In an earlier work we looked into Ricardo's theory of the value of money and how it stands to the prices of commodities, so here we can keep to what is essential. According to Ricardo, the value of metal money is set by the labour-time that has gone into it, but only for as long as the quantity of money stands in the right proportion to the quantity and the price of the commodities to be exchanged. If the quantity of money rises above that proportion, its value falls and commodity prices rise; if it falls below the right proportion, its value rises and commodity prices fall, with other circumstances unchanged.
In the first case, the country where this surplus of gold sits will export the gold that has sunk below its value and import commodities; in the second, gold will flow to the countries where it is valued above its worth, while the undervalued commodities flow out from there to other markets, where they can get normal prices.
On these assumptions, gold itself, as coin or as bullion, can become a value-token representing more or less metallic value than it actually has, so it stands to reason that any convertible banknotes in circulation share the same fate. Banknotes are convertible, so their real value answers to their nominal value; all the same, the total currency, the metal and the convertible notes taken together, can appreciate or depreciate, depending on whether its total quantity rises above or falls below the level set by the exchange-value of the commodities in circulation and the metallic value of gold. This depreciation, not of paper against gold but of gold and paper taken together, of a country's whole mass of means of circulation, is one of Ricardo's main discoveries, and Lord Overstone and Co. pressed it into their service and turned it into a founding principle of Sir Robert Peel's bank legislation of 1844 and 1845.
We do not need to repeat here the demonstration, given in that same text, of how wrongheaded this theory of Ricardo's is. The only thing that interests us is the way Ricardo's propositions were worked up by the school of banking theorists who dictated Peel's Bank Acts.
The commercial crises of the nineteenth century, above all the great crises of 1825 and 1836, produced no further development of Ricardo's money theory, but only new uses for it. What people faced was no longer a single economic phenomenon, as Hume had faced the depreciation of the precious metals in the sixteenth and seventeenth centuries, or Ricardo the depreciation of paper money in the eighteenth and early nineteenth; it was the great storms of the world market, in which the antagonism of every element of the bourgeois production process discharges itself. The origin of these storms, and the defence against them, were looked for in the most superficial and abstract sphere of that process, the sphere of money circulation. The actual theoretical starting point of the school of economic weather experts is in truth nothing other than the dogma that Ricardo had discovered the laws of purely metallic circulation. What was left for them to do was to subject the circulation of credit money, or banknotes, to those laws.
The most general and most striking phenomenon of commercial crises is a sudden, general fall in commodity prices, coming after a longer general rise. A general fall in commodity prices can be expressed as a rise in the relative value of money compared with all commodities, and a general rise in prices, the other way round, as a fall in money's relative value. Both ways of putting it state the phenomenon; neither explains it. The change of wording leaves the task as untouched as translating it out of German into English would. Ricardo's money theory therefore came extremely handy, since it gives a tautology the appearance of a causal relation. What causes the periodic general fall in commodity prices? A periodic rise in the relative value of money. What causes, the other way round, the periodic general rise in commodity prices? A periodic fall in the relative value of money. It could be said with equal correctness that the periodic rise and fall of prices comes from their periodic rise and fall.
Once the transformation of the tautology into a causal relation is granted, everything else follows easily. The rise in commodity prices comes from a fall in the value of money. And the fall in the value of money, as we know from Ricardo, comes from an over-full circulation, that is, from the mass of circulating money rising above the level fixed by its own immanent value and the immanent values of the commodities. Conversely, the general fall in commodity prices comes from the value of money rising above its immanent value, as a result of an under-full circulation. So prices rise and fall periodically because periodically too much or too little money circulates. Now suppose it is shown that a rise in prices went together with a diminished money circulation, and a fall in prices with an increased one: even then it can be asserted that, owing to some reduction or increase in the mass of commodities in circulation, one that cannot be demonstrated statistically at all, the quantity of circulating money has been increased or diminished, not absolutely but relatively.
We have seen that on Ricardo's account these general price fluctuations must occur even under a purely metallic circulation, but that they even out through their alternation. An under-full circulation, for instance, brings a fall in commodity prices; the fall in commodity prices brings an export of commodities abroad; that export brings an import of gold into the country; and this inflow of money in turn brings a rise in commodity prices. The opposite holds for an over-full circulation: commodities are imported and gold exported. Since, then, despite these general price fluctuations which spring from the very nature of Ricardo's metallic circulation, their violent and forceful form, their crisis form, belongs to the periods of developed credit, it becomes clear as day that the issue of banknotes is not regulated exactly according to the laws of metallic circulation. Metallic circulation carries its own remedy in the import and export of the precious metals, which step into circulation at once as coin and so, by their inflow or outflow, make commodity prices rise or fall. The same effect on commodity prices now has to be produced artificially by the banks, by imitating the laws of metallic circulation. If money flows in from abroad, that proves the circulation is under-full, the value of money too high and commodity prices too low, and banknotes must therefore be thrown into circulation in proportion to the newly imported gold. Conversely, they must be withdrawn from circulation in proportion as gold flows out of the country. In other words, the issue of banknotes must be regulated by the import and export of the precious metals, or by the rate of exchange.
Ricardo's false presupposition, that gold is only coin, so that all imported gold increases the money in circulation and therefore raises prices, while all exported gold reduces the coin and therefore makes prices fall, this theoretical presupposition now becomes a practical experiment: to make as much coin circulate as there is gold present at any given time. Lord Overstone (the banker Jones Loyd), Colonel Torrens, Norman, Clay, Arbuthnot and a number of other writers, known in England as the school of the currency principle, have not only preached this doctrine; through Sir R. Peel's Bank Acts of 1844 and 1845 they made it the basis of English and Scottish bank legislation. Their shameful fiasco, in theory as in practice, after experiments on the largest national scale, can only be presented in the doctrine of credit.
The critique of this school came from Thomas Tooke, James Wilson (in The Economist of 1844 to 1847) and John Fullarton. How inadequately they too saw through the nature of gold, and how unclear they were about the relation between money and capital, we have seen more than once, in particular in Chapter 28 of this book. Here now a few more points, following the proceedings of the House of Commons Committee of 1857 on the Peel Bank Acts (B.C. 1857) - F. E.
J. G. Hubbard, a former Governor of the Bank of England, gives his evidence before the committee.
2400. Hubbard's answer: the export of bullion has nothing whatever to do with the prices of commodities. What it does bear on — and bear on very heavily — is the price of interest-bearing securities, because as the rate of interest moves, the value of the securities that embody that interest is necessarily and powerfully affected.
He lays two tables before the committee, covering 1834-1843 and 1845-1856. They show how the movement of prices for fifteen of the most important articles of commerce was quite independent of the inflow and outflow of gold and of the rate of interest.
They show the other kind of result too: the inflow and outflow of gold — in the evidence's own words, 'the representative of our capital seeking investment' — stands in a close connection with the rate of interest.
[2402.] In 1847 a very large amount of American securities went back to America, and Russian securities back to Russia, and other continental securities back to the countries we got our grain from.
Hubbard's table below rests on fifteen main articles: raw cotton, cotton yarn, cotton cloth, wool and woollen cloth, flax and linen, indigo and pig-iron, tin and copper, tallow, sugar, coffee and silk.
Hubbard adds this comment on them:
Hubbard's own summary of the tables runs thus: as in the ten years 1834-1843, so in 1844-1853, movements in the Bank's gold were in every case accompanied by an increase or a decrease in the loanable value of money advanced on discount; and on the other side, the changes in domestic commodity prices show a complete independence of the amount of circulation as it appears in the fluctuations of the Bank of England's gold. (Bank Acts Report, 1857, II, pp. 290 and 291.)
Demand and supply set the market prices of commodities. That being so, it is clear how false Overstone's identification is: he takes the demand for loanable money capital — or rather the deviations of its supply, as the discount rate expresses them — and identifies it with the demand for real 'capital'. The claim that commodity prices are regulated by fluctuations in the amount of currency now hides itself under a phrase: that fluctuations in the discount rate express fluctuations in the demand for real material capital, by contrast with money capital. We have already seen how both Norman and Overstone actually maintained this before that same committee, and what lame evasions the latter in particular was driven to, until he was finally cornered (Chapter 26).
So it is in fact the old humbug: that changes in the amount of gold there is, by adding to or taking from the country's means of circulation, must raise or lower commodity prices inside that country. If gold is exported, then on this currency theory prices in the country the gold goes to must rise, and with them the value of the gold-exporting country's exports on the market of the gold-importing country; whereas the value of the importing country's exports on the exporting country's market would fall, since it would rise in their country of origin, where the gold goes.
In fact, though, a smaller amount of gold does no more than raise the rate of interest, while a larger amount brings it down; and if these movements in the rate of interest did not come into account when cost prices are established, or when demand and supply are determined, they would leave commodity prices completely untouched.
In the same report, N. Alexander, head of a large firm in the India trade, gives this account of the heavy drain of silver to India and China in the mid-1850s. Part of the cause was the civil war in China, which put a stop to the sale of English fabrics there; part was the silkworm disease in Europe, which sharply cut back silk growing in Italy and France.
4337. Is the drain for China or for India? — The silver goes to India, and with a good part of it you buy opium, and all of that goes on to China, to build up funds for buying silk; and the state of the markets in India (in spite of the accumulation of silver there) makes it more profitable for the merchant to lay down silver than to send piece-goods or other British manufactures. — 4338. Was there not a large drain from France, which is where we got the silver? — Yes, a very large one. — 4344. Instead of bringing silk in from France and Italy, we send it out there in large quantities, both Bengal silk and Chinese.
So silver was shipped to Asia — the money metal of that part of the world — instead of goods. Not because the prices of those goods had risen in the country that produced them (England), but because they had fallen, fallen through excessive imports, in the country that took them in. And this even though the silver had to be got from France and paid for in part with gold.
On the currency theory, an import of that kind should have made prices fall in England and rise in India and China.
Another example. Giving evidence before the Lords' committee (C. D. 1848/1857), Wylie, one of the leading Liverpool merchants, said this:
1994. Wylie, a Liverpool merchant, told the committee that towards the end of 1845 there was no trade that paid better, and none that threw off such big profits (than cotton spinning). The cotton stock was large, and good usable cotton could be had at 4d. per pound, and good secunda mule twist no. 40 could be spun from such cotton at an outlay of a like 4d., so about 8d. per pound in all for the spinner. This yarn was sold in great masses in September and October 1845, and delivery contracts on the same scale were concluded, at 10 1/2 and 11 1/2d. per pound, and in some cases the spinners made a profit equal to what they had paid for the cotton. — 1996. The trade went on paying until the beginning of 1846. — 2000. On 3 March 1844 the cotton stock (627,042 bales) was more than twice what it is today (on 7 March 1848, when it was 301,070 bales), and even so the price stood 1 1/4d. per pound higher (6 1/4d. as against 5d.). In the same period yarn — good secunda mule twist no. 40 — slipped from 11 1/2-12d. to 9 1/2d. by October, and to 7 3/4d. at the end of December 1847; yarn was sold at the price at which the cotton it was spun from had been bought. (ibid., nos. 2021 and 2023.)
This is what exposes the interested wisdom of Overstone: money is supposed to be "dear" because capital is "scarce". On 3 March 1844 the Bank rate stood at 3 per cent; in October and November 1847 it went to 8 and 9 per cent, and on 7 March 1848 it was still at 4 per cent. The complete stagnation of sales and the panic, with the high rate of interest that went with it, drove cotton prices far below the level that answered to the state of supply. One result was an enormous fall in imports in 1848, another a fall in production in America; hence a fresh rise in cotton prices in 1849.
According to Overstone, commodities were too dear because there was too much money in the country.
2002. The recent worsening in the state of the cotton industry is not to be blamed on a shortage of raw material, since the price is lower even though the stock of raw cotton is very much reduced.
But Overstone has a comfortable confusion between the price, or the value, of a commodity and the value of money — and the value of money here means the rate of interest. Answering question 2026, Wylie gives his overall verdict on the currency theory. Cardwell and Sir Charles Wood had asserted in May 1847 that the Bank Act of 1844 had to be carried through in its whole content:
These principles, Wylie says, seem to him to be of a kind that would give money an artificially high value and all commodities an artificial, ruinously low one.
He says more about what this Bank Act did to business in general:
Bills at four months are the regular drafts drawn by the manufacturing towns on merchants and bankers against goods bought and destined for the United States. These could now be discounted only at great sacrifices, and so the execution of orders was checked to a considerable extent, until after the Government Letter of 25 October (suspension of the Bank Act), when those four-month bills became discountable again. (2097.)
So the suspension of this Bank Act worked like a deliverance in the provinces too.
2102. Last October (1847) almost every American buyer who buys goods here cut his orders back as far as he could straight away; and when news that money had grown dear reached America, all new orders stopped. — 2134. Corn and sugar were special instances. The corn market was affected by the harvest outlook, and sugar by the enormous stocks and imports. — 2163. Of our payment obligations to America, a great deal was settled by forced sales of consigned goods, and a great deal, I fear, was annulled by the bankruptcies here. — 2196. If I recollect rightly, in October 1847 our stock exchange was paying interest of up to 70 per cent.
The crisis of 1837 with its long aftermath, followed in 1842 by a further, full-blown crisis, and the interested blindness of the industrialists and merchants, who flatly refused to see any overproduction — for on the vulgar economists' showing this was nonsense and an impossibility! — had finally produced the confusion in people's heads that let the currency school translate its dogma into practice on a national scale. The bank legislation of 1844-5 went through.
The 1844 Bank Act splits the Bank of England into an Issue Department and a Banking Department. The first of these receives securities — for the most part government stock — to the value of £14 million, along with the whole metal reserve, of which no more than a quarter may be silver, and issues notes to the same total amount. So long as these notes are not in the public's hands, they stay in the Banking Department and form its ever-ready reserve, together with the small amount of coin needed for daily use (about £1 million). The Issue Department gives the public gold for notes and notes for gold; every other dealing with the public is the Banking Department's business. The private banks in England and Wales that were entitled in 1844 to issue their own notes keep that right, but the number of notes they may issue is capped. If one of these banks stops issuing its own notes, the Bank of England may raise the part of its own note issue that gold does not cover by two-thirds of the quota thus freed; in this way the figure had risen by 1892 from £14 million to £16 1/2 million (£16,450,000 to be precise).
For every £5 in gold that flows out of the Bank's reserve, a £5 note returns to the Issue Department and is destroyed; for every five sovereigns that come into the reserve, a new £5 note enters circulation. With that, Overstone's ideal paper circulation — one governed exactly by the laws of metallic circulation — is carried out in practice; and with that, on the currency people's own contention, crises are made impossible for ever.
In reality, though, splitting the Bank into two independent departments took away the directors' ability to dispose freely of all their available means at decisive moments. So situations could arise in which the Banking Department stood on the edge of bankruptcy while the Issue Department still held several millions in gold and, on top of that, its £14 million in securities untouched. And this was all the easier to happen because almost every crisis has a stretch in which a heavy drain of gold abroad takes place, which has to be covered mainly out of the Bank's metal reserve.
For every £5 that flows abroad during such a drain, a £5 note is withdrawn from circulation at home: the quantity of means of circulation is reduced at exactly the moment when most of it is needed, and needed most urgently. So the Bank Act of 1844 directly provokes the whole world of commerce, as a crisis breaks out, to lay in a reserve of banknotes in good time — which speeds the crisis up and makes it sharper. And because this artificially raised demand for monetary accommodation, that is, for means of payment, takes effect at the decisive moment while the supply of those is restricted at the same time, it drives the interest rate in crises up to a previously unheard-of height. So instead of abolishing crises, it drives them to the point where either the whole industrial world has to go to pieces, or else the Bank Act.
Twice, on 25 October 1847 and 12 November 1857, the crisis had climbed to that height; the government then freed the Bank from the restriction on its note issue by suspending the Act of 1844, and on both occasions this was enough to break the crisis. In 1847 the mere certainty that banknotes could again be had against first-class securities sufficed to bring the hoarded £4-£5 million in notes back into the light of day and into circulation; in 1857 a little under £1 million in notes was issued above the legal quota, but only for a very short time.
The 1844 legislation also still shows traces of the memory of the century's first twenty years — the time when the Bank suspended payment in cash and the notes lost their value. The fear that banknotes might lose their credit is still very noticeable; and it was a quite superfluous fear, since as early as 1825 the issue of a rediscovered stock of old £1 notes, withdrawn from circulation, had broken the crisis, and had thereby proved that even then the credit of the notes stood unshaken, even in a time of the most general and strongest distrust. And this is entirely understandable, for in fact the whole nation stands behind these tokens with its credit. - F. E.
Let us hear now a few witnesses on what the Bank Act has done. J. St. Mill believed that the Act of 1844 had held over-speculation down. This wise man had the good fortune to give his evidence on 12 June 1857. Four months later the crisis broke out. He literally congratulates the bank directors and the commercial public in general on the fact that they
understand the nature of a commercial crisis far better than they did before, and the very great harm they do to themselves and to the public by supporting over-speculation. (B. A. 1857, no. 2031.)
The wise Mill's view is that if £1 notes are issued
as advances to manufacturers and others who pay out wages ... then the notes can pass into the hands of other people who spend them on consumption, and in that case the notes themselves constitute a demand for goods, and may for a time tend to bring about a rise in prices. [no. 2066.]
So Mr Mill assumes that manufacturers will pay higher wages because they pay them in paper rather than in gold? Or does he think that if the manufacturer gets his advance in £100 notes and changes them into gold, that wage would make less demand than if it were paid straight away in £1 notes? And does he not know that in certain mining districts, for instance, wages were paid in notes of local banks, so that several workers together received a £5 note? Does that increase their demand? Or will the bankers advance money to manufacturers more readily and in greater quantity in small notes than in large ones?
This strange fear of Mill's about £1 notes would be inexplicable if his whole work on political economy did not display an eclecticism that shies away from no contradiction. On the one hand he agrees with Tooke against Overstone on many things; on the other hand he believes that commodity prices are determined by the quantity of money present. So he is by no means convinced that for every £1 note issued — all other circumstances being equal — a sovereign travels into the Bank's vault; what he fears is that the mass of means of circulation might be increased and so devalued, that is, that commodity prices would rise. That is what hides behind the caution above, and nothing more. — F. E.
On the splitting of the Bank into two and the excessive precaution taken to secure the redemption of the banknotes, Tooke gives his evidence before the C. D. 1848/1857:
The greater fluctuations of the interest rate in 1847, compared with 1837 and 1839, were due only to the separation of the Bank into two departments (3010). — The safety of the banknotes was not affected, in 1825 or in 1837 and 1839 (3015). — The demand for gold in 1825 had no other aim than to fill the empty space created by the complete discredit of the £1 notes of the provincial banks; that empty space could be filled only with gold, until the Bank of England too issued £1 notes (3022). — In November and December 1825 there was not the slightest demand for gold for export (3023).
Where the discredit of the Bank is concerned, at home and abroad, a suspension of the payment of dividends and deposits would have far more serious consequences than a suspension of the payment of the banknotes. (3028.)
3035. Would you not say that any circumstance that in the last instance endangered the convertibility of the banknotes could create new and serious difficulties at a moment of commercial pressure? — Not at all.
In the course of 1847, an increased issue of notes might perhaps have helped to fill up the Bank's gold reserve again, as it did in 1825. (3058.)
Before the B. A. 1857, Newmarch states:
1357. The first bad effect ... of this separation of the two departments (of the Bank), and of the division of the gold reserve that necessarily followed from it, was that the banking business of the Bank of England — that whole branch of its operations which brings it into more direct contact with the country's trade — was carried on with only half the amount of the former reserve. Because of this splitting of the reserve, as soon as the Banking Department's reserve shrank even slightly, the Bank was forced to raise its discount rate. This reduced reserve has therefore caused a series of jerky changes in the discount rate. — 1358. Such changes since 1844 (up to June 1857) have been some sixty in number, while before 1844 in the same period they came to barely a dozen.
Of particular interest too is the evidence of Palmer before the Lords' C. D. Committee (1848/1857), a director of the Bank of England since 1811 and for a time its Governor:
828. In December 1825 the Bank had only about £1,100,000 of gold left. At that time it must infallibly have failed completely if this Act (of 1844) had then been in existence. In December it issued, I believe, 5 or 6 million in notes in a week, and that considerably eased the panic of the time.
825. The first period (since 1 July 1825) in which the present bank legislation would have broken down, if the Bank had tried to carry through the transactions once entered upon, was 28 February 1837; at that time the Bank held £3,900,000 to £4,000,000, and it would then have had only £650,000 left in reserve. Another period is 1839, lasting from 9 July to 5 December. — 826. What was the amount of the reserve in that case? The reserve was minus £200,000 altogether on 5 September. On 5 November it rose to about 1 to 1½ million. — 830. The Act of 1844 would have prevented the Bank from assisting the American trade in 1837. — 831. Three of the principal American houses failed ... almost every house in the American trade was put out of credit, and had the Bank not come to the rescue then, I do not believe that more than one or two houses could have held their ground. — 836. The pressure of 1837 is not to be compared with that of 1847. The 1837 pressure was chiefly confined to the American trade. — 838. (Early in June 1837 the Bank's management discussed how the pressure might be relieved.) Whereupon some gentlemen defended the opinion ... that the correct principle was to raise the rate of interest, whereby commodity prices would fall; in short, to make money dear and commodities cheap, by which the payment abroad would be accomplished. — 906. The introduction of an artificial restriction on the Bank's powers through the Act of 1844, in place of the old and natural limit of its powers, the actual amount of its metal reserve, produces artificial difficulty in business and hence an effect on commodity prices that was wholly unnecessary without this Act. — 968. Under the working of the Act of 1844 the Bank's metal reserve cannot, under ordinary circumstances, be materially reduced below 9½ million. This would cause a pressure on prices and credit that would have to bring about such a change in foreign exchange rates that gold imports rose and thereby increased the amount of gold in the Issue Department. — 996. Under the present restriction you (the Bank) have not the command of the silver that is required at times when silver is needed to act on the foreign exchanges. — 999. What was the purpose of the rule restricting the Bank's silver reserve to one-fifth of its metal reserve? — That question I cannot answer.
The aim was to make money dear; and so too, quite apart from the currency theory, was the separation of the Bank into two departments, and the compulsion on the Scottish and Irish banks to keep gold in reserve for any note issue beyond a certain amount. A decentralization of the national metal reserve arose in this way, which made it less able to correct unfavourable exchange rates. All these provisions come down to raising the interest rate: that the Bank of England may not issue notes above 14 million except against a gold reserve; that the Banking Department is to be managed as an ordinary bank, pressing the interest rate down in times of excess money and driving it up in times of pressure; the restriction of the silver reserve, the principal means of rectifying exchange rates with the Continent and with Asia; the rules for the Scottish and Irish banks, which never need gold for export and must now hold it under the pretext of an entirely illusory convertibility of their notes. The fact is that the Act of 1844 produced the first run for gold on the Scottish banks in 1857. The new bank legislation likewise makes no distinction between a drain of gold abroad and one for the interior, although their effects are self-evidently quite different. Hence the constant violent fluctuations in the market rate of interest. On silver, Palmer says twice, at 992 and 994, that the Bank can buy silver against notes only when the exchange rate is favourable to England, so that the silver is superfluous; for:
1003. The only purpose for which a considerable part of the metal reserve can be held in silver is to make foreign payments easier during the time when the exchange rates are against England. — 1004. Silver is a commodity which, because it is money throughout the rest of the world, is therefore the most suitable commodity ... for this purpose (payment abroad). Only the United States have recently taken gold alone.
In his view, in times of pressure the Bank did not need to raise the interest rate above the old level of 5 per cent, so long as no unfavourable exchange rate drew gold abroad. Were it not for the Act of 1844, it could have gone on discounting without difficulty all the first-class bills presented to it (1018 to 1020). But with the Act of 1844, and in the position the Bank was in in October 1847,
there was no rate of interest the Bank could have demanded from houses of credit that they would not have paid willingly, in order to carry on their payments. [1022.]
And this high rate of interest was precisely the aim of the Act.
1029. I must make a great distinction between the effect of the interest rate on foreign demand (for precious metal) and a rise in the rate for the purpose of checking a run on the Bank during a period of domestic shortage of credit. — 1023. Before the Act of 1844, when the exchanges were in England's favour and there was uneasiness, indeed positive panic, in the country, no limit was placed on the issue of notes, and that alone could relieve this state of pressure.
That is how a man speaks who sat on the board of the Bank of England for thirty-nine years. Let us now hear a private banker, Twells, a partner in Spooner, Attwood & Co. since 1801. He is the only one of all the witnesses before the B. A. 1857 who gives a view into the real state of the country and sees the crisis approaching. In other respects he is a kind of Birmingham little-shilling man, just as his partners, the Attwood brothers, are the founders of that school (see A Contribution to the Critique of Political Economy, p. 82). He states:
At question 4488 Twells was asked how he thought the Act of 1844 had worked. Were he to answer as a banker, he would say it had worked quite outstandingly, since it had yielded a rich harvest for bankers and for (money-) capitalists of every description. But for the honest, hard-working tradesman, who needs the discount rate to hold steady so that he can make his arrangements with confidence, it had worked very badly ... it had turned money-lending into a most profitable line of business. At 4489 he was asked whether it — the Bank Act — enabled the London joint-stock banks to pay their shareholders 20 to 22 per cent; one of them had lately paid 18 per cent and he thought another 20 per cent, and they had every reason to speak up very firmly for the Act. At 4490 he was asked about the small tradesmen and respectable merchants who have no large capital ... it squeezes them very hard ... The only way he had of finding this out was that he saw such an astonishing mass of their acceptances going unpaid. Those acceptances are always small, perhaps between £20 and £100; many of them are not paid and come back short-paid to all parts of the country, and this is always a sign of pressure among ... the small shopkeepers.
At 4494 he explains that business is not profitable now. His following remarks are important, because he saw the crisis already latent when none of the others suspected it.
4494. Prices in Mincing Lane are still holding up fairly well, but nothing is sold; one cannot sell at any price; people hold on to the nominal price.
4495. He tells of a case. A Frenchman sends a broker in Mincing Lane goods worth £3,000 to be sold at a certain price. The broker cannot get the price, and the Frenchman cannot sell below it. The goods lie there, but the Frenchman needs money. So the broker advances him £1,000, in such a way that the Frenchman draws a three-month bill for £1,000 on the broker, with the goods as security. After three months the bill falls due, but the goods are still unsaleable. The broker then has to pay the bill, and although he has cover for £3,000 he cannot turn it into cash, and he runs into difficulties. So one drags another down with him.
4496. As for the heavy exports ... when business at home is depressed, that necessarily also calls forth heavy exports. — 4497. Do you think domestic consumption has fallen? — Very considerably ... enormously ... the small shopkeepers here are the best authority. — 4498. And yet imports are very large; does that not point to heavy consumption? — Yes, if you can sell; but many warehouses are full of these things; in the case I have just described, £3,000 worth of goods were imported that cannot be sold.
4514. When money is dear, would you say that capital is then cheap? — Yes indeed.
So this man is by no means of Overstone's opinion, that a high rate of interest is the same thing as dear capital.
How business is conducted now:
4516. ... Others go in for it on a very great scale, doing an enormous trade in exports and imports, far beyond the measure their capital entitles them to; of that there can be no doubt at all. These people may succeed; some stroke of luck may make them great fortunes and let them pay everything off. That is very much the system on which a great part of business is carried on these days. Such people will willingly lose 20, 30 and 40 per cent on a shipment; the next venture may bring it back to them. If one venture after another fails, then they are ruined; and that is precisely the case we have often seen recently: business houses have failed without a shilling of assets left.
4791. The lower rate of interest (over the last ten years) does indeed work against bankers, but without showing you the books I should find it very hard to explain to you how much higher the profit (his own) now is than formerly. When the interest rate is low, as a result of excessive note issue, we have large deposits; when the rate is high, that brings us a direct gain. — 4794. When money is to be had at a moderate rate, we have more demand for it; we lend out more; it works (for us bankers) that way. When it rises, we get more for it than is fair; we get more than we ought to.
We have seen that every expert treats the credit of Bank of England notes as unshakeable. All the same, the Bank Act ties up £9 to £10 million in gold, absolutely, so that those notes can be cashed. The reserve is held holy and untouchable, and that rule is carried much further than the old hoarders of treasure ever carried it. W. Brown of Liverpool testified (C. D. 1847/1857, no. 2311):
Brown said that as for any use this money was put to at the time — the metal reserve in the Issue Department — it might just as well have been thrown into the sea. Not the smallest part of it could be touched without breaking the Act of Parliament.
The building contractor E. Capps — the same man quoted earlier, from whose evidence the description of the modern London building system was taken (Volume 2, Chapter 12) — sums up his view of the 1844 Bank Act like this (B. A. 1857):
5508. Was his general view, then, that the present system of bank legislation is a very clever arrangement for bringing the profits of industry, at regular intervals, into the usurer's bag? — That was his view. He knew it had worked that way in the building trade.
As mentioned already, the Bank Act of 1845 forced the Scottish banks into a system close to the English one. For each bank a ceiling on its note issue was fixed, and beyond that ceiling the bank had to hold gold in reserve. What effect this had is shown by a few pieces of evidence given here before the B. A. 1857.
Kennedy, director of a Scottish bank:
3375. Was there anything in Scotland that could be called a circulation of gold before the Act of 1845 came in? — Nothing of the kind. 3376. Has any extra circulation of gold appeared since? — None whatever; the people dislike gold. 3450. In his view the £900,000 or so in gold that the Scottish banks have been compelled to hold since 1845 is nothing but harmful, and it absorbs a part of Scotland's capital unproductively.
Then Anderson, director of the Union Bank of Scotland.
3558. Was the one heavy demand made on the Bank of England by the Scottish banks a demand arising out of the foreign exchanges? — It was; and holding gold in Edinburgh does nothing to reduce that demand. 3590. As long as we have the same amount of securities lying in the Bank of England (or with the private banks in England), we keep the same power we had before to bring about a drain of gold from the Bank of England.
Finally, one more article from The Economist (Wilson):
The Scottish banks keep idle sums of cash with their London agents, and those agents keep the money in the Bank of England. Within the limits of those sums, this gives the Scottish banks command over the metal reserve in the Bank — and there the metal always sits exactly where it is needed, whenever foreign payments have to be made.
This system was broken up by the Act of 1845:
Because of the Act of 1845 for Scotland, a heavy drain of coin out of the Bank of England has lately taken place, to meet a merely possible demand in Scotland, one that might perhaps never arise... Since that time a substantial sum has been regularly locked up in Scotland, and another considerable sum is constantly travelling back and forth between London and Scotland. When a time comes in which a Scottish banker expects more demand for his notes, a box of gold is sent over from London; when that time is past, the same box goes back to London, usually without ever having been opened. (The Economist, 23 October 1847.)
And what does the father of the Bank Act, the banker Samuel Jones Loyd, alias Lord Overstone, have to say to all this?
Back in 1848, before the Lords Committee, he had already repeated that
money pressure and a high rate of interest, brought on by a lack of sufficient capital, cannot be eased by issuing more banknotes (1514).
Yet the mere permission to issue more notes, contained in the government letter of 25 October 1847, had been enough to blunt the edge of the crisis.
He holds to the position that
the high rate of interest and the depressed state of manufacturing industry was the necessary result of the diminution of the material capital that could be used for industrial and commercial purposes (1604).
And yet for months the depressed state of manufacturing industry had consisted in this: that material commodity capital filled the warehouses to overflowing and was simply unsaleable, and that for that very reason material productive capital lay wholly or partly idle, so as not to turn out still more unsaleable commodity capital.
And before the Bank Acts Committee of 1857 he says:
Overstone told the Bank Acts Committee of 1857 that by keeping strictly and promptly to the principles of the Act of 1844, everything had run smoothly and easily: the monetary system stands safe and unshaken, nobody disputes the prosperity of the country, and public trust in the Act of 1844 grows stronger every day. If the Committee wants yet more practical proof that the principles on which the Act rests are sound, and that the results it has secured are good, then the honest and complete answer is this: look around you, look at how trade stands in the country just now, look at how content the people are, look at the wealth and prosperity that spread through every class of society. And once it has done that, the Committee will be in a position to decide whether it wants to stop an Act from being continued, when results like these have been achieved under it. (B. A. 1857, no. 4189.)
Overstone sang this dithyramb to the Committee on 14 July. The answering strophe came on 12 November of the same year: a letter addressed to the Bank's directors, in which the government suspended the wonder-working Act of 1844 so as to save whatever could still be saved. - F. E.
In an earlier work we looked into Ricardo's theory of the value of money and how it stands to the prices of commodities, so here we can keep to what is essential. According to Ricardo, the value of metal money is set by the labour-time that has gone into it, but only for as long as the quantity of money stands in the right proportion to the quantity and the price of the commodities to be exchanged. If the quantity of money rises above that proportion, its value falls and commodity prices rise; if it falls below the right proportion, its value rises and commodity prices fall, with other circumstances unchanged.
In the first case, the country where this surplus of gold sits will export the gold that has sunk below its value and import commodities; in the second, gold will flow to the countries where it is valued above its worth, while the undervalued commodities flow out from there to other markets, where they can get normal prices.
On these assumptions, gold itself, as coin or as bullion, can become a value-token representing more or less metallic value than it actually has, so it stands to reason that any convertible banknotes in circulation share the same fate. Banknotes are convertible, so their real value answers to their nominal value; all the same, the total currency, the metal and the convertible notes taken together, can appreciate or depreciate, depending on whether its total quantity rises above or falls below the level set by the exchange-value of the commodities in circulation and the metallic value of gold. This depreciation, not of paper against gold but of gold and paper taken together, of a country's whole mass of means of circulation, is one of Ricardo's main discoveries, and Lord Overstone and Co. pressed it into their service and turned it into a founding principle of Sir Robert Peel's bank legislation of 1844 and 1845.
We do not need to repeat here the demonstration, given in that same text, of how wrongheaded this theory of Ricardo's is. The only thing that interests us is the way Ricardo's propositions were worked up by the school of banking theorists who dictated Peel's Bank Acts.
The commercial crises of the nineteenth century, above all the great crises of 1825 and 1836, produced no further development of Ricardo's money theory, but only new uses for it. What people faced was no longer a single economic phenomenon, as Hume had faced the depreciation of the precious metals in the sixteenth and seventeenth centuries, or Ricardo the depreciation of paper money in the eighteenth and early nineteenth; it was the great storms of the world market, in which the antagonism of every element of the bourgeois production process discharges itself. The origin of these storms, and the defence against them, were looked for in the most superficial and abstract sphere of that process, the sphere of money circulation. The actual theoretical starting point of the school of economic weather experts is in truth nothing other than the dogma that Ricardo had discovered the laws of purely metallic circulation. What was left for them to do was to subject the circulation of credit money, or banknotes, to those laws.
The most general and most striking phenomenon of commercial crises is a sudden, general fall in commodity prices, coming after a longer general rise. A general fall in commodity prices can be expressed as a rise in the relative value of money compared with all commodities, and a general rise in prices, the other way round, as a fall in money's relative value. Both ways of putting it state the phenomenon; neither explains it. The change of wording leaves the task as untouched as translating it out of German into English would. Ricardo's money theory therefore came extremely handy, since it gives a tautology the appearance of a causal relation. What causes the periodic general fall in commodity prices? A periodic rise in the relative value of money. What causes, the other way round, the periodic general rise in commodity prices? A periodic fall in the relative value of money. It could be said with equal correctness that the periodic rise and fall of prices comes from their periodic rise and fall.
Once the transformation of the tautology into a causal relation is granted, everything else follows easily. The rise in commodity prices comes from a fall in the value of money. And the fall in the value of money, as we know from Ricardo, comes from an over-full circulation, that is, from the mass of circulating money rising above the level fixed by its own immanent value and the immanent values of the commodities. Conversely, the general fall in commodity prices comes from the value of money rising above its immanent value, as a result of an under-full circulation. So prices rise and fall periodically because periodically too much or too little money circulates. Now suppose it is shown that a rise in prices went together with a diminished money circulation, and a fall in prices with an increased one: even then it can be asserted that, owing to some reduction or increase in the mass of commodities in circulation, one that cannot be demonstrated statistically at all, the quantity of circulating money has been increased or diminished, not absolutely but relatively.
We have seen that on Ricardo's account these general price fluctuations must occur even under a purely metallic circulation, but that they even out through their alternation. An under-full circulation, for instance, brings a fall in commodity prices; the fall in commodity prices brings an export of commodities abroad; that export brings an import of gold into the country; and this inflow of money in turn brings a rise in commodity prices. The opposite holds for an over-full circulation: commodities are imported and gold exported. Since, then, despite these general price fluctuations which spring from the very nature of Ricardo's metallic circulation, their violent and forceful form, their crisis form, belongs to the periods of developed credit, it becomes clear as day that the issue of banknotes is not regulated exactly according to the laws of metallic circulation. Metallic circulation carries its own remedy in the import and export of the precious metals, which step into circulation at once as coin and so, by their inflow or outflow, make commodity prices rise or fall. The same effect on commodity prices now has to be produced artificially by the banks, by imitating the laws of metallic circulation. If money flows in from abroad, that proves the circulation is under-full, the value of money too high and commodity prices too low, and banknotes must therefore be thrown into circulation in proportion to the newly imported gold. Conversely, they must be withdrawn from circulation in proportion as gold flows out of the country. In other words, the issue of banknotes must be regulated by the import and export of the precious metals, or by the rate of exchange.
Ricardo's false presupposition, that gold is only coin, so that all imported gold increases the money in circulation and therefore raises prices, while all exported gold reduces the coin and therefore makes prices fall, this theoretical presupposition now becomes a practical experiment: to make as much coin circulate as there is gold present at any given time. Lord Overstone (the banker Jones Loyd), Colonel Torrens, Norman, Clay, Arbuthnot and a number of other writers, known in England as the school of the currency principle, have not only preached this doctrine; through Sir R. Peel's Bank Acts of 1844 and 1845 they made it the basis of English and Scottish bank legislation. Their shameful fiasco, in theory as in practice, after experiments on the largest national scale, can only be presented in the doctrine of credit.
The critique of this school came from Thomas Tooke, James Wilson (in The Economist of 1844 to 1847) and John Fullarton. How inadequately they too saw through the nature of gold, and how unclear they were about the relation between money and capital, we have seen more than once, in particular in Chapter 28 of this book. Here now a few more points, following the proceedings of the House of Commons Committee of 1857 on the Peel Bank Acts (B.C. 1857) - F. E.
J. G. Hubbard, a former Governor of the Bank of England, gives his evidence before the committee.
2400. Hubbard's answer: the export of bullion has nothing whatever to do with the prices of commodities. What it does bear on — and bear on very heavily — is the price of interest-bearing securities, because as the rate of interest moves, the value of the securities that embody that interest is necessarily and powerfully affected.
He lays two tables before the committee, covering 1834-1843 and 1845-1856. They show how the movement of prices for fifteen of the most important articles of commerce was quite independent of the inflow and outflow of gold and of the rate of interest.
They show the other kind of result too: the inflow and outflow of gold — in the evidence's own words, 'the representative of our capital seeking investment' — stands in a close connection with the rate of interest.
[2402.] In 1847 a very large amount of American securities went back to America, and Russian securities back to Russia, and other continental securities back to the countries we got our grain from.
Hubbard's table below rests on fifteen main articles: raw cotton, cotton yarn, cotton cloth, wool and woollen cloth, flax and linen, indigo and pig-iron, tin and copper, tallow, sugar, coffee and silk.
Hubbard adds this comment on them:
Hubbard's own summary of the tables runs thus: as in the ten years 1834-1843, so in 1844-1853, movements in the Bank's gold were in every case accompanied by an increase or a decrease in the loanable value of money advanced on discount; and on the other side, the changes in domestic commodity prices show a complete independence of the amount of circulation as it appears in the fluctuations of the Bank of England's gold. (Bank Acts Report, 1857, II, pp. 290 and 291.)
Demand and supply set the market prices of commodities. That being so, it is clear how false Overstone's identification is: he takes the demand for loanable money capital — or rather the deviations of its supply, as the discount rate expresses them — and identifies it with the demand for real 'capital'. The claim that commodity prices are regulated by fluctuations in the amount of currency now hides itself under a phrase: that fluctuations in the discount rate express fluctuations in the demand for real material capital, by contrast with money capital. We have already seen how both Norman and Overstone actually maintained this before that same committee, and what lame evasions the latter in particular was driven to, until he was finally cornered (Chapter 26).
So it is in fact the old humbug: that changes in the amount of gold there is, by adding to or taking from the country's means of circulation, must raise or lower commodity prices inside that country. If gold is exported, then on this currency theory prices in the country the gold goes to must rise, and with them the value of the gold-exporting country's exports on the market of the gold-importing country; whereas the value of the importing country's exports on the exporting country's market would fall, since it would rise in their country of origin, where the gold goes.
In fact, though, a smaller amount of gold does no more than raise the rate of interest, while a larger amount brings it down; and if these movements in the rate of interest did not come into account when cost prices are established, or when demand and supply are determined, they would leave commodity prices completely untouched.
In the same report, N. Alexander, head of a large firm in the India trade, gives this account of the heavy drain of silver to India and China in the mid-1850s. Part of the cause was the civil war in China, which put a stop to the sale of English fabrics there; part was the silkworm disease in Europe, which sharply cut back silk growing in Italy and France.
4337. Is the drain for China or for India? — The silver goes to India, and with a good part of it you buy opium, and all of that goes on to China, to build up funds for buying silk; and the state of the markets in India (in spite of the accumulation of silver there) makes it more profitable for the merchant to lay down silver than to send piece-goods or other British manufactures. — 4338. Was there not a large drain from France, which is where we got the silver? — Yes, a very large one. — 4344. Instead of bringing silk in from France and Italy, we send it out there in large quantities, both Bengal silk and Chinese.
So silver was shipped to Asia — the money metal of that part of the world — instead of goods. Not because the prices of those goods had risen in the country that produced them (England), but because they had fallen, fallen through excessive imports, in the country that took them in. And this even though the silver had to be got from France and paid for in part with gold.
On the currency theory, an import of that kind should have made prices fall in England and rise in India and China.
Another example. Giving evidence before the Lords' committee (C. D. 1848/1857), Wylie, one of the leading Liverpool merchants, said this:
1994. Wylie, a Liverpool merchant, told the committee that towards the end of 1845 there was no trade that paid better, and none that threw off such big profits (than cotton spinning). The cotton stock was large, and good usable cotton could be had at 4d. per pound, and good secunda mule twist no. 40 could be spun from such cotton at an outlay of a like 4d., so about 8d. per pound in all for the spinner. This yarn was sold in great masses in September and October 1845, and delivery contracts on the same scale were concluded, at 10 1/2 and 11 1/2d. per pound, and in some cases the spinners made a profit equal to what they had paid for the cotton. — 1996. The trade went on paying until the beginning of 1846. — 2000. On 3 March 1844 the cotton stock (627,042 bales) was more than twice what it is today (on 7 March 1848, when it was 301,070 bales), and even so the price stood 1 1/4d. per pound higher (6 1/4d. as against 5d.). In the same period yarn — good secunda mule twist no. 40 — slipped from 11 1/2-12d. to 9 1/2d. by October, and to 7 3/4d. at the end of December 1847; yarn was sold at the price at which the cotton it was spun from had been bought. (ibid., nos. 2021 and 2023.)
This is what exposes the interested wisdom of Overstone: money is supposed to be "dear" because capital is "scarce". On 3 March 1844 the Bank rate stood at 3 per cent; in October and November 1847 it went to 8 and 9 per cent, and on 7 March 1848 it was still at 4 per cent. The complete stagnation of sales and the panic, with the high rate of interest that went with it, drove cotton prices far below the level that answered to the state of supply. One result was an enormous fall in imports in 1848, another a fall in production in America; hence a fresh rise in cotton prices in 1849.
According to Overstone, commodities were too dear because there was too much money in the country.
2002. The recent worsening in the state of the cotton industry is not to be blamed on a shortage of raw material, since the price is lower even though the stock of raw cotton is very much reduced.
But Overstone has a comfortable confusion between the price, or the value, of a commodity and the value of money — and the value of money here means the rate of interest. Answering question 2026, Wylie gives his overall verdict on the currency theory. Cardwell and Sir Charles Wood had asserted in May 1847 that the Bank Act of 1844 had to be carried through in its whole content:
These principles, Wylie says, seem to him to be of a kind that would give money an artificially high value and all commodities an artificial, ruinously low one.
He says more about what this Bank Act did to business in general:
Bills at four months are the regular drafts drawn by the manufacturing towns on merchants and bankers against goods bought and destined for the United States. These could now be discounted only at great sacrifices, and so the execution of orders was checked to a considerable extent, until after the Government Letter of 25 October (suspension of the Bank Act), when those four-month bills became discountable again. (2097.)
So the suspension of this Bank Act worked like a deliverance in the provinces too.
2102. Last October (1847) almost every American buyer who buys goods here cut his orders back as far as he could straight away; and when news that money had grown dear reached America, all new orders stopped. — 2134. Corn and sugar were special instances. The corn market was affected by the harvest outlook, and sugar by the enormous stocks and imports. — 2163. Of our payment obligations to America, a great deal was settled by forced sales of consigned goods, and a great deal, I fear, was annulled by the bankruptcies here. — 2196. If I recollect rightly, in October 1847 our stock exchange was paying interest of up to 70 per cent.
The crisis of 1837 with its long aftermath, followed in 1842 by a further, full-blown crisis, and the interested blindness of the industrialists and merchants, who flatly refused to see any overproduction — for on the vulgar economists' showing this was nonsense and an impossibility! — had finally produced the confusion in people's heads that let the currency school translate its dogma into practice on a national scale. The bank legislation of 1844-5 went through.
The 1844 Bank Act splits the Bank of England into an Issue Department and a Banking Department. The first of these receives securities — for the most part government stock — to the value of £14 million, along with the whole metal reserve, of which no more than a quarter may be silver, and issues notes to the same total amount. So long as these notes are not in the public's hands, they stay in the Banking Department and form its ever-ready reserve, together with the small amount of coin needed for daily use (about £1 million). The Issue Department gives the public gold for notes and notes for gold; every other dealing with the public is the Banking Department's business. The private banks in England and Wales that were entitled in 1844 to issue their own notes keep that right, but the number of notes they may issue is capped. If one of these banks stops issuing its own notes, the Bank of England may raise the part of its own note issue that gold does not cover by two-thirds of the quota thus freed; in this way the figure had risen by 1892 from £14 million to £16 1/2 million (£16,450,000 to be precise).
For every £5 in gold that flows out of the Bank's reserve, a £5 note returns to the Issue Department and is destroyed; for every five sovereigns that come into the reserve, a new £5 note enters circulation. With that, Overstone's ideal paper circulation — one governed exactly by the laws of metallic circulation — is carried out in practice; and with that, on the currency people's own contention, crises are made impossible for ever.
In reality, though, splitting the Bank into two independent departments took away the directors' ability to dispose freely of all their available means at decisive moments. So situations could arise in which the Banking Department stood on the edge of bankruptcy while the Issue Department still held several millions in gold and, on top of that, its £14 million in securities untouched. And this was all the easier to happen because almost every crisis has a stretch in which a heavy drain of gold abroad takes place, which has to be covered mainly out of the Bank's metal reserve.
For every £5 that flows abroad during such a drain, a £5 note is withdrawn from circulation at home: the quantity of means of circulation is reduced at exactly the moment when most of it is needed, and needed most urgently. So the Bank Act of 1844 directly provokes the whole world of commerce, as a crisis breaks out, to lay in a reserve of banknotes in good time — which speeds the crisis up and makes it sharper. And because this artificially raised demand for monetary accommodation, that is, for means of payment, takes effect at the decisive moment while the supply of those is restricted at the same time, it drives the interest rate in crises up to a previously unheard-of height. So instead of abolishing crises, it drives them to the point where either the whole industrial world has to go to pieces, or else the Bank Act.
Twice, on 25 October 1847 and 12 November 1857, the crisis had climbed to that height; the government then freed the Bank from the restriction on its note issue by suspending the Act of 1844, and on both occasions this was enough to break the crisis. In 1847 the mere certainty that banknotes could again be had against first-class securities sufficed to bring the hoarded £4-£5 million in notes back into the light of day and into circulation; in 1857 a little under £1 million in notes was issued above the legal quota, but only for a very short time.
The 1844 legislation also still shows traces of the memory of the century's first twenty years — the time when the Bank suspended payment in cash and the notes lost their value. The fear that banknotes might lose their credit is still very noticeable; and it was a quite superfluous fear, since as early as 1825 the issue of a rediscovered stock of old £1 notes, withdrawn from circulation, had broken the crisis, and had thereby proved that even then the credit of the notes stood unshaken, even in a time of the most general and strongest distrust. And this is entirely understandable, for in fact the whole nation stands behind these tokens with its credit. - F. E.
Let us hear now a few witnesses on what the Bank Act has done. J. St. Mill believed that the Act of 1844 had held over-speculation down. This wise man had the good fortune to give his evidence on 12 June 1857. Four months later the crisis broke out. He literally congratulates the bank directors and the commercial public in general on the fact that they
understand the nature of a commercial crisis far better than they did before, and the very great harm they do to themselves and to the public by supporting over-speculation. (B. A. 1857, no. 2031.)
The wise Mill's view is that if £1 notes are issued
as advances to manufacturers and others who pay out wages ... then the notes can pass into the hands of other people who spend them on consumption, and in that case the notes themselves constitute a demand for goods, and may for a time tend to bring about a rise in prices. [no. 2066.]
So Mr Mill assumes that manufacturers will pay higher wages because they pay them in paper rather than in gold? Or does he think that if the manufacturer gets his advance in £100 notes and changes them into gold, that wage would make less demand than if it were paid straight away in £1 notes? And does he not know that in certain mining districts, for instance, wages were paid in notes of local banks, so that several workers together received a £5 note? Does that increase their demand? Or will the bankers advance money to manufacturers more readily and in greater quantity in small notes than in large ones?
This strange fear of Mill's about £1 notes would be inexplicable if his whole work on political economy did not display an eclecticism that shies away from no contradiction. On the one hand he agrees with Tooke against Overstone on many things; on the other hand he believes that commodity prices are determined by the quantity of money present. So he is by no means convinced that for every £1 note issued — all other circumstances being equal — a sovereign travels into the Bank's vault; what he fears is that the mass of means of circulation might be increased and so devalued, that is, that commodity prices would rise. That is what hides behind the caution above, and nothing more. — F. E.
On the splitting of the Bank into two and the excessive precaution taken to secure the redemption of the banknotes, Tooke gives his evidence before the C. D. 1848/1857:
The greater fluctuations of the interest rate in 1847, compared with 1837 and 1839, were due only to the separation of the Bank into two departments (3010). — The safety of the banknotes was not affected, in 1825 or in 1837 and 1839 (3015). — The demand for gold in 1825 had no other aim than to fill the empty space created by the complete discredit of the £1 notes of the provincial banks; that empty space could be filled only with gold, until the Bank of England too issued £1 notes (3022). — In November and December 1825 there was not the slightest demand for gold for export (3023).
Where the discredit of the Bank is concerned, at home and abroad, a suspension of the payment of dividends and deposits would have far more serious consequences than a suspension of the payment of the banknotes. (3028.)
3035. Would you not say that any circumstance that in the last instance endangered the convertibility of the banknotes could create new and serious difficulties at a moment of commercial pressure? — Not at all.
In the course of 1847, an increased issue of notes might perhaps have helped to fill up the Bank's gold reserve again, as it did in 1825. (3058.)
Before the B. A. 1857, Newmarch states:
1357. The first bad effect ... of this separation of the two departments (of the Bank), and of the division of the gold reserve that necessarily followed from it, was that the banking business of the Bank of England — that whole branch of its operations which brings it into more direct contact with the country's trade — was carried on with only half the amount of the former reserve. Because of this splitting of the reserve, as soon as the Banking Department's reserve shrank even slightly, the Bank was forced to raise its discount rate. This reduced reserve has therefore caused a series of jerky changes in the discount rate. — 1358. Such changes since 1844 (up to June 1857) have been some sixty in number, while before 1844 in the same period they came to barely a dozen.
Of particular interest too is the evidence of Palmer before the Lords' C. D. Committee (1848/1857), a director of the Bank of England since 1811 and for a time its Governor:
828. In December 1825 the Bank had only about £1,100,000 of gold left. At that time it must infallibly have failed completely if this Act (of 1844) had then been in existence. In December it issued, I believe, 5 or 6 million in notes in a week, and that considerably eased the panic of the time.
825. The first period (since 1 July 1825) in which the present bank legislation would have broken down, if the Bank had tried to carry through the transactions once entered upon, was 28 February 1837; at that time the Bank held £3,900,000 to £4,000,000, and it would then have had only £650,000 left in reserve. Another period is 1839, lasting from 9 July to 5 December. — 826. What was the amount of the reserve in that case? The reserve was minus £200,000 altogether on 5 September. On 5 November it rose to about 1 to 1½ million. — 830. The Act of 1844 would have prevented the Bank from assisting the American trade in 1837. — 831. Three of the principal American houses failed ... almost every house in the American trade was put out of credit, and had the Bank not come to the rescue then, I do not believe that more than one or two houses could have held their ground. — 836. The pressure of 1837 is not to be compared with that of 1847. The 1837 pressure was chiefly confined to the American trade. — 838. (Early in June 1837 the Bank's management discussed how the pressure might be relieved.) Whereupon some gentlemen defended the opinion ... that the correct principle was to raise the rate of interest, whereby commodity prices would fall; in short, to make money dear and commodities cheap, by which the payment abroad would be accomplished. — 906. The introduction of an artificial restriction on the Bank's powers through the Act of 1844, in place of the old and natural limit of its powers, the actual amount of its metal reserve, produces artificial difficulty in business and hence an effect on commodity prices that was wholly unnecessary without this Act. — 968. Under the working of the Act of 1844 the Bank's metal reserve cannot, under ordinary circumstances, be materially reduced below 9½ million. This would cause a pressure on prices and credit that would have to bring about such a change in foreign exchange rates that gold imports rose and thereby increased the amount of gold in the Issue Department. — 996. Under the present restriction you (the Bank) have not the command of the silver that is required at times when silver is needed to act on the foreign exchanges. — 999. What was the purpose of the rule restricting the Bank's silver reserve to one-fifth of its metal reserve? — That question I cannot answer.
The aim was to make money dear; and so too, quite apart from the currency theory, was the separation of the Bank into two departments, and the compulsion on the Scottish and Irish banks to keep gold in reserve for any note issue beyond a certain amount. A decentralization of the national metal reserve arose in this way, which made it less able to correct unfavourable exchange rates. All these provisions come down to raising the interest rate: that the Bank of England may not issue notes above 14 million except against a gold reserve; that the Banking Department is to be managed as an ordinary bank, pressing the interest rate down in times of excess money and driving it up in times of pressure; the restriction of the silver reserve, the principal means of rectifying exchange rates with the Continent and with Asia; the rules for the Scottish and Irish banks, which never need gold for export and must now hold it under the pretext of an entirely illusory convertibility of their notes. The fact is that the Act of 1844 produced the first run for gold on the Scottish banks in 1857. The new bank legislation likewise makes no distinction between a drain of gold abroad and one for the interior, although their effects are self-evidently quite different. Hence the constant violent fluctuations in the market rate of interest. On silver, Palmer says twice, at 992 and 994, that the Bank can buy silver against notes only when the exchange rate is favourable to England, so that the silver is superfluous; for:
1003. The only purpose for which a considerable part of the metal reserve can be held in silver is to make foreign payments easier during the time when the exchange rates are against England. — 1004. Silver is a commodity which, because it is money throughout the rest of the world, is therefore the most suitable commodity ... for this purpose (payment abroad). Only the United States have recently taken gold alone.
In his view, in times of pressure the Bank did not need to raise the interest rate above the old level of 5 per cent, so long as no unfavourable exchange rate drew gold abroad. Were it not for the Act of 1844, it could have gone on discounting without difficulty all the first-class bills presented to it (1018 to 1020). But with the Act of 1844, and in the position the Bank was in in October 1847,
there was no rate of interest the Bank could have demanded from houses of credit that they would not have paid willingly, in order to carry on their payments. [1022.]
And this high rate of interest was precisely the aim of the Act.
1029. I must make a great distinction between the effect of the interest rate on foreign demand (for precious metal) and a rise in the rate for the purpose of checking a run on the Bank during a period of domestic shortage of credit. — 1023. Before the Act of 1844, when the exchanges were in England's favour and there was uneasiness, indeed positive panic, in the country, no limit was placed on the issue of notes, and that alone could relieve this state of pressure.
That is how a man speaks who sat on the board of the Bank of England for thirty-nine years. Let us now hear a private banker, Twells, a partner in Spooner, Attwood & Co. since 1801. He is the only one of all the witnesses before the B. A. 1857 who gives a view into the real state of the country and sees the crisis approaching. In other respects he is a kind of Birmingham little-shilling man, just as his partners, the Attwood brothers, are the founders of that school (see A Contribution to the Critique of Political Economy, p. 82). He states:
At question 4488 Twells was asked how he thought the Act of 1844 had worked. Were he to answer as a banker, he would say it had worked quite outstandingly, since it had yielded a rich harvest for bankers and for (money-) capitalists of every description. But for the honest, hard-working tradesman, who needs the discount rate to hold steady so that he can make his arrangements with confidence, it had worked very badly ... it had turned money-lending into a most profitable line of business. At 4489 he was asked whether it — the Bank Act — enabled the London joint-stock banks to pay their shareholders 20 to 22 per cent; one of them had lately paid 18 per cent and he thought another 20 per cent, and they had every reason to speak up very firmly for the Act. At 4490 he was asked about the small tradesmen and respectable merchants who have no large capital ... it squeezes them very hard ... The only way he had of finding this out was that he saw such an astonishing mass of their acceptances going unpaid. Those acceptances are always small, perhaps between £20 and £100; many of them are not paid and come back short-paid to all parts of the country, and this is always a sign of pressure among ... the small shopkeepers.
At 4494 he explains that business is not profitable now. His following remarks are important, because he saw the crisis already latent when none of the others suspected it.
4494. Prices in Mincing Lane are still holding up fairly well, but nothing is sold; one cannot sell at any price; people hold on to the nominal price.
4495. He tells of a case. A Frenchman sends a broker in Mincing Lane goods worth £3,000 to be sold at a certain price. The broker cannot get the price, and the Frenchman cannot sell below it. The goods lie there, but the Frenchman needs money. So the broker advances him £1,000, in such a way that the Frenchman draws a three-month bill for £1,000 on the broker, with the goods as security. After three months the bill falls due, but the goods are still unsaleable. The broker then has to pay the bill, and although he has cover for £3,000 he cannot turn it into cash, and he runs into difficulties. So one drags another down with him.
4496. As for the heavy exports ... when business at home is depressed, that necessarily also calls forth heavy exports. — 4497. Do you think domestic consumption has fallen? — Very considerably ... enormously ... the small shopkeepers here are the best authority. — 4498. And yet imports are very large; does that not point to heavy consumption? — Yes, if you can sell; but many warehouses are full of these things; in the case I have just described, £3,000 worth of goods were imported that cannot be sold.
4514. When money is dear, would you say that capital is then cheap? — Yes indeed.
So this man is by no means of Overstone's opinion, that a high rate of interest is the same thing as dear capital.
How business is conducted now:
4516. ... Others go in for it on a very great scale, doing an enormous trade in exports and imports, far beyond the measure their capital entitles them to; of that there can be no doubt at all. These people may succeed; some stroke of luck may make them great fortunes and let them pay everything off. That is very much the system on which a great part of business is carried on these days. Such people will willingly lose 20, 30 and 40 per cent on a shipment; the next venture may bring it back to them. If one venture after another fails, then they are ruined; and that is precisely the case we have often seen recently: business houses have failed without a shilling of assets left.
4791. The lower rate of interest (over the last ten years) does indeed work against bankers, but without showing you the books I should find it very hard to explain to you how much higher the profit (his own) now is than formerly. When the interest rate is low, as a result of excessive note issue, we have large deposits; when the rate is high, that brings us a direct gain. — 4794. When money is to be had at a moderate rate, we have more demand for it; we lend out more; it works (for us bankers) that way. When it rises, we get more for it than is fair; we get more than we ought to.
We have seen that every expert treats the credit of Bank of England notes as unshakeable. All the same, the Bank Act ties up £9 to £10 million in gold, absolutely, so that those notes can be cashed. The reserve is held holy and untouchable, and that rule is carried much further than the old hoarders of treasure ever carried it. W. Brown of Liverpool testified (C. D. 1847/1857, no. 2311):
Brown said that as for any use this money was put to at the time — the metal reserve in the Issue Department — it might just as well have been thrown into the sea. Not the smallest part of it could be touched without breaking the Act of Parliament.
The building contractor E. Capps — the same man quoted earlier, from whose evidence the description of the modern London building system was taken (Volume 2, Chapter 12) — sums up his view of the 1844 Bank Act like this (B. A. 1857):
5508. Was his general view, then, that the present system of bank legislation is a very clever arrangement for bringing the profits of industry, at regular intervals, into the usurer's bag? — That was his view. He knew it had worked that way in the building trade.
As mentioned already, the Bank Act of 1845 forced the Scottish banks into a system close to the English one. For each bank a ceiling on its note issue was fixed, and beyond that ceiling the bank had to hold gold in reserve. What effect this had is shown by a few pieces of evidence given here before the B. A. 1857.
Kennedy, director of a Scottish bank:
3375. Was there anything in Scotland that could be called a circulation of gold before the Act of 1845 came in? — Nothing of the kind. 3376. Has any extra circulation of gold appeared since? — None whatever; the people dislike gold. 3450. In his view the £900,000 or so in gold that the Scottish banks have been compelled to hold since 1845 is nothing but harmful, and it absorbs a part of Scotland's capital unproductively.
Then Anderson, director of the Union Bank of Scotland.
3558. Was the one heavy demand made on the Bank of England by the Scottish banks a demand arising out of the foreign exchanges? — It was; and holding gold in Edinburgh does nothing to reduce that demand. 3590. As long as we have the same amount of securities lying in the Bank of England (or with the private banks in England), we keep the same power we had before to bring about a drain of gold from the Bank of England.
Finally, one more article from The Economist (Wilson):
The Scottish banks keep idle sums of cash with their London agents, and those agents keep the money in the Bank of England. Within the limits of those sums, this gives the Scottish banks command over the metal reserve in the Bank — and there the metal always sits exactly where it is needed, whenever foreign payments have to be made.
This system was broken up by the Act of 1845:
Because of the Act of 1845 for Scotland, a heavy drain of coin out of the Bank of England has lately taken place, to meet a merely possible demand in Scotland, one that might perhaps never arise... Since that time a substantial sum has been regularly locked up in Scotland, and another considerable sum is constantly travelling back and forth between London and Scotland. When a time comes in which a Scottish banker expects more demand for his notes, a box of gold is sent over from London; when that time is past, the same box goes back to London, usually without ever having been opened. (The Economist, 23 October 1847.)
And what does the father of the Bank Act, the banker Samuel Jones Loyd, alias Lord Overstone, have to say to all this?
Back in 1848, before the Lords Committee, he had already repeated that
money pressure and a high rate of interest, brought on by a lack of sufficient capital, cannot be eased by issuing more banknotes (1514).
Yet the mere permission to issue more notes, contained in the government letter of 25 October 1847, had been enough to blunt the edge of the crisis.
He holds to the position that
the high rate of interest and the depressed state of manufacturing industry was the necessary result of the diminution of the material capital that could be used for industrial and commercial purposes (1604).
And yet for months the depressed state of manufacturing industry had consisted in this: that material commodity capital filled the warehouses to overflowing and was simply unsaleable, and that for that very reason material productive capital lay wholly or partly idle, so as not to turn out still more unsaleable commodity capital.
And before the Bank Acts Committee of 1857 he says:
Overstone told the Bank Acts Committee of 1857 that by keeping strictly and promptly to the principles of the Act of 1844, everything had run smoothly and easily: the monetary system stands safe and unshaken, nobody disputes the prosperity of the country, and public trust in the Act of 1844 grows stronger every day. If the Committee wants yet more practical proof that the principles on which the Act rests are sound, and that the results it has secured are good, then the honest and complete answer is this: look around you, look at how trade stands in the country just now, look at how content the people are, look at the wealth and prosperity that spread through every class of society. And once it has done that, the Committee will be in a position to decide whether it wants to stop an Act from being continued, when results like these have been achieved under it. (B. A. 1857, no. 4189.)
Overstone sang this dithyramb to the Committee on 14 July. The answering strophe came on 12 November of the same year: a letter addressed to the Bank's directors, in which the government suspended the wonder-working Act of 1844 so as to save whatever could still be saved. - F. E.