Plus ça change

Corresponding on the "Run Free Financial System," François Velde at the Chicago Fed sends me an interesting paper, "Early Public Banks" with William Roberds.  François and William document nicely just how long bank runs have been going on, just how long we've been struggling with money-like bank liabilities, and just how long narrow-banking proposals have been around.

The focus of the paper is on "Public banks," predecessors of central banks.

Abstract: Public banks were created to "create a liquid and reliable monetary asset," but "even well-run banks could become unstable over time as their success made them susceptible to fiscal exploitation." "A prominent exception was the Bank of England, whose adept management of a fiscally backed money provided a foundation for the development of central banks as they exist today." I think we have about a thousand years of experience well distilled in those few sentences.

Runs go back a long way. Here is a lovely description (p. 16):

When advocating the creation of a public bank in 1584, Tommaso Contarini... emphasized the inherent fragility of the banking business (Lattes 1869, 124):

A suspicion born, a voice heard, that there is no cash or that the banker has suffered some loss, a person seen at that time withdrawing money, is enough to incite everyone to take his money and the bank, unable to meet the demand, is condemned to fail. The failure of a debtor, a disaster in some venture, the fear of war is enough to destroy this enterprise, because all creditors, fearing the loss of their money, will want to insure themselves by withdrawing it and will bring about its complete destruction. It is too difficult, indeed impossible that in the space of a few years one of these events fails to occur that bring about the ruin of the bank. 

Bank-created money goes back a long way:

That banks did not maintain 100% reserves is apparent from a law of 1322; indeed, it appears that by then the main elements of the payments system were in place: payment in bank money (that is, by transfer on the books of a bank) was considered final payment, that bankers kept fractional reserves, and that they kept accounts with each other.

 1322.  Bank regulation goes back a long way:

The [1322] law also indicates that legislators felt the need to intervene, since it required bankers to redeem deposits on demand within three days, and in cash rather than with claims on other bankers (Mueller 1997, 16).  This was but one of many legislative attempts to remedy the fragility of banks, which more often relied either on some primitive form of capital requirements or else restricted allowable activities.

If you will recall, the central innovations of the Dodd-Frank act are.. to impose capital requirements and to restrict allowable activities.

Venice did not have limited liability as Siena and Florence did, so a banker’s patrimony provided security in addition to the bond...

Clawbacks, skin-in-the-game rules, and so on go back a long way.

The first proposal for a public bank was made in 1356, following the failure of a major bank and a resulting liquidity crunch marked by high interest rates (Mueller 1997, 112,142). The Senator Giovanni Delfin proposed that a bank be set up alongside existing private banks, headed by three noblemen appointed by the city. It would be prohibited from lending or investing money and paying interest: its sole function was to receive deposits for the purpose of making payments by transfer. 

Narrow banking proposals go back a long way. In the 21st century, we allow noblewomen too to run our central banks. Progress.

François chides me gently, that if bank debt and bank runs have been with us for nearly a thousand years, and if narrow banking based on government debt has not succeeded in all that time, surely there must be a reason. I gave two answers, expanding a bit on the arguments in "run-free." First, technology has really changed. We don't need fixed-value claims for transactions or liquidity. Electronic transactions, index funds, instant communications make a difference. Second, not all that is, is good. The Venetians also poured sewage into the lagoon for centuries. Short term runnable debt really is an externality, so its existence is not proof of its optimality.

But I appreciate François' insistence on this point. There is merit in the Chicago philosophy: if you see something durable that you don't understand, work harder to figure out why it lasts so long. It's the opposite of the Cambridge philosophy: if you see something durable that you don't understand, get on a plane to Washington and tell them to pass a law making the world in to the way you think it should be. (I use "Chicago" and "Cambridge" just as humorous ways to describe a philosophy, as plenty of interventionists live here, and there is lots of humility there.) Somewhere in the middle is the optimum.

Blog readers who don't know François, take the aftenoon off and read "Macroeconomic Features of the French Revolution" with Tom Sargent. All of modern monetary and macroeconomics unfolds, pretty well understood by the actors of the time.  Proceed to a Chronicle of a Deflation Unforetold. 18th century France had a fascinating dual currency system, with a unit of account "Livres" separate from the medium of exchange "ecus." Find out what happens when the exchange rate changes. Proceed to The Big Problem of Small Change also with Tom. It reads as a thousand-year discovery of MV=PY, though I read it as a thousand-year discovery of the fiscal theory of the price level. I've been plotting blog posts on all three at some point. (And plenty more, but that's a good start.)

In any case, you will be humbled by how well our ancestors understood monetary issues, and how hard they struggled with the same issues we do. (And, like me, you'll wish you could write papers like these.) It makes you wonder if we're really making progress. In the end I think that being able to write down the equations and quantify the results of old ideas really is progress after all. Diamond and Dybvig really are better than Contarini, no matter how poetic the latter, in part because it's much harder to come up with contrary equations than it is to come up with even more poetic prose that describes fallacies. But most economists don't appreciate that these issues go back quite so far, or that our forebears understood things as well as they did.

PS:  François sent along the original of the above quote in 16th century Venetian (see bottom of p. 124 on the link) which fellow italophiles will appreciate for its poetry. It also raises my appreciation for the kind of original source material François plods through to find these gems.

Un suspetto che nasca, una voce, che si senta, che non vi sia danaro, ò che il banchier habba patido qualche perdita; una persona, che si veda in tal occasion à estraher contadi, è bastante à eccitar tutti, che vadano à cavar i suoi danari; à che non potendo supplir in banco, è astretto à ruinar senza remedio. Un fallimento di qualche suo debitor, un sinistro di qualche suo negotio, il timor di una guerra, è causa potente à destrugger questa fabrica ; poiche tutti i cerditori insuspettidi di non perder il suo danaro, per assicurarsene vanno à estraherlo, e gli apportano la total iattura.

Più cambia, più è la stessa cosa.