bank note case (r.g. hawtrey)

The Portuguese Bank Notes CaseAuthor(s): R. G. HawtreySource: The Economic Journal, Vol. 42, No. 167 (Sep., 1932), pp. 391-398Published by: Wiley on behalf of the Royal Economic SocietyStable URL: http://www.jstor.org/stable/2224021 .

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THE PORTUGUESE BANK NOTES CASE

THE history of swindles has been enriched in recent years by several sensational examples, but by none more notable than that which led to the case, Banco de Portugal v. Waterlow and Sons, Ltd., decided by the House of Lords on the 28th April, 1932.

Messrs. Waterlow, the well-known printers of bank notes, were the victims of a peculiarly audacious conspiracy. They held a contract for printing notes for the Bank of Portugal, and they were induced to produce notes, which were in all technical respects apparently genuine, to the value of about ?3,000,000, for a gang of forgers. Before the fraud was discovered, notes to the amount of over ?1,000,000 had actually been put into circulation by the conspirators, and Messrs. Waterlow had in the end to pay damages to the amount of ?610,000, being the net loss suffered by the Bank after setting off the assets recovered from the conspirators. The conspirators included the Portuguese Minister at The Hague and the diplomatic representative of a South American State. The negotiations with Messrs. Waterlow were carried on through a Dutchman named Marang, who from time to time produced forged letters and documents purporting to convey the authority of the Bank of Portugal for what was to be done.

The story put forward was that a loan was to be made to the Portuguese Colony of Angola by a syndicate which was to have the privilege of issuing notes in Angola. Inquiries which would have exposed the fraud at once were guarded against by represent- ing the whole business as extremely secret, on the ground that it was opposed by some of the directors of the Bank of Portugal, and that the Banco Ultramarino, which already issued notes in the Colonies, would raise objection if the project were known.

How were the notes to be numbered ? If they were given numbers not recorded at the Bank of Portugal as ever having been issued, the officials of the Bank could hardly fail to discover them immediately. Instructions were given to Waterlows that the numbers were to be duplicates of those on the last batch of notes genuinely ordered by the Bank of Portugal. That was arranged without arousing the suspicions of Messrs. Waterlow,

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392 THE ECONOMIC JOURNAL [SEPT.

but it involved the risk of notes with duplicate numbers being seen and the fact of forgery being thereby established.

The printing of the notes began early in 1925. They were all of the denomination of 500 escudos, or about ?5. The first consignment, delivered in February and March 1925, consisted of 200,000 notes, and the second, delivered from August to November 1925, of 380,000. The two together represented a value of 290,000,000 escudos.

The principal difficulty in the way of forgers of currency and false coiners has always been the introduction of their product into circulation. The conspirators surmounted this obstacle by founding a new bank, the Banco Angola e Metropole, with head office at Oporto. That required the permission of the Minister of Finance, and at first there was a hitch on account of the unsatisfactory reputation of some of the promoters. But some apparently respectable names were added, and on the 25th June, 1925, permission was granted, and the bank was duly constituted.

The appearance of unusual quantities of new 500-escudo notes presently awakened a certain amount of suspicion. But the notes of course were to all appearance perfectly genuine, even according to expert tests, and at first the suspicions were met with reassuring denials. The circumstance that led to discovery was that the packets of new notes received from the Banco Angola e Metropole by a jeweller at Oporto, who bought foreign exchange on behalf of the bank, differed from those ordinarily received from the Bank of Portugal in that they were not arranged in consecutive numerical order. An Oporto bank cashier, who was employed in his spare time by the jeweller, noticed this, and communicated his suspicions to the banker for whom he worked and the latter informed the Bank of Portugal.

The cashier had also observed that the pages in the account book on which the transactions in the suspicious notes were entered were always torn out.

The shuffling of the notes out of numerical order was, no doubt, an essential precaution to make the discovery of duplicate numbers less likely, but it remained itself a cause of suspicion. In fact, combined with the torn account book, it was regarded as sufficient ground for arresting the manager of the Banco Angola e Metropole the next day, the 5th December, 1925, and f6r conducting an investigation of the premises.

Bundles of new notes were found, some in numerical order and some rearranged. Comparison with the genuine notes at



1932] TITE PORTUGUESE BANK NOTES CASE 393

the Oporto Branch of the Bank of Portugal revealed four cases of duplicate notes. The fact of forgery was proved, but its extent was still unknown.

The Bank of Portugal took prompt action. The forged notes were all 500-escudo notes, with a portrait of Vasco da Gama in the design. A notice was issued on Monday the 7th December, calling in all the notes of that denomination and design, and offer- ing in exchange other notes not open to suspicion. The Government sanctioned the exchange being made up to the 26th December, and by that date very nearly all the suspect notes, both genuine and forged, had been withdrawn.

Among the notes withdrawn, 135,318, with a face value of 67,659,000 escudos, were definitely proved to be forged by certain small distinctive marks which showed that they had been printed from plates which had never been used for genuine notes at all. Expert scrutiny subsequently found means of distinguishing even those which had been printed from the same plates as genuine notes, and the total of forged notes withdrawn was placed at 209,718 with a face value of 104,859,000 escudos, or ?1,092,281, at the rate of 96 to the ?1. The number seized without ever getting into circulation was 363,602, so that 6,680 remained unaccounted for.

The Bank of Portugal sued Messrs. Waterlow for damages in respect of the redemption of the forged notes. The courts had no difficulty in deciding that Messrs. Waterlow were liable. They had committed a breach of an implied term of their contract and it was not even necessary to prove negligence. But when it came to determining the amount of the damages, doubts were evinced which were mainly connected with the special position of a central bank of issue.

In the first place, was the Bank justified in honouring the forged notes at all? All the judges agreed that, so long as the Bank had no means of distinguishing the forged notes from the genuine, they had no alternative but to honour both. It was contended on behalf of Messrs. Waterlow that the Bank could readily have obtained from the firm within a few days information enabling them to distinguish all those forged notes which had been printed from the later plate. The distinctive mark was a small letter at the corner of the design, which the Bank cashiers could have read with an ordinary magnifying glass.

Both Mr. Justice Wright in the King's Bench, and the Court of Appeal ruled that any of these distinguishable notes that had been exchanged after the interval within which the necessary




information as to the distinctive marks could have been obtained, ought to be excluded from the claim for damages. There was some difference of opinion as to the length of the interval, but that is a matter of detail.

The House of Lords decided otherwise. They allowed the cost of exchanging all the forged notes up to the 26th December, 1925, the interval prescribed by the Government for the process, and ruled that the relatively negligible amount exchanged after that date were honoured as an act of grace by the Bank. (As they allowed a part of the assets recovered from the forgers to be set against the notes exchanged after the 26th December, the House of Lords in effect allowed even these to be included in the claim.)

The ground for undertaking to exchange the forged notes at all was the danger of discredit of the currency and consequent panic. That was a matter of public interest on which it was for the Government and not for the Bank of Portugal to take the responsibility of deciding. Had the public interest not been in question, the Bank might have invited holders to deposit their 500-escudo Vasco da Gama notes for a suitable period in order that after scrutiny the genuine ones might be paid and the forgeries rejected. There might perhaps have resulted a claim by the Bank for damages in respect of its loss of credit and reputation, but that is a hypothetical matter which it is not necessary to pursue. The public interest required the complete relief of the holders of the forged notes, the Government took the responsibility of authorising the Bank to exchange them, and the House of Lords accepted the Bank's plea of the public interest. Since the genuine 500-escudo Vasco da Gama notes constituted one- sixth of the entire currency of the country, the consequences of distrust (which would probably have spread to the rest of the currency) would have been very serious indeed.

The Portuguese paper currency had been inconvertible into gold ever since 1891. The escudo had fallen from its old parity of 4s. 6d. to 2'd. Counsel for the defence argued, as Mr. Justice Wright put it, that the Bank had euffered no loss because it had simply exchanged pieces of paper which were not convertible into gold for other pieces of paper which were also not convertible into gold. This contention Mr. Justice Wright would not allow. "In Portugal," he said, "the notes were the currency of the country. They would purchase commodities, including gold. They could buy foreign exchange, including sterling or dollars or any currency which was convertible. They could do that



1932] TILE PORTUGUESE BANK NOTES CASE 395

because they had behind them the liability of the Bank of Portugal."

In the higher Courts a minority of the judges took the contrary view, and wanted to let off Waterlows with a liability for no more than the cost of printing new notes to take the place of those withdrawn (estimated at ?8,922).

On one point of principle Mr. Justice Wright was, I think, in error, that is to say, in arguing that the notes " had behind them the liability of the Bank of Portugal." An inconvertible legal tender note is not a liability of the issuing bank at all, except in the sense that for accounting purposes it must be entered among the liabilities in the balance sheet. It cannot be " paid " because it is itself the means of payment. The judges appear to have taken for granted that a bank which issues legal tender notes is obliged at any rate to go through the form of " paying " them on demand- by handing out one note in exchange for another. But I venture to doubt whether that is so, either in Portugal or in England or anywhere else. If the bank of issue accepts one of its notes from a holder, it simply becomes indebted to him for the amount, and is thereupon able to discharge the debt with the same note. Moreover, the bank of issue is under no general legal obligation to receive its own notes at all except in payment of debts due to it, though of course it may be obliged by express statutory enactments to pay out new for soiled notes, or small denominations for large, for the convenience of the public.

In the case of the Bank of England, notes take the form of promises to pay. But that makes no difference. The notes for ?1 and 10s. are legal tender in payments by the Bank, and the words " I promise to pay " are merely ornamental so long as that is so. They signify nothing more than the aspiration of the Bank of England to return to the use of gold coin as hand-to-hand currency at some time in the future. The notes of the Bank of Portugal (like those of most Continental banks of issue) contain no such formula. They do not even pretend to be debts, but are simply money.

There is thus no liability incurred by a bank of issue when it issues inconvertible notes. But that has no bearing on the question of the loss incurred when it issues notes and does not receive value for them. When that occurs, the bank is clearly and inevitably so much the worse off.

If it issues notes to redeem forgeries, it can maintain the assets received in exchange for its issues undiminished provided it can




increase the total currency in circulation by the requisite amount. That is an argument that deserves consideration. The effect of the increased issue may be to depreciate the currency. But Lord Warrington pointed out in the House of Lords that the Bank of Portugal did not attempt to prove that they suffered loss directly or indirectly by the increase in the currency and the consequent depreciation of its purchasing power, or by injury to their credit or interference in their relations with the Government.

Their note issue was limited by law. In 1925 the note issue included 1,640,000,000 against advances to the Government at a nominal rate of interest, and a " commercial issue " which was subject to a maximum limit of 195,630,000 escudos. At the time the forgery was discovered the commercial issue amounted to 64,000,000. The forged notes had displaced a corresponding amount of genuine notes and so encroached on the commercial issue. The exchange of notes, which was contrary to law in that the good notes were issued against no backing, made the encroachment manifest.

The commercial issue was of course the profitable part of the note issue, and had this encroachment upon it remained unrelieved, the loss would have been obvious. But legislation soon followed extending the Bank's power of issue. A decree of 19th July, 1926, authorised an issue of 100,000,000 escudos to be repaid out of the sums to be received from Waterlows, and a further addition of 100,000,000 to the commercial issue. (A further sum of 125,000,000 to be used in colonial development does not seem to have constituted an addition either to the advances to the Govern- ment or to the note issue.) Thus the Bank was empowered by law to issue pieces of paper in exchange for pieces of paper. Where then was its loss?

I do not think this line of argument can be sustained. The note issue being limited by law, it cannot be assumed that in extending the limit the legislative authority (in this case the Government acting by decree) was guided by any other motive than the public interest. If the public interest dictates the amount of the currency, then the profits' of issue are correspondingly limited. Any encroachment on the assets by which the issue is backed and from which the profits are. derived is a dead loss to the issuing authorities.

It may perhaps be objected that in the case of Portugal the legislative authority avowedly did not determine the extension of the note issue according to the public interest. Alongside the more



1932] THE PORTUGUESE BANK NOTES CASE 397

permanent increases was one of 100,000,000 which was expressly redeemable out of the damages to be received from Waterlows. It was a temporary extension. It was presumably in excess of normal requirements, and its inflationary effect would be none the less on account of its temporary character.

But it is in any case a mistake to suppose that a bank of issue necessarily can recoup itself for its losses by increasing its issues. Apart from any gold and foreign exchange that it may hold, its assets are themselves expressed in the national currency unit and are subject to the same depreciation as its note issue. Banks of issue are not usually allowed to profit by an addition to the currency value of their gold holdings through depreciation, and it is unlikely that such other " real " values as the bank might hold would be enough to safeguard its private capital against depreciation.

A court of law may sometimes legitimately proceed on the assumption that money remains invariable in value. But it could hardly adhere to that assumption if it were at the same time supposing that the issuing authority was free to increase the supply of currency at its discretion.

It is not easy to formulate the monetary policy of Portugal with precision. Up to 1924 the currency had been rapidly depreciating and the escudo touched its minimum gold value of 2-8 cents (U.S.A.) in July 1924. By July 1925 it had recovered to 5 1 cents, and at the time of the discovery of the forgeries in December 1925 it had been pegged at that rate or about 96 to ?1 for five months. The pegging was effected by exchange control rather than by convertibility. Nevertheless, the rate prevailing in the illicit open market did not differ much from the official rate. The official rate was modified to 99 to ?1 in 1927. In the course of 1928 the open market rate, after fluctuating rather wildly for a short time, was stabilised at about 108, the official rate becoming merely the rate at which a certain portion of the foreign exchange derived from the export trade was requisitioned by the Government.

At last, in June 1931, the exchange was stabilised by law at 110 to ?1.

Whatever the precise significance of these measures may have been, they at any rate imply a serious preoccupation with the exchange value of the currency and a desire to guard against a recrudescence of depreciation. And there is no evidence to show that the extension of the issues in 1926 either was intended to allow a further depreciation or actually had that effect. In



398 THE ECONOMIC JOURNAL [SEPT. 1932

fact the note issue did not vary materially in the period 1925-7, as the following figures show a

Note Issue.

(Millions of escudos.)

Dec. 1924 . 1763 Dec. 1925 . . 1821 Dec. 1926 . . . 1854 Dec. 1927 . . . . 1857 Dec. 1928 . . . 1976

It was only when a stable free open market rate was attained in 1928 that the note issue increased to any material extent.

The Portuguese authorities were pursuing an eminently sane and rational monetary policy. Their methods may not have been above criticism, but any device for compensating the Bank of Portugal for its losses by a bit of inflation would have been flagrantly inconsistent with that policy. The " piece of paper" argument was utterly out of place.

The upshot would. seem, therefore, to be that justice was done. The House of Lords rejected all the fallacious arguments, and arrived at the correct decision.

If the view of the dissentient judges makes some appeal to common-sense, that is perhaps because it is hard on the manufacturer whose scale of financial operations is based on the mere cost of production of the notes to be exposed by an accident to a liability of an entirely different order of magnitude, arising from the face value of the notes. A fraud of this kind is an accident. There may be negligence. But even if Messrs. Waterlow were negligent, that was not part of the case. It was not material to their liability for breach of contract. Con- sequently, the fraud may be regarded as a mere accident, and the question was, who was to bear the loss ? Was it to be those who manufactured the notes or those who used them ? The ground for placing it upon the manufacturers was that it was they whose precautions (whether negligently taken or not) failed to prevent the fraud. A manufacturer of explosives assumes a certain liability for accidents, and he cannot pass it on to his customers on the ground that they procured him to manufacture the dangerous product. The apparatus for the manufacture of bank notes has an explosive quality, and whoever undertakes the business does so at his peril.

R. G. HAWTREY



bank note case (r.g. hawtrey)

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