Kim Abildgren Danmarks Nationalbank 1818-2018 2 Kim Abildgren Danmarks Nationalbank 1818-2018 DANMARKS NATIONALBANK 4 Content PREFACE 7 PART I — BIRTH OF DANMARKS NATIONALBANK CHAPTER 1 State bankruptcy and a chaotic monetary system 13 CHAPTER 2 The Danmarks Nationalbank Act of 1936 25 PART II — PRICE STABILITY CHAPTER 3 Low inflation for 200 years – with a few exceptions 37 CHAPTER 4 A fixed exchange rate has provided for stable prices 47 CHAPTER 5 Danmarks Nationalbank’s toolbox: Interest rates and foreign exchange reserves 61 PART III — THE STABILITY OF THE FINANCIAL SYSTEM CHAPTER 6 From savings banks to financial supermarkets 77 CHAPTER 7 When history repeats itself: banking and financial crises 91 CHAPTER 8 Credit and house price bubbles 103 PART IV — SAFE AND SECURE PAYMENTS CHAPTER 9 From coins to mobile apps – means of payment over 200 years 115 CHAPTER 10 From counterfeiting to cybercrime 129 PART V — A ROBUST ECONOMY CHAPTER 11 200 years with a rising standard of living – despite fluctuations 141 APPENDIX Danmarks Nationalbank's banknotes since 1818 151 SOURCES, NOTES AND IMAGE CREDITS 165 6 Preface Danmarks Nationalbank’s 200-year history has been characterised by long periods of a robust economy, but also by dramatic episodes during which the stability of prices, payment systems and the financial sector have been jeopardised. This anni- versary book provides a brief overview of Danmarks Nationalbank’s 200-year his- tory, stressing the elements that are particularly relevant for today’s readers. The establishment of Danmarks Nationalbank – or Nationalbanken i Kjøben- havn, as it was called then – in 1818 was a result of an extensive crisis in the monet- ary system in the wake of the period of high inflation and the massive government finance problems during the Napoleonic Wars. In the first half of the 19th century, Danmarks Nationalbank had focus on resto- ring the monetary system. It succeeded, and prices subsequently remained stable un- til the outbreak of World War I. From around the mid-19th century, Denmark followed first the silver standard and later the gold standard. This meant fixed exchange rates against the currencies of many other countries adhering to the same standards. In the second half of the 19th century, the basic structure of the financial sys- tem we know today emerged, with private financial institutions playing a central role in terms of extending credit and offering savings products. But the second half of the 19th century and the early 20th century also brought the first banking crises and a need to regulate the financial sector. The 1920s saw a crisis in the Danish banking sector, and in the early 1930s, the international gold standard system collapsed. However, Denmark upheld its long- standing fixed exchange rate policy tradition. In the second half of the 1930s, Den- mark pursued a fixed exchange rate policy against the pound sterling. After World War II, the framework for the fixed exchange rate policy was first the international dol- lar-based Bretton Woods system and later the European exchange rate cooperation. In the first three decades after World War II, the financial sector was charac- terised by stability. The same could not be said about prices. This situation culmin- ated in the late 1970s and early 1980s, when inflation reached double-digit rates and government budget deficits and current account deficits were massive. In the 1980s, price stability was restored thanks to a notable shift in economy policy towards more stability-oriented fiscal policy and a consistent fixed exchange rate policy, first against the German D-mark and later against the euro. In the last 30 years, inflation has been low. All the same, this period has also seen banking crises and a need to impose new rules on the financial sector. In addition, payment systems have undergone marked transformations and are now based on complex IT systems with resultant new types of risk. The book targets a wide audience and is richly illustrated. At Danmarks Na- tionalbank’s website, you will find not only the electronic version of the book, but also a web appendix with literature. The anniversary book was prepared by Kim Abildgren. A number of external persons have contributed with valuable comments on the draft for the whole book or parts of it. They are Øyvind Eitrheim, Jan Fredrik Qvigstad, Gitte Keinicke Staghøj and Frank Øland. Furthermore, many employees of Danmarks Nationalbank have made a huge contribution by commenting on the draft and assisting with adminis- tration, archive and library searches, linguistic editing, graphical layout and verifi- cation of the contents of the book. SNAPSHOT FROM THE HISTORY OF DANMARKS NATIONALBANK OF DANMARKS THE HISTORY FROM SNAPSHOT the firm from Lips in Danmarks Nationalbank’s Door for vaults main building in Holmens Kanal. Copenhagen, 4 July 2018 7 Part I 8 Birth of Danmarks Nationalbank Danmarks Nationalbank was established in 1818 with the aim of rebuilding the monetary system. Since then, its objective has been to ensure stable prices, a stable financial system and safe and secure payments. 9 10 Chapter 1 11 Bombardment of Copenhagen in 1807 After the British bombardment of Copenhagen in 1807, Denmark sided with France in the Napoleonic Wars. The considerable war expenditure and decline in government revenue were to a large extent covered by printing more money. This led to very high inflation and de facto collapse of Denmark’s currency system. 12 CHAPTER 1 State bankruptcy and a chaotic monetary system Fiscal policy ran wild during the Napoleonic Wars in the early 1800s, and the enormous government budget deficit was financed by printing more money. This caused inflation to soar, requiring an extensive currency reform. As part of this reform, Danmarks Nationalbank was established in 1818 with a monopoly on issuing banknotes in Denmark. It was considered essential to ensure Danmarks Nationalbank’s independence of the state, so that it could not be ordered to engage in monetary financing of government budget deficits. Danmarks Nationalbank spent the first decades of its existence restoring people’s trust in the monetary system. It succeeded, but this process illustrates how quickly credibility can be lost and how long it takes to restore it. 13 War and a chaotic monetary system Inflation was soaring in Denmark in 1808-13. In 1813 alone, prices rose by more than 300 per cent, cf. Chart 1.1. The background was that Denmark had sided with France in the Napoleonic Wars after the British bombardment of Copenhagen in 1807. This brought Den- mark’s foreign trade almost to a halt, and government revenue plum- meted. Since the central government was struggling to raise loans, the considerable war expenditure was financed by printing more money. This strongly eroded the purchasing power of Danish banknotes, and Denmark’s financial system collapsed de facto. The central government showed that it had also lost confidence in the currency system by requiring payment of certain taxes in kind (grain) rather than banknotes. Order and stability: The currency reform of 1813 In June 1812, the Minster for Finance presented a proposal to re- structure the currency system. On 5 January 1813, this proposal was implemented as ”Forordning om Forandring af Pengevæsenet for Kongerigerne Danmark og Norge samt Hertugdømmerne Slesvig og Holsten” (Decree on changing the currency system for the Kingdoms of Denmark and Norway and the Duchies of Schleswig and Holstein). The preface to the Decree said, inter alia: ”Since the government’s existing currency system is shaken to the core, we have decided to bring order and stability to the system by establishing a permanent and unshakeable foundation for it. … Any inconvenience which a change as sudden and extensive as this one may cause should just be regarded as being in the interest of our mother country.” The reform included the establishment of a new, state-owned central bank, Rigsbanken. It was granted a monopoly on issuing banknotes in a new currency unit, rigsbankdaler, which the Danes were obliged to accept. The currency reform of 1813 is often called the ”state bank- ruptcy”. The reform meant exchange of existing banknotes in the old currency unit (kurantdaler) for new banknotes at an exchange rate of 6 kurantdaler to 1 rigsbankdaler. CHART 1.1 Consumer price inflation 1808-13 Per cent, year-on-year 350 300 250 200 150 100 50 0 1808 1809 1810 1811 1812 1813 14 FACTBOX Why was a silver or gold standard But the rules of the game were not always observed. In many cases, a country chose to for banknotes introduced? abandon the silver or gold standard, not con- And why was it abandoned? verting the issued banknotes to precious metal. So although the currency system was, in prin- ciple, linked to a product (silver or gold), the real value of the banknotes was ultimately only secured by the government’s ability to pursue economic policy that would not generate infla- tion and erode the purchasing power of money. In a large part of the 19th century and until A fundamental drawback of issuing banknotes the beginning of the 20th century, the currency linked to precious metal was that the volume system in Denmark and many other countries of banknotes could not be increased if needed followed first a silver and then a gold standard. in an economic upturn. Nor was it possible to Coins had a certain content of precious metal, increase the volume of banknotes if an urgent and banknotes could be exchanged freely for sil- need for liquidity were to arise in connection ver or gold coins at the central bank according with a banking crisis. This seriously restrained to the official conversion table.