Bank of Amsterdam

The Amsterdam Exchange Bank (Wisselbank, or Bank of Amsterdam) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces, where there were no fewer than fourteen different mints and copious quantities of foreign coins. By allowing merchants to set up accounts denominated in a standardized currency, the Exchange Bank pioneered the system of cheques and direct debits or transfers that we take for granted today. This allowed more and more commercial transactions to take place without the need for the sums involved to materialize in actual coins. One merchant could make a payment to another simply by arranging for his account at the bank to be debited and the counterparty’s account to be credited. The Exchange Bank maintained something close to a 100 per cent ratio between its deposits and its reserves of precious metal and coin. As late as 1760, when its deposits stood at just under 19 million florins, its metallic reserve was over 16 million.

Background

Medieval kings quickly found that an empty state treasury could be filed by debasing the currency. The powerful Charles V was among the most culpable for altering the value of money. These alterations in the Netherlands came by monetary decree. In 1524, Charles raised the value of his gold coins from 9 or 10, to 11 3/8 times their weight in silver coins. This manipulation created immense displeasure throughout the kingdom and in 1542, Charles returned to a ratio of ten to one, not by lowering the value of his gold coins back to their value before 1524, but by degrading his silver coins. Four years later, in 1546, Charles struck again suddenly raising the value of his gold coins to 13 1/2 times the value of silver coins. These actions served to first overvalue and undervalue gold in relation to its market value to silver,2 with the result being that the overvalued money drove the undervalued money out of circulation (a phenomenon known as Gresham’s Law). A silver ducat went from 54 grains fine down to 35 grains fine. Thus, with silver coins being the primary circulating medium of Holland, the new debased and overvalued silver coins drove the undervalued gold coins from circulation. This action raised the value of gold nearly 50 percent and by this device, Charles was able to replenish his dwindling treasury.

This transgression, in 1546, may have been "the straw that broke the patience of his long suffering subjects." A revolution was then sparked in the Netherlands and although Charles was able to check any upheaval during his reign, with the accession of Phillip the Bigot, the smoldering revolutionary fires burst into intense flames. After the "Confederation of Beggars" formed in 1566, six years later the revolution was proclaimed.

One of the first measures instigated by the revolutionary government was "free" or "individual" coinage. The State would mint coins out of any quantity of metal delivered to it, either making no charge to the person delivering the metal, or merely a very small charge to cover cost. Free coinage was an immediate success. Possessors of silver and gold bullion obtained in America, "had vainly sought to evade the coinage exactions of the European princes; now the door of escape was open; they had only to be sent to Holland, turned into guilders and ducats, and credited as silver metal under the name of sols banco".

As the seventeenth century began, the Dutch were the driving force behind European commerce. With Amsterdam as capital of Holland, it served as the central point of trade. Amsterdam’s currency consisted primarily of the coins of the neighboring countries and to a lesser extent its own coins. Many of these foreign coins were worn and damaged, thus reducing the value of Amsterdam’s currency about 9 percent below that of "the standard" or the legal tender. Thus, it was impossible to infuse any new coins into circulation. Upon the circulation of newly minted coins, these new coins were collected, melted down, and exported as bullion. Their place in circulation was quickly taken by newly imported "clipped" or "sweated" coins. Thus, undervalued money was driven out by overvalued or degraded money, due to the legal tender status given these degraded coins.

To remedy this situation, the Bank of Amsterdam was originated in 1609. The Bank was to facilitate trade, suppress usury, and have a monopoly on all trading of specie. But the bank’s chief function was the withdrawal of abused and counterfeit coin from circulation. Coins were taken in as deposits, with credits, known as bank money, issued against these deposits, based not on the face value of the coins, but on the metal weight or intrinsic value of the coins. Thus, a perfectly uniform currency was created. This feature of the new money, along with its convenience, security and the city of Amsterdam’s guarantee, caused the bank money to trade at an agio, or premium over coins. The premium varied (4 to 6 and 1/4 percent), but generally represented the depreciation rate of coin below its nominal or face value.

Workings

One of the services that the bank provided was to transfer, upon order from a depositor, sums (deposits) to the account of creditors, by book entry. This is called a giro banking operation. This service was so popular that the withdrawal of deposits from the bank became a very rare occurrence. If a depositor wanted to regain his specie, he could easily find a buyer for his bank money, at a premium, due to its convenience. Additionally, there was a demand for bank money from people not having an account with the bank. As Adam Smith related in the Wealth of Nations: "By demanding payment of the bank, the owner of a bank credit would lose this premium." The city of Amsterdam’s guarantee (the City of Amsterdam was responsible for the coin or bullion’s security while at the bank, against fire, robbery, or any other accident), in addition to the requirement that all bills drawn upon or negotiated in Amsterdam, in the amount of six hundred guilders or more, must be paid in bank money, "took away all uncertainty in the value of the bills," and thus forced all merchants to keep an account at the bank, "which necessarily occasioned a certain demand for bank money."

Smith goes on to explain the mechanics of how the Bank of Amsterdam issued bank money. The Bank would give credit (bank money in its books for gold and silver bullion deposited, at roughly 5 percent below the bullion’s then current mint value. At the same time as this bank credit was issued, the depositor would receive a receipt that entitled the depositor, or bearer, to draw the amount of bullion deposited from the bank, within six months of the deposit. Thus, to retrieve a bullion deposit, a person had to present to the bank: (1) a receipt for the bullion, (2) an amount of bank money equal to the book entry, and (3) payment of a 1/4 percent fee for silver deposits, or 1/2 percent fee for gold deposits. Should the six month term expire with no redemption, or without payment of a fee to extend for an additional six months, "the deposit should belong to the bank at the price at which it had been received, or which credit had been given in the transfer books." Thus, the bank would make the 5 percent fee for warehousing the deposit, if not redeemed within the six-month time frame. The higher fee charged for gold was due to the fact that gold was thought to be riskier to warehouse, because of its higher value. A receipt for bullion was rarely allowed to expire. When it did happen, more often than not, it was a gold deposit because of its higher deposit fee.

This system created two separate instruments that were combined to create an obligation of the Bank of Amsterdam. As Smith explains:

The person who by making a deposit of bullion obtains both a bank credit and a receipt, pays his bills of exchange as they become due with his bank credit; and either sells or keeps his receipt according as he judges that the price of bullion is likely to rise or to fall. The receipt and the bank credit seldom keep long together, and there is no occasion that they should. The person who has a receipt, and who wants to take out bullion, finds always plenty of bank credits, or bank money to buy at ordinary price; and the person who has bank money, and wants to take out bullion, finds receipts always in equal abundance.

The holder of a receipt cannot draw out the bullion for which it is granted, without re-assigning to the bank a sum of bank money equal to the price at which the bullion had been received. If he has no bank money of his own, he must purchase it of those who have it. The owner of bank money cannot draw out bullion without producing to the bank receipts for the quantity which he wants. If he has none of his own, he must buy them of those who have them. The holder of a receipt, when he purchases bank money, purchases the power of taking out a quantity of bullion, of which

the mint price is five per cent. above the bank price. The agio of five per cent. therefore, which he commonly pays for it, is paid, not for an imaginary, but for the real value. The owner of bank money, when he purchases a receipt, purchases the power of taking out a quantity of bullion of which the market price is commonly from two to three per cent. above the mint price. The price which he pays for it, therefore, is paid likewise for a real value. The price of the receipt, and the price of the bank money, compound or makeup between them the full value or price of the bullion.

The same system that Smith describes above, also applied to coins that were deposited with the bank. Smith does assert that deposits of coinage were more likely to "fall to the bank" than deposits of bullion. Due to the high agio (Smith indicates typically five percent) of bank money over common coin, the paying of the bank’s six-month storage fee created a loss for holders of receipts.

The amount of bank money for which the receipts had expired, in relation to the total amount of bank money was very small. Smith writes:

The bank of Amsterdam has for these many years past been the great warehouse of Europe for bullion, for which the receipts are very seldom allowed to expire or, as they express it, to fall to the bank. The far greater part of the bank money, or of the credits upon the books of the bank, is supposed to have been created, for these many years past, by such deposits which the dealers in bullion are continually both making and withdrawing.

The bank was highly profitable for the city of Amsterdam. Besides the aforementioned warehouse rent and sale of bank money for the agio, each new depositor paid a fee of ten guilders to open an account. Any subsequent account opened by that depositor would be subject to a fee of three guilders. Transfers were subject to a fee of two guilders, except when the transfer was for less than 600 guilders. Then the fee was six guilders (to discourage small transfers). Depositors were required to balance their accounts twice a year. If the depositor failed to do this, he incurred a 25 guilder penalty. A fee of 3 percent was charged if a depositor ordered a transfer for more than the amount of his account.

Tulip mania

Main article: Tulip mania

The effects of free coinage combined with the stability of the Bank of Amsterdam, created the impetus that channeled the large amounts of precious metals being discovered in the Americas, and to a lesser degree in Japan, toward Amsterdam. This acute increase in the supply of money fostered an atmosphere, that was ripe for speculation and malinvestment, and led to one of the first recorded panics or speculative bubbles.

Fall of the Bank

In the beginning, the Bank of Amsterdam did not perform a credit function; it was strictly a deposit bank, with all bank money backed 100 percent by specie. The administration of the Bank of Amsterdam was the charge of a small committee of city government officials. This committee kept the affairs of the bank secret. Because of the secretive nature of its administration, it was not generally known that individual depositors had been allowed to overdraw their accounts as early as 1657. In later years, the Bank also provided large loans to the Dutch East India Company and the Municipality of Amsterdam. By 1790 word of these loans became public and the premium on the bank money (usually 4 percent, but sometimes as high as 6 and 1/4) disappeared and fell to a 2 percent discount. By the end of that year the Bank virtually admitted insolvency by issuing a notice that silver would be sold to holders of bank money at a 10 percent discount. The City of Amsterdam took the Bank over, and eventually closed it for good in 1819.

Links

• Bank of Amsterdam at Wikipedia