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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 Relation Between Bank of England Operations and Specie Movements

The Bank of England did not itself engage directly in import or export transactions in bullion or specie. It was obligated, however, to give specie upon demand in exchange for its own notes, and as a part of its regular routine it also upon demand gave notes in exchange for specie, cashed its depositors' checks in specie, and bought gold bullion of standard fineness at the fixed price of £3.17.9 per ounce. In addition, the Bank operated its bullion department on ordinary commercial principles, buying and selling silver bullion and gold bullion of other than the standard fineness at the prevailing market prices. Periods of business expansion were also as a rule periods of expansion of Bank note circulation, of increased indebtedness to the Bank of private bankers and other clients, and of decline in the Bank's specie reserves. As long as the Bank of England would freely discount, a credit expansion could go on indefinitely, without a rise in the rate of interest or depletion of the cash reserves of private1 banks. A credit expansion, if peculiar to England, or relatively more marked there than abroad, would operate to stimulate imports and, through increased domestic absorption of supplies, to check exports, and would thus tend to create an unfavorable balance of payments. Even a credit expansion in which England was lagging behind the rest of the world might deplete specie reserves in England if it resulted in a substantial internal drain of gold to satisfy the demand for increased hand-to-hand specie circulation. The role of the Bank of England under such circumstances, whether she acted to protect her own specie reserves or to control the credit situation, was to check such credit expansion before it had reached a dangerous level. We are here concerned with the contemporary views as to the mechanism whereby the Bank of England could influence the flow of specie into and out of the country and thus into and out of her own coffers.

It was common doctrine that the market rate of interest influenced the flow of specie, a high rate operating to attract specie and a low rate to force it out, and that the Bank of England could regulate the flow of specie through its power over the market rate of interest. It was taken for granted that normally there were no idle funds outside the Bank of England, and that any reduction by the Bank of England of the volume of credit it had outstanding, whether accomplished through raising its discount rate, rationing, sales of securities in the open market, or borrowing from the market, would, other things being equal, force a rise in the market rate of interest.2 It was pointed out, however, that at times the market was sufficiently independent of the Bank to make the Bank's discount rate ineffective as a controlling factor unless supported by open-market sales and, in extreme cases, by borrowing from the market.3 On the other hand, there was recognition of the possibility that increases in the Bank rate might act as a deflationary factor not only directly through their influence on the volume of advances to the Bank's own customers, but also indirectly through their psychological influence on the market judgment as to business prospects and therefore on the willingness of private bankers to lend and of businessmen to borrow and on the velocity of circulation.4

Most of the discussions of the role of the interest rate referred only to short-run disturbances, including periodic business fluctuations, or “cycles,” 5 and the changes in interest rates were related to specie movements mainly in terms of their influence on the international movement of short-term funds, and their influence on relative prices was commonly held to be too slow-working to be an important factor in restoring international equilibrium.6 Most emphasis was put on the international mobility of funds devoted to investment in securities, in response to relative changes in the market rates of interest in London and abroad,7 but many other ways in which a relative rise of the English interest rate could attract short-term funds from abroad or check their flow to abroad were noted.8

Most of the writers of the period conceded the efficacy of the Bank discount rate, if employed skillfully and forcibly enough, as a regulator of specie movements through its influence on the international movement of short-term funds and, to a less extent, on the commodity trade balance. A skeptical note, however, was struck occasionally in the literature. It was pointed out that in so far as the movement of short-term funds was concerned what mattered was only the relative height of market rates of interest in London and abroad, and that rates were likely to rise and fall simultaneously in the important money markets. It was later claimed, moreover, that the foreign central banks, and especially the Banque de France, for a time during this period systematically followed the practice of meeting increases in the English discount rate by increases in their own rates in order to protect their reserves.9 A rise in the discount rate, moreover, might be interpreted as a signal of impending financial stress and thus instead of attracting funds to England might frighten them away.10 One writer, otherwise favorable to its use, regarded it as a defect of the discount rate as a regulator of specie flows that it operated to check exports, presumably by making it more costly or more difficult to finance them.11 Finally, the opponents of a metallic standard or of central bank control thereof tended either to deny in general terms the efficacy of the discount rate as a regulator of specie movements, or to deny any need of such control given the existence of a self-regulating mechanism, or to claim that the regulation, whether effective or not in protecting specie reserves, was costly to internal prosperity when it involved increase in the discount rate and contraction of credit, or to find still other objections to it.12

[1]In the absence for England of a term corresponding to the American “member bank,” I use “private bank” to designate banks and bankers of all kinds other than the Bank of England. The joint-stock banks, of course, normally did not borrow directly from the Bank of England, but they did borrow indirectly through bill brokers, and there were exceptional instances of their borrowing directly from the Bank of England.

[2]Cf. T. H. Milner, Some remarks on the Bank of England, 1849, p. 21: “there is never any spare capital out of the Bank.” Cf. also “N” (Newmarch) in London Times, April 27, 1863, as cited in W. J. Duncan, Notes on the rate of discount in London, 1867, pp. 69–70.

[3]See supra, pp. 259–60.

[4]Cf. Overstone, Thoughts on the separation of the departments of the Bank of England [1844], in Tracts, p. 264:

... a rise in the rate of interest ... tends to produce a contractive effect upon the country circulation, and still more on the state of confidence and of the auxiliary currency [i.e., bank deposits and bills of exchange] which rests upon that confidence. Cf. also Norman's evidence, Report from Select Committee on banks of issue, 1840, p. 158: ... I do not look at a rise in the rate of discount merely as it affects the securities and the circulation of the Bank; it produces a much greater and more important effect than that in its general influence upon credit; it limits all banking expedients; I have no doubt that it increases the reserves of bankers; it diminishes the efficiency, therefore, of a given amount of currency; it renders persons less willing to discount bills; and it makes merchants less disposed to buy, and more disposed to sell.

[5]See especially Hamer Stansfeld, The currency act of 1844, 1854, pp. 17–19, for an account of the business cycle emphasizing the status of the interest rate, the balance of trade, and the balance of payments at each stage of the cycle. Cf. also William Miller, A plan for a national currency, 1866, pp. 16 ff.

[6]Overstone gives the following account of the sequence of events resulting from an increase in the interest rate:

Contraction of circulation acts—first upon the rate of interest—then upon the price of securities—then upon the market for shares, &c.—then upon the negotiation of foreign securities—at a later period, upon the tendency to enter into speculation in commodities—and lastly, upon prices generally. These effects may be retarded or accelerated by other circumstances; possibly they may not occur precisely in the manner here stated; but this is something like the order of succession in which the effects of contraction of the circulation are gradually developed. (Thoughts on the separation of the departments [1844], in Tracts, 1857, p. 253.) See also the substantially similar accounts in R. K. Douglas, Brief considerations on the income tax and tariff reform, in connection with the present state of the currency, 1842, p. 28, and Robert Somers, The errors of the banking acts of 1844–5, 1857, p. 10. Cf. also J. S. Mill, Principles of political economy [1848], Ashley ed., p. 497: “... it is a fact now beginning to be recognized, that the passage of the precious metals from country to country is determined much more than was formerly supposed, by the state of the loan market in different countries, and much less by the state of prices.”

[7]Cf. T. H. Milner, Some remarks on the Bank of England, 1849, p. 16: “One per cent may make all the difference, whether capital be invested at home or in another country.” See also, infra, pp. 403 ff.

[8]Cf. e.g., Tooke's evidence, Report from Select Committee on banks of issue, 1840, p. 359: ... the effect upon the exchanges of a rise in the rate of interest would be that of inducing foreign capitalists to abstain from calling for their funds from this country, to the same extent as they otherwise might do, and it would operate at the same time in diminishing the inducements to capitalists in this country to invest in foreign securities, in order to make investments in British stocks or shares. It would likewise operate in restraining credits from the merchants in this country by advances on shipments outwards, and it would have the effect of causing a larger proportion of the importations into this country to be carried on upon foreign capital.

[9]Cf. R. H. Patterson, “On the rate of interest ... during commercial and monetary crises,” Journal of the Statistical Society of London, XXXIV (1871), 343; Robert Somers, The Scotch banks and system of issue, 1873, pp. 177 ff.; Richard Webster, Principles of monetary legislation, 1874, p. 113.

[10]“History and exposition of the currency question,” ll'estminster and foreign quarterly review. XLVIII (1848), 468, note; R. H. Patterson, loc. cit.

[11]William Hooley, “On the bullion reserve of the Bank of England,” Transactions of the Manchester Statistical Society, 1859–60, p. 89: One of the least satisfactory features of the present mode of effecting this object [the correction of the exchanges], by increasing the rate of interest and lessening the amount of accommodation, is, that its effect on imports cannot be felt until after the lapse of months, whilst its effect on exports is immediate, and unfortunately in the wrong direction, viz., restriction.

[12]Cf. Robert Somers, The errors of the banking acts of 1844–5, 1857, p. 78:

The time has come when the theory of regulating foreign trade by the Bank screw must be discarded. It is no longer suited to the state and circumstances of commerce. Free trade has introduced a new and more natural regulator into the transactions of nations. We do not now speculate in foreign trade so much as simply barter the produce and manufactures of the United Kingdom for the goods of our neighbours. Our import and export trade have thus received a simplicity, an adaptation, and equality, which could not possibly be realized under a system of prohibition and protection. The connection of the most distant countries by railways and telegraphs, securing the utmost rapidity of motion and intelligence, and the cosmopolitan attributes of capital, creating one money market and keeping trade equally active throughout the world, all cooperate with the principle of free commerce in harmonizing the exchanges and preventing those oscillations and inequalities in imports and exports which were formerly the frequent cause of monetary and commercial derangement. Somers further objects to the discount rate-mechanism, that specie does not necessarily flow to the high-rate market and may flow in the opposite direction (p. 18); that when imports are discouraged by a rise in the discount rate, exports are correspondingly checked by the resultant fall in purchasing power of the countries which are the source of the imports (p. 77); that the increase in the interest rate, by increasing capital costs, instead of increasing, impairs the ability of English exporters to meet foreign competition (p. 78); and that in general, more attention should be paid, in credit policy, to the needs of the internal market than to specie flows.