Henry Dunning Macleod.

A dictionary of political economy: biographical, bibliographical ..., Volume 1 online

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might not be much danger. But suppose politi-
cal troubles to arise, and the securities to be de-
preciated 10 or 20 per cent., where is the security
for the notes then ? It is clear that the Govern-
ment is insolvent. And as these notes are payable
on demand, there would of course be a run for
gold. How is that to be met? By the sale
of securities — that would at once send them down
to such a discount as would be fatal to the
Government. But even then the Government
would be bankrupt, as the sum that might be
raised by selling securities would leave a very
large uncovered deficit.

Our readers will at once See how utterly pre-
posterous it is to suppose that such a scheme was
m any way analogous to the issues of the Bank of
England which are covered by such an immense
excess of assets above liabilities. In fact, the
more one considers it, the more incredible does it
appear that such a visionary delusion should have
emanated from any man of sense It is quite
clear that the Government securities in the hands
of their own agent were no securities at all. Di-
rectly the Government bought up its own obliga-
tions, it is quite clear they were extinguished.

To suppose that the Government holding its
own securities could make them a basis for paper
issues, is as absurd as to suppose that if the
Directors of the Bank of England were to sigti
obligations, and deposit them with the issue de-
partment, they could make them a basis for
paper issues ! Or to suppose that if a man were
to sign a promissory note of £1000 to himself,
J and put it into his own pocket, he could make
^ that a basis for issuing to the pnblic a thousand
XI notes payable to bearer on demand I

What then was the real practical result of this
wonderful financial scheme r It was simply this :
By means of obtaining 252 in specie from the
public, by a series of exchanges, it created 252
of notes payable on demand, and also turned 504
of funded debt, of which only the interest was

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demandable from the Government, into 504 of
notes payable to bearer on demand !

It is quite easy to see that if this scheme had
ever been carried out, it would have infallibly
brought on a tremendous financial catastrophe,
which would have done more to overthrow the
Government than half a dozen mutinies. Fortu-
nately it was immediately quashed by the home
authorities. But that such a scheme should ema-
nate from any one holding such a position, is a
deep disgrace to British finance in the nineteenth

To shew thai the quantity of money in a country
at any time bearx no necessary relation whatever
to the quantity of other floods ^c, in it^ or to their

Many writers have supposed that the quantity
of money in a country beiars some necessary rela-
tion to the quantity of other things in it. Thus
Smith says, Book II. c. 2. — "What is the propor-
tion which the circulating money of any country
bears to the whole value of the annual produce
circulated by means of it, it is perhaps impossible
to determine. It has been computed by different
authors at a fifth, at a tenth, at a twentieth, and
at a thirtieth part of that value.'* Many more
; have supposed that variations in prices are caused
. by variations in the quantity of specie ; or, that
. the prices of commodities are determined by the
proportion which the quantity of money bears to
the quantity of commodities. That this is a very
grievous error can easily be shown. Thus, let us
suppose that two pei^sons, A and B, are reciprocally
indebted to each other for the sale of goods. Let
us deal with small figures, as that will exhibit the
principle of the thing as well as large ones. Let
us suppose that A has bought goods of B to the
amount of £10, and B has bought goods of A to
the amount of £13 ; then it is quite clear that
there are three different ways of settling their

1. Each may send a clerk to the other with the
amount of his debt to the other. To settle the
matter in this way, would require £23.

2. A may cany £10 to B in discharge of his
debt ; and B may pay it back to A, together with
£3, in discharge of his own. This method would
require £13.

3. They may meet and set off their mutual debts
against each other, and pay only the difference in
coin. This method would require only £3.

Now it is quite clear that a very different amount
of money would be required to carry on any given
amount of business, according as either of these
three methods was adopted. Between the first
and the third there is a difference of £20 ; but
there would be no difference in the prices of com-
modities. So that by a simple change in the
method of doing business, £20 might be with-
drawn from circulation altogether, if only the same
quantity of business can be carried on.

From these considerations it manifestly appears
that there may be great quantities of money in a
country which may exercise no influence whatever
on prices, and that the proportion between money
and commodities may vary greatly, according to
the method in which business is carried on. Few
countries, after adopting the third method, would
|o back to the first. But many might change
from the first to the third. As an example of

the change from the first to the third, we may
mention the case of the London banks. Every
bank in London has, probably, claims against
every other, every morning. The old method
used to be, that every morning each bank used to
send out clerks to collect the sums due to it from
its neighbours. But at the same time it was
obliged to keep in reserve a lai'ge stock of specie
and notes to meet its neighbours* claims on it.
The consequence of this system was vary manifest
There was an enormous mass of specie and notes
kept for no other purpose but to be carried back-
wards and forwards from one bank to another to
settle claims, which might be much more eaaly
settled by being simply set off one against the
other. To facilitate tliis change, a considerable
number of the London Banks agreed to have a
room where their clerks should meet and set off
their mutual claims against each other, and only
pay the differences in specie. By a further im-
provement in the organisatioii of this institution,
no specie or bank notes at all are now used.
This method saves the use of many millions of
specie or bank notes, which would be required if
it did not exist, and it is clear that this vast sum
of money, which would be required to fulfil the
purpose of the Clearing House, would exercise no
influence on prices.

On the Theory of Regulating the Paper Currency
by the Discount of Mercantile Bills,
Adam Smith, who is supposed to countenance
the doctrine discussed in the preceding section,
called the Currency Principle, has, a few pages
further on, started another theory, which was
strenuously supported by the Directors of the
Bank of Ireland in 1804, and those of the Bank of
England in 1810 ; namely, that, as long as Notes
are issued in the discount of bond fide mercantile
bills, they cannot be excessive. This very spe-
cious theory was controverted by the Bullion
Committee, but not in our opinion conclusively.
We have endeavoured to demonstrate its fallacy
under Bullion Repoat, § 51. /


On the Regulation of the Paper Currency by
means of the Rale of Discount.

Having shown that the two theories of Paper
Currency which have obtained the greatest noto-
riety in recent times are inconsistent witk^ each
other, and both erroneous, we have now to con-
sider what other means thci*e may be of regu-
lating the Paper Currency.

Although it is an error to suppose that the
Paper Currency must always be exactly equal
to what the specie would have been if there were
no paper, and in fact can by no possibility do so
whilst the business of banking is allowed to
continue, yet it is unquestionably true that the
paper should vary proportionably to the specie.
The framers of the Bullion Report and of the
Act of 1819, as well as all the best authorities
of the period, maintained that the mere nume-
rical amount of notes was no criterion as to
whether they were over-abundant or not They
maintained that the true criterion was to be
found in the price of gold bullion and the state
of the Foreign Exchanges. Having regard to
these, they said that the more paper there was
the better, as it only showed the activity of

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So long as the paper is convertible at the will
of the holder, the price of gold bullion may be
omitted, because though the Bank may endanger
its stability by excessive issues, yet the market
price of gold cannot be aflTected by them until cash
payments have been suspcuded, and the notes
become inconvertible. So long, therefore, as the
Paper Currency is convertible, the state of the
Foreign Exchanges is the principal thing that
need be looked to.

Directly we observe that a debt is an article of
merchandise, and may be bought and sold like
any other commodity— which was perfectly well
understood uutil the erroneous doctrine was
adopted by Economists that labour and mate-
riality are necessary to value — and that the laws
governing the price of debts are perfectly analo-
gous to those which govern the prices of all other
commodities, we shall find that the subject becomes
quite clear and simple.

For many centuries, it was the custom, in this
and other countries, to fix the prices of labour
and com. It was considered a heinous crime to
lay up corn for the purpose of selling it again.
Those who did so were called by various un-
couth names, such as Forestallers, Rcgi*aters,
&c., the meaning of which, we hope, will shortly
be known only to antiquaries. At last, writers
began to see the fallacy of this. It is one of
Smithes merits, we believe, to have been among
the first to show the useful part played by corn
speculators, who bought up corn when it was
cheap, and kept it in reserve until there was a
scarcity. After laborious efforts, it came to be
generally understood that corn factors, instead
of being the cause of the scarcity and dearness of
corn, were, in fi4Ct, the very persons who pre-
vented it being a great deal more scarce and dear
than it was ; and, so far from aggravating varia-
tion in prices, were in fact the great mitigators of
them. That, so far from being the noxious ver-
min they were supposed by the ignorant vulgar
to be, they were great public benefactors.

But long after the evil effects of meddling with
the value of labour and commodities were ftilly
understood, people clmig to the chimera of fixmg
a maximum price for debts, or discount, and while
it was lawful to take any amount by way of com-
mission, or extraneous charges, it was held to be
a legal and moral crhne to take anything above a
certain amount by way of interest. Such is the
weakness of human natm-e, that Adam Smith him-
self, who had done so much to enlighten the world
as to the mischief of meddling with prices, gives
most fantastical reasons for maintaining a maxi-
mum rate of interest. This called forth Bentham's
admirable Defence of Usury. The usury laws
produced the most serious inconveniences in every
commercial crisis, and yet no effort was made tf)
repeal them till 1834, when bills and notes of not
more than three months' date, were exempted
from their operation ; and it was not till 1854, that
the last remnants of them were abolished, and con-
tracts for money left fi*ee.

Directly we observe that a debt is simply an
article of meixihandise, and that banking is simply
buying and selling debts, we have only to observe
the analogy between that and every other species-
of merchandise, and the proper method of con-
trolling the paper currcncv becomes obvious and

As discounting bills is simply buying debts, the
price of such debts must follow exactly the same
laws a.s the price of com, or any other ai-ticle.
If money is very scarce, and wheat very abund-
ant, the price of wheat must rise. The price of
debts otfeys the same rules. If money becomes
very scarce, the price of debts must fall, i.e., the dis-
count must rise. If money becomes abundant, the
price of debts will rise, t.e. the discount will fall.
The price of debts, then, must follow the same
great laws of nature that the price of wheat
does. Every one knows now that it is a great
error to control the price of com. As we have
shown (Pbicbs ; Thbobt op) it is not the fluctu-
ation of the price of wheat that is the evil. The
real evil is the change in the proportion of the
demand and supply, and the fluctuation of the
price is the grand natural corrector of the evil.
A high price of com is the way to attract corn
to where it is deficient, and a low price repels it
from where it is already too abundant. Nothing
can be more erroneous policy than to force down
the price of wheat when there is a real scarcity,
and to sell it below the price it would naturally
attain to.

Now apply all the arguments which irresistibly
govern the case of wheat to the case of credit, or
debts, and the same results follow. The same
great law of nature operates to preserve the due
proportion between money and credit, and any
interference with this great law must necessarily
be attended with the same evil consequences as
an interference with the natural price of wheat.
And yet almost all legislation up to a veiy recent
period, and the great majority of writers on poli-
tical economy, and too many of the commercial
world were in a perverse combination to thwart
this great law of nature, and to attempt to keep
the rate of discount, or the price of debts, fixed at
a uniform rate !

While, therefore, the greater part of commer-
cial complaints were levelled against variations in
the rate of discount as the great evil — the truth is,
they are only the sign of the evil. The real evil is
I the altered proportion between money and credit,
' and a variation in the rate of discount is the grand
] natural corrector of the evil. To attempt to keep
I the rate of discount imiform, is to thwart and con-
I travene the laws of nature just the same as an
attempt to fix the price of wheat. Like all trae
laws of nature, the simplicity, beauty and perfec-
tion of its action is marvellous, and it produces
a multitude of results which are not perhaps very
obvious at first. K money is leaving the country
and becoming scarce compared to credit, every
principle of nature shows that the value of money
must rise, i.e., the rate of discount must rise ; and
this prevents the outflow of bullion, and attracts
it from abroad. On the other hand, if money be
flowing into the country, and likely to become too
abundant compared to credit, a fall in its value,
or a fall in the rate of discount repels it from
the country. If a nation be visited with a great
fiailure of the crops, it can only buy such food
from foreign countries with its commodities, or its
money — it cannot send its credit as permanent pay-
ment abroad. Now, if commodities are too dear,
it must pay with money, and credit in this country
is the great producing power ; and credit, for a
timey is a great sustainer of prices by enabling
people to withhold their commodities from the

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market. Now, raising the rate of discount cur-
tails credit, forces sales, and thereby lowers the
price of commodities, and makes it less profit-
able to export specie, and more profitable to ex-
port goods. Moreover, this rise in the value of
money here, t.c., the low price of debts and
commodities, tempts buyers from neighbouring
countries to bring their money here. It thus
causes an influx of money, and brings the value
of the currency here to a nearer level with that
of other countries. Again, if this nation has to
spend a great part of its money in buying foreign
com, it is quite clear it ha6 not got so much to
spend in purchasing goods ; an over-production of
goods therefore can only end in a disastrous fitll
in prices. And here, too, the beautiful action of
this great law of nature is manifest. So enormous
a proportion of the commodities of this country
are produced by the credit system, that a rise in
the rate of discoimt just bits profits between wind
and water, as we may say. Consequently, a rise
in the rate of discount retards and curtails pro-
duction in proportion to the diminished consum-
ing powers of the nation, and so prevents such a
ruinous fall in price, as would necessarily follow
an undiminished production, accompanied by a
diminished power of consumption.

In fact, when a commercial crisis occurs in a
country, it invariably means that more persons
are wishing to sell than there are persons wishing
to buy, or at least at remunerative prices. A
commercial crisis invariably arises from a lack of
purchasers, which is, in fact, over-production.
True prudence, therefore, shows, that in all com-
mercial crises, production shoxild he curbed. It Is
better not to produce at all, than to produce and
be obliged to sell at a loss. To produce and be
obliged to sell below cost of production is loss of
capital. It is better, therefore, not to employ the
capital at all than to lose it. Raising the rate of
discount, therefore, acts as a timely warning to
producers to hold hard. It is necessary to dispose
of the stock already produced before producing
more, and if the stream of sale is stopped while
production continues, it can only tend to a more
aggravated fall at last.

Tf ow, what is the necessary consequence of an
attempt to thwart this great law of nature? In
time of scarcity of food, and a necessary export
of money to buy it, if the rate of discount be
kept unnaturally low, nothing but money will go,
commodities are too dear, they will not go. Agun,
money being kept at an unnaturally low rate here,
no one will bring it here from neighbouring
countries ; consequently, great quantities of money
will go out and none will come in, till at last the
circulating medium will be nothing but *^ promises
to pay,** and no money to pay them with. Then,
at last^ violent convulsiops, total destruction of
credit, every one wishing to sell, and no one
wishing or able to buy.

On the other hand, if, when money is flowing in
with too great abundance, it be not repelled by a
due diminution in the value of money, i.^., a fall
in the state of discount, it will continue to do so
until it is so superabundant, that a violent fall
takes place. Persons who are accustomed to
depend on the income they receive from the in-
terest of money, suddenly find their means are
seriously diminished. Then wild speculations
find favour in the public mind, promising higher

profits, and thus the community goes through the
cycle of bubble speculation, extravagant credit,
ending in commercial catastrophe. In 1824, money
was so abundant^ that the Scotch Banks gave no
interest on deposits. Then came 1826. It is per-
fectly certain that during the various crises this
country has passed through, if more attention had
been paid to observe the natural rate of dis-
count, instead of thwarting the course of nature,
though the variations would have been more fre-
quent, they would have been less violent and ex-
treme. If money is coming in with too great
speed, it is good to lower the rate of discount
quickly, to prevent it getting lower ; if money is
going out too rapidly, it is good to raise the rate
quickly, to prevent it being higher.

Hitherto, however, a great number of persons
have thought that a uniform and invariable rate
of discount is the great thing to be preserved, no
matter what nature may say to the contrary ; and
much ingenuity has been given to devise a plan
for always keeping it so, just as if the governor of
a steam engine ought always to revolve with uni-
form velocity. The inevitable consequence of
taking these means to thwart nature will be, Uiat
when money is scarce, it will be repelled by a
lower rate than the natural one ; when it is already
too abundant, it will be still further attracted by
a rate higher than the natural one.

Many have supposed that the object ought to be
to maintain the currency at a uniform amount,
and have proposed that as ^old goes out, paper
should be issued to supply its place. Thus, Sir
Archibald Alison, who condemns the theory that
gold and paper should vary together, says (Uktory
of Europe^ Vol. 11, p, 891 .J :— " The fane system
would be just the reverse. Proceieding on the
principle that the great object is to equalise the
currency, and with it prices and speculation, it
would enlarge the paper currency when the pre-
cious metals are withdrawn, and credit is threatened
with a stoppage, and proportionally contract it
when the precious metal returns, and the currency
is becoming adequate without any considerable
addition to the paper.** This plan has been tried
over and over again; and has been uniformly
attended with a catastrophe. When gold was
leaving the country in vast quantities, in 1796, the
Bank of England still maintained its issues, against
- its own will, it is true, but yet the fact illustrates
the principle — and the consequence was tlie suspen-
sion of cash payments, in 1797. When the Bank
had got right again, in 1817, a drain for foreign
loans began, and the Bank extended its issues in
1818, and the consequence was the second susp^i-
sion of cash payments, in 1819. In 1824, when
bullion was departmg firom the counfay like a flood,
the Bank extended its issues. Then, when it saw
itself right in the vortex of bankruptcy, it sud-
denly altered its policy, and the result of this was
the catastrophe of 1825. In 1838-9, a similar
drain occurred ; the Bank, with marvellous per-
versity, maintained its rate of discount considera-
bly below the market rate, and the result was ^
monetary crisis of 1839. In 1847, there was the
same error, and the same result. Surely these
instances are enough to destroy this fatal delusion.

In fact, those writers who maintain this doctrine
— or rather, we mav say, who did so, because
they are almost if not quite extinct — ^wholly
mistake the object to be sought for in so delicate

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Jrnd artificial a machine as a Paper Currency.
The object to be aimed at is not to preserve a
uniform rate of discount, or a nniform quantity
of currency in this country, but to ninintaln a
nnifcrmity in the Value of the British Currency
with that of other countries. If money be made
artificially cheap in this country, that is, cheaper
than it is in neighbouring countries, persons in
this country will export it to where it is of greater
value ; they will buy foreign securities, they will
buy foreign commodities. On the other hand,
foreign nations will flood this country with their
securities, just as the Americans did in 1839—
when the Bank kept down the rate of discount
below its proper level— because they can sell them
at a better price here than in their own country.
If a man wishes to sell a horse, and my neighbour
will only give £90 for it, and I will give £96, he
of course will sell the horse to me and take away
my fcash. So, when the Americans wished to sell
their debts, and found that in their own country
they could only get £90 per cent, for them,
whereas they could get £97 per cent for them in
England, as a natural consequence they sent them
to England for sale, and took away the cash. The
only way for England to have stopped this would
have been to give no more for these securities
than the Americans would themselves ; in other
words, to maintain a uniformity in value between
the currencies of the two countries.

There are, also, other considerations which shew
that the rate of discount is the true method of
acting upon the Paper Currency. It has almost
universally been supposed that Bills of Exchange
arise only out of previous commercial transac-
tions between connti-ies; and, therefore, that if
there have been no transactions there can be no
Bills. Under the article Exchanges, Fobeign,
we have shown the fallacy of this notion, and
explained that when The Rate of Discount in two
countries exceeds the Cost of the transmission of
Bullion between them. Bills of Exchange are
fabricated for the express purpose of exporting
bullion. If the rate of discount at Paris is 6 per
cent., and the rat<j in London 4 per cent., not
"only will debts fly from Paris to buy bullion, and
bullion fly from London to Paris to buy debts,

Online LibraryHenry Dunning MacleodA dictionary of political economy: biographical, bibliographical ..., Volume 1 → online text (page 179 of 180)