Front Page Titles (by Subject) CHAP. X - An Enquiry into the Nature and Effects of the Paper Credit of Great Britain
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CHAP. X - 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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Objections to the Doctrine of the two preceding Chapters answered—Of the Circumstances which render it necessary that the Bank should impose its own Limit on the Quantity of its Paper.—Effect of the Law against Usury.—Proof of the Necessity of restricting the Bank Loans, drawn from the Case of the Transfer of Capital to Foreign Countries.
Since it is not improbable that the reasoning of the preceding Chapters may have failed to produce full conviction in the mind of those who have been in the habit of deeming all limitation of the bank paper by the bank itself to be unnecessary; some few pages may be usefully employed in answering popular objections to the doctrine which has been laid down, and in more fully elucidating the subject.
“The encrease of Bank of England paper,” we will suppose it to be still said by an objector, “is the effect and not the cause of an advanced price of commodities. To enlarge the Bank of England notes merely in proportion as safe and real bills are offered in return for them, is only to exchange one species of paper for another, namely, Bank of England notes for bills, which, though not so current or so safe as bank notes, are sufficiently worthy of credit. It is, therefore, simply to afford a guarantee to the transactions of the merchant, and thus to render that accommodation to commerce which it belongs to the bank to give.”
“The depreciation of paper,” it may be added, “is apt to arise not so much from an extension of its quantity, as from a want of sufficient confidence in it. The great object of the bank should, therefore, be to maintain the public confidence; to which it contributes by furnishing, in return for bills confessedly good, a species of paper still better. The evil of an unfavourable exchange, and of a consequent high price of gold, arises from an unfavourable balance of trade, and from that cause only. The true mode of preventing this evil, or of remedying it, if unfortunately it exists, is to encrease the national industry. The way to encourage industry is to give full scope to trade and manufactures by a liberal emission of paper. The balance of trade will not fail to be rendered favourable by that abundance of exportable articles which the labour thus excited must necessarily create. The course of exchange will, consequently, be supported; all excess of the market price above the mint price of gold will be prevented; and thus the value of our paper will be sustained by the very means of its encrease.” Suppose a reasoner, on the same side, to add, that when the credit of the assignats of France was overthrown, the fall, especially at the first, was owing rather to the prevalence of distrust than to the excessive quantity of the article, and that the depreciation of assignats rarely bore a regular proportion to the extension of their amount* .
It may, with equal truth, be affirmed by the objector, that if a reference be made to the prices of corn in the London corn-market at various æreas, and also to the account of the quantity of bank notes stated by the bank to have been in circulation at the same or at immediately preceding periods, the price of grain in London will by no means be found to have been high in proportion as the number of Bank of England notes has been great, and low in proportion as it has been small; but that the very contrary has often been remarkably the case.
To these objections it may be answered, that they who represent an unlimited issue of Bank of England paper as having no tendency to produce the evils of a rise in the price of commodities in Great Britain, of a fall in our exchange, and of an excess of the market price above the mint price of gold, are bound to prove one of the two following propositions: either, first, that, supposing the directors of the bank to make the most enormous addition to their paper; to raise it, let us suppose, to fifty millions, even this augmentation will not lead to the consequences which have been mentioned; or if they do not affirm this strong position, but admit that there is a certain quantity of notes which will not fail to produce the evils in question, then, secondly, in order to prove that the bank need not place any limit to the issue of its own paper, they are bound to shew that the bank paper has a natural tendency sufficiently to limit itself.
Let us separately investigate each of these two points.
When we assume the fact of the bank paper being raised from its present amount of about fifteen millions to the sum of fifty millions, we are led, in the first place, to enquire in whose hands the additional sum of thirty-five millions would be placed, and what would be the motive for holding it? I admit, or rather it is a point on which I would insist, that the maintenance of the price of the assignats of France by no means rested entirely, nor, for a time, even principally, on their quantity. It depended much on the opinion entertained by Frenchmen respecting the value of the lands declared to be purchasable by means of this particular kind of paper, and respecting the fidelity of the French government to its engagements. Assignats, it is true, bore no interest; but the prospect of an ultimate profit to be reaped by the possessor of them, would operate, for a time, exactly like an accruing interest, in causing many persons to detain them; and, therefore, although they were used as a circulating medium, it is probable that only a part of them was turned to this purpose, and that even that part circulated but slowly. The reader is here desired to recollect a point which was explained in an early part of this work; namely, that the quantity of circulating medium which can be employed without injury to its value, is to be estimated not merely by its proportion to the quantity of trade or of payments, but also by the relative rapidity of its circulation. A species of circulating medium which changes hands once in ten days, will need to be a hundred times as great in quantity as the paper which passes through ten hands in one day. When that sanguine spirit which had at first inspired the holders of assignats subsided, the article would naturally sink in value with considerable rapidity; and in proportion as its price fell, the French government would be under the necessity of extending its issues. It is, therefore, not at all surprising that French assignats should, for a time, have borne a price which was proportionate not so much to their quantity as to their credit. Their quantity, however, after a certain period, operated on their credit, and became a very powerful cause of their depreciation.
Bank of England notes are exactly the converse to assignats in the points which have been mentioned; and their value, on that account, will be found to depend not so properly on their credit as on their quantity. It is true, that when, in consequence of alarm, a run is made upon the bank for guineas, the same confidence which is placed in gold is not reposed in Bank of England paper. Even in this case, however, it is only a small part of the community which is eager for gold: the holders of a very large proportion of the bank paper remain exactly as well contented as before to use it as the medium of their payments. And since the hoarders of gold prefer it not to paper only, but to land, to goods, and to almost every species of property, the paper of the bank cannot be affirmed to fall into discredit in consequence of applications for coin made with a view to hoard it, so properly as gold may be said to come into peculiar demand. In a season of alarm, our guineas are preferred by some persons both to our bank notes and to goods, on the same principle on which, in a state of extreme political convulsion, diamonds, because they may be still more easily transported or concealed, would probably be preferred to gold.
By saying, therefore, that the value of bank notes depends not on their credit, but on their quantity, I mean to affirm that their credit, so far as it affects their value, is always good, and that the common fluctuations of their price, in exchange both for goods and bullion, are not, in the smallest degree, to be referred to variations in the degree of confidence placed by Englishmen in the good faith or the solidity of the Bank of England. The magnitude of its capital is perfectly well known, and not the slightest doubt subsists respecting the sufficiency of its effects to answer much more than all its engagements. If the rise and fall in the public confidence in bank notes were the cause of the gradations in their price, the period at which their value would have been the lowest would have been that which followed the suspension of the cash payments of the bank; an event certainly calculated, more than any other which has been experienced, to affect the reputation of that company. But it is a most remarkable fact, and a fact decisive on the present point, that the exchanges of this country improved, or, in other words, that Bank of England paper rose in value when compared with bullion, in the months subsequent to the suspension of its payments in cash.
Bank of England paper, therefore, is not apt to vary in its value in consequence of the fluctuations of the public confidence in it; but essentially differs in this respect from the late assignats of France. It presents to the holder no hope of future profit from the detention of it. Not only does it bear no interest (in this point, indeed, resembling assignats), but it offers no substitute for interest; it holds out no privileges, certain or contingent, real or pretended, tempting the possessor to detain it. There is, on the contrary, a known and continually increasing loss sustained by keeping it. On this account the quantity held by each person is only that which the amount of payments to be effected by it renders, in his opinion, necessary.
We are at present assuming, for the sake of illustrating the subject, that thirty-five millions of additional bank paper are retained in the hands of the public. Imagine a London banker to acquire his share in them. The supply of bank notes which he chuses to reserve in his drawer is always estimated by the scale of his payments; or, to speak more correctly, by the probable amount of the fluctuations in his stock of notes, which fluctuations are proportionate, or nearly proportionate, to the scale of his payments. So long, therefore, as his payments remain the same (and they will not materially alter while the price of goods suffers no variation, supposing his transactions to retain their former proportion to those of the whole kingdom), he will be perfectly indisposed to hold fifty thousand pounds in bank notes, in the place of each fifteen thousand pounds which he has been accustomed to deem necessary. He will make haste to part with the whole superfluous quantity; he will offer to lend it to any safe merchants, and even at a reduced rate of interest, in case he shall find that borrowers cannot otherwise be invited.
If we imagine the merchants to become possessed of the new paper, the same difficulty of accounting for the detection of it remains; unless we admit that the principles laid down in the two former Chapters are just, and that the larger quantity of circulating medium will cause goods to rise in value, and will thus find for itself employment.
There seems to be only two modes in which we can conceive the additional paper to be disposed of. It may be imagined either, first, to be used in transferring an encreased quantity of articles, which it must, in that case, be assumed that the new paper itself has tended to create; or, secondly, in transferring the same articles at a higher price.
Let us examine the first of these cases.
An encreased quantity of articles can only arise from additional commodities either brought from abroad or produced at home through the exertion of new industry. An extraordinary issue of paper will bring goods from abroad only so far as it enables the country to export either gold, or additional commodities created at home, as the means of paying for the foreign articles. The export of gold has its limit. It is, moreover, desirable, for reasons which have been fully stated, that this limit should be narrow. Whether a very great emission of notes tends to encrease the quantity of goods produced at home, is the point which remains to be considered.
In examining this question, an error into which it is very natural to fall must be developed. When the Bank of England enlarges its paper, it augments, in the same degree, as we must here suppose, its loans to individuals. These favoured persons immediately conceive, and not without reason, that they have obtained an additional though borrowed capital, by which they can push their own particular manufacture or branch of commerce; and they are apt, also, though not with equal justice, to infer, that the new capital thus acquired by themselves is wholly an accession to that of the kingdom; for it does not occur to them that the commerce or manufactures of any other individuals can be at all reduced in consequence of this encrease of their own.
But, first, it is obvious, that the antecedently idle persons to whom we may suppose the new capital to give employ, are limited in number; and that, therefore, if the encreased issue is indefinite, it will set to work labourers, of whom a part will be drawn from other, and, perhaps, no less useful occupations. It may be inferred from this consideration, that there are some bounds to the benefit which is to be derived from an augmentation of paper; and, also, that a liberal, or, at most, a large encrease of it, will have all the advantageous effects of the most extravagant emission.
Let us also consider the mode in which the new paper operates through the medium of these individual borrowers, as unquestionably it does, in giving life to fresh industry. The bank notes convey to them the power of obtaining for their own use, or of destining to such purposes as they please, a certain portion of purchasable commodities. The extraordinary emission of paper causes no immediate difference in the total quantity of articles belonging to the kingdom. This is self-evident. But it communicates to the new borrowers at the bank a power of taking to themselves a larger share of the existing goods than they would otherwise have been able to command. If the holders of the new paper thus acquire the power over a larger portion of the existing stock of the kingdom, the possessors of the old paper must have the power over a smaller part. The same paper, therefore, will purchase fewer goods, or, in other words, commodities will rise in their nominal value. The proprietors of the new paper will become greater encouragers of industry than before; the owners of the old paper, being able to command less property, will have less power of employing labour. For industry is excited, strictly speaking, not by paper, but by that stock which the paper affords the means of purchasing. Money of every kind is an order for goods. It is so considered by the labourer when he receives it, and is almost instantly turned into money’s worth. It is merely the instrument by which the purchasable stock of the country is distributed with convenience and advantage among the several members of the community.
It may be said, however, and not untruly, that an encreased issue of paper tends to produce a more brisk demand for the existing goods, and a somewhat more prompt consumption of them; that the more prompt consumption supposes a diminution of the ordinary stock, and the application of that part of it, which is consumed, to the purpose of giving life to fresh industry; that the fresh industry thus excited will be the means of gradually creating additional stock, which will serve to replace the stock by which the industry had been supported; and that the new circulating medium will, in this manner, create for itself much new employment.
The supposition which has now been made is admitted to be just. Let the reader, however, take notice, that it assumes the demand both for goods and labour to become more eager than before.—Now the consequence of this encreased eagerness in the demand must, unquestionably, be an enhancement of the price of labour and commodities, which is the very point for which I am contending. Indeed, whatever view we take of the subject, we seem obliged to admit, that, although additional industry will be one effect of an extraordinary emission of paper, a rise in the cost of articles will be another.
Probably no small part of that industry which is excited by new paper is produced through the very means of the enhancement of the cost of commodities. While paper is encreasing, and articles continue rising, mercantile speculations appear more than ordinarily profitable. The trader, for example, who sells his commodity in three months after he purchased it, obtains an extra gain, which is equal to such advance in the general price of things as the new paper has caused during the three months in question:—he confounds this gain with the other profits of his commerce; and is induced, by the apparent success of his undertakings, to pursue them with more than usual spirit. The manufacturer feels the same kind of encouragement to extend his operations; and the enlarged issue of paper supplies both him and the merchant with the means of carrying their plans into effect. Bs soon, however, as the circulating medium ceases to encrease, the extra profit is at an end; and, if we assume the augmented paper to be brought back to its ordinary quantity, we must suppose industry to languish for a time, through the ill success which will appear to attend mercantile transactions.
Mr. Hume has an observation in his Essay on Money, which, in some degree, confirms the remarks which have been made in the text. Having represented an influx of money as exciting industry (and we may presume an encrease of paper to have exactly the same effect), “At first,” he says, “no alteration is perceived; by degrees the price rises first of one commodity, then of another, till the whole, at last, reaches a just proportion with the new quantity of specie which is in the kingdom. In my opinion, it is only in this interval or intermediate situation between the acquisition of money and rise of prices” (Mr. Hume must mean, no doubt, the completion of the rise, and not the commencement of it) “that the encreasing quantity of gold and silver is favourable to industry* .”
It must be also admitted, that, provided we assume an excessive issue of paper to lift up, as it may for a time, the cost of goods though not the price of labour, some augmentation of stock will be the consequence; for the labourer, according to this supposition, may be forced by his necessity to consume fewer articles, though he may exercise the same industry. But this saving, as well as any additional one which may arise from a similar defalcation of the revenue of the unproductive members of the society, will be attended with a proportionate hardship and injustice. This supposition also implies the acknowledgment of the point for which we are contending, that an encreased issue of paper tends to raise the price of commodities.
It has thus been admitted that paper possesses the faculty of enlarging the quantity of commodities by giving life to some new industry. It has, however, been affirmed, that the encrease of industry will by no means keep pace with the augmentation of paper. The question now to be considered is, whether, if we suppose thirty-five millions of new paper to be suddenly issued, the fresh industry which would, consequently, be excited, would create a quantity of goods, the sale of which would give employment to all the new paper. Let it be admitted, for the sake of illustrating this point, that the thirty-five millions of additional bank notes will have the extraordinary power of calling at once into being thirty-five millions of new goods; still it may be remarked, that even all this additional property would by no means find employment for that equal quantity of paper which is here assumed to have given existence to it.
We shall be able to explain this circumstance, as well as to throw some new light on the general subject, by supposing an individual, A, to become, in consequence of an extraordinary issue of paper, a new borrower at the bank to the extent of twenty thousand pounds. The twenty thousand pounds, while it is held in the shape of paper, affording him no interest; he will make haste to part with it, by purchasing goods, stocks, land, or some other article, to the extent of the sum in question. Suppose him to make the purchase from B, in three days after he received the notes. B is now in possession of twenty thousand pounds in new bank paper, created by the extraordinary emission; and is, in like manner, in haste to part with it. Imagine him, also, to pay away the same paper in return for goods at the end of three days. Thus the same notes will in six days have effected two purchases amounting together to forty thousand pounds. If we imagine the like transaction to be repeated again and again; the same notes will in twelve days have effected the purchase of goods amounting to eighty thousand pounds; in about a month to two hundred thousand pounds; and in a year to about two millions. Thirty-five millions of new paper will thus effect in a year the sale of goods to the extent of two or three thousand millions. In order, therefore, to account for the employment of the thirty-five millions, we must assume, if we allow no rise in prices to take place, such a new quantity of goods to be called into existence by the magic influence of the new paper, as to become a subject for purchases, amounting, in a year, to no less than these two or three thousand millions. We must assume the creation not of thirty-five millions of property, but of five, ten, or, perhaps, twenty times that sum; or else we must suppose, what is not supposable, that the newly created capital of thirty-five millions changes hands as frequently as the thirty-five millions of bank notes which created it; that is to say, that the new property undergoes a fresh sale on every third day.
The case which has been put is inaccurate, inasmuch as the payments effected by bank notes are on the account not merely of goods and other articles sold, but likewise of numberless sums borrowed and repaid. It is probable, however, that payments of this latter kind will always bear a nearly uniform proportion to those of the other class. The general inference which was intended to be drawn from the case, will, therefore, be just.
In speaking formerly of the reduction of bank paper, much pains were taken to point out the important difference between that limitation of loans which leads to a diminution of paper, and that which produces no such diminution; and it was then observed, that it was by the quantity of Bank of England paper, and not by the amount of loans, or by the amount of loans so far only as they influence the quantity of paper, that a judgment was to be formed of the pressure on the metropolis, and of the reduction of prices. Many of the remarks then made respecting the limitation of bank paper, apply with nearly equal force to the subject of its encrease.
It has now been fully shewn, first, that Bank of England paper is an article of such a nature, that a very superfluous quantity of it will never be for a long time retained in any quarter; and, secondly, that the vast encrease of it, which, for the sake of more convenient discussion, was assumed to take place, cannot possibly create such a new capital as shall furnish the new paper with employment. There remains, therefore, no other mode of accounting for the uses to which the additional supply of it can be turned, than that of supposing it to be occupied in carrying on the sales of the same, or nearly the same, quantity of articles as before, at an advanced price the cost of goods being made to bear the same, or nearly the same, proportion to their former cost, which the total quantity of paper at the one period bears to the total quantity at the other.
We are thus brought, though by a different course, to the point at which we arrived in an early part of a former Chapter. An enlarged issue of paper, it was then observed, produces an encreased facility of borrowing, as well as an opinion of encreased facility; and thus adds to the eagerness of purchasers. It communicates an additional power of purchasing, not only to the original borrower at the bank, but successively, also, as has now been shewn, to all the other individuals into whose hands the new bank notes pass in the course of their circulation.
Very strong confirmation of the present doctrine may be furnished by a reference to the case of gold. No one doubts, that, in the event of an augmented supply of this article from the mines, the value of it would fall nearly in proportion to the extension of its quantity; especially if it were used for the sole purpose of a circulating medium, and were also the only kind of circulating medium. The metropolis of Great Britain is so circumstanced, that the issue of an extraordinary quantity of bank paper for the purpose of effecting the payments of London, in a considerable degree resembles the creation of an extraordinary supply of gold for the general uses of the world.
It was stated in the beginning of this Chapter, as one objection to the doctrine which I have been endeavouring to establish, that “to enlarge the quantity of Bank of England notes merely in proportion as sufficient and real bills are offered in return for them, is only to exchange one species of paper for another, namely, Bank of England notes for bills, which, though not so current or so safe as bank notes, are sufficiently worthy of credit. That it was, therefore, simply to afford a guarantee to the transactions of the merchant, and thus to render that accommodation to commerce where it belongs to the bank to give.” This objection will be sufficiently answered by repeating an observation which has been already frequently made, namely, that the effect produced by paper credit on the price of articles depends not merely on the quantity of paper in existence, but also on its currency, or, in other words, on the rapidity of its circulation. It was admitted in the objection, that bills are not current like bank notes, and that it is the greater currency of the latter which causes the exchange to be desired.
It was mentioned, as another argument against the doctrine which has been laid down, that corn has not usually borne any sort of proportion to the quantity of Bank of England paper in circulation at the same time. The answer is, that the directors of the bank have never augmented their notes in such a degree as to be likely to produce any material alteration in the general price of goods; that one or more of those circumstances which were dwelt upon in the preceding Chapter, may have counteracted the tendency of the fluctuations of the quantity of paper to produce correspondent variations in the price of commodities; and, above all, that even a small reduction of the supply of grain can hardly fail to lead to a rise in its value when exchanged for paper, so great as to forbid all comparison between the effects of an alteration of the quantity of the one article and of an alteration of the quantity of the other. Paper has been spoken of as raising the cost of commodities, at the most, only in proportion to its encreased quantity. But in the case of a diminished supply of corn, the price rises according to a very different ratio; and for this obvious reason, that we cannot accustom ourselves to the use of a reduced allowance of grain, in the same manner in which we are able, by degrees, to accommodate ourselves to a smaller quantity of circulating medium* .
Let the principle which was laid down as regulating the cost of all articles be recollected. The question of prices is a question of power, and of power only; and, in the event of the scarcity of any commodity, the buyers are more or less under the power of the sellers, in proportion as the article in question is of more or less urgent necessity.
That the quantity of circulating paper must be limited, in order to the due maintenance of its value, is a principle on which it is of especial consequence to insist, as it has been overlooked by some writers on paper credit. In the work of Sir James Stewart on Political Œconomy, banks are discussed at considerable length; but little intimation is given of the necessity of confining the total quantity of circulating paper, or of the tendency of an excessive emission to render the exchange unfavourable, and thus to cause gold to be drawn away. On the other hand, the duty of not giving out bank paper, except for sufficient value received (a point on which, at the present time, there is less occasion to enlarge), is strongly urged by this writer, and the security of bills of exchange is implied by him to be inadequate, that of land alone being fully approved. Bank notes emitted without obtaining value in return, are termed by him paper issued for “value consumed;” and are represented as the great source both of loss and danger to a banking company. His mode of expressing himself on this point is such as to make him appear to lend much countenance to the error which it is the object of the present Chapter to expose; namely, that of imagining that a proper limitation of bank notes may be sufficiently secured by attending merely to the nature of the security for which they are given* .
Dr. A. Smith, who is a more late writer, has asserted the necessity of a limitation of paper, in the passage which was quoted in an early part of this work; but he has done this in terms which are inaccurate, and he has given an erroneous and inadequate idea of the evil which may result from a very extended emission.
Mr. Locke has lent some countenance to the error which I am endeavouring to expose, by his way of considering the subject of the balance of trade, which is the same mode in which I supposed, in the beginning of this Chapter, an objector to conceive of it. “The evil of an unfavourable exchange,” I imagined my opponent to say, “and of a consequent high price of gold, arises from an unfavourable balance of trade, and from that only. The true way of preventing this evil, or of remedying it, if it unfortunately exists, is to encrease the national industry; and the way to encourage industry, is to give full scope to trade and manufactures by a liberal emission of paper. The balance of trade will not fail to be rendered favourable by that abundance of exportable articles which the labour thus excited must necessarily be supposed to create.”
Mr. Locke’s language respecting an unfavourable balance of trade, and its influence in causing gold to be melted down and exported, is as follows.
“Profit,” he says, “can be made by melting down our money, but only in two cases. First, when the current prices of the same denomination are unequal and of different weights, some heavier some lighter; for then the traders in money cull out the heavier, and melt them down with profit.—The other case wherein our money comes to be melted down, is a losing trade, or, which is the same thing in other words, an over great consumption of foreign commodities. Whenever the over-balance of foreign trade makes it difficult for our merchants to get bills of exchange, the exchange presently rises. If the law makes the exportation of our coin penal, it will be melted down; if it leaves the exportation of our coin free, it will be carried out in specie—one way or other, go it must. But this melting down carries not away one grain of our treasure out of England.—The coming and going of that depends wholly upon the balance of trade* .”
The error which I consider as encouraged and supported by this passage of Mr. Locke (and much similar language is to be found in other writers), is this:—the passage implies, that it is the comparative state of our exports and imports which regulates the exchange, and not at all the state of the exchange which regulates the comparative state of our exports and imports. It leads us to suppose, that an unfavourable balance of trade (that is, the excess of the goods imported above those exported) is exclusively the cause, and that the bad state of the exchange is altogether the effect. The passage inclines us not at all to suspect a circumstance which Mr. Hume admits in a note in his Essay on Money, namely, “that an unfavourable exchange becomes a new encouragement to export.”
The point which I wish here to establish may be still more clearly explained in the following manner. It has been shewn in a former Chapter, and, indeed, it is stated by Mr. Locke, that the selling price of bills determines the rate of exchange. When, therefore, for example, persons abroad wishing to sell bills on England are more numerous than those who are disposed to buy them, the price of bills must drop; and it must continue to fall until it becomes so low as to tempt some individuals to become purchasers of them. They who buy the bills on England, are the buyers of so many orders to receive in England either money or bank notes. The money or bank notes thus received, unless left in some English hand (and they will be so left in some few cases only), must be invested in British articles, and exported. The profit afforded by the fall in the selling price of the bills must, therefore, be sufficient to cause the speculation of the buyers of the bills to answer—the speculation I mean of either bringing over British gold, which would not otherwise have been transferred, or of purchasing and exporting British commodities which would not otherwise have been at that time transported. Thus, therefore, an unfavourable exchange may be considered not only as becoming, according to Mr. Hume’s expression, “a new encouragement to export,” but as affording all that degree of encouragement to export which is necessary to secure as much actual exportation either of gold or of goods, or both, as shall serve to equalize the exports and imports; unless, indeed, the same cause, namely, the unfavourableness of the exchange, should tempt foreigners to remit money to England, and lodge it for a time in our hands, with a view to the profit to be obtained by this species of speculation.
The principle which I would lay down on the subject now under consideration, is, I think, simple and intelligible, and it applies itself to all periods of time, and to every kind of circulating medium which may happen to be in use. I would be understood to say, that in a country in which coin alone circulates, if, through any accident the quantity should become greater in proportion to the goods which it has to transfer than it is in other countries, the coin becomes cheap as compared with goods, or, in other words, that goods become dear as compared with coin, and that a profit on the exportation of coin arises. This profit, indeed, soon ceases through the actual exportation of the article which is excessive.
I would say again, that in a country in which coin and paper circulate at the same time, if the two taken together should, in like manner, become, in the same sense of the term, excessive, a similar effect will follow. There will, I mean, be a profit on sending away the coin, and a consequent exportation of it.
I would say, thirdly, that in a country in which paper alone circulates, if the quantity be in the same sense excessive, supposing the credit of the banks which issued it to be perfect, the paper will fall in value in proportion to the excess, on an exactly similar principle; or, in other words, that goods will rise; and that a necessity will exist for granting, in the shape of exchange, a bounty on the exportation of them equal to that which would have been afforded in the two former suppositions, assuming the quantity of circulating medium to be excessive in an equal degree in all the three cases.
It thus appears, that “the coming and going of gold” does not (as Mr. Locke expresses it, and as was supposed in the objection at the beginning of this Chapter) “depend wholly on the balance of trade.” It depends on the quantity of circulating medium issued; or it depends, as I will allow, on the balance of trade, if that balance is admitted to depend on the quantity of circulating medium issued. Mr. Locke, however, is very far from leading his reader to conceive that the balance of trade depends on the quantity of circulating medium issued; for he describes an unfavourable balance as resulting from a “losing trade,” and from an “over great consumption of foreign commodities;” terms which seem to imply an unprosperous state of commerce, and a too expensive disposition in the people, and which naturally lead to the conclusion, that the prosperity of the country will effectually secure us against the danger of the exportation of our coin, whatever may be the quantity of our paper.
It has now, I trust, been made sufficiently to appear, that banks, if they pay in gold, or if, while not paying in gold, they maintain the value of their notes, must observe some limit in respect to their emission of them.
If, indeed, we could suppose a country to have no intercourse with any other, we might imagine an unlimited issue of paper to take place without producing any difference in its value when exchanged for gold. In that case it would be necessary to assume the price of goods to rise indefinitely, but the people to be content to use a less and less proportion of gold to paper, and on that account to continue to consider the relative value of gold and paper as the same. This unlimited rise in the price of goods, and equally indefinite fall in the value of gold, are everywhere precluded by the commercial communications which take place between different parts of the world; gold in exchange for goods, allowing for the expense of transporting them, necessarily bearing that price, or nearly that price, in each country which it bears in all. The variations in the value of bullion, as compared with that of the circulating medium, serve, therefore, to detect and restrain that too great emission of notes to which all countries would otherwise be prone; and those operations of the exchange, which have been described, are the means by which every bank is compelled to make the value of its paper conform itself to the ancient standard.
Let the case of the continental bank notes, already spoken of, be here adverted to. The depreciation of these has been apt to originate, as I conceive, in the state of the exchanges. The unfavourable exchange has produced a difference between the value of bullion and that both of the current paper of those banks and of the current coin; and, when this difference has become permanent and considerable, a discount on the paper has established itself; in other words, coin has ceased to bear the price of paper, and has taken the price of bullion, and from that time the paper alone has passed at the reduced rate. The difference between the value of the circulating medium of this country and that of bullion has always been sufficiently small to prevent the like discount from arising, and so long as we avoid a discount, persons, in general, do not discover that any depreciation of our paper exists. But even the most insignificant of those depressions in the value of our circulating medium, which are indicated by the exchange, are to be referred to the same immediate cause from which the depreciation of the bank paper on the continent has originated. I do not mean that our smaller and their greater depreciations are alike to be referred to an excess of paper. I would affirm, however, that they have equally resulted from the circumstance of goods, at the time in question, being too high in value (possibly, in the one case, through an excess of paper, and, in the other, through a fluctuation in the markets) to bear to be exported in sufficient quantity to satisfy the debt for which payment has been demanded, unless an advantage in the exchange was granted to the exporting merchant.
It may be convenient to the reader here to recapitulate the several points which have been lately dwelt upon.
I have shewn, first, that since Bank of England paper affords no profit to the holder, a very superfluous quantity is not likely to be held in any quarter; and that the additional thirty-five millions, which have been spoken off, must, therefore, be supposed to be employed either in transferring an encreased quantity of goods, which, in that case, it must be assumed to have itself created, or in transferring the same goods at a higher price. I have, then, insisted, that since the fresh industry which is excited cannot be supposed to be commensurate with the new paper, it is necessary to assume (conformably to the principles of a former Chapter), that a great rise in the price of commodities will take place. This rise in the cost of articles in Great Britain must produce, as has been also shewn, a diminution of the demand for them abroad, unless a compensation for their high price is given to the foreigner in the rate of exchange; so that the too great emission of paper will be the cause of a disadvantageous balance of trade, and also of an unfavourable exchange; or, in other words, of a low valuation of the circulating medium of Great Britain when compared with that of other countries.
It has, likewise, been observed, that even the smallest of those depressions in the value of our circulating medium, which are indicated by the exchange, arise out of the same circumstance which has produced the greater depreciations of the continental bank paper; goods, it has been said, being rendered too high (in the one instance, probably, by an excess of paper, in the other by a fluctuation in the markets) to bear to be exported in sufficient quantity to satisfy the debts for which payment has been demanded, unless a bounty, in the shape of the exchange, be granted to the exporting merchant* .
We come next to the second topic of enquiry, namely, whether those bounds within which Bank of England paper must be confined, in order to guard against a dangerous depreciation of it, are likely to be observed, in consequence of some natural tendency which it has to limit itself, so that it is unnecessary that the bank should restrain it.
In examining this question, I mean also to enquire whether the adoption merely of such rules as may tend, in a general way, to confine the loans of the bank, may be sufficient; or whether, also, any limitation of the specific sums lent may be necessary.
First, it is obvious that the principle of lending, simply in proportion to the property of those who desire to borrow, cannot be a safe one. If mere capital were to give a title to bank loans, the borrowers might become beyond measure numerous; even all proprietors of the public funds might prefer a claim for assistance.
If it should be said that the bank loans ought to be afforded only to traders, and on the security of real bills, that is to say, of bills drawn on the occasion of an actual sale of goods, let it be remembered that real bills, as was observed in an early part of this work, may be multiplied to an extremely great extent; and, moreover, that it is only necessary sufficiently to extend the customary length of credit, in order to effect the greatest imaginable multiplication of them. If the bank directors were to measure their discounts by the amount of real bills offered, it may be apprehended, that bankers and other discounters, who now take this better kind of paper, might become much more considerable holders of mere notes of hand, or of fictitious bills; and that an opportunity might thus be afforded of pouring a vast additional quantity of real bills into the Bank of England.
It may be imagined, that if the directors were to govern their conduct by a regard partly to the capital of the borrowers, partly to the species of bills offered, but partly, also, to the probability of punctual payment, the addition of this third check to the former might suffice. But it is here to be recollected, that the bank itself, if we suppose a progressive enlargement of notes, must be assumed to furnish perpetually encreasing means of effecting payments, and thus to render punctuality in fulfilling even the most extravagant engagements convenient and easy to the merchants.
It only remains to enquire, lastly, whether any principle of moderation and forbearance on the part of borrowers at the bank may be likely to exempt the directors of that institution from the necessity of imposing their own limit.
It may possibly be thought, that a liberal extension of loans would soon satisfy all demands, and that the true point at which the encrease of the paper of the bank ought to stop, would be discovered by the unwillingness of the merchants to continue borrowing.
In order to ascertain how far the desire of obtaining loans at the bank may be expected at any time to be carried, we must enquire into the subject of the quantum of profit likely to be derived from borrowing there under the existing circumstances. This is to be judged of by considering two points: the amount, first of interest to be paid on the sum borrowed; and, secondly, of the mercantile or other gain to be obtained by the employment of the borrowed capital. The gain which can be acquired by the means of commerce is commonly the highest which can be had; and it also regulates, in a great measure, the rate in all other cases. We may, therefore, consider this question as turning principally on a comparison of the rate of interest taken at the bank with the current rate of mercantile profit.
The bank is prohibited, by the state of the law, from demanding, even in time of war, an interest of more than five per cent., which is the same rate at which it discounts in a period of profound peace. It might, undoubtedly, at all seasons, sufficiently limit its paper by means of the price at which it lends, if the legislature did not interpose an obstacle to the constant adoption of this principle of restriction.
Any supposition that it would be safe to permit the bank paper to limit itself, because this would be to take the more natural course, is, therefore, altogether erroneous. It implies that there is no occasion to advert to the rate of interest in consideration of which the bank paper is furnished, or to change that rate according to the varying circumstances of the country.
At some seasons an interest, perhaps, of six per cent. per annum, at others, of five, or even of four per cent., may afford that degree of advantage to borrowers which shall be about sufficient to limit, in the due measure, the demand upon the bank for discounts. Experience, in some measure, proves the justice of this observation, for, in time of peace, the bank has found it easy to confine its paper by demanding five per cent. for interest; whereas, in war, and especially in the progress and towards the conclusion of it, as well as for some time afterwards, the directors have been subject, as I apprehend, to very earnest solicitations for discount, their notes, nevertheless, not being particularly diminished. It is, therefore, unreasonable to presume that there will always be a disposition in the borrowers at the bank to prescribe to themselves exactly those bounds which a regard to the safety of the bank would suggest. The interest of the two parties is not the same in this respect. The borrowers, in consequence of that artificial state of things which is produced by the law against usury, obtain their loans too cheap. That which they obtain too cheap they demand in too great quantity. To trust to their moderation and forbearance under such circumstances, is to commit the safety of the bank to the discretion of those who, though both as merchants and as British subjects they may approve in the general of the proper limitation of bank paper, have, nevertheless, in this respect, an individual interest, which is at variance with that of the Bank of England.
The temptation to borrow, in time of war, too largely at the bank, arises, as has been observed, from the high rate of mercantile profit. Capital is then scarce, and the gain accruing from the employment of it is proportionably considerable.
The reader, possibly, may think that an extension of bank loans, by furnishing additional capital, may reduce the profit on the use of it, and may thus lessen the temptation to borrow at five per cent. It has been already remarked in this Chapter, that capital by which term bonâ fide property was intended, cannot be suddenly and materially encreased by any emission of paper. That the rate of mercantile profit depends on the quantity of this bonâ fide capital and not on the amount of the nominal value which an encreased emission of paper may give to it, is a circumstance which it will now be easy to point out.
I admit, that a large extension of bank loans may give a temporary check to the eagerness of the general demand for them. It will cause paper to be for a time over abundant, and the price paid for the use of it, consequently, to fall.
It seems clear, however, on the principles already stated, that when the augmented quantity of paper shall have been for some time stationary, and shall have produced its full effect in raising the price of goods, the temptation to borrow at five per cent. will be exactly the same as before; for the existing paper will then bear only the same proportion to the existing quantity of goods, when sold at the existing prices, which the former paper bore to the former quantity of goods, when sold at the former prices: the power of purchasing will, therefore, be the same; the terms of lending and borrowing must be presumed to be the same; the amount of circulating medium alone will have altered, and it will have simply caused the same goods to pass for a larger quantity of paper. To assume under such circumstances the same rate of mercantile profit to subsist, is only to suppose that the trader will be situated neither more nor less advantageously than before; and that the annual gain which he will obtain by trading with the same quantity of goods, will bear the same proportion as before to their current cost. If this observation be just, there can be no reason to believe that even the most liberal extension of bank loans will have the smallest tendency to produce a permanent diminution of the applications to the bank for discount. It is the progressive augmentation of bank paper, and not the magnitude of its existing amount, which gives the relief. It thus appears, that the moderation and forbearance among borrowers, which were supposed likely to restrain the too great emission of paper, are only to be excited by the means of its perpetual encrease; by the means, that is to say, of the very evil which it was assumed that they would be sufficient to prevent.
The danger of enlarging the loans of the bank in proportion to the extension of the demand for them, may be nore particularly shewn by adverting to the case of the sudden transfer to foreign countries of capital which had been antecedently lodged in this. Let us suppose the foreign owners, either of British stocks, or of property left in the hands of English correspondents, to draw during the space of three months to a very large amount; and let us imagine that, in consequence of such an event, the exchange turns against Great Britain to the extent of five per cent.; and moreover that at the end of the three months, the drafts ceasing, and the mercantile state of the country improving, the exchange returns to its proper level. In this case any Englishman who can send goods abroad on his own account, and draw for them during the three months in question, will gain an extra profit of five per cent., supposing him to buy them in England for the same English money and to sell them abroad for the same foreign money, for which goods may be bought and sold at the periods preceding, and following the interval of time of which we are speaking. A similar extra profit will be obtainable during the same three months by a variety of other modes of employing capital. It is obvious, for example, that the public funds may be expected to experience a sudden fall through the great sale of foreign property in the stocks, which we have imagined to take place. He, therefore, who shall buy into the funds at the season of depression, and shall sell out at the expiration of the three months, will be likely to derive a benefit from this species of speculation. It is also plain that the quantity of goods in Great Britain will be reduced through the enlarged exportations, as well as through the suspension of imports, to which the state of the exchange will have given occasion. The profit, therefore, on the use of the remaining stock will be generally augmented. The exportation of bullion will afford a gain of the same sum of five per cent the expence of transporting it being, indeed, deducted. The demand upon the bank for discounts is, therefore, likely to be particularly earnest during the period of which we are speaking; and it is important here to notice, that the ground on which it will be made will not be that which was spoken of in an early part of this work. It will not be the privation of that quantity of circulating medium which is necessary for carrying on the accustomed payments, for these will be very immaterially encreased; the cause of the extraordinary applications to the bank will be the temporary advantage which may be gained, or the loss which may be avoided, by borrowing, during the three months in question, at the rate of five per cent. A pressure, it is true, may be occasioned by the multitude of foreign drafts, and it may resemble that which would arise from a diminution of Bank of England paper. Some of those merchants in whose hands the foreign property had been placed may not be able, with sufficient readiness, to spare from their commerce the sums necessary to answer the bills drawn upon them. Creditors, not being permitted to demand more than five per cent. interest from their debtors, are apt, at particular junctures, to call in their money, for the sake of taking to themselves the extraordinary benefit to be obtained by the use of capital. The disappointments thus brought on persons trading with borrowed wealth are often productive of much evil. The maintenance of the accustomed quantity of Bank of England notes may, therefore, be insufficient to furnish the means of securing the usual regularity of the payments of the metropolis; and a material diminution of paper may be particularly inconvenient. Possibly an augmentation of it may be necessary to the due maintenance of credit. If we suppose, however, a very great encrease of bank notes to take place (and an encrease, probably, equal to the total capital transferred on account of foreigners, will immediately be desired), the result must be a very important fall in the exchange, in addition to the fall of five per cent. already mentioned; and a new and proportionate danger to the Bank of England.
The point which it has been the object here to explain, might have been equally illustrated by imagining either the case of a strong disposition in many British subjects to transfer their own property to foreign countries, in order to lodge it there; or the case of a general eagerness to extend foreign commerce; for we must assume the transfer to foreign parts of an additional British capital to take place on either of these suppositions.
The preceding observations explain the reason of a determination, adopted some time since by the bank directors, to limit the total weekly amount of loans furnished by them to the merchants. The adoption of a regulation for this purpose seems to have been rendered necessary by that impossibility of otherwise sufficiently limiting, at all times, the Bank of England paper, which it has been the design of this Chapter to point out.
The regulation in question I consider as intended to confine within a specific, though in some degree fluctuating, sum, the loans of the bank, for the sake of restricting the paper. The variations in the amount of loans fail of producing exactly correspondent variations in the amount of paper, in proportion as the gold of the bank fluctuates. But the regulation being a weekly one, opportunity is afforded of correcting this attendant imperfection before any material evil can have arisen. The changes which occur in the amount of the loans to government form another ground for taking into weekly consideration the sum which shall, in the succeeding week, be afforded to the merchants.
To limit the total amount of paper issued, and to resort for this purpose, whenever the temptation to borrow is strong, to some effectual principle of restriction; in no case, however, materially to diminish the sum in circulation, but to let it vibrate only within certain limits; to afford a slow and cautious extension of it, as the general trade of the kingdom enlarges itself; to allow of some special, though temporary, encrease in the event of any extraordinary alarm or difficulty, as the best means of preventing a great demand at home for guineas; and to lean to the side of diminution, in the case of gold going abroad, and of the general exchanges continuing long unfavourable; this seems to be the true policy of the directors of an institution circumstanced like that of the Bank of England. To suffer either the solicitations of merchants, or the wishes of government, to determine the measure of the bank issues, is unquestionably to adopt a very false principle of conduct.
[* ]The following extract from Mr. Arthur Young’s Tour through France, seems to establish the abovementioned fact.
[* ]Mr. Hume, in observing that, when money encreases, “the price rises first of one commodity, then of another, till the whole, at last, reaches a just proportion with the new quantity of specie which is in the kingdom,” appears to me not sufficiently to advert to the tendency of money to go abroad as soon as it shall have raised the gold price of articles above their level in other countries, allowing for the charges of transportation; a subject which will be more fully treated of in the next Chapter. He also describes the operation of an encrease of coin in raising prices as proceeding somewhat more slowly than, perhaps, it would be found to do. An augmentation of Bank of England notes operates, no doubt, in this respect, more quickly than an encrease of money; for the London bankers, who are the great holders of bank paper, are likely to be much less disposed to detain, for example, a double quantity of it, than all the individuals of the kingdom are to detain in their several drawers, or in their pockets, a double quantity of guineas. The banking system, by committing the business of payments to few hands, has made much difference in respect to the time within which an encreased quantity of circulating medium may be supposed to raise the price of articles. It has given to many great holders of Bank of England paper a very strong interest on the side of not keeping a superfluous quantity of it.
[* ]The following extract from the work of Sir W. Davenant, who wrote from 1695 to 1712, may give some idea of the vast effect which a small failure of the supply of corn has on the price of this necessary of life.
“So that, when corn rises to treble the common rate, it may be presumed that we want above one-third of the common produce; and if we should want five-tenths, or half the common produce, the price would rise to near five times the common rate.”
[* ]“When paper is issued for no value received, the security of such paper stands alone upon the original capital of the bank; whereas, when it is issued for value received, that value is the security on which it immediately stands, and the bank stock is, properly speaking, only subsidiary.
[* ]Further Considerations concerning raising the Value of Money.
[* ]Some proof of the tendency of a too great emission of paper to render the exchange unfavourable by the means which have been described, and to cause the current coin to be exported, is furnished by the following extracts from arrets of the French government, issued a short time after the establishment of Mr. Law’s bank. The reader is desired to take notice, that this bank was instituted on the same professed principles with the Bank of England; was, for a time, independent of the government, though sanctioned by it; possessed a capital of one hundred millions of livres, and lent money on good security. Being, however, permitted to issue notes to the vast amount of about thirty-eight millions sterling, the credit (in some degree a well founded one) which this bank obtained, encouraged the formation of the Mississippi scheme, and led to other doubtful undertakings. The bank paper being rendered exchangeable for the actions (or stock) of the Mississippi company, though at a regulated discount, the value of it, like that of the late assignats of France, was made to depend on the public opinion of the profits of a speculation, and, therefore, on the credit of the circulating article, rather more, perhaps, than on its quantity.