Tuesday, July 29, 2014

Foley versus Hill and the History of Fractional Reserve Banking

The British court case Foley versus Hill is another case relevant to the history of fractional reserve banking.

Here is the relevant record:
“FOLEY V. HILL and Others.

[#399]
1844: March 1, 14, 15.
In the case of a legal demand, a Court of Equity acts in obedience, and not merely by analogy, to the Statute of Limitations.
A banking firm, who, on opening an account with a customer, had agreed to allow him interest at 3 per cent on the balances which should from time to time be standing to his credit, set up the Statute of Limitations as a defence to a bill filed against them, by the customer, for an account. The account, as it stood in the bankers’ book, showed a considerable balance due to the Plaintiff, but there being no item in it, or evidence of any transaction connected with it, of a date within six years prior to the filing of the bill, nor any suggestion in the bill, that the bankers were bound, by the agreement or otherwise, to have actually entered the interest as it became due to the credit of the customer in the account, or that they had omitted so to do with a fraudulent intent, the defence was allowed to prevail.
An account between a banker and his customer, consisting of three items only and interest, held not to be a proper subject for a bill in equity.

The Defendants in the year 1829 carried on the business of bankers at Stourbridge, under the firm of Hill & Co. In the year 1834, the Defendant, Hill, retired from the business, which was thenceforth carried on by the other two Defendants under the firm of Bate and Robins.

The bill, which was filed on the 27th of January 1838, stated that, in the month of April 1829, the Plaintiff opened an account with Messrs. Hill and Co., and on the same day paid the sum of 6117l. 10s. into the bank, for which they sent him a receipt inclosed in a letter, in which they agreed to allow him interest at 3 per cent, per annum upon the balances from time to time in their hands. That at the time when that account was opened the Plaintiff and one Sir Edward Scott, who was his partner in working some collieries, kept a joint account at the same bank, which account was distinct from the Plaintiff’s private account, and related exclusively to the transactions of the colliery; and that between the month of April 1829 and the month of August 1834, when the joint account was closed, the agent of the collieries drew cheques half yearly against the joint account in favour of the Plaintiff in respect of his share of the profits of the colliery; and that the amounts of such cheques were on those occasions, carried to the credit of the Plaintiff’s private account. The bill further stated that during the same period Messrs. Hill and Co. paid various sums on account of the Plaintiff, which were placed to the debit of his private account; and that they had, in pursuance of their agreement, from time to time entered in their books, to the credit of the plaintiff on his private account interest, at 3 per cent upon the balance from time to time due to him. The bill then charged that the private account was still open and unsettled, and that it consisted of numerous items on each side, and could not be fairly adjusted except under the decree of a court of equity; and, after suggesting that the Defendants intended to rely on the Statute of Limitations, it contained various charges to the effect that the Defendants had, by correspondence between themselves and otherwise, recognized the private account as an open account, and the balance due thereon to the Plaintiff as a subsisting debt; but it contained no express charge that it was the duty of the bankers under the agreement to have regularly entered interest to the credit of the private account, or that if they had omitted to do so it was with a fraudulent intent.

The Defendants by their answer admitted the agreement to allow 3 per cent, on the balances from time to time in their hands on the Plaintiff’s private account; but they stated (and so it appeared from their books) that the only items of which that account consisted were the original deposit of 6117l. 10s. on the credit side, and two sums of 1700l. and 2000l. on the debit side, both being payments made in the year 1830; and that, though previously to and down to the 35th of December 1831, interest at 3 per cent on the balances from time to time due to the Plaintiff had been calculated and placed in the interest column of his private account in their books; the amount of Such interest had never been actually entered to the credit of such account, and that since the 25th of December 1831 no interest had ever been even calculated.

With respect to the cheques drawn upon the joint account, and the amount of which were alleged by the bill to have been placed to the Plaintiff’s credit in his private account, the Defendants, in a passage of their answer, which was read by the Plaintiff as evidence, stated that those cheques had always been paid to the agent who presented them, either in cash, or, when so required by him, by bills Upon the London correspondents of the bank, payable to the Plaintiff or to his London banker’s and that the amounts of such cheques were placed to the debit of the joint account; but that none of them had ever been entered in the private account, such transactions being, as the Defendants insisted, distinct, and independent transactions having no connection with the private account.

The Defendants admitted that the private account had never been balanced or settled with the Plaintiff; but they submitted whether, under the circumstances above stated, such account still remained open and unsettled, and they claimed the benefit of the stat 21 Jac. 1. c. 16., insisting that they had never, within six years before the filing of the bill, promised to pay the Plaintiff balance of such account, or to come to any account with him in respect thereof.

The only evidence adduced on the part of the Plaintiff of an express acknowledgment by the Defendants of the subsistence of the private account within the six years, consisted of two letters, written by one of the Defendants to another, but which the Lord Chancellor, as will be seen from his judgment, did not consider to amount to such acknowledgment.

On the hearing of the cause before the Vice-Chancellor of England, his Honor made the usual decree for an account, from which decree the Defendants appealed.

The appeal now coming on to be heard,

Mr. Stuart and Mr. G. Russell, for the Plaintiff, argued that the relation between a banker and his customer was not simply that of a debtor and creditor, but a confidential relation, which imposed on the former an obligation to keep the account according to the agreement made between the parties when the account was opened; and that the Defendants being in this case under an express engagement to allow interest at 3 per cent, on the balances from time to time in their hands, it was their duty to have entered such interest regularly to the credit of the Plaintiff’s account, which would have ousted the plea of the statute; and that to allow them, under such circumstances, to avail themselves of the statutes, would be to enable them to take advantage of their own wrong. That, they said, was the ground on which the Vice-Chancellor had expressly rested his decision; and they relied on the doctrine laid down by Sir Anthony Hart in Sterndale v. Hankinson, (a) ‘that pleas of the statute were allowed in Courts of Equity by analogy only, and to prevent stale demands; and that where the circumstances of a case were such as to make it against conscience to apply the rule founded on that analogy, the Court would not enforce it.’

Independently, however, of this point, they contended that the bill transactions which had arisen out of some of the cheques drawn in favour of the Plaintiff against the joint account, and several of which were admitted to have taken place within the six years, were private dealings between the Plaintiff and the bank, and ought to have been entered as such in his private account.

Mr. Bethell and Mr. K. Parker, for the Defendants, as to the relation between a banker and his customer, cited Devalues v. Noble ;(a) and, as to pleas of the statute in Courts of Equity, Hovenden v. Lord Annesley ;(b) and they insisted that, after leaving out of the case the transactions connected with the joint account, which they contended were wholly independent of the private account, the latter was no longer a proper subject for a suit in equity; as all that was required was a computation of what was due for principal and interest on the sum of 6117l. 10s., after deducting the two sums of 1700l. and 2000l, Dinwiddic v. Bailey ;(c) King v. Rossett.(d)

Mr. Stuart, in reply.

THE LORD CHANCELLOR.—The Defendants in this case car¬ried on the business of bankers at Stourbridge, under the firm of Hill and Co. The Plaintiff Foley deposited with them, in the year 1829, the sum of 6117l. 10s., and received from them the usual receipt; and in a note inclosing the receipt, they engaged to allow him 3 per cent, interest on the balances, which should from time exist in his favour on the account. Foley subsequently drew two cheques, at different times, for 1700l. and 2000l. upon this account. The latter of these cheques was drawn in July 1830. The Defendants en¬tered these payments, according to the usual custom, in a ledger, and also calculated interest on the balances up to December 1831. From that time there has been no payment in respect of the account; no entry in the books, no acknowledgment of debt. The Defendants, under these circumstances, set up the Statute of Limitations. And the question is, whether that is a valid de¬fence to the suit.

It is quite clear, that a banker is not to be considered a trustee for his customer in the legal sense of the term. Money advanced by a customer to a banker is a loan, and constitutes a debt. If it were necessary to refer to authorities in support of this propo¬sition, I might refer to Sims v. Bond,(a)in the Queen’s Bench, where it was laid down, that sums paid to the credit of a custo¬mer with his banker, though usually called deposits, are in truth loans to the banker. And that is in accordance with the doctrine of Sir Grant in Devaynes v. Noble. He says, ‘There is a fallacy in likening the dealings of a banker to the case of a deposit, to which, in legal effect, they have no sort of resemblance: money paid into a banker’s, becomes immediately a part of his general assets; and he is merely a debtor for the amount.’ And he lays down the same doctrine in Carr v. Carr.(b) Here, there was a loan by Foley to the defendants, to be repaid with interest at 3 per cent.: that was the simple transaction between them, and if this were a case at law, a plea of the Statute would be a sufficient answer, unless there were some special circumstances to take the case out of the Statute; and the only question therefore is, whe¬ther that defence is to have the same effect in a court of equity.

Now, the doctrine on that point is clearly and satisfactorily stated by Lord Redesdale in the case referred to at the bar, of Hovenden v. Lord Annesley.{c) He says, ‘it is a mistake in point of language to say, that Courts of Equity act merely by analogy to the statute; they act in obedience to it—that is, as as [sic] he afterwards explains himself, ‘upon all legal titles and le¬gal demands’—(and this, it will be observed, is a legal demand.) ‘I think,’ he adds, ‘the statute must be taken virtually to in¬clude courts of equity: for when the legislature, by statute, limi¬ted the proceedings at law, in certain cases, and provided no ex¬press limitations for proceedings in equity, it must be taken to have contemplated that equity followed the law; and, therefore, it must be taken to have virtually enacted in the same cases a limitation for courts of equity also.’ If, therefore, the Statute would in this case be a good defence at law, (I am now on the general question without reference to any specialty,) it constitutes a sufficient answer here: and the only remaining question is, whether there are any special circumstances to take the present case out of the statute.

[His Lordship then adverted to the letters above referred to, and to the transactions connected with the joint or colliery account; and, after stating his opinion, that neither the one nor the other amounted to an acknowledgment that the debt was due or the account open, he proceeded as follows:—]

It is further said, however, that it was the duty of the Defendants, as bankers, or by reason of the mode in which they usually conducted their business, to have entered the interest half-yearly in their books, on the balance remaining due: that if such entries had been regularly made, the case would have been taken out of the statute; and that having neglected to do this, they ought not to be allowed to profit from their neglect by setting up the Statute of Limitations as a defence founded on their own omission. But no such question is raised by the bill, no such equity is insisted upon or suggested. The bill is confined entirely to the statement of subsequent transactions for the purpose of taking the case out of the statute.

But, assuming it to have been the duty of the bankers to keep the account between them and the Plaintiff, and that the neglect of this duty had been made matter of complaint in the bill, what is there to shew that it was their duty to keep the account in any particular form? In the account produced, the interest is calculated upon the balance of the principal money due after the last payment, and for a year from that time. The balance remaining afterwards unchanged, the subsequent interest would be a matter of easy calculation whenever it might be necessary to make it for any purpose.

If it is meant to be said, that the Defendants ceased to enter the interest for a fraudulent purpose, that should have been made matter of charge in the Plaintiff’s bill; but there is no such suggestion, the only facts relied upon to meet the defence on the statute being, as I have already stated, the subsequent transactions between the parties.

I think, therefore, the Statute of Limitations is a sufficient defence, as the record is at present constituted.

But there is another point which is of great importance to the practice of the Court. This bill is filed for an account: that is the sole object of it. Now the account consists of three items only; one on one side and two on the other. I am of opinion that such an account as that is not a proper subject for a bill in this Court: it is a case for an action for money had and received. A party has no right to come here upon a simple transaction of this kind, when justice may be administered in a more simple way and at less expense in a court of law. When this objection was made before the Vice-Chancellor, he stated that two actions would have been necessary in a court of law, because one partner had left the firm; but that was a misapprehension: for it appears that Hill was a partner up to the date of the last transaction; and if that fact had been present to the mind of the Vice-Chancellor, he would, probably, on principle, have come to the same conclusion upon the last point that I have.

The bill, therefore ought to be dismissed, and, on the last ground, with costs.
(Phillips 1848: 398–407).
As we can see, the primary issue in this case appears to have been the relevance of the “statute of limitations” to the defence of the defendants in the case.

With respect to the nature of the banking contract between client and banker, the important passage is here:
“It is quite clear, that a banker is not to be considered a trustee for his customer in the legal sense of the term. Money advanced by a customer to a banker is a loan, and constitutes a debt. If it were necessary to refer to authorities in support of this propo¬sition, I might refer to Sims v. Bond,(a)in the Queen’s Bench, where it was laid down, that sums paid to the credit of a custo¬mer with his banker, though usually called deposits, are in truth loans to the banker. And that is in accordance with the doctrine of Sir Grant in Devaynes v. Noble. He says, ‘There is a fallacy in likening the dealings of a banker to the case of a deposit, to which, in legal effect, they have no sort of resemblance: money paid into a banker’s, becomes immediately a part of his general assets; and he is merely a debtor for the amount.’ And he lays down the same doctrine in Carr v. Carr.(b)
This merely confirms what had been accepted in the Carr versus Carr case, and even in that case there is no evidence that the judge in the case did anything but recognise what had been accepted legal and business practice.

BIBLIOGRAPHY
Phillips, Thomas Jodrell. 1848. Reports of Cases Argued and Determined in the High Court of Chancery during the Time of Lord Chancellor Lyndhurst: With a Few during the Time of Lord Chancellor Cottenham. Vol. I. 1841–1847. Banks, Gould and Co. New York.

Monday, July 28, 2014

John Quiggin on Apriorism in Austrian Economics

John Quiggin has an excellent post here on the apriorist method in Austrian economics:
John Quiggin, “Austrian Economics and Flat Earth Geography,” John Quiggin, July 28th, 2014.

Also posted here:
John Quiggin, “Austrian Economics and Flat Earth Geography,” Out of the Crooked Timber, July 27, 2014.
One minor point here is that John Quiggin says that apriorist praxeology was “also endorsed, in a more qualified fashion, by Hayek.”

Actually, Hayek rejected Mises’ apriorism and adopted a – more or less – Popperian method for economics.

We know this because Hayek said so explicitly in a letter to Terence W. Hutchison dated 15 May, 1983. In this, Hayek stated:
“I had never accepted Mises’ a priorism. .... Certainly 1936 was the time when I first saw my distinctive approach in full clarity – but at the time I felt it that I was merely at last able to say clearly what I had always believed – and to explain gently to Mises why I could not ACCEPT HIS A PRIORISM”. (quoted in Caldwell 2009: 323–324).
In fact, in 1937 Hayek had published an article called “Economics and Knowledge” where he criticised Mises’ apriorism; Hayek also appears to have moved closer to Popperian ideas on methodology in later years:
“I became one of the early readers [sc. of Karl Popper’s Logik der Forschung, 1934]. It had just come out a few weeks before …. And to me it was so satisfactory because it confirmed this certain view I had already formed due to an experience very similar to Karl Popper’s. Karl Popper is four or five years my junior; so we did not belong to the same academic generation. But our environment in which we formed our ideas was very much the same. It was very largely dominated by discussion, on the one hand, with Marxists and, on the other hand, with Freudians. Both these groups had one very irritating attribute: they insisted that their theories were, in principle, irrefutable. Their system was so built up that there was no possibility – I remember particularly one occasion when I suddenly began to see how ridiculous it all was when I was arguing with Freudians, and they explained, ‘Oh, well, this is due to the death instinct.’ And I said, ‘But this can’t be due to the [death instinct].’ ‘Oh, then this is due to the life instinct.’ … Well, if you have these two alternatives, of course there’s no way of checking whether the theory is true or not. And that led me, already, to the understanding of what became Popper’s main systematic point: that the test of empirical science was that it could be refuted, and that any system which claimed that it was irrefutable was by definition not scientific. I was not a trained philosopher; I didn’t elaborate this. It was sufficient for me to have recognized this, but when I found this thing explicitly argued and justified in Popper, I just accepted the Popperian philosophy for spelling out what I had always felt. Ever since, I have been moving with Popper.” (Nobel Prize-Winning Economist: Friedrich A. von Hayek, pp. 18–19).
So Hayek lumped in apriorism in economics with Marxism and Freudianism!

It is also clear that Mises disliked Popper and Popper’s approach to epistemology in his seminal book Logik der Forschung (1934; later published in English as The Logic of Scientific Discovery, 1959):
“Popper was familiar with the early [sc. socialist] calculation debate – Polanyi’s seminar discussed it – but not much taken by it. He knew of Mises and his circle, but it is unlikely that he read Mises closely. He strongly disliked subjectivism and libertarianism. He ‘first met Mises early in 1935 in Vienna, owing to his interest in my first book. . . . Both he and I were aware of a strong opposition between our views in the field of the theory of knowledge and methodology. Mises saw me as a dangerous opponent.’” (Hacohen 2000: 478).
So it could not be more clear: Mises saw Popper “as a dangerous opponent”; but Hayek, rejecting apriorism, essentially endorsed Popper’s views on epistemology and method.

Nevertheless, Quiggin’s point that Misesian apriorist praxeology as a method for economics is untenable is right.

Mises needed synthetic a priori knowledge and a type of Kantian epistemology to justify his praxeology, but the arguments for synthetic a priori knowledge are unconvincing and must be rejected. Misesian praxeology does not yield universally and necessarily true empirical statements about economic reality.

Furthermore, not even the human action axiom can be known a priori: it is clearly a synthetic a posteriori proposition.

In addition, the very idea that Mises in Human Action succeeded in deducing all his theories by deductive logic is manifestly untrue, and Misesians and Rothbardians have never answered the challenge of George J. Schuller to set out Human Action in a formal symbolic form in which all axioms, premises, and deductions are shown formally and proven.

Even modern Kantians have rejected Mises’ attempt to ground his praxeology on Kant’s epistemology.

There has also arisen amongst modern Austrians a feeble and ignorant belief that Mises was not really using a synthetic a priori epistemology. This is simply untrue, as I have shown here and here, and even if it were true and praxeology were simply analytic a priori, then it would follow logically that praxeology cannot give necessary truth about the real world.

Further Reading
“Limits of the Human Action Axiom,” February 28, 2011.

“Hayek on Mises’ Apriorism,” May 23, 2011.

“What is the Epistemological Status of Praxeology and the Action Axiom?,” July 27, 2013.

“Barrotta’s Kantian Critique of Mises’s Epistemology,” July 28, 2013.

“David Friedman versus Robert Murphy,” August 4, 2013.

“Mises Fails Philosophy of Mathematics 101,” August 30, 2013.

“Bob Murphy All At Sea on Geometry and Economic Epistemology,” August 31, 2013.

“Mises’s Non Sequitur on synthetic a priori Knowledge,” September 2, 2013.

“Hoppe’s Caricature of Empiricism,” September 10, 2013.

“Hoppe on Euclidean Geometry,” September 11, 2013.

“Robert Murphy gets Mises’s Epistemology Wrong,” September 13, 2013.

“Hoppe on Euclidean Geometry, Part 2,” September 14, 2013.

“Mises on Kant and Praxeology,” September 15, 2013.

“Mises was Confused about the Analytic–Synthetic Distinction,” September 15, 2013.

“Schuller’s Challenge to Misesian Apriorists has never been answered,” December 7, 2013.

“Mises versus Ayer on Analytic Propositions and a priori Reasoning,” March 16, 2014.

“David Gordon on Praxeology and the Austrian Method: A Critique,” March 13, 2014.

“Why Mises’s Praxeological Theories are not Necessarily True of the Real World,” March 15, 2014.

“Mises and Empiricism,” April 17, 2014.

“Why Should we reject the Existence of Synthetic a priori Knowledge?,” May 23, 2014.

BIBLIOGRAPHY
Caldwell, B. 2009. “A Skirmish in the Popper Wars: Hutchison versus Caldwell on Hayek, Popper, Mises, and methodology,” Journal of Economic Methodology 16.3: 315–324.

Hacohen, Malachi Haim. 2000. Karl Popper, The Formative Years, 1902–1945: Politics and Philosophy in Interwar Vienna. Cambridge University Press, Cambridge, UK and New York.

Hayek, F. A. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.
https://archive.org/details/nobelprizewinnin00haye