The Paper Currency of England Dispassionately Considered / With Suggestions Towards a Practical Solution of the Difficulty

by John Haslam

Before proceeding any further with our inquiry, it will now be desirable to take a rapid survey of the ground already traversed. We found at starting, that according to one of the best established doctrines of monetary science, the issue of paper money is essentially a function of the State, and should be exercised exclusively for the promotion of public interests. To the immediate establishment of a State bank of issue, however, there appeared to be one cogent practical objection, arising out of a political necessity which is very generally recognised, that the Government of the day should have no direct control over the monetary system. In lieu of a State Bank, therefore, we were obliged to go in search of the best possible substitute; and guided by the well-grounded principle, that there should only be a single bank of issue, we arrived at the conclusion that, under existing circumstances, the safest and most consistent course would be to entrust the whole circulation of England and Wales to the Bank of England, on condition that the Bank should equitably share its profits with the public treasury. The general subject of the extent of the paper circulation next passed under review; and while it did not seem prudent that the unrepresented issues should at present undergo any considerable increase beyond the £22,000,000 which are now the statutable limit, it yet appeared very necessary that the absolute prohibition of any issue in excess of that limit should be removed, and that the Bank of England should be allowed to expand its unrepresented issues in conformity with the wants of trade, subject only to certain regulations required for their due adjustment. On the other hand, we found it manifestly desirable that the Bank should be encouraged freely to increase its issues on bullion, and that, in order to accomplish this, it should at once be permitted to issue at least from £5,000,000 to £10,000,000 of notes under five pounds sterling. Returning, then, to the country banks of issue, it was shown to be a matter of justice, that they should be granted sufficient time for the gradual withdrawal of their issues, and the substitution of Bank of England paper. We, therefore, proposed that they should contract their authorized circulation by one-tenth annually, for the next ten years, the Bank of England as gradually supplying the vacancy according as the notes should be withdrawn. We then proceeded to consider the mode in which the Bank of England should be required to share its profits with the public, and found upon examination that the most advantageous plan would be that of imposing an annual rate on the amount of unrepresented notes retained in circulation, or, rather, a series of rates arranged upon an ascending principle, viz.—a minimum rate on the £11,000,000 of notes issued in consideration of the loan to Government; a medium rate on whatever notes might be required to increase the total unrepresented circulation of the country to £22,000,000 (the amount varying from £3,000,000 at present to £11,000,000 at the expiration of the ten years’ arrangement with the country banks), and a maximum rate on whatever notes might at any time be issued in excess of the total £22,000,000. And, on further consideration, it appeared that 1, 2, and 4 per cent. would form a not unreasonable scale for the three respective charges.

In embracing so extensive a field as the preceding, in the compass of a single paper, we have necessarily omitted any reference to several important branches of the subject. The expediency of the separation of the banking from the issuing department in the Bank of England has been sometimes canvassed, but the best authorities are agreed in regarding the separation simply as a matter of account. Should the alterations we have suggested be adopted, some corresponding changes would be required in the weekly returns of the assets and liabilities of the Bank, but no peculiar difficulty would arise out of this necessity. Another and a more important feature in the present system, has sometimes been assailed, but as appears to us on a very nugatory grounds. We refer to the provisions by which the Bank is required to purchase all the gold that may be presented, at £3 17s. 9d. per ounce, and to render gold for all the notes that may be tendered for payment, at £3 17s. 10½d. per ounce. As one of these provisions is absolutely requisite for securing the convertibility of the issues, and as the other is equally indispensible for preserving an adequate stock of bullion, we are not aware of any valid reason for objecting to either. We may also remark that it is now the opinion of some of the most influential bankers, and of Mr. Gurney amongst the rest, that the proportion of silver on which the Bank may issue bullion notes as compared with gold, might judiciously be increased to one-third. So far as we know, this appears a very judicious proposition; at the same time we think that the permission to issue small notes, if conceded, would in great measure remove the necessity for its adoption.

There now remains for consideration the probable effect of the measures we have proposed, in meeting and providing for those great commercial crises, which have hitherto invariably produced severe disasters, and the periodical recurrence of which, under the existing system, can be predicted with almost scientific certainty. We have indeed already in part anticipated this inquiry, but its pre-eminent importance to the pecuniary interests of the whole trading community, demands an ampler treatment at our hands. And if it should be found that the system we propose would not be calculated to alleviate the evils produced by such calamities, or if at least it cannot be shown that it would prevent their unnecessary aggravation, we shall be perfectly willing to abandon it as unworthy of adoption. For we fully unite with those who maintain that the merits of a system of currency are not to be tested by its operation during the ordinary course of trade, but by its adaptibility to those periods of convulsion when the machinery of commerce is subjected to the severest dislocations.

Now we think it will be generally admitted, that nearly every monetary crisis arises either out of some deficiency or excess in the circulating medium, or else out of some circumstance that is intimately connected with such deficiency or excess. And if this be admitted, it will clearly follow that the principal object that ought to be kept in view in the regulation of a system of currency, is the prevention of any undue increase or diminution in the amount of the circulating medium, and the immediate restoration of a state of equilibrium, wherever the balance may have been, through whatever cause, disturbed. Unfortunately, however, it is the peculiarity of the present system, that whenever the money market is tending either to an excess or a deficiency, the inevitable effect of the Act of 1844 is to aggravate and not to neutralize the tendency. It may at first sight appear extraordinary, if not incredible, that the same system should at different periods produce results apparently so opposed to each other; but a little consideration will show that this is undoubtedly the fact. And we shall first take the case in which the tendency is towards an excess of circulating medium.

It is a well understood circumstance, that whenever any unusual stimulus is imparted to the work of production, and the export trade proceeds with more than ordinary activity, the necessary consequence is, that the exports exceed the imports, and that gold flows into the country from those nations which have purchased more largely of our commodities, than they have paid for in their own. Now, whether this gold is converted into coin, and is directly expended in the purchase of commodities or the payment of wages, or whether it is taken to the Bank of England and exchanged for paper, in either case it immediately increases the amount of circulating medium in the possession of the public; in the one case in the form of metal, in the other in the form of bullion notes. And just in proportion as money becomes abundant, prices rise, and the rate of discount falls in a corresponding ratio. This in itself, although in some degree inevitable, is nevertheless a serious evil. But unfortunately, the tendency of the present currency system, instead of alleviating, is to aggravate it. For, as money becomes abundant with the commercial public, it simultaneously increases with those who usually deposit in the Bank of England, and they immediately enlarge the amount of their deposits. Now every addition to the deposits, is really an addition to the unemployed reserve of unrepresented notes in the Bank; in proportion, therefore, as money becomes abundant with the public, the Bank reserve increases; so that it very speedily exceeds the amount which the ordinary rules of sound banking would hold to be necessary for discharging the functions of a reserve. In such circumstances it becomes the immediate interest of the Bank to force the superabundant notes of the reserve again into circulation; and this it can only do by entering keenly into the competition of the loan and discount market, and by proffering advances on more advantageous terms than those allowed by other banks and capitalists. And as the superabundance of money must have already produced a considerable decline in the rate of interest, and a corresponding rise in the scale of general prices, and must have thereby given an impetus to the spirit of undue speculation, so this disastrous competition of the Bank of England for an extended share of business, must not only induce a still further depreciation in the one case and enhancement in the other, but must inevitably impart a very powerful incentive to the rapid progress of speculation.

We are not now dealing with mere surmises, but with well ascertained facts which every intelligent reader may verify from his own experience. That the liberty to issue £14,000,000 of unrepresented notes free of charge, does actually induce the Bank of England, when money is abundant, to make advances at an injuriously low rate of discount is a matter of common observation. For a glaring illustration of this we need only refer to the year 1844, when, a few months after the passing of the Act, so ardent was the competition of the Bank Directors for an increased share of discounts, that they even forced accommodation on the public at 1¾ and 2 per cent. And that the effect of this course was extremely mischievous is now a matter of universal agreement. We have indeed the testimony of the Committee of the House of Lords on Commercial Distress—a testimony fully sustained by the witnesses examined before the Committees of both Houses—to the fact that the operation of this low rate of discount, in imparting an active stimulus to speculations of every kind, was to contribute in no small degree to the severity of the crisis in 1846–7. The mode in which it produces such a result is readily intelligible. It does so in two ways. In the first place, the rise of prices at home, unless it should happen by an extraordinary coincidence to be accompanied by a corresponding rise of prices in all the foreign countries with which we trade, must necessarily have the two-fold effect of putting a check to the export of our own commodities to the foreign markets, and of encouraging an increased importation from those foreign markets to our own. And in the second place, the decline in the rate of interest produces a proportionate rise in the price of public securities; and this rise in the price of securities, unless accompanied by a simultaneous enhancement in the price of foreign securities, has the two-fold effect of preventing foreign capitalists from purchasing our securities and of inducing our own capitalists to sell out their securities at home and purchase in the foreign market. Now, the effect of both of these operations—the one on the relation between our imports and exports, and the other between domestic and foreign securities is to necessitate the transmission of the unfavourable balance in treasure to those foreign countries from which we have obtained the increased securities and imports. The ultimate result therefore of the low rate of interest is in both respects an exportation of gold, and this exportation of gold is so serious an evil that it becomes an essential object, in currency legislation, to adopt every possible precaution against any occurrence that might unnecessarily induce or aggravate it.

Now in this most important particular the superiority of our proposed measures over the present system must be at once apparent. It is unquestionable that the Bank of England could never have been induced to force its notes upon the money market, at so low a rate of interest as 1¾ and 2 per cent. if it had not been allowed the privilege of issuing, for the purpose of loans, at no expense to itself. If a certain rate of interest had been charged upon the issue of all its unrepresented notes, that rate would have sufficed to prevent its loaning or discounting on such terms. And, supposing 1¾ per cent. to be the lowest rate at which the Directors might consider it profitable to advance money to the public, when the notes were perfectly free of charge, it is only a legitimate conclusion, that if a certain rate should be imposed on the issue of the notes, they would then be restrained from making advances on lower terms than the sum of that rate, added to the 1¾ per cent. supposed to be the present minimum. Now, the rate we have proposed to be levied on the first £11,000,000 of the unrepresented issues, being 1 per cent., there is no probability, according to this principle, that they would ever make loans on securities at a lower rate than 2¾, or discount lower than 3 per cent. In practise, indeed, it is not likely that they would ever descend so low as this, as it is highly improbable that the unrepresented issues would not at all times exceed £11,000,000, and, in that case, the imposition of the 2 per cent. upon the notes in excess of the first £11,000,000, would inevitably keep the rates of interest and discount about 1 per cent. higher than if the issues were ever to consist entirely of notes that would be subject to no higher charge than 1 per cent. On our plan, therefore, there appears no probability that the Bank rate of discount would ever fall, for any considerable period, below 3½ to 4 per cent. And, if this be correct, then whatever evils are admitted to arise from the encouragement of undue speculation, and the ultimate aggravation of a drain of the precious metals, through the low rate of discount at times adopted by the Bank of England, it must be conceded that our scheme of currency possesses this one advantage in addition to those already described, that it would, in very great measure, provide an adequate safeguard against such aggravation.

So far with respect to the operation of the present system in augmenting the evils arising out of an excess of circulating medium, together with our provision for preventing that augmentation. We have still to justify our assertion that the present system also aggravates the evils arising out of a deficiency of circulating medium, and that our proposed system provides a remedy for this as well as the former evil. And here the subject will demand a greater degree of amplification. For a deficiency of circulating medium may arise out of several different causes, each of which will require a special consideration. To treat of them generally, in the first place, they may be disposed of under two cases, the one proceeding from an actual drain of the precious metals, the other arising out of the hoarding of currency by merchants and bankers, through the dread of monetary pressure. In point of fact, these two cases are not always kept distinct; indeed the former is not unfrequently accompanied by the latter. But it will be more convenient to treat of them separately, and to dispose of the latter before proceeding with the former.

The principal instance of a domestic drain, that is of a scarcity of money produced by domestic hoarding, which has occurred in recent years, was that which took place in October, 1847. In this case, as is well known, there was no actual deficiency of currency in the country at the moment of pressure. There was no unfavourable exchange; on the contrary, gold was steadily returning after the drain of the previous twelve months. The apparent deficiency, therefore, as compared with the pressure of the preceding April, originated solely in the accumulation of currency by the merchants and bankers. And this accumulation is admitted to have been caused exclusively by the knowledge that the Bank of England was rapidly drawing towards the end of its resources, under the law that limits the unrepresented issues to £14,000,000; and the truth of this is clearly demonstrated by the fact, that the temporary suspension of the Act of 1844, at once removed the panic without requiring the issue of a single note beyond the statutable limitation. Now, we contend that our provision for allowing the Bank of England to issue unrepresented notes, beyond the £22,000,000 at present allowed to be issued by the whole united banks of England and Wales, subject to the charge of 4 per cent., would entirely preclude the possible recurrence of any similar panic. For it was not the rate of interest at which the Bank had been discounting in the previous months that produced the alarm, but solely the knowledge that the reserve of unrepresented notes was nearly exhausted, and that the provisions of the Act prohibited the extension of that reserve, no matter what rate of interest might be offered by the public for increased accommodation. The certainty, therefore, that whenever the rate of interest should materially exceed 4 per cent., the Bank would be placed in a position to afford any further accommodation that might be required by the public, would effectually prevent the recurrence of any apprehension as to the possible exhaustion of the Bank’s available resources.

We will now proceed to the case in which the deficiency of currency is produced by an actual drain of the precious metals. Such a drain may obviously arise from a variety of causes too numerous to specify. But there are three cases which are not only in themselves the most important, but which also serve as fair representatives of the remainder. These three are, first, a drain arising out of general high prices at home, originally produced by an excess of currency and great overtrading; secondly, the exportation of gold to pay for some staple article of food or manufacture, caused by the deficient supply of such article at home; and thirdly, the maintenance of a large military expenditure abroad during time of war. The first of these was the main cause of the crisis of 1825; the second was the chief, but not the exclusive, agent in producing the pressure of April, 1847; the third is now in operation, and should the war prove of long continuance, may possibly subject the present system to as severe a test as that of October, 1847, provided the Act should not in the mean time undergo amendment.