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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

IV. The Bank Act of 1844

The Act of 1844 put into effect these proposals of the currency school. But any expectations which may have been held that the provisions of the act were sufficient to insure protection against currency disturbances were destined to meet with early disappointment. The Bank of England took too seriously the freedom from statutory regulation of its banking department under the act, and proceeded immediately to reduce its discount rate from 4 to 2½ per cent, the lowest rate in its history up to that time, and to expand its commercial discounts.1

Its reserves in the banking department soon began to fall. In 1847, the public, noting the decline in these reserves, and aware that under the Act of 1844 the Bank would be unable to meet the claims of its depositors with its own notes or with specie once the reserves of the banking department had been exhausted, took alarm, and proceeded to draw out their deposits. The Bank's attempts to check the drain by rationing, successive increases in the discount rate, sale of securities, and borrowing from the market, did not succeed. On October 22, 1847, the reserves in the banking department had fallen to £2,376,472, and a panic was in full sweep in the country. The Bank was still confident that it could continue to meet its payments, but the government, in order to allay the panic, stepped in, authorized the Bank to issue notes uncovered by gold in excess of the statutory maximum, and requested the Bank to discount freely, but at a high rate of interest. The panic ceased at once, gold began to flow back to the Bank, and no issue in excess of the statutory maximum was actually made. But it had been demonstrated that under the Act of 1844 gold could be withdrawn from the Bank by means of the deposits as well as by presentation of its notes for payment in specie, and that in a period of alarm knowledge that the power of the Bank to issue notes was legally restricted could operate to promote such withdrawal. In 1857 and 1866, suspension of the Bank Act was again invoked to prevent exhaustion of the reserves in the banking department. The Act of 1844 may have established an absolute guarantee of convertibility of the note issue, subject only to the condition that the amount of notes voluntarily remaining in the hands of the public did not fall below £14,000,000.2 It clearly failed to guarantee adequately good management of its credit operations on the part of the Bank of England.

The necessity of suspending the Bank Act three times within twenty-five years of its enactment was disappointing to its currency school advocates, but they denied that it justified the claims of the banking school that the currency school doctrines had been erroneous and that the act was injurious in its effects. Overstone even denied that the divergent fluctuations after 1844 in the note circulation of the Bank and in its bullion holdings disproved the contention of the currency school that the Act of 1844 would automatically enforce a correspondence between these fluctuations. He was able to show that when prior to the passage of the act he had supported the rule of forcing correspondence between the bullion holdings of the Bank and the note circulation in the hands of the public, instead of between the bullion holdings of the Bank and the notes outside the issue department, he had done so only because until 1844 information was not available as to the holdings of its own notes by the Bank as “till money.” Had such information been available, he would have included notes held by the Bank in the banking department in the “circulation” whose fluctuations should be made to correspond with the fluctuations of the bullion holdings of the Bank.3 The Act of 1844 did guarantee absolute correspondence between the variations in the amount of notes outstanding at the issue department and the amount of bullion held by the issue department.

The great fault of the currency school was the exaggerated importance which they encouraged the public to attribute to the automatic regulation of the issue department as contributing to a proper functioning of the Bank of England as a whole. In his speech introducing the Bank Act in the House of Commons, Sir Robert Peel had stated: “With respect to the banking business of the Bank, I propose that it should be governed on precisely the same principles as would regulate any other body dealing with Bank of England notes.” 4 In his opinion regulation of the operations of the issue department would suffice—or perhaps more accurately, would be likely to suffice—to assure sound management of the currency. In this respect Peel went further than his currency school supporters, and he later admitted that he had been overoptimistic.5 Torrens and Overstone had never committed themselves to the doctrine that regulation of the note issues was a remedy for all banking ills, although this was often charged against them, both by contemporary and by later critics of the currency school. They had recognized that careful management by the Bank of its discounts would be necessary if its banking department reserves were not to be exhausted through drawing down of deposits. In their discussion of the Palmer rule, they had pointed out that suitable management of its discounts was an essential element in the proper functioning of the Bank. But they had believed that the Act of 1844, by requiring segregation of part of the bullion reserve as cover for the notes, beyond achieving its primary objective of assuring convertibility of the note issue, would force the Bank to give close attention to the fluctuations in the unsegregated or marginal reserve held in the banking department, and therefore to act more promptly to check a threatening drain of gold.6 They now held that the difficulties of 1847 were due to mismanagement of the Bank, not to the Act of 1844, and that had it not been for the Act of 1844 the Bank would have carried its imprudence even further:

It was a case of banking mismanagement on the part of the Bank of England acting upon the community, at that moment peculiarly susceptible of alarm under vague and ignorant apprehensions of the effect of the new law ... Danger from undue exhaustion of the bullion is the evil against which the Act undertakes to protect the community; against an improper exhaustion of the banking reserve, and the consequent inconveniences, it is the duty of the Bank of England to take timely and effectual measures of precaution.7

But if the currency school were prepared to admit that proper functioning of the banking system required proper management by the Bank of England of its credit operations as a whole as well as of its note issues, why did they content themselves with proposals for the regulation of the note issue only? The answer lay partly in the fact that their primary objective was guarantee of convertibility of the note issue, and this the Act of 1844 substantially accomplished. As Overstone claimed: the Act of 1844 “has preserved the convertibility of the bank note; the purpose for which it was passed, and that which alone its authors promised that it should do.” 8 The currency school tended also to minimize or to deny the importance of bank credit in other forms than notes as a factor influencing prices, or, as in the case of Torrens, to claim that the fluctuations in the deposits were governed closely by the fluctuations in the note issues.9 They had a hankering also for a simple, automatic rule, and could find none suitable for governing the general credit operations of the Bank.10 They also had laissez-faire objections to extending legislative control of the banking system any further than seemed absolutely necessary.

The currency school held that their critics exaggerated the significance of suspension of the Bank Act. Overstone had prior to passage of the act conceded that, in case of an internal panic, suspension of the act would be desirable. In such a case, resort must be had to “that power, which all governments must necessarily possess, of exercising special interference in cases of unforeseen emergency and great state necessity.” But an explicit provision in the act authorizing its suspension in an emergency would be objectionable, for it would tend to convert into a routine and anticipated procedure what should be regarded as only an emergency measure.11 Later he argued that the suspensions which had occurred were of small consequence. During a panic an interval would elapse before a contraction of the note circulation would be offset by an inflow of gold from abroad: “To meet this temporary difficulty, which was purely technical and not depending upon any principle, an important provision of the Act was for a short time suspended.” 12

The banking school objected to the Bank Act of 1844, both that it was no remedy against overexpansion of bank credit and that overexpansion of convertible bank notes was impossible. But they never supported any proposals for legislative control of the volume of bank credit, partly because they thought it impracticable, partly because, like the currency school, they objected to such control on general laissez-faire grounds. In spite of the past record of the English banking system, which they interpreted as unfavorably as did the currency school, they apparently saw no alternative but reliance on the hope that the English bankers would in time learn to do better:

If the country banks have erred at all, it has not been in their conduct as banks of issue, but in their conduct as banks for discounts and loans; a matter altogether different and distinct, with which the legislature has no more to do than with rash speculations in corn or cotton, or improvident shipments to China or Australia.13

Were it possible, by any legislative proceeding, to restrain effectually the errors and extravagances of credit, that would be the true course to a really beneficial reform of our banking system. But these errors and extravagances are unfortunately rather beyond the pale of legislation, and can only be touched by it incidentally, or by a sort of interference which would be more vexatious and intolerable than even the evil which it sought to correct.14

The banking school were not willing to concede any merit whatsoever to the Act of 1844. They either denied that it would force the Bank to contract its issues more promptly in case of an external drain,15 or, if they granted this, they denied that this was an advantage.16 John Stuart Mill took an intermediate position. While in general hostile to the Act of 1844, he conceded that when an external drain took place, the act forced upon the Bank a prompter contraction of credit than it might carry out in the absence of the act. But he held that where the drain was due to a temporary factor and would soon cease of its own accord, such contraction was undesirable. The act, moreover, hindered the Bank from taking the steps which would give relief when a crisis had already occurred.17

[1]Palmer testified before the Lords Committee on the Commercial Distress in 1848 that the Bank had lowered its discount rate to 2½ per cent in September, 1844, “from the circumstance of its being supposed to be the proper course for the Bank to take to employ a given portion of the reserve in the banking department for the benefit of the proprietors.” Report, p. 108.

[2]Subject to this condition, it did provide an absolute guarantee of convertibility, if in case of default by the Bank in meeting the liabilities of the banking department the holders of Bank notes would legally have a prior claim on the gold remaining in the issue department, a disputed question.

[3]The evidence, given by Lord Overstone, before the Select Committee of the House of Commerce of 1857, on bank acts, 1858, pp. 119 ff.

[4]Hansard, Parliamentary debates, third series, LXXIV (May 6, 1844), 742.

[5]“I say, then, that the bill of 1844 had a triple object. Its first object was that in which I admit it has failed, namely, to prevent by early and gradual, severe and sudden contraction, and the panic and confusion inseparable from it, but the bill had two other objects of at least equal importance; the one to maintain and guarantee the convertibility of the paper currency into gold—the other to prevent the difficulties which arise at all times from undue speculation being aggravated by the abuse of paper credit in the form of promissory notes. In these two objects my belief is, that the bill has completely succeeded.” Hansard, Parliamentary debates, 3d series, XCV (Dec. 3, 1847), 657.

[6]Cf. Torrens, A letter to Thomas Tooke, 1840, pp. 10–11: “The difference 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.” Cf. also Overstone, Thoughts on the separation of the departments of the Bank of England [1844], Tracts, pp. 263 ff.; ibid., Evidence ... before the ... Committee of the House of Commons, 1858, pp. 163–64; Sir William Clay, Remarks on the expediency of restricting the issue of promissory notes, 1844, p. 71.

[7][Overstone], Letters of Mercator on the Bank charter act of 1844, 1855–1857, pp. 57–58.

[8]Correspondence between the Right Hon. Lord Overstone, and Henry Brookes, Esq., 1862, p. 36.

[9]See infra, p. 250.

[10]Cf. Sir William Clay, Remarks, 1844, p. 26.

[11]Thoughts on the separation of the departments, 1844 (written in 1840), Tracts, pp. 282–84.

[12]Correspondence between ... Lord Overstone, and Henry Brookes, Esq., 1862, p. 23. The public, in fact, soon became convinced that in case of need the statutory limitation of the uncovered note issue of the Bank would not be permitted to stand in the way of the Bank's extending credit when it was urgently needed to prevent a panic, but would be suspended. Cf. Governor Weguelin of the Bank of England, in Report from the Select Committee on Bank acts, 1857, part II, p. 3: “This power [of suspension] having been once exercised already, there is no cause to apprehend a panic, such as occurred in 1847. The public believe that it would be exercised again under similar circumstances”

[13]Samuel Bailey, A defence of joint-stock banks, 1840, pp. 85–86, cited, with approval, by Tooke, An inquiry into the currency principle, 2d ed., 1844, p. 93.

[14]Fullarton, On the regulation of currencies, 2d ed., 1845, p. 195. Cf. also J. W. Gilbart, A practical treatise on banking, Ist American (=5th English) ed., 1851, p. 92.

[15]James Wilson, Capital, currency, and banking, 1847, pp. 22 ff.

[16]Cf. J. W. Gilbart, A practical treatise on banking, 1851, p. 94.

[17]J. S. Mill, Principles of political economy, bk. iii, chap. xxiv. Cf. also his testimony in Report from the Select Committee on the Bank acts, part I, 1857, pp. 180 ff.