Free or central banking? Liquidity and financial deepening in Sweden, 1834–1913

Explorations in

Explorations in Economic History 43 (2006) 64–93

www.elsevier.com/locate/eeh

Economic History

Free or central banking? Liquidity andfinancial deepening in Sweden, 1834–1913

Anders Ogren *

Stockholm School of Economics and Stern School of Business, New York University, New York, NY 10012, USA

Received 13 May 2005

Abstract

During Sweden’s nineteenth-century modernization, Enskilda banks contributed to economicexpansion and integration by providing generally accepted means of payment beyond what wouldhave been possible for the central bank, the Riksbank. The Riksbank was constrained by specie-con-vertibility requirements for Sweden’s currency. Contrary to previous arguments, however, the Ens-kilda banks did not operate according to free banking theory. The Enskilda banks held Riksbanknotes instead of specie as base-money reserves. This arrangement led to a higher supply of formalliquidity than what would have been the case with either a free banking system or a pure deposit-based commercial banking system. The consequence for Sweden was a rapid rate of monetizationand financial deepening.� 2005 Elsevier Inc. All rights reserved.

JEL: E42; E51; N13; N23

Keywords: Central banking; Classical silver and gold standards; Fractional reserves; Free banking; Liquidity;Money supply

1. Introduction

In 1834, Sweden re-established the silver standard it had abandoned in 1809. Thisaction marked the beginning of a fixed exchange rate regime that lasted for more than

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* Fax: +1 212 995 4218.E-mail addresses: [email protected], [email protected].

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A. Ogren / Explorations in Economic History 43 (2006) 64–93 65

eighty years, until the outbreak of World War I. During this entire period, the mainte-nance of the specie standard was the principal duty of the central bank, the Riksbank.Sweden’s specie standard was important for growth and guaranteed international integra-tion, but it impeded the provision of credit and acceptable means of payment in large sec-tions of the country.1 The nineteenth century witnessed great changes in the Swedisheconomy. Local, national and international markets became integrated during this epoch.These changes affected not only the money market, but also the very nature of the moneyin circulation.2

The initial extent of Swedish poverty during this period is well illustrated by the verylimited and stagnant circulation of metallic coins, as well as a supply of specie metal insuf-ficient to provide the country with an adequate supply of generally accepted means of pay-ments. Instead, the Swedish economy relied heavily on personal credits, IOUs and othertypes of informal means of payments, accepted only on a personal or regional basis, thushindering more widespread economic integration. In fact, financial development as suchseems to have been as much in terms of quality of newer financial instruments as of theirquantity. Sweden like many other economies in the nineteenth century had a large infor-mal financial sector. The overall increase in size of financial services was not as impressiveas it might seem once older, informal credit arrangements are taken into account.3 Duringthe era of rapid economic expansion Sweden was able to preserve a specie standard whilesimultaneously replacing the informal means of payments originally in circulation withmeans of payments accepted throughout the country.4

The dominant commercial banking system of the nineteenth century, the Enskildabanks, was based on unlimited liability and the right to issue notes. The right of the Ens-kilda banks to issue credit notes was established by Parliament in 1824. Because of theshortage of formal money (legal tender and specie), the right to issue notes was considerednecessary for increasing the extent of banking.5 Because of their note issue rights, the Ens-kilda banks made a major contribution in supplying Sweden with a means of payment thatbecame accepted everywhere in the country. Notes issued by the Enskilda banks replacedthe less formal means of payments that had circulated previously. The reason for the suc-cess of the Enskilda bank notes was that they were backed by reserves of Riksbank notes,by the banks’ equity capital, and—because of unlimited liability—by the personal assets ofbank owners.

1 According to Eichengreen and Flandreau (1994), adherence of a country to a convertible specie standard hashistorically been of fundamental importance for economic growth. Despite being one of the poorest Europeancountries operating under a convertible standard, Sweden in 1873 followed Germany in converting from silver togold (Eichengreen and Flandreau, 1994).2 For a discussion of the effects of ongoing economic and financial integration on the role, as well as the form,

of money, see Goodhart (2003).3 Lindgren (2002). Similar research has reached the same conclusions for Canada, France and the US, see

Hoffman and Rosenthal (2000) and Di Matteo (1997).4 The pioneer in researching the importance of the financial system for growth in the Swedish economy was

Lars G. Sandberg. Sandberg’s work was criticized by Kindleberger who based on Sweden’s most famouseconomic historian, Heckscher, argued that Sweden had no banking system worth mentioning before 1900 (seeKindleberger (1982) and Sandberg (1978, 1979, 1982)).5 KFO (1824), RdSkr, 1823, No. 346, see Ogren (2003a, Chapter 2) for an in-depth analysis of the political

struggle in the establishment of the Enskilda bank system. The right of these banks to issue notes consequentlywas not the result of a coincidence or a misunderstanding when establishing the charter of the first bank, aspreviously has been argued (Brisman, 1924; Jonung, 1989; Nilsson, 1981).

66 A. Ogren / Explorations in Economic History 43 (2006) 64–93

I argue here that labeling the Enskilda banks as a free banking system, as some scholarshave done, is not accurate. Rather, such a labeling appears to be based on the assumptionthat since the Enskilda banks issued notes, free banking theory can account for the work-ing of the system. Analysis of the Enskilda banks’ contribution to the Swedish monetiza-tion, in contrast, indicates that the Enskilda bank system did not work in accordance withfree banking theory, but instead functioned as a central-bank-based system.6

The description of the Enskilda banking system as a system of free banking is based onthree interlinked assumptions: (1) That the Enskilda banks and the Riksbank competitive-ly issued notes, (2) that the Riksbank merely functioned as a commercial bank amongother banks, and consequently that Riksbank notes did not serve as base money, and(3) that no lender of last resort existed or was required.7 I argue that assumptions (2)and (3) cannot be empirically supported, and that assumption (1) depends on a vague def-inition of notes that fails to distinguish between inside and outside money.

Riksbank notes and Enskilda bank notes were two completely different kinds of notes.While the Riksbank issued base money, which was used as reserves by the banking system,Enskilda banks issued the equivalent of highly liquid demand deposits. The Swedish bank-ing system in all important respects thus functioned as a commercial banking systemworking in symbiosis with a rudimentary form of central bank that managed the currencyand issued base money. Enskilda banks’ note issuance was backed by, and redeemed for,base money issued by the Riksbank. This was a form of ‘‘bottom-up’’ central bankingbecause the Enskilda banks voluntarily relied on Riksbank notes rather than specie forreserves. Swedish law never prevented Enskilda banks from choosing to hold reserves ofspecie instead of Riksbank notes, and thus to challenge the position of Riksbank notesas base money. But contrary to the free banking argument, Enskilda banks did not holdspecie as reserves until they were forced to by law. And then only to the degree the lawrequired, while they continued to rely on Riksbank notes as reserves.

To argue that a free banking system may rest on base money issued by a monetaryauthority is inconsistent with free banking theory. It also denies any fundamental differ-ence between a central-bank-based and a free banking system. The argument that the goldstandard in itself made the Riksbank without importance, and thus that the choice of theEnskilda banks to hold Riksbank notes instead of gold in reality made no difference, isboth naıve and inconsistent with free banking theory. It is naıve because, as historicalexperience repeatedly makes clear, no exchange rate regime maintains itself automatically.Different currencies were regarded with different degrees of trust among countries operat-ing under the gold standard.8 Thus, to rely on the notes issued by the Riksbank as reserveswas far from the same as to rely on reserves consisting of gold.

The Riksbank, like any central bank working under a fractional reserve system, con-stantly had to face the trade-off between supplying the economy with base money and tak-ing actions to maintain the note-to-specie ratio that was deemed necessary to preserve the

6 Ogren (2003b,c). It is worth pointing out that empirically testing to what extent different monetary andbanking systems have been cases of free banking is not the same as discrediting free banking theory itself or thepredictions regarding monetary and banking stability made in accordance with this theory.7 Jonung (1989), Schuler (1992, pp. 31–32, 40), and Selgin (1988, p. 7).8 Bordo and Meissner (2005), Flandreau and Sussman (2005) and Ogren (2005). Sweden was for instance not

allowed to borrow in its own currency on international capital markets. Portugal, which in 1854 was the firstcountry after the UK to enter the gold standard, abandoned it in 1890.


specie standard. It is probable that this trade-off was even more important because Swedenwas a relatively small economy.9 But, the fractional reserve system also gave some roomfor flexibility under the specie standard. As shown in the extensive research on monetarypolicy under the gold standard, few, if any, central banks followed the rules of the game.Thus even under the gold standard there was room for the central bank to run indepen-dent monetary policy within the boundaries of the rules set by this monetary regime. Asseen in Section 3 below, the Riksbank also had some flexibility under the speciestandard.10

The Swedish system, combining the Riksbank, an issuer of base money with the ulti-mate responsibility for preserving international specie convertibility, with the private Ens-kilda banks as domestic note issuers allowed a greater expansion of trustworthy means ofpayments than otherwise would have been the case. The choice of the Enskilda banks—supported by the public—to rely on Riksbank notes for their reserves led to a greaterexpansion of formal liquidity than would have been possible with either a pure deposit-based banking system or a pure free banking system based entirely on specie reserves.

There are three main points in this paper: (1) The voluntary division of labor betweenthe rudimentary central bank, the Riksbank, and the private note-issuing Enskilda banksmade the Swedish banking system similar to other central-bank-based systems at the time.Hence, Swedish banking did not function in accordance with free banking theory. (2)More liquidity was provided by this system than would have been possible under eithera free banking system or a central bank system with a note-issuing monopoly. Thus,the system chosen was a better way of providing liquidity for the growing Swedish econ-omy than either of the two alternatives. (3) Although the Enskilda banks have beenaccused of delaying the emergence of deposit-based banking, the need for clearing createdthe necessary instruments, namely postal bank bills, to make deposits a liquid part of thepayment system all over the country. Thus, financial deepening represented by a boom inSweden’s broad money supply in the middle of the 1860s came in conjunction with increas-ing Enskilda bank establishments at that time.

The data analyzed in the paper are derived from the Enskilda banks’ balance sheets.These have been collected on annual basis between 1834 and 1877, and on monthly basisbetween 1878 and 1900. The balance sheets are unique in that they include vital informa-tion concerning the precise composition of reserves, as well as the extent to which thebanks utilized their legal ability to issue notes.11

9 That upholding the specie standard was by no means automatic is well documented; see for instance Brisman(1931), Jonung (1984), Lobell (2000) and Ogren (1995, 2003d, 2005).10 Regarding the tendency to violate the rules of the game see for instance Bloomfield (1978) and Bordo (1984).For the case of Sweden, see Jonung (1984) and Ogren (2003d). Recently also Bordo and MacDonald (2005) hasshown that there was room for independent monetary policy (i.e. to violate the rules of the game) under the goldstandard. Sweden was one of the countries included in this research.11 The accuracy and reliability of the figures reported by the Enskilda banks might be questioned, but whendifferences were detected compared to other sources, the balance sheets reported less favorable (lower) ratios ofreserves to notes issued. See BaU, 1853/54, Brisman (1924, pp. 246–247), Finanskommitten (1858) and SverigesRiksbank (1931, pp. 172–185). Brisman listed the Enskilda banks’ holdings of legal tender for the years 1834–1856, but he did not provide the source (although it probably was the Financial Committee of 1858). Jonungrelied on Brisman’s data for the years it was available. For the years 1857–1870, Jonung assumed that Enskildabank holdings of Riksbank notes remained constant at ten million SEK (Jonung, 1989).


2. Free banking theory under a specie standard

In the free banking literature several historical cases are pointed out as examples of suc-cessful episodes of free banking, among them the case of nineteenth century Sweden. Towhat extent these are actual cases of free banking, however, is much debated. As each his-torical episode referred to as free banking was free and/or regulated in different ways, theterm free banking implies one thing in the case of United States, another in Scotland, andyet another in Sweden.12 Even the most recognized case, Scotland, is subject to differentinterpretations.13

White (1984) formalized amodel for the free banking systembased on specie. Themodel isof a system operating under a specie standard and with fractional reserves. It is thus quitesimilar to the Swedish institutional setting, and it is the version of free banking that is referredto in this paper.White’s theoretical framework, which others developed further,14 should beapplicable to historical cases of free banking since they usually operated under a commoditystandard. The model shows how a free banking system achieves monetary and bankingstability.

A free banking system is based on the principle that banking should not be subjected toany legislation distinct from that which applies to any type of business. Thus there is noneed for restrictions on note issue, barriers to entry, or legislation regulating reserves. NoState-sponsored monetary authority should be endowed with the right to issue base moneyto be used as reserves by the banking system.15

In a free banking system, banks lack an incentive to hold other banks’ notes as reserves.Hence, an inter-bank clearing mechanism will emerge. The law of adverse clearing impliesthat a bank holding other banks’ notes provides a competitive advantage to the other issu-ing banks. Thus exchanging other banks’ notes for reserves (gold or silver) is in everybank’s interest since it increases the possibility to issue its own notes.

Such a system is fully self-adjusting, with the supply of notes matching the demand.Any bank that over-issues notes will experience adverse clearings and lose reserves becauseof the public’s reluctance to hold its notes. The bank’s reputation will suffer and the publicwill choose higher quality notes, those of banks with a higher reserve ratio. Thus, even inthe absence of formal regulations, a consensus concerning a sound reserve-to-notes ratiowill emerge over time.16

12 The Minister of finance C.D. Skogman, wrote that the reason the Scottish system was not adopted in Swedenwas the difficulty of transforming Swedes into Scots (Skogman, 1846:2, pp. 53–54). See also Agardh (1865, pp.295–322), Nilsson (1981, pp. 30–34) and Nordstrom (1853, pp. 193–205).13 Hickson and Turner (2004) shows that many early joint-stock banks did not adopt free banking. IgnacioBriones and Rockoff (2005) summarize general empirical findings on what has been labeled free banking inhistory. Checkland (1975) in his history of Scottish banking indicated that the note issuance of the Scottish banksultimately rested on the reserves of Bank of England. Notes issued by the privileged chartered Scottish banks maywell have been used as reserves in the Scottish banking system as well. Sechrest (1993), also points out that thefreedom of the Scottish banking system has been overvalued. Two banks were granted privileged charters throughthe political process, putting them in a favorable position relative to other commercial banks. Usury laws andrestrictions on note denominations also limited the possibilities of free banking.14 See Dowd (1993), Sechrest (1993), Selgin (1988, 2001), Selgin andWhite (1994) andWhite (1989) to name a few.15 Selgin and White (1994, pp. 1718–1719).16 Sechrest (1993, p. 14), Selgin and White (1994, p. 1720), White (1985, pp. 119–121) and White (1989, pp. 21–22, 27–28, 23–36). Theoretically, the bank has a contractual obligation to the bearer of the bank note to exchangeit on demand.


Specie has the role of base money in the theory of free banking under a specie standard,i.e., it is the only acceptable form of outside money. Private bank notes will not be used asbase money, and hence, in the free banking model, bank deposits and bank notes are bankliabilities with nearly the same properties. Both notes and deposits are inside money cre-ated by the banking system in accordance with the money multiplier.17 Thus, in the freebanking system and the central bank system alike, the broad money supply (inside plusoutside money) is a function of: (1) the supply of base money (outside money), (2) publicpreferences for holding base money as liquidity, (3) the demand for base money held bythe banking system as reserves.18

The lack of an authority with the power to issue base money is of utmost importance.The existence of such a monetary authority may disrupt the working of the adjustmentmechanism and thus threaten the value of the currency. As argued by Smith (1990), itis precisely the lack of discretionary power of the monetary authority that makes the freebanking alternative better suited to preserving a stable value of money.19 White (1985)argued for the same reason that the international adjustment mechanism under a speciestandard is not fully operational without a pure free banking system.20 In short, a mone-tary authority with the power to issue base money out of reach of competition can distortthe effects of international capital flows and thus affect the value of the currency. Allowingthe commercial banking system to rely on base money issued by a central bank removeswhat is regarded as a fundamental difference between the central-bank-based systemand the free banking system.

2.1. The view of the Enskilda banks as a system of free banking

Jonung (1989) is an influential paper concerning the Enskilda banks and free banking.In it, Sweden’s note-issuing Enskilda banks were described as a successful historical exam-ple of free banking because the notes issued by the Enskilda banks were described as theprivate alternative to the notes issued by the Riksbank. Jonung argued that the notesissued by Enskilda banks displaced Riksbank notes from circulation because the publicpreferred the former. Notes issued by the Riksbank and the Enskilda banks were assumedto have the same properties and thus competed over the same market shares. Moreover,Jonung contended that the purported free banking system was stable because no Enskildabank ever experienced financial difficulties that required any State or Riksbank assistance.

17 White (1984, Chapter 1).18 In the free banking model the amount of base money is set solely by the production of specie plusinternational capital flows (i.e., specie flows). In the central-bank-based banking system the amount of basemoney is a combination of the amount of specie plus notes issued as base money by the domestic central bank.Commercial banks’ requirements for reserves may be set solely by the market, as in the free banking model, or bythe market with a legal minimum as in any regulated central-bank-based banking system.19 Smith (1990). It should be noted that this argument was pursued in relation to the difficulties of upholding theinternational gold standard during the interwar period, in itself a good illustration that the working of a speciestandard never is fully automatic. This is also why some free banking advocates argue for complete speciecoverage of all notes (Rothbard, 1985, pp. 13–14).20 White (1985, pp. 119–121). Thus, it is puzzling that it sometimes is argued that a free banking system still is afree banking system even when the note issuing banks are operating with central bank notes as reserves.Especially so as research has shown that central banks frequently violated the rules of the gold standard. Thepossibility to impede the adjustment mechanism was even greater as many central banks operated with fractionalreserves and/or held other assets as reserves than specie.


These conclusions appear to be based directly on free banking theory rather than historicalfacts. Nonetheless, among writers on banking history they have been accepted as repre-senting the Swedish experience of free banking.21

Schuler (1992) repeated the free banking arguments concerning Sweden. He did notconsider the possibility that notes issued by the Riksbank were ‘‘driven out of circulation’’because they were held as reserves by the commercial banking system. Instead, he contend-ed that Sweden was a free banking system without any form of rudimentary monetaryauthority issuing base money. Schuler distinguishes the way countries operating with cen-tral banks supposedly differed from Sweden and other countries claimed to be cases of freebanking:

21 Jonbarrier22 Sch23 Bri24 See1930s.conducof circof highthat thcontraissuing1924, 1

Most countries that had monopoly note-issuing banks allowed competition in bankdeposits, but fixed-rate convertibility between notes and deposits and the demand fornotes made by deposit customers, made the monopoly notes into a kind of reserve(high-powered money) for the deposit banks. The note-issuing banks thus becamerudimentary central banks, though not until later did they develop other character-istics that are now typical of central banks.22

The actual role of the Parliament-owned bank Riksbank thus is of vital importance forthe analysis whether the Enskilda banks in fact constituted a free banking system. TheRiksbank is not usually considered as a central bank in the modern sense until the enact-ment of the banking law of 1897, which gave the Riksbank a monopoly of note issuance.Before 1897, the Riksbank has been described as a State-sponsored commercial bank com-peting with the Enskilda banks.23 The free banking argument rests on the assumption thatthe Riksbank notes and the Enskilda bank notes shared the same properties and thus com-peted with one another for public acceptance.24

As seen in Fig. 1, there was a large gap between issued Riksbank notes and Riksbanknotes held by the public. The simple reason was that these Riksbank notes served asreserves in the commercial banks. In Section 4 it is shown that the commercial bankingsystem did not hold other Enskilda bank notes to nearly the same extent as Riksbanknotes. If the Enskilda banks had wanted to out-compete the Riksbank, the Enskilda bankswould of course redeem Riksbank notes for specie. In a free banking system, as notedabove, there are no incentives for one bank to hold notes issued by competing banks.Not redeeming other banks’ notes gives the other banks a competitive advantage.

ung (1989), Schuler (1992) and Selgin (1988). In fact the first part of the period was marked by formidables to entry, and the second by increasing taxes and other impediments on note issuance.uler (1992, p. 15).sman (1924, 1934).Jonung (1989). These interpretations may be sourced to the writings of Sven Brisman in the 1920s andBrisman viewed the note issuing of the Enskilda banks as competition aimed directly at the note issuanceted by the Riksbank. He claimed that Enskilda-bank competition successfully drove Riksbank notes outulation. That contention led others to conclude that the public preferred the Enskilda bank notes as beinger quality than Riksbank notes. But Brisman did not support the free banking interpretation. He arguede Swedish banking system in the nineteenth century was backward. This backwardness was proven bysting this system lacking a central bank with that of the interwar period containing a central bank with notemonopoly managing discount policy; by Brisman regarded as the peak of banking evolution (Brisman,931, 1934).

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Fig. 1. Enskilda bank and Riksbank notes in circulation, 1834–1900 (1000s of SEK). Sources: Post and InrikesTidning (1835–1871), Sammandrag af Bankernas Uppgifter (1871–1900) and Sveriges Riksbank (1931, pp. 45–49).


In fact the Swedish banking system in all important respects functioned as Schuler por-trayed a rudimentary central banking system. The Riksbank issued base money that washeld as reserves by the commercial banking system (both by the note issuing and non-noteissuing commercial banks). There was a fixed one-to-one rate convertibility between com-mercial bank deposits, Enskilda bank notes and Riksbank notes held as reserves.25

Clearly the Riksbank and the Enskilda banks issued two different forms of notes: theRiksbank issued base money and the Enskilda banks a form of ‘‘liquid deposits.’’ TheRiksbank notes served as commercial banking reserves, and thus also as backing for theEnskilda bank notes. Since the Riksbank’s obligation to preserve international specie con-vertibility limited its ability to supply credit and means of payment, this task was insteadundertaken by the Enskilda banks. The fact that the Riksbank issued base money madethe level of Riksbank reserves a matter of the utmost importance.

3. The operations of the Riksbank and the issuance of base money

According to the banking legislation of 1834, note issuance of the Riksbank was to bebased on a fractional reserve system. Reserves were supposed to cover 40% of issued notes,and only specie metals were valid as cover for note issue.

Regulatory changes introduced in 1845 permitted the Riksbank to include holdings suchas deposits in foreign banks and foreign treasury bills among its reserves, and to utilize themas backing for its note issue. The system of fractional reserves was altered to one of differen-tial reserves, the issue of Riksbank notes being limited to reserves plus 30 million SEK. In1879, maximum Riksbank note issue was increased to reserves plus 35 million SEK.26

25 Unlike in the US discounts between different bank’s notes were absent in the Swedish system, perhaps as aresult of less competition.26 The increase in the right to issue notes for the Riksbank was made at the same time as the Enskilda banks wereprohibited from issuing five SEK notes and the Riksbank notes of one SEK. The withdrawal of funds this meantfor the Enskilda banks was met by a special subsidized credit from the Riksbank (PrAK, 1879, Vol. IV, No. 50;PrFK, 1879, Vol. III, No. 35; RdSkr, 1879, No. 52).

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Fig. 2. Backing of Riksbank notes issued, 1834–1913 (in percentages). Source: Sveriges Riksbank (1931, pp.54–71).


Fig. 2 shows that throughout the period 1834–1913, even when a differential reserve sys-tem was used, specie reserves of the Riksbank covered approximately 40% of the Bank’snote issue. As early as 1845, the Riksbank began to intervene in the currency market bybuying and selling foreign bills of exchange. The principal motivation for these actionswas the shortage, and high import cost, of specie.27 Consequently it was the foreign com-ponent of the Riksbank’s reserves that fluctuated most, while its specie reserves remainedrelatively stable.

The reserves of the Riksbank deviated from the ‘‘ideal’’ specie standard model in threeregards: First, during the business cycle the Riksbank could vary its note issue within cer-tain legal parameters. That is, it could utilize its right to issue notes to a different extentduring periods when capital was flowing in or out. During most of the period between1834 and 1913, the Bank allowed the degree of backing for its notes to vary with the sizeof its reserves.28

Second, the Riksbank could alter the composition of its formal reserves and otherassets, as well as of its liabilities. Thus the Bank could hold assets that did not qualifyas backing for notes but which could be transformed into reserves through sale in thedomestic or the international capital market. In 1872, the Riksbank established a fundconsisting of assets that did not qualify as reserves but which were to be used to offset,and thus sterilize, outflows of reserves.29 In addition the bank utilized open market oper-ations to increase the demand for Swedish currency.30

27 BaU (1868, No. 2, pp. 2–3) and Lobell (2000).28 Correlations between percentile changes in the size of the reserves and the backing of notes were highlypositive and significant at the 1% level for both the silver and the gold standard period.29 Brisman (1931, pp. 116–119, 143–145) and Ogren (2003d). The Riksbank acted in this manner during theentire period, and it should be noted that besides ensuring convertibility the Riksbank was meant to providecredits in a stable manner. This was of course far from as important as maintaining international convertibility,but it shows that the working of the Riksbank under the classical specie standard did not admit to any ‘rules ofthe game.’30 See Lobell (2000).

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Fig. 3. The Riksbank’s contribution to the monetary base in percent of the total monetary base, 1834–1913.Source: Sveriges Riksbank (1931, pp. 54–71).


Third, starting in 1845, foreign assets as well as specie were considered to be part of theBank’s formal reserves. The fact that the Riksbank was the central bank of a small periph-eral country allowed its reserves to be more elastic than otherwise would have been pos-sible under the specie standard. Credit instruments beyond specie could be used asreserves. The Riksbank’s foreign assets that counted were foreign national governmentbonds, deposits with foreign banks, and, between 1858 and 1872, foreign bills of exchange.

In Fig. 3 the contribution of the Riksbank to the monetary base is calculated as issuedRiksbank notes plus its demand deposits minus its holdings of specie, foreign assets legallyadmitted as basis for its note issuance, and specie holdings in the banking system.31 Asseen in Fig. 3, the task of supplying liquidity was more and more undertaken by the Ens-kilda banks. This had the desirable effect that to maintain liquidity in the economy theRiksbank did not need to issue as many notes in relation to its reserves as otherwise wouldhave been the case. Still, the contribution to the monetary base made by the Riksbank wassignificant.

Taking an international perspective, the Riksbank maintained a lower coverage of itsnotes than did the principal European countries. Its coverage, however, was similar to thatof Finland, another peripheral country.32 The fact that the Riksbank backed the currencyto a lesser extent than the core European countries supports the impediment that specieconvertibility placed on its ability to provide enough formal means of payments so asnot to hinder economic activity.

A free banking system operating under a pure specie standard would have met the sameproblem. Such a system could be expected to be problematic for an expanding economy,causing it to suffer from a shortage of specie and, consequently, of notes. According to freebanking theory, the reserve ratio of the banks could change in response to public demand.That, however, would be contrary to the international requirements of the specie standard.

31 For an extended discussion on the Swedish monetary base and its components, see Ogren (2003d).32 Flandreau (2000), Pipping (1961, pp. 509, 512), Pipping (1969, p. 432) and Sveriges Riksbank (1931,pp. 45–49).


A conflict would thus arise between maintaining the reserve ratio in order to safeguardspecie convertibility and satisfying the domestic demand for money.33

4. The Enskilda banking system and the supply of liquidity

Three kinds of commercial banks existed in Sweden during the nineteenth century. Theso-called Filial banks existed between 1852 and 1863. The Filial bank was an attempt tocreate a commercial banking system based on Riksbank credit. When political support forFilial banks ended, they reformed as or merged with already existing Enskilda banks (seeFig. 4). In 1864, a new form of commercial bank with a new form of ownership was intro-duced, the limited-liability Joint-Stock bank. These new banks did not have the right toissue notes and thus operated exclusively with deposits and equity capital. As a result theylocated in areas with a good supply of capital; i.e., the main cities.34 Enskilda banking wasby far the largest and most extensive banking system throughout Sweden in the nineteenthcentury. Although its main feature was the right to issue notes, Enskilda bank depositsexceeded notes as early as 1867.

The Enskilda banks existed as note issuing banks in Sweden between 1831 and 1903.Given the detailed regulations and the limits on bank establishment and entry, the peri-od 1831–1863 cannot be considered as a period of free banking. If there was a period offree banking, it is likely that it started with the enactment of the banking law of 1864,which standardized bank regulations and meant liberal rights to establish banks underthese regulations. Instead note issuance became subject to increasing taxes.35 The resultof the more liberal possibilities to start banks in the middle of the 1860s is visible inFig. 4.

More consistent with free banking was the new banking act of 1874, marking Sweden’sswitch to the gold standard. The law of 1874 dissolved the special status of Riksbank notesby not allowing them to be used as legal backing for Enskilda bank notes, and that lawcame to embrace all Enskilda banks from 1878. In 1897, it was decided that the right ofEnskilda banks to issue notes was to be withdrawn from the year 1903, and that all Ens-kilda bank notes were to be taken out of circulation before the end of 1906. The decisionto end the Enskilda banks’ note issuance led to a sharp decrease in their notes in circula-tion after the end of 1900. Consequently, the most likely period of free banking in Swedenwas the period 1878 until 1900. During this period the Enskilda bank note issuance in alegal sense was carried out without connection to the note issuance conducted by theSwedish central bank, the Riksbank.36 Banking practice, however, was quite different fromwhat law prescribed. The Swedish system seems in many ways to be similar to that of the

33 Swedish 19th century economic debate fully recognized the difficulty of combining a fixed exchange rate with agrowing demand for money and credit. See for instance, Agardh (1865, p. 154) and Wennberg (1829, p. 7).34 See Ogren (2003a, Chapter 2) and Ogren (2003b). The jump in the number of Joint Stock banks in the 1890s isexplained by more oppressive legislation for savings banks that made many of them reform into so-called Folkbanks.35 Taxes on Enskilda bank note issuance was in 1861 imposed at 0.2 percent, increased to 0.3 percent in 1887, 0.5percent in 1892 and finally to 1 percent in 1893 (RdSkr, 1887, No. 49; 1892, No. 98; 1893, No. 45; SFS, 1861:34,§15).36 See Ogren (2005) and SFS (1874:44).

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Fig. 4. No. of commercial banks, 1834–1900. Sources: Brisman (1924), Sveriges Riksbank (1931).


United States in its early years when the two Banks of the United States issued convertiblebase-money used by US state banks as reserves.37

4.1. Enskilda bank reserves

According to the Law of 1846, as well as earlier Enskilda bank charters, the principalbasis for note issuance was the Enskilda bank’s equity capital. Equity capital was divid-ed into two parts. Between 60 and 75% consisted of bonds and shares. These were eitherdeposited in a municipal office or kept in the bank’s safe. The rest was held in legal-ten-der cash. A bank’s note issue had to be fully backed by the sum of: (1) the securitiesheld as part of the bank’s equity capital, (2) the legal tender held by the bank, eitherat its exchange office or with the Riksbank, (3) the silver held by the bank, and (4) col-lateral for the bank’s loans up to an amount not to exceed 50% of the bank’s equitycapital.38

Accompanying the switch from the silver to the gold standard, new bank legislation wasenacted in 1874. According to the new rules, a bank’s note issue had to be fully backed bythe sum of: (1) the securities portion of the bank’s equity capital, (2) the reserve fund of thebank, (3) the claims of the bank, not to exceed 50% of the bank’s equity, on the conditionthat the bank’s main office hold gold coin equal to at least 10% of the bank’s equity, and(4) any gold holdings in excess of 10% of the equity capital. Fig. 5 shows that in practice,these rules did not constrain the note issuance of the Enskilda banks. Indeed, the bankscontinually failed to reach their allowable note issue limits.

Instead, what effectively limited Enskilda bank note issuance was the liquid reservesthese banks had available to redeem their notes for legal tender. Prior to the 1874 legisla-tion, banks were free to exchange their notes either for coins or for Riksbank notes. At no

37 See Officer (2002).38 SFS (1846:1, §§8, 11) and Skogman (1846:2, pp. 38–42, 50–54). In its early days, a bank could count theowners’ personal promissory notes as part of its equity capital (Post and Inrikes Tidning, 2/2, 9/5-1843). The twoearliest banks counted their own notes as equity during 1834–1839, and until 1846 all the banks counted the notesof other Enskilda banks (Post and Inrikes Tidning, 1835–1847, especially 21/3, 29/4-1835, 9/3, 26/4-1836).

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point did the law or bank charters prevent the banks from limiting their reserves to specie,which would have made them independent of the Riksbank.

According to the Banking Law 1874, the formal backing of the Enskilda banks’ notesdid not include any holdings of Riksbank notes.39 Despite the fact that Riksbank noteslegally were as useless for note coverage as were notes of other Enskilda banks, the Ens-kilda banks continued to hold large amounts of Riksbank notes, and only negligibleamounts of notes issued by other Enskilda banks (see Fig. 6). Competition was one reasonfor not holding the notes of other Enskilda banks. But why favor the Riksbank by holdinglarge quantities of its notes? The answer is that the public literally considered the Riksbanknotes to be as good as gold. As a result, the effective reserves of the Enskilda banks con-sisted of Riksbank notes and, to a lesser extent, specie.

As seen in Fig. 6, bank holdings of Enskilda bank notes were stable and small as a per-centage of cash assets. This is as expected because these notes were considered an undesir-able form of asset, to be exchanged for base money as soon as possible. The amount ofRiksbank notes held stands sharply in contrast to the amount of Enskilda bank notes.It is apparent that Riksbank notes functioned as reserves for the Enskilda banking systemin a manner not shared by Enskilda bank notes.

After 1874, Enskilda banks in accordance with the new banking law had to back theirnote issuance with gold. By 1878, all Enskilda banks operated under the banking law of1874. This law made gold holdings an important part of the Enskilda banks reserves, asit stated that the banks had to hold at least 10% of their equity capital in gold. Moreover,Riksbank notes were no longer legal reserves for Enskilda-bank note issuance. Hence, theperiod from 1878 until 1900 stands out as a period when the Enskilda banks by law notonly had the possibility to, but actually as far as note issuance was concerned wererequired to, follow the free banking model. Still, as shown in Fig. 7, the amount of Riks-bank notes held was considerable.

39 SFS (1874:44, §§26–28). The legislation that required the redemption of notes with gold coins can be seen aslimiting the legal tender status of Riksbank notes. Indeed, it was suggested that the constitutional clauseconferring such status should be revoked (Flux, 1910, p. 63; Nilsson, 1994, p. 101).

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Fig. 7. Monthly data on Enskilda banks cash assets in relation to issued notes, 1878–1900. Source: Sammandragaf Bankernas Uppgifter (1878–1900).

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Fig. 6. Annual data on Enskilda banks cash assets in relation to issued notes, 1843–1900. Sources: Post andInrikes Tidning (1835–1871) and Sammandrag af Bankernas Uppgifter (1871–1900).


Despite the law of 1874, Riksbank notes continued to be the main ingredient in the Ens-kilda banks reserves. This suggests that in practice Enskilda bank notes were redeemed forRiksbank notes. The Enskilda banks holdings of gold had been forced upon them by law,but the banks and the public continued to prefer Riksbank notes as base money.

Before the law of 1874 was put into practice, Enskilda banks held virtually no specie asreserves. After 1874, gold reserves were quickly accumulated and remained between 10 and14% of the equity capital for the rest of the period. After the note-issuing rights of the Ens-kilda bank were ended in 1898, their gold holdings quickly diminished from 9.5 millionsSEK in 1900 to 0.25 million SEK in 1903.40

40 Sammandrag af Bankernas Uppgifter (1871–1911) and Ogren (2003c).


The limited liability banks without the right to issue notes that were authorized by lawin 1864 relied neither on gold reserves nor Enskilda bank notes. These commercial banks’reserves also consisted of Riksbank notes. Enskilda bank notes were held to such a smallextent by these new limited-liability banks that we can infer that the new banks were sim-ply waiting to exchange of these for base money, i.e., Riksbank notes.

If the Riksbank had been nothing but a State-sponsored commercial bank whose noteswere substitutes for Enskilda bank notes, commercial banks would not have utilized themfor reserves. The most important fact with the system of the Enskilda banks was that thesebanks through the entire period had the possibility to be independent of the Riksbank, butchose not to build such a system. The market solution appears to be that the central-bank-ing-based system was viewed as better suited to operate in the growing Swedish economythan its alternatives.

4.2. Statistical test of the basis for Enskilda bank note issuance

The volume of Riksbank notes held by banks demonstrates that Riksbank notes wereused as reserves in the commercial banking system. Thus, the Riksbank worked as a rudi-mentary form of central bank maintaining the value of the currency and issuing basemoney.

An argument in this paper is that the Enskilda banks chose to hold Riksbank notes asreserves instead on relying on specie, which they could have done from the outset of thesystem. Consequently, the public must have been content with redeeming Enskilda banknotes for Riksbank notes instead of specie. This seems to have been true even after thelaw in 1874 required the Enskilda banks to exchange their notes for specie and not forRiksbank notes. Thus, specie holdings were not demanded by bank customers as backingfor liabilities of the Enskilda banks; instead the market preference was for Enskilda banksto rely on the base money issued by the Riksbank. Enskilda bank holdings of speciereserves seemed to be imposed by law, and thus were hardly in line with the free bankingargument.

To analyze the importance of Riksbank notes and Enskilda banks’ gold holdings asmonetary base, we ask if it is possible to find any statistical link between these forms ofbase money and Enskilda bank note issues for the period 1878 until 1900. Can we discoverwhether Enskilda banks based their note issuance on reserves of Riksbank notes or gold?

Variables analyzed are: Issued Riksbank notes (ISSRBN), Riksbank notes held asreserves by the Enskilda banks (EBRBN), gold held as reserves by the Enskilda banks(EBGOLD), and issued Enskilda bank notes (ISSEBN). Observations are monthly, whichgives 276 observations of the variables. Also in logarithmic form the time series are notstationary, hence we use changes (first differences) in the variables. If we expect one kindof reserve component to be redeemed for notes we can assume that changes in thesereserve components are what should lead to changes in note issuance, so using the first dif-ference in this case makes sense. The logarithmic form allows interpretation of the relationbetween the variables as elasticities, i.e., in percent.

In the OLS-regressions reported in Table 1, it is assumed that the changes in Enskildabank note issuance were dependent on changes in reserves (Eqs. (1) and (2)) and/or inissued Riksbank notes (Eq. (3)). This assumption is based on the observation that the Ens-kilda banks held large amounts of Riksbank notes. The results in Eqs. (1) and (2) showthat changes in the amount of Riksbank notes held affected the note issuance of the Ens-

Table 1OLS-regressions of issued Enskilda bank notes (ISSEBN) as dependent on changes in Enskilda bank reservecomponents of gold (EBGOLD), Riksbank notes (EBRBN) and changes in issued Riksbank notes (ISSRBN)(Eqs. (1)–(3)), and changes in Enskilda bank holdings of Riksbank notes as dependent on changes in issuedRiksbank notes (Eq. (4)), 1878–1900

Eq. (1) Eq. (2) Eq. (3) Eq. (4)DLOG(ISSEBN) DLOG(ISSEBN) DLOG(ISSEBN) DLOG(EBRBN)

Constant 0.002 0.002 0.001 �0.002t Stat. 0.544 0.537 0.159 �0.234Prob. 0.587 0.592 0.874 0.815

DLOG(EBGOLD) 0.150 0.1420.733 0.7050.464 0.481

DLOG(EBRBN) 0.059

3.0420.003

DLOG(ISSRBN) 0.402 0.897

8.579 5.9140.000 0.000

R2 0.002 0.035 0.212 0.114Adj. R2 �0.002 0.028 0.209 0.110

Monthly data.Source: Sammandrag af Bankernas Uppgifter (1878–1900).


kilda banks. This was, however, not the case for specie, as changes in the holdings of golddid not significantly affect note issuance by Enskilda banks. The explanatory power (R2) ofthe reserves’ influence on Enskilda bank note issuing, however, is a merely 3%.

Table 1 supports the importance of Riksbank notes being held as reserves by Enskildabanks. As expected the Enskilda banks’ gold holdings were unrelated to their note issu-ance. The interpretation that the gold holdings of the Enskilda banks were forced bylaw without any connection to the preferences of the market thus holds.

There is thus a strong and significant correlation between changes in the issued amountof Riksbank notes and Riksbank notes being held as Enskilda bank reserves (Eq. (4)).Changes in the amount of issued Riksbank notes explain (R2) 21% of the changes inthe amount of issued Enskilda bank notes, a strong result with data that are first-differ-enced. For every SEK issued by the Riksbank, the Enskilda banks issued 0.4 SEK. Thereis a risk that the strong correlation in this case is due to external changes in the demand forliquidity. There is, however, no reason to dismiss the label ‘‘central-bank-based system’’on the grounds that the Enskilda banks were flexible and thus had the possibility to supplyliquidity when demanded. What it shows is that the banks often held reserves in excess ofthe legally required levels and/or had the possibility to substitute notes for deposits.

To study more fully the relationship between changes in the issuance of Riksbank andEnskilda bank notes and the reserve components of the Enskilda banks, a VAR-test isused. The VAR-test is useful when economic theory does not make clear which variablesare exogenous, and which are endogenous. Each variable is tested as potentially endoge-nous, being dependent on lagged values of all variables, including the endogenous variableitself. It therefore helps to analyze more complicated relationships between the variables,

Table 2VARModels of changes in issued Riksbank notes (ISSRBN), changes in the Enskilda banks’ reserve componentsof gold (EBGOLD), Riksbank notes (EBRBN) and changes in issued Enskilda bank notes (ISSEBN), 1878–1900

Independent variables Dependent variable Dependent variable Dependent variable Dependent variableDLOG(ISSRBN) DLOG(ISSEBN) DLOG(EBRBN) DLOG(EBGOLD)

DLOG(ISSRBN) �0.910 (0.000) 0.231 (0.000) 1.581 (0.041) 0.151 (0.021)DLOG(ISSEBN) �0.523 (0.000) �1.690 (0.000) �0.370 (0.024) 0.142 (0.273)DLOG(EBRBN) �0.193 (0.280) �0.162 (0.015) �2.201 (0.000) �0.014 (0.770)DLOG(EBGOLD) 0.575 (0.266) 0.245 (0.185) �0.270 (0.700) �0.585 (0.000)

R2 0.573 0.573 0.431 0.149Adj. R2 0.539 0.539 0.385 0.081

Monthly data. Five lags.Note. Reported in the table is the sum of the significant regression coefficients for each variable block. Inparentheses is the significance level of the F test for the Granger test.


that is, to reveal to what extent a variable is dependent upon others in the VAR system.VAR-analysis thus has the advantage of testing instead of assuming the causality betweenvariables.

In Table 2 the results of the VAR is summarized, following the scheme for VAR-modelsdeveloped by Rousseau (2003). Again differenced logarithmic values are used to makeinterpretation of the coefficients in percents. The VAR-test supports the importance ofRiksbank notes for Enskilda-bank note issuance. When summarizing significant coeffi-cients, the Riksbank’s issuance of base money affected the issuance of Enskilda bank notesand their reserve holdings positively. Every 100 SEK issued during the previous periodsled to 1.8 SEK issued in Enskilda bank notes, nearly 50 SEK to be held as reserves bythe Enskilda banks in Riksbank notes and another 13 SEK were exchanged for gold. Pre-vious changes in gold holding only led to negative changes in gold holdings but did notaffect issuance of notes.

Previous increases in issued notes, and especially Riksbank notes held by the Enskildabanks, were met by decreases in the issuance of Riksbank notes. This suggests that theRiksbank protected the gold standard by limiting money supply expansion. In the samemanner previous increases in Enskilda bank notes issuance were offset by decreases in Ens-kilda note issuance. The result supports qualitative evidence showing that note issuance ofthe Enskilda banks ultimately was dependent on the reserves of the Riksbank.41

The importance of Riksbank notes as base money for the Enskilda banking systemshows that although this banking system had the right to issue notes, it was workingas a central-bank-based banking system and not as a free banking system. The Swedishpublic and the Enskilda banks chose the central-bank-based banking system, i.e. a freebanking system could have been, but was not, chosen.

4.3. The Enskilda bank notes and the supply of liquidity

That the Enskilda bank notes were not circulating as currency in competition withRiksbank notes does not mean that these notes were without importance. On the contrary,

41 BaU (1853/54) and Finanskommitten (1858).


Enskilda bank notes functioned as a form of liquid and transferable check that carried theguarantee of the bank, but did not involve the transaction costs of having to engage thebank as a middle man in the transaction. The fact that these notes were not a base-moneycurrency allowed them to be supplied to the extent needed in the growing economy. Inshort, the Enskilda bank notes were an efficient way of creating the liquidity needed forfinancial deepening to occur.

That the Enskilda banks continued to work within a central bank system did notimpede their flexibility. As long as reserve requirements were not impeding the efficiencyof the banks, a banking system operating with reserves issued by a central bank couldbe as flexible as a free banking system, if not more so. Fig. 8 shows that despite using cen-tral bank notes as reserves, the note issuance of the Enskilda banks was flexible enough tomeet seasonal and other demands for liquid Enskilda bank notes.

Establishment of the specie standard in 1834 created an impediment to the provision offormal money. The most striking feature of the Swedish money market of the day was theshortage of specie, coins and other official means of payment. Indeed, contemporaryobservers considered this shortage to be a constraint on economic growth. Although theircirculation was negligible, coins were regarded as real money by the authorities and byscholars. Notes were thought of as ‘‘representing’’ coins.42 Clearly, the lack of formalforms of money forced the practical Swedish concept of money to be quite elastic.

Authorized assignments constituted the permissible value of checks drawn on the Riks-bank. Such checks circulated as means of payment just like bank notes, and, since theirtotal value could exceed the drawer’s deposits and credits with the Riksbank, they addedfurther to the money supply.43 Promissory notes issued by companies or individuals werecommonly used, and were widely accepted by the public, as means of payment.44 In addi-tion to various types of IOUs, bonds, despite their interest bearing nature, also circulatedas a means of payment.45 Thus, informal money was supplied in response to demand. Itsquality (or really lack thereof), however, restricted its circulation to relatively narrow geo-graphic regions and personal networks.

Prior to the establishment of the Enskilda banks, the ‘‘shortage’’ of money was resolvedthrough the utilization of informal notes. These informal notes were totally independent ofthe specie standard. The challenge facing the financial system that emerged in connectionwith Sweden’s economic integration, was replacing these informal notes with more reli-

42 Agardh (1865, pp. 78, 146), BaU, 1834/35, No. 8, p. 9; 1879, No. 8, pp. 2–3, Heckscher (1965, pp. 294–296),Kock (1931, p. 18), Nordstrom (1853, p. 90), Rosenberg (1878, p. 84) and Wennberg (1829, p. 7). The Riksbank’sright to issue one SEK notes was rescinded in 1878 to pave the way for a more ‘‘civilized usage of coins’’ (BaU,1879, No. 8, p. 3).43 BaU, 1850–1851, No. 2, p. 18. Formally, authorized assignment could be over issued because the velocity ofcirculation could be taken into account by the issuer. Informally, it was realized that a reduction of assignments incirculation would severely dampen economic activity. See also Engdahl (2002).44 In the 1790s, the issuance of private promissory notes with engraved or printed denominations was banned.The ban on private notes with engraved or printed denominations was renewed in the nineteenth century. Duringthe period 1810–1816, the three existing discount companies circulated promissory notes with a value of up to35% of the Riksbank notes in circulation. Until the 1820s, the deposit certificates of discount companiescirculated as bank notes (Brisman, 1924, pp. 47–51, 244; Lindgren, 2002; Sveriges Riksbank, 1931, pp. 44–45).45 Post and Inrikes Tidning, 7/7-1840. The use of domestic bonds as means of payments payment was discussedrelative to the growing money stock.

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Fig. 8. Monthly data on Riksbank and Enskilda bank notes in circulation, 1878–1900 (in SEK). Source:Sammandrag af Bankernas Uppgifter (1878–1900).


able, nationally accepted, means of payment, without, however, endangering the convert-ibility that was the corner stone of the international monetary regime.

There is an important distinction between the banks’ ability to issue notes and theirability to keep them in circulation.46 Keeping notes in circulation depended on three fac-tors: (1) the geographical distance between the point of issue and the areas of circulation,(2) the denomination of the notes—smaller denominations tended to circulate longer, and(3) alternative available means of payment.

Throughout the period, the Riksbank was authorized to issue smaller-denominationnotes than were the Enskilda banks. This increased the incentive of the latter to spreadtheir notes throughout the country. In order to accomplish this, the banks opened branchoffices or engaged other financial actors as exchange agents. These were usually merchants,private banking firms, or savings banks. An often asserted strategy of the Enskilda bankswas to get their notes into circulation in isolated areas, thus reducing the chance of quickredemption for legal tender.47

In connection with the establishment of an inter-bank clearing system, StockholmEnskilda Bank invented the so-called ‘‘postal bank bill’’ (postremissvaxel) to substitutefor the mailing of bank notes. Instead of mailing bank notes, a postal bank bill was pur-chased at the nearest bank and sent by ordinary mail. The recipient could then cash thebill at any conveniently located bank. Payable on demand, and not being subject to anydiscount, the postal bank bill functioned as a lubricant in the clearing machinery.

46 Dowd (1993, p. 29) and White (1989, p. 21).47 Brisman (1934, pp. 23–25) and Petersson (1999).


Instead of locking up bank notes in postal bags, and thus removing them from circula-tion for several days, these written payment orders were utilized. By cashing these postalbank bills, a bank had an opportunity to place its own notes on the market and keepthem in circulation.48

Enskilda banks were willing to bear some costs in order to make their notes closer sub-stitutes for Riksbank notes. In order to assure holders of the convertibility of Enskildabank notes into legal tender, exchange agents were compensated in proportion to thequantity of a bank’s notes that they exchanged for legal tender.49 Furthermore, in at leastsome parts of the country the Enskilda banks paid a small fee to the municipal tax author-ities to act as exchange agents in connection with tax payments.50 Thus, despite their lackof legal-tender status, in practice Enskilda bank notes could be used to pay taxes.

In view of the large circulation of Enskilda bank notes starting in the 1860s, it is likelythat they had succeeded in becoming acceptable nationwide. Previously, in 1855, legisla-tion had standardized the size of Enskilda bank notes of a given denomination.51 In1869, the Riksbank officially began accepting Enskilda bank notes if these could beredeemed immediately. Since the Enskilda banks held large amounts of deposits in theRiksbank, it is likely that this was merely an official acknowledgment of an already exist-ing practice. The large deposits made by the Enskilda banks in the Riksbank suggest thatthe Riksbank also was used for clearing.52

The achievement of the Enskilda banks was not in successfully competing with Riks-bank notes, as free-banking analysts suggest. Rather, Enskilda bank notes came toreplace previous widely used, local, non-specie connected, informal means ofpayment.53

Enskilda banks had an advantage in not being subordinated to the specie standard andtherefore not having to cover their critical liabilities, such as demand deposits and bank-post bills, to nearly the same extent as the Riksbank. Since the latter’s ultimate responsi-bility for preserving the specie standard prevented it from holding insufficient reserves, itsnotes were of a higher quality than the Enskilda bank notes. This enabled Enskilda banksto use the Riksbank notes as a base for issuing their own notes, and, as a consequence,they tended to hoard Riksbank notes.

For the ordinary Swede, however, the Enskilda bank notes were a close substitute forRiksbank notes since they always could be exchanged for the latter. While not as wellbacked as Riksbank notes, the Enskilda bank notes were of much better quality as a

48 Nilsson (1989, pp. 113–119). Trust in the postal bank bills as a way of transferring payments wasunquestioned. They were even accepted in the neighboring countries (Flux, 1910, p. 56).49 Engdahl (2002).50 Nilsson (1989, pp. 135–136) and SmalB (1840,1845). In 1841, a Parliamentary bill proposing the acceptance ofEnskilda bank notes for tax payments, was defeated (StU, 1840/41, No. 143, 209).51 Rosenberg (1878, p. 85).52 A bill requiring the Riksbank to accept Enskilda bank notes was rejected during the 1865/66 session (BaU,1865/66, No. 18). In 1869, the chairman of the Standing Committee on Banking was still opposed (BaU, 1869,No. 6, p. 3). Regarding the Enskilda banks’ deposits in the Riksbank see Sammandrag af Bankernas Uppgifter.53 An example of this development concerns the right to over issue authorized assignments. In 1834, theRiksbank raised this as a problem, but opposed any corrective measures since their effect would be to harm therural economy. The abolition of such rights in 1851 was justified by the claim that there no longer was any ruralshortage of small denominations (Bankkomiten, 1883, pp. 149–151 and BaU, 1850/51, No. 2, p. 18). In fact,however, public confidence in authorized assignments had been undermined by a number of frauds that occurredduring the crisis of 1847/48. Enskilda bank notes were considered more trustworthy (see Engdahl, 2002).

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Fig. 9. Percentile contribution to liquidity by the Enskilda banks’ note issuance, 1834–1900. Sources: Post andInrikes Tidning (1835–1871), Sammandrag af Bankernas Uppgifter (1871–1900) and Sveriges Riksbank (1931,pp. 45–49).


medium of exchange than were other circulating instruments. Enskilda bank notes werenot only related to the specie standard, being backed by Riksbank notes, but were alsoguaranteed by the bank’s equity capital and the unlimited liability of the owners. Thesewere confidence-inducing features that other substitutes lacked.

From the foregoing analysis it can be concluded that the Enskilda bank notes did notdisplace Riksbank notes because they were preferred by the public. The Swedish need forcredit and means of payments institutionalized two types of notes, exchangeable at par.The Riksbank notes were legal tender and could be used as a base for issuing Enskildabank notes. The Enskilda bank notes, in turn, could be used for virtually all domestictransactions.

The Enskilda banks’ note issuance based on Riksbank notes increased domestic liquid-ity. As seen in Fig. 3 earlier, it decreased pressure on the exchange rate by allowing theRiksbank the possibility to issue less notes to supply liquidity.

To estimate the contribution to liquidity by the Enskilda banks the percentile expansionof the formal liquidity by the Enskilda banks is calculated in Fig. 9. Issued Riksbank notes(ISSRBN) plus the Enskilda banks’ specie holdings (EBGOLD) are considered as the totalamount of base money. The Enskilda banks’ contribution to liquidity is calculated as cir-culating Enskilda bank notes (EBNOTES) minus holdings of Riksbank notes (EBRBN)and gold (EBGOLD) as reserves. This measure is then divided by the total amount of basemoney to get a percentile estimate of the Enskilda banks contribution to liquidity;((EBNOTES) � (EBRBN) � (EBGOLD))/((ISSRBN) + (EBGOLD)).

The issuance of Enskilda bank notes rapidly increased the amount of notes in circula-tion, i.e. the formal domestic liquidity. The Enskilda banks after the freer establishment ofbanks in the middle of the 1860s increased liquidity by 60–80%, some years even more.54

54 The sudden dive in the Enskilda banks’ contribution to liquidity in 1868 is probably due to the exceptionalcircumstances during the famine this year (see Nilsson (1981)) as well as a case of problem with the data.

0

5

10

15

20

25

30

35

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45

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1870

1874

1878

1882

1886

1890

1894

1898

1902

1906

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V=PY/Base Money

V=PY/Liquidity

Fig. 10. The velocity of base money (issued Riksbank notes plus specie held by the Enskilda banks) and liquidity(circulating Enskilda and Riksbank notes), 1834–1913. Sources: Krantz (1997, pp. 20–22), Post and InrikesTidning (1835–1871), Sammandrag af Bankernas Uppgifter (1871–1900) and Sveriges Riksbank (1931, pp. 45–50,172–185).


We have seen that the specie exchange system allowed more formal liquidity in relationto specie reserves than what otherwise would have been the case. A measure of monetiza-tion utilized by Fisher and Thurman is the velocity of circulation of means of payments. Adecrease of this velocity implies increased monetization.55 By calculating the velocity ofdifferent monetary components it is possible to see to what extent these were related toeconomic growth.

The Swedish economy was growing rapidly from the 1870s, and the banking system wasable to supply the economy with the liquidity needed throughout the country. As seen inFig. 10, the Riksbank–Enskilda bank specie exchange system managed to supply liquidityat an almost stable manner in relation to GDP from the middle of the 1850s.

Note issuance conducted by the Enskilda banks was not less important because it wasbased on base money issued by the Riksbank. On the contrary, this arrangement allowedmore formal liquidity to circulate than would have been the case under either a central-bank-based system where the central bank held monopoly on note issuance or a free bank-ing system operating in accordance with free banking theory.

4.4. Lender of last resort and state support

The free banking literature argues that one of the hallmarks of a free banking system isthat the banking system operates without the interference of authorities in times of crises.Hence there is no need for any form of lender of last resort activities.

The alleged stability of Sweden’s Enskilda banking system is correct in the sense that noEnskilda bank failed in a way that made holders of its liabilities lose their money. At leasttwice, however, in 1857–1858 and in 1878–1879, the State had to intervene as lender of lastresort to save banks most troubled by the crises. In these cases the threatened banks were

55 Fisher and Thurman (1989, pp. 629–631).


the most important banks, the Skane Enskilda bank in 1857–1858 and the StockholmEnskilda bank in 1878–1879.

State support to the banks in Sweden did not exactly follow Bagehot’s classical recipefor a lender of last resort. But this does not mean that no support was provided by theState to the banks in times of distress. A study of lender of last resort in Sweden duringthe classical specie standard, 1834–1913, shows that the way lender of last resort supportwas provided suited a small economy with a vulnerable currency.

The Riksbank would deploy its reserves until it feared that further deployments wouldendanger maintenance of the specie standard. When this point was reached the Stateassigned the National Debt Office, its debt-management authority, the responsibility ofraising international capital that could be used to sustain the banks. Proceeds of foreignloans would then be deposited in the Riksbank, which could lend them to distressedbanks. This allowed the Riksbank to concentrate on preserving the international valueof the currency, while the ultimate support to the banks was provided by another author-ity. Together, the two public authorities acted as a lender of last resort in support ofbanks.56

Sweden’s financial crisis of 1878–1879 showed that it did not matter to the publicwhether bank liabilities were in the form of notes or deposits. The Stockholm Enskildabank that was the first and most threatened bank in this crisis operated mainly with depos-its and to a lesser extent with note issuance. The run on the Stockholm Enskilda bank wasaimed at its deposits. This crisis indicated that demand deposits and Enskilda bank noteswere perceived as having similar properties, and that issuing notes did not make a bankmore vulnerable to runs than did relying primarily on demand deposits.

5. The Enskilda banks and financial deepening

We have seen that the combination of the Riksbank and the Enskilda banks managedto supply more liquidity than what would have been possible without this system. One waythe Enskilda banks were criticized by opponents was that their note issuance took awaythe incentives for these banks to accept deposits. It is true that it took some time beforedeposits broke through as the main form of funding for the Enskilda banks. But, afterthe establishment of the Stockholm Enskilda bank and its introduction of the ‘‘postal-bank bill’’ as a way of smoothing inter-bank clearing in 1856, deposits in Enskilda bankstook off (see Fig. 11).57

The broad money supply (M2) stayed fairly stable between 1855 and 1868 but notes incirculation decreased. During this period the Enskilda banks altered their liabilities by

56 Regarding the crises see for instance Gasslander (1962), Nilsson (1994), Soderlund (1964). As it was stated inthe laws and the charters of the banks that these should not expect any support from the public, official support tothe banks as in these crises was a political issue. Both crises resulted in special committees on banking that weresupposed to resolve the problem of the ‘‘instability’’ of the banking system (Bankkomiten, 1883; Finan-skommitten, 1858). Regarding the role of the National Debt Office as source of liquidity for the banking systemsee Nygren (1989) and Schon (1989). Regarding lender of last resort in nineteenth century Sweden as a case of aperipheral economy, see Ogren (2005). One bank failed in the aftermaths of the 1878 crisis, but the liabilities ofthis bank was taken over by another bank.57 The importance of the Stockholm Enskilda bank for the increased interest in deposits is well documented, seefor instance Gasslander (1962) and Nilsson (1981, 1984). The Stockholm Enskilda bank was established in themain capital market of Sweden and was thus less dependent on issuing notes than other banks.

Fig. 11. Per capita money supply in 1000s of SEK, 1834–1913. Logarithmic scale. Sources: Myrdal and Bouvin(1933), Post and Inrikes Tidning (1835–1871), Sammandrag af Bankernas Uppgifter (1871–1900), SCB (1955,1960, pp. 99, 102–103) and Sveriges Riksbank (1931, pp. 45–49, 172–179).


substituting deposits for notes. The increased usage of deposits was a result of the intro-duction of the ‘‘postal-bank bill’’ that made deposits more liquid than before. Taxesincreased the costs to issue notes, making notes nearly as costly as deposits.58

In the late 1860s, from the trough year of 1868, both note issuance as well as depositsstarted to grow again, and from the year 1867, deposits were the main component of thebroad money supply. Also in relation to GDP the broad money supply increased enor-mously during a few years in the late 1860s and early 1870s suggesting a breakthroughin monetization between the years 1868 until 1872.

In conjunction with the breakthrough of deposit-based banking at both Enskilda banksand the joint-stock non-issuing banks authorized in 1863, monetization of the Swedisheconomy took off in the late 1860s. Starting in the 1870s, the Swedish money stock inclu-sive of commercial bank deposits and also savings bank deposits began to grow rapidly.By 1867, Enskilda bank deposits exceeded the value of Enskilda bank notes in circula-tion.59 From that year forward, the principal source of bank business financing wasdeposits.

The remarkable growth of the Swedish money supply is well illustrated by the factbetween 1834 and 1913, M2 per capita increased nearly forty times. To a considerable

58 Tax on Enskilda bank note issuance was in 1861 imposed at 0.2 percent, increased to 0.3 percent in 1887, 0.5percent in 1892 and finally to 1 percent in 1893 (RdSkr, 1887, No. 49; 1892, No. 98; 1893, No. 45; SFS, 1861:34,§15). Interest rates for demand deposits were around 2 to 3 percent (Sammandrag af Bankernas Uppgifter) andthe cost for note issuance has been estimated to around 1.5 percent.59 Post and Inrikes tidning and Sveriges Riksbank (1931, p. 177).

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Fig. 12. Velocity of means of payment (M2), 1834–1906 (index form, 1870 = 100). Sources: Krantz (1997, pp. 20–22), Post and Inrikes Tidning (1835–1871), Sammandrag af Bankernas Uppgifter (1871–1900), SCB (1960, pp. 99,102–103) and Sveriges Riksbank (1931, pp. 45–50, 172–185).


degree, this was a result of the low starting point for credit money. Obviously, not all com-ponents of the money supply grew that rapidly. The most liquid part of the money stock,circulating notes, increased three and one half times over during the period. The differencebetween the extremely rapid growth of Ml and M2 compared to notes underscores the cru-cial role played by the banking system in the process of expanding the money supply dur-ing these eight decades of profound economic transformation. Again the Fisher andThurman measure of monetization is utilized to compute this process of monetizationas part of financial deepening (see Fig. 12).60

A major acceleration in broad monetization occurred in the late 1860s, coinciding, notsurprisingly, with the rapid establishment of new banks and an increased emphasis onfinancing banking activity with deposits. In overall economic terms, the 1860s were nota prosperous decade in Sweden. Nonetheless, financial-system changes in that decade laidthe foundations for the economic growth experienced during the latter part of the nine-teenth century.

6. Conclusions

The key actors in Sweden’s monetization and financial deepening were the EnskildaBanks and the Riksbank. The Riksbank, being the sole issuer of legal tender, supplied basemoney under restrictions imposed by an obligation to maintain international specie con-vertibility of Swedish money. The Enskilda banks issued what might be described as‘‘transferable demand deposits’’ backed primarily by Riksbank notes. As was essentialduring a period of national market integration, the Enskilda bank notes came to be accept-ed nationwide. This domestic specie exchange system permitted the development of aSwedish credit market.

This Swedish system was of importance for the monetization, development of the finan-cial system, and economic growth. A specific feature of the commercial banking system,

60 Fisher and Thurman (1989, pp. 629–631). A decrease of this velocity implies increased monetization.


the right of Enskilda banks to issue notes, was a main ingredient in this developing pro-cess. It solved the problem of creating the necessary conditions for a financial system in apoor, under-monetized, and geographically dispersed country.

The Swedish experience with private note issuance was more than suggested by free-banking analysts’ assumption of competition between the Enskilda banks and the Riks-bank. To a great degree, the success of the Enskilda bank notes depended on the Riksbankacting to maintain their effective convertibility into specie. Between 1834 and 1900, it waspossible to combine international specie convertibility with the monetary needs of a grow-ing economy. The supply of money expanded at a rate that would not have been possiblewithout the special features of the Swedish financial system.

By 1859, Enskilda bank notes became dominant in circulation. At the same time, thesenotes replaced other means of payment that were independent of the specie standard.Thus, as the principal, nationally accepted, means of payment, the Enskilda bank notesplayed a major role in the economic integration of Sweden. Such integration would havebeen impossible without a means of payment having nation wide acceptability, a qualitymost of the informal note substitutes lacked.

In addition to the ‘‘high powered’’ Riksbank notes, large amounts of Enskilda banknotes, backed by Riksbank notes, were in circulation. Since these were exchangeable atpar and were accepted nationwide, they can be considered to be national liquid meansof payments that economized on the total specie reserves of the Riksbank and the Enskildabanks. Compared to Finland, another peripheral country but with a different monetarysystem, Sweden enjoyed a higher liquidity in circulation in relation to its specie reserves.61

The Riksbank alone would not have been able to circulate such a large quantity of liquid-ity without increasing its reserves, and thus its costs. This liquidity laid the foundation forthe deposit based expansion of the money supply.

The system of Enskilda banks resembled a theoretical free banking system in that theirissuance of notes resulted in the emergence of clearing activities and offices. Furthermore,it was the requirements of the public, not any legal regulations, that effectively limited thenote issue. The most important argument for rejecting the free banking label is that notonly was there a central bank issuing base money, but the Enskilda banks voluntarilychose to back their notes with Riksbank notes.

Nothing prevented the Enskilda banks from accumulating specie reserves and practic-ing free banking. Throughout the period, however, they preferred to hold their reserves inthe form of Riksbank notes. Even after the legislation of 1874 formally made the Enskildabank notes redeemable only for domestic gold coins, they continued to base their noteissuance on Riksbank notes. Most of the Enskilda banks held gold only as a responseto the requirements of the 1874 law, not to back their notes. For domestic note holders,Riksbank notes were a close and acceptable alternative to gold reserves. Thus, allowingthe Enskilda banks to issue their own notes backed by Riksbank notes was not only pre-ferred by the public, but it was better suited to provide formal liquidity than a pure freebanking system would have been.

The Enskilda banks were also important in the breakthrough of deposit banking.Although the Enskilda banks accepted deposits from the beginning, it was not until the‘‘postal-bank bill’’ was introduced to facilitate clearing that the Enskilda banks started

61 Pipping (1961, pp. 509, 512) and Pipping (1969, p. 432).


to utilize deposits to any large extent. For the public the clearing instruments made thedeposits more liquid, and the Enskilda banks altered their portfolios by decreasing theirnotes in circulation in favor of deposits. After the wave of Enskilda bank establishmentsin the middle of the 1860s, notes as well as deposits increased. But deposits became by farthe main part of the booming money supply, surpassing notes by 1867.

Acknowledgment

I would like to thank Torbjorn Engdahl, William H. Greene, Olle Krantz, Mats Lars-son, Hakan Lindgren, Hakan Lobell, Mike Rafferty, Duncan Ross, Peter L. Rousseau,Lars G. Sandberg, Richard Sylla, Krim Talia, the participants at the Financial HistorySeminar at Stern School of Business (NYU) and the Workshop in Monetary and FinancialHistory at Rutgers University and two anonymous referees. I am also grateful to MarcFlandreau for sending me data. All errors are my own. Research grants from the SwedishResearch Foundation, the Silfven foundation, the American Scandinavian Foundation,and the Sweden America Foundation are gratefully acknowledged.

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Documents

Free or central banking? Liquidity and financial deepening in Sweden, 1834–1913