The Portuguese Bank Notes Case

Author(s): R. G. Hawtrey
Source: The Economic Journal, Vol. 42, No. 167 (Sep., 1932), pp. 391-398
Published by: Wiley on behalf of the Royal Economic Society
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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 representing 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,
D D2

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392

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[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

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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 offering 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

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394

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[SEPT.

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 onesixth 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

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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

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396

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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 Government 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

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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

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1932

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

Note Issue.
Dec.
Dec.
Dec.
Dec.
Dec.

(Millions of escudos.)
1924
.
.
1925
1926
.
.
.
1927
.
.
.
.
.
1928

.
.
.

1763
1821
1854
1857
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. Consequently, 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

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