Section XII. Inconveniences to which the Use of Paper Money is Liable

The inconveniences to which paper money is liable, seem all to be comprehended under three heads.

First,—The failure of the parties, by whom the notes are issued, to fulfil their engagements.

Secondly,—Forgery.

Thirdly,—The alteration of the value of the currency.

1. The failure of the parties, by whom notes are issued, is an evil against which, under good institutions, the most powerful securities are spontaneously provided.

If competition were allowed to operate freely, and if no restriction were imposed on the number of the partners, who might be engaged in a bank, the business of banking, and of issuing notes, would naturally place itself on a footing, which would render paper currency very secure.

The number of banks would of course be multiplied; and no one bank would be able to fill with its circulation more than a certain district.

As little risk, where the partners were numerous, would be incurred by each of them, as the profits would be very sure, and the importance of having a good currency would be sensibly felt; there would be motive sufficient, to all the principal noblemen and gentlemen of the county, or other district, to hold shares in the local bank, and add to the security of the public.

In competition with such an establishment, any bank, of doubtful credit, would vainly endeavour to introduce its notes into circulation. The sense of interest keeps the attention sufficiently awake, and where education and knowledge are tolerably advanced, and the press is free, intellect is not wanting to guide the most ignorant to the proper conclusions. The people may be trusted to reject the notes of a suspected party, when they may have those of a party in whom they confide.

Another great advantage is gained, by the scheme of numerous banks, each supplying, under the safeguard of freedom and competition, a limited district; that if one of them fails, the evil is limited, and produces inconvenience to but a small portion of the community.

The interest, also, which banks, where numerous, have in supplanting one another, places them on the watch to discover any symptom of deficiency on the part of a rival; and each of them, knowing that it is vigilantly watched, is careful to avoid any fault, which can lead to a diminution of its credit.

In Scotland, where banking is nearly placed upon this desirable footing, and where paper money spontaneously filled the channels of circulation, long before the suspension of cash payments at the Bank of England, there have been few failures in the numerous banks which issued paper, notwithstanding all the fluctuations in the value of money, produced by that suspension, and all the convulsions of credit of which those fluctuations were the cause.

Such are the securities which the interest and intelligence of the parties would provide, without the intervention of the legislature. Of the securities which might be provided by the legislature, the following are among those which most obviously present themselves.

It might be rendered imperative upon every bank to transmit to some organ of government two monthly statements, one of the amount of its notes, another of the securities with which it was provided to meet the demands to which it was liable; while appropriate powers might be granted, for taking the necessary steps to protect the public, where proper securities might appear to be wanting.

As a great profit attends the issuing of notes in favourable circumstances, it is desirable that the benefit, if unattended with preponderant evil, should accrue to the public. The profit, it is observable, arising from the interest upon the notes as they are lent, is altogether distinct from the other benefit, arising from the conversion of a costly medium of exchange into instruments of production.

The issuing of notes is one of that small number of businesses, which it suits a government to conduct a business which may be reduced to a strict routine and falls within the compass of a small number of clear and definite rules. If the public were its own banker, as it could not fail in payments to itself, the evils, liable to arise from the failure of the parties who issue notes to fulfil their engagements, could not possibly have place. The people, in this case, would provide the funds to fulfill the engagements, and the people would receive them. Political Economy does not contemplate the misapplication of the funds provided by the people. The cases of national bankruptcy, and of the non-payment of a government paper, by which the people of various countries have suffered, have all been cases in which the Many have been plundered for the benefit of the Few. When the people, as a body, are to receive the payment, which the people, as a body, provide the funds to make, it would be absurd to speak of their loss by a failure.

The chance of evil, then, from a failure in discharging the obligations contracted by the issue of paper money, is capable of being so much reduced, as to constitute no valid objection against an expedient, the benefits of which are great and indisputable. There are persons, however, who say, that if the benefits derived from paper money did surpass the chance of evil in quiet and orderly times, the case is very different in those of civil war or foreign invasion.

Civil war, and foreign invasion, are words which raise up vague conceptions of danger; and vague conceptions of danger are too apt to exert undue influence on the understanding.

In the first place, there is, in the present state or the civilised world, so little chance of civil war, or foreign invasion, in any country having a good government and a considerable population that, in contriving the means of national felicity, small allowance can be rationally required for it. To adopt a course of action, disadvantageous at all but times of civil war and foreign invasion, only because it were good on those occasions, would be as absurd, as it would be, in medicine, to confine all men continually to that species of regimen which suits a violent disease. If the advantages, which arise from the use of paper money, are enjoyed, without any considerable abatement, at all times, excepting those of civil war and foreign invasion, the utility of paper money is sufficiently provcd.

To save ourselves from the delusion which vague conceptions of danger are apt to create, it is proper to inquire, what are the precise evils which may arise from paper money, during those rare and extraordinary times.

A civil war, or a foreign invasion, is attended with a great derangement of the circulating medium, when it is composed of gold and silver. At such a period there is a general disposition to hoard: a considerable proportion, therefore, of the medium of exchange is withdrawn from circulation, and the evils of a scarcity of money are immediately felt; the prices of commodities fall; the value of money rises; those who have goods to sell, and those who have debts to pay, are subject to losses; and calamity is widely diffused.

From the evils of hoarding, the community would be, in a great measure, secured, by the prevalence of paper money. And there are many reasons which may draw us to conclude, that those arising from the diminution of credit would be very little to be feared.

If the paper were issued by a government, which deserved the confidence of the people, a foreign invasion, which would concentrate the affections of the people towards the government, would not destroy the credit of its notes.

It would not be the interest of the invaders to destroy their credit, even in that part of the country, of which they might be in possession; because it would not be their interest to impair its productive powers.

Nobody would lose, ultimately; because, even if the circulation of the notes were prevented in the districts possessed by the enemy, they would recover their value the moment the enemy were expelled.

The effects would not be very different, if the circulation were provided by a well-conducted system of private banking. It would be the interest of all parties to preserve the circulating medium in credit. It would be the interest of the enemy to preserve it in the districts which he possessed. At most, he could only prevent the circulation for a time; for, after his expulsion, the notes would be redeemed; either by the responsible parties who had issued them; or, if they had lost their property through the operations of the enemy, out of the compensation money which the government would allow.

It is not probable, that, even in a civil war, any considerable discredit should attend a well-established paper currency. The country is, of course, divided between the hostile parties, in portions more or less nearly equal. It is evidently not the interest of the government, in that part of the country which it commands, to discredit the paper currency, whether it had been issued by itself, or by private bankers. As little is it the interest of the opposite party, to do any thing which shall disorder the regularity of transactions, in that part of the country, where it governs, and from which all its means of prevailing over its opponents must be drawn. If the circulating medium consists of the notes of private bankers, situated within that part of the country, it is the interest, on a double account, of the party to protect them. It is its interest to protect them, even if they are paper of the government. For whom would it injure, as the holders of them, but its own people? Whose business would it disturb by the want of a circulating medium, but the people upon whose means and affections it wholly depends? By protecting the paper of the government, it makes it, in reality, its own.

Experience is in favour of all these conclusions; since it has been repeatedly found, that the presence of hostile armies, and even internal commotions, have occasioned little disturbance to a paper currency, the value of which was but tolerably secured.

2. Forgery, to which bank notes are exposed, is an evil of the same sort as counterfeiting. This, though an evil of great magnitude, under so imperfect a system of banking as that, which is created by the existence of a great monopolizing establishment, like the Bank of England, would, under such a system of banking, as that which we have been just contemplating, be inconsiderable. Where one great bank supplies the circulation of a great part of the country, there is opportunity for the circulation of a great amount of forged notes, and motive to incur both a great risk and a great expense. But if every bank supplied only a small district, a small amount of the forged notes of such a bank could find their way into the circulation. Banks, too, which are subject to the useful principle of competition, are afraid to discredit their own notes and render the people shy of taking them, by refusing payment of such as are forged; they rather choose to pay them in silence, to detect as well as they can the authors of the forgery, and circumscribe its amount. In this manner individuals severally are exempted from loss; and if a loss is willingly sustained by the banks, it is only because they find compensation.

3. The last of the three inconveniences, liable to arise from the use of paper money, is all alteration in the value of the currency.

This alteration is always an act of the government; and is not peculiar to paper money.

We have already seen, that the value of a metallic currency is determined by the value of the metal which it contains. That of a paper currency, therefore, exchangeable at pleasure, either for coins or for bullion, is also determined by the value of the metal which can be obtained for it. The reason is obvious. If the paper should at any time be reduced below the value of the metal, every person who held a bank note, the less valuable commodity, would demand for it the more valuable commodity, the metal. If the promise were, as in England, to pay an ounce of gold for 3l. 17s. 10½d. of paper, it would be the interest of the holders of the notes to demand gold in exchange, the moment 3l. 17s. 10½d. in paper became of less value than an ounce of gold; that is, the moment gold rose above the mint price.

But, in these circumstances, it would be the interest of those who issued the notes to raise their value by reducing their quantity. If they endeavoured to maintain the high quantity, they would be condemned perpetually to issue and perpetually to withdraw; because every man who became possessed of any of their notes would have an interest in bringing them back again for gold; and on each of these occasions the issuers would sustain a loss. They would issue the notes at the rate of 3l. 17s. 10½d.; that is they would receive a value of 3l. 17s. 10½d. when they issued them; but when they received them back, they would be obliged to pay an ounce of gold, for 3l. 17s. 10½d. of their notes; and that ounce might cost them 4l., or any greater sum.

If the currency were supplied by paper, without coins, the issuers of the paper could, by lessening its quantity, and thereby enhancing its value, reduce the price of gold. Suppose, by this means, they were to reduce it to 3l. per ounce. They might fill their coffers with gold at this price; and having done so, they might raise its price by increasing their issues till it became the interest of the holders of their notes to demand it or them at 3l. 17s. 10½d. They would make a profit of 17s. 10½d. on every ounce of gold thus trafficked; and they might continually repeat the operation. A simple expedient, however, would be an effectual security against this danger. As the obligation to sell gold at a fixed price renders it the interest of those who issue paper not to increase their notes in such a manner as to raise gold above that price, so an obligation on them to buy gold at a fixed price would render it their interest not to reduce the amount of their notes in such a manner as to sink it below that price. The value of the notes might thus be kept very steadily conformable to that of the metallic standard.

In the case of a metallic currency, government can reduce the value of the coins, only by lessening the quantity of the precious metal contained in them; otherwise, as soon as it reduced the value of the coins sufficiently to afford a motive for melting them, they would, as fast as issued, disappear. In the case of a paper currency, it is only necessary for government to withdraw the obligation to pay metal for it on demand, when the quantity may be increased, and thereby the value diminished, to any amount.

Paper currency is issued without obligation to pay for it, in two ways: either, when government is the issuer, and renders its paper legal tender, without obligation to give metal for it in exchange; or when the paper currency is regulated by one great establishment, as the Bank of England, and government suspends its obligation to pay for its notes.

The effects of an increase of the quantity, and consequent diminution of the value of the currency in any particular country, are two: first, a rise of prices; secondly, a loss to all those persons who had a right to receive a certain sum of money of the old and undiminished value.

By the term price, I always understand the quantity of money which is given in exchange. An alteration in the value of money, it is obvious, alters the relative value of nothing else. All things—bread, cloth, shoes, &c. rise in value as compared with money; but not one of them rises in value as compared with any other.

This difference of price is, in itself, of no consequence to any body. The man who has goods to sell gets more money for them, indeed; but this money will purchase him just the same quantity of commodities, as he was enabled to purchase with the price he obtained before. The man who has goods to purchase has more money to give for them; but he is enabled to do so, by getting just as much more for the commodities he has to sell.

With respect to the second effect of a degradation in the value of money, it is to be observed, that there exists at all times, in civilized countries, a number of obligations to pay certain sums of money to individuals: either all at once, as debts; or in succession, as annuities. It is very obvious, that the individual who has contracted with a man to receive 100l. sustains a loss when the currency is reduced in value and he receives no more than 100l. It is equally obvious that the party who has to pay the sum, is benefitted to the same amount. These circumstances are reversed when the alteration which has taken place is an increase of the value. In that case the man who has to pay sustains the loss; the man who receives payment makes the gain. These losses are evils of great magnitude, as far as men's feelings and happiness are concerned; and they imply a gross violation of those rules for the guardianship of that happiness, which are comprehended under the term justice. It is, however, no destruction, and consequently no loss, of property.

Hume has supposed that certain other effects are produced by the increase of the quantity of money. When an augmentation of money commences, individuals, more or fewer, go into the market with greater sums. The consequence is, that they offer better prices; and Hume affirms, that the increased prices give encouragement to producers, who are incited to greater activity and industry, and that an increase of production is the consequence.

This doctrine implies a want of clear ideas respecting production. The agents of production are the commodities themselves, not the price of them. They are the food of the labourer, the tools and machinery with which he works, and the raw materials which he works upon. These are not increased by the increase of money: how then can there be more production? This is a demonstration that the conclusion of Hume is erroneous. It may be satisfactory also to unravel the fallacy of his argument.

The man who goes first to market with the augmented quantity of money, either raises the price of the commodities which he purchases, or he does not.

If not, he gives no additional encouragement to production. The supposition, therefore, must be, that he does raise prices. But exactly in proportion as he raises prices, he sinks the value of money. He therefore gives no additional encouragement to production.

It will perhaps be said, by a persevering objector, that the man who first goes to market with the additional quantity of money, raises the price of the commodities which he immediately purchases: that the producers of those commodities are therefore encouraged to greater industry, because the price of other commodities, namely, of all those which they have occasion to purchase, has not risen. But this he is not allowed to say. The first man who came with an additional quantity of money into the market to purchase the commodities of those producers, raised the price of those commodities. And why? Because he came with an additional quantity of money. They go into the market to purchase another set of commodities, and go with an additional quantity of money. They raise, therefore, the price of those commodities. And in this manner the succession goes on. Of all those commodities with which no additional quantity of money has yet come in contact the price remains unaltered. The moment an additional quantity of money comes in contact with them, the price is proportionally raised.

The whole of the business of any country may be considered as practically divided into a great number of little markets, some in one place, some in another, some of one sort of commodity, some of another: the money, of course, distributed proportionally among them. Into each of these markets, in the ordinary state of things, there comes, on the one side, a certain quantity of commodities; on the other side a certain quantity of money; and the one is exchanged against the other. Wherever any addition takes place in the quantity of goods, without any addition to the quantity of money, the price falls, and of necessity in the exact proportion of the addition which has been made. If this is not clear to every apprehension already, it may be rendered palpable by adducing a simple case. Suppose the market to be a very narrow one; of bread solely, on the one side; and money on the other. Suppose that the ordinary state of the market is 100 loaves on the one side, and 100 shillings on the other; the price of bread, accordingly, a shilling a loaf. Suppose, in these circumstances, that the quantity of loaves is increased to 200, while the money remains the same: it is obvious that the price of the bread must fall one half, or to sixpence per loaf. It would not be argument to say, that part of the bread would not be sold. but taken away unsold. If it is taken away unsold, it is the same thing, with respect to the market, as if it had never been brought. These conclusions, with respect to an increase in the quantity of commodities, no man disputes. Is it not obvious that the some conclusions are true with respect to an increase in the quantity of the opposite commodity—the money?

All the consequences, therefore, of altering the value of money, whether by raising or depressing it, are injurious. There is no security, however, against it, as it is a deed of government, but that which is the sole security against the misdeeds of government; its dependence upon the people. The obligation of paying the notes in the metal is a necessary security, where they are issued at pleasure by private bankers. If they were issued by a government strictly responsible to the people, it would not be indispensible; for in that case the utility of keeping gold at the mint price, or, in other words, the currency of the same value as if it was metallic, might be so distinctly understood, that it would not be the interest of those intrusted with the powers of government to allow it to vary.

We have already seen, in treating of the properties which recommended the precious metals for the instrument of exchange, that they are less than almost any other commodity subject to fluctuation of value. They are not, however, exempt from changes, partly temporary, and partly permanent. The permanent changes take place, chiefly in consequence of a change in the cost of procuring them. The greatest change of this kind, recorded in history, is that which took place on the discovery of the mines of America, from which, with the same quantity of labour a greater quantity of the metals was obtained. The temporary changes take place, like the temporary changes in the value of other commodities, by a derangement of the balance of demand and supply. For the payment of troops in a foreign country, or subsidies to foreign governments and other operations, a great quantity of gold or silver is sometimes bought up, and sent out of the country. This enhances the price, till the balance is restored by importation. The profit which may be acquired operates immediately as a motive to restore it. In the interval, however, an advantage may be derived from a paper money not convertible immediately into the metals. If convertible, gold will be demanded, paper will be diminished, and the value of the currency will be raised. If not convertible, the currency may be retained of the same or nearly the same value as it was before. This, indeed, can scarcely be done, and the remedy applied with safety, unless where the whole is paper, and government has the supply in its own hands. In that case the sameness in the quantity of the currency, as it would be perfectly known, would be a sufficient index and security. If the price of gold rose suddenly above the mint price, or, in other words, above the rate of the bank notes, without any alteration in the quantity of the currency, the sameness in the quantity of currency would be a sufficient index that the rise was owing to a sudden absorption of the gold; which, after a time, would return. If in such circumstances the obligation of keeping up the value of the paper to that of the gold were suspended for a short time, a sufficient security against any considerable alteration in the value of the currency would be found in the obligation of keeping the quantity of it the same; because, during any short period of time, there can be no such diminution or increase of the quantity of business to be done by it, as to require any material alteration. That in the hands of an irresponsible government such power of suspension would be dangerous, is true. But an irresponsible government involves all kinds of danger, and this among the rest.