Why would money have been in short supply in the colonies? One reason could have been the mercantilist policies of the mother countries. So long as colonies were expected to send home more in value than they received in return, it would seem inevitable that the means of payment would flow back to the mother country and thus cause a "shortage" of money in the colonies. While this kind of "currency drain" effect is plausible, it is not established that there actually was a shortage of money in the colonies. It is possible that the currency shortages in the colonies were simply a manifestation of Gresham’s Law, that bad money forces out good. Redish suggests that what was in short supply was "good" money. Because inferior money circulated, what was regarded as the best money was taken out of circulation and hoarded by individuals concerned with preserving their wealth.
When "official" money was scarce, substitute forms of money were devised. The best known example of this was the playing card money resorted to in New France late in the 17th century. The colonial administration there often found it difficult to pay the troops and meet other obligations between the beginning of the year and the arrival of ships from France with new supplies of currency. In 1685 the Intendant hit upon the expedient of simply creating paper money. Lacking suitable paper and printing facilities, he cut up packs of playing cards, inscribed on them different denominations and used them to pay the government’s creditors. Despite official disapproval in France, these issues of playing card money were made from then until 1719. Although there were problems with counterfeiting, the playing card money of New France worked well and proved popular. The issues were withdrawn in the 1720’s, but reinstated in 1730 and card money subsequently circulated until the British conquest.
After the conquest, the British sterling standard was applied in all the British North American colonies, although a variety of coins from different countries continued to circulate. Spanish dollars, rated by Halifax merchants at four to the pound and by the British authorities at five shillings (the "Halifax standard") circulated widely. So did American gold coins. During the War of 1812 British Army money ("Army Bills") also circulated and proved popular, helping establish public acceptance of paper money. Once banks were established, paper notes issued by the banking companies became an important new component of the money supply.
The early banks in British North America performed the usual functions of financial intermediaries, gathering the funds accumulated by savers and making them available to borrowers. But then, as now, banks differed from other financial institutions in that their debts circulated and were widely acceptable as a means of payment. Unlike modern banks, most of the circulating debt of early banks was in the form of paper notes issued by each bank, but during the 19th century bank deposit liabilities gradually became more important than the note issue. People found it increasingly convenient to make larger payments by writing cheques against their bank accounts instead of by exchanging bank notes or coin. Montreal merchants first tried to set up a bank as early as 1782, but their efforts were unsuccessful until the Bank of Montreal was established in 1817. (It did not obtain its charter until 1822.) The Bank of New Brunswick was chartered in 1820 and the Chartered Bank of Upper Canada in 1821. These new banks conformed closely to American precedents.
Oddly, these precedents were more influential in British North America than in the US itself. The First Bank of the United States had been set up as a privately-owned, but national bank which its creator, Alexander Hamilton, Secretary of the Treasury, hoped would serve many of the same functions as modern central banks do, including acting as fiscal agent for the federal government. It operated for 20 years after its creation in 1791, but, despite considerable success, was terminated when Congress refused to renew its charter. Its opponents, mainly Republicans, argued that it was unconstitutional, that it represented too great a concentration of economic power, that it was falling under foreign (British) influence, and that it competed unfairly with the State-chartered banks. The latter subsequently came to dominate the American system, which became highly decentralized, contrary to the model originally intended by Hamilton.
Canadian banking by contrast conformed to the earlier American model and was to become highly centralized and nationally rather than regionally oriented. One reason for this was that particularly heavy restrictions were imposed on entrepreneurs seeking to establish new banking companies in Canada. Large initial capital requirements were required. Close ties between business interests (exemplified by the Family Compact oligarchy in Upper Canada) and the colonial governments made it difficult for individuals or groups outside a favoured circle to establish banking or other financial enterprises in competition with those already established. Such obstacles notwithstanding, by 1867 twenty-eight bank charters had been issued.
Did the coming of the banks affect early Canadian economic development? It is possible that the banks made the money supply greater than it otherwise would have been. If the expansion of economic activity had previously been restricted by a shortage of the means of payment, increasing the money supply could have facilitated development. But it is by no means clear that this was the case. In the absence of banks, the money supply might have been expanded adequately by other means. Nor is there any reason to assume that such an expansion of the money supply would have been associated with an increase in real output. Thinking of this relationship in terms of the classical equation of exchange, MV=PT, it is evident that if the economy in the 19th century tended to operate at or near full employment, an increase in M would force prices up. How would producers react to a rise in prices? In a predominantly rural, agricultural and hence competitive economy, higher prices conceivably could reduce, not increase, the incentive to produce. Thus it is not certain that institutional changes which increased the money supply would necessarily cause an increase in output in such an economy. Another possibility is that banks could have been important sources of long-term credit of the kind required by farmers and other entrepreneurs to finance the expansion of real productive capacity in the economy. Many European commercial banking systems played an important role in the industrialization of European economies by providing long-term funding for private commercial ventures or even by initiating such undertakings. In British North America, however, banks did not function in this capacity. (Nor did they in the US where the great financial panic of 1837 led most states to pass restrictive legislation preventing banks from engaging in long-term investment activity.) Instead, this function was performed mainly by other types of financial institutions, especially the building and loan companies and the insurance companies.
The actual role played by the banks in Canadian economic development is consequently difficult to assess. In the absence of any specific agreed connection between banking and the development of real productive capacity, most writers on the subject revert to the supposition that the banks and other financial institutions served to "lubricate" the wheels of commerce, facilitating exchange, assisting in the broadening of markets, and thereby raising productivity.
Two special features of the Canadian banks should be noted. One is their heavy involvement with government. From their inception the Canadian banks had strong, often direct, ties to the colonial governments before Confederation and to both the federal and provincial governments thereafter. Banks were important for governments in the 19th century because they helped create a market for government bonds. Much early banking legislation was designed to encourage or even require banks to hold government bonds as part of their asset structure. A second important feature of the banks throughout Canadian history has been their importance as foreign exchange dealers. It is likely that the banks played a role in facilitating the transfer of savings from Britain and other countries into Canada, a process which became increasingly important in the second half of the 19th century.
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