VIII. The Possibility of Excess Issue by Banks

There were among the anti-bullionists some crude inflationists for whom no amount of currency could be too great. Most of the anti-bullionists, however, recognized that there were limits beyond which it was not desirable to go in the issue of currency. What these limits were, they failed to specify, except in terms of the “needs of business.” They claimed that as long as currency was issued only by banks, and was issued by them only in the discount of genuine and sound short-term commercial paper, it could not be issued in excess of the needs of business, since no one would borrow at interest funds which he did not need. If currency should perchance be issued to excess, it would rapidly return to the banks either in liquidation of bank loans or, under convertibility, for redemption in specie. To this doctrine the directors of the Bank of England and prominent members of the Cabinet also subscribed, and the authority of Adam Smith was appealed to in support thereof.

The bullionists explicitly denied the validity of this doctrine, at least for an inconvertible currency. Thornton in 1797 had objected against the usury laws that they limited the Bank of England to a rate at which “there might be a much greater disposition to borrow of the Bank ... than it might become the Bank to comply with,” and in 1802 he pointed out that the extent to which the charge of interest acted as a check on the demand for discounts depended on the rate of interest which was charged; the Bank of England was prevented by the usury laws from charging more than 5 per cent, and if the prevailing rate of commercial profit were higher than that, the demand for loans would be greater than the Bank should meet. Lord King put it more strongly: when the market rate of interest exceeds the bank rate, the demand for discounts “may be carried to any assignable extent,” and in this somewhat extreme form it was repeated by other bullionists. In a speech in the House of Commons on May 7, 1811, Henry Thornton expounded with great ability, and with interesting references to the experience of other central banks, the mode of operation of the rate of interest as a regulator of the volume of note issue. He pointed out that even John Law's bank had issued only on loans at interest, and that it was Law's error that “he considered security as every thing and quantity as nothing” and failed to see the significance of the rate at which he offered to lend. Thornton argued, moreover, that during a period of rising prices the real rate of interest was less than the apparent rate; while businessmen did not generally perceive this, they did realize that borrowing at such times was usually profitable, and therefore increased their demands for loans if the bank rate did not rise.

Ricardo agreed with the other bullionists that the “needs of commerce” for currency could not be quantitatively defined, and that through a resultant change in prices commerce could absorb whatever amount was issued. But he ordinarily denied any relationship between the rate of interest and the quantity of money, and presumably also between the rate of interest and the demand for loans: “Whilst the Bank is willing to lend, borrowers will always exist, so that there can be no limit to their overissues, but that which I have just mentioned,” i.e., convertibility. In a speech in Parliament he expressly denied that the rate of interest was a check to the amount of issues: “For ... what the directors thought a check, namely, the rate of interest on money, was no check at all to the amount of issues, as Adam Smith, Mr. Hume, and others had satisfactorily proved.” Here once more Ricardo was applying long-run considerations to a short-run problem. But in his Principles we find Ricardo at one point expounding the same views as the other leading bullionists:

The applications to the Bank for money, then, depend on the comparison between the rate of profits that may be made by the employment of it, and the rate at which they are willing to lend it. If they charge less than the market rate of interest, there is no amount of money which they might not lend,—if they charge more than that rate, none but spendthrifts and prodigals would be found to borrow of them. We accordingly find, that when the market rate of interest exceeds the rate of 5 per cent at which the Bank uniformly lends, the discount office is besieged with applications for money; and, on the contrary, when the market rate is even temporarily under 5 per cent, the clerks of that office have no employment.

To the denial by the bullionists that the charge of interest on loans was a sufficient guarantee, irrespective of the rate charged, against overissue, the anti-bullionists apparently never attempted to reply. In evidence before the Bullion Committee, Bank of England officials had emphatically denied that the security against overissue by the Bank would be reduced if the discount rate were to be lowered from 5 to 4 or even to 3 per cent. No person, they insisted, would pay interest for a loan which he did not need, whatever the rate, unless it were for the purpose of employing it in speculation, “and provided the conduct of the Bank is regulated as it now is, no accommodation would be given to a person of that description.”

That the quantity of bank loans demanded is dependent on the rate of discount is now universally accepted by economists and need not be further argued. On the question whether or not the rate of 5 per cent uniformly charged by the Bank of England during the Restriction was lower than the market rate, there is, however, a conflict of opinion. The usury laws would operate to prevent any overt charge of more than 5 per cent, and the uniform 5 per cent rate which is often said to have prevailed during the Restriction period may have been only nominally that. There is contemporary evidence that bankers found means of evading the restrictions of the usury laws. In 1818, the Committee on the usury laws stated in its Report that there had been “of late years ... [a] constant excess of the market rate of interest above the rate limited by law.” Thornton notes that borrowers from private banks had to maintain running cash with them, and borrowers in the money market had to pay a commission in addition to formal interest, and that by these means the effective market rate was often raised above the 5 per cent level. Another writer relates that long credits were customary in London and a greater discount was granted for prompt payment than the legal interest for the time would amount to.

More convincing evidence that the 5 per cent rate was not of itself always an effective barrier to indefinite expansion of loans by the banks is to be found in the fact that the directors of the Bank of England, although they professed that they discounted freely at the rate of 5 per cent all bills falling within the admissible categories for discount, in reply to questioning admitted that they had customary maxima of accommodation for each individual customer and occasionally applied other limitations to the amount discounted.

Even if it were conceded that the Bank rate was never lower than the market rate of discount for the same classes of loans, it might still be low enough to permit or even to foster a wild inflation, if the Bank rate was low absolutely, and if it was the Bank rate which determined the market rate. On important classes of loans the Bank of England was a direct competitor with other lending agencies, and it was certainly important enough as a lending agency to exercise at least an important influence on the market rate. Also, by lowering its credit standards, or offering its credit to a wider range of applicants for commercial loans, it could actively promote currency expansion without lowering its interest rate below the hitherto prevailing level. It may be accepted, therefore, that the 5 per cent rate was not necessarily an adequate check to the volume of bank credit extended to commercial borrowers.

The powers of the Bank of England to expand its note issues, moreover, were not confined to its commercial discount activities. The Bank could also, and did, get its notes into circulation by advances to the government, by purchases of exchequer bills and public stocks in the open market, and by advances to investors in new issues of government stocks. Since even many of the anti-bullionists conceded that there was no automatic check to excess issue where the issues were made in connection with loans to the government, there should have been no occasion for extended controversy as to the existence of a possibility of excess issue.