Lecture II.: On Some Effects of Paper Money.

In the last lecture, I considered the effects produced on the value of money in any country by the skill and diligence with which the labour of that country is applied. These effects are gradual and permanent. In this and the following lecture, I shall consider some of the effects produced on the value of money in any country by the use or disuse of the substitutes for money. These effects are sudden but transitory.

If a country should suddenly adopt, to a considerable extent, any substitute for money; if, for instance, England, having previously prohibited the issue of notes for small sums payable to bearer, should suddenly legalise them, and notes equal in value to one-third of the former metallic currency, which we will suppose to have been of the value of forty-five millions sterling, should be issued, either the issuers must, at the same time that they issue their notes, export the money received in exchange for them, or both the notes and money must circulate together. If the first mode were adopted, it is obvious that the real exchange must be against England, in almost every quarter, until the export of money had ceased. We should for a time be in the situation of a mining country, and as neither the productiveness of our labour nor the amount of our currency would be altered, the consequences would be that some foreign commodities would be more abundant during the continuance of the increased importation,—that our capital would be increased by that portion of them which would be reproductively employed,—and that we should be able to turn to other purposes some of the labour and capital formerly employed in supplying the wear of fifteen millions of specie—a saving perhaps of 150,000l. a year. These consequences would be beneficial.

But unfortunately the business would be very differently conducted. The issuers of notes are seldom persons engaged in foreign commerce, and they seldom issue them in immediate exchange for money. Notes are generally advanced as loans, repayable, at the earliest, in two or three months, and often in not less than two or three years. In the case which I have put, the coin and the notes would at first probably circulate together. All prices would rise, and they would rise not merely to the extent of the excess of money, but to the spirit of speculation which such an excess would create. While the rise of prices was going on, all purchases made for the purposes of resale would be advantageous. Great profits would be obtained, and still greater ones expected, and every man possessed of money or credit would be eager only to become a purchaser, feeling no doubt of his gains as a seller. Such circumstances would obviously check our exports and increase our imports. It would become profitable in England to import many things which, when foreign and English prices bore their former relation, would not bear the expenses of transport; it would no longer suit foreigners to import from England many things which were importable at our former prices.

The necessary consequences would be a generally unfavourable exchange, and an export of money. As long as the issue of notes continued to exceed the export of money, prices would continue to rise, and the apparent prosperity would go on increasing. And, if we could suppose both the issuers and the takers of notes utterly ignorant or regardless of the consequences of what was going on, the issue might continue until the last piece of metallic money had been exported. The crash would then be instantaneous: as prices would then be at their height, so would be the profits on the exportation of money. Those holders of notes who were sending money abroad, would call on the issuers of notes for payment in money; and there being no money in the country, every issuer of notes must stop payment. No more notes could be issued, and the existing ones would lose their value. The country would be without money, and without the principal substitute for money, credit. There would, at first, be no such thing as price, but exchanges would be performed by barter; and we may be sure that the discomfort and insecurity of a state of barter would create an intense desire for money. The holders of exportable goods would be eager to send them off. The holders of bills on foreign countries would require their remittances to be made in money. Importation would of course be suspended, and the exchange would be in our favour with all the world. Money would come in from all quarters, though, for several reasons, less rapidly than it went out.

In the first place, the competition of our exporting merchants would sink the prices of our commodities abroad; and secondly, the waste and misapplication of capital, during the previous period of prosperity and speculation, the difficulty of obtaining supplies of foreign materials from abroad during our subsequent adversity, and the interruption of that division of labour which is founded on a general system of credit, would probably much diminish the productiveness of our labour.

The last circumstance, by diminishing the value of English labour in the general market of the world, would keep down, while it lasted, all our money prices; and it may be supposed, therefore, that the same amount of money as circulated before the issue of the notes took place would not now be necessary. But, during the absence of credit, money would be the only substitute for barter. The exchanges in which it would be necessary would be far more numerous, and its circulation far less rapid. If forty-five millions sterling were necessary before, it is probable, that, after such a panic as must have been created by the events which I have supposed, ninety millions would not be enough even to keep up prices at three-fourths of their former amount.

It is impossible, however, that such a state of things should occur,—that a whole country should at once find itself drained of all its money, unless the imprudence of individuals were heightened by the still greater imprudence of government. In the first place, no banker issues notes without making some reserve of metallic money to meet them. Even if the shock were unforeseen, and the discredit of all the notes simultaneous, there would be some money in the country to meet it. And in the second place, the shock could not be unforeseen, nor the discredit universal or simultaneous. The credit, the prudence, and the wealth of the issuers of notes must be of every different degree. In such a country as England, there are some bankers whom no individual would trust with five hundred pounds, and who might be reduced to insolvency by an unexpected demand for one thousand pounds, and others, who at a day’s notice could draw hundreds of thousands from their own resources, and obtain millions from their connexions. There are some who move in the track which experience has shewn to be safe, with the impassive regularity of mechanism; and others, who, when extraordinary gain is suggested to them, seem not only willing to encounter chances, but to be deprived of the power of calculating them.

It is impossible that the rise of prices and extension of speculation, which I have supposed, could continue long, before accident or imprudence should expose some establishments to a demand for money, which they would be unable to answer; a general feeling of distrust would follow, and would cause a simultaneous demand of money for notes, or, to use a word which the unhappy experience of the year 1825 has rendered familiar, a “run,” upon all those establishments whose character for riches did not place their solvency above suspicion; at first, indeed, an indiscriminate run upon all. The first effect of this would be to bring out the reserves of money: the second would be the failure of many establishments, and the discredit of their notes; but many would probably stand it, and suffer scarcely a momentary interruption of their credit and circulation. Prices certainly would fall, the exchange would turn in our favour, money would come in, thousands would be ruined irretrievably, and years might be necessary to restore the country to its former state of settled prosperity; but all these effects would be produced in a lower degree than in the extreme instance with which I set out.

It will be observed, that I have allowed nothing for the general fall in the value of the precious metals throughout the world, which might be expected to arise from the additional supply afforded by the disuse of metallic money in a single country. Some effect of this kind would be produced, but it would be so slight, that it may safely be disregarded.

The whole amount of the precious metals throughout the world, in bullion, coin, and plate, has been supposed to be of the value of about two thousand millions sterling. The whole metallic currency of Great Britain and Ireland is not supposed to exceed thirty millions; it is subject to much variation, but I believe it to be usually less. Even if we were to export our last sovereign, and our last shilling, how trifling would be the effect in the general market of the world, of an addition of thirty millions to two thousand!

The power of individuals, therefore, to affect the currency of a country is limited—that of a government is not so.

Suppose that, at the commencement of the panic imagined in my last instance, government had taken one banking company under its protection—had forbidden it to pay its notes in coin or in any other equivalent—had permitted it to issue, and continue to issue, fresh notes to any amount—had directed that its notes should be received in all payments to government, and in private transactions, as of equal value with the money which they professed to promise to pay, and had prohibited the exchange of coined gold and silver, for more than an equal nominal amount in notes,—

It would be in the power of the banking company in question, by lending to the different banks of the country a sufficient number of its own notes, notes which would cost merely the expense of making and stamping paper, to relieve the difficulties of those which were tottering—to fill the void of those which had fallen, and to enable all those which had still a reserve of metallic money to make use of it, keeping the notes of the favoured bank in its room. And it would also be in its power, by still further increasing its issues, either by way of loan, or by dividing them as profits between its own partners, to keep up the high prices, and the unfavourable exchange, until the last piece of coined gold or silver had quitted the kingdom.

It would be in its power, by still further increasing its issue, to raise prices as estimated in its paper to any scale it thought fit. It would also be in its power, by diminishing its issues, to sink them to any point not lower than the metallic prices of foreign countries. It could not sink bread to a farthing a quartern loaf, but it would be able to raise it to a hundred pounds.

The real par of exchange between England and foreign countries would be at an end. English paper money, having neither intrinsic utility nor ascertainable limitation of supply, would be incapable of export. It still, however, must be used as a medium of exchange, and as an expression of value even in international transactions. The French exporter of wine to England must, in the first instance, sell his wine for a certain quantity of English notes of a given denomination. These notes, as he could not export them, he must again exchange for some other commodity in England; and his profit, or loss, would depend on the comparative values in France of that commodity, and of his wine, after deducting the expenses of carriage. We have already seen that no commodities are so permanent in their value, so uniform in their quality, or so easy of transport, as gold and silver. The quantity of gold or silver which they could purchase would unquestionably be the standard by which he would estimate the value of the English notes which he received for his wine. This gold and silver would of course be in an uncoined state, or, in commercial language, bullion. If five French Napoleons and four English sovereigns, while English sovereigns existed, had each contained the same quantity, say an ounce, of gold bullion, the real par of exchange between England and France would of course have been five Napoleons for four sovereigns. If four English notes, professing to promise to pay four sovereigns, would purchase in England only half an ounce of gold bullion, the nominal exchange would be fifty per cent. against England, or, in other words, a bill in France on England for eight hundred sovereigns, which, if payable in coin, would have sold in France for one thousand Napoleons, would sell for only five hundred. And a bill in England on France, which would have sold for four hundred coined sovereigns, would sell for eight hundred pounds payable in notes. And supposing the transactions between England and France equal in amount, they would be adjusted by the exchange of bills at this rate of exchange.

If, however, the exports from England to France should exceed the value of the imports—if, for instance, the French had to pay us five thousand Napoleons, and we had to pay them notes to the nominal value of four thousand sovereigns, bills for two thousand five hundred Napoleons would be capable of discharging the whole English debt. In that case, the remaining two thousand five hundred must be sent from France in gold; and as all the English creditors would be anxious to avoid the expense of transporting the gold, they would be willing to purchase French bills on England, which would entitle them to obtain payment from their own countrymen, at the rate of something more than eight sovereigns for five Napoleons. Instead of being fifty per cent. against England, the nominal exchange might therefore, for a time, be only forty-eight or forty-nine per cent. against England.

And, by reversing the facts, we may suppose it fifty-one or fifty-two; fifty being always the central point to which it would tend, while the quantity of bullion contained in a Napoleon, and that purchasable with an English note, for a sovereign, continued to bear the same proportion to one another.

It may, however, be supposed that we should have no bullion. While the exportation of our coin was going on, we certainly should have none, as it could not be our interest at the same time to import bullion and export coin. But before our export of coin began, we must have been in the habit of importing from the mining countries a certain quantity of bullion, to supply the wear of coin and plate. After our export of coin had ceased, we could have no difficulty in renewing that intercourse. The bullion trade, as it is essentially a trade of barter, would probably be the least disturbed of all our foreign commercial relations. There would still be the same demand for English commodities in the mining countries, and the same supply of gold and silver offered in exchange for them. To a very slight degree indeed, we should probably obtain bullion on better terms than before. First, because we should want rather less of it, our annual wear of coin being at an end, and our import of bullion confined to the supply of plate and the small stock necessary to meet sudden alterations in our real exchange with other countries; and secondly, because our export of coin would have had, as I observed before, a very slight tendency to increase the supply of bullion in the rest of the world. The real price, the sum of the produce of English industry, which we should pay for a given quantity of bullion, would be governed by the same causes as before. It would still depend on the cost of producing, in the mining countries, the whole quantity of bullion which they exported, the amount of that quantity, and the portion of it which they would be willing to give in exchange for the results of a given sum of English industry. And as none of these circumstances would be altered, or, if altered, altered slightly in our favour, there is no reason why our supply of bullion should be more difficult, or its value less steady than before.

It would appear, however, more unsteady, because real variations in the value of the precious metals, which are not easily ascertained when they are employed in the form of money, would now be detected. As the mint in this country returns an equal weight of coin for gold, when we say that the mint price of gold is 3l. 17s. 10½d. an ounce, we merely express that 2 lbs. of gold of a given fineness are coined into eighty-nine pieces called guineas, and that 40 lbs. of gold are coined into 1869 pieces called sovereigns. And it is obvious that, while gold money is our medium of exchange, and the melting and exportation of money is permitted, the market price of gold bullion can never be above the mint price; for no man would give more than eighty-nine guineas, that is, 2 lbs. of coined gold, for 2 lbs. of gold bullion, that is, 2 lbs. of uncoined gold. And if there were a mint in every town, which, on demand, exchanged coined gold for bullion, the market price of gold bullion could never be below the mint price; as no man would sell 2 lbs. of bullion for less than eighty-nine guineas, when he could obtain eighty-nine guineas for it, without delay or trouble, at the Mint. As, however, we have but one mint, and that mint does not give coin for bullion till after a short delay, the market price is sometimes below the mint price. When the delay was six weeks, the difference was sometimes 4½d. an ounce, or, in other words, 208 ounces of bullion might be purchased with a very small fraction more than 207 ounces of coin. And it is obvious, also, that no increase or diminution in the expense of procuring bullion would, in the slightest degree, affect its money price, as any cause which should raise or depress the value of 2 lbs. of gold, would equally raise or depress the value of the eighty-nine guineas into which it may be coined, and which form its money price.

But when our medium of exchange became paper, the market price of bullion, though it could not sink below the mint price, might rise to any extent above it. I started with the supposition that our currency, when notes were first introduced, amounted to forty-five millions sterling. And I will also suppose that at that time 2 lbs. of gold were coined into eighty-nine guineas, or, in other words, that the mint price of gold was 3l. 17s. 10½d. per ounce. If we suppose the forty-five millions sterling of metallic money displaced by an issue of notes of the nominal value of ninety millions sterling, though the same amount of English industry would still obtain from Brazil an ounce of gold, yet, as the nominal sum which must be paid as wages and profits to the persons who produce the English commodities in exchange for which it is obtained would be doubled, when expressed in notes, the price of the gold, in notes, would be doubled also, or the persons employed in producing commodities for the purpose of importing gold would not be on a par with the rest of the community. Gold bullion, therefore, would rise to 7l. 15s. 9d. an ounce; and as long as the cost of obtaining gold and the amount of our paper currency each remained unaltered, the price of gold would be steady at 7l. 15s. 9d. If, however, the cost of obtaining gold should increase, which, of course, might arise from any cause which should diminish either the power of the South Americans to produce it, or their demand for English commodities, the market price of gold might rise, though the amount of our paper currency should remain unaltered. We have seen that, with a gold currency, this effect could not be produced. Our inconvertible paper currency would, therefore, afford a new test of alterations in the value of gold.

With a metallic currency, if the cost of obtaining gold should increase five per cent., it probably would be long before the fact would be acknowledged. The fall of price in each particular instance would be attributable to some fact connected with the commodity itself. Corn would fall from three guineas to three pounds a quarter; it would be said that the harvest was better than had been supposed. Labour would fall; that would be attributed by most reasoners to the fall in the price of corn; and the fall in the price of almost all other articles would be attributed (and rightly enough) to the fall in the price of labour. At the same time, there is no doubt that some of the commodities, the supply of which depends on the seasons, would rise, as no season is equally favourable to all. This would help to keep the real fact out of sight; and it could be proved only by a very wide induction, and after a considerable period. With an inconvertible and stationary paper currency, if other prices remained unaltered, and bullion rose, the fact would at once be attributed to its true cause.

But if an increased cost of obtaining bullion, and an increased issue of notes should be contemporaneous, there would probably be considerable difficulty in apportioning the consequent rise in the price of bullion between the two causes; and the difficulty of estimating the part to be attributed to the increased expense of obtaining bullion, would be still greater if instead, or contemporaneously with the issue of notes, there should be an increased rapidity in their circulation, or an increased use of credit, or of balancing accounts, or of any other substitute for money. When the use of these substitutes increases in a country employing a metallic currency, they cause a rise of prices, an export of money, and then a return of prices to their former level. In a country possessing solely an inconvertible paper currency, they must operate solely by producing a rise of prices.

In my hypothesis, I have supposed a substitution of ninety millions of paper for forty-five millions of money. In such a case, the facts would be so glaring, that no one could doubt that the profuse issue of paper had occasioned almost all the alterations observable in prices. But if the issue had been gradual, and there had never been more than sixty millions in notes at one time in circulation, if the circulation of the inconvertible paper had lasted ten or twelve years; and if, during that time, variations, might have been supposed to have occurred from time to time in the expense of obtaining gold, in the rapidity of our circulation, and in the use of substitutes for money, much dispute would probably arise as to the causes of the variations of the market price of gold from its mint price, and as to the respective force of those causes. Some would say that it was not the paper which had fallen, but the gold which had risen, or, in other words, that the market price of gold was above its mint price, not because more notes had been issued than the amount of the metallic money previously in circulation, but because the expense of obtaining gold had subsequently increased. Others would consider the rise of prices as principally occasioned by those improvements in banking and commerce, which diminish the use and quicken the circulation of money. And others probably would deny the existence of either of the above causes, and attribute the whole difference to the amount of the issues of paper.

And history bears me out in saying that there might exist a body who would deny the existence of any difference at all, and who would, after debate, solemnly resolve “that the notes of the Company have hitherto been, and are at this time, held, in public estimation, to be equivalent to the legal coin of the realm;” or, in other words, that when eighty-nine guineas would purchase twenty-four ounces of gold bullion, and ninety-four pounds in notes would not purchase twenty ounces, the notes were more valuable than the guineas; or, to put it in a different shape, that when one hundred sovereigns would purchase one hundred and thirty pounds in notes, yet that one hundred and one pounds in notes were of more value than one hundred sovereigns.

You must all have long been aware that in my supposition of a country using a currency consisting of inconvertible paper, I have been describing England during the continuance of the Bank Restriction Act.

Before the memorable year 1797, the Bank of England was, what it now is again, a corporation of great wealth, issuing notes payable in gold, and protected by no privilege from the necessity of making that payment on demand. In the beginning of that year, circumstances, which I will not now attempt to explain, occasioned a run upon the Bank, to which the Directors believed their reserve of gold to be inadequate; and in an evil hour for the country, though a fortunate one for the Bank, they begged the assistance of their principal debtor, the Government. Silver and gold Mr. Pitt had not, but he gave them an order, restricting the Bank from paying its notes in gold; a restriction which, after some interlocutory prolongations, was extended to six months after a general peace, and which, in fact, continued in force nearly a quarter of a century. This restriction removed the danger of bankruptcy; but, though it appeared to enable the Bank to issue as many of their notes as they pleased without the possibility of being called on for immediate payment, yet as no one was obliged to take them, the commercial existence of the corporation was in danger of being destroyed. The value of bank notes was, however, for some time kept upon a par with the gold which they represented, partly from habit, partly from their being both received and tendered in payment by Government, and principally from their not being issued in a greater amount than was necessary to replace the coin which had been withdrawn.

Towards the year 1809, however, circumstances occurred which, if our currency had been metallic, would have occasioned a less amount of it to be necessary. The interruption of our commerce by the general extension of the war, and by Napoleon’s decrees, subsequently aided by our own orders in council, threw great difficulties in the way of obtaining the precious metals from other quarters. At the same time extraordinary importations of corn, subsidies to foreign powers, and a large government consumption abroad, part of which was paid for in bills on England, drawn by our own commissariat, and for all of which gold was the readiest remittance, kept up a constantly increasing demand for bullion. An unfavourable exchange, an export of coin, and the increased value and efficiency of the portion retained, would have been the consequences if our currency had been metallic. Being inconvertible paper, the consequences must have been a rise of the market price of bullion over the mint price, and a depression of the exchange at least in that proportion, even if the amount of our paper had continued unaltered. On the contrary, it was increased; and the price of bullion, both causes acting upon it in the same direction, continued to rise. The exchange fell not only to the amount of the difference between paper and gold, but still lower, both because the foreign holder of a bill on England could never be sure that bullion would not rise still higher before he received notes for his bill, and because the bills drawn on England by government agents abroad were thrown on the market without the caution or the skill of men acting on their own account. I have often wondered that, under such circumstances, three years were suffered to elapse before any English creditor endeavoured to enforce payment either in gold, or in notes estimated at the gold they would purchase.

At length, however, in June, 1811, Lord King, probably with a view to demonstrate by an experimentum crucis the real value of Bank of England notes, gave notice to his tenants that he would no longer receive notes at par, but that his rents must thenceforth be paid in guineas, or in an equal weight of Portuguese gold coin, or in Bank of England notes of a sufficient nominal value, to purchase such an equal weight.

Lord King’s attempt at practical reasoning met with a practical answer. The 51 Geo. III. cap. 127, was passed, which made the buying or selling coin at a rate above its nominal value, or the giving or receiving Bank of England notes at a rate below their nominal value, a crime punishable by fine and imprisonment; and prohibited a distress for rent after a tender in Bank of England notes of the amount due. Arrest for debt after such a tender had before been prohibited.

The act seems liable to be easily evaded, and probably would have been so, if there had been any sudden and enormous depreciation of bank notes; if there had been a sudden issue, for instance, sufficient to sink their value one-half. It was, however, submitted to, with the exception of a petty smuggling traffic, by which the remaining guineas, except a few which were hoarded, were gradually exported. I recollect, however, so late as 1814 being offered 10,000 guineas for 14,000l. in notes.

The Directors of the Bank abused their power much less than could have been expected. It is true they did not diminish their issues, when the rise in the market price of gold shewed that an increased use of the substitutes for money, or an increased difficulty in obtaining gold, had made them still more excessive. It is true, also, that they did, after a time, increase their issues from less than twenty-three millions and a half, the amount in the beginning of 1811, to 28,979,876l., the amount towards the end of 1814; but such conduct, injurious as it was, is a model of sobriety and moderation when compared with that of any other individual or community invested with similar powers.

At length a period arrived when peace had diminished our foreign expenditure, and put an end to our subsidies: trade had returned to regular channels, and more regular, but, perhaps, lower profits. All prices had fallen from the conversion of unproductive into productive consumers; and, in some main articles, from favourable seasons, great commercial losses in the preceding years had diminished speculation and credit, and bank notes were rising to a par, indeed had almost reached a par, with gold. The restriction act was gradually repealed, the market price sunk fourpence halfpenny per ounce below the mint price, and the subsequent disorders of our currency cannot be charged on the direct interference of the legislature.

The 51 Geo. III. was passed to prevent bank notes from being at an open discount. “The Bank,” said Lord Stanhope who introduced it, “is one of the bottom planks of the ship of England, and woe to us if we permit it to be bored through.” There can, I think, be little doubt now, that an open discount in bank notes, a recognised difference between paper and metallic prices, would have been the best palliative of the restriction act. It is not impossible that it might have induced the Bank to reduce their issues, until their paper had been at a par with gold. They must have been anxious to save their notes from avowed depreciation, and little as they admitted that the amount of their notes had any thing to do with their value, still they probably would have tried the experiment of diminishing that amount, if it were only to shew their opponents the uselessness of such a measure; and when they found the plan succeed, perhaps even bank directors, such as bank directors then were, might have been convinced. If, however, their conduct had remained unaltered, the public would have had the power, and probably the will, to secure to themselves the use of a less variable currency. Two prices would have been established, one in gold, the other in notes, diverging or approaching as the price of guineas in notes rose or fell. Or more probably, all prices would have been estimated in guineas, and paid in notes according to the discount of the day. The consequences of an increased difficulty in obtaining gold, or of an increased use of credit, or of the substitutes for gold, would have been, that less gold would have been sufficient. The power of arresting for any debt payable in gold would indeed have been suspended, or at least diminished, as the debtor would have been able to protect himself by tendering the amount in bank notes; but it may be questioned whether that would have been any public injury: in all other respects we might have returned to the state of things before the restriction—and we should have escaped the temporary evils produced by the restriction from 1811 to 1819, and the permanent ones which have survived it. We should have escaped that part of the variation of prices during those eight years which is attributable to the varying issues of bank notes; and permanent contracts would not have been entered into, when 1869l. in notes were worth only thirty pounds of gold, to be performed when they were worth forty pounds.

I have said that the bank directors exercised their power with extraordinary moderation: I cannot support this remark by comparing their conduct with that of any other individuals in a precisely similar situation, because I am not aware that the power of issuing notes having a forced circulation, with a suspended liability of payment, and that payment guaranteed only by the issuers, has in any other instance been confided by the government of a country to any of its subjects. But that power has often been assumed by the government itself, and it is with the conduct of governments, therefore, that we must compare that of the bank. The lowest depreciation of bank notes, or, in other words, the greatest difference between the market and the mint price of gold, was thirty per cent.; and a part of this difference is probably to be attributed, not to the original excess, but to the absence of subsequent contraction, an imprudence on the part of the bank, but a much less glaring one than over issue.

In the next Lecture we shall see what governments have done.