It might be pointed out, on the other hand, that this somewhat complicated mechanism can only operate very slowly, and that considerable time must elapse before the prices of goods begin to respond to the change in the quantity of money. But as a matter of fact it is not necessary to wait until this phenomenon becomes established, for another striking feature precedes it and announces its approach so to speak, and this is, as Smith had already noted, a change in the value of bills drawn on foreign countries. The foreign exchanges are so sensitive that the slightest rise is enough to stimulate exportation and to check importation.
Accordingly money seldom leaves a country, or only leaves it for a short time. In other words, contrary to the generally accepted opinion, silver and gold in international trade do little more than oil the wheels of commerce. The trade is carried on as if the metals were non-existent. In short, it is essentially of the nature of barter.[358]
The explanation is very schematic. Every incidental phenomenon is omitted, and the whole theory implies the validity of the quantity theory of money, which is now open to considerable criticism as being altogether inadequate for an explanation of the facts involved. But this theory of the automatic regulation of the balance of trade by means of variations in the value of money, although already hinted at by Hume and Smith, is none the less a discovery of the first order, and one that has done service as a working hypothesis for a whole century.[359]
Its explanation turns upon a particular theory of international trade which we can only mention in passing, but which we shall find more fully developed in Stuart Mill’s theory of international values.
4. Paper Money, its Issue and Regulation
The enunciation of the principles which should govern the conduct of bankers in issuing paper money is another debt that we owe to the genius of Ricardo. The Bank Act of 1822, and that of 1844 especially, which laid down the future policy of the Bank of England, represent an attempt on the part of the Government to put his principles into practice.
Ricardo was an eye-witness of the great panic of February 26, 1797, when the reserves of the Bank of England fell from ten millions to a million and a half, necessitating an Order in Council suspending cash payments. The suspension, which was supposed to be a temporary expedient, extended right up to 1821. The depreciation in the value of the bank-note averaged about 10 per cent., but at one period towards the end of the Napoleonic wars it rose as high as 30 per cent. He also witnessed the suffering which such depreciation caused. Landlords demanded the payment of their rents in gold, or claimed an increase in the rent equal to the fall in the value of the note.
Ricardo tried to unravel the causes of this depreciation in his pamphlet entitled The High Price of Bullion, published in 1809, and came to the conclusion that there was only one cause, namely, an excessive supply of paper. At this distance of time it might not be thought such an extraordinary discovery after all. Still, he had the greatest difficulty in getting people to admit this, and in refuting the absurd explanations which had previously been suggested. He showed how a depreciation in the value of the note necessarily resulted in the exportation of gold, although most of his contemporaries, on the contrary, believed that the exportation of gold was the cause of all the mischief which they sought to check by an Act of Parliament. “The remedy which I propose for all the evils in our currency is that the Bank should gradually decrease the amount of their notes in circulation until they shall have rendered the remainder of equal value with the coins which they represent, or in other words till the prices of gold and silver bullion shall be brought down to their Mint price.”[360]
But if that is the case why not cut the Gordian knot and suppress paper money altogether? The reply shows how well Ricardo had studied Smith: “A well-regulated paper currency is so great an improvement in commerce that I should greatly regret if prejudice should induce us to return to a system of less utility.” “The introduction of the precious metals for the purposes of money may with truth be considered as one of the most important steps towards the improvement of commerce and the arts of civilised life; but it is no less true that with the advancement of knowledge and science we discover that it would be another improvement to banish them again from the employment to which, during a less enlightened period, they had been so advantageously applied.”[361]