENT VIOLATION
OF THE IRREGULAR-DEPOSIT CONTRACT
It is a remarkable fact that three of the most noted mone-
tary theorists of the eighteenth and early nineteenth centuries
were bankers: John Law, Richard Cantillon,120and Henry
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 111
Oeconomy, by Sir James Steuart (pp. 235–91). An enlightening and theo-
retically solid analysis of the financial, monetary, and banking systems
in eighteenth-century France is found in F.A. Hayek’s article “First
Paper Money in Eighteenth Century France,” first published as chapter
10 in the book, The Trend of Economic Thinking: Essays on Political Econo-
mists and Economic History, vol. 3 of The Collected Works of F.A. Hayek,
W.W. Bartley III and Stephen Kresge, eds. (London and New York: Rout-
ledge, 1991), pp. 155–76. The best biography of John Law is by Antoin E.
Murphy, John Law: Economic Theorist and Policy Maker (Oxford: Claren-
don Press, 1997).
120Richard Cantillon was the first to maintain that “safe” banking could
be conducted with only a 10 percent reserve ratio: “Dans ce premier
exemple la caisse d’un Banquier ne fait que la dixième partie de son
commerce.” See p. 400 of the original edition of Essai sur la nature du
commerce en général, published anonymously (and falsely) in London,
Fletcher Gyles in Holborn, 1755. Incredibly, Murray Rothbard does not
mention this in his brilliant study on Cantillon. See Rothbard, Economic
Thought Before Adam Smith, pp. 345–62.
Thornton. Their banks all failed.121Cantillon alone escaped
relatively unscathed, not only because he stopped his risky
speculation in time, but also (and most importantly) because
of the large profits he fraudulently obtained by violating the
obligation to safeguard his customers’ assets.
Indeed, Cantillon clearly violated the contract of irregular
deposit, however in this case the deposit was not of money,
but shares of stock in the Mississippi Trading Company,
founded by John Law. Cantillon’s fraudulent scheme was as
follows: he loaned large amounts of money to his customers to
allow them to buy shares in the company, on the condition
that the stocks act as collateral and remain at Cantillon’s bank
as an irregular deposit, in this case of fungible and indistin-
guishable shares. Later Cantillon, unbeknownst to his clients,
misappropriated the deposited securities, selling them when
he thought their market price was high and keeping the
money from the sale. Once the shares had lost practically all of
their value, Cantillon bought them back for a fraction of their
old price and restored deposits, securing a hefty profit.
Finally, he demanded repayment of the loans he had initially
made to his clients, who were unable to return the money,
since the collateral they had at the bank was worth close to
nothing. These fraudulent operations led to multiple criminal
charges and civil suits against Cantillon, who, upon being
arrested and briefly incarcerated, was forced to leave France
in a hurry and flee to England.
Cantillon, in defense, put forward the same argument so
often used throughout the Middle Ages by writers deter-
mined to confuse the irregular deposit with the loan. In fact,
112
Money, Bank Credit, and Economic Cycles
121Admittedly, Thornton’s bank did not fail until after his death, in
December 1825. See pp. 34–36 of F. A. Hayek’s “Introduction” to Henry
Thornton’s book An Inquiry into the Nature and Effects of the Paper Credit of
Great Britain, originally published in 1802 and reissued by Augustus M.
Kelley, 1978. A.E. Murphy also notes that Law and Cantillon share the
unhappy “distinction” of being the only economists, apart from Antoine
de Montchrétien, who were accused of murder and other crimes. See A.E.
Murphy, Richard Cantillon: Entrepreneur and Economist (Oxford: Clarendon
Press, 1986), p. 237. Thornton’s religious and puritanical reputation at
least protected him from being charged with such atrocities.
Cantillon tried to defend himself by claiming that the stocks
deposited with him as unnumbered fungible goods had not
actually constituted a true deposit, but a loan implying the
full transference of ownership and availability to the banker.
Thus, Cantillon considered his operations perfectly “legiti-
mate.” Nevertheless, we know his legal argument was
unsound and even though the deposit of securities was con-
sidered an irregular deposit of fungible goods, the obligation
to safeguard the shares and maintain continual possession of
all of them remained. Therefore, when Cantillon sold the
shares to the detriment of his customers he clearly committed
the criminal act of misappropriation. F.A. Hayek explains
Cantillon’s attempt to justify his fraudulent actions:
His point of view was, as he later explained, that the shares
given to him, since their numbers had not been registered,
were not a genuine deposit, but rather—as one would say
today—a block deposit so that none of his customers had
claim to specific securities. The firm actually made an
extraordinary profit in this way, since it could buy back at
reduced prices the shares sold at high prices, and mean-
while the capital, for which they were charging high inter-
est, lost nothing at all but rather was saved and invested in
pounds. When Cantillon, who had partially made these
advances in his own name, asked for repayments of the
loans from the speculators, who had suffered great losses,
and finally took them to court, the latter demanded that the
profits obtained by Cantillon and the firm from their shares
be credited against these advances. They in turn took Can-
tillon to court in London and Paris, charging fraud and usury.
By presenting to the courts correspondence between Cantil-
lon and the firm, they averred that the entire transaction was
carried out under Cantillon’s immediate direction and that
he therefore bore personal responsibility.122
In the next chapter we will explain that the violation of the
irregular deposit of securities is just as corrupt from a legal
standpoint as the violation of the irregular deposit of money
and gives rise to very similar economic and social evils. Aper-
fect example in the twentieth century was the failure of the
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 113
122See Hayek, “Richard Cantillon (1680–1734),” chapter 13 of The Trend
of Economic Thinking, pp. 245–93, esp. p. 284. And also the report by
Bank of Barcelona and of other Catalonian banks that system-
atically accepted the irregular deposit of securities without
keeping full custody of them.123Instead, to attain a profit, they
used them in all sorts of speculative operations to the detri-
ment of their true owners, just as Cantillon had done two hun-
dred years earlier. Richard Cantillon was brutally murdered at
his London home in 1734, after twelve years of litigation, two
arrests, and the constant threat of imprisonment. Although the
official version was that he was murdered and his body
burned beyond recognition by an ex-cook who killed him to
rob him, it is also plausible that one of his many creditors
instigated the murder, or even, as suggested by A.E. Murphy,
his most recent biographer, that Cantillon staged his own
death to escape and to avoid more years of lawsuits and legal
action against him.124
114
Money, Bank Credit, and Economic Cycles
Cantillon’s lawyer Henry Cochin, Memoire pour Richard Cantillon, intimé
& apellant (Paris: Andre Knapen, 1730).
123On the irregular deposit of securities and the type of misappropria-
tion committed by Cantillon and later Catalonian bankers until the start
of the twentieth century, see La cuenta corriente de efectos o valores de un
sector de la banca catalana: su repercusión en el crédito y en la economía, su cal-
ificación jurídica en el ámbito del derecho penal, civil y mercantil positivos
españoles según los dictámenes emitidos por los letrados señores Rodríguez
Sastre, Garrigues, Sánchez Román, Goicoechea, Miñana y Clemente de Diego,
seguidos de un estudio sobre la cuenta de efectos y el mercado libre de valores
de Barcelona por D. Agustín Peláez, Síndico Presidente de la Bolsa de Madrid
(Madrid: Delgado Sáez, 1936).
124Antoin E. Murphy, Richard Cantillon: Entrepreneur and Economist
(Oxford: Clarendon Press, 1986), pp. 209 and 291–97. Murphy mentions
the following facts in support of this last thesis: (1) Cantillon liquidated
a substantial part of his assets the day prior to his murder; (2) The body
was burned beyond recognition; (3) His family displayed a mysterious
indifference following the murder; and (4) The accused behaved
strangely, never acting like the typical murderer
general legal principles governing the monetary irregular
deposit and to set up an efficient system of government con-
trol to adequately define and defend depositors’ property
rights took place with the creation of the Municipal Bank of
Amsterdam in 1609. It was founded after a period of great
monetary chaos and fraudulent (fractional-reserve) private
banking. Intended to put an end to this state of affairs and
restore order to financial relations, the Bank of Amsterdam
began operating on January 31, 1609 and was called the Bank
of Exchange.103The hallmark of the Bank of Amsterdam was
its commitment, from the time of its creation, to the universal
legal principles governing the monetary irregular deposit.
More specifically, it was founded upon the principle that the
obligation of the depository bank in the monetary irregular-
deposit contract consists of maintaining the constant avail-
ability of the tantundem in favor of the depositor; that is,
maintaining at all times a 100-percent reserve ratio with
respect to “demand” deposits. This measure was intended to
ensure legitimate banking and prevent the abuses and bank
failures which had historically occurred in all countries
where the state had not only not bothered to prohibit and
declare illegal the misappropriation of money on demand
deposit in banks, but on the contrary, had usually ended up
granting bankers all sorts of privileges and licenses to allow
their fraudulent operations, in exchange for the opportunity
to take fiscal advantage of them.
98
Money, Bank Credit, and Economic Cycles
103As for the curious reference to the public banks of Seville (and
Venice) as models (!) for the Bank of Amsterdam, included in a petition
from leading Dutch merchants to the Council of Amsterdam, see José
Antonio Rubio Sacristán, “La fundación del Banco de Amsterdam (1609)
y la banca de Sevilla.”
For a very long time, over one hundred fifty years, the
Bank of Amsterdam scrupulously fulfilled the commitment
upon which it was founded. Evidence reflects that during the
first years of its existence, between 1610 and 1616, both the
bank’s deposits and its cash reserves came very close to one
million florins. From 1619 to 1635, deposits amounted to
nearly four million florins and cash reserves exceeded three
million, five hundred thousand. After this slight imbalance,
equilibrium was restored in 1645, when deposits equaled
eleven million, two hundred eighty-eight thousand florins and
cash reserves added up to eleven million, eight hundred thou-
sand florins. Equilibrium and growth were more or less stable,
and in the eighteenth century, between 1721 and 1722, the
bank’s deposits totaled twenty-eight million florins and its
stock of cash reached nearly that amount, twenty-seven mil-
lion. This great increase in the deposits of the Bank of Amster-
dam stemmed, among other causes, from its role as a refuge for
capital fleeing the crazy inflationist speculation that the system
of John Law produced in France in the 1720s. We will deal with
this more in depth later. This continued until 1772, in which
both deposits and cash reserves totaled twenty-eight to twenty-
nine million florins. As is evident, during this entire period, to
all intents and purposes the Bank of Amsterdam maintained a 100-
percent cash reserve. This allowed it, in all crises, to satisfy each
and every request for cash withdrawal of deposited florins.
Such was true in 1672, when panic caused by the French threat
gave rise to a massive withdrawal of money from Dutch
banks, most of which were forced to suspend payments (as
occurred with the Rotterdam and Middelburg banks). The
Bank of Amsterdam was the exception, and it logically had no
trouble returning deposits. Increasing and lasting confidence
in its soundness resulted, and the Bank of Amsterdam became
an object of admiration for the civilized economic world of the
time. Pierre Vilar indicates that in 1699 the French ambassador
wrote in a report to his king:
Of all the towns of the United Provinces, Amsterdam is
without any doubt the foremost in greatness, wealth and the
extent of her trade. There are few cities even in Europe to
equal her in the two latter respects; her commerce stretches
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 99
over both halves of the globe, and her wealth is so great that
during the war she supplied as much as fifty millions a year
if not more.104
In 1802, when, as we will now see, the Bank of Amsterdam
started to become corrupt and violate the principles on which
it was founded, the bank still enjoyed enormous prestige, to
the point that the French consul in Amsterdam noted:
At the end of a maritime war which has kept the treasures
of the mines pent up in the Spanish and Portuguese
colonies, Europe is suddenly inundated with gold and silver
in quantities far above what is needed, so that they would
decline in value if they were put into circulation all at once.
In such an eventuality, the people of Amsterdam deposited
the metal in ingots in the Bank, where it was kept for them
at a very low cost, and they took it out a little at a time to
send to different countries as the increase in the rate war-
rants it. This money, then, which if allowed to flood in too
rapidly would have driven up the prices of everything
exceedingly, to the great loss of all who live on fixed and
limited incomes, was gradually distributed through many
channels, giving life to industry and encouraging trade. The
Bank of Amsterdam, then, did not act only according to the
special interests of the traders of this city; but the whole of
Europe is in its debt for the greater stability of prices, equi-
librium of exchange and a more constant ratio between the
two metals of which coin is made; and if the bank is not re-
established, it could be said that the great system of the
trade and political economy of the civilised world will be
without an essential part of its machinery.105
100
Money, Bank Credit, and Economic Cycles
104Pierre Vilar, A History of Gold and Money, 1450–1920, Judith White,
trans. (London: NLB, 1976), p. 207. The deposit and reserve figures we
have cited in the text are also found here on pp. 208–09. Two other Euro-
pean banks modeled after the Bank of Amsterdam were the Bank of
Venice and the Bank of Hamburg. They were both founded in 1619.
Although the first eventually violated the strict safekeeping obligation
and disappeared in 1797, the Bank of Hamburg operated in a more con-
sistent manner and survived until merging with the Reichsbank in 1873.
J.K. Ingram, “Banks, Early European,” in Palgrave’s Dictionary of Political
Economy, Henry Higgs, ed. (London: Macmillan, 1926), vol. 1, pp. 103–06.
105Vilar, A History of Gold and Money, 1450–1920, p. 209.
Therefore, we see that the Bank of Amsterdam did not try
to attain disproportionate profits through the fraudulent use
of deposits. Instead, in keeping with the dictates of Saravia de
la Calle and others we have mentioned, it contented itself with
the modest benefits derived from fees for safeguarding
deposits and with the small income obtained though the
exchange of money and the sale of bars of stamped metal.
Nevertheless, this income was more than sufficient to satisfy
the bank’s operating and administration costs, to generate
some profit and to maintain an honest institution that fulfilled
all of its commitments.
The great prestige of the Bank of Amsterdam is also evi-
denced by a reference to it found in the incorporation charter
of the Spanish Banco de San Carlos in 1782. Although this
bank, from its very inception, lacked the guarantees of the
Bank of Amsterdam, and it was created with the intention of
using its deposits, authority, and clout to help finance the
Treasury, it could not escape the immense influence of the
Dutch bank. Thus, its article XLIV establishes that private
individuals may hold deposits or
equivalent funds in cash in the bank itself, and whoever
wishes to make deposits shall be allowed to do so, either in
order to draw bills on the money or to withdraw it gradu-
ally, and in this way they will be exempt from having to
make payments themselves, their bills being accepted as
payable at the bank. In their first meeting, the stockholders
will determine the amount per thousand which merchants
must pay the bank in relation to their deposits, as they do in
Holland, and will establish all other provisions concerning
the best dispatch of discounts and reductions.106
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 101
106We quote directly from a copy of the Real Cédula de S. M. y Señores del
Consejo, por la qual se crea, erige y autoriza un Banco nacional y general para
facilitar las operaciones del Comercio y el beneficio público de estos Reynos y
los de Indias, con la denominación de Banco de San Carlos baxo las reglas que
se expresan (Royal Charter of H.M. and Members of the Council, by
which a universal, national bank is created, erected and authorized, to
promote trade and the common good of these kingdoms and the New
World), printed by Pedro Marín (Madrid, 1782), pp. 31–32; italics added.
There is an excellent profile on the history of the Banco de San Carlos by
DAVID HUME AND THE BANK OF AMSTERDAM
Asign of the enormous prestige of the Bank of Amsterdam
among scholars and intellectuals, as well as merchants, is the
express mention David Hume makes of it in his essay Of
Money. This essay first appeared, with others, in a book called
Political Discourses, published in Edinburgh in 1752. In it
David Hume voices his opposition to paper currency and
argues that the only solvent financial policy is that which
forces banks to maintain a 100-percent reserve ratio, in accor-
dance with traditional legal principles governing the irregular
deposit of money. David Hume concludes that
to endeavour artificially to encrease such a credit, can never
be the interest of any trading nation; but must lay them
under disadvantages, by encreasing money beyond its nat-
ural proportion to labour and commodities, and thereby
heightening their price to the merchant manufacturer. And
in this view, it must be allowed, that no bank could be more
advantageous, than such a one as locked up all the money it
received, and never augmented the circulating coin, as is usual, by
returning part of its treasure into commerce. A public bank, by
this expedient, might cut off much of the dealings of private
bankers and money-jobbers; and though the state bore the charge
of salaries to the directors and tellers of this bank (for, according
to the preceding supposition, it would have no profit from its deal-
ings), the national advantage, resulting from the low price of
labour and the destruction of paper credit, would be a sufficient
compensation.107
Hume is not completely correct when he claims the bank
would not earn a profit, since its safekeeping fees would be
sufficient to cover operating costs, and it might even generate
modest profits, as in fact the Bank of Amsterdam did. How-
ever his analysis is categorical and reveals that, in defending
102
Money, Bank Credit, and Economic Cycles
Pedro Tedde de Lorca, entitled El banco de San Carlos, 1782–1829
(Madrid: Banco de España and Alianza Editorial, 1988).
107We quote from pp. 284–85 of the excellent reissue of David Hume’s
work, Essays: Moral, Political and Literary, edited by Eugene F. Miller and
published by Liberty Fund, Indianapolis 1985; italics added.
the creation of a public bank with these characteristics, he had
in mind the success of the Bank of Amsterdam and the exam-
ple it had already set for over one hundred years. Furthermore
the third edition of his Essays and Treatises on Several Subjects,
published in four volumes in London and Edinburgh,
1753–1754, includes a note by Hume in reference to the
phrase, “no bank could be more advantageous, than such a
one as locked up all the money it received.” Footnote number
four contains the following words: “This is the case with the
Bank of Amsterdam.” It appears that Hume wrote this foot-
note with the intention of more clearly emphasizing his view
that the Bank of Amsterdam was the ideal model for a bank.
Hume was not the very first to propose a 100-percent reserve
requirement in banking. He was preceded by Jacob Vanderlint
(1734) and especially by the director of the Royal mint, Joseph
Harris, for whom banks were useful as long as they “issued no
bills without an equivalent in real treasure.”108
SIR JAMES STEUART, ADAM SMITH,
AND THE BANK OF AMSTERDAM
Sir James Steuart offers us an important contemporary
study of the Bank of Amsterdam’s operation in his treatise
published in 1767 entitled, An Enquiry into the Principles of
Political Oeconomy: Being an Essay on the Science of Domestic
Policy in Free Nations. In chapter 39 of volume 2, Steuart pres-
ents an analysis of the “circulation of coin through the Bank of
Amsterdam.” He maintains that “every shilling written in the
books of the bank is actually locked up, in coin, in the bank
repositories.” Still, he states,
Although, by the regulations of the bank, no coin can be
issued to any person who demands it in consequence of his
credit in bank; yet I have not the least doubt, but that both the
credit written in the books of the bank, and the cash in the reposi-
tories which balances it, may suffer alternate augmentations and
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 103
108Quoted by Rothbard, Economic Thought Before Adam Smith, pp. 332–35
and 462.
diminutions, according to the greater or less demand for bank
money.109
At any rate, Steuart indicates that the bank’s activities “are
conducted with the greatest secrecy,” in keeping with the tra-
ditional lack of openness in banking and especially significant
in the case of the Bank of Amsterdam, whose statutes and
operation demanded the maintenance of a continuous 100-
percent reserve ratio. If Steuart is correct and this ratio was at
times violated, it is logical that at the time the Bank of Ams-
terdam tried to hide the fact at all costs.
Although there are signs that at the end of the 1770s the
Bank of Amsterdam began to violate the principles upon
which it had been founded, in 1776 Adam Smith still affirmed
in his book, An Inquiry into the Nature and Causes of the Wealth
of Nations, that
The Bank of Amsterdam professes to lend out no part of
what is deposited with it, but, for every guilder for which
it gives credit in its books, to keep in its repositories the
value of a guilder either in money or bullion. That it keeps
in its repositories all the money or bullion for which there
are receipts in force, for which it is at all times liable to be
called upon, and which, in reality, is continually going from
it and returning to it again, cannot well be doubted. . . . At
Amsterdam no point of faith is better established than that
for every guilder, circulated as bank money, there is a corre-
spondant guilder in gold or silver to be found in the treas-
ure of the bank.110
Adam Smith goes on to say that the city itself guaranteed
the operation of the Bank of Amsterdam as described above
104
Money, Bank Credit, and Economic Cycles
109We quote from the original edition, published by A. Miller and T.
Cadell in the Strand (London, 1767), vol. 2, p. 301; italics added. Prior to
Steuart’s analysis, we find a more superficial study of the Bank of Ams-
terdam’s operation in the Abbot Ferdinando Galiani’s famous book,
Della moneta. The original edition was published by Giuseppe Raimondi
(Naples, 1750), pp. 326–28.
110We quote directly from the original edition of Adam Smith, An
Inquiry into the Nature and Causes of the Wealth of Nations (London: W.
Strahan and T. Cadell in the Strand, 1776), vol. 2, pp. 72–73.
and that it was under the direction of four burgomasters
who changed each year. Each burgomaster visited the
vaults, compared their content in cash with deposit entries
in the books and with great solemnity declared under oath
that the two coincided. Adam Smith remarks, tongue-in-
cheek, that “in that sober and religious country oaths are not
yet disregarded.”111He ends his commentary by adding that
all of these practices were sufficient to guarantee the absolute
safety of deposits in the bank, a fact which was demonstrated
in various Dutch political revolutions. No political party was
ever able to accuse the prior of disloyalty in the management
of the bank. By way of example, Adam Smith mentions that
even in 1672, when the king of France marched into Utrecht
and Holland was in danger of being conquered by a foreign
power, the Bank of Amsterdam satisfied every last request for
repayment of demand deposits. As we stated before, this
acted as an even more impressive reinforcement of the pub-
lic’s confidence in the absolute solvency of the bank.
As additional evidence that the Bank of Amsterdam main-
tained a 100-percent reserve ratio, Adam Smith offers the
anecdote that some coins removed from the bank appeared to
have been damaged in the building fire that struck the bank
soon after its creation in 1609, which shows those coins had
been kept in the bank for over one hundred fifty years. Finally,
Adam Smith, in strict keeping with the true legal nature of the
irregular-deposit contract, which requires that it be the depos-
itors who pay the bank, indicates that the bank’s income
stemmed from safekeeping fees:
The City of Amsterdam derives a considerable revenue from
the bank, besides what may be called the warehouse-rent
above mentioned, each person, upon first opening an
account with the bank, pays a fee of ten guilders, and for
every new account three guilders three stivers; for every
transfer two stivers; and if the transfer is for less than three
hundred guilders, six stivers, in order to discourage the
multiplicity of small transactions.112
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 105
111Ibid., p. 73.
112Ibid., p. 74.
In addition, Adam Smith refers to other sources of income
we have already mentioned, such as the exchange of money
and the sale of gold and silver bars.
Unfortunately, in the 1780s the Bank of Amsterdam began
to systematically violate the legal principles on which it had
been founded, and evidence shows that from the time of the
fourth Anglo-Dutch war, the reserve ratio decreased drasti-
cally, because the city of Amsterdam demanded the bank loan
it a large portion of its deposits to cover growing public expen-
ditures. Hence, deposits at that time amounted to twenty mil-
lion florins, while there were only four million florins’ worth of
precious metals in the vaults; which indicates that, not only did
the bank violate the essential principle of safekeeping on
which it had been founded and its existence based for over one
hundred seventy years, but the reserve ratio had been cut from
100 percent to less than 25 percent. This meant the final loss of
the Bank of Amsterdam’s long-standing reputation: deposits
began to gradually decrease at that point, and in 1820 they had
dwindled to less than one hundred forty thousand florins.113
The Bank of Amsterdam was the last bank in history to main-
tain a 100-percent reserve ratio, and its disappearance marked
the end of the last attempts to found banks upon general legal
principles. The financial predominance of Amsterdam was
replaced by the financial system of the United Kingdom, a
much less stable and less solvent system based on the expan-
sion of credit, deposits and paper currency.
THE BANKS OF SWEDEN AND ENGLAND
The Bank of Amsterdam was a forerunner of the Bank of
Stockholm (Riksbank), which began operating in 1656 and
was divided into two departments: one responsible for the
safekeeping of deposits (using a 100-percent reserve ratio) and
modeled after the Bank of Amsterdam; and another devoted
to loans. Although the departments supposedly functioned
106
Money, Bank Credit, and Economic Cycles
113Vilar, AHistory of Gold and Money, 1450–1920, p. 208. On the operation
of the Bank of Amsterdam see also Wicksell, Lectures on Political Economy
vol. 2, pp. 75–76.
separately from one another, in practice they were separate
only on paper, and the Bank of Stockholm soon abandoned the
standards set by the Dutch bank.114The Swedish authorities
nationalized it in 1668, making it the first government bank of
the modern world.115Not only did it violate the traditional
principles which guided the Bank of Amsterdam, but it also
initiated a new fraudulent and systematic practice: the
issuance of banknotes or deposit receipts for a sum higher than
actual deposits received in cash. This is how banknotes were
born, along with the lucrative practice of issuing them for a
higher amount than the total of deposits. Over time, this activ-
ity would become the banking practice par excellence, especially
in the centuries that followed, during which it deceived schol-
ars, who failed to realize that the issuance of banknotes had the
same repercussions as artificial credit expansion and deposit
creation, two practices which, as A.P. Usher has noted, had
been at the core of the banking business from its origins.
The Bank of England was created in 1694 and was also pat-
terned after the Bank of Amsterdam, due to the considerable
influence Holland exerted on England following the accession
of the House of Orange to the English throne. However, the
bank was not constituted with the same legal guarantees of
safekeeping as the Bank of Amsterdam. Instead, one of its main
aims from the outset was to help finance public expenditures.
For this reason, although the Bank of England was intended to
stop the commonplace, systematic abuses committed by pri-
vate bankers and the government,116in practice this goal was
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 107
114In this sense, as Kindleberger perceptively points out in A Financial
History of Western Europe, pp. 52–53, the Riksbank’s system of organiza-
tion was a precursor to the structure which two centuries later the Peel
Act (Bank Charter Act) of 1844 assigned the Bank of England.
115In celebration of the tercentenary of the Bank of Stockholm in 1968,
an endowment was made to fund a yearly Nobel Prize in economics.
116For instance, in 1640, Charles I, echoing the policies pursued in Spain
a hundred years earlier by his namesake the emperor Charles V, seized
the gold and valuables deposited for safekeeping in the Tower of London
and in the process completely ruined the reputation of the mint as a safe
place for valuables. Thirty-two years later, Charles II also failed in his
duty, causing the royal treasury to suspend payments and precipitating
never achieved. In short, the Bank of England eventually
failed, despite its privileged role as the government’s banker,
its monopoly on limited liability in England and its exclusive
authorization to issue banknotes. As a result of its systematic
neglect of the safekeeping obligation and its practice of grant-
ing loans and advances to the Treasury against the bank’s
deposits, the Bank of England eventually suspended pay-
ments in 1797 after various colorful vicissitudes, including the
South Sea Bubble.117Also in 1797, the same year the Bank of
England was forbidden to return deposits in cash, it was
declared that taxes and debts were to be paid in bills issued by
108
Money, Bank Credit, and Economic Cycles
the bankruptcy of many private banks that had extended loans to the
crown or had directly bought treasury bonds with funds from demand
deposits. See Kindleberger, A Financial History of Western Europe, pp.
53–54.
117In 1720 the South Sea Company devised an ambitious plan to take
over Britain’s national debt for a sum of money. This company emerged
from the Tory party, just like the Bank of England, and was intended to
help finance the war. In return, the government granted privileges to
certain corporations. The actual aim of South Sea Company promoters
was to speculate with company stock, to the extent that government
debt obligations were accepted in payment for new stocks. During that
year the Bank of England extended loans on its own securities to facili-
tate their acquisition, just as the South Sea Company had done. This set
off an inflationary process in which the price of company and bank
stock was driven to great heights, generating huge profits. Specula-
tors, including many company officials, took advantage of these bene-
fits. A portion of profits was invested in land, the price of which also
rose significantly. All of this speculative and inflationist mania came to
an abrupt halt during the summer of 1720, at the same time John Law’s
network of speculation began to deteriorate in Paris. Once prices began
to fall it became virtually impossible to stop their plunge. South Sea
Company stock prices plummeted from 775 points in September to 170
in mid-October and Bank of England stocks dropped from 225 points to
135 in just one month. Parliament responded by passing the Bubble Act,
which from that time on severely limited the establishment of corpora-
tions. However, it was not until 1722, and after much difficult negotia-
tion, that the financial problem was alleviated. That year Parliament
approved an agreement between the Bank of England and the South Sea
Company, stipulating that the former was to receive four million
pounds of the latter’s capital through yearly payments of 5 percent,
guaranteed by the Treasury. See also the end of footnote 43 of chapter 7.
the bank, and an attempt was made to limit advances and
loans to the government.118This was the dawn of the modern
banking system, based on a fractional-reserve ratio and a cen-
tral bank as lender of last resort. In chapter 8 we will analyze
in detail the reasons central banks were created, their role and
theoretical incapability of fulfilling it, as well as the central
banking vs. free banking controversy and its influence on the
different theories of money, banking and economic cycles. The
current chapter would not be complete, however, without a
brief reference to the development of banking and paper
money in eighteenth-century France.
JOHN LAW AND EIGHTEENTH-CENTURY BANKING IN FRANCE
The history of money and banking in eighteenth-century
France is closely linked to the Scottish financier John Law and
the “system” he concocted and put into practice there. Law
persuaded the French regent, Philippe d’Orleans, that the
ideal bank was one that made use of the deposits it received,
since this increased the amount of money in circulation and
“stimulated” economic growth. Law’s system, like economic
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 109
118From this point on many theorists, especially in the United States,
proclaimed the great threat posed to individual liberty by an implicit or
explicit alliance between bankers and governments. This type of pact
was expressed through the continual, systematic granting of privileges
to allow banks to violate their legal commitments by suspending the
cash repayment of deposits. For example, John Taylor, an American sena-
tor from the second half of the eighteenth century, classified this practice
as true fraud, stating that “under our mild policy the banks’ crimes may
possibly be numbered, but no figures can record their punishments,
because they are never punished.” See John Taylor, Construction Construed
and Constitutions Vindicated (Richmond, Va.: Shepherd and Polland, 1820;
New York: Da Capa Press, 1970), pp. 182–83. Another very interesting
piece on this topic is James P. Philbin’s article entitled “An Austrian Per-
spective on Some Leading Jacksonian Monetary Theorists,” published in
Journal of Libertarian Studies 10, no. 1 (Fall, 1991): 83–95, esp. 89. Murray N.
Rothbard wrote a magnificent summary of the emergence of fractional-
reserve banking in the early United States: “Inflation and the Creation of
Paper Money,” chapter 26 of Conceived in Liberty, vol. 2: “Salutary
Neglect”: The American Colonies in the First Half of the 18th Century (New
York: Arlington House, 1975), pp. 123–40; 2nd ed. (Auburn, Ala.: Ludwig
von Mises Institute, 1999).
interventionism in general, arose from three different, though
interconnected factors. First, disregard for traditional legal
and moral principles, particularly the requirement for contin-
ual safekeeping of 100 percent of deposited money. Second, a
reasoning error that appears to justify violating legal princi-
ples to attain seemingly beneficial goals quickly. Third, the
fact that there will always be certain agents who view in pro-
posed reforms an opportunity to make huge profits. The com-
bination of these three factors allowed a political dreamer like
Law to launch his “banking system” in France at the begin-
ning of the eighteenth century. In fact, once the bank had
earned people’s trust, it began to issue banknotes far exceed-
ing deposits on hand and to extend loans against deposits.
The quantity of bills in circulation increased very rapidly, and
as is logical, a significant artificial economic boom resulted. In
1718 the bank was nationalized (becoming the royal bank) and
began churning out even more bills and granting more loans.
This encouraged stock market speculation in general, and in
particular speculative buying and selling of shares of Law’s
Compagnie de la Lousiane ou d’Occident or Mississippi Trading
Company, aimed at fostering trade and advancing coloniza-
tion of this French territory in America. By 1720 the absurd
proportions of the financial bubble had become clear. Law
tried desperately to stabilize the price of the company’s stock
and the value of his bank’s paper money: the bank and trad-
ing company were merged, company stock was declared legal
tender, coins lost part of their weight in an attempt to restore
their relationship to bills, etc. However, all was in vain and the
inflationary bubble burst, bringing financial ruin not only to
the bank but also to many French investors who had placed
their trust in it and in the trading company. The losses were so
heavy and the suffering so immense that for over a hundred
years it was even considered a faux pas in France to utter the
word “bank,” a term which for a time was synonymous with
“fraud.”119The ravages of inflation plagued France again a
110
Money, Bank Credit, and Economic Cycles
119A detailed account of Law’s notorious bank failure in France by a
scholar with first-hand knowledge of the events can be found in the
book Della moneta by Ferdinando Galiani, pp. 329–34; and in chapter
23 through 35 of volume 2 of An Enquiry into the Principles of Political
few decades later, as evidenced by the serious monetary chaos
during the revolutionary period and the uncontrolled
issuance of assignats at that time. All these phenomena made a
permanent impression on the collective psyche of the French,
who are still aware today of the grave dangers of paper
money inflation and preserve the custom of storing consider-
able amounts of gold coins and ingots. In fact, France,
together with India, is one of the countries whose people hold
the largest stock of gold on a private basis.
All of the above notwithstanding, and in spite of his ill-
fated banking experiment, John Law made some contribu-
tions to monetary theory. Although we cannot accept his infla-
tionist and proto-Keynesian views, we must acknowledge, as
Carl Menger did, that Law was the first to formulate a sound
theory on the spontaneous, evolutionary origins of money.
RICHARD CANTILLON AND THE FRAUDULENT VIOLATION
OF THE IRREGULAR-DEPOSIT CONTRACT
It is a remarkable fact that three of the most noted mone-
tary theorists of the eighteenth and early nineteenth centuries
were bankers: John Law, Richard Cantillon,120and Henry
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 111
Oeconomy, by Sir James Steuart (pp. 235–91). An enlightening and theo-
retically solid analysis of the financial, monetary, and banking systems
in eighteenth-century France is found in F.A. Hayek’s article “First
Paper Money in Eighteenth Century France,” first published as chapter
10 in the book, The Trend of Economic Thinking: Essays on Political Econo-
mists and Economic History, vol. 3 of The Collected Works of F.A. Hayek,
W.W. Bartley III and Stephen Kresge, eds. (London and New York: Rout-
ledge, 1991), pp. 155–76. The best biography of John Law is by Antoin E.
Murphy, John Law: Economic Theorist and Policy Maker (Oxford: Claren-
don Press, 1997).
120Richard Cantillon was the first to maintain that “safe” banking could
be conducted with only a 10 percent reserve ratio: “Dans ce premier
exemple la caisse d’un Banquier ne fait que la dixième partie de son
commerce.” See p. 400 of the original edition of Essai sur la nature du
commerce en général, published anonymously (and falsely) in London,
Fletcher Gyles in Holborn, 1755. Incredibly, Murray Rothbard does not
mention this in his brilliant study on Cantillon. See Rothbard, Economic
Thought Before Adam Smith, pp. 345–62.
Thornton. Their banks all failed.121Cantillon alone escaped
relatively unscathed, not only because he stopped his risky
speculation in time, but also (and most importantly) because
of the large profits he fraudulently obtained by violating the
obligation to safeguard his customers’ assets.
Indeed, Cantillon clearly violated the contract of irregular
deposit, however in this case the deposit was not of money,
but shares of stock in the Mississippi Trading Company,
founded by John Law. Cantillon’s fraudulent scheme was as
follows: he loaned large amounts of money to his customers to
allow them to buy shares in the company, on the condition
that the stocks act as collateral and remain at Cantillon’s bank
as an irregular deposit, in this case of fungible and indistin-
guishable shares. Later Cantillon, unbeknownst to his clients,
misappropriated the deposited securities, selling them when
he thought their market price was high and keeping the
money from the sale. Once the shares had lost practically all of
their value, Cantillon bought them back for a fraction of their
old price and restored deposits, securing a hefty profit.
Finally, he demanded repayment of the loans he had initially
made to his clients, who were unable to return the money,
since the collateral they had at the bank was worth close to
nothing. These fraudulent operations led to multiple criminal
charges and civil suits against Cantillon, who, upon being
arrested and briefly incarcerated, was forced to leave France
in a hurry and flee to England.
Cantillon, in defense, put forward the same argument so
often used throughout the Middle Ages by writers deter-
mined to confuse the irregular deposit with the loan. In fact,
112
Money, Bank Credit, and Economic Cycles
121Admittedly, Thornton’s bank did not fail until after his death, in
December 1825. See pp. 34–36 of F. A. Hayek’s “Introduction” to Henry
Thornton’s book An Inquiry into the Nature and Effects of the Paper Credit of
Great Britain, originally published in 1802 and reissued by Augustus M.
Kelley, 1978. A.E. Murphy also notes that Law and Cantillon share the
unhappy “distinction” of being the only economists, apart from Antoine
de Montchrétien, who were accused of murder and other crimes. See A.E.
Murphy, Richard Cantillon: Entrepreneur and Economist (Oxford: Clarendon
Press, 1986), p. 237. Thornton’s religious and puritanical reputation at
least protected him from being charged with such atrocities.
Cantillon tried to defend himself by claiming that the stocks
deposited with him as unnumbered fungible goods had not
actually constituted a true deposit, but a loan implying the
full transference of ownership and availability to the banker.
Thus, Cantillon considered his operations perfectly “legiti-
mate.” Nevertheless, we know his legal argument was
unsound and even though the deposit of securities was con-
sidered an irregular deposit of fungible goods, the obligation
to safeguard the shares and maintain continual possession of
all of them remained. Therefore, when Cantillon sold the
shares to the detriment of his customers he clearly committed
the criminal act of misappropriation. F.A. Hayek explains
Cantillon’s attempt to justify his fraudulent actions:
His point of view was, as he later explained, that the shares
given to him, since their numbers had not been registered,
were not a genuine deposit, but rather—as one would say
today—a block deposit so that none of his customers had
claim to specific securities. The firm actually made an
extraordinary profit in this way, since it could buy back at
reduced prices the shares sold at high prices, and mean-
while the capital, for which they were charging high inter-
est, lost nothing at all but rather was saved and invested in
pounds. When Cantillon, who had partially made these
advances in his own name, asked for repayments of the
loans from the speculators, who had suffered great losses,
and finally took them to court, the latter demanded that the
profits obtained by Cantillon and the firm from their shares
be credited against these advances. They in turn took Can-
tillon to court in London and Paris, charging fraud and usury.
By presenting to the courts correspondence between Cantil-
lon and the firm, they averred that the entire transaction was
carried out under Cantillon’s immediate direction and that
he therefore bore personal responsibility.122
In the next chapter we will explain that the violation of the
irregular deposit of securities is just as corrupt from a legal
standpoint as the violation of the irregular deposit of money
and gives rise to very similar economic and social evils. Aper-
fect example in the twentieth century was the failure of the
Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 113
122See Hayek, “Richard Cantillon (1680–1734),” chapter 13 of The Trend
of Economic Thinking, pp. 245–93, esp. p. 284. And also the report by
Bank of Barcelona and of other Catalonian banks that system-
atically accepted the irregular deposit of securities without
keeping full custody of them.123Instead, to attain a profit, they
used them in all sorts of speculative operations to the detri-
ment of their true owners, just as Cantillon had done two hun-
dred years earlier. Richard Cantillon was brutally murdered at
his London home in 1734, after twelve years of litigation, two
arrests, and the constant threat of imprisonment. Although the
official version was that he was murdered and his body
burned beyond recognition by an ex-cook who killed him to
rob him, it is also plausible that one of his many creditors
instigated the murder, or even, as suggested by A.E. Murphy,
his most recent biographer, that Cantillon staged his own
death to escape and to avoid more years of lawsuits and legal
action against him.124
114
Money, Bank Credit, and Economic Cycles
Cantillon’s lawyer Henry Cochin, Memoire pour Richard Cantillon, intimé
& apellant (Paris: Andre Knapen, 1730).
123On the irregular deposit of securities and the type of misappropria-
tion committed by Cantillon and later Catalonian bankers until the start
of the twentieth century, see La cuenta corriente de efectos o valores de un
sector de la banca catalana: su repercusión en el crédito y en la economía, su cal-
ificación jurídica en el ámbito del derecho penal, civil y mercantil positivos
españoles según los dictámenes emitidos por los letrados señores Rodríguez
Sastre, Garrigues, Sánchez Román, Goicoechea, Miñana y Clemente de Diego,
seguidos de un estudio sobre la cuenta de efectos y el mercado libre de valores
de Barcelona por D. Agustín Peláez, Síndico Presidente de la Bolsa de Madrid
(Madrid: Delgado Sáez, 1936).
124Antoin E. Murphy, Richard Cantillon: Entrepreneur and Economist
(Oxford: Clarendon Press, 1986), pp. 209 and 291–97. Murphy mentions
the following facts in support of this last thesis: (1) Cantillon liquidated
a substantial part of his assets the day prior to his murder; (2) The body
was burned beyond recognition; (3) His family displayed a mysterious
indifference following the murder; and (4) The accused behaved
strangely, never acting like the typical murderer
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