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CHAP. V. - Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain 
An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, edited and with an Introduction by F.A. Hayek (London: George Allen and Unwin, 1939).
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This works appears online with the permission of the Estate of F.A. Hayek. A further annotated version of Hayek’s introduction appears as a chapter in volume 3 of the Collected Works of F.A. Hayek (University of Chicago Press, 1991).
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Of the Balance of Trade.—Of the Course of Exchange.—Tendency of an unfavourable Exchange to take away Gold.—Of the Probability of the Return of Gold.—Of the Manner in which it may be supposed that exported Gold is employed on the Continent.—Reasons for having renewed the Law for suspending the Cash Payments of the Bank of England.
The law which authorised the suspension of the cash payments of the bank having been re-enacted; the high price of provisions having given occasion to much speculation on the subject of paper credit; the course of exchange having again turned greatly against the country; and gold having to a material degree disappeared, its place being occupied by small paper notes; it is not surprising that suspicions of the necessity of an alteration in the system of our paper credit should have become prevalent. Some consideration shall here be given to that unfavourable state of the exchange between this country and Europe, which operated during the last two years of the war, in again drawing away our guineas.
It may be laid down as a general truth, that the commercial exports and imports of a state (that is to say, the exported and imported commodities, for which one country receives an equivalent from another) naturally proportion themselves in some degree to each other; and that the balance of trade, therefore (by which is meant the difference between these commercial exports and imports), cannot continue for a very long time to be either highly favourable or highly unfavourable to a country. For that balance must be paid in bullion, or else must constitute a debt. To suppose a very great balance to be paid, year after year, in bullion, is to assume such a diminution of bullion in one country, and such an accumulation of it in another, as are not easy to be imagined: it may even be questioned whether the commercial prosperity of a state does not tend, on the whole, to reduce, rather than augment, the quantity of gold in use, through that extension of paper credit to which it leads. To suppose large and successive balances to be formed into a debt, is to assume an accumulation of debt, which is almost equally incredible. A prosperous nation commonly employs its growing wealth, not so much in augmenting the debts due to it from abroad, as in the enlargement of its capital at home; I mean, in the cultivation of its lands, in the encrease of its buildings, the extension of its machinery, the multiplication of its docks and its canals, and in a variety of other improvements, which become the sure sources of an encreasing income. The state may be progressive in these respects, even in years in which the balance of trade is unfavourable. There is a customary length of credit in foreign parts which the British exporter, however overflowing his capital may be, is not very willing to enlarge. And events fail not occasionally to arise, which remind him of the danger of committing too great a portion of his property into the hands of those who are not subject to the same laws with himself; and whose country may suddenly be involved, at any moment, in a war with Great Britain.
The equalization of the commercial exports and imports is promoted not only by the unwillingness of the richer state to lend to an unlimited extent, but also by a disinclination to borrow in the poorer. There is in the mass of the people, of all countries, a disposition to adapt their individual expenditure to their income. Importations conducted with a view to the consumption of the country into which the articles are imported (and such, perhaps, are the chief importations of a poor country), are limited by the ability of the individuals of that country to pay for them out of their income. Importations, with a view to subsequent exportation, are in like manner limited by the ability to pay which subsists among the individuals of the several countries to which the imported goods are afterwards exported. The income of individuals is the general limit in all cases. If, therefore, through any unfortunate circumstance, if through war, scarcity, or any other extensive calamity, the value of the annual income of the inhabitants of a country is diminished, either new economy on the one hand, or new exertions of individual industry on the other, fail not, after a certain time, in some measure, to restore the balance. And this equality between private expenditures and private incomes tends ultimately to produce equality between the commercial exports and imports.
But though the value of the commercial exports and imports of a country will have this general tendency to proportion themselves to each other, there will not fail occasionally to arise a very great inequality between them. A good or a bad harvest, in particular, will have a considerable influence in producing this temporary difference. The extra quantity of corn and other articles imported into Great Britain in this and the last year, with a view to supply the deficiency of our own crops, must have amounted in value to so many millions, that it may justly excite surprise that we should have been able, during an expensive war, to provide the means of cancelling our foreign debt so far even as we have done; especially when the peculiar interruptions to our commerce are also considered. In this country, however, as in all others, the two principles of economy and exertion are always operating in proportion to the occasion for them. But the economy and exertion follow rather than accompany the evil which they have to cure. If the harvest fails, and imports are necessary, in order to supply the deficiency, payment for those imports is almost immediately required: but the means of payment are to be supplied more gradually through the limitation of private expenditure, or the encrease of individual industry. Hence a temporary pressure arises at the time of any very unfavourable balance. To understand how to provide against this pressure, and how to encounter it, is a great part of the wisdom of a commercial state.
By the commercial exports and imports which have been spoken of, those articles have been intended for which an equivalent is given; not those which form a remittance, for which nothing is obtained in exchange. Many of our exported and some of our imported commodities are of that class which furnish no return.
For example, numerous stores were shipped, during the war, for the support of our navy and army in foreign parts. Remittances were made, in the way of loan and subsidy, to our allies. Some dividends may be supposed to have been transmitted to the foreign proprietors of British stock. Much property is also sent out of the kingdom, which constitutes a capital employed in the cultivation of lands in the West Indies. On the other hand, capital is transmitted to Great Britain from the East Indies, both by the India Company and by individuals.
Although exports and imports of this class form no part of the commercial exports and imports which have been spoken of, they affect the quantity of those commercial exports and imports, and they contribute, exactly like the circumstance of a bad harvest, to render the balance of trade unfavourable* ; they tend, that is to say, in the same manner, to bring Great Britain into debt to foreign countries, and to promote the exportation of our bullion. Our mercantile exports and imports, nevertheless, by whatever means they may be rendered disproportionate, necessarily become, in the long run, tolerably equal; for it is evident that there is a limit, both to the debt which foreigners will permit British merchants to incur, and also to the quantity of British bullion which is exportable.
Gold has been spoken of in this Chapter as that article by which a balance of trade is discharged, and not as itself constituting a commodity. Gold, however, when exported and imported, may be considered in the same light with all other commodities; for it is an article of intrinsic value: its price, like that of other commodities, rises and falls according to the proportion between the supply and the demand; it naturally seeks, like them, that country in which it is the dearest; and it is, in point of fact, like them, exported by our merchants accordingly as the export or import is likely to yield a profit. Some description of the circumstances which cause the export of gold to become a profitable speculation to the merchant may serve to illustrate this subject.
When a bill is drawn by one country on another—by Hamburgh, for instance, on London—it is sold (or discounted) in the place in which it is drawn, to some person in the same place; and the buyer or discounter gives for the bill that article, whatever it may be, which forms the current payment of the spot. This article may consist either of gold or silver coin, or of bank paper, or, which is much the same thing as bank paper, of a credit in the books of some public bank.
Let us now suppose that the exporter of corn from Hamburgh to London draws a bill for 100l. on London, and offers it for sale on the Hamburgh Exchange at the season when great exportations of corn to London are taking place. The persons in Hamburgh having occasion to buy bills are fewer, in such a case, than those who want to sell them; and the price of the bill, like that of any other article, fluctuates according to the proportion subsisting between the supply and the demand. The disproportion, then, between the number of those persons at Hamburgh who want to sell London bills for Hamburgh coin, and the number of those who want to sell Hamburgh coin for London bills, causes the price of London bills to fall, and of Hamburgh coin to rise. Thus gold is said to rise at Hamburgh; and the exchange between London and Hamburgh becomes unfavourable to London. This fluctuation in the exchange will, in the first instance, be small. It will be limited to that trifling sum which it costs to transport bullion from one place to the other, so long as there is bullion to be transported. But let us now suppose the number of Hamburgh bills on London, drawn for the payment of the goods imported into the latter place, to be so numerous, that the exportation of all the bullion which is purchasable in Great Britain, has not sufficed for their payment. Gold coin, in this case, will be exported, being first melted down for the purpose. Coin, indeed, is not allowed to be exported from Great Britain, nor gold which has been melted down from coin; an oath being required of every exporter of gold, that the gold which he exports does not consist of guineas which have been melted. There are, however, many ways of escaping the law which imposes this oath. The law is dishonestly evaded either by the clandestine exportation of guineas, no oath at all being taken; or by taking a false oath; or by contriving that the person taking the oath shall be, in some degree, ignorant of the melting which has been practised. The operation of the law is avoided without this dishonesty, through the exportation of gold which had been turned, or had been about to be turned, to the purposes of gilded and golden ornaments, the place of this gold being supplied by gold melted down from coin. The state of the British law unquestionably serves to discourage and limit, though not effectually to hinder, that exportation of guineas which is encouraged by an unfavourable balance of trade; and, perhaps, scarcely lessens it when the profit on exportation becomes very great. The law tends, indeed, to produce a greater interchange of gold for paper at home. But it encreases whatever evil arises from an unfavourable state of the exchange with foreign countries.
Let it now be considered how this high price of gold in London must operate in respect to the Bank of England. Great demands for guineas will be made on the bank; and, in general, probably by persons not intending to melt or export guineas themselves, but wishing only to supply that want which all have begun to experience in consequence of the large illicit exportations carried on by a few unknown persons. It is assumed, for the present, that the bank is paying in guineas. What, then, is the course which the bank will naturally pursue? Finding the guineas in their coffers to lessen every day, they must naturally be supposed to be desirous of replacing them by all effectual and not extravagantly expensive means. They will be disposed, to a certain degree, to buy gold, though at a losing price, and to coin it into new guineas; but they will have to do this at the very moment when many are privately melting what is coined. The one party will be melting and selling, while the other is buying and coining. And each of these two contending businesses will now be carried on not on account of an actual exportation of each melted guinea to Hamburgh, but the operation (or, at least, a great part of it) will be confined to London; the coiners and the melters living on the same spot, and giving constant employment to each other.
The bank, if we suppose it, as we now do, to carry on this sort of contest with the melters, is obviously waging a very unequal war; and even though it should not be tired early, it will be likely to be tired sooner than its adversaries.
The dilemma in which the bank is thus placed, is evidently one which implies no deficiency in its wealth, in its credit, or in the strength of its resources. The public, during all this time, may have the highest confidence in it. The notes of the bank may be of the same number as usual, possibly somewhat lower in number; its capital and savings may be immensely great, and perfectly well known; its stock may be selling at much above par; its clear annual profits may be considerable. Its gold, nevertheless, through the operation of that one cause which has just been named, may be growing less and less. And it is not at all impossible, if an alarm at home should draw away the gold at the same time, that, however ample its general fund may have been, it may be reduced to its last guinea; and may actually be brought under the necessity of making a temporary suspension of its payments.
An important subject of enquiry here suggests itself. Dr. Smith, as was remarked in the beginning of the former chapter, in some degree leads his reader to assume the Bank of England to be in fault (that is, to have issued too many notes) whenever an excess of the market price above the mint price of gold takes place, an excess which produces, as shall immediately be shewn, that difficulty in replenishing the coffers of the bank which has been recently described. If the observation of Dr. Smith be, without exception or qualification, true, then the quantity of paper issued by the Bank of England has undoubtedly been excessive throughout the last two years; for the excess of the market price above the mint price of gold has been, during that time, considerable. Then, also, it is the bank which has placed in its own way that obstacle to the purchase of gold which has been spoken of. Any enquiry tending to indicate the causes which place the bank under this singular difficulty, seems to be important.
I shall here endeavour clearly to explain what is meant by the high and the low price of gold; and also by that difference between the mint price and the market price, which has such material consequences.
Gold must be considered as dear, in proportion as goods for which it is exchangeable are cheap; and as cheap, in proportion as goods are dear. Any circumstance, therefore, which serves to make goods generally dear, must serve to make gold generally cheap, and vice versa; and any circumstance which serves to make goods dear at any particular time or place, must serve to make gold cheap at that time or place, and vice versa.
The reason of the difference between the mint price and the market price of gold, does not easily occur. If the bank, from time to time, buys gold at a high price, that is, if it gives for gold a large quantity of goods (or something convertible into a large quantity, which is the same thing); it is natural, on the first view, to suppose that the high price given by the bank, which is the principal and almost the only English purchaser, must form the current English price; and that this high current price of gold in England will prove the means both of bringing it hither, and of detaining it here; causing goods, which are cheap, to go abroad; and gold, which is dear, to come hither, and also to remain in the country. Undoubtedly gold would remain in England, when tempted hither by the high price given for it by the bank, if it were not for the following circumstance. Gold is bought by the bank, in order to be converted into coin; and, when turned into coin, it forms a part of the circulating medium of the country, paper constituting another part. If, then, this paper is by any means rendered cheap, and if the paper so rendered cheap is currently interchanged for one sort of gold, namely, for gold which has been coined, then the coined gold will partake in the cheapness of the paper; that is, it will buy, when in the shape of coin, a smaller quantity of goods than it will purchase when in the form of bullion. In other words, an ounce of gold coming from the mint in the shape of guineas, and making 3l. 17s. 10½d. (for that is the sum into which an ounce always is coined at the mint), will be worth less than the same ounce of gold was worth before it went to the mint, and less than it would again be worth if converted back into bullion. There arises, therefore, a temptation to convert back into bullion, and then to export; or, which is the same thing, to export, and then convert back into bullion; or, which is also the same thing, to convert back into bullion, and then sell to the bank, at the price which would be obtained by exportation, that gold which the bank had turned from bullion into coin. In proportion as the difficulty of collecting, melting, and sending abroad the gold coin is augmented (and it encreases as the quantity of coin diminishes), the difference between the mint and market price of bullion will become more considerable, supposing the demand for gold in foreign countries to continue. Thus it is through the interchangeableness of gold coin with paper, that gold coin is made cheap in England; or, in other words, that goods, in comparison with gold coin, are made dear. The goods which are dear remain, therefore, in England; and the gold coin, which is cheap (for the bank is indisposed to buy it, on account of the loss sustained on each coinage), goes abroad.
There is, undoubtedly, much ground for the supposition of Dr. Smith, that a diminution of the quantity of paper has a tendency to cure this evil* . It tends to render the paper more valuable, and, therefore, to make that gold coin more valuable for which the paper is interchangeable, and thus to destroy that excess of the market price above the mint prince of gold, which forms the obstacle to the introduction of a supply of gold into the coffers of the bank. There seems, nevertheless, to be much of inaccuracy and error in the doctrine of Dr. Smith on this subject. He begins by representing the quantity of paper which may properly circulate, as to be measured by that of the gold which would circulate if there were no paper. The reader is, therefore, led to believe, that a difference between the mint price and the market price of gold arises from an issue of a greater quantity. Dr. Smith also too much countenances an idea, that the excess consists of paper forced into circulation; for he terms the proper quantity that paper which will “easily circulate.” He, moreover, induces his reader to suppose, that the excessive issue is an issue to a more than usual amount. At the time of a very unfavourable balance of trade (an event which Dr. Smith leaves totally out of his consideration), it is very possible, as I apprehend, that the excess of paper, if such it is to be called, is merely an excess above that very low and reduced quantity to which it is necessary that it should be brought down, in order to prevent the existence of an excess of the market price above the mint price of gold. I conceive, therefore, that this excess, if it arises on the occasion of an unfavourable balance of trade, and at a time when there has been no extraordinary emission of notes, may fairly be considered as an excess created by that unfavourable balance, though it is one which a reduction of notes tends to cure.
The fair statement of the case seems to be this. At the time of a very unfavourable balance (produced, for example, through a failure of the harvest), a country has occasion for large supplies of corn from abroad: but either it has not the means of supplying at the instant a sufficient quantity of goods in return, or, which is much the more probable case, and the case which I suppose more applicable to England, the goods which the country having the unfavourable balance is able to furnish as means of cancelling its debt, are not in such demand abroad as to afford the prospect of a tempting or even of a tolerable price; and this want of a demand may happen possibly through some political circumstance which has produced, in a particular quarter, the temporary interruption of an established branch of commerce. The country, therefore, which has the favourable balance, being, to a certain degree, eager for payment, but not in immediate want of all that supply of goods which would be necessary to pay the balance, prefers gold as part, at least, of the payment; for gold can always be turned to a more beneficial use than a very great overplus of any other commodity. In order, then, to induce the country having the favourable balance to take all its payment in goods, and no part of it in gold, it would be requisite not only to prevent goods from being very dear, but even to render them excessively cheap. It would be necessary, therefore, that the bank should not only not encrease its paper, but that it should, perhaps, very greatly diminish it, if it would endeavour to prevent gold from going out in part of payment of the unfavourable balance. And if the bank do this, then there will arise those other questions, which Dr. Smith leaves totally out of his consideration; namely, whether the bank, in the attempt to produce this very low price, may not, in a country circumstanced as Great Britain is, so exceedingly distress trade and discourage manufactures as to impair, in the manner already specified, those sources of our returning wealth to which we must chiefly trust for the restoration of our balance of trade, and for bringing back the tide of gold into Great Britain. It is also necessary to notice in this place, that the favourable effect which a limitation of bank paper produces on the exchange is certainly not instantaneous, and may, probably, only be experienced after some considerable interval of time; it may, therefore, in many cases, be expected that the exchange will rectify itself before the reduction of bank paper can have any operation. It is also to be recollected (a point, indeed, which Dr. Smith himself states), that gold is retained or drawn away, not by the limitation or the encrease of the Bank of England paper alone, but by that of their paper, conjointly with that of the other paper of the country. The bank paper serves, it is true, to regulate, in a great degree, that other paper; but not with exactness. The bank, by proceeding to that reduction of its own paper which is necessary to bring gold into the country, may possibly annihilate, before it is aware, a part or even almost the whole of the circulating country bank notes, and much other paper also; and it may, in that case, have to supply gold sufficient to fill the whole void, perhaps more than the whole void, which it has created; for it may be called upon to furnish large additional sums which may forthwith be hoarded in consequence of the alarm thus occasioned. Hence, even though it should encrease the supply of gold from abroad; it may augment, in a far greater degree, the demand for it at home. For this reason, it may be the true policy and duty of the bank to permit, for a time, and to a certain extent, the continuance of that unfavourable exchange, which causes gold to leave the country, and to be drawn out of its own coffers: and it must, in that case, necessarily encrease its loans to the same extent to which its gold is diminished. The bank, however, ought generally to be provided with a fund of gold so ample, as to enable it to pursue this line of conduct, with safety to itself, through the period of an unfavourable balance; a period, the duration of which may, to a certain degree, be estimated, though disappointment in a second harvest may cause much error in the calculation.
The more particular examination of this subject of an unfavourable exchange, brings us, therefore, to the same conclusion to which we were led in the former Chapter; namely, that the bank ought to avoid too contracted an issue of bank notes. The absence of gold, though itself an evil, may prevent other evils of greater moment; and may thus conduce, under certain circumstances, to the good of the country. Our gold has lately furnished the prompt payment for a part of that corn, which has been necessary for our consumption. The common manufacturer, if he understood his own interest, would approve rather than complain of the temporary substitution of paper for gold, which has been thus occasioned; for the export of gold has served to ease him in the first instance: his labour, indeed, must hereafter purchase back again the gold which has been exported, but he will have to buy it back by exertions less severe than would otherwise have been needful. The price of the goods which he manufactures, and, consequently, the price also of his own labour, is rendered somewhat higher by not glutting the foreign market with a quantity of articles altogether disproportionate to the demand. It should farther be remembered, that gold is an unproductive part of our capital: that the interest upon the sum exported is so much saved to the country: and that the export of gold serves, as far as it goes, to improve the exchange, by discharging the debt due on account of an unfavourable balance of trade; and to prevent the depreciation of our own paper currency, as compared with the current money payments of other countries.
It may probably be thought that the exported gold will not return. This subject may deserve a careful enquiry. It should be observed, in the first place, that, in order to produce an improvement in the exchange, we have only to suppose the present degree of the pressure for payment of goods imported to abate. It may happen, for instance, that in consequence of Hamburgh having become richer through the favourable harvest enjoyed in the surrounding countries, and through the high price obtained for its exported corn, while Britain has become poorer; the antecedent custom of Hamburgh merchants being in debt to London merchants may change, and a contrary custom may become prevalent. If this new debt of London to Hamburgh should be permitted to exist in the same manner as the Hamburgh debt may be supposed to have existed before, the exchange will not be affected by it. The debt which affects the exchange is only that sort of debt, the payment of which is more or less eagerly demanded. A country, therefore, seems likely soon to arrive at a limit in this respect. It has only to diminish not the debt itself, but the pressure of the demand for payment, and the exchange begins to mend. Let the two countries become equally satisfied to allow the debt to continue as it is, and the exchange finds its level. Again; let the country in debt prove itself to be somewhat more desirous to pay its debt, a debt of course running at interest, than the creditor country is to receive payment; and the exchange will be even in favour of the debtor country.
It may naturally be enquired what becomes of the gold which has been supposed to go from this country to Hamburgh; and how it comes to pass that it is there demanded in such large quantities. When Britain has already spared out of its circulation, and out of the coffers of its principal bank, many millions, perhaps, of gold; whence happens it that Europe, having only the same trade as before, uses all that is sent, and continues to call, by means of the exchange, for a still encreasing supply?
I understand that, at the period of every very favourable exchange to Hamburgh, most of the gold poured in thither is melted down into the several sorts of coin which are current on the continent; and that it then becomes an article of remittance to various places. It is, of course, remitted to those parts in which the balance of trade with Hamburgh is unfavourable to that city. Still, however, the difficulty of accounting for the new and general demand for gold seems to remain. The following considerations may afford some solution of it. When the trade of the world, or of many separate and considerable places, is more than usually fluctuating, as in times of political uncertainty or convulsion it can hardly fail to be, a larger quantity of gold is wanted than when confidence is high, and when the several exports and imports of different countries more nearly balance each other. Gold, during any extraordinary irregularity in trade between independent states, is the most commodious of all articles of remittance. It is a species of return which Hamburgh, for instance, can send to every place from which its spirit of speculation may have called for articles of commerce. It is, indeed, only the balance of the accounts which is paid in money; but, at different times, there may be balances of different sizes to be thus discharged. Whatever event, therefore, so disturbs the course of trade over the continent as to cause an encrease in the balances of the trade of independent countries, seems likely to cause an augmentation of the general demand for gold. But the general demand for gold is also affected by the degree of confidence at the same time subsisting. It has been already shewn, that the quantity of gold requisite for the circulation of any single country may be very different at different periods, and that the difference is proportioned to the degree of confidence between man and man existing at the several seasons. The quantity of gold wanted for the general trade of the world may also fluctuate, in some degree, from the same cause. It is, however, likely also to vary from a variation in the confidence subsisting between independent countries. For the sake of illustration, let us suppose that Hamburgh owes to some town in Prussia, one hundred miles distant, 100,000l. sterling, in consequence of an unfavourable balance of trade occasioned by corn purchased there, and exported by Hamburgh merchants to London; a balance which, if the creditors in the Prussian town were willing to wait six months, would probably by that time be repaid, and even more than repaid, through the importation into the same town of West India articles which Hamburgh would have received within that period from Great Britain. If confidence is high, the merchants of this town will be content, for the sake, perhaps, of an addition of one per cent. to the stipulated interest, to permit the debt to remain unextinguished for the six months; and in this case the course of exchange between the Prussian town and Hamburgh will alter to the extent of one per cent. But if, through the want of confidence subsisting between the Prussian town and Hamburgh, an addition not of one, but of two per cent. to the current interest should be considered to be the adequate compensation for the risk incurred, the exchange will fluctuate two per cent.; and a variation of two per cent. in the exchange will produce, let it be supposed, to the Hamburgh debtors a greater loss than would be incurred by the expence of transporting 100,000l. in gold to the Prussian town in question. Gold is, therefore, in that case, transported. On the two circumstances, taken together, of the largeness of the balance between the independent places, and the degree of confidence subsisting between them, appears to depend the quantity of bullion required. It seems, therefore, by no means difficult to account for the manner in which large quantities of gold exported from this country may be employed on the continent in seasons of general distrust, even though we should not suppose any great portion to be hoarded.
Bullion to a very large amount was retained in the Spanish settlements, during the latter period of the war, through the fear of capture; and perhaps, therefore, we might trace in part the want of gold, of which we have complained, to those successful exertions in watching the ports of the enemy which have been made by the British navy.
The immediate cause, however, of the exportation of our coin has been an unfavourable exchange, produced partly by our heavy expenditure, though chiefly by the superadded circumstance of two successively bad harvests. When the recurrence of a favourable balance of trade is long delayed, the fluctuation of the exchange may be expected to be not an immaterial one. The exchange is, in some degree, sustained for a time, which is thought likely to be short, through the readiness of foreigners to speculate in it; but protracted speculations of this sort do not equally answer, unless the fluctuation in the exchange is very considerable. If, for example, a foreigner remits money to London, at a period when the exchange has become unfavourable to England to the extent of three per cent., places it at interest in the hands of a British merchant, and draws for it in six months afterwards, the exchange having by that time returned to its usual level, he gains two and a half per cent. for half a year’s interest on his money, and also three per cent. by the course of exchange, which is five and a half per cent. in half a year, or eleven per cent. per annum. But if the same foreigner remits money to England when the exchange has, in like manner, varied three per cent., and draws for it not in six months but in two years, the exchange having returned to its usual level only at the end of that long period, the foreigner than gains ten per cent. interest on his money, and three per cent. by the exchange, or thirteen per cent. in two years: that is to say, he gains in this case six and a half per cent. per annum, but in the other eleven per cent. per annum. If a variation of three per cent. is supposed necessary to induce foreigners to speculate for a period which is expected to end in six months, a variation of no less than twelve per cent. would be necessary to induce them to speculate for a period which is expected to end in two years. The improvement of our exchange with Europe having been delayed through a second bad harvest, it is not surprising that the expectation of its recovery within a short time should have been weakened in the mind of foreigners. Indeed, many circumstances, some of which have been already touched upon* , concurred, towards the conclusion of the war, in rendering our exchange unfavourable.
Some gold, it may be presumed, was retained in the bank coffers, which, if the cash payments of that company had not been suspended, would have found its way to foreign countries, and have contributed to remedy the existing evil.
We depended chiefly, as will be shewn hereafter, on the proper limitation of the quantity of our circulating paper, though partly, also, on the degree of expectation which was kept up abroad of the future improvement of our exchange; an expectation which might be rendered greater or less by a variety of circumstances. Great Britain has had this great advantage over those countries which are in the habit either of depreciating their coin or of allowing a discount on their paper, that they, in anticipating the return of a more favourable state of their trade, look forward only to a time when their uncertain and unstable rate of exchange may be meliorated in a degree not easy to be calculated; whereas we have anticipated a period when an intrinsically valuable and specific standard would be restored, when our banks would be obliged to pay fully in guineas containing the same weight of gold as before, and when our exchange, therefore, might be expected completely to return to its former level.
Undoubtedly, circumstances of so great and extraordinary a nature may arise as to prevent the return of gold at an early or assignable period. It may, however, be safely affirmed, that when the main sources of a country’s wealth are unimpaired; when its population, its industry, its manufacturing and trading capital, its general commerce, its credit, its colonial possessions, its political strength and independence, its laws and constitution remain; and when, moreover, its paper is confined within its accustomed bounds; the absence of its gold, more especially if it be the obvious consequence of one or more unfavourable seasons, is an evil which is likely neither to be durable, nor in any respect very important.
Under such circumstances, to alter materially the old and accustomed system of paper credit, and, in particular, to restrain in any very extraordinary degree the issues of paper of more responsible banks, is to deprive a country of those means of recovering itself which it naturally possesses. This seems to be the fair inference from the observations which have been stated in the present and preceding Chapters. The return of gold is to be promoted not so much by any legislative measure directed to that immediate object, as by cherishing the general industry, and attending to the higher and more leading interests of the community.
It may be proper here to add, that the experience of past times, both of war and peace, leads us to suppose, that the exchange between Great Britain and foreign countries is not likely to remain for any long period unfavourable to Great Britain. Experience has likewise proved, that the return of gold has not been precluded by the law which authorized the continuance of the suspension of the cash payments of the bank; for, while that law was in force, there occurred one season during which gold flowed with a remarkably strong tide into the country.
It seems scarcely necessary now to dwell on the reasons which evince that the repeal of the law in question, in the last period of the war, would have been inexpedient. It would have been to repeal it at a time not a little resembling that in which the parliament first thought proper to enact it: for it would have been to repeal it when gold had been recently drawn out of the country by an unfavourable exchange; and when we were subjected, as before, to alarms of invasion. To have opened the bank would have been, moreover, to have subjected it not only to a demand for gold on these two accounts, but also to such extra calls as might have arisen from the anxiety of the country banks to provide for the event of the first opening more amply than might have been permanently necessary. The renewal, therefore, of the law for suspending the cash payments of the bank stood on the ground of the particular circumstances of the times, and not on any principle which necessarily implied the permanence or even the long continuance of the suspension.
[* ]This point may be illustrated in the following manner:—
[* ]That the diminution of the circulating paper has a tendency to bring down the price of goods at home, and to cause those goods to go abroad for the sake of a better market, was observed in the preceding Chapter, and will again be insisted on when we proceed to treat of the importance of properly limiting the quantity of Bank of England notes. Many remarks, however, were added, in the former Chapter, respecting those detrimental effects of a reduction of paper, which are to be set against the good consequences of it. In the present Chapter the same arguments, on each side, are about to recur, and they will, therefore, be but slightly touched upon.
[* ]A mistaken idea of the bank payments having been suspended through the improper largeness of its loans to government, and of its resembling the continental banks which have issued excessive quantities of paper for the service of their several governments, was before stated to be not unlikely to have prevailed abroad, too much countenance having been given in this country to such a sentiment. Foreigners, if such was their opinion, would conceive that our exchange was a permanently declining one, and that it would, therefore, answer better to them to draw than to remit, and to draw immediately than to delay drawing. The idea that foreign property might be seized in England, as an act of retaliation for the British property seized in the north of Europe, may also have had some influence. The expectation of seizures on each side would prejudice the exchange of whichever country was in debt, and the country in debt happened to be Great Britain.