ABSTRACT

Despite these potential benefits, option clauses have received very little attention from economists, and most of that has been unfavourable. Adam Smith condemned them in The Wealth of Nations (1776: 290-1), and most succeeding economists who have discussed the issue have agreed with him (e.g. Graham 1886: 65; Kerr 1918: 74; MacLeod 1896: 188-9 and Whittick 1896: 67-9, to mention only four). Significantly, though, the only writer to examine the issue in any detail at all was Meulen (1934),1 and he was unequivocally in favour of them. He argued that option clauses would stabilize a free banking system as well as promote the replacement of gold by paper and thereby encourage the further spread of credit. This chapter takes up where Meulen left off and analyses further the potential of option clauses to stabilize the banking system. The chapter first outlines how a laisse~-faire banking system driven purely by private interest might develop the option clause to deal with the problem of potential illiquidity to which fractional reserve banking is otherwise subject. It then

suggests reasons why individual noteholders would be prepared to accept option-clause notes in preference to notes convertible on demand - an important point which Meulen glossed over - and discusses how option clauses would both protect the banking system against liquidity crises and reduce the probability of such crises occurring in the first place. It then goes on to consider the historical experience of option clauses in Scotland in the period 1730-65. This clearly confirms the claim that option clauses would be acceptable to the public and is not obviously inconsistent with the claim that option clauses would help to stabilize the monetary system.