On The Principles of Political Economy, and Taxation

by David Ricardo

Experience however shews, that neither a state nor a bank ever have had the unrestricted power of issuing paper money, without abusing that power: in all states, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose, as that of subjecting the issuers of paper money to the obligation of paying their notes, either in gold coin or bullion.

A currency is in its most perfect state when it consists wholly of paper money, but of paper money of an equal value with the gold which it professes to represent. The use of paper instead of gold substitutes the cheapest in place of the most expensive medium, and enables the country, without loss to any individual, to exchange all the gold which it before used for this purpose, for raw materials, utensils, and food, by the use of which both its wealth and its enjoyments are increased.

In a national point of view it is of no importance whether the issuers of this well regulated paper money, be the government or a bank, it will on the whole be equally productive of riches, whether it be issued by one or by the other; but it is not so with respect to the interest of individuals. In a country where the market rate of interest is 7 per cent., and where the state requires for a particular expense 70,000l. per annum, it is a question of importance to the individuals of that country, whether they must be taxed to pay this 70,000l. per annum, or whether they could raise it without taxes. Suppose that a million of money should be required to fit out an expedition. If the state issued a million of paper, and displaced a million of coin, the expedition would be fitted out without any charge to the people; but if a bank issued a million of paper, and lent it to Government at 7 per cent., thereby displacing a million of coin, the country would be charged with a continual tax of 70,000l. per annum: the people would pay the tax, the bank would receive it, and the society would in either case be as wealthy as before; the expedition would have been really fitted out by the improvement of our system, by rendering capital, of the value of a million, productive in the form of commodities, instead of letting it remain unproductive in the form of coin; but the advantage would always be in favour of the issuers of paper; and as the state represents the people, the people would have saved the tax, if they, and not the bank, had issued this million.

I have already observed, that if there were perfect security that the power of issuing paper money would not be abused, it would be of no importance with respect to the riches of the country collectively, by whom it was issued; and I have now shewn that the public would have a direct interest that the issuers should be the state, and not a company of merchants or bankers. The danger, however, is, that this power would be more likely to be abused, if in the hands of Government, than if in the hands of a banking company. A company would, it is said, be more under the control of law, and although it might be their interest to extend their issues beyond the bounds of discretion, they would be limited and checked by the power which individuals would have of calling for bullion or specie. It is argued that the same check would not be long respected, if Government had the privilege of issuing money; that they would be too apt to consider present convenience, rather than future security, and might, therefore, on the alleged grounds of expediency, be too much inclined to remove the checks, by which the amount of their issues was controlled.

Under an arbitrary government this objection would have great force, but in a free country, with an enlightened legislature, the power of issuing paper money, under the requisite checks of convertibility at the will of the holder, might be safely lodged in the hands of commissioners appointed for that special purpose, and they might be made totally independent of the control of ministers.

The sinking fund is managed by commissioners, responsible only to parliament, and the investment of the money entrusted to their charge, proceeds with the utmost regularity; what reason can there be to doubt that the issues of paper money might be regulated with equal fidelity, if placed under similar management?

It may be said, that although the advantage accruing to the state, and, therefore, to the public, from issuing paper money, is sufficiently manifest, as it would exchange a portion of the national debt, on which interest is paid by the public, into a debt bearing no interest, yet it would be disadvantageous to commerce, as it would preclude the merchants from borrowing money, and getting their bills discounted, the method in which bank paper is partly issued.

This, however, is to suppose that money could not be borrowed, if the Bank did not lend it, and that the market rate of interest and profit depends on the amounts of the issues of money, and on the channel through which it is issued. But as a country would have no deficiency of cloth, of wine, or any other commodity, if they had the means of paying for it, in the same manner neither would there be any deficiency of money to be lent, if the borrowers offered good security, and were willing to pay the market rate of interest for it.

In another part of this work, I have endeavoured to shew, that the real value of a commodity is regulated, not by the accidental advantages which may be enjoyed by some of its producers, but by the real difficulties encountered by that producer who is least favoured. It is so with respect to the interest for money; it is not regulated by the rate at which the Bank will lend, whether it be 5, 4, or 3 per cent., but by the rate of profits, which can be made by the employment of capital, and which is totally independent of the quantity, or of the value of money. Whether a bank lent one million, ten millions, or a hundred millions, they would not permanently alter the market rate of interest; they would alter only the value of the money which they thus issued. In one case 10 or 20 times more money might be required to carry on the same business, than what might be required in the other. The applications to the Bank for money, then, depend on the comparison between the rate of profits that may be made by the employment of it, and the rate at which they are willing to lend it. If they charge less than the market rate of interest, there is no amount of money which they might not lend,—if they charge more than that rate, none but spendthrifts and prodigals would be found to borrow of them. We accordingly find, that when the market rate of interest exceeds the rate of 5 per cent. at which the Bank uniformly lend, the discount office is besieged with applicants for money; and, on the contrary, when the market rate is even temporarily under 5 per cent. the clerks of that office have no employment.

The reason then why for the last twenty years, the Bank is said to have given so much aid to commerce, by assisting the merchants with money, is, because they have, during that whole period, lent money below the market rate of interest; below that rate at which the merchants could have borrowed elsewhere; but I confess that to me this seems rather an objection to their establishment, than an argument in favour of it.