|An inquiry Into The Currency Principle|
REVIEW OF THE CURRENCY PRINCIPLE IN ITS APPLICATION TO OUR BANKING SYSTEM.
If the views which have thus far been unfolded are admitted to be correct, it can hardly fail of being seen as a fair deduction from them, that the whole of the ground on which the theory of the Currency principle proceeds is unsound. The error of supposing that, if the currency were purely metallic, every export or lin- port of bullion would be so much taken from or added to the quantity of money in circulation, is so obvious, so palpable, as to make it a matter of surprise that such a notion should ever have been entertained. And must it not, as an inevitable consequence, follow that it is equally an error to suppose that the paper money, if administered upon the footing proposed by the currency doctrine, of a single source of issue, having a fixed amount on securities, and beyond that, exchanging only paper against gold, and vice versa, would vary in amount and value in the hands of the public, with variations in the quantity of bullion exported or imported, or in the quantity of bullion in the coffers of the Bank?
I would not misrepresent the doctrine; but in- stances innumerable might be adduced from the writings, and from the examination by the Committee on Banks of Issue, of the advocates of that doctrine, that it goes to the full extent here stated; tabular statements being exhibited of the discrepancies between bullion in the Bank and notes out of it, with a view to prove, according to the occasion, sometimes against the country banks, and sometimes against the Bank of England, the charge of mismanagement. One source of their error is their imagining that, in their supposed Bank of exclusive Issue, the notes paid for gold exported must necessarily be taken from out of those circulating among the public, and that the gold imported would be taken to the Bank m exchange for bank notes, which would go into the hands of the public; and they hold it to be the opprobrium of the present system, that this is not now the case. It must, however be clear, if I have made myself at all intelligible, that in neither case would it necessarily or generally be the case, or rather, it would be rarely so, under a single bank of issue; and, except under extraordinary circumstances, the amount of notes in the hands of the public would be nearly, if not quite, the same under one system as under the other.
It may be asked, and the question is a very natural one for those who are impressed with the notion that bank notes are operative by their amount, and who are not aware of the distinction between currency and capital, how it is that the Bank of England, or the banks collectively, if they cannot contract the circulation, (as I maintain that they cannot by any direct operation,) nor operate through that medium on the prices of commodities, are to be supposed to have the power of influencing the exchanges? The answer is, that it is only by a forcible action on their securities that they can influence the exchanges, so as to arrest a drain, or to resist an excessive influx. By a forcible action on securities is meant a great advance in the rate of interest on the one hand, or a great reduction of it on the other. And the rationale of such operation on the rate of interest is, that it renders disposable capital in the one case scarce, and in the other abundant; forcing it from foreign countries in the former, and to them in the latter case. The effect of the pumping in or forcing out of bullion by this means is infallible; and the only practical question is of the moral, or commercial, or political considerations, which may interfere with the full exertion of the power.
A forcible operation by the Bank on its securities, in either direction, will not, of necessity, as I have shown, be attended with an immediate or direct effect on the prices of commodities. The effect, if any, can be only indirect, through the medium of credit, and dependent on the previous state of the market.
I have before had occasion to notice, in referring to the examinations of the country bankers, the con- founding of currency with capital, which was observable in the questions put by some of the members of the Committee. That confusion, being traceable to the deep-seated impression which they seem to have been under, that the amount of bank notes in the hands of the public was the main point for consideration, as having a direct and an important influence on prices, and on credit, and on trade, instead of being as it is, a mere effect or indication of the circum- stances which call out and maintain that amount. The same wedded attachment to the doctrine of the Currency principle which looks to bank notes, and to bank notes only, as the primum mobile in our monetary system, may account for the little research which the Committee made into the causes and effects of variations in the rate of interest, and for the strange misconception which pervaded the questions relating to that point, of those of its members who took a leading part in the examinations. They seem from first to last to have looked upon variations in the rate of interest as of importance only, inasmuch as those variations might be supposed to affect the amount of the circulation.
In point of fact, the liability to variation, greater or less, in the rate of interest, constitutes in the next degree only to the preservation of the convertibility of the paper, the most important consideration in. the question whether the present system, with some amendment, should be continued, or some one or other of the numerous schemes for a government or national bank should be substituted for it. Mr. Bosanquet, in his publication, to which I have alluded, entertains such exaggerated views of the disastrous effects on the commerce of the country, of a considerable advance in the rate of interest, which he seems to consider as an alteration of the value of the currency, that in his scheme for a bank or banks of issue, he would prescribe a compulsory maximum and minimum of the rate, variable between six and four per cent, according to certain rules which he lays down with reference to the exchanges: and rather than allow a forcible operation on the rate of interest, in order to stop a drain on the treasure of the Bank, he would resort first to a temporary issue of 1 l. notes, and if that should prove insufficient, suspend the convertibility of the paper! How any well-informed person, not of the Birmingham school, could seriously propose to have cash payments suspended, rather than that the mercantile community should be subjected to some inconvenience from an advance in the rate of interest, and what he chooses to consider as a necessary consequence, a fall of prices, is to me matter of unutterable surprise. It may serve as a proof of the exaggerated views entertained in some quarters of the effects of a forcible operation on the rate of interest, and it forms a contrast to the little attention paid to that point, not only by the committee on Banks of Issue, but by the propounders of the various schemes for a government or national bank.
Now, without attaching such exaggerated importance as Mr. Bosanquet and Mr. Gilbart, and some others who oppose the currency principle do, to the effects of great variations in the rate of interest, I am inclined to think, that excepting the convertibility of the paper and the solvency of banks, which are and ought to be within the province of the legislature most carefully to preserve, the main difference between one system of banking and another, is the greater or less liability to abrupt changes in the rate of interest, and in the state of commercial credit incidental to one as compared with the other; and a careful consideration of the various plans which have been submitted to the public for carrying out the currency principle, has led to a confirmation of the opinion which I have before expressed, that under a complete separation of the functions of issue and banking, the transitions would be more abrupt and violent than under the existing system; unless, and upon this, in my opinion, the question hinges, the deposit or banking department were bound to hold a much larger reserve than seems to be contemplated by any of the plans which I have seen.
The difference between the two systems cannot be placed in a more striking point of view than in the following passages of a printed letter which Colonel Torrens addressed to me on occasion of the opinions which I had expressed on the subject in a former work.
The difference," Colonel Torrens says, "between us is this, you contend that the proposed separation of the business of the bank into two distinct departments would check over-trading in the department of issue, but would not check over-trading in the department of deposit; while I maintain, on the contrary, that the proposed separation would check over- trading in both departments. The manner in which the separation would have this two-fold effect will be seen by the following example.
"Let us assume that the bank holds 18,000,000 l. of securities and 9,000000 l. of bullion, against 18,000,000 l. of out- standing notes and 9,000,000 l. of deposits, and let an adverse exchange require that the depositors should draw out their deposits in bullion to the amount of 3,000,000 l. "In this case, if the business of issue were mixed up with that of deposit, the drawing out of the 3,000,000 l. of deposits in bullion would have no other effect than that of reducing both deposits and bullion by the amount of 3,000,000 l., while the amount of the circulation and of the securities, and the power of the bank, as its securities fell due, to continue the discount business to the same extent as before, would suffer no diminution. But let the department of issue be wholly separated from that of deposit, and the result would be widely different.
"As soon as the separation was effected the deposit department holding 9,000,0001. of deposits with 9,000,000 l. of securities would be obliged to sell some part of its securities, say one-third, in order to be prepared to meet the demands of its depositors. The state of the two departments would then stand thus Circulating Department.
|Reserve in bank notes||3,000,000|
"This being the previous state of things, the demand of the depositors for 3,000,000 l., in gold would produce the following changes. The 3,000,000 l. of bank notes held by the deposit department as reserve would be drawn out by the depositors and paid into the circulating department in exchange for gold, while the directors of the deposit department, in order to recover a reserve equal to one-third of their deposits would be obliged to sell 2,000,000 l. out of the 6,000,000 l. held in securities. The results would be, that in the circulating department the bullion would be reduced from 9,000,000 l. to 6,000,000 l., and the circulation from 18,000,000 l. to 15,000,000 l., and that in the deposit department the deposits would be reduced from 9,000,000 l. to 6,000,000 l., the securities from 6,000,000 l., to 4,000,000 l., and the reserve from 3,000,000 l. to 2,000,000 l. It is self-evident that the effect of these changes would be not only a contraction of the circulation but a limitation to the power to over-trade in discount and loans."
I am willing to admit this statement as exhibiting in substance the difference between us. According to my view, as there may be variations of international payments, in other words, of a balance of trade, without any grounds for inference of alterations in the value of the currencies of the countries from which or to which such balance may be due, the presumption is, that an occasional efflux of four or five or six millions would be followed at no distant period by a fully equal reflux. Such was the case in 1828-29 and 1831-32, when the treasure of the Bank having been reduced by five or six millions was replenished without the slightest operation of the Bank on the amount of its securities, or its rate of interest. And such efflux and reflux might again take place under a continuance of the present system, provided that the Bank habitually held a large reserve, without any disturbance of the money-market, and without any influence on the amount of bank notes in the hands of the public. Now, under a system of separation, and in the position of the two departments in the case supposed by Colonel Torrens, what would be the operation of a demand for export to the extent of three millions of gold? In all probability, this demand would almost exclusively fall upon the deposit department.
This being the case, the Directors would not have a moment to lose upon the first manifestation of such demand, without taking measures for retaining or restoring the proportion of their reserve. They must sell securities, or allow the existing ones, if short-dated, to run off, and they must inexorably shut their doors to all applications for advances or discounts. This would, as Colonel Torrens justly observes, operate as a limitation of the power to over-trade in discount and loans. Most effectual, indeed, would it be, and under certain circumstances of the trade, it would operate with a degree of violence on the state of credit of which, as it appears to me, Colonel Torrens has no adequate idea. This is not to be wondered at in a writer not practically conversant with trade or banking; but that other advocates for the measure of separation, who number among them merchants and bankers, should be so unaware of it as they seem to be, does indeed surprise me. Before two or three millions of bank notes could be forcibly abstracted from the amount in circulation among the public, the pressure upon the reserves of the London bankers must be extreme. They would, of course, to the utmost extent practicable, call in their loans, and resolutely refuse further accommodation.
Although there is no modern experience of such a state of things, if any merchant, banker, or money- dealer were to have the case laid distinctly before them, could any of them for a moment have a doubt as to the extremity of pressure which it would cause? I am most intimately persuaded that it would be within the mark to suppose that a rate of discount (assuming that the doors of the Bank and the ears of the Directors were inexorably closed against all applications) of 20 per cent and upwards would, in many cases, be submitted to, and sacrifices of goods, if any large proportion were held on credit, would be made at a still greater loss. And, after all, it might be a question, whether even this effort of the Bank on its securities would be effectual in restoring its reserve in sufficient time to meet the exigency. This would depend entirely upon the character of its deposits. If these were strictly payable on demand, while the circumstances determining the efflux were strong and urgent, the payment of 3,000,000 l. accompanied by forced sales of securities might prove insufficient in point of time to arrest the demand; and in this case, while the circulating department would still have 6,000,000 l. of bullion, the deposit department would have no alternative but to stop payment. A most absurd, however disastrous a state of things. But it would be too disastrous, and too absurd to be allowed to take its course. If such a crisis were to happen, as most probably it would at the time when the dividends on the public funds became due, the Government would be imperatively called upon to interfere and prevent so ridiculous, however lamentable, a catastrophe. And the only interference that could meet the emergency would be to authorise a temporary transfer of coin from the issuing to the banking department.
The truth is, that no bank of mere deposit could undertake the Government business, involving an annual receipt and expenditure of 50,000,000 l., subject to deficiency of the revenue at one time, and to overflow at another, with so small a reserve as 3,000,000 l., whatever its other business might be; and it is difficult to conceive how it could, without the profit of the circulation, afford the much larger amount which would be requisite: But this is a point which it is foreign to my purpose to discuss. What I have to observe is, that supposing the violent effort of the Bank, on its securities, to be effectual, there cannot be a doubt that the violence of the effort would have been attended with inconvenience to the public. And all this inconvenience may have been purely gratuitous, as a sacrifice to the currency principle; because the utmost demand for gold might have been satisfied by an export of 3,000,000 l. or 4,000,000 l. which, under a system of union of issuing and banking, would have been attended, as in the instances of 1828-29, and 1831-32, with no inconvenience whatever.
But it may be asked; and here is the point; supposing that the demand for export of bullion be such that not three or four millions, but nine or ten mil- lions will be required to satisfy it. What then becomes of a plan of quiescence? My answer is, that I would not be accountable for a plan of quiescence upon an amount of treasure in the Bank not exceeding nine millions at the outset of a drain. It was an error of the Bank in 1839, to have been perfectly quiescent until a loss of treasure from 9,336,000 l. to 5,119,000 l. had taken place. And the only effort then made was an advance of the rate of interest, step by step, to 6 per cent, and a reduction of the date of the bills admissible for discount from ninety days to sixty days; the limitation of days being of much more importance than the increase of the rate.
This effort was altogether inadequate; a difference in the rate of discount of 2 per cent per annum, is a trifling consideration on bills having at the utmost sixty days to run; and accordingly, the Bank did not only not succeed by these measures in reducing its securities, but, as was inevitable as long as the door for discounts was left open, actually increased them. So that with advances on deficiency bills, the securities instead of being diminished, were actually increased by three or four millions during the greatest pressure of the drain. Still, with the aid of the credits on Paris, the drain was surmounted; and although this last resource was any thing but creditable, yet, inasmuch as the crisis was thus got over, merit may be claimed in behalf of the system for having come through with little, if any, suffering or inconvenience, commercial or financial. The markets for produce were perfectly undisturbed, there were no mercantile, or manufacturing, or banking failures of any note, and there was no great fall in the prices of public securities; so that the actual inconvenience proved to be in effect very unimportant. This exemption from suffering or material inconvenience, in surmounting the drain was, as some may think, and I among them, dearly purchased: but so it was.
Now, how would the case have stood, if the separation had existed in 1839?
Taking the actual situation of the Bank in January, 1839, and on the supposition of a separation of the functions, allotting twelve millions of securities (instead of nine millions, an amount obviously too low) to the circulating department, the two branches would have stood as follows: Circulating Department.
Upon the occurrence of the demand for gold (which would naturally be, and was in point of fact made, by depositors in the banking department), and which was to the extent of a little more than a million between January and March, it may be taken. for granted that the directors would see reason to sell or to allow the running off of securities to the same extent, and if they at the same time shut their doors against discounts and advances on deficiency bills, their liabilities would be reduced to the same extent. The notes would be taken from the banking to the circulating department in exchange for gold, and leave the amount of the circulation in the hands of the public without any alteration. And this process might by supposition have continued till the remain- ing bank notes were transferred from the banking to the issuing department, without producing the slightest effect on the amount of the circulation in the hands of the public.
A forcible reduction, however, of the securities to the extent supposed, would doubtless have abated the force of the drain, and might possibly have overcome it; but seeing the combination of circumstances which led to that drain, it may fairly be doubted whether the effort here assumed would have been sufficient to arrest it. My strong conviction is, that it would not have been sufficient, if even it had been practicable; but I doubt whether it would have been practicable. Notwithstanding the endeavours of the directors, when their attention had been fully roused to the importance of taking measures of precaution, and notwithstanding a rise in the rate of discount and a limitation of the date of bills admissible, the securities not only were not reduced by three millions, as I have supposed they would be under a separation, but were actually increased by three millions, partly by advances on deficiency bills. Now between a withdrawal from employment of disposable capital to the extent of three millions, and an actual advance to the same amount, is a difference of six millions. Such a reduction, suddenly effected, in the amount of available capital in the hands of the public, could not fail to be attended with very important and highly inconvenient effects. The state of credit would necessarily be deranged, as would be the markets into which credit entered largely.
But great as might be the inconvenience, it ought to be submitted to rather than that the Bank should fail in its engagements.
What I wish to impress by this view is, that by the separation, the banking department would not have time to judge of the nature and probable extent of the drain, but must take forcible measures for self-preservation upon the first manifestation of it. And with only such a proportion of treasure, that is, of bank notes and coin, as has hitherto been supposed necessary to allot to it, the chances are, that under such circumstances as occurred in 1839, (as also, indeed, in 1835 and 1836,) the measures to be taken to arrest a drain, however prompt and forcible, might not be effectual in sufficient time to prevent a sus- pension of payment by the banking department; while, by the time gained under a system of union, and the aid to the treasure of the deposit department by gold obtained from the circulating department, the pressure might be greatly diminished, and eventually got over, without any inconvenience to the public.
But then again comes the question, What is the security that the pressure would be eventually got over, and the convertibility of the paper preserved?
I have on this point only to refer to the opinions which I have on former occasions expressed, and which all the additional light since thrown upon the subject by the mass of information contained in the Reports of the Committees on Banks of Issue, and by the currency pamphlets, and, above all, by recent experience, has tended to confirm and strengthen.
In a work published in the spring of 1838, I took occasion to observe, "that as far as the eventful experience of the last fourteen years, viz, since 1824, can serve as a guide for judgment, there appear to be good grounds for believing that not less than 10,000,000 l. can ever be considered as a safe position of the treasure of the Bank of England, seeing the sudden calls to which it is liable." And two years later, in February 1840, I ventured to suggest the following plan as that according to which, as it appeared to me, the circulation might be conducted with the greatest convenience to the public, and with the least danger to the convertibility of the paper
"The plan which I would propose is, that when the tide of the metals sets fully in again, the Bank rate of discount should be kept so steadily above the market rate, as progressively to reduce the securities through that channel, without increasing them by other investments. The effect of this would be to ensure a replenishment of their coffers to ten millions; and with the purpose of endeavouring to preserve that amount on an average, it would not be expedient on the part of the Bank to take any active measures for the increase of its securities. It is not improbable, judging by the strength and fulness of the tide with which the metals have flowed in on some former occasions, that the amount might thus reach fifteen millions, beyond which, according to analogy from former experience, it is not likely that it would go. The probability is, that in the fluctuations to which our trade, particularly that in corn, is liable, the exchanges would take an adverse turn; bullion would flow out, the market rate of interest would rise to the Bank rate, and then it would be that the advantage of the large stock of bullion would be felt; because to the extent of five millions the foreign exchanges or internal demand might be allowed to operate upon the stock of bullion, without the necessity on the part of the Bank to counteract that demand by any active measures in raising its rate of discount or selling its public securities. The quantity of money in such case in actual circulation would not be reduced, excepting in a small proportion only, to the reduction of the amount of bullion, because the withdrawal of deposits would, under the alight pressure on the money market which would attend a rise in the market rate of discount to the Bank rate, restore to the circulation an amount of Bank notes nearly equivalent to that which had been in circulation against the bullion taken out. In the majority, of cases of the variations in the value of our currency relative to the currencies of other countries, whether originating on this side or the other, the balance of payments would m all probability be satisfied by the export of that amount of bullion. If the drain, however, on the coffers of the Bank should, after a reduction to ten millions, continue so as to give reason to apprehend the existence of more extensive and deeper seated causes of demand for the metals, measures might be taken for its counteraction, without producing alarm and disturbance of the money market on the one hand, or endangering an extreme and unsafe degree of reduction of the Bank treasure on the other.
"A latitude for variation between fifteen millions and five millions would afford a much greater exemption from shocks on the money market than a variation, as it has recently been, between ten millions and nothing.
"That the Bank might, by a regulation of its securities, maintain a high average amount of - bullion, such as has here been suggested of fully ten millions, cannot admit of any reasonable doubt. And I believe that such a regulation would be more easily practicable than either that of maintaining the securities even, or of preserving the bullion in any given proportion to the liabilities. The money market would be less liable to be disturbed than under either of the two latter alter- natives. The utmost alteration of the rate of discount to which the Bank might have occasion to resort would probably not exceed 1 per cent; and the occasions for an alteration even to that extent would probably be rare. A system like this would be less restrictive, that is, the principle of limitation would operate less rigidly under such a regulation of the bullion, consistently with a blending, as at present, of the issue and deposit departments in the Bank of England, than by their total separation."(31)
After the lapse of four years since the passage here quoted was written, I see nothing to alter in this recommendation. The treasure has reached the maximum which I had contemplated; and this circumstance will render more practicable any scheme of regulation which should have for its object the maintenance of a high average amount of treasure. The main objection or difficulty in the way of maintaining so large an average amount of treasure as ten millions, is in its unproductiveness, and its consequent drawback from the profits of the Bank: but against this consideration must be set the greater security of its position; and, after all, the amount is not larger than any prudent banker would deem it right to hold against liabilities so large and so fluctuating as those of the Bank of England.
In addition to this objection, which naturally has great weight, I took occasion in the same work, p. 198, from which the foregoing passage has been extracted, to state another, which, although in my opinion of no real weight, is so specious and popular that the remarks which I then made upon it may be worth here repeating.
"One among other reasons that might and probably would be urged against any scheme involving so large a reserve of bullion as has here been suggested, rests on the supposition that the attracting of the extra amount must be preceded by, and attended with, an undue and unnatural contraction of the currency, the effect of which would be, a depression of prices to an unnecessary extent.
"This is a consideration with a view to the public, which, coinciding as the reasoning does with the objection on the score of profit, to a large reserve, it is probable weighed with the Bank directors in their efforts to stop the influx, and to get rid of what they seem to have considered the excess, of bullion, in the spring of 1838. With reference to the influx at that time, Mr. Norman, in the tract before quoted, observed,
"It is probable that an increase will be found in the treasure of the Bank, between its lowest amount last spring and the highest just previous to the next turn of the exchanges, of from seven to eight millions. Now such an influx of treasure is unnatural, and could never occur with a metallic circulation. Its effects, greater or less in proportion to the error. will be accompanied in the first instance by a depression of prices, unnecessary in extent and continued too long, and finally by a reaction, which will occasion an equally unnecessary and faulty excess on the other." p. 91.
"Why such an influx of treasure could never occur with a metallic circulation, or why it should be considered as unnatural, does not very clearly appear. With our very extended foreign trade, which is habitually conducted on the footing of a large proportion of our exports being on long credits, while our imports are mostly paid for at short dates, and with our present restrictions on the corn trade, there might be, as there have been, on the one hand, large sudden payments abroad requiring a considerable export of bullion before any excess of merchandise exported could bring returns; and, on the other hand, when the demand for corn and for other imports, including foreign securities, ceased or abated, the returns for an excess of former exports would be coming forward, and bullion must in that case form, for want of other means, a large part of such returns. Such was the case in 181516, in 182022, and, excepting as regards corn, such was the case with the influx of bullion in 1826, and in the early part of 1838. If the ports should be shut against the importation of corn for the next two or three years, and, at the same time, from salutary distrust or other causes, there should be a diminished demand for foreign securities, there is likely to be a strong tendency to an influx of the metals, and it is not easy to understand why it should not be equally strong with a purely metallic variation. The Bank of England may doubtless, as in 1836 and 1838, by a competition for the investment of its deposits, create a renewed demand for foreign securities, and so stop the influx of bullion; but so the deposit department likewise might do if its functions were separated from the issuing department.
"But it is to the supposed unnatural depression of prices, ascribed as an effect of the contraction of the circulation which is assumed to lead to the influx of the metals, that my remark is directed. This hypothesis rests upon the currency theory of prices, which supposes that the contraction of the circulation, in such a case as that alluded to, reduces prices, and that the reduced prices force an influx of the metals; whereas the contraction, or rather the diminution of the circulation, is in such cases the consequence of a fall of prices from causes arising from the state of trade, and peculiar circum- stances affecting the supply and cost of production on the one hand, and consumption on the other. As to an increased value of the precious metals, which might be supposed to be the consequence of retaining permanently an addition of fully five millions as a reserve in the coffers of the Bank, it would, according to any received grounds of computation, amount to so very minute a per centage, as to have no perceptible influence, and may, therefore, safely be neglected."
The views which have here been presented for consideration, lead to the conclusion that a union of the business of banking with that of issue, when conducted by well regulated banks, is calculated to be much more convenient to the public than a separation of those functions.
Mr. Norman and Mr. Loyd have, very wisely as I think, refrained from committing themselves to any specific plan for carrying their views of the separation of functions into effect. Other writers who have espoused the same views have not been so cautious; and numerous, therefore, have been the schemes which have been proposed for establishing a single source of issue, and, for the most part, a government bank. It is not my purpose to enter into a detailed examination of any of them; but I cannot help remarking that, among those which have come under my notice, the greater part are crude and undigested, while some of them are so fanciful as to border on the burlesque. I have seen none in which the supposed advantages of the plans sketched out are not greatly exaggerated; while the inconveniences attending so great a change are underrated in the same degree, and in all of them the arguments urged in favour of the proposed alteration proceed upon a complete misconception of the nature of the machinery, and the working of the present system, which they seek to displace.
SUMMARY OF CONCLUSIONS.
The conclusions which I have thus endeavoured to establish are,
1. That if a purely metallic currency existed in a country situated as this is, transmissions of the precious metals might and would take place occasion- ally between this and other countries to a considerable amount (five or six millions at least), without affecting the amount or value of the currency of the country from which or to which the transmissions were made; and without being a cause or a consequence of alteration in general prices.
2. That consequently the doctrine by which it is maintained that every export or import of bullion in a metallic circulation must entail a corresponding diminution of, or addition to, the quantity of money in circulation, and thus cause a fall or rise of general prices, is essentially incorrect and unsound.
3. That the distinction set up by the currency theory between bank notes and other forms of paper credit, is not founded in any essential difference, except in so far as relates to the lowest denomination of notes, which are required in the transactions between dealers and consumers; that is, in the retail trade, and in the payment of wages.
4. That bills of exchange might, but for the obstacle of stamp duties, be extensively substituted in all transactions of purchase and sale between dealers and dealers for bank notes of 10 l. and upwards, and that, in point of fact, they were extensively so used until a disproportioned duty was laid upon the smaller bills.
5. That cheques perform the functions of money as conveniently, in most respects, as bank notes, and more conveniently in many respects.
6. That bank notes of the higher denominations are used for peculiar purposes, chiefly in settlements, such as the clearing house, and in sales of landed and fixed property, as regards Bank of England notes; and in the provision markets and cattle fairs, as regards the country circulation; purposes for which substitutes might easily be found if bank notes were suppressed, by bills of exchange, and as regards the settlements among bankers, by exchequer bills, and by what have recently been termed economical expedients.
7. That the amount of bank notes in the hands of the public is determined by the purposes for which they are required, in circulating the capital, and in distributing the revenues of the different orders of the community, valued in gold.
8. That it is not in the power of Banks of Issue, including the Bank of England, to make any direct addition to the amount of notes circulating in their respective districts, however disposed they may be to do so. In the competition of Banks of Issue to get out their notes, there may be an extension of the circulation of some one or more of them in a large district, but it can only be by displacing the notes of rival banks.
9. That neither is it in the power of Banks of Issue directly to diminish the total amount of the circulation; particular banks may withhold loans and discounts, and may refuse any longer to issue their own notes; but their notes so withdrawn will be replaced by the notes of other banks, or by other expedients calculated to answer the same purpose.
10. That it is consequently an error to suppose that, however well informed the country bankers might be of the state of the foreign exchanges, and disposed to follow those indications, they would be able to regulate their circulation in conformity with such views. And that it is equally an error to suppose that the Bank of England can exercise a direct power over the exchanges, through the medium of its circulation.
11. That neither the country banks nor the Bank of England have it in their power to make additional issues of their paper come in aid of their banking resources. All advances by way of loan or dis- count, when the circulation is already full, can only be made by Banks of Issue in the same way as by non- issuing banks, out of their own capital, or that of their depositors.
12. That the prices of commodities do not depend upon the quantity of money indicated by the amount of bank notes, nor upon the amount of the whole of the circulating medium; but that, on the contrary, the amount of the circulating medium is the consequence of prices.
13. That it is the quantity of money, constituting the revenues of the different orders of the State, under the head of rents, profits, salaries, and wages, destined for current expenditure, that alone forms the limiting principle of the aggregate of money prices, the only prices that can properly come under the designation of general prices. As the cost of production is the limiting principle of supply, so the aggregate of money incomes devoted to expenditure for consumption is the determining and limiting principle of demand.
14. That a reduced rate of interest has no necessary tendency to raise the prices of commodities. On the contrary, it is a cause of diminished cost of production, and consequently of cheapness.
15. That it is only through the rate of interest and the state of credit, that the Bank of England can exercise a direct influence on the foreign exchanges.
16. That the greater or less liability to variation in the rate of interest constitutes, in the next degree only to the preservation of the convertibility of the paper and the solvency of banks, the most important consideration in the regulation of our banking system.
17. That a total separation of the business of issue from that of banking is calculated to produce greater and. more abrupt transitions in the rate of interest, and in the state of credit, than the present system of union of the departments.
There has recently been a good deal of animation in the markets for colonial produce, attended with a rise in the prices of several articles. And this improvement, and the speculative feeling with which, as usual on such occasions it is accompanied, have been, according to the prevailing doctrine which enters into all the reasonings of brokers in their circulars, and into the accounts furnished to the newspapers, ascribed to the abundance of money. Now I would, in the first place, ask those who assign this as the cause of the recent advance of prices to point out a single article in respect of which there are not, in the opinion of persons most conversant with the market, sufficient grounds, by reference to the actual and contingent supply compared with the rate of consumption, to justify a rise of price. A rise, be it observed, from a lower point of depression, in the case of several of the articles, than had ever been known, and in some cases below the lowest cost of production.
During the great and long continued fall, the dealers both wholesale and retail, and the manufacturers, having been repeatedly disappointed, by finding the price give way after they had got into stock, became disposed to run off their existing stocks before they re-embarked in fresh purchases. From the extensive prevalence of this disposition, there has been, in some of the leading articles of merchandise, a great reduction of stocks, both of raw produce and of finished goods, in the hands of dealers, and manufacturers, and shopkeepers; at the same time, the unprecedentedly low prices had extended the consumption both at home and abroad. Attention being at length drawn to this state of things, and confidence being acquired that prices had seen their lowest, a general disposition has naturally arisen to get into stock. Now it must be clear that, if a disposition among dealers and manufacturers to get out of stock is attended, as it is known to be, with dull and declining markets, a disposition to replenish their stocks when greatly reduced cannot fail of having an opposite effect. And as they erred in too confident an anticipation of a further fall of prices, they are liable to err in the opposite direction.
That some rise of prices, under such circumstances, is a necessary result, must be obvious. The degree of the rise must be matter of opinion, in the exercise of which there must be much latitude for miscalculation, till it be brought to the test of facts, viz, the supply and the consumption; the demand by consumers being the ultimate limit to the returns to be received by the wholesale purchasers, whether manufacturers, dealers, or speculators.
If, therefore, there be, as there can be no doubt that there is, in every instance of the recent rise of prices, a sufficient, or, at least, a plausible, reason for it on the plain mercantile ground of supply compared with consumption, why call in the aid of abundance of money, meaning the low rate of interest, as a cause originating or even contributing? And why, if the low rate of interest is the present stimulus to purchases, did it not stimulate dealers and speculators a twelve-month ago, when the rate of interest was as low as it is now, or only six months ago, when there was not a trace of a speculative tendency in the markets for commodities? or why, above all, did it not operate in deterring the dealers and manufacturers from getting out of stock, and in thus arresting the decline of prices which (with the exception of those of corn) took place nearly, pari passu, with the fall in the rate of interest, or as it would in the modern use of the word be called, the increasing abundance of money from 1840 to the summer of 1843?
I have just now before me some of the circulars of the most considerable brokers in the markets for colonial produce; for it is in these that the recent advance of prices has given occasion to the supposition that what is called the abundance of money has been the cause of the rise. And it is not a little amusing to observe, that while the writers of the circulars think it incumbent upon them, according to the prevailing fashion, to ascribe considerable influence to the abundance of money, the information which they convey, respecting each of the articles that has been the subject of advance, is quite decisive in proving that the recent rise of prices has nothing to do with the low rate of interest, but is in each instance amply justified upon the simple and obvious ground of a diminution of supply and an increase of the consumption.
So striking and whimsical is this exhibition of the prevalence of what may be called currency pedantry, that although a detailed reference to actual or comparative prices, and the state of markets, formed no part of my plan in this publication, I am induced to give the following brief view of them, as showing how little they bear out the opinion expressed in the circulars, that it is the abundance of unemployed capital that has led to the investments in commodities.
In a circular dated 2d March, 1844, full of just and accurate information of the position of the markets for transatlantic produce, the details relative to that position are prefaced by the following remarks:
"A very large amount of capital, both here and on the Continent, has been employed in the purchase of goods, and almost every article in the Colonial market has already felt the influence of it. These operations have not altogether been influenced by any calculation of supply and demand, but were entered into from a conviction that the lowest point of depression had been reached, and that the abundance of unemployed money and the improved condition of trade were at length about to cause a general advance in prices. This effect has been partially attained; during the past fortnight an increased value of from ten to fifteen per cent. has been realised upon coffee, sugar, rice, and many minor articles, and more animation has been witnessed in Mincing Lane than has existed for the last ten years.
"It cannot be denied that a decided movement has commenced, and that, from many circumstances, it bears the probability of further extension. The great commercial difficulties under which nations have laboured have been mainly surmounted; the financial condition of Great Britain has been materially improved, money is still very abundant, and the Bank coffers are full of bullion. All public funds have increased in value, and investments in railway securities (from their magnitude a most important item) have become less eligible, owing to their advanced price. It was therefore almost an inevitable consequence, that articles of foreign merchandise which bore so depressed a value should attract money to them; and if the operations are confined within reasonable bounds, they seem legitimate enough, but it will become important to keep a watchful eye on the money market."
In former times, and in plain mercantile language, the expression of the first sentence would have been simply, that large purchases had been made, and that prices had risen in consequence a very natural consequence. But the passage following, which I have marked with italics, exemplifies, in a pre-eminent degree, the tendency to introduce the money market, à tort et à travers, into the markets for commodities. If the operations alluded to were not altogether influenced by a calculation of supply and demand, all that could be said of them would be, that they were very silly ones. But it will be seen by the showing of this very circular, that they were very wise ones, proceeding as they are proved to have done, upon a very sound and rational view of supply and demand. Before entering upon the proofs to that effect, I would merely call attention to the last sentence of the above extract, remarking, however, upon it only, that instead of recommending to the operators in the markets for commodities to keep a watchful eye on the money market, the sounder recommendation would be to shut their eyes altogether to it, but to be wide awake to all circumstances affecting the actual and probable supply on the one hand, and the consumption, whether at home or abroad, on the other.
The articles alluded to in the circular as having experienced the most decided improvement are, sugar, coffee, and rice, and the following are the statements respecting these descriptions of produce:
"Sugar.There has been a very steady demand for British Plantation sugar throughout the month, and the West India market continuing very barely supplied, especially with good and fine qualities, and the arrivals of East India and Mauritius being very moderate, prices have advanced 1s. @ 2s., the greatest rise being on the lower descriptions. An additional reason for this improvement is the large increase of the deliveries for the first two months of this year, which not only exceed the same period both of 1842 and 1843, but are in excess of the imports to this date, by nearly 13,000 tons, thus producing a large decrease of stock; to this circumstance may also be added a general belief that the crop in Jamaica will be deficient. The supplies near at hand are not large, prices consequently, are likely to be well maintained, par- ticularly as consumption is evidently so largely on the in- crease,
"The Imports of East and West India and Mauritius into Great Britain amounted to 19,000 tons, against 26,500 in 1843, and 19,900 in 1842; the deliveries to 30,800 tons, against 26,800 in 1843, and 21,000 in 1842; and the stock to 29,800 tons, against 39,500 in 1843, and 28,800 in 1842."
And the demand for foreign sugars, independent of short stocks relatively to the exports, was increased by a prevailing impression of the chance of a reduction of duty.
"Coffee.The business in the home market has been very large, the trade having bought extensively. The imports have fallen off, and the consumption has again increased, and as there cannot be any arrivals of importance for some time, there is a probability of still further advance in price, as the rise in the value of foreign descriptions suitable for the home trade will prevent their being brought into competition. Nearly 13,000 bags of Ceylon have changed hands, at 65s. @ 68s. 6d., which is an advance of 2s. @ 3s. since the first ultimo. In foreign East India sorts 3,000 bags of Java have been sold at 36s. @ 53s.; from 3,000 @ 4,000 bags Padang at 26s. @ 32s.; and 1,500 bales Mocha, at 68s. 75s.
"A very important speculation has taken place in all descriptions of foreign coffee. It commenced in Holland, and has been extended to London, Hamburgh and Antwerp, and will doubtless spread throughout Europe. Statements of an extensive operation were privately put forth in certain quarters as early as the month of November last, and measures were silently prepared which have since been effectually accomplished. Upwards of 300,000 bags (19,000 tons) have been sold here and on the Continent, and an advance of 3s. @ 5s. has been realized in this market These large transactions appeared rather unexpectedly, for although the stocks at the end of the year were less than it was calculated they would be, coffee had been so long subjected to neglect, that it was not a favourite article."
Could there be a better ground for a rise of price than that the stocks were less than had been calculated, and that the article had been long neglected? There seems, likewise, to have been an idea prevalent that some alteration of the duty might take place.
"Rice. In common with many articles of extensive general consumption, rice of late has attracted attention as an object for investment, and large transactions accordingly have resulted therefrom, causing an advance in prices of is. 1s. 6d. per cwt. The quotations for Bengal being now 12s. @ 12s. 6d. per cwt., and Java 9s. @ 12s. No less than 50,000 bags have changed hands in the course of the month, and the market still presents a buoyant aspect. The imports for the first two months amount to 11,300 bags, against 27,200 for the corresponding period in 1843, and the stock stands at 107,000 bags, against 139,600."
The speculation in cotton, and the rapid rise in the price of that article, took place some months ago, when reports of a deficiency of the crop of 1843 began to gain ground. That the crop has been a deficient one is on all hands now admitted; but as the advance of price had some weeks since reached the utmost height, which, as the result of the conflict of opinions and interests, the deficiency of the crop, combined with a view to the rate of consumption, seemed to warrant, this article has not participated in the animation which is described as prevailing in the markets for several other articles of transatlantic produce.
It would weary the reader to go on with a statement respecting other articles which had risen in price. Suffice it to say that there is not one, as to which it is not proved, that, upon the principle of supply and demand, there has been clearly a ground for some advance, and in no one does the rise of price hitherto appear to have been unreasonable.
While Indigo, of which the crop is reported to be unusually large, has of late experienced a fall of up- wards of 20 per cent.
At the same time, several important articles, such, among others, as those of Baltic produce, are in a perfectly quiescent state.
I will only further give an extract from another price current, dated 5th March, 1844, for the purpose of a remark which I shall have to make upon it.
We confess it was always matter of surprise to us to see coffee so long and so fearfully depressed, not being like many things which are deteriorated by keeping; this, on the contrary, improves. The abundance of money having at length caused the attention of capitalists to be turned to goods, coffee has been one of the favoured articles; the speculation commenced abroad, but its influence was soon communicated to our market, causing, as before noticed, a rapid and great advance. The bulk of the transactions here have comprised Brazil and St. Domingo. The impression of many is that prices will be forced up still higher; and this, is more likely to be the case, if, as is stated, the small merchants and shop-keepers abroad are entirely bare of stock.
Here, again, we have the money market gratuitously brought in. It was not the abundance of money that directed the attention of the capitalists (as it is be- coming the fashion to call wealthy merchants), but the low price and long previous neglect of the article. But what I have principally to remark upon is, the observation in the above extract, that the small merchants and shopkeepers abroad had become bare of stock. This process of getting out of stock by the dealers commonly accompanies, and is both cause and effect of declining prices when supplies have increased or consumption fallen off for some length of time, beyond the expectation of the dealers; till stocks have diminished, and consumption has increased, when attention is drawn to them, and a re-action is the consequence.
The best informed merchants and dealers are commonly the first to have their attention so drawn; and, as in the case of the large coffee speculation, which has had its origin in Holland, the parties to it having, the most extensive correspondence on the Continent; were the best calculated and most likely to obtain information, and to act successfully upon it, respecting an article, the supplies of which are derived from many sources, and the stocks and consumers of which are spread over the whole civilised world. They have thus anticipated the smaller merchants and dealers, as is mentioned in the circular. It is not their abundance of capital that directed their attention, for of capital they have long had abundance, but their attention being habitually engaged in the article, they must have been collecting information respecting it for some time, till they became assured that the consumption at the existing prices, which were below the cost of production, was rapidly gaining ground upon the supply; and when they became so assured, they acted upon that view, as they would equally have done, whether the interest of money had been 2 per cent or 5 per cent. The only difference that this makes is, that, in a small degree, they may be induced to realise by re-sale at a lower price than if the cost had been somewhat raised by the charge of higher interest.
I have been induced to notice this point at some length, because I am convinced that opinions like those contained in the extracts which I have quoted are calculated to mislead, by inducing, in those to whom they are an authority, a reliance upon a supposed general cause, which has no existence, to the neglect of the more correct rule of reasoning and acting, according to the best information as to the actual and contingent supply and the rate of consumption. It cannot be too often repeated, that abundance of money in the hands of capitalists is in itself a cause of cheapness, while abundance of money in the hands of consumers is a cause of dearness.
There is one other remark suggested by the accounts in the Circulars, of the animation which prevails in Mincing Lane, and that is, that the speculation which has attracted most attention, namely, that in coffee has had its rise in Holland, and has extended in its effects to other towns on the Continent, as well as to this country; the prices abroad, however, being full as high as here, or, if anything, higher. And I understand that, in the case of nearly all the articles which have recently experienced a considerable advance in this country, the advance on the Continent of Europe is in fully the same, if not in a greater proportion. And, generally speaking, prices on the Continent, I mean of articles of consumption of its population, are fully as high in proportion as they are here, bating corn and such other articles as are subject to high or prohibitory duties in this country. Now, according to the currency theory, prices abroad ought to be depressed, and at a much lower range than they are here, seeing the large quantity of the precious metals which has been abstracted from them to form the accumulation of bullion now existing in the coffers of the Bank of England.
The present state of facts, therefore, may be considered as adding, if any addition were wanting, to the arguments which have in the foregoing pages been adduced to show the unsoundness of that theory.