The Controversy of 1844
Although Prime Minister Peel’s intentions regarding the restructuring of the Bank of England and the restriction of the issuance of bank notes were well known among those in the financial community, opposition to the Currency Plan surfaced only as the hearings on the renewal of the bank’s charter were about to begin.
The primary opponents of the Act were Thomas Tooke, well-known monetary economist and collector of economic data; John Fullarton, who recently had returned to England from India; John Stuart Mill, economist and philosopher; James Wilson, founding editor of The Economist magazine, and James Gilbart, a well-known banker and advocate of free banking. In no sense did the Banking School project a coordinated front in their opposition to the Bank Act; their only common purpose was to defeat the proposed changes in the structure and operations of the Bank of England.Tooke was the standard-bearer for the Banking School. He laid out his opposition to the Act in An Inquiry into the Currency Principle (Tooke 1844), one of two book-length critiques of the Currency Principle and the Bank Act. The second was Fullarton’s On the Regulation of Currencies (Fullarton 1844), its title specifying one of the major complaints of the Banking School advocates: that the currency of Great Britain did not consist solely of coin and bank notes. In fact, a large portion of the transactions in the wholesale trade were carried out with bills of exchange, just as Henry Thornton had observed more than four decades earlier in An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802).
Tooke’s Inquiry into the Currency Principle
Even before writing the Inquiry into the Currency Principle Tooke had been a critic of the Currency School’s theory, arguing that implementation of the Act would increase monetary instability and increase the danger of periods of inconvertibility.
Tooke began his Inquiry into the Currency Principle with a statement of the Banking Principle:
It was held by most writers of any authority on the subject of the Currency, till within the last few years, that the purposes of a mixed circulation of coin and paper were sufficiently answered, as long as the coin was perfect, and the paper constantly convertible into coin; and that the only evils to be guarded against by regulation were those attending suspension of payment and insolvency of the banks, a large proportion of which blend an issue of promissory notes with their other business. This, in point of fact, is what is understood in general terms as the banking principle, and is that upon which our system of currency is constructed and conducted. (Tooke 1844: 1)
However, according to Tooke, a “new canon of currency” had been promulgated by the members of the Currency School. The convertibility of the paper currency into gold had always been the criterion of the soundness of banknotes, but according to the currency theory, the “bank notes in circulation should be made to conform to the gold, into which they are convertible, not only in value, but in amount” (Tooke 1844: 2). The purpose of Tooke’s Inquiry was to examine the wisdom of requiring the quantity of bank notes outstanding, above the fiduciary issue of £14 million, to be limited by the quantity of gold held by the Issuing Department.
Tooke provided a summary of his conclusions in the Inquiry in the form of 17 points (1844: 121-4). For our purpose, let us stress the first twelve of them. First, he argued that if the currency consisted entirely of precious metals, large inflows and outflows of bullion, up to “at least” £5 million to £6 million could take place without affecting the amount or the value of the British currency. Second, this implied that the belief that the currency would necessarily be affected by such bullion flows was false. Third, Tooke argued that the distinction between banknotes and other forms of paper credit overstated their differences; only small banknotes, used in retail trade, were essentially different.
Fourth, if “the obstacle of stamp duties” were removed from bills of exchange, bills could be used to transact nearly all business in the wholesale trade. Fifth, checks were widely used in retail trade and were generally as convenient as bank notes, if not more so. Sixth, higher denomination notes were generally used for “peculiar” purposes, such as clearinghouse settlements, provision markets, and purchases of fixed property. Bills of exchange could easily substitute for banknotes in such uses.Seventh, “the amount of bank notes in the hands of the public is determined by the purposes for which they are required, in circulating the capital, and in distributing the revenues of the different orders of the community, valued in gold” (Tooke 1844: 122). Eighth, banks of issue, including the Bank of England, cannot increase the quantity of notes in circulation unless the public wish to hold more notes, though one bank might expand its note issue at the expense of another bank. Ninth, banks lack the power to diminish the total quantity of notes in circulation; a reduction of the note issue of one bank will be offset by an increase of the notes circulated by other banks. Tenth:
That it is consequently an error to suppose that, however well informed the country bankers might be of the state of the foreign exchanges, and disposed to follow those indications, they would be disposed to regulate their circulation in conformity with such views. And that it is equally an error to suppose that the Bank of England can exercise a direct power over the exchanges, through the medium of its circulation. (Tooke 1844: 123, original emphasis)
Eleventh, neither country banks nor the Bank of England have the power to enlarge their note circulation unless more notes are demanded by the public. Forcing notes into circulation reduces bank capital. Twelfth and finally, the quantity of money in circulation does not determine prices; rather, prices determine the quantity of notes in circulation; that is, the money supply is endogenous, with the general level of prices tied to gold.