[First published in The Westminster Review for January 1858.]
Among unmitigated rogues, mutual trust is impossible. Among people of absolute integrity, mutual trust would be unlimited. These are truisms. Given a nation made up of liars and thieves, and all trade among its members must be carried on either by barter or by a currency of intrinsic value: nothing in the shape of promises-to-pay can pass in place of actual payments; for, by the hypothesis, such promises being never fulfilled, will not be taken. On the other hand, given a nation of perfectly honest men—men as careful of others’ rights as of their own—and nearly all trade among its members may be carried on by memoranda of debts and claims, eventually written off against one another in the books of bankers; seeing that as, by the hypothesis, no man will ever issue more memoranda of debts than his goods and his claims will liquidate, his paper will pass current for whatever it represents. Coin will be needed only as a measure of value, and to facilitate those small transactions for which it is physically the most convenient. These we take to be self-evident truths.
From them follows the corollary that in a nation neither wholly honest nor wholly dishonest, there may, and eventually will, be established a mixed currency—a currency {327} partly of intrinsic value and partly of credit-value. The ratio between the quantities of these two kinds of currency, will be determined by a combination of several causes.
Supposing that there is no legislative meddling to disturb the natural balance, it is clear from what has already been said, that, fundamentally, the proportion of coin to paper will depend on the average conscientiousness of the people. Daily experience must ever be teaching each citizen, which other citizens he can put confidence in, and which not. Daily experience must also ever be teaching him how far this confidence may be carried. From personal experiment, and from current opinion, which results from the experiments of others, every one must learn, more or less truly, what credit may safely be given. If all find that their neighbours are little to be trusted, but few promises-to-pay will circulate. And the circulation of promises-to-pay will be great, if all find that the fulfilment of trading engagements is tolerably certain. The degree of honesty characterizing a community, being the first regulator of a credit-currency; the second is the degree of prudence. Other things equal, it is manifest that among a sanguine, speculative people, promissory payments will be taken more readily, and will therefore circulate more largely, than among a cautious people. Two men having exactly the same experiences of mercantile risks will, under the same circumstances, respectively give credit and refuse it, if they are respectively rash and circumspect. And two nations thus contrasted in prudence, will be similarly contrasted in the relative quantities of notes and bills in circulation among them. Nay, they will be more than similarly contrasted in this respect; seeing that the prevailing incautiousness, besides making each citizen unduly ready to give credit, will also produce in him an undue readiness to risk his own capital in speculations, and a consequent undue demand for credit from other citizens. There will be both an increased pressure for credit and a diminished resistance; and therefore a more {328} than proportionate excess of paper-currency. Of this national characteristic and its consequences, we have a conspicuous example in the United States.
To these comparatively permanent moral causes, on which the ordinary ratio of hypothetical to real money in a community depends, have to be added certain temporary moral and physical causes, which produce temporary variations in the ratio. The prudence of any people is liable to more or less fluctuation. In railway-manias and the like, we see that irrational expectations may spread through a whole nation, and lead its members to give and take credit almost recklessly. But the chief causes of temporary variations are those which directly affect the quantity of available capital. Wars, deficient harvests, or losses consequent on the misfortunes of other nations, will, by impoverishing the community, inevitably lead to an increase in the ratio of promissory payments to actual payments. For what must be done by the citizen disabled by such causes from meeting his engagements?—the shopkeeper whose custom has fallen off in consequence of the high price of bread; or the manufacturer whose goods lie in his ware-rooms unsaleable; or the merchant whose foreign correspondents fail him? As the proceeds of his business do not suffice to liquidate the claims on him that are falling due, he is compelled either to find other means of liquidating them, or to stop payment. Rather than stop payment, he will, of course, make temporary sacrifices—will give high terms to whoever will furnish him with the desired means. If, by depositing securities with his banker, he can get a loan at an advanced rate of interest, well. If not, by offering an adequate temptation, he may mortgage his property to some one having good credit; who either gives bills, or draws on his banker for the sum agreed to. In either case, extra promises to pay are issued; or, if the difficulty is met by accommodation-bills, the same result follows. And in proportion to the number of citizens obliged to resort to one {329} or other of these expedients, must be the increase of promissory payments in circulation.
Reduce this proposition to its most general terms, and it becomes self-evident. Thus:—All bank-notes, cheques, bills of exchange, etc., are so many memoranda of claims. No matter what may be the technical distinctions among them, on which upholders of the “currency principle” seek to establish their dogma, they all come within this definition. Under the ordinary state of things, the amount of available wealth in the hands, or at the command, of those concerned, suffices to meet these claims as they are severally presented for payment; and they are paid either by equivalents of intrinsic value, as coin, or by giving in place of them other memoranda of claims on some body of undoubted solvency. But now let the amount of available wealth in the hands of the community be greatly diminished. Suppose a large portion of the necessaries of life, or of coin, which is the most exchangeable equivalent of such necessaries, has been sent abroad to support an army, or to subsidize foreign states; or, suppose that there has been a failure in the crops of grain or potatoes. What follows? It follows that part of the claims cannot be liquidated. And what must happen from their non-liquidation? It must happen that those unable to liquidate them will either fail, or they will redeem them by directly or indirectly giving in exchange certain memoranda of claims on their stock-in-trade, houses, or land. That is, such of these claims as the deficient floating capital does not suffice to meet, are replaced by claims on fixed capital. The memoranda of claims which should have disappeared by liquidation, re-appear in a new form; and the quantity of paper-currency is increased. If the war, famine, or other cause of impoverishment, continues, the process is repeated. Those who have no further fixed capital to mortgage, become bankrupt; while those whose fixed capital admits of it, mortgage still further, and still further increase the promissory {330} payments in circulation. Manifestly, if the members of a community whose annual returns but little more than suffice to meet their annual payments suddenly lose part of their annual returns, they must become proportionately in debt to one another; and the documents expressive of debt must be proportionately multiplied.
This a priori conclusion is in perfect harmony with mercantile experience. The last hundred years have furnished repeated illustrations of its truth. After the enormous export of gold in 1795–6 for war-loans to Germany, and to meet bills drawn on the Treasury by British agents abroad; and after large advances made under a moral compulsion by the Bank of England to the Government; there followed an excessive issue of bank-notes. In 1796–7, there were failures of the provincial banks; a panic in London; a run on the nearly-exhausted Bank of England; and a suspension of cash-payments—a State-authorized refusal to redeem promises to pay. In 1800, the further impoverishment consequent on a bad harvest, joined with the legalized inconvertibility of bank-notes, entailed so great a multiplication of them as to cause their depreciation. During the temporary peace of 1802, the country partly recovered itself; and the Bank of England would have liquidated the claims on it had the Government allowed. On the subsequent resumption of war, the phenomenon was repeated; as in later times it has been on each occasion when the community, carried away by irrational hopes, has locked up an undue proportion of its capital in permanent works. Moreover, we have still more conclusive illustrations—illustrations of the sudden cessation of commercial distress and bankruptcy, resulting from a sudden increase of credit-circulation. When, in 1793, there came a general crash, mainly due to an unsafe banking-system which had grown up in the provinces in consequence of the Bank of England monopoly—when the pressure, extending to London, became so great as to alarm the Bank-directors and to cause {331} them suddenly to restrict their issues, thereby producing a frightful multiplication of bankruptcies; the Government (to mitigate an evil indirectly produced by legislation) determined to issue Exchequer-Bills to such as could give adequate security. That is, they allowed hard-pressed citizens to mortgage their fixed capitals for equivalents of State-promises to pay, with which to liquidate the demands on them. The effect was magical. £2,202,000 only of Exchequer-Bills were required. The consciousness that loans could be had, in many cases prevented them from being needed. The panic quickly subsided; and all the loans were very soon repaid. In 1825, again, when the Bank of England, after having intensified a panic by extreme restriction of its issues, suddenly changed its policy, and in four days advanced £5,000,000 notes on all sorts of securities, the panic at once ceased.
And now, mark two important truths. As just implied, those expansions of paper-circulation which naturally take place in times of impoverishment or commercial difficulty, are highly salutary. This issuing of securities for future payment when there does not exist the wherewith for immediate payment, is a means of mitigating national disasters. The process amounts to a postponement of trading-engagements which cannot at once be met. And the alternative questions to be asked respecting it are—Shall all the merchants, manufacturers, shopkeepers, etc., who, by unwise investments, or war, or famine, or great losses abroad, have been in part deprived of the means of meeting the claims upon them, be allowed to mortgage their fixed capital? or, by being debarred from issuing memoranda of claims on their fixed capital, shall they be made bankrupts? On the one hand, if they are permitted to avail themselves of that credit which their fellow-citizens willingly give them on the strength of the proffered securities, most of them will tide over their difficulties; and in virtue of that accumulation of surplus capital ever going on, they will be {332} able, by-and-by, to liquidate their debts in full. On the other hand, if they are forthwith bankrupted, carrying with them others, and these again others, there follows a disastrous loss to all the creditors: property to an immense amount being peremptorily sold at a time when there can be comparatively few able to buy, must go at a great sacrifice; and those who in a year or two would have been paid in full, must be content with 10s. in the pound. Added to which evil comes the still greater one—an extensive damage to the organization of society. Numerous importing, producing, and distributing establishments are swept away; tens of thousands of their dependents are left without work; and before the industrial fabric can be repaired, a long time must elapse, much labour must lie idle, and great distress be borne. Between these alternatives, who, then, can pause? Let this spontaneous remedial process follow its own course, and the evil will either be in great measure eventually escaped, or will be spread little by little over a considerable period. Stop this remedial process, and the whole evil, falling at once on society, will bring wide-spread ruin and misery.
The second of these important truths is, that an expanded circulation of promises to pay, caused by absolute or relative impoverishment, contracts to its normal limits as fast as the need for expansion disappears. For the conditions of the case imply that all who have mortgaged their fixed capitals to obtain the means of meeting their engagements, have done so on unfavourable terms; and are therefore under a strong stimulus to pay off their mortgages as quickly as possible. Every one who, at a time of commercial pressure, gets a loan from a bank, has to give high interest. Hence, as fast as prosperity returns, and his profits accumulate, he gladly escapes this heavy tax by repaying the loan; in doing which he, directly or indirectly, takes back to the bank as large a number of its credit documents as he originally received, and so diminishes the {333} credit-circulation as much as his original transaction had increased it. Considered apart from technical distinctions, a banker performs, in such case, the function of an agent in whose name traders issue negotiable memoranda of claims on their estates. The agent is already known to the public as one who issues memoranda of claims on capital that is partly floating and partly fixed—memoranda of claims that have an established character, and are convenient in their amounts. What the agent does under the circumstances specified, is to issue more such memoranda of claims, on the security of more fixed, and partially-fixed, capital put in his possession. His clients hypothecate their estates through the banker, instead of doing it in their own names, simply because of the facilities which he has and which they have not. And as the banker requires to be paid for his agency and his risk, his clients redeem their estates, and close these special transactions with him, as quickly as they can: thereby diminishing the amount of credit-currency.
Thus we see that the balance of a mixed currency of voluntary origin is, under all circumstances, self-adjusting. Supposing considerations of physical convenience out of the question, the average ratio of paper to coin is primarily dependent on the average trustworthiness of the people, and secondarily dependent on their average prudence. When, in consequence of unusual prosperity, there is an unusual increase in the number of mercantile transactions, there is a corresponding increase in the quantity of currency, both metallic and paper, to meet the requirement. And when from war, famine, or over-investment, the available wealth in the hands of citizens is insufficient to pay their debts to one another, the memoranda of debts in circulation acquire an increased ratio to the quantity of gold: to decrease again as fast as the excess of debts can be liquidated.