An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith (ebook reader with highlighter txt) 📖

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the different banking companies of Scotland was fully equal, or rather was

somewhat more than fully equal, to what the circulation of the country could

easily absorb and employ. Those companies, therefore, had so long ago given

all the assistance to the traders and other undertakers of Scotland which it

is possible for banks and bankers, consistently with their own interest, to

give. They had even done somewhat more. They had over-traded a little, and

had brought upon themselves that loss, or at least that diminution of

profit, which, in this particular business, never fails to attend the

smallest degree of over-trading. Those traders and other undertakers, having

got so much assistance from banks and bankers, wished to get still more. The

banks, they seem to have thought, could extend their credits to whatever sum

might be wanted, without incurring any other expense besides that of a few

reams of paper. They complained of the contracted views and dastardly spirit

of the directors of those banks, which did not, they said, extend their

credits in proportion to the extension of the trade of the country ;

meaning, no doubt, by the extension of that trade, the extension of their

own projects beyond what they could carry on either with their own capital,

or with what they had credit to borrow of private people in the usual way of

bond or mortgage. The banks, they seem to have thought, were in honour bound

to supply the deficiency, and to provide them with all the capital which

they wanted to trade with. The banks, however, were of a different opinion ;

and upon their refusing to extend their credits, some of those traders had

recourse to an expedient which, for a time, served their purpose, though at

a much greater expense, yet as effectually as the utmost extension of bank

credits could have done. This expedient was no other than the well known

shift of drawing and redrawing; the shift to which unfortunate traders have

sometimes recourse, when they are upon the brink of bankruptcy. The practice

of raising money in this manner had been long known in England ; and, during

the course of the late war, when the high profits of trade afforded a great

temptation to over-trading, is said to have been carried on to a very great

extent. From England it was brought into Scotland, where, in proportion to

the very limited commerce, and to the very moderate capital of the country,

it was soon carried on to a much greater extent than it ever had been in

England.

 

The practice of drawing and redrawing is so well known to all men of

business, that it may, perhaps, be thought unnecessary to give any account

of it. But as this book may come into the hands of many people who are not

men of business, and as the effects of this practice upon the banking trade

are not, perhaps, generally understood, even by men of business themselves, I

shall endeavour to explain it as distinctly as I can.

 

The customs of merchants, which were established when the barbarous laws

of Europe did not enforce the performance of their contracts, and which,

during the course of the two last centuries, have been adopted into the laws

of all European nations, have given such extraordinary privileges to bills

of exchange, that money is more readily advanced upon them than upon any

other species of obligation; especially when they are made payable within so

short a period as two or three months after their date. If, when the bill

becomes due, the acceptor does not pay it as soon as it is presented, he

becomes from that moment a bankrupt. The bill is protested, and returns upon

the drawer, who, if he does not immediately pay it, becomes likewise a

bankrupt. If, before it came to the person who presents it to the acceptor

for payment, it had passed through the hands of several other persons, who

had successively advanced to one another the contents of it, either in money

or goods, and who, to express that each of them had in his turn received

those contents, had all of them in their order indorsed, that is, written

their names upon the back of the bill; each indorser becomes in his turn

liable to the owner of the bill for those contents, and, if he fails to pay,

he becomes too, from that moment, a bankrupt. Though the drawer, acceptor,

and indorsers of the bill, should all of them be persons of doubtful credit;

yet, still the shortness of the date gives some security to the owner of the

bill. Though all of them may be very likely to become bankrupts, it is a

chance if they all become so in so short a time. The house is crazy, says a

weary traveller to himself, and will not stand very long; but it is a chance

if it falls to-night, and I will venture, therefore, to sleep in it

to-night.

 

The trader A in Edinburgh, we shall suppose, draws a bill upon B in London,

payable two months after date. In reality B in London owes nothing to A in

Edinburgh; but he agrees to accept of A ‘s bill, upon condition, that before

the term of payment he shall redraw upon A in Edinburgh for the same sum,

together with the interest and a commission, another bill, payable likewise

two months after date. B accordingly, before the expiration of the first two

months, redraws this bill upon A in Edinburgh ; who, again before the

expiration of the second two months, draws a second bill upon B in London,

payable likewise two months after date; and before the expiration of the

third two months, B in London redraws upon A in Edinburgh another bill

payable also two months after date. This practice has sometimes gone on, not

only for several months, but for several years together, the bill always

returning upon A in Edinburgh with the accumulated interest and commission

of all the former bills. The interest was five per cent. in the year, and

the commission was never less than one half per cent. on each draught. This

commission being repeated more than six times in the year, whatever money A

might raise by this expedient might necessarily have cost him something more

than eight per cent. in the year and sometimes a great deal more, when

either the price of the commission happened to rise, or when he was obliged

to pay compound interest upon the interest and commission of former bills.

This practice was called raising money by circulation.

 

In a country where the ordinary profits of stock, in the greater part of

mercantile projects, are supposed to run between six and ten per cent. it

must have been a very fortunate speculation, of which the returns could not

only repay the enormous expense at which the money was thus borrowed for

carrying it on, but afford, besides, a good surplus profit to the projector.

Many vast and extensive projects, however, were undertaken, and for several

years carried on, without any other fund to support them besides what was

raised at this enormous expense. The projectors, no doubt, had in their

golden dreams the most distinct vision of this great profit. Upon their

awakening, however, either at the end of their projects, or when they were

no longer able to carry them on, they very seldom, I believe, had the good

fortune to find it .

 

{The method described in the text was by no means either the most common or

the most expensive one in which those adventurers sometimes raised money by

circulation. It frequently happened, that A in Edinburgh would enable B in

London to pay the first bill of exchange, by drawing, a few days before it

became due, a second bill at three months date upon the same B in London.

This bill, being payable to his own order, A sold in Edinburgh at par ; and

with its contents purchased bills upon London, payable at sight to the order

of B, to whom he sent them by the post. Towards the end of the late war, the

exchange between Edinburgh and London was frequently three per cent. against

Edinburgh, and those bills at sight must frequently have cost A that

premium. This transaction, therefore, being repeated at least four times in

the year, and being loaded with a commission of at least one half per cent.

upon each repetition, must at that period have cost A, at least, fourteen

per cent. in the year. At other times A would enable to discharge the first

bill of exchange, by drawing, a few days before it became due, a second bill

at two months date, not upon B, but upon some third person, C, for example,

in London. This other bill was made payable to the order of B, who, upon its

being accepted by C, discounted it with some banker in London ; and A

enabled C to discharge it, by drawing, a few day’s before it became due, a

third bill likewise at two months date, sometimes upon his first

correspondent B, and sometimes upon some fourth or fifth person, D or E, for

example. This third bill was made payable to the order of C, who, as soon as

it was accepted, discounted it in the same manner with some banker in

London. Such operations being repeated at least six times in the year, and

being loaded with a commission of at least one half per cent. upon each

repetition, together with the legal interest of five per cent. this method

of raising money, in the same manner as that described in the text, must

have cost A something more than eight per cent. By saving, however, the

exchange between Edinburgh and London, it was less expensive than that

mentioned in the foregoing part of this note ; but then it required an

established credit with more houses than one in London, an advantage which

many of these adventurers could not always find it easy to procure.}

 

The bills which A in Edinburgh drew upon B in London, he regularly

discounted two months before they were due, with some bank or banker in

Edinburgh ; and the bills which B in London redrew upon A in Edinburgh, he

as regularly discounted, either with the Bank of England, or with some other

banker in London. Whatever was advanced upon such circulating bills was in

Edinburgh advanced in the paper of the Scotch banks ; and in London, when

they were discounted at the Bank of England in the paper of that bank.

Though the bills upon which this paper had been advanced were all of them

repaid in their turn as soon as they became due, yet the value which had

been really advanced upon the first bill was never really returned to the

banks which advanced it ; because, before each bill became due, another bill

was always drawn to somewhat a greater amount than the bill which was soon

to be paid: and the discounting of this other bill was essentially necessary

towards the payment of that which was soon to be due. This payment,

therefore, was altogether fictitious. The stream which, by means of those

circulating bills of exchange, had once been made to run out from the

coffers of the banks, was never replaced by any stream which really ran into

them.

 

The paper which was issued upon those circulating bills of exchange

amounted, upon many occasions, to the whole fund destined for carrying on

some vast and extensive project of agriculture, commerce, or manufactures ;

and not merely to that part of it which, had there been no paper money, the

projector would have been obliged to keep by him unemployed, and in ready

money, for answering occasional demands.