CHAPTER V. MONETARY AND BANKING THOUGHT I. THE EARLY BULLYONIST CONTROVERSY
I. THE RESTRICTION AND THE EMERGENCE OF THE BULLYONIST CONTROVERSY
The Bank of England had been the bulwark of the English and, by serving as banker's bank
of the Scottish banking system since its founding in 1694, the bank was the recipient of an
An enormous amount of monopoly privilege from the British government.
Not only was it the receiver of all public funds, but no other corporate banks were allowed
to exist, and no partnerships of more than six partners were allowed to issue banknotes.
As a result, by the late 18th century, the Bank of England was serving as an inflationary
engine of bank deposits, and especially of paper money, on top of which a flood of small
All partnership banks, country banks, were able to pyramid their own notes, using Bank
of England notes as their reserve.
As if this were not enough privilege, when the bank got into trouble by over-inflating,
it was permitted to suspend specie payment, that is, refuse to meet its obligation to
redeem its notes and deposits in specie.
This privilege was granted to the bank several times during the century after it opened its
doors.
However, each time the suspension or restriction of specie payment lasted only a few years.
In the 1790s, however, a startlingly new epoch began in the history of the British monetary
system.
In February 1793, a generation of fierce warfare broke out between revolutionary France and
the crowned heads of Europe, led by Great Britain.
While not exactly continuous, the war lasted with slight interruptions until Napoleon was
finally defeated in 1815, and the monarchies of Europe reimposed the Bourbon dynasty upon
the French nation.
This massive war effort meant a rapid escalation of monetary inflation, government spending
and public debt by the British government.
During the 1780s, the inflationary process of bank credit expansion had nearly 400 by
the outbreak of war.
The shock of the war led to a massive financial crisis, including runs on the country banks,
as well as numerous bankruptcy country banks suspended specie payment during 1793.
For a few years the bank saved itself by pursuing a cautious and conservative policy, but soon
inflationary war finance, the drain of gold abroad in response to higher purchasing power
elsewhere, the alarms of war and the increased demand for gold upon the banks, all combined
to precipitate a massive run on banks, including the Bank of England, in February 1797.
The country banks suspended specie payments, and the government brought matters to a head
by forcing the bank to suspend specie payments, a restriction which the Bank of England, of
course, was all too delighted to accept.
For the bank could now continue operations, could expand credit, inflate its supply of
The Federal Reserve notes and deposits and insists that its debtors must repay their loans, while it could avoid the bother of redeeming its own obligations in specie.
In effect, banknotes were unofficially legal tender, indeed virtually the only legal tender, and they were made official legal tender in 1812 until the resumption of specie payments in 1821.
At the beginning, the general view held the restriction to be strictly temporary and, indeed, the decree at any given time was only supposed to last for a few years.
But the restriction was extended repeatedly and was eventually continued for 24 years, from 1797 to 1821.
Until the end of the 18th century, it was unthinkable that Great Britain could be on an irredeemable fiat standard for an entire generation.
Apart from a few years during the continental paper period of the American Revolution, the South Sea and Mississippi bubbles of the early 18th century,
the hyperinflated assignats during the French Revolution, or a few brief suspensions of specie payment,
Payment. The world had always been on some form of gold or silver standard. All these
episodes had been mercifully brief, if catastrophic. But now, after a while, it began to dawn
on the British public that the era of inflationary fiat paper would continue indefinitely.
Great Britain suspended specie payments indefinitely so as to permit the Bank of England and the
and the banking system as a whole to maintain and greatly expand the previously inflated
system of fractional reserve banking.
Accordingly, the bank was able to greatly inflate credit and the money supply of notes
and deposits.
Statistics for the period are sparse, but it is clear that from 1797 until the end of
the Napoleonic Wars, the supply of money approximately doubled.
This monetary inflation had several predictable and generally unwelcome consequences.
Domestic prices skyrocketed.
The price of silver and especially of gold bullion vaulted upwards in relation to the
official par with the pound, and the pound depreciated in the foreign exchange market.
The monetary inflation, as usual, proceeded in fits and starts rather than as a smooth
and Wine, and so the various consequences in domestic prices, bullion and foreign exchanges
were themselves scarcely uniform or proportional.
But the rough general trend was unmistakable, with the three latter effects each eventually
rising to a peak of approximately 40 or 50 percent over their pre-restriction levels.
Before 1800, decades of inconvertible paper money in England would have been considered
unthinkable, and so previous monetary theorists had scarcely contemplated or analyzed such
an economy.
But now, writers were forced to come to grips with fiat paper and to propose policies to
cope with an unwelcome new era.
The political controversies during the restriction period centered on explaining the price inflation
and depreciation, and on assessing the role of the Bank of England.
The bullionists pointed out that the cause of the price inflation, the rise in the price
of bullion over par, and the depreciation of the pound, was the fiat money expansion.
They further maintained that the central role in that inflation was played by the Bank of
of England, freed of its necessity to redeem in specie.
Their opponents, the anti-bullionists, tried absurdly to absolve the government and its
privileged bank of all blame and to attribute all unwelcome consequences to specific problems
in the particular markets involved.
Depreciation in foreign exchange was charged to the outflow of bullion caused by excessive
to imports or by British war expenditures abroad, presumably unrelated to the increased
amount of paper pounds or to the lowered purchasing power of the pound.
The rise in the price of bullion was supposedly caused by an increased real demand for gold
or silver, again unrelated to the depreciated paper pound.
The increases in domestic prices received less attention from the two sides of the debate,
but they were attributed by the anti-bullionists to wartime disruptions and shortages in supply.
Any ad hoc cause could be seized upon, so long as the great integrating cause, the expansion
of bank credit and paper money, was carefully ignored and let off the hook.
In short, the anti-bullionists reverted to mercantilist worry about ad hoc causes and
the balance of trade on the market.
The previous hard-won analysis of money and overall prices went by the board.
2.
The Bullionist Controversy Begins
The announcement of the restriction brought a flurry of activity pro and con, consisting
denounced the reluctance of the government to make banknotes legal tender until nearly
the end of the war, although its policies made them legal tender de facto.
The opposition leader, Charles James Fox, 1749-1800 denounced the restriction and called
for resumption of specie payments, and also pointed out that the war against France bore
for ultimate responsibility for the plunge into fiat paper, and the distinguished playwright
and Whig member of parliament, Richard Brinsley Sheridan, 1751-1816, warned that we were doomed
to all the horrors of a paper circulation.
The inflationist economic historian Norman Silberling summed up the Fox-Sheridan position
Unsympathetically, as follows Fox and Sheridan constituted themselves the leaders of a persistent tie-raid against the bank suspension, not upon grounds of financial principle, but because the suspension permitted that institution to support the activities of what they regarded as a militaristic, reactionary and, with all, bankrupt administration.
They concentrated their eloquent invective against this alliance of bank and state,
which was productive of robbery and fraud.
And they urged that the bank be divorced forthwith from their public responsibilities
and their participation in the war.
Let the ministry repay the debts of the bank, if it could,
and let the bank resume the honest payment of their notes.
For the first few years, however, all seemed well.
The initial caution of the bank and the minimal expansion of government demands on its credit
combined with the inevitable time lag between issue of new money and rise in prices
to lull Britain's into a false sense of security.
The price of food rose substantially in 1799, but it was easy for the anti-bullionists
and other administration apologists to dismiss this rise in a flurry of pamphlets as the
product of crop failure and wartime disruption in the import of grain.
Even the Rev. Thomas Robert Malthus, afterwards to emerge as at least a partial bullionist,
diffidently raised the monetary question and then dismissed the increase of paper money
Money as rather the effect than the cause of the high price of provisions.
In the spring of 1800, however, war expenditures and bank financing government debt accelerated,
leading to a depreciation of the pound by 9% in the main foreign exchange market of
Hamburg and gold bullion appreciated to 9% above its official par value.
In addition, domestic prices rose even more sharply than before.
The depreciation of the pound had evidently begun.
The first phase of the bullionist controversy, 1800 to 1804, started when one of the best
of the bullionists published his remarkable pamphlet on the cause of the depreciation.
Finally there was little in the previous career of Walter Boyd circa 1754 to 1837, a wealthy
adventurer and seeker of state privilege, to prepare one for a pamphlet of keen insight
into the calamitous consequences of irredeemable paper money.
Boyd had been a wealthy English banker in Paris, the chief partner of Boyd, Kerr and
Company, who had to flee for his life in 1793 from the wrath of the French Revolution, which
also confiscated his property.
Back in London, Boyd established the banking firm of Boyd, Benfield and Company, of which
he was principal partner.
A close friend of Prime Minister William Pitt for many years, Boyd rode high in the British
of the Jewish Establishment, becoming a member of parliament in 1796 from his partner Paul
Benfield's pocket borough.
In 1794, the firm floated an important loan to the Austrian Emperor.
Furthermore, Boyd Benfield received the enormous contract of 30 million pounds in government
debt after the beginning of the war with France.
Things began to go sour for Boyd in 1796, however, when the Bank of England, whose loans
had been keeping Boyd, Benfield and Company afloat, failed to renew its discounts.
Boyd tried desperately to get Parliament to establish a new board for the issue of a massive
amount of notes, and the scheme received considerable support, but it was ended by the opposition
of William Pitt.
The only thing left for Boyd was to try to get more Bank of England loans, and in Parliament
during 1796 and 1797 he denounced the bank for too tight a credit policy, presumably
not mentioning himself as one of the prominent sufferers from its allegedly tight money.
Facing ruin, Boyd managed to obtain financial aid from friends in the Navy office, and he
He finally got the bank to lend Boyd, Benfield and Company 80,000 pounds in 1798.
But Samuel Thornton, 1755 to 1838, Deputy Governor of the Bank of England and Member
of Parliament, warned Pitt that Boyd, Benfield and Company was only being kept alive by bank
largesse.
And as a result, Pitt refused to let the House of Boyd contract for the 1799 public loan.
Finally, Boyd, Benfield and company went bankrupt in March 1800 and the result was total financial
ruin, so much so that Walter Boyd was reluctant to show his face in Parliament.
As might be expected, Boyd put the blame for his failure not on his own reckless feeding
at the Public Trough, but on the niggardly policies of the Bank of England.
In November 1800, Boyd wrote a letter to the right honourable William Pitt, published in
1801, which won quick fame and caused Boyd to publish a second edition later that year.
With Boyd's letter, the bullionist controversy was born, Boyd now denouncing the Bank of
of England, not for overly tight credit, but to the contrary, for generating the inflation
and monetary depreciation in the first place.
His newfound fame did boyed little personal good, however, and he promptly went to France
for financial maneuvering.
There he was arrested the following year and jailed by the French until the end of the
Napoleonic Wars.
He then returned to England, wrote other financial pamphlets and, once again, became a member
of parliament.
3.
Boyd's Letter to Pitt
Walter Boyd did not intend his pamphlet, the Letter to Pitt, to be a treatise on monetary
theory.
It was, as one historian put it, a tract for the times, written in a heated temper, and
The tract assumed a generally accepted set of monetary principles on the part of his
readers. Nonetheless, since Adam Smith and the other 18th century economists could not
have addressed their analyses to a non-existent, inconvertible fiat money, Boyd felt called
upon to extend the conventional analysis to this unwelcome new system that had suddenly
and how they come to Great Britain. In the course of doing so, Boyd not only launched the bullionist controversy, but also set forth an excellent exposition of what came to be known as the bullionist position in the great controversy.
pointed to the three new and unwelcome conditions, the premium of gold bullion over the paper
pound, the depreciation of the pound on the foreign exchange market, and the increase
in the prices of almost all articles of necessity, convenience and luxury, and indeed of almost
every species of exchangeable value, which has been gradually taking place during the
for the last two years and which had recently arrived at so great a height.
He argued that the cause of all three troublesome phenomena was the same, a depreciation of
the value of the pound, brought about by the issue of banknotes, uncontrolled by the obligation
of paying them in specie on demand. An increase in the supply of money diminishes its value,
are in the form of a premium on gold bullion or of a rise in the prices of goods, and the
same circumstances which raise the value of gold in the home market necessarily tend to
depreciate our currency when compared with currency of other countries.
Boyd summed up the bullionist position clearly in the preface to the second edition, 1801,
of his letter.
The premium on bullion, the low rate of exchange and the high prices of commodities in general
are symptoms and effects of the superabundance of paper.
If the supply of money is crucial to the movement of prices, bullion and exchange rates, it
becomes vital to clarify what precisely that supply may be.
Before Adam Smith, the 18th century British writers on money, such as Hume and Harris,
muddied the waters by including in the concept of money virtually all liquid assets, such
as bills of exchange and government securities.
In the wealth of nations, however, Smith helped matters by distinguishing clearly between
Money, the general medium of exchange, and the final means of payment, and other liquid
instruments that are exchanged against money. Following Smith, Walter Boyd makes the distinction
between money or ready money and other assets crystal clear. By the words means of circulation,
Circulating Medium and Currency, which are used almost as synonymous terms in this letter.
I understand always ready money, whether consisting of banknotes or specie, in contradistinction
to bills of exchange, navy bills, exchequer bills, or any other negotiable paper which
form no part of the circulating medium, as I have always understood that term.
The latter is the circulator, the former are merely objects of circulation.
Not only that, Boyd proceeded to go beyond Smith and to be the first to clearly identify
bank demand deposits as fully ready money as banknotes.
As he put it, credits in the books of the banks may be considered as banknotes virtually,
though not really in circulation.
Such grief and error would have been spared economic thought as well as the development
of money and banking if the currency school, the mid-19th century successors to the bullionists,
had heeded this lesson and understood that demand deposits were equivalent to bank notes
as a part of the supply of money.
On another crucial point, too, Boyd proved to be far superior to Adam Smith.
Like Catillon and Turgot, Boyd objected to the unfortunate doctrine propounded by Hume
and then by Smith that an increase in the quantity of money results in an equiproportional
increase in the price level.
Considering the essence of the Hume model of assuming a magically great proportionate
increase in the money supply and discussing the consequences, Boyd echoes Catillon rather
Other Than Hume.
If this country had acquired by supernatural means, and thrown into every channel of circulation
the same additional currency in gold and silver within the same period, this influx, altogether
disproportioned to the progress of the industry of the country within that period, could not
have failed to produce a very great rise in the price of every species of property, not
all with equal rapidity, but each by different degrees of celerity according to the frequency
or rarity of its natural contact with money. Internationally, such a magical influx of
gold and silver, according to Boyd and Smith before him, would ordinarily have rapidly
The Theory of Money and Credit The Theory of Money and Credit
As reported, there is no mechanism, as there is with specie, for draining off an excess quantity of money to foreign countries.
As a result, in the first place, the price rise resulting from an influx of specie would not be so great as that which has been occasioned by the introduction of so much paper, destitute of the essential quality of being constantly convertible into specie.
More specifically, according to Boyd, the depreciation of fiat paper in terms of other currencies would be reflected in a rise in the price of gold or silver bullion and an appreciation of foreign currencies on the foreign exchange market.
This view, as Professor Salerno points out, provides the germ of the purchasing power parity theory of exchange rates under inconvertible fiat currencies.
Specifically, Boyd contends that an increase in the supply of inconvertible paper money affects a general rise in domestic prices,
Or, what is the same thing, a depreciation in the exchange value of the currency in terms of commodities, which necessarily drives down the value of domestic currency in terms of foreign currencies whose exchange values have remained unchanged.
This fall in the value of the inflated and depreciated domestic currency relative to foreign
currencies is manifested in the depreciation of the exchange rate. Contained in Boyd's
argument is the seminal formulation of the purchasing power parity of exchange rate determination,
which of course is the logical outcome of the application of the monetary approach to
to Conditions of Inconvertible Paper Currency.
In addition, Walter Boyd set the tone for the bullionists following him by placing the
full blame for the monetary inflation on the Bank of England rather than the country banks.
For the country banks could not have expanded their notes in circulation, Boyd pointed out,
unless their reserve base had expanded proportionately, and that reserve base was constituted by notes
of the Bank of England.
For the country banks remain under the same salutary control as the Bank of England had
been under before the advent of restriction.
Just as the bank's notes had to be redeemed on demand in specie, so do the country bank's
Bank notes still have to be redeemed in the notes of the Bank of England.
The key to the problem is the escape from redeemability that the government had permitted
to the Bank of England.
As Boyd put it, the circulation of country bank notes must necessarily be proportioned
to the sums in specie or Bank of England notes requisite to discharge such of them as may
be presented for payment.
But the paper of the Bank of England has no such limitation.
It is itself now become what the coin of the country only ought to be, the ultimate element
into which the whole paper circulation of the country resolves itself.
The Bank of England is the great source of all the circulation of the country, and by
the increase or diminution of its paper, the increase or diminution of that of every country
Every bank is infallibly regulated.
Walter Boyd specifically cited and patterned himself on Adam Smith, and unfortunately also
followed Smith in hailing the expansion of private redeemable banknotes as providing
a less costly and more efficient highway in the sky, though Boyd did not use that phrase.
But being an embattled Smithian in a new world of fiat money, Boyd stressed his militant
opposition to banknotes in a context of fiat money.
Boyd denounced inconvertible or forced paper money as that dangerous quack medicine which
far from restoring vigor gives only temporary artificial health, while it secretly undermines
is the vital powers of the country that has recourse to it.
Boyd concluded that restoring the nation's currency to its pristine purity would be not
only proper and practical, but indispensable necessary in order to prevent the numberless
calamities which the uncontrolled circulation of paper, not convertible into specie, must
infallibly produce.
Fried was what we may call a complete bullionist, and was therefore a sophisticated one.
He fully recognized that partial real factors, such as government expenditures abroad, a
sudden scarcity of food, or a sudden diminution of the confidence of foreigners in consequence
of any great national disaster, could influence overall prices or the status of the pound
in the foreign exchange market.
And he also realized that such influences can only be trivial and temporary.
The overriding causes of such price or exchange movements, not just in some remote long run,
but at all times except temporary deviations, are monetary changes in the supply of and
demand for money.
Changes in real factors can only have an important impact on exchange rates and general prices
by altering the composition and the height of the demand for money on the market.
But since market demands for money are neither homogeneous nor uniform, nor do they ever
change equi-proportionately, real changes will almost always have an impact on the demand
for money.
As Professor Salerno writes, since real disturbances are invariably attended by distribution effects,
that is, gains and losses of income and wealth by the affected market participants, it is
most improbable that initially non-monetary disturbances would not ultimately entail relative
changes in the various national demands for money.
Here in convertible conditions, the relative changes in the demands for the various national
currencies, their quantities remaining unchanged, would be reflected in their long-run appreciation
or depreciation on the foreign exchange market.
Here we must emphasize a crucial distinction between the proper status of the short-run
and the long-run in economic theory.
In price theory proper, the short run should take precedence, because it is the real world
market price, while the long run is the remote ultimate tendency that never occurs, and could
only take place if all the data were frozen for several years.
In sum, we could only live in the improbable, if not impossible, world of long run general
General Equilibrium, where all profits and losses are zero, if all values, technologies
and resources were frozen for years.
But in monetary theory, the order of precedence should be different.
For in monetary theory, the impact of partial real factors on the price level, exchange
The monetary influences are not long-run in the sense of far-off and remote, but are underlying and dominant every day in the real world.
The monetary influence corresponding to the long run of general equilibrium would be a condition where all price levels and all real wage levels in a gold standard world would be identical or strictly proportionate to the relative currency weights of gold.
In a freely fluctuating fiat money world, this would be the situation where all price levels would be strictly proportionate to the currency ratios at the international market exchange rates.
But dominant influences of the supply and demand for money on price levels and exchange rates occur in the real world all the time and always predominate over the ephemera of real specific price and expenditure changes.
Changes. Hence, real-world analysis, which must always predominate, comprises short-run
price analysis and slightly longer run, but still far from final equilibrium, monetary
reasoning. To put it another way, in the real world all
prices are determined by the interaction of supply and demand. For individual prices,
This means consumer valuations and consumer demands for a given stock, supply and demand
in the real world.
This is short-run microanalysis.
For overall prices or the price level, the relevant supply and demand is the supply of
and demand for money, the result of individual utility valuations of the given stock of money
at any time, and while equally real and dominant in the macrosphere, this is determinant in
a slightly longer run than the superficial real factors stressed by anti-bullionists
in all ages.
4. The Storm Over Boyd, The Anti-Bullionist Response
The letter by someone of Boyd's renown and stature stung the British banking establishment
to the quick.
The establishment responded with a flurry of pamphlets in opposition to Boyd, some of
which were subsidized by the government.
The key point was to defend the actions of the Bank of England, and to attribute the
undesirable consequences of the inflation and depreciation to a hodgepodge of real
rather than monetary factors.
The most eminent critic whom Boyd could rebut in the second edition of the letter, published
a few months after the original, was Sir Francis Baring, 1740-1810, founder of the famous
banking house of Baring Brothers and Company.
Baring had been born to a clothing manufacturer in Exeter.
After plunging into commerce in London, Bering founded his own mercantile firm and became
a multimillionaire and known as the leading merchant in Europe.
In addition to his mercantile and banking prominence, Bering was also a director and
then chairman of the board of the East India Company, as well as a long-time Whig member
of parliament.
Curiously enough, when the restriction first appeared, Baring, in his first monetary pamphlet,
while strongly supporting the suspension as a necessary wartime measure, was worried about
the inevitable depreciation that would accompany over-issue of paper, and suggested a strict
limit on the bank's issue.
This pamphlet, Observations on the Establishment of the Bank of England, 1797, went through
two quick additions, followed by a supplementary further observations later the same year.
Now that the bank was under substantial attack, however, Sir Francis rallied round, his previous
qualifications and warnings forgotten.
In his observations on the publication of Walter Boyd, 1801, Baring absurdly defended
the bank from the charge of causing increases in domestic prices by pointing out that the
The depreciation of the pound on the foreign-exchange market was less than the rise in price.
But Boyd had not claimed equi-proportional rises in all prices, as he pointed out in
his rebuttal.
Bering also claimed, conveniently enough, that an increase in the money supply could
only affect foreign-exchange rates and not domestic prices.
Another inveterate defender of the bank and an anti-bullionist who entered the controversy
in this period was Henry Bowes, 1763 to 1827.
Bowes joined the fray in 1802 and wrote five anti-bullionist pamphlets between then and
1811.
He insisted that under conditions of inconvertibility, exchange rates had nothing to do with the
and the supply of money, but were only determined by the balance of international payments,
which in turn was supposed to be set solely by real rather than monetary factors.
As Bose put it dogmatically, the rate of exchange is governed by the balance of exchange operations
and great political convulsions apart by no other principle whatever.
In his 1802 tract, Guineas and Unnecessary and Expensive Incumbrance on Commerce, Boehm,
as his title indicates, carried the fallacious Smithian highway-in-the-sky argument to its
logical conclusion.
The restriction was so beneficial that it should be made permanent, a permanent measure
of prudence and sound policy.
Who was this Boes, this point man for inflation and fiat money?
Born in Cornwall, he went to live for years in Brittany and then returned to London where
he became a corresponding clerk in 1788 in the banking firm of Ransom, Morland and Hammersley.
The outbreak of the French Revolution the following year found Boes, with his extensive
of French Connections in a good spot to obtain considerable funds for support of a number
of émigré French clergy and nobility in England.
Boes then rose rapidly in the bank, becoming chief clerk and then managing partner in 1799.
He was also a distinguished evangelical, being a leading member of the London Missionary
Society and founder of the British and Foreign Bible Society.
After retiring to Cornwall in 1809, Henry Bowes became a partner in the Penzance Union
Bank and Mayor of Penzance.