CHAPTER 1V

BANKS PROVIDE AN INEXPENSIVE SUBSTITUTE FOR
METALLIC CURRENCY

Smith’s statement of the doctrine. — Minor corrections at the hands of American
writers. — Critics of this alleged benefit of banking. — Summary.

THE crude notion that expansion of the currency by means of
bank notes implies a direct increase of capital became more and
more generally discredited after 1820. Doubtless the orgy of inflation
 introduced by the suspension of specie payments during
our second war with England helped to emphasize the absurdity
of the error. At about the same time that this earlier doctrine
was being abandoned, the claim that the issue of bank notes effects
an increase in the amount of capital in the country began to be
made upon quite a different basis. This newer thesis contended
merely that banks afford an inexpensive substitute for the costly
currency of gold and silver, thereby introducing an economy
which, to all intents and purposes, increases the nation’s wealth to
a like extent.
That bank notes (and government paper also) are a circulating
medium far less costly than one of the precious metals, and yet,
within certain limits, equally effective, seemed an obvious observation
 at an early date. Adam Smith laid stress upon the manner
in which banks cause metallic currency to be replaced by their
own paper, and made this their chief service. It was the doctrine
as formulated by Smith that bulked large in later discussion of the
merits of banking, in America as in England.

The substitution of paper in the room of gold and silver money [Smith
explained] replaces a very expensive instrument of commerce with one much
less costly, and sometimes equally convenient. . . . Let us suppose, for
example, that the whole circulating money of some particular country
amounted, at a particular time, to one million sterling, that sum being then
sufficient for circulating the whole annual produce of their land and labor.
Let us suppose too, that some time thereafter, different banks and bankers
issued promissory notes, pavable to the bearer, to the extent of one million.