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					                               Free or Central Banking?
                   Private Bank Notes in Sweden, 1834 – 1906



                                            Anders Ögren∞


                                      (Draft paper, Mars 2005)


                                             ABSTRACT
      In this paper the note issuing Enskilda banks operating in Sweden during the
      nineteenth century are studied. The question is if this system really was a system
      of free banking as has been claimed. The general argument in the paper is that it is
      of importance to study the properties of banks liabilities, and the components of
      their reserves before it can be referred to as a free banking system. If the note
      issuance conducted by private banks was dependent on base money issued by a
      politically privileged bank, or a central bank, the label free banking is not
      applicable.
      In the case of the Swedish Enskilda bank empirics clearly show that the note
      issuance of these banks was dependent on the base money issued by the
      Parliamentary owned Riksbank. Statistical analysis in the form of OLS-
      regressions and VAR-tests of causality supports this conclusion.
      Even after the law of 1874 stated that Riksbank notes was not a legal backing of
      Enskilda bank notes, this arrangement continued. The gold holdings of the
      Enskilda banks were in fact forced thorugh by law. Consequently, the market
      viewed the central bank based system as more efficient than the free banking
      system.




         This paper is part of a research project entitled “Means of Payment in Circulation. Money
         and Credit in Sweden, 1668 – 1903”, funded by the Swedish Research Council. I would
         like to thank Oskar Broberg, Torbjörn Engdahl, Håkan Lindgren and Ulf Olsson for
         insightful comments and suggestions. All errors are my own.




∞
  Stern School of Business, New York University and Stockholm School of Economics, Sweden. Contact:
aogren@stern.nyu.edu
Introduction
To allow the market to determine the money supply through competitive note issuance by
private banks is a well developed theory. In the free banking literature several historical cases
are pointed out as empirical examples of successful episodes of free banking, among them the
case of nineteenth century Sweden. To what extent there has been actual cases of free banking
in history is however debated in research. Even the degree of free banking in the most
recognized example, that of Scotland before the adoption of the Peel’s act in 1844, is subject
to different interpretations.1
      Between the years 1831 and 1903 Sweden had a commercial banking system based on the
right to issue notes, so called Enskilda banks. This banking system was of importance for the
Swedish monetization, development of the financial system, and the economy as a whole. The
specific feature of this commercial banking system, the right to issue notes, was beyond doubt
a main ingredient in this developing process. This solved the problem of creating the
necessary conditions for a financial system in a poor, un-monetized and geographically
dispersed country. Thus, it is from the Swedish experience not possible to question the
existence of private note issuing banks from an economic efficient perspective.2
      Due to the right of the Enskilda banks to issue notes, this period has been put forward as an
historical example of free banking.3 But, the argument in this paper is that labeling this as a
free banking system is not based on empirical facts, but rather on the assumption that since
these banks issued notes, free banking theory explained the working of this system. Research
on the Enskilda banks’ contribution to the Swedish monetization shows that it was far from
obvious that the Enskilda bank system was working in accordance with banking theory.4
      A free banking system lacks specific banking legislations that are limiting the possibility to
run banking business, for instance by obstructing market entrance and/or the right to issue
notes. The focus on note issuance in free banking theory is based on the view of notes as
being what ultimately determines the volume of credit in society. Providing a politically


1
  See for instance Sayers, R.S. (1976) and Sechrest, L.J. (1993). Sayers argues that the note issuance of the
Scottish banks ultimately rested on the reserves of Bank of England. Sechrest, although being in favor of free
banking argues that the freedom of the Scottish banking system has been overvalued. Two banks were granted
privileged charters through the political process, putting them in a favorable position relative to other
commercial banks. Usury laws and restrictions on note denominations also limited the possibilities of free
banking.
2
  Ögren, A. (2003a), (2003b). The argument here makes the existence of locally based note issuing banks of
interest for what is considered as transitional economies.
3
    Jonung, L. (1989), Schuler, K. (1992), Selgin, G.A. (1988)
4
    Ögren, A. (2003c)


                                                           2
priviliged bank with the right to issue notes means that this bank thus enjoys the (un-
stabilizing and discretionary) right to determine the volume of credit.5
      The argument in this paper is that the right of private banks to issue notes is in itself not a
sufficient condition for labeling a banking system a system of free banking. If the notes issued
by private banks functioned as a more liquid form of deposits, being de facto circulating as
checks drawn on deposits or granted credit in a private bank, while the private banks held
central bank notes as reserves, the structure of the banking system in all important aspects
resembles a commercial banking system under a central bank.
      Thus, the question is to what extent notes issued by any politically privileged bank,
including a central bank, were utilized as reserves by the banking system at large. If any
politically privileged bank was the issuer of what can be considered as the monetary base, the
banking system in question can not be considered as a free banking system.
      The general statement in this paper is that the role of notes issued by commercial banks,
politically privileged banks and/or central banks has to be clarified before naming a system a
free banking system. Consequently, it has to be empirically tested if issued private bank notes
actually can be considered as currency, i.e. if the private bank notes were based on notes
issued by politically privileged banks and/or central banks, or were issued independently of
any monetary authority.6 In this paper the question is empirically tested on the case of Sweden
between 1834 and 1900, referred to as a classical and succesful example of free banking.
Especially the period 1878 until 1900 is focused since this was the period that filled most of
the legal criteria of a free banking system.
      The hypothesis is that the Swedish banking system in all important respects functioned as a
commercial banking system working in symbiosis with a central bank that managed the
currency and issued base money. Moreover, especially during the period 1878 until 1900
there were no legal incentives for depending on central bank notes as reserves, but the
Enskilda banks still preferred to rely on central bank notes as reserves. If this was the case, it
is possible to assume that the Enskilda banks preferred a central bank system before a free
banking system because it was more efficient.
      The empirical material consists of the Enskilda banks’ balanced sheets. These have been
collected on annual basis between 1834 and 1877, and on monthly basis between 1878 and

5
    Smith, V.C. (1990) pp. 9-10
6
 It is worth pointing out that empirically testing to what extent different monetary and banking systems really
have been cases of free banking is not the same as falsifying the predictions regarding monetary stability made in
accordance with free banking theory.


                                                          3
1900. Between the years 1835 and 1870 the balance sheets were published in the Official
Swedish Gazette (Post & Inrikes tidning), and from 1871 and onwards in Collected reports of
the Commercial Banks (Sammandrag af Bankernas Uppgifter).

Free banking theory
The basis of free banking theory is that banking as any other business should be obeying to
the laws of competition, and hence be regulated no different from any other business venture.
Free banking is not one monolithic theory on banking, roughly speaking there are two main
forms of free banking theory: 1) A free banking system where the banks chose the anchor
currency, i.e. the unit of the account, by themselves. In this case notes issued by the banks
will be guaranteed by the issuer for instance to maintain purchasing power in relation to a
basket of commodities. This form of free banking was proposed by Hayek in the book
Denationalisation of Money, but it is questionable wheter such a form of free banking ever
has existed in reality.7 2) A free banking system where the reserves consits of a commodity
used as an international currency, for instance specie.8 This form of free banking theory is
based on the historical experiences from the eighteenth and nineteenth centuries. That is free
banking with fractional reserves based on specie, as illustrated by the case of Scotland.
      The latter type of free banking theory dominates the literature on free banking. It is thus
self evident within the free banking theory that the gold standard in the nineteenth century is
regarded as a fully self adjusting system, which success was without, or even due to the lack
of, central bank interference.9
      Free banking is a strand within the monetarist school based on intrinsically value of
commodity based money and the monetary approach to the balance of payments in how
adjustments between regions, and banks, are conducted. Because of the monetarist
assumption that notes in circulation provides the basis for the total money supply and the
volume of credit in society, the most fundamental part of a free banking system is the right of
private banks to issue notes.10 Circulating private bank notes are in the free banking model


7
  Hayek, F.A. (1978). An interesting empirical question is if actually any of the new electronic currencies that
are created on the WWW are done so without being pegged to the value of an already existing currency. Without
having made a study of it I have not yet encountered a web based currency with an unique unit of account.
8
  It is also an empirical question wether the gold standard really was a case of a commodity standard or in reality
an international currency managed by the central banks of the main economies of the nineteenth century (see for
instance Gomes, L (1993)).
9
 Lawrence H. White argues that the gold standard is not fully functional without a real free banking system (see
White, L.H. (1985)).
10
     Smith, V.C. (1990) pp. 9-10


                                                          4
together with circulating specie what constitutes the domestic amount of currency. The notes
should be redeemable for specie and thus beyond the control of any monetary authority. Thus,
private bank(s) will be the issuers of what can be considered as currency, based on their
holdings of specie reserves.11
      The specie reserves held by the note issuing private banks in turn is the monetary base. As
the free banking theory is built upon the theory of international adjustment known as the
monetary approach to the balance of payments, the amount of base money held by the
banking system is to be decided by the domestic public in conjunction with international
capital flows. There should be no legal restrictions on note issuance, thus the domestic supply
of notes is to be determined by international flows of specie, determined by the balance of
payments, in conjunction with the publics demand for reserve backing of these notes as well
as the publics’ preferences for holding liquidity.
      From this observation comes that a free banking system is renounced of a central bank, or
any kind of politically privileged bank acting as a monetary authority. The definition of a
monetary authority in this case must be an agent that due to a political decision is endowed
with the monopolistic right to issue base money used as reserves by the banking system.
      If a political decision lies behind a specific bank’s possibility to issue base money, this
increases the possibility of the bank to violate the rules of the fixed exchange rate and to
engage in discretionary monetary policy, which in extension may endanger the value of the
currency. The possibility of a politically privileged bank to in a discretionary manner sterilize
the effects of international capital flows on the money supply is also the main argument why
the free banking school prefers the supply of domestic currency to be determined solely by the
market and not by a central bank. In accordance with the theory it is the monopolistic power
of the central bank to issue base money that will lead to a deteriorating currency.

The variables defining a free banking system
Besides the most obvious issue, that there should be no monetary authority issuing base
money, there are also other variables that are important for a banking system to be system of
free banking. All of these are related to the existence of an ideal market solution to the
domestic supply of currency.
      There should be free entry into banking. No specific laws are to limit the competition by
differing requirements on setting up banks from starting up other forms of businesses. Note


11
     White, L.H. (1984) Chapter 1


                                                  5
issuance is purely competitive so no authority should tax or restrict issue of notes (for instance
by regulating minimum denominations).
   Consumers and note holders will evaluate the prudence of the banks. Subsequently, the
reserve requirements of the banks will be set by the public on an open market and not by a
political process. Hence, banks do not have to submit to regulations on reserves set by any
authorities outside of competition.
   Due to the banks’ incentives, or rather lack thereof, to hold other banks’ notes as reserves,
an inter bank clearing mechanism will emerge. The law of adverse clearing states that holding
other banks’ notes leads to a competitive advantage of the issuing banks, and thus exchanging
other banks notes for reserves is in every banks interest.

Bank notes, money and currency in free banking
It is clear in the gold standard version of free banking that specie has the role of base money.
Despite the focus on the private banks’ right to issue bank notes in free banking theory, there
is no clear and fully satisfying definition of how to regard these bank notes and their function
in the economy.
   The basic definitions of the how the money supply is created by international capital flows,
public preferences, and the banking system helps structure the issue of how to regard bank
notes. Five basic equations explain how banks, the public and the monetary base (with or
without monetary authorities) in conjunction determines the broad money supply, as well as
its components.
   (1)    M = C + D; where M denotes the money supply, C the public’s holding of money
          and D the public’s deposits in the banking system.
   (2)    B = C + R; where B is base money, usually defined as monetary liabilities of the
          authorities, and is equaled with assets that actually, or potentially, can be used as
          reserves by the banking system. R denotes reserves held by the banking system.
   (3)    r = R / D; r is seen as the banks reserve to deposit ratio, and it is through this
          mechanism the banking system affects the money supply, as this is part of the
          money multiplier.
   (4)    c = C / M; c is the currency money ratio which is displaying the public’s preferences
          for holding money. As part of the money multiplier this is how the preferences of
          the public is determining the money supply.
   (5)    M = B / (c + r – cr); this is the equation for how the supply of base money (B)
          determines the total money supply (M) through the multiplier (1 / (c + r – cr)). This
          last equation is often written as M = mB; where m denotes the multiplier.

   Equation (1) defines the (broad) money supply as consisting of currency, and deposits.
Equation (2) states that base money either can be circulating among the public or off set as
reserves in the banking system. If it is held by the public it is referred to as currency. By this



                                                 6
definition currency has to be in the form of base money in this model. Money that is not part
of base money has to be in the form of deposits in the banking system, i.e. all private bank
liabilities held by the public are deposits.
      But, because of the central role of bank notes, free banking theory makes a clear distinction
between notes issued by the banks and deposits in these banks. Generally the private bank
notes are viewed as currency, something that clearly distinguishes notes from deposits.
Although, arguably the actual difference in practice between the two forms of bank liabilities
is not clear. In the free banking model as presented by Lawrence H. White it is concluded that
notes and deposits share the same properties. Von Mises introduced the idea of fiduciary
issue. However, notes regarded as fiduciary issue share the same function and properties of
short term deposits, with a system for checking. Basically the fiduciary issue is the fractional
reserve system for private banks. Banks can issue money on top of the (specie) reserves which
is considered as ‘real money’ (base money). Also in this definition bank notes are not part of
the monetary base, but very liquid deposits.
      The problem of defining private bank notes is both important and fraught with difficulties
in a banking system with both monetary authorities and private bank note issuance. What
properties that are given to the notes issued by respectively the monetary authority and the
private banks largely determines to what extent the private banks are able to operate
independently of the monetary authority.
      Definitions of bank notes and money are shifting and sometimes vague in empirical
literature on experiences of free banking systems, including so in the case of Sweden.12 The
concept of money is sometimes referred to as currency, i.e. private bank notes plus specie, and
sometimes to a more broad measure including also deposits. But in the ideal free banking
system as modeled by Lawrence H. White it is clear that the monetary base consists of specie,
and not of notes issued by a politically privileged bank. To make the competition of the free
banking system enforce the law of adverse clearing and also to make banks to follow the rules
of the specie standard in the adjustment process, i.e. not have the possibility to sterilize the
effect of the international specie flows, no bank can enjoy the possibility to distort this
practice by the possibility to issue base money.
      As issued private bank notes will not be used as base money, and hence in accordance with
the free banking model deposits and private bank notes are to be regarded as liabilities with
the same properties. The key to a banking system being a free banking system lies in the

12
     See Jonung, L. (1975), (1989)


                                                   7
absence of any authoritarian interference, i.e. in the absence of legislation and the banking
system not relying on a monetary authority issuing base money for reserves. In short, only the
right to issue notes is in itself not enough for a banking system to be a free banking system.
      Also in a central bank system any commercial bank can alter its balance sheet to meet
demands for credit, within the boundaries of reserve requirements. In this case the increased
liabilities in the form of notes are met by an equal increase in assets, i.e. the loan. Instead of
issuing notes as a loan, a bank without the right to issue notes may grant a credit and allow the
customer to issue checks on this credit. Or the bank can issue deposits (increasing the
liabilities), give a loan (increase the assets) and allow the customer a check book to be drawn
on the deposits. The working of these latter two cases for the deposit issuing bank is the same
as for the note issuing bank. Either only the asset side of the balance sheet is affected, as each
check coming in to the bank increases assets by being utilized credits, but as each check has
to be redeemed assets in the form of reserves decreases with the same amount. In the other
case the decrease in reserves as assets are met by a similar decrease in liabilities through
deposits.

Previous research on the Enskilda banks as a system of free banking
The note issuing Enskilda banks has been described as a successful example of free banking
in history. Free banking because the Enskilda banks were allowed to issue notes, and
successful because it is claimed that the system in itself was entirely stable.13 The latter
should show that the Enskilda banks managed well without any monetary authority, or any
lender of last resort activities, i.e. is viewed as a good empirical example of free banking. The
system of Enskilda banks was stable in itself and not subject to any panics or failures.14
Unfortunately the empirics in the case of the Swedish Enskilda banks do not support the free
banking interpretation.
      The alleged stability of the Enskilda banking system is true in the meaning that now
Enskilda bank failed in a way that made holders of their liabilities lose their money. But, at
least twice, in 1857/58 and in 1878/79, the State had to interfere as lender of last resort to save
banks most troubled by the crises. In these cases the threatened banks were among the most



13
  Jonung, L. (1989), Schuler, K. (1992), Selgin, G. A. (1988). There are claims that the absence of regulations in
the Swedish Enskilda bank system was an important part of the success of the system (Selgin, G. A. (1988) p. 7).
This claim is in itself a mystery, since the first part of the period was marked by massive barriers to entry, and
the second by increasing taxes and other impediments on note issuance.
14
     Jonung, L. (1984) p. 373, Jonung, L. (1989) p. 29, Schuler, K. (1992) p. 32


                                                            8
important bank, the Skåne Enskilda bank and the Stockholm Enskilda bank respectively.15
The last of these crises showed that to the public it did not matter if the liabilities of the bank
were in the form of issued notes or deposits, since the Stockholm Enskilda bank despite its
right to issue notes relied far more on deposits as source of funds.16
      The characterization of the Swedish Enskilda banks as a free banking system is not
possible unless the only criteria needed for a commercial banking system to be a free banking
system is that the banks have the right to issue notes. As the right to issue notes in itself in
practice does little difference for the flexibility and freedom of a banking system, this criteria
is not enough to label the Enskilda banks a free banking system.
      Two things in prior research lies behind the interpretation of Enskilda banks as a case of
free banking: 1) the idea of the Riksbank during the nineteenth century as merely a
commercial bank among others, without any features of a central bank whatsoever, and 2) the
interpretation that the Enskilda bank notes forced Riksbank notes out of circulation.
      The role of the Parliamentary owned bank, the Riksbank, thus is of vital importance for the
analysis whether the Enskilda banks in fact constituted a free banking system. Usually the
Riksbank is not considered as a central bank in the modern sense until the enactment of the
banking law of 1897, that among other things guaranteed the Riksbank monopoly on note
issuance.
      It is clear that the Riksbank did not fulfill all the tasks that today are considered as parts of
the responsibility of a central bank. It was not acting as the bank of the banking system by
providing services such as lender of last resort and act as clearing central. The Riksbank did
not act as lender of last resort because of the responsibility for the specie standard. Instead
lender of last resort was provided by the State as a whole through international capital imports
administered by the National Debt Office. However, if this would be enough to claim the
Riksbank being a State sponsored commercial bank, the same would be true for the Riksbank
today. In fact, the same solution for solving the trade off between a stable currency and acting
as lender of last resort was adopted in the crises in the twentieth century, including the most
recent in the early 1990s. Clearing between commercial banks however was until the late
nineteenth century carried out by the commercial banks themselves, the Stockholm Enskilda
bank between 1856 and 1864, and then the none-note issuing limited liability Skandinaviska


15
  One bank actually failed in the 1878 crisis, but the liabilities of this bank was taken over by another Enskild
bank.
16
     See Nilsson, G.B. (1994), Söderlund, E. (1964)


                                                         9
Kreditaktiebolaget.17 Hence the Riksbank has been described as a State sponsored commercial
bank competing with the Enskilda banks.18
      Only notes issued by the Riksbank officially held the status as legal tender. Clearly the
Riksbank was responsible for issuing notes that could be considered as currency, or even part
of the monetary base. The Riksbank and many members of Parliament viewed the note
issuance of the Enskilda banks as problematic since these were regarded as dependent upon
the reserves of the Riksbank. In short, the Riksbank was responsible for maintaining the
specie standard, something that was of utmost importance also for the liabilities of the
Enskilda banks. The free banking argument rests on the assumption that the Riksbank notes
and the Enskilda bank notes shared the same properties competed over the same market
shares.
      What probably lies behind the latter interpretation is the writings of Sven Brisman in the
1920s and 1930s. Brisman viewed the note issuing conducted by the Enskilda banks as
competition directly aimed at the note issuance conducted by the Parliamentary Riksbank,
claiming that the Enskilda banks started a successful race to push the Riksbank notes out of
circulation. Among the advocators of the Enskilda banks as a free banking system this has led
to the description of Enskilda bank notes as being of higher quality than Riksbank notes.19

Figure 1: Riksbank and Enskilda bank notes, 1834 – 1900
                                               Enskilda Bank notes held by the public.
         90,000                                Issued RB notes
         80,000                                RB notes held by the public

         70,000
         60,000
         50,000
         40,000
         30,000
         20,000
         10,000
               0
                   1834

                          1838
                                 1842
                                        1846

                                                1850
                                                       1854

                                                              1858
                                                                     1862

                                                                            1866
                                                                                   1870

                                                                                          1874
                                                                                                 1878
                                                                                                        1882

                                                                                                               1886
                                                                                                                      1890

                                                                                                                             1894
                                                                                                                                    1898




Sources: Post & Inrikes tidning, 1835 – 1871, Sammandrag af Bankernas Uppgifter 1871 – 1900


17
     Simonsson, K.G., Ögren, A. (2003a) Chapter 6.
18
     Brisman, S. (1924), (1934)
19
     See Jonung, L. (1989)


                                                                                   10
      Looking at the figures of Enskilda and Riksbank notes held by the public, this statement
makes sense. The problem with the interpretation of Enskilda bank notes and Riksbank notes
as competing over shares in the same market is that as an issuing bank, it does not matter if
the notes are being held by the public or other agents, as long as the notes are not redeemed
for specie. As long as the notes are circulating this is an advantage for the issuing bank, even
more so if the notes are functioning as reserves (base money) for other banks.
      If the Enskilda banks really wanted to out-compete the Riksbank, the Enskilda banks
would of course redeem the Riksbank notes for specie. In a free banking system there are no
incentives for holding other bank notes, because other Enskilda bank notes can be exchanged
for reserves (specie) to serve as backing for further note issuance. Not to redeem other banks’
notes gives them a competitive advantage. The free banking system is built on the idea that
because of these incentives the market will clear inter bank note issuance.
      The fact that it is difficult to fit in the notes issued by the Enskilda banks into the five
equations in the traditional model of the banking system is shown in the previous research by
Lars Jonung. The problem of how to characterize the Enskilda bank notes, i.e. if these notes
were part of the public’s preference for holding money or part of the public’s deposits in the
banking system, was not discussed. Along the lines of free banking theory the Enskilda bank
notes were included in the money stock as part of the public’s holdings of notes, that is
currency, when the measure was defined. But when calculations were made regarding the
currency-money ratio the Enskilda bank notes were defined as (and thus included in)
commercial bank deposits. Notes issued by the Riksbank, however, was included as base
money functioning as reserves and currency.20 Clearly this suggests that there was a
difference in properties between the Riksbank and the Enskilda bank notes, that the Riksbank
notes had uses the Enskilda bank notes had not.
      Before naming the system of Enskilda banks a free banking system, it has to be clarified
what role in the financial system the Riksbank and the Enskilda bank notes had. As seen in
figure 1 above, there was a large gap between issued Riksbank notes and Riksbank notes held
by the public. The simple question is if these Riksbank notes served as banking reserves or if
commercial banks held other Enskilda bank notes to the same extent as Riksbank notes.




20
     Jonung, L. (1975) pp. 13, 54, 71, 78, 215


                                                  11
Empirical evidence on the Enskilda banking system
The Enskilda bank existed as note issuing banks in Sweden between 1831 and 1903. More
than seventy years of Enskilda banks is not possible to consider as one period with a coherent
banking system. As a result, the question whether the system really was a case of free banking
has to take the difference over time into account. Given the detailed regulations and the limits
on bank establishment, the first period 1831 until 1863 is unlikely to qualify as a period of
free banking.

Figure 2: No of Commercial banks, 1834 – 1900
 70

 60                        Enskilda banks


 50                        Joint Stock banks

 40
                           Filial banks
 30

 20

 10

  0
      1834
             1837
                    1840
                            1843
                                   1846
                                          1849
                                                 1852
                                                        1855
                                                               1858
                                                                      1861
                                                                             1864
                                                                                    1867
                                                                                           1870
                                                                                                  1873
                                                                                                         1876
                                                                                                                1879
                                                                                                                       1882
                                                                                                                              1885
                                                                                                                                     1888
                                                                                                                                            1891
                                                                                                                                                   1894
                                                                                                                                                          1897
                                                                                                                                                                 1900
Sources: Brisman (1924), Sveriges Riksbank (1931)

   If there in fact was a period of free banking it is likely that it started with the enactment of
the banking law 1864. The law of 1864 standardized bank regulations and meant an in
practice unlimited right to establish banks under these regulations. Even more so with the new
banking act due to the switch to the gold standard in 1874.
   The law of 1874 dissolved the special status of Riksbank notes by not allowing them to be
used as legal backing of Enskilda bank notes, a law that came to embrace all Enskilda banks
from 1878. In 1897 it was decided that the possibility to issue notes for the Enskilda banks
was withdrawn from the year 1903, and that all Enskilda bank notes should be taken out of
circulation before the end of 1906. The decision to end the Enskilda banks’ note issuance led
to a sharp decrease in their notes in circulation after the end of 1900. Consequently, the most
likely period of free banking in Sweden was the period 1878 until 1900. During this period




                                                                                     12
the Enskilda bank note issuance formally was done without connection to the note issuance
conducted by the Swedish central bank, the Riksbank.21

1831 – 1864; monopoly commercial banking system
It has been claimed that the right of the Enskilda banks to issue notes was due to a legal coupe
by the first Enskilda bank, Skane Enskilda bank. But this is not true, instead the original
proclamation of 1824 allowed the Enskilda banks the right to issue notes. The reason was
practical; there was not enough liquidity for banks to run banking businesses without the right
to issue notes. The note issuance was seen as the only possible way of financing banking
business due to the lack of formal means of payments that could be pooled as deposits.
      Already with the establishment of the first Enskilda bank, Skåne Enskilda bank, in 1831, it
was clear how important the currencies connection to the silver was. The right to establish an
Enskild bank had been proclaimed in 1824, but no application was filed until the decision to
adopt the silver standard was made in 1830.22
      The view on Enskilda bank notes changed among large groups in Parliament in the 1840s
because the banks in question utilized their monopoly situations and refused to redeem their
notes or even to accept deposits. The refusal to redeem the notes was costly for the note
holders as this made it impossible for them to pay their taxes. This was particularly sensitive
as the owners of shares in the Enskilda banks enjoyed high dividens, often between fifteen
and twenty five percent annually. As competition and political pressure increased, the
Enskilda banks more and more started to accept the discount costs for making their notes a
closer alternative to legal tender, i.e. Riksbank notes. As an example the Enskilda banks
started to utilize the tax collectors as exchange agents, why the Enskilda bank notes were
exchanged for Riksbank notes when the tax payment was done.23
      If the Enskilda banks had wanted to operate independently of the Riksbank, or any other
monetary authority, the regulation from the beginning and throughout the period allowed
them to base their note issuance solely on specie. But, despise this, the Enskilda banks


21
     See Ögren, A. (2003d) and SFS 1874:44
22
   The founders of this bank themselves pointed out the importance of the silver standard for this decision (see
Kock, K. (1931) pp. 45-50. Regarding the general belief in the importance of the Riksbank working under a
fixed exchange rate see Bankkomitén (1883) p. 138, Nordström, J.J. (1853) p. 245, Rosenberg, C.M. (1878) p.
81
23
   Ögren, A (2003a) Chapter 2 and Chapter 4. From the beginning the groups in Parliament advocating low
restrictions on note issuance at the same time advocated high barriers of entry, and vice versa. Clearly the former
group represented those with owners’ interest in the banks, and the latter those who wanted to get access to the
market and had to carry the costs of holding the Enskilda bank notes.


                                                         13
operated with reserves consisting mainly of Riksbank notes. The difference in importance
between Enskilda bank notes and Riksbank notes was quite striking in this respect, as seen in
figure 3 below.

Figure 3: Annual data on Enskilda banks cash assets in relation to issued notes, 1834 – 1900
 60%
                                                                                                     EB's Holdings of Eb Notes

 50%                                                                                                 EB's holdings of RB notes

                                                                                                     EB's holdings of specie
 40%


 30%


 20%


 10%


  0%
       1843

              1846

                     1849

                            1852

                                   1855

                                          1858

                                                 1861

                                                        1864

                                                               1867

                                                                      1870

                                                                              1873

                                                                                     1876

                                                                                            1879

                                                                                                   1882

                                                                                                          1885

                                                                                                                 1888

                                                                                                                        1891

                                                                                                                               1894

                                                                                                                                      1897

                                                                                                                                             1900
Source: Post & Inrikes tidning 1835 – 1871, Sammandrag af Bankernas Uppgifter 1871 – 1900

   The amount of Enskilda bank notes held was stable and small in size. This is as expected
as these notes were considered an unwanted form of asset, to be exchanged for base money as
soon as possible. The amount of Riksbank notes held stands sharply in contrast to the amount
of Enskilda bank notes. Clearly the Riksbank notes functioned as reserves for the Enskilda
banking system in a manner no Enskilda bank notes did.
   From 1874 Enskilda banks started to back their note issuance with gold in accordance with
the law. From this year on these banks were not officially allowed to back their note issuance
with specie. Still the amount of Riksbank notes held was considerable.

1878 – 1900; De juro Free banking, but not de facto
From the year 1878 all Enskilda banks operated under the banking law of 1874. This law
made gold holdings an important part of the Enskilda banks reserves, as it stated that the
banks had to hold at least ten percent of their equity capital in gold to have the right to issue
notes at all. And as noted earlier, Riksbank notes were no longer legal basis for note issuance.
Given the definitions in free banking, that private banks should be able to issue notes without
interference of any monetary authority, the period from 1878 until 1900 stands out as a period




                                                                             14
when the Enskilda banks by law not only had the possibility to but actually as far as note
issuance was concerned were required to follow the ideal free banking model.

Figure 4: Monthly data on Enskilda banks cash assets in relation to issued notes, 1878 –
1900
  35%                                                                    Gold in percent of issued notes
                                                                         Riksbank notes in percent of issued notes
                                                                         Other Enskilda bank notes in percent of issued notes
  30%


  25%


  20%


  15%


  10%


    5%


    0%
          187801
                   187901
                            188001
                                     188101
                                              188201
                                                       188301
                                                                188401
                                                                          188501
                                                                                   188601
                                                                                            188701
                                                                                                     188801
                                                                                                              188901
                                                                                                                       189001
                                                                                                                                189101
                                                                                                                                         189201
                                                                                                                                                  189301
                                                                                                                                                           189401
                                                                                                                                                                    189501
                                                                                                                                                                             189601
                                                                                                                                                                                      189701
                                                                                                                                                                                               189801
                                                                                                                                                                                                        189901
                                                                                                                                                                                                                 190001
Source: Sammandrag af Bankernas Uppgifter 1878 – 1900

   Riksbank notes continued to be the main ingredient in the Enskilda banks reserves despite
the law of 1874. Other Enskilda bank notes were still only held as a result of friction in the
clearing process. But, the Riksbank notes continued to keep their position as part of the
reserves and thus monetary base. In fact, the Enskilda banks published the ratio of gold
holdings plus Riksbank notes in percent of issued notes in their balance sheets throughout the
period.
   Obviously also the holdings of Riksbank notes was most volatile in relation to issued notes
of the Enskilda banks. This suggests that what in practice Enskilda bank notes were redeemed
for was not gold but Riksbank notes. The Enskilda banks holdings of gold was forced upon
them by law (except in the case of the Stockholm Enskilda bank which was most dependent
upon international credit), and hence a side step from what the market regarded as the most
efficient system.
   The fact that the gold holdings was enforced upon the Enskilda banks is empirically clear,
before the law of 1874 was put into practice the banks held virtually no specie as reserves.
The gold reserves were quickly built and remained between ten and fourteen percent of the


                                                                                                                15
equity capital for the rest of the period (again with the exception of the Stockholm Enskilda
bank who held between twenty and twenty-eight percent). After the note issuing right of the
Enskilda bank was decided to end their gold holdings quickly diminished from 9.5 millions in
1900 to 0.25 million in 1903.24
      In addition to the empirical evidence of the specific position of Riksbank notes as reserves
in the banking system also after the law of 1874, the limited liability banks without the right
to issue notes that started to establish in 1864 did not rely on gold reserves nor on Enskilda
bank notes. The absolute main part of these commercial banks’ reserves consisted of
Riksbank notes. Enskilda bank notes were held to such a small extent that it clearly was in the
process of awaiting exchange of these for base money, i.e. Riksbank notes.
      The fact that the Enskilda banks continued to work within a central bank system did not
impede their flexibility. As long as the reserve requirement is not impeding the efficiency of
the banks, a banking system operating with reserves issued by a central bank may be well as
flexible as the free banking system.

Figur 5: Monthly data on Riksbank and Enskilda bank notes in circulation, 1878-1900 (in
SEK)
     120,000,000



     100,000,000                     Riksbank notes in circulation
                                     Enskilda bank notes in circulation


      80,000,000



      60,000,000



      40,000,000



      20,000,000



              0
                   187801
                            187812
                                     187911
                                              188010
                                                       188109
                                                                188208
                                                                         188307
                                                                                  188406
                                                                                           188505
                                                                                                    188604
                                                                                                             188703
                                                                                                                      188802
                                                                                                                               188901
                                                                                                                                        188912
                                                                                                                                                 189011
                                                                                                                                                          189110
                                                                                                                                                                   189209
                                                                                                                                                                            189308
                                                                                                                                                                                     189407
                                                                                                                                                                                              189506
                                                                                                                                                                                                       189605
                                                                                                                                                                                                                189704
                                                                                                                                                                                                                         189803
                                                                                                                                                                                                                                  189902
                                                                                                                                                                                                                                           190001
                                                                                                                                                                                                                                                    190012




Source: Sammandrag af Bankernas Uppgifter 1878 – 1900




24
     Sammandrag af Bankernas Uppgifter 1871 – 1911, Ogren, A. (2003a) Chapter 4


                                                                                                                          16
   Figure 5 above shows that despite using central bank notes as reserves, the note issuance of
the Enskilda banks was flexible enough to meet the demands for liquid Enskilda bank notes.
The demand for Enskilda bank notes clearly followed a seasonal pattern of an agricultural
economy.
   If the Riksbank had been nothing but a State sponsored commercial bank, which’s notes
were substitutes for Enskilda bank notes, commercial banks would not have utilized them for
reserves. The Riksbank notes never relied on Enskilda bank notes as reserves. The most
important fact with the system of the Enskilda banks was that these banks through the entire
period had the possibility to be independent of the Riksbank, but chose not to build such a
system. The market solution in this case was that the central banking based system, that
apparently was viewed as more efficient.

Statistical test of the central bank hypothesis
To further investigate the importance of the Riksbank notes as monetary base, the question is
if it is possible to find any link between Riksbank notes and issued Enskilda bank notes for
the period 1878 until 1900. Or rather the question is, on what reserves did the Enskilda banks
base their note issuance.
   Variables are: Issued Riksbank notes (ISSRBN), Riksbank notes held as reserves as by the
Enskilda banks (EBRBN), Gold held as reserves by the Enskilda banks (EBGOLD) and
Issued Enskilda bank notes (ISSEBN). Observations are monthly which gives 277
observations of the variables. The time series are not stationary, hence changes (first
differences) in the variables are used. Changes in reserve components are also what should
lead to changes in note issuance, so using the first difference in this case makes sense.
   In the OLS-regressions it is assumed that the changes in Enskilda bank note issuance was
dependent on changes in the reserves. Clearly changes in the amount of Riksbank notes held
affected the note issuance of the Enskilda banks. This was however not the case for specie, as
changes in the holdings of gold not affected note issuance.




                                                 17
Figure 6: OLS-regression of issued Enskilda bank notes (ISSEBN) as being dependent on
changes in reserve components of gold (EBGOLD) and Riksbank notes (EBRBN), 1878-1900.
Monthly data.
Dependent Variable: D(ISSEBN)
Method: Least Squares
Date: 03/30/05 Time: 00:10
Sample(adjusted): 2 276
Included observations: 275 after adjusting endpoints
       Variable        Coefficient    Std. Error    t-Statistic       Prob.
         C               120692.1      197698.3      0.610487        0.5420
     D(EBGOLD)           0.614213      1.372939      0.447371        0.6550
     D(EBRBN)            0.393369      0.126654      3.105855        0.0021
R-squared                 0.035113    Mean dependent var           127829.5
Adjusted R-squared        0.028018    S.D. dependent var           3323822.
S.E. of regression        3276928.    Akaike info criterion        32.85356
Sum squared resid         2.92E+15    Schwarz criterion            32.89302
Log likelihood           -4514.364    F-statistic                  4.949134
Durbin-Watson stat        2.260467    Prob(F-statistic)            0.007741
Source: Sammandrag af Bankernas Uppgifter 1878 – 1900

Since both these variables are part of total reserves and could be expected to fluctuate in
harmony, the OLS-model was tested for multicolinearity between these variables, which was
not found. Figure 7 shows an OLS-regression with only gold as independent variable, still
changes in the holdings of gold was far from significantly affecting the Enskilda bank note
issuance.

Figure 7: OLS-regression of issued Enskilda bank notes (ISSEBN) as being dependent on
changes gold reserves (EBGOLD), 1878-1900. Monthly data.
Dependent Variable: D(ISSEBN)
Method: Least Squares
Sample(adjusted): 2 276
Included observations: 275 after adjusting endpoints
       Variable         Coefficient    Std. Error    t-Statistic      Prob.
         C               124877.2      200799.9      0.621899        0.5345
     D(EBGOLD)           0.689007      1.394296      0.494161        0.6216
R-squared                 0.000894    Mean dependent var           127829.5
Adjusted R-squared       -0.002766    S.D. dependent var           3323822.
S.E. of regression        3328416.    Akaike info criterion        32.88114
Sum squared resid         3.02E+15    Schwarz criterion            32.90744
Log likelihood           -4519.156    F-statistic                  0.244196
Durbin-Watson stat        2.356367    Prob(F-statistic)            0.621590
Source: Sammandrag af Bankernas Uppgifter 1878 – 1900

The question is also to what extent the note issuance of the Enskilda banks was affected by
the note issuance conducted by the Riksbank. That is if the changes in the reserves in the form
of Riksbank notes were directly affected by changes in the issuance of these notes. Figure 8
below supports the importance not only of Riksbank notes being held as reserves, but also of
the link from issued Riksbank notes to issued Enskilda bank notes. There was also a high



                                                    18
degree of correlation between changes in the issued amount of Riksbank notes and Riksbank
notes being held as Enskilda bank reserves.

Figure 8: OLS-regression of changes in issued Enskilda bank notes (ISSEBN) as being
dependent on changes in the amount of notes issued by the Riksbank (ISSRBN), 1878-1900.
Monthly data.
Dependent Variable: D(ISSEBN)
Method: Least Squares
Sample(adjusted): 2 276
Included observations: 275 after adjusting endpoints
       Variable         Coefficient   Std. Error    t-Statistic      Prob.
          C              40627.65      172848.6     0.235048        0.8143
      D(ISSRBN)          0.514830      0.052432     9.818914        0.0000
R-squared                 0.260986    Mean dependent var          127829.5
Adjusted R-squared        0.258279    S.D. dependent var          3323822.
S.E. of regression        2862583.    Akaike info criterion       32.57959
Sum squared resid         2.24E+15    Schwarz criterion           32.60590
Log likelihood           -4477.694    F-statistic                 96.41106
Durbin-Watson stat        2.044551    Prob(F-statistic)           0.000000
Source: Sammandrag af Bankernas Uppgifter 1878 – 1900

   In fact changes in the amount of issued Riksbank notes explained changes in the amount of
Enskilda bank notes to twenty-five percent.
   Finally, changes in the issuance of Riksbank notes in prior periods also affected the
issuance of Enskilda bank notes and their reserve holdings positively. A VAR-analysis of
monthly changes the variables for issued Riksbank notes (ISSRBN) ), Riksbank notes held as
reserves as by the Enskilda banks (EBRBN), Gold held as reserves by the Enskilda banks
(EBGOLD) and Issued Enskilda bank notes (ISSEBN) with up to five lags supports the
importance of the Riksbank notes.
   The results of this VAR-analysis is seen in figure 9 below. With lags of two, three and four
months the amount of issued Riksbank notes positively affected the reserve holdings of the
Enskilda banks. Moreover, the issued Riksbank notes with lags of one and two months
negatively affected the amount of issued Enskilda bank notes, but positively so with three and
four months lags. It should be noted that the issuance of Riksbank notes had the same relation
to itself with an added positive influence with a lag of five months. The size of these
coefficients were about the same for positive and negative influence.




                                                   19
Figure 9: VAR-test of precedence between issued Riksbank notes (ISSRBN), issued Enskilda
bank notes (ISSEBN), changes in Enskilda bank reserve components of gold (EBGOLD) and
Riksbank notes (EBRBN), 1878-1900. Monthly data.
Sample(adjusted): 7 276
Included observations: 270 after adjusting endpoints
Standard errors & t-statistics in parentheses
                      D(ISSRBN)       D(EBRBN)         D(ISSEBN)    D(EBGOLD)
  D(ISSRBN(-1))        -0.356932       0.054930        -0.167641    -0.004649
                        (0.06443)      (0.03881)        (0.07131)    (0.00437)
                       (-5.53968)      (1.41536)       (-2.35090)   (-1.06392)

  D(ISSRBN(-2))        -0.257665       0.076808        -0.171157     0.004700
                        (0.06585)      (0.03967)        (0.07288)    (0.00447)
                       (-3.91284)      (1.93640)       (-2.34847)    (1.05224)

  D(ISSRBN(-3))         0.185051       0.140273         0.165626     0.011261
                        (0.06783)      (0.04085)        (0.07507)    (0.00460)
                        (2.72833)      (3.43347)        (2.20643)    (2.44802)

  D(ISSRBN(-4))        -0.148055       0.092093         0.244321     0.012407
                        (0.06726)      (0.04051)        (0.07444)    (0.00456)
                       (-2.20117)      (2.27308)        (3.28207)    (2.71956)

  D(ISSRBN(-5))        -0.203605       0.055532         0.083519     0.004523
                        (0.06646)      (0.04003)        (0.07355)    (0.00451)
                       (-3.06358)      (1.38720)        (1.13548)    (1.00351)

  D(EBRBN(-1))         -0.270696       -0.719393       -0.217188    -0.000340
                        (0.10865)       (0.06545)       (0.12025)    (0.00737)
                       (-2.49135)      (-10.9919)      (-1.80611)   (-0.04609)

  D(EBRBN(-2))         -0.388398       -0.547286       -0.139641    -0.006362
                        (0.12992)       (0.07826)       (0.14379)    (0.00881)
                       (-2.98956)      (-6.99358)      (-0.97118)   (-0.72199)

  D(EBRBN(-3))         -0.540708       -0.404569       -0.285416    -0.008358
                        (0.13696)       (0.08250)       (0.15158)    (0.00929)
                       (-3.94783)      (-4.90392)      (-1.88291)   (-0.89975)

  D(EBRBN(-4))         -0.276045       -0.201556       -0.170126     0.002331
                        (0.13320)       (0.08023)       (0.14742)    (0.00903)
                       (-2.07240)      (-2.51215)      (-1.15404)    (0.25802)

  D(EBRBN(-5))         -0.093763       -0.060801       -0.402974    -0.001190
                        (0.11071)       (0.06669)       (0.12253)    (0.00751)
                       (-0.84690)      (-0.91173)      (-3.28874)   (-0.15849)

  D(ISSEBN(-1))        -0.019513       -0.057124       -0.287719     0.008533
                        (0.05775)       (0.03478)       (0.06391)    (0.00392)
                       (-0.33791)      (-1.64233)      (-4.50204)    (2.17873)

  D(ISSEBN(-2))         0.000274       -0.019357       -0.437547     0.002835
                        (0.05419)       (0.03264)       (0.05997)    (0.00368)
                        (0.00505)      (-0.59304)      (-7.29589)    (0.77135)

  D(ISSEBN(-3))         0.037803       0.068881        -0.247425     0.005008
                        (0.05742)      (0.03459)        (0.06355)    (0.00389)
                        (0.65835)      (1.99151)       (-3.89342)    (1.28589)



                                                       20
  D(ISSEBN(-4))       -0.231623     -0.007636      -0.527815    0.003483
                       (0.05325)     (0.03208)      (0.05893)   (0.00361)
                      (-4.34971)    (-0.23805)     (-8.95602)   (0.96430)

  D(ISSEBN(-5))       -0.229702     -0.026052      -0.242229    0.001335
                       (0.05793)     (0.03490)      (0.06412)   (0.00393)
                      (-3.96499)    (-0.74656)     (-3.77798)   (0.33982)

  D(EBGOLD(-1))       1.015479      -0.254607       0.687128    -0.298919
                      (0.93294)      (0.56195)      (1.03252)    (0.06328)
                      (1.08847)     (-0.45308)      (0.66549)   (-4.72406)

  D(EBGOLD(-2))       1.347798       0.637851       1.289002    -0.132208
                      (0.95206)      (0.57347)      (1.05368)    (0.06457)
                      (1.41566)      (1.11227)      (1.22333)   (-2.04742)

  D(EBGOLD(-3))       0.594526      -0.444299       0.309077    -0.035798
                      (0.94968)      (0.57204)      (1.05105)    (0.06441)
                      (0.62603)     (-0.77670)      (0.29407)   (-0.55578)

  D(EBGOLD(-4))       -0.361791     -0.536865      -1.452072    -0.060347
                       (0.94531)     (0.56940)      (1.04621)    (0.06411)
                      (-0.38272)    (-0.94286)     (-1.38794)   (-0.94123)

  D(EBGOLD(-5))       0.625566      -0.130114      -0.223101    -0.039155
                      (0.91612)      (0.55182)      (1.01390)    (0.06214)
                      (0.68284)     (-0.23579)     (-0.22004)   (-0.63016)

         C            286562.5      -36907.12       301066.4    -758.5164
                      (128726.)      (77537.2)      (142465.)    (8730.73)
                      (2.22615)     (-0.47599)      (2.11326)   (-0.08688)
 R-squared             0.646279       0.427989      0.573304     0.149203
 Adj. R-squared        0.617868       0.382044      0.539031     0.080866
 Sum sq. resids        1.05E+15       3.81E+14      1.29E+15     4.83E+12
 S.E. equation         2053119.       1236685.      2272264.     139251.4
 F-statistic           22.74723       9.315313      16.72767     2.183339
 Log likelihood       -4296.598      -4159.728     -4323.980    -3570.072
 Akaike AIC            31.98220       30.96835      32.18504     26.60054
 Schwarz SC            32.26208       31.24823      32.46492     26.88041
 Mean dependent        155546.7       14255.16      120862.6     3454.211
 S.D. dependent        3321292.       1573187.      3346748.     145248.0
 Determinant Residual Covariance      3.95E+47
 Log Likelihood                      -16327.72
 Akaike Information Criteria          121.5683
 Schwarz Criteria                     122.6878
Source: Sammandrag af Bankernas Uppgifter 1878 – 1900

   Issued Riksbank notes also affected changes in the amount of gold held by the Enskilda
banks with lags of three and four months. And as expected in a central banking system, the
amount of commercial bank liabilities did not positively affect the amount of central bank
liabilities. Issued Enskilda bank notes were negatively related to the amount of issued
Riksbank notes with lags of three and four months. This supports the qualitatively evidence
that stated that the note issuance of the Enskilda banks ultimately was dependent on the
reserves of the Riksbank.


                                                   21
   The importance of Riksbank notes as base money for the Enskilda banking system clearly
shows that although this banking system had the right to issue notes it was working as a
central bank based banking system and not as a free banking system. Moreover, the choice of
the market to maintain the central bank based banking system shows that this was the most
efficient solution. Hence, despite the right of the Enskilda banks to issue notes, this was not a
free banking system.

Conclusions
What has been referred to as a successful example of free banking in history, the Swedish
system of note issuing Enskilda banks, was in fact a central bank based system. The Enskilda
banks based their note issuance throughout the entire period on notes issued by the central
bank, the Riksbank, which was responsible for the fixed exchange rate.
   The notes of the Enskilda banks functioned as a more liquid bank liability than demand
deposits at the time, but was never close to be utilized as reserves in the banking system.
Unlike the Enskilda bank notes, all commercial banks, including those without the right to
issue notes, held Riksbank notes as reserves. Clearly Riksbank notes and Enskilda bank notes
had different properties.
   Also after the law of 1874 had stated that Riksbank notes no longer was a legal backing for
issuing Enskilda bank notes did the dependence on Riksbank notes disappear. On the
contrary, Riksbank notes continued to be the reserves used in practice, whereas gold as
favored by the law never had this position. In fact, the gold holdings of the Enskilda banks
was forced through by law. Thus, a banking system dependent on the currency issued by a
central bank was the market favored solution in the case of the Enskilda banks.
   Finally the study of the Swedish Enskilda banks shows that it is important to regard the
properties and roles of liabilities issued by politically privileged banks, and/or monetary
authorities, before naming a banking system a system of Enskilda banks. Not least the
reserves of the banking system are of importance for how to classify a banking system.
Further studies of other countries experiences with note issuing banks are of importance
before claiming the empirical support of the success of free banking.

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