The fi rst in history and its printing machine

Rose Marie Boudeguer Director of Research Services

MONTHLY STRATEGY REPORT November 2015 Monthly Strategy Report. November 2015

The fi rst central bank in history and its banknote printing machine

For centuries the value of money was linked to metals. Paper instrument and , which date to seventh century China, were backed by gold, silver and other precious metals. The concept of fi duciary money, i.e. not backed by metals, came to Europe in the seventeenth century in the hands of a young Dutch businessman.

Johan Palmstruch was the son of a merchant in . While he was still young he moved to Stockholm, which at the time was ringing in an era of prosperity already enjoyed in the . Palmstruch knew the ins and outs of the successful Dutch banking system. Thanks to his contacts, he was granted an audience with King Charles X Gustav of , who was quite impressed by Johan’s knowledge of the fi nancial system, and hoping to modernize the Swedish fi nancial system, authorised him to found the Bank of Stockholm. Of course, part of the bank’s profi t was to go to the crown. This was 30 November 1656.

The fi nance system in Sweden was quite antiquated at the time. Copper was primarily used as the monetary standard, although silver coins with a much greater value were also in circulation. This caused certain problems. On the one hand, the value of copper fl uctuated more than the value of silver, leading to changes in the value of the Swedish currency, the daler. On the other hand, dalers were issued in an impractical way, in the form of large metal plates weighing several kilograms.

The Bank of Stockholm set up a system that off ered the service of safeguarding these metal plates, which were stored in the bank’s safety deposit vaults. A voucher was provided as proof of receipt and a commission was charged for the service. This was no diff erent from what the big banks in Amsterdam and were doing. The success of this idea, which eliminated the burden of needing to carry around heavy plates of copper, generated exponential growth in demand for the Bank of Stockholm’s vaults.

Over time, Palmstruch realized that these metals would stay in the vaults for long periods without being claimed. So he decided to them to businesses, noblemen and to the crown itself, who were all rather in need of funds. And so, the bank became a lending institution, using not its own resources, as was customary at the time, but unused customer deposits. The institution’s prosperity grew yet more thanks to the interest it earned, trade grew and the general welfare improved considerably in Stockholm... for six years.

When King Gustav died, the governing council decided to coin new coper ingots worth less than the old ones. So the citizens of Stockholm went to the bank to withdraw their old copper plates. However, since a large part of them had been used to provide , there were not enough dalers in the safety deposit vault for everyone.

Palmstruch’s solution was to decouple the issuance of vouchers, or banknotes, from the deposited copper. From this moment forward, the only guarantee for the vouchers issued by the Bank of Stockholm was the bank itself. And so it became the fi rst bank in Europe to put banknotes into circulation that were denominated in round numbers, that were not issued in the name of a particular person. These promised a cash payment for the amount marked on them to the bearer. They were called Kreditivsedlar, Europe’s fi rst Kreditivsedlar. was born, and with it, the seeds of the banknotes Monthly Strategy Report. November 2015 fi rst central bank in history were sown.

Local confi dence in the daler remained steady, since the Bank of Stockholm was able able to guarantee the stability of the new currency. Their banknote printing press was able to maintain the era of prosperity and economic growth. But an excess of liquidity caused a symptom as yet unknown to the Swedish economy, infl ation. When Palmstruch increased the supply of money in circulation above the level backed by metals, the price of everything went up.

Aft er a period of disquiet and infi ghting, a decision was made to cut credit and substantially reduce the amount of dalers in circulation. This only made the crisis worse, leaving the country to the brink of an economic depression. When people went to the bank to claim their payments in metal, the bank was not able to honour its commitments and went bankrupt. The crisis forced the government to close the Bank of Stockholm in 1667 and Palmstruch was sentenced to death. The bank eventually pardoned him and sent him to prison, where he remained for many years.

Aft er a few months, parliament decided that a national bank was needed. The Bank of Sweden, as it was called, was founded in 1668 and eventually became the sole issuer of banknotes. The bank later changed its name to Sveriges Riksbank (Swedish National Bank), considered to be the oldest of the central banks. Twenty-six months later, in 1694, the Bank of England was founded, the model on which most of the modern central banks are based.

The conclusions of the story I will leave to you, our dear readers. For the moment, let’s look at some of the talking points raised by the the tale. The fi rst is, if the recovery stimulated by printing money in excess compensates for the damage that can be caused by hyperinfl ation and fi nancial bubbles. Or perhaps money can be printed without creating infl ation. Or—in more pedestrian voice—in light of what happened to Palmstruch, should our current central bankers consider hiring a lawyer?