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• Preface
• Studies In the Theory of International Trade
• Chapter I: English Theories of Foreign Trade, Before Adam Smith: I
• I. Introduction
• II. “ Mercantilism” and “bullionism”
• III. the Balance-of-trade Doctrine
• IV. Reasons For Wanting More Bullion
• V. Employment and the Balance of Trade
• Chapter II: English Theories of Foreign Trade, Before Adam Smith: Ii
• I. Legislative Proposals of Mercantilists
• II. the Collapse of Mercantilist Doctrine
• III. Some Modern Interpretations of English Mercantilism
• Chapter III: The Bullionist Controversies: I. The Inflation Phase
• I. the Participants In the Controversy
• II. the Factual Background
• III. Premium On Bullion As Evidence of Excess Issue: the Bullionist Position
• IV. Qualifications Conceded By the Bullionists
• V. Possible Objections to the Bullionist Position
• VI. the Anti-bullionist Position
• VII. the Balance of Payments Argument
• VIII. the Possibility of Excess Issue By Banks
• IX. Responsibility For the Excess Issue: Bank of England Vs. Country Banks
• X. Responsibility For Excess Issue: the Credit Policy of the Bank of England
• Chapter IV: The Bullionist Controversies: II. The Deflation Phase
• I. the Resumption of Cash Payments
• II. Responsibility of Resumption For the Fall In Prices
• III. the Economic Effect of Changing Price Levels
• IV. Ricardo's Position On the Gold Standard
• V. Reform Without Departure From the Metallic Standard
• VI. Paper Standard Currencies
• Chapter V: English Currency Controversies, 1825–1865
• I. Introduction
• II. the “currency School” -“banking School” Controversy
• III. the “palmer Rule ”
• IV. the Bank Act of 1844
• V. the Possibility of Overissue of Convertible Bank Notes
• VI. the Role of Deposits, Bills of Exchange, and “credit” In the Currency System
• VII. the Technique of Credit Control
• VIII. the Relation Between Bank of England Operations and Specie Movements
• IX. Currency Reform Proposals
• Chapter VI: The International Mechanism Under a Simple Specie Currency
• I. Introductory
• II. the Mechanism According to Hume
• III. an Omitted Factor? Relative Changes In Demand As an Equilibrating Force
• IV. Prices In the Mechanism: the Concept of “price Levels ”
• V. the “terms-of-trade” Concept
• VI. the Prices of “domestic” Commodities
• VII. the Mechanism of Transfer of Unilateral Payments In Some Recent Literature
• VIII. a Graphical Examination of Pigou's Analysis 1
• IX. Some Elaborations On the Basis of Pigou's Analysis
• X. an Alternative Solution
• XI. Types of Disturbance In International Equilibrium
• XII. Specie Movements and Velocity of Money
• XIII. Commodity Flows and Relative Price Levels
• XIV. Exchange Rates
• XV. A Criticism of the Purchasing-power Parity Theory 1
• Chapter VII: The International Mechanism In Relation to Modern Banking Processes
• I. Automatic Vs. Managed Currencies
• II. Primary and Secondary Expansion of Means of Payments
• III. Short-term Loans In the International Mechanism
• IV. Primary and Secondary Expansion In Canada , 1900–13
• V. the International Mechanism and Business Cycles
• Chapter VIII: Gains From Trade: the Doctrine of Comparative Costs
• I. the Nature and Origin of the Doctrine
• II. the Division of the Gain From Trade
• III. Trade In More Than Two Commodities
• IV. Trade Between More Than Two Countries
• V. Transportation Costs
• VI. Increasing and Decreasing Costs
• VII. Prices, Money Costs, and Real Costs
• VIII. Dependence of Comparative Cost Doctrine On a Real-cost Theory of Value
• IX. Differences In Wage Rates In Different Occupations
• X. Variable Proportions of the Factors and International Specialization
• XI. Variable Proportions of the Factor and Comparative Real Costs
• XII. “ Opportunity Cost” Analysis As a Substitute For Real Cost Analysis
• Chapter IX: Gains From Trade: the Maximization of Real Income
• I. “ Mass of Commodities” and “sum of Enjoyments”: Ricardo and Malthus
• II. Reciprocal Demand and the Terms of Trade
• III. Terms of Trade and the Amount of Gain From Trade
• IV. “ Net Benefit” In International Trade: Marshall
• V. Total Net Utility Derived From International Trade: Edgeworth
• VI. the Gain From Trade Measured In Money
• Appendix: a Note On the Scope and Method of the Theory of International Trade

VIII. The Possibility of Excess Issue by Banks

There were among the anti-bullionists some crude inflationists for whom no amount of currency could be too great. Most of the anti-bullionists, however, recognized that there were limits beyond which it was not desirable to go in the issue of currency. What these limits were, they failed to specify, except in terms of the “needs of business.” They claimed that as long as currency was issued only by banks, and was issued by them only in the discount of genuine and sound short-term commercial paper, it could not be issued in excess of the needs of business, since no one would borrow at interest funds which he did not need. If currency should perchance be issued to excess, it would rapidly return to the banks either in liquidation of bank loans or, under convertibility, for redemption in specie.1 To this doctrine the directors of the Bank of England and prominent members of the Cabinet also subscribed, and the authority of Adam Smith was appealed to in support thereof.2

The bullionists explicitly denied the validity of this doctrine, at least for an inconvertible currency. Thornton in 1797 had objected against the usury laws that they limited the Bank of England to a rate at which “there might be a much greater disposition to borrow of the Bank ... than it might become the Bank to comply with,” 3 and in 1802 he pointed out that the extent to which the charge of interest acted as a check on the demand for discounts depended on the rate of interest which was charged; the Bank of England was prevented by the usury laws from charging more than 5 per cent, and if the prevailing rate of commercial profit were higher than that, the demand for loans would be greater than the Bank should meet.4 Lord King put it more strongly: when the market rate of interest exceeds the bank rate, the demand for discounts “may be carried to any assignable extent,” 5 and in this somewhat extreme form it was repeated by other bullionists.6 In a speech in the House of Commons on May 7, 1811, Henry Thornton expounded with great ability, and with interesting references to the experience of other central banks, the mode of operation of the rate of interest as a regulator of the volume of note issue. He pointed out that even John Law's bank had issued only on loans at interest, and that it was Law's error that “he considered security as every thing and quantity as nothing” and failed to see the significance of the rate at which he offered to lend.7 Thornton argued, moreover, that during a period of rising prices the real rate of interest was less than the apparent rate; while businessmen did not generally perceive this, they did realize that borrowing at such times was usually profitable, and therefore increased their demands for loans if the bank rate did not rise.8

Ricardo agreed with the other bullionists that the “needs of commerce” for currency could not be quantitatively defined, and that through a resultant change in prices commerce could absorb whatever amount was issued.9 But he ordinarily denied any relationship between the rate of interest and the quantity of money, and presumably also between the rate of interest and the demand for loans: “Whilst the Bank is willing to lend, borrowers will always exist, so that there can be no limit to their overissues, but that which I have just mentioned,” i.e., convertibility.10 In a speech in Parliament he expressly denied that the rate of interest was a check to the amount of issues: “For ... what the directors thought a check, namely, the rate of interest on money, was no check at all to the amount of issues, as Adam Smith, Mr. Hume, and others had satisfactorily proved.” 11 Here once more Ricardo was applying long-run considerations to a short-run problem. But in his Principles we find Ricardo at one point expounding the same views as the other leading bullionists:

The applications to the Bank for money, then, depend on the comparison between the rate of profits that may be made by the employment of it, and the rate at which they are willing to lend it. If they charge less than the market rate of interest, there is no amount of money which they might not lend,—if they charge more than that rate, none but spendthrifts and prodigals would be found to borrow of them. We accordingly find, that when the market rate of interest exceeds the rate of 5 per cent at which the Bank uniformly lends, the discount office is besieged with applications for money; and, on the contrary, when the market rate is even temporarily under 5 per cent, the clerks of that office have no employment.12

To the denial by the bullionists that the charge of interest on loans was a sufficient guarantee, irrespective of the rate charged, against overissue, the anti-bullionists apparently never attempted to reply.13 In evidence before the Bullion Committee, Bank of England officials had emphatically denied that the security against overissue by the Bank would be reduced if the discount rate were to be lowered from 5 to 4 or even to 3 per cent. No person, they insisted, would pay interest for a loan which he did not need, whatever the rate, unless it were for the purpose of employing it in speculation, “and provided the conduct of the Bank is regulated as it now is, no accommodation would be given to a person of that description.” 14

That the quantity of bank loans demanded is dependent on the rate of discount is now universally accepted by economists and need not be further argued. On the question whether or not the rate of 5 per cent uniformly charged by the Bank of England during the Restriction was lower than the market rate, there is, however, a conflict of opinion. The usury laws would operate to prevent any overt charge of more than 5 per cent, and the uniform 5 per cent rate which is often said to have prevailed during the Restriction period15 may have been only nominally that. There is contemporary evidence that bankers found means of evading the restrictions of the usury laws. In 1818, the Committee on the usury laws stated in its Report that there had been “of late years ... [a] constant excess of the market rate of interest above the rate limited by law.” 16 Thornton notes that borrowers from private banks had to maintain running cash with them, and borrowers in the money market had to pay a commission in addition to formal interest, and that by these means the effective market rate was often raised above the 5 per cent level.17 Another writer relates that long credits were customary in London and a greater discount was granted for prompt payment than the legal interest for the time would amount to.18

More convincing evidence that the 5 per cent rate was not of itself always an effective barrier to indefinite expansion of loans by the banks is to be found in the fact that the directors of the Bank of England, although they professed that they discounted freely at the rate of 5 per cent all bills falling within the admissible categories for discount,19 in reply to questioning admitted that they had customary maxima of accommodation for each individual customer and occasionally applied other limitations to the amount discounted.20

Even if it were conceded that the Bank rate was never lower than the market rate of discount for the same classes of loans, it might still be low enough to permit or even to foster a wild inflation, if the Bank rate was low absolutely, and if it was the Bank rate which determined the market rate. On important classes of loans the Bank of England was a direct competitor with other lending agencies, and it was certainly important enough as a lending agency to exercise at least an important influence on the market rate. Also, by lowering its credit standards, or offering its credit to a wider range of applicants for commercial loans, it could actively promote currency expansion without lowering its interest rate below the hitherto prevailing level. It may be accepted, therefore, that the 5 per cent rate was not necessarily an adequate check to the volume of bank credit extended to commercial borrowers.

The powers of the Bank of England to expand its note issues, moreover, were not confined to its commercial discount activities. The Bank could also, and did, get its notes into circulation by advances to the government, by purchases of exchequer bills and public stocks in the open market, and by advances to investors in new issues of government stocks. Since even many of the anti-bullionists conceded that there was no automatic check to excess issue where the issues were made in connection with loans to the government, there should have been no occasion for extended controversy as to the existence of a possibility of excess issue.21

[1]Cf. e.g., Bosanquet, Practical observations, 2d ed., 1810, pp. 49–64; John Hill, An inquiry into the causes of the present high price of gold bullion, 1810, p. 36; Coutts Trotter, The principles of currency and exchanges, 2d ed., 1810, pp. 10 ff. In view of his subsequent prominence as an advocate of the “currency principle,” it is of interest that Torrens at this period should have subscribed to the doctrine that it was impossible to issue even inconvertible paper money to excess if it were issued only upon discount of good mercantile bills. (R. Torrens, An essay on money and paper currency, 1812, p. 127.) James Mill also subscribed to this doctrine: see his review of Thomas Smith's, Essay on the theory of money, 1807, Edinburgh review, XIII (1808), 57–60.

[2]Cf. Wealth of nations, Cannan ed., II, 287.

[3]Report of the Lords Committee, 1797, p. 83.

[4]The paper credit of Great Britain, 1802, pp. 287–90.

[5]Thoughts on the effects of the Bank Restrictions, 2d ed., 1804, p. 22.

[6]E.g., J. L. Foster, Essay on the principle of commercial exchanges, 1804, p. 113; Report of the Bullion Committee, 1810, pp. 56–57; Dugald Stewart, in a memorandum to Lord Lauderdale, 1811, first published in his Collected Works, 1855, VIII, 444; McCulloch, review of Ricardo's Proposal for an economical and secure currency, Edinburgh review, XXXI (1818), 62.

The Bank of Ireland was compelled by law to discount at one per cent below the legal maximum rate of interest. Lauderdale in 1805 commented that: “By the restriction, ..., unattended with the repeal of the clause compelling discount below the legal interest, the Bank [of Ireland] was obviously exposed to all the ordor of solicitation which must naturally attend the practice of discounting at an inferior rate of interest, whilst the check on the extent to which the indulgence might be carried was completely annihilated.” (Thoughts on the alarming state of the circulation, 1805, pp. 23–24.)

[7]Substance of two speeches of Henry Thornton, Esq. On the Bullion Report, 1811, pp. 19–37.

[8]Ibid., pp. 20 ff. This contains the essence of Irving Fisher's theory of the influence of changing price levels on interest rates. Cf. his Appreciation and interest, Publications of the American Economic Association, XI (1896, No. 4).

[9]Cf. Reply to Mr. Bosanquet's practical observations, Works, p. 341.

[10]Three letters on the price of gold [1809], p. 11.

[11]Hansard, Parliamentary debates, Ist series, XL (May 24, 1819), 744. The doctrine of Hume and Smith to which he refers is apparently their denial that there is a close connection between the volume of money and the rate of interest (see supra, p. 89), a doctrine requiring qualification for the short run.

[12]Principles of political economy and taxation, 3d ed. [1821], in works, p. 220. This passage is unchanged from the first edition, 1817.

Earlier in the same paragraph Ricardo had argued that the market rate of interest was determined, not by the Bank rate of discount, but by the rate of profits which could be made by the employment of capital, which was totally independent of the quantity or of the value of money. “Whether a bank lent one million, ten million, or a hundred millions, they would not permanently after the market rate of interest; they would alter only the value of the money which they thus issued.” (Italics not in original.)

[13]Cf., however, W. T. Comber, A view of the nature and operation of bank currency, 1817, p. 16: “These advances [of the Bank of England] did not depend, as many suppose, on the caprice of the Bank, but were regulated by the amount of cash payments on transactions, which would afford a profit to the borrower after paying an interest of five per cent to the Bank.”

[14]Report of the Bullion Committee, 1810, Minutes of evidence, p. 129. Cf. also the testimony of Dorrien, Governor of the Bank, in 1819: “The demand for discount always proceeds from the wants of the public, and if the bank were to discount at a lower rate of interest than five per cent, in my opinion there would be no greater application than if it were to discount at the present rate.” Report of [Commons] Committee, 1819, p. 145.

[15]Cf. Thomas Tooke, A history of prices, I (1838), 159: “... the market rate of interest for bills of the description which were alone discountable at the Bank [“good mercantile bills, not exceeding sixty-one days' date” ], did not materially, or for any length of time together, exceed the rate of five per cent per annum.”

Silberling, “British prices and business cycle,” Review of economic statistics, preliminary volume V (1923), supplement 2, p. 241: “The Usury Laws fixed the maximum rate of interest and discount at five per cent, and contemporary literature indicates that this rate was, at least from 1790 to 1822, the prevailing and unvarying rate of discount throughout the country. Instead of varying their rates, the banks either granted or refused loans.”

In evidence given in 1857 before a Parliamentary Committee, John Twells, a member of a London banking firm who had operated as a banker in London since 1801, stated that 5 per cent was the only rate charged by bankers during the Restriction and that no one ever thought of any other rate. (Evidence of John Twells ... before the select committee, 1857, pp. 13–15.)

[16]Report from the select committee on the usury laws, 1818, p. 3. Cf. also Ricardo, On protection to agriculture [1822], Works, p. 474: “During the last war the market rate of interest for money was, for years together, fluctuating between 7 and 10 per cent; yet the Bank never lent at a rate above 5 per cent.”

[17]Substance of two speeches, 1811, p. 20.

[18]David Prentice, Thoughts on the repeal of the Bank restriction law, 1811, p. 14. A later writer states that: “During the war it was very customary to make loans which were to be repaid by the transfer of a sum of stock, instead of money. This was done to secure to the capitalist the market rate of interest, which was then higher than he could have legally reserved in the deed.” (James Maclaren, The effect of a small fall in the value of gold upon money, 1853, p. 12.)

[19]Report of Bullion Committee, 1810, p. 26.

[20]Ibid., pp. 22, 24; Minutes of evidence, p. 89. Cf. also Thornton, Paper credit. 1802, pp. 179, 294; A. W. Acworth, Financial reconstruction in England, 1815–1822, 1925, p. 146.

[21]There was some discussion as to the comparative susceptibilities to excess of issue through commercial discount and through loans to government. Some writers contended that there was no difference between the two, but most writers agreed that the latter was more susceptible to excess. Mathias Attwood presents an ingenious a priori argument in support of the greater tendency of advances to government to raise prices than of the same amount of commercial discounts, resting in effect on the greater velocity of circulation of the former (Letter to Lord Hamilton, 1823, pp. 50–56). But there are grounds for believing that during the Restriction period the advances to the government of the Bank of England had an unusually low velocity of circulation, because of the practice of the government of holding exceptionally large idle balances at the Bank of England. See infra, p. 169.