David Ricardo, Paper Money, and the Abuse of Power

Found in The Works of David Ricardo (McCulloch ed. 1846, 1888)

It is commonly accepted that modern finances started with the establishment of the Bank of England (BoE) in 1694. In exchange for securing a loan from a group of merchants, the Crown asked Parliament to give the bank a charter that would allow them to issue banknotes that would be accepted in payment of taxes owed to the crown. Those banknotes would be redeemable in gold coins on demand by the bank, and with that, a system by which money began to be supplied both by government, in the form of metal coins and by the commercial banks in the form of banknotes redeemable in gold or silver coins took shape.

Experience, however, shows that neither a State nor a Bank ever have had the unrestricted power of issuing paper money without abusing that power: in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issuers of paper money to the obligation of paying their notes either in gold coin or bullion. (FROM CHAPTER XXVII.: ON CURRENCY AND BANKS)

About a century later, in 1794, the Crown decreed a suspension on the redemption of banknotes by the BoE and started to take loans from the bank in order to pay for the Napoleonic wars.

The bank obliged, issuing banknotes, now without the constraint of being required to redeem those notes in gold coins and inflationary war finance ensued.

When David Ricardo first published “The Principles of Political Economy and Taxation” in 1817, two years after Napoleon’s final defeat at Waterloo, the currency in England remained unconvertible. It was only in 1821, the same year of his final edition of the book that redemption was finally resumed.

Not that the suspension during the Napoleonic was the first case in history of abuses of paper money. The case of John Law’s Bank Royale in early 18th century France and the case of the Assignats, more recently, in revolutionary France were certainly in Ricardo’s mind when he was writing about currency and banks.

It is only with reference to the arrangements of modern finances with suspended redemption of the currency still in place in England at the time of this writings, six years after the end of the war, that we can fully understand Ricardo’s admonitions about the abuses of nonconvertible currency, both by the state and the bank.