An Austrian Perspective on the History of Economic Thought

7.1   The trauma of 1825

In 1823, the British economy finally recovered from the post-Napoleonic War and post-1819 agricultural depression. In fact, an expansionary boom got under way, so much so as to quieten the vociferous agricultural advocates of higher prices and the opponents of the return to gold. Unsurprisingly, Bank of England credit expansion led the way in this new inflationary boom, its total credit rising from £17.5 million in August 1823 to £25.1 million two years later, a huge increase of 43 per cent or 21.7 per cent uncompounded per annum. Much of the monetary and credit boom came through investment in highly speculative Latin American mining stocks. The great hard-money radical William Cobbett kept up a drumfire of attack on this inflation but, significantly, he was also joined, if more privately, by such moderate hard-money men as William Huskisson, who worried that ‘this universal Jobbery in Foreign Stock will turn out the most tremendous Bubble ever known’.

By late 1824, the exchanges turned unfavourable, and gold began to flow abroad; by the following year, Britons began to demand gold from the banks in increasing numbers. Huskisson repeatedly warned the Cabinet in the Spring of 1825 that ‘the Bank, in its greedy folly, was playing over again the game of 1817’. In late June, a bank in Bristol refused outright to give gold to a noteholder who spurned payments in Bank of England notes, and this ominous incident was widely publicized by Cobbett. Bank of England cash reserves were at their lowest in five years at the end of February, at £8.86 million; and from that low point they fell alarmingly to no more than £3.0 million at the end of October. Bank runs and a bank panic ensued and at the height of that panic, in mid-December, a noteholder of the recalcitrant Bristol bank distributed a leaflet warning the citizens of the city: ‘As there is no knowing what may happen, get Gold, for if Restriction come it will be too late’. During the panic, the late Henry Thornton’s important bank, Pole, Thornton & Co. went under, despite last-minute borrowing from the Bank of England and despite the fact that Sir Peter Pole, head of the bank, was connected by marriage with the governor of the Bank of England, Cornelius Buller.

After a week of hysteria in mid-December, the Bank of England, pursuing a highly risky policy of massive loans to the banks and rediscounting of bills, managed to stem the run, even though its cash reserves had been reduced to £1.0 million by the end of the year.

The country was saved by a hair’s breadth from another suspension of specie payments by the Bank of England. The bank pleaded with the government to order such a suspension, but the Tory government, largely due to the ardent pressure of Huskisson and Canning, resisted the bank’s demands. The prime minister, Robert Banks Jenkinson, the earl of Liverpool, much to the disgust of his fellow High Tories of the duke of Wellington faction, agreed with Huskisson that, in the words of one prominent Wellington man, ‘if the [Bank] stopped payment, it would be a good opportunity of taking their Charter from them,... for letting the Bank break’.

The boom and crisis of 1825 dealt a traumatic lesson to thoughtful analysts of the monetary and economic scene. For these dramatic events demonstrated that the gold standard, important as it was as a check on monetary and banking inflation, was not enough;: bank failures, and boom and bust cycles, could and would still occur. Something further, then, was needed to fulfil the promise of the bullionists; something more than the gold standard was needed to counter the ills of boom-and-bust and of fractional-reserve banking.

The most concrete and immediate response to the panic of 1825 was a decision of the government to outlaw small denomination (under £5) bank notes, a measure that even the pro-bank credit Adam Smith had favoured. In that way, at least for these popular and widely used small denominations, the public would be using only specie as money. On 22 March 1826, Parliament forbade banks in England and Wales to issue new small notes, or to reissue any old ones after April 1829. After June 1826, the Bank of England continued to obey this edict for a little over a century. In another banking reform, Parliament ended the system that had prevailed since the turn of the eighteenth century: the Bank of England had a monopoly of all commercial banking except for partnerships of less than six persons. This monopoly was now shaken. Corporate and large partnership banks were now permitted in England, by an act of 26 May 1826. Unfortunately, this liberalization was greatly weakened by the act’s preserving the bank’s monopoly of corporate and large-scale banking inside a 65-mile radius of London. In short, corporate or joint-stock banking was permitted only to the ‘country’ banks.

Political pressure by Scottish Tories gained an exemption from these reforms for Scotland. In the first place, Scotland already had joint-stock banking and, more importantly, Scotland had long been a swamp of small-bank note inflationism. Even after resumption of the gold standard in 1821, Scotland did not have a gold standard in practice. Frank Fetter discloses the solution as follows:

Even after the resumption of payments in 1821 little coin had circulated; and to a large degree there was a tradition, almost with the force of law, that banks should not be required to redeem their notes in coin. Redemption in London drafts was the usual form of paying noteholders. There was a core of truth in the remark of an anonymous pamphleteer (1826): Any southern fool who had the temerity to ask for a hundred sovereigns [gold coins], might, if his nerves supported him through the cross examination at the bank counter, think himself in luck to be hunted to the border.1

To work, a gold standard must, of course, be truly in effect – in practice as well as in the official statutes.

The Scottish Tories, led by the eminent novelist Sir Walter Scott, successfully blocked application of the anti-small-note reform to Scotland. The mouthpiece for Scottish High Toryism, Blackwood’s Edinburgh Magazine, after hailing Scott’s campaign, published two articles on ‘The Country Banks and the Bank of England’, in 1827–28, in which it wove together two major strains of ultra-inflationism: going off the gold standard, and praising the country banks. Blackwood’s also attacked the Bank of England as overly restrictionist, thus helping to launch the legend that the bank was too restrictive instead of being itself the main engine of inflation. In contrast, the Westminster Review, mouthpiece for the philosophical radicals, scoffed at the Scots for threatening ‘a civil war in defence of the privilege of being plundered’ by the bank credit system.

It was also in this period in 1827, that Henry Burgess founded the powerful committee of country bankers, and edited for over 20 years the committee’s influential periodical, Circular to Bankers. For that entire period, Burgess kept up a drumfire of inflationist vilification of the gold standard, of ‘those ignorant, vain, and obstinate, projectors – Huskisson, Peel, and Ricardo’, and of the Bank of England for being too restrictive of bank credit. He also denounced the ‘Political Economists’ as being ‘the curse of the country’ because of their generally hard-money views. For its part, Blackwood’s Edinburgh Magazine pursued a similar unwavering line for nearly three decades, denouncing the return to gold in 1819 as having given ‘the Jews, stockbrokers, and attorneys of the country, an enormous advantage, at the expense of classes connected with land...’.

On the other hand, William Cobbett continued his hard-hitting anti-bank paper stance, proclaiming in 1828 that ‘Ever since that hellish compound Paper-money was understood by me, I have wished for the destruction of the accursed thing: I have applauded every measure that tended to produce its destruction, and censured every measure having a tendency to preserve it’. Blasting the inflationist and privileged Scottish country banks as ‘the Scottish monopolists’, Cobbett also denounced the Scotsman John Ramsay McCulloch for defending bank paper – ‘this Scotch stupidity, conceit, pertinacity and impudence’. Cobbett escalated the attack by asserting that ‘these ravenous Rooks of Scotland have been a pestilence to England for more than two hundred years’. It might be commented, of course, that one simple way for England to cast off that ‘pestilence’ was for England to give Scotland back its independence, a solution that Cobbett and the other nationalist English radicals somehow failed to consider.

Despite the continuing inflationism of the High Tories and of the Birmingham Attwoods, and despite the imminent clash of economic opinion over banking reform, the bulk of economists stood foursquare, from the mid-1820s on, in defence of the gold standard. That much had been agreed upon, and accomplished. Their differences on banking did not prevent unity on this fundamental monetary question. John Ramsay McCulloch, James Mill and Nassau W. Senior, stood solidly in favour of gold. Even the alleged radical, and for a time, pre-Keynesian Malthus expressed complete support for return to the gold standard in 1823 and thereafter. Archbishop Whately, Mountifort Longfield, Thomas Perronet Thompson, even the arch inductivist and historicist Richard Jones of Cambridge, were all staunch supporters of gold. Even the often confused and irenic John Stuart Mill was hard-hitting in defence of gold. The younger Mill, upon reading the testimony, in 1821, of Thomas Attwood in favour of a combined silver and inconvertible fiat paper standard, denounced the idea of depreciating the standard as a ‘gigantic plan of confiscation’. Mill thundered ‘that men who are not knaves in their private dealings should understand what the word “depreciation” means, and yet support it, speaks but ill for the existing state of morality on such subjects’ 2

7.2   The emergence of the currency principle

The prohibition of small notes, however, scarcely tackled the main problem. The first to go beyond this minor aspect of banking and go straight to the heart of the matter was a brilliant and influential thinker who has remained as little known to historians as he was obscure in his own day. It is with justice that Lionel Robbins has wittily referred to James Pennington (1777–1862) as the ‘Mycroft Holmes’ of the later monetary controversy of the classical period.3

James Pennington was born into a prominent Quaker family in the town of Kendal, in Westmorland; his father, William, was a bookseller, printer and architect, who eventually became mayor of Kendal. Graduating from a first-rate Quaker school at Kendal, Pennington moved to London. Little is known of his personal life thereafter, except that he lived in Clapham, and that he and his large family of seven children were parishioners, and James a trustee, of the famous Clapham Anglican parish church, obviously abandoning the Quakerism of his youth. Apart from that, we know that he was a merchant, ‘gentleman’ and accountant, and briefly became a member of the board of control for India in 1832. From then on, retired from commerce, he would be consulted repeatedly in technical financial matters by the government.

In the wake of the great banking crisis of December 1825, London was agog with discussions of money and banking, the august Political Economy Club dealing with this topic in its meetings of 9 January and 6 February, 1826. At the latter occasion, Pennington was present as a guest and, stimulated by the discussion, he sat down to write a memorandum on the subject to the powerful president of the board of trade, the liberal Tory William Huskisson. Huskisson did not request the memo, but he was known to be receptive to intelligent memoranda on crucial topics, and this method of promoting his views may have been suggested to Pennington by his longtime friend, and one of the original founders of the Political Economy Club, the merchant and economist Thomas Tooke. In this first memo to Huskisson on 13 February ‘On the Private Banking Establishments of the Metropolis’, Pennington outlined with crystal clarity how private banks, by expanding loans, create demand deposits which function as part of the money supply. Walter Boyd and others had pointed this out, but Pennington’s exposition was unmatched in its lucidity and, when published as an appendix to Tooke’s Letter to Grenville (1829), greatly influenced the banking controversies of the era. Unfortunately, the Letter did not sufficiently influence Pennington’s own camp, the currency school, who stubbornly and tragically failed to realize that bank demand deposits formed part of the supply of money, equivalent to bank notes.

Without any encouragement from Huskisson, Pennington followed up his first memorandum with another, a year later (16 May 1827) on ‘Observations on the Coinage’. After explaining the technical procedures of the gold standard, Pennington detailed the dangers to gold of the existence of a paper currency, and then added a tantalizing hint: ‘It is possible to regulate an extensive paper circulation... to render its contraction and expansion... subject to the same Law as that which determines the expansion and contraction of a currency wholly and exclusively metallic’. Here was the first indication in Great Britain of the ‘Currency Principle’: that more than simple gold redeemability was needed to transform bank money into a mere surrogate of gold.

William Huskisson finally sat up and took notice, writing to Pennington that:

I perceive that towards the end of your Paper on Coinage, you state an opinion that means may be found of preventing those alternations of excitement and depression which have been attended with such alarming consequences to this Country. This, for a long time, has appeared to me to be one of the most important matters which can engage the attention...[T]he too great facility of expansion at one time, and the too rapid contraction of paper credit... at another, is unquestionably an evil of the greatest magnitude.

In short, bank credit and paper money were perceived by Huskisson as responsible for the business cycle; what, then, could be done about it? He urged Pennington to elaborate on his tantalizing suggestion.

The upshot was an ironic one: while James Pennington’s third memorandum, in reply, ‘On the management of the Bank of England’, 23 June, was the first fateful elaboration of the justly famous currency principle, it was scarcely action-oriented enough to suit the minister. At any rate, monetary matters faded temporarily, and Huskisson himself resigned his post the following year, to die three years later. But Pennington’s memorandum, nevertheless, was very important, for it declared that to make bank paper currency stable and tied to gold, it must be regulated to conform to the movements of the gold supply. If the Bank of England were the monopoly issuer of notes, Pennington prophetically counselled, it would be easy for it to control the total supply; in lieu of that, the private banks, London and country, could in some way be totally and immediately controlled by the bank. In either case, the bank could then be compelled to keep its securities (i.e. its earning assets) fixed in total amount; if so, its note issues would move in the same direction, and to the same extent, as its stock of gold. While the bank would not have 100 per cent gold reserves to its notes, the legally fixed gap between them would mean that bank notes (and by extension, the total money supply) would move in the same way and to the same extent as the gold supply – thus arriving at the equivalent of 100 per cent specie money for all further operations of the bank. Here was the seed of Peel’s great Act of 1844, the embodiment of the currency principle.

But Huskisson could not seize on this point, because of Pennington’s hesitations and qualifications; in particular, Pennington, of all people, knew full well that bank deposits are just as much creatures of bank credit as bank notes, and that to ‘regulate them [deposits] properly will be no easy task’.

It becomes a mystery that Pennington, the founder of the currency principle, should have been so alert to bank deposits’ role as money, while the currency school concentrated with such fierce insistence on bank notes alone. They applied this variant of 100 per cent gold money to notes exclusively, leaving deposits to go unchecked and unregulated on their own. Some historians speculate that the currency school made the conscious decision to avoid applying their principle to deposits, because of an alleged difficulty in practical application, and because they believed that note-holders – presumably being a broader or less wealthy section of the population – were more likely to cash in for gold than deposit-holders.4 If so, then this ‘practical’ decision to forget about deposits proved, in the long run, to be the height of impracticality – indeed, fatal to the currency, or 100 per cent gold, cause. For Peel’s Act’s prohibitions on further fractional-reserve note issue simply induced the banking system, led by the Bank of England, to shift their inflationary and expansionary attentions to deposits alone – a condition that still prevails throughout the world.

Currency school myopia on demand deposits scarcely extended to their cousins in the United States. On the contrary, such 100 per cent gold leaders and Jacksonian theorists as Condy Raguet, Amos Kendall and the magnificent Jacksonian William M. Gouge of Philadelphia (1796—1863), were perfectly aware of deposits’ equivalent role to notes in the issue of bank money. A Philadelphia editor, Gouge became a treasury official in the 1830s, and remained there from that point on. Gouge held firmly that deposits are in all cases equal to notes, that they may be created by bank lending, and that they have the same inflationary effect on prices as bank notes. He called for a return to the 100 per cent gold reserves backing the deposits of the original banks of Hamburg and Amsterdam. Gouge was also the main theoretician of the Van Buren-Polk independent treasury system, in which the federal government would separate itself totally from banking, first by keeping no deposits in any banks, spending its funds directly in specie, and second, by accepting in taxes only specie and no bank notes or deposits. In that way, the American banking system would be free, not only of a central bank (as ensured by President Jackson in the early 1830s), but also of any link to or support by the federal government.5

Other influential expressions of the currency principle emerged from the panic of 1825. The highly influential Sir Henry Drummond (1786–1860)6, banker and MP, in the fourth edition (1826) of his Elementary Propositions on the Currency, was driven by the crisis to the realization that mere specie convertibility was not enough to avoid boom-bust crises in money and in prices. He therefore concluded that the quantity of paper money should be kept constant, so that variations in the money supply would only reflect changes in the stock of specie. In the same year, Richard Page, writing as ‘Daniel Hardcastle’, state the currency principle in crystal-clear form: ‘That only is a sound and well-regulated state of things, when no greater numerical amount of paper is in circulation than would have circulated of the precious metals if no paper had existed’ 7

After the crisis of 1825, then, a consensus began to form, beginning with James Pennington and spreading through knowledgeable circles in Britain, that the gold standard is not enough; and that bank credit must not be allowed to expand unduly. At the ultimate pole were the currency school, who believed that commercial banks must be restricted to 100 per cent of gold, at least for any further note issues. Most of the school unfortunately left demand deposits out of their reckoning as not part of the money supply. Other established leaders, such as bank governor John Horsley Palmer, developed the far more qualified view advocating more control by the Bank of England: bank money should pyramid on top of a fixed ratio of reserves to liabilities maintained by the Bank of England.

But if bank credit was to be confined to movements of gold, and thereby to end the threat of inflation and the business cycle, by what mechanism was this to be accomplished? In most cases, and certainly among virtually all adherents of the currency school, the answer was to be the Bank of England itself: the very institution which bullionists and their successors had long seen to be the central agent of inflation and credit expansion. The idea was that the bank would either ride herd over the private banks, or, in the developing consensus, to assume a monopoly over all issue of bank notes — leaving banks to issue demand deposits in a way that tied them inexorably to the Bank of England. In short, the modern banking system, with all its deep inflationary flaws, was what was envisioned and brought forth by the currency school. In the name of ultra-hard money, they unwittingly imposed upon Great Britain, and later the world, the modern, centralized inflationary, fractional-reserve and central bank-dominated banking system. The theory was that the bank would control the private banks through monopoly of note issue and other measures, while the government would rigidly control the bank itself.

The other main instrument of bank control over private banks was to centralize gold in the hands of the bank, and to make Bank of England notes legal tender for all citizens and banks. In that way, the banks would be induced to surrender their gold to the Bank, and to happily pyramid their loans and deposits on top of their bank reserves. Their demand deposits at the bank could always be cashed in for legal tender currency. In short, as this proposed structure came to be established in Britain and then elsewhere, the world was saddled with the modern banking system.

It is still a mystery how men so keenly aware and critical of the cartellizing and inflationary role of the Bank of England should have proposed centralizing control into the hands of the very same bank, and all in the name of stopping inflation and tying the monetary system closely and one-to-one to gold. It was truly putting the fox in charge of the proverbial chicken coop. A minority of currency men, it is true, favoured another variant, first recommended by the spiritual father of the currency school, David Ricardo himself. Already, at the end of his 1816 pamphlet on Economical and Scarce Currency, Ricardo had hinted at this solution, influenced by an unpublished proposal of J.B. Say in 1814. In his last, posthumous work, published in 1824, The Plan for the Establishment of a National Bank, Ricardo put forward and elaborated the new plan: the appointment of a government board to be in charge of a national note issue monopoly, with the Bank of England essentially confined to credit and deposit banking. The idea was that since the bank could not be trusted to be in charge of monopoly note issue, that function should be trusted to the central government. But, surely, here was even more of a fox, if not a wolf, to be placed in command. Government is just as much, if not more, inclined toward monetary and credit inflation as any private central bank. Government can always use inflation to finance the deficits it desires and to subsidize credit to its political allies.

There were other far more effective ways to restrict bank credit expansion. During the Jackson-Van Buren era in the United States (approximately 1828–40s), which roughly coincided with the period of the currency-banking school controversies in Britain, the programme of the hard-money Jacksonian movement was far more thoroughgoing, and ultimately far more realistic, than their spiritual cousins of the currency school. Both groups aimed at achieving hard money, tied very closely to specie, in order to end inflation and the boom-bust cycle. But, instead of maintaining and strengthening the central bank, the Jacksonians, far more logically, made it their first order of business to destroy it. The next step, for Gouge, Kendall, Raguet and their followers, who included Presidents Jackson and Van Buren, was to separate the federal government totally from money, by establishing an independent treasury system, passed by the Van Buren administration in 1840, repealed by the Whigs, and then permanently re-established by the Jacksonian Polk administration in 1846. The idea of the independent treasury was, first for the treasury to keep its own funds, without depositing them in any banks; and second, for the treasury to accept in taxes and other fees only specie, and not even notes of specie-redeeming banks. In that way, the federal government would give no encouragement whatever to the circulation of bank notes or deposits. Another plank in the Van Buren programme, considered but never passed, as being too hard-hitting, was a federal bankruptcy law which would have forced any bank to close its doors whenever it failed to meet its contractual obligations to redeem its notes or deposits in specie on demand. Other parts of the Jacksonian programme were state enforcement of bankruptcy the moment a bank should fail to pay in specie, and even the outlawing of all fractional-reserve banking as inherently fraudulent, as promising something that could not possibly be fulfilled: instantaneous redemption of all demand liabilities in specie.8

Less thoroughgoing than the Jacksonian proposals but better than the currency school’s reliance on the central bank were the proposals of a free banking group that arose after 1825, calling for elimination of the Bank of England. The free banking proponents, however, were scarcely united in their theoretical outlook or in their goals; some wanted free banking in order to eliminate what they considered to be Bank of England restraint on bank credit expansion; while others wanted it for the opposite reason: to approach the currency school goal of pure specie money.

In the former category, for example, was the veteran inflationist and anti-bullionist, Sir John Sinclair. On the other hand, a particularly important example of the latter, hard-money, category was the long-time bullionist and clerk at the Royal Mint, Robert Mushet. In his substantial book, An Attempt to Explain from Facts the Effect of the Issues of the Bank of England... (1826), Mushet set forth a currency principle type of business cycle theory. The Bank of England, he pointed out, set into motion an expansionary policy that created an inflationary boom, and that later had to be reversed into a contractionary depression. Like the later currency school, Mushet’s aim was to arrive at a purely metallic currency or its equivalent, but he saw that free banking rather than central banking was a better way to achieve it. Thus, Mushet hailed the act of 1826, allowing joint-stock banking outside of the environs of London, as an improvement on the previous system, but still leaving intact the ‘main evil’, ‘because they do not take the power from the Bank of England of adding extensively to the currency’. But ‘when the monopoly of the Bank expires [in 1833], and the trade in money is perfectly free, a better order of things may arise’. The better order included stability, a currency not suffering from over-expansion, and an end to the boom-bust cycle.9

But by far the most important hard-money free banking advocate was the veteran bullionist Sir Henry Brooke Parnell, a leading MP who had taken the bullionist side in the Irish money question in 1804, was a prominent member of the bullion committee, and had supported resumption in 1819. As early as 1824, Parnell had moved in Parliament for an investigation of the Bank of England’s charter. In 1826, he denounced the bank’s ‘exclusive and mischievous privilege’. In 1826 and again the following year, Parnell organized a discussion at the Political Economy Club, on the theme, ‘Might not a proper Currency be secured by leaving the business of Banking wholly free from legislative interference?’ He left no doubt that his own answer was, Yes.

Parnell set forth his free banking views in his 1827 tract Observations on Paper Money, Banking, and Overtrading (1827, 2nd ed., 1829). He began, following Mushet, by placing the blame for the panic of 1825 on the Bank of England’s over-issues of 1824–25. The problem was that the law had taken away from the bank ‘the great check over abuses in issuing paper money, namely, the competition of rival banks’. Going beyond Mushet, Parnell was not willing to wait for the bank’s charter to expire in six years; no, the power of the bank over money, and thereby over prices and the general state of business, was ‘so entirely repugnant... that it ought not be tolerated any longer’. Parnell concluded that the remedy was ‘a free system of banking’, and, overlooking a few pages at the end of Mushet’s work, proclaimed that he himself was the first man in England to raise the banner of free banking.10

It is hardly surprising, on the other hand, that George Poulett Scrope, the inveterate underconsumptionist, should also have been an inflationist advocate of free banking in this period. In several books and in an article in the Quarterly Review, heralded by articles of other like-minded men in that leading Tory journal, Scrope called for the legalizing of small bank notes and an end to the London note issue monopoly of the Bank of England. His programme was designed to fit inflationist ends. Thus the competing banks would be able to redeem their notes in bullion rather than coin. The proclaimed goal of this banking programme was, in Scrope’s words, to ‘everywhere lower the values of the metals, and with them that of money’.11

7.3   Rechartering the Bank of England

The Bank of England’s charter expired in 1833, and this seemed to offer critics of the existing system a golden opportunity to effect a fundamental reform. A bank charter committee was selected by the House of Commons in 1832 to engage in a detailed enquiry into the banking system, focusing on the question of the bank’s existing monopoly of bank note issue in London and environs. The committee’s hearings and inquiry was the most thorough examination of British banking to date, but Parnell, the only member of the committee to vote against rechartering the bank, complained with some justice that the roster of witnesses was stacked against the proponents of free banking by the manoeuvres of the chancellor of the exchequer in Lord Grey’s Whig government, the Viscount Althorp.12

It was clear that a consensus of witnesses was building towards centralizing note issue in the hands of a strengthened Bank of England, a policy both the currency school, in its misguided way, and the moderately inflationist Establishment, could support. Only a few witnesses favoured bank competition in note issue in London, and only one, the Manchester merchant and joint-stock banker Joseph Chesborough Dyer, opposed the fateful proposal to invest Bank of England notes with legal tender power.

Based on the committee inquiry, Viscount Althorp presented Parliament in 1833 with his legislative programme: to keep the status quo of bank charter and bank note-issue monopoly in London and a 65-mile radius, and to centralize banking further by granting bank notes legal tender power. This meant that, from then on, private and joint-stock banks need not keep any of their reserves in gold, since depositors and note-holders would be compelled by law to accept bank notes in payment; and that only the Bank of England itself would have to meet its contractual obligations to redeem its notes or deposits in gold. This measure of 1833 went a long way to reduce the role of gold coin in everyday life, and to encourage its replacement by bank notes and bank deposits. In presenting his programme, Althorp noted that since the committee hearings, ‘the public have been more inclined to look favourably on the management of the Bank of England...’. In short, the loaded committee had done its work well. He further provided a harbinger of the future by stating that his goal was to have all bank notes issued by the Bank of England — which of course is the modern centralized banking system.

The powerful country banking lobby, however, rose up in high dudgeon at this threat to its note-issue privileges, and the Cabinet was forced to back down on its goal of note-issue monopoly for the Bank of England. Lord Althorp was so chagrined at this successful pressure that he almost resigned from the government.

Although there was only one witness against it, the legal tender provision for Bank of England notes only carried in Commons by virtue of support from arch-inflationists opposed to the gold standard; the vote for legal tender was 214 to 156, with hard-money stalwarts Sir Henry Parnell and Sir Robert Peel, the leader of the Tory opposition, voting against.

Outrage against the legal tender law among the public was led, as might be expected, by the country bankers. The committee of country bankers, led by Henry William Hobhouse, pointed out that the law would ‘violate private rights, and secure to the Bank of England an unjust and perpetual monopoly’. The committee’s memorial justly pointed out that the government had taken measures against the expansionary tendencies of the country banks, but had ignored the ‘operation of the same principle’ at work in the Bank of England, in its case unchecked by the competition of other banks.

Leading the public reaction against legal tender was the prolific free banking advocate, the Scottish attorney Alexander Mundell. Mundell warned that the 1833 law would lead to the centralization of specie reserves in the country into the hands of the Bank of England. He charged that ‘Your [English] industry, which has been already taxed by the exclusive privileges of the Bank of England as it now exists, is thus to be taxed still more by extension of it’.13

7.4   The crisis of 1837 and the currency school controversy

For the first time, the law of 1826 had allowed joint-stock banking (except for the Bank of England) to exist in England. But various remaining restrictions had held the number of joint-stock banks down to 14; the act of 1833 had removed these restrictions, and the result was a veritable orgy of joint-stock banks formed in England. Forty-four new banks were added from 1831 to 1835, topped by no less than 59 in 1836 alone, 15 of them established between 1 May and 15 June of that year. A powerful joint-stock bank, the London and Westminster Bank, was even established in London itself in 1834, although of course it was banned from issuing notes.

Along with the increase in the number of banks came an expansion in bank money. Thus the circulation of country bank notes rose from £10 million at the end of 1833 to over £12 million in mid-1836. Of this growth, almost all came from the issue of the new joint-stock banks: from £1.3 million to £3.6 million in the same period.

Although the Bank of England and the private country banks complained at the new competition, the expansion of credit by the bank fuelled this new burgeoning of banks and bank notes. Discounts of the bank expanded from £1.0 million in April 1833 to £3.4 million in July 1835, and rose to over £11 million by the end of the latter year. Total bank credit, in turn, rose from £24 million in 1833 to over £35 million at the beginning of 1837. This expansion took place in the teeth of the bank’s loss of specie reserves from £11 million in 1822 to less than £4 million at the end of 1836. So much for the currency principle, and for its modified ‘Palmer rule’, which the bank’s governor, John Horsley Palmer, had explained to the bank charter committee in 1832 that the Bank of England had been following. There is no way that such a practice -of expanding credit while specie reserves were falling – could be tortured into even an approximation of the currency ideal that the money supply should move as if it were the stock of specie in the country.

To top it off, the bank credit expansion led, in what was becoming the usual way, to a financial crisis and panic at the end of 1836 and the beginning of 1837, replete with bank runs, especially in Ireland. There followed the typical signs of recession: contraction of bank credit, decline of production, collapse of stock prices, numerous bankruptcies of banks and other businesses, and a swelling of unemployment.

It is not surprising that the new boom-bust cycle gave rise to parliamentary inquiries – by committees on joint-stock banks in 1836, 1837, and 1838, and even more so to vigorous debates on the banking situation in pamphlets and in the press. Indeed, more than 40 pamphlets were published on the banking system in 1837 alone, and a large number continued the following year.

The pamphlet war was touched off by a remarkable pamphlet by Colonel Robert Torrens,14 remarkable not only for being the best presentation of the currency school, but also because it signified a sudden conversion of Torrens into the currency ranks. For Torrens, though a distinguished political economist, a friend of Ricardo, and a founder and leading member of the Political Economy Club, had been an ardent, almost wild, inflationist and anti-bullionist during the bullion Report struggles. Indeed, Torrens’s inflationism had continued at least into 1830.

Then, in the course of confused and bewildering speeches in Parliament in the critical year of 1833, Torrens continued his old bitter anti-deflationist attacks on the resumption act of 1819, but in the midst of them, also inconsistently enunciated the currency principle in clear form:

Extensive and calamitous experience had established the fact, that a currency, consisting of precious metals, and of paper convertible into these metals on demand, was liable to sudden and very considerable fluctuation, between the extremes of excess and of deficiency... A mixed currency... would suffer a much more considerable contraction... than a purely metallic... Unless our present system of currency were amended by the timely interference of the Legislature, it would go on to occasion periodical and aggravated distress, until, in a national bankruptcy it would find its euthanasia.15

In another speech on rechartering the Bank of England, Torrens warned that ‘the adoption of the measures proposed by Government for continuing and increasing the exclusive privileges of the Bank of England would inflict upon the country a periodic recurrence in aggravated forms of revulsions of trade, and of panics in the money market...’.

In his notable Letter to Lord Melbourne, all hesitation finally fell away, and Colonel Torrens joined the leadership of the currency school ranks. He began by pointing out, in contrast to most of his currency colleagues, that bank deposits were money equally with bank notes, paying tribute to James Pennington for pointing this out. Torrens explained the nature of deposits as money very clearly, showing that a shift of bank liabilities from notes to deposits or vice versa would not change the amount of bank money by which merchants and others can make purchases. He also noted that while most people have learned how an increase in coin and bank notes raises prices and depreciates foreign exchanges, neither the government nor the directors of the Bank of England understand how loans and deposits do the same thing. But tragically, Torrens then inconsistently dismissed deposits as unimportant, apparently on the ground that the bank, not the public, decides whether to keep its liabilities in notes or deposits, and on the further erroneous assumption that country and joint-stock banks pyramid at a fixed ratio upon bank notes as their reserves but not upon bank deposits. From then on, Torrens wrote and acted as if deposits were irrelevant to the money supply.

Torrens also unfortunately conceded that the bank must function as a lender of last resort to banks in distress, but then confined his attack on the bank to its stoking the fires of inflationary credit and not conforming to the currency principle from the beginning. In order to force the currency principle upon the bank, Torrens, for the first time in print, urged that Parliament rigidly separate the bank into an issue department and a banking department. The issue department would be forced to limit its note issues to its actual supply of gold, so that bank notes could only fluctuate to the extent that the bank’s stock of gold increases or decreases. In that way, wrote Torrens, ‘the circulation [of bank notes] would always remain in the same state, both with respect to amount and to value, in which it would exist were it wholly metallic’.

The problem is that the banking department, in Torrens’s and hence the currency plan, would be left totally free and unregulated, on the assumption that the bank could issue credits and deposits, and that those loans and demand deposits would be totally irrelevant to the money supply. The neglect of deposits was the tragic flaw in the currency plan.

Colonel Torrens’s assault on the bank was in effect, though not by name, answered in a pamphlet by bank director and former governor John Horsley Palmer.16 As in the case of bank apologists for decades, Palmer put the blame for the inflation and recession on every institution but the bank: on shipments of funds abroad, on bank runs, and on reckless credit expansion by private and joint-stock English and Irish banks. He concluded that the solution – a particular favourite of the bank – was that the bank must have a monopoly of all note issue. Ironically, the currency school, so hostile to the bank, proposed the same plan for different reasons: so that the government could have but one central bank to regulate.

In his Letter to Lord Melbourne, Torrens had given credit to the banker Samuel Jones Loyd for originating the idea of the separation of the Bank of England into issue and banking departments. Loyd now weighed in with a pamphlet attack on Palmer, in which he assumed the leadership of the currency camp.17 Far more simplistic than Torrens, Loyd dogmatically but fatally asserted that notes and deposits are forever absolutely different and therefore can and must be treated totally differently. Professor Fetter offers an amusing and accurate explanation of the triumph of Loyd’s simple-minded stance:

He [Loyd] stated as a fundamental that no man in his right mind could question that note issuing and deposit business were completely separate and that a mixed circulation of coin and notes should fluctuate exactly as would an all-metallic circulation. Despite its theoretical vacuity, there was no denying the effectiveness of Loyd’s argument... Loyd’s prestige as a successful banker undoubtedly made his words carry conviction to many who... felt that something ought to be done about the Bank of England and that a man who made money in banking must understand banking.18

Throughout 1837 and 1838, the currency principle was advocated in highly influential pamphlets – again by Loyd, by David Ricardo’s brother Samson, and – in a particularly important pronouncement – by long-time Bank of England director George Warde Norman. Like Loyd, Torrens and Pennington, Norman was a member of the Political Economy Club. His pamphlet of 1838 was a revision of a pamphlet that he had privately printed five years earlier.19 Norman agreed with Loyd that notes and deposits are totally different, and also suggested granting to the Bank of England a monopoly of all bank notes. Since Norman was a powerful bank director, it would seem that his adoption of the allegedly ‘anti-bank’ currency principle was akin to B’rer Rabbit urging not to be thrown into the briar patch!

Another economist lending his prestige as one of the last of the Ricardians to the currency principle was the prolific John Ramsay McCulloch, both in a review of some of the year’s pamphlets in the Edinburgh Review for April 1837, and again in a new edition of Smith’s Wealth of Nations, which he published the following year. In 1840, at the next stage of the debate, another leading economist joined the fray on behalf of the currency principle: S. Mountifort Longfield, in a notable four-part article, ‘Banking and Currency’, in Dublin University Magazine, an article influenced heavily by McCulloch’s writings.

7.5   The crisis of 1839 and the escalation of the currency school controversy

A mild boom in 1837 and 1838 was followed by another economic crisis towards the end of 1838 and during 1839. Bankruptcies and bank runs ensued, and the Bank of England’s gold reserve fell from £9.8 million in December 1838 to an extremely low £2.4 million by September 1839. Not only that; but in the teeth of shrinking reserves, the bank, instead of following anything like its own Palmer rule, let alone the more rigorous currency principle, expanded credit still further, thus precipitating an even greater drain of gold from the bank. By July and August 1839, the chancellor of the Exchequer was beginning to contemplate another restriction, another suspension of specie payment on behalf of the bank. The bank was saved only by massive credits from the Bank of France and from Hamburg.

Clearly, the banking situation was becoming intolerable, and something had to be done. Parliament appointed a select committee on banks of issue on 1840 and again in 1841, and massive hearings were held on the question. Disputes in parliamentary testimony and pamphlet controversy were redoubled, and were made more urgent by Horsley Palmer’s concession that the bank was finding it almost impossible to adhere to his rule.

Several other groups now arose to challenge the growing currency school consensus. The free banking adherents took a lead from the currency school in lashing out at the Bank of England’s responsibility for inflation and for the business cycle. But the force of their opposition to the bank was vitiated by their uniform apologia for the country and joint-stock banks. While it is true that those banks were largely governed by the actions of the bank, it was egregious for them to claim that the private banks were totally passive and blameless in the entire process. The free banking school was particularly discredited by the fact that virtually all of its spokesmen – with the exception of Sir Henry Parnell, who died in 1842, in the middle of the controversy -were themselves joint-stock or country bankers, so that the special pleading in their stance was all too evident. If this group had confined their advocacy of free banking to the largely political point that the bank would inevitably be more inflationary and dangerous than competitive banking, they would have been far more persuasive. But such restraint is not the usual practice of special pleaders.

The only distinguished economist to take up the free banking cause was Samuel Bailey, the subjective value theorist. But Bailey had founded and was now chairman of the Sheffield Banking Company, and his fervent apologia was all too suspect. Bailey, indeed, was one of the worst offenders in insisting on the passivity of the country and joint-stock banks, and in attacking the very idea that there is something wrong with worrying about changes in the quantity of the money supply. By assuring his readers that competitive banking would always provide ‘nice adjustment of the currency to the wants of the people’, Bailey overlooked the fundamental Ricardian truth that there is never any social value to increasing the money supply, once the commodity is established, and that inflationary increases in bank credit take place as a process of fraudulent issue of fake warehouse receipts to standard money.

Another school of thought arising in this period was the banking school, at this early point consisting solely of one prominent man, Thomas Tooke. Tooke (1774–1858) was by now an elderly merchant in the Russian trade who, born the son of a chaplain, had started working in St Petersburg at the age of 15, and had become a partner in a mercantile firm in London. Long interested in economic matters, Tooke had been one of the founders of the Political Economy Club, and continued to attend meetings of the club until his death. In the bullion controversy, Tooke was a staunch bullionist, and he strongly supported the resumption of specie payments in 1819. At best, however, Tooke was a confused and inchoate thinker, and whatever theoretical acumen he had was apparently warped beyond repair by decades of immersion in his life-work, a four-volume History of Prices and of the State of the Circulation from 1792, published from 1838 to 1848.20 Inductive play with his statistics was able to convince Tooke, for example, as early as his 1838 volumes, first that high and rising prices during the Napoleonic periods were solely due to bad harvests, lowering the supply of farm products, as well as obstructions of foreign trade, while, second, falling prices after the war were caused by better harvests and the resumption of trade. Having concluded that, Tooke was able to press on, in his third volume of the History of Prices in 1840, and in his parliamentary testimony the same year, to launch the banking school with the absurd proposition – to quote from a crystal-clear formulation of Tooke four years later – that: ‘the prices of commodities do not depend upon the quantity of money indicated by the amount of bank notes, nor upon the amount of the whole of the circulating medium: but that, on the contrary, the amount of the circulating medium is the consequence of prices’.

To be fair to Tooke and his banking school colleagues, they did not mean -or profess to mean – to apply this old fallacy to inconvertible currency, as their anti-bullionist forbears had done, but only to convertible currency. But this did not make their analysis or conclusion one whit less absurd. The masterful critique by Torrens deserves to be quoted at some length: Torrens first points out that Tooke has ‘the deserved reputation, which even he himself cannot destroy’ of having shown by ‘an extensive induction from existing and from historical facts... that the value of everything declines as its quantity is increased in relation to the demand’. But then, Torrens notes, Tooke ‘turns his back upon himself by affirming that the value of money does not decline, as its quantity is increased in relation to the demand’. Or at least he affirms this for a convertible money standard. But Torrens concludes incisively that the effects of an increase are the same, for convertible or inconvertible currency. The only difference is that there are limits to increases imposed by a convertible currency. Thus: ‘Mr. Tooke falls into the misconception of imagining that the limitation to a further decline of value which convertibility imposes, prevents the previous existence of the decline which it subsequently arrests.’ Like Adam Smith, the banking school was blithely assuming that the adjustments and restraints of redeemability were instantaneous, and therefore that no problems would be created in the actual processes of the real world.

A particular rapier thrust against Tooke by Torrens four years later cannot be resisted: ‘Throughout interminable pages of inconsistent affirmation [in the multi-volume History of Prices], he reiterates the inference, that the value of commodities has fluctuated in relation to money and that, therefore, the value of money has not fluctuated in relation to commodities’.

The corollary proposition of the banking school, taken from the anti-bullionists and now brought again to the fore by Tooke, is that the Bank of England cannot increase the supply of money (as Tooke put it starkly, ‘The Bank of England has not the Power to add to the Circulation’). Even applying this claim only to convertible currency, as the banking school did, it is difficult to hold such a manifest absurdity at length. In practice, therefore, Tooke and the other banking school adherents usually modified this blunt statement to apply only to bank notes issued in loans to private borrowers, and not to purchases of government securities. To the question: what’s the difference?, the main contribution to Tooke’s doctrine was made in 1844 by John Fullarton: namely, that notes issued in purchase of government securities are ‘paid away’ and remain permanently in circulation, thus adding to the quantity of money, whereas bank notes ‘are only lent and are returnable to the issuers’21 and presumably therefore do not add to the money supply. This was what Fullarton dubbed the ‘principle of reflux’ of notes returning to the banks. Once again, the incisive refutation came from Colonel Torrens, who pointed out that to carry any weight, the ‘vaunted principle of reflux’ requires instantaneous repayment of all loans: ‘Allow any interval to elapse between the loan and the repayment and no regularity of reflux can prevent redundancy from being increased to any conceivable extent.’22

The same, as well as many other, strictures apply to a variant of Fullarton’s and others in the banking school, which, again stemming from the anti-bullionists, held that banks can never over-issue notes provided that their notes are only issued in the course of making short-term, self-liquidating loans matched by inventories of goods in process – the so-called ‘real bills’ doctrine.

Torrens’s role in the currency vs banking controversy has a fascinating reverse symmetry with the path taken by Tooke. Whereas Torrens began as an anti-bullionist and apologist for the Bank of England, and now ended as a currency schoolman and opponent of bank credit inflation, Tooke began as a solid bullionist yet ended his days as a pro-bank, anti-bullionist.

Among the various grave inconsistencies in the banking school approach, one particularly stands out: if it is true that banks can do no wrong (at least in a convertible currency), that they cannot over-issue notes or over-expand credit, and that even if they did it could have no effect in raising prices or causing a business cycle, then why not adopt free banking? Why have a privileged monopoly like the Bank of England? Yet the banking school remained a determined enemy of free banking and devoted apologists for the bank. Thomas Tooke’s most famous dictum was the striking: ‘Free trade in banking is synonymous with free trade in swindling.’ Fair enough. But, if we analyse this pronouncement logically and we find that banking is synonymous with swindling, then what is the rationale for placing the power of state privilege behind a monopoly ‘swindler’? Even if banking is swindling, isn’t ‘competitive swindling’ better than a state-privileged and dominant monopoly swindler? And yet Tooke fiercely fought to preserve the bank and its exclusive privileges in London and environs; his only proposed reform was to induce the bank to hold a higher reserve of specie to liabilities.

The one contribution of the banking school was to continue to emphasize -what Torrens knew but Loyd and Norman did not – that bank notes and bank demand deposits were equal and coordinate parts of the supply of money. Because of their grave error on this point (in Torrens’s case to dismiss deposits as always in a fixed ratio to notes), the currency school, and its embodiment in Peel’s Act, left deposits as the big hole in their attempt to make the money supply conform to movements in gold. As we have noted, the currency school counterparts in the United States did not make that error.

Free trade and laissez-faire thought was growing in dominance in Great Britain during this era, led by the intrepid merchants, manufacturers and publicists from Manchester. But where to stand on the vexed question of banking? Should banking be free or is fractional-reserve banking really ‘swindling’ and therefore different from normal honest enterprise? Was Chancellor of the Exchequer Thomas Spring Rice correct when he stated in Parliament in 1839 ‘I deny the applicability of the general principle of freedom of trade to the question of making money?’

Of one thing the men of Manchester were certain: there was no quarter to be given the Bank of England. Thus, John Benjamin Smith, the powerful president of the Manchester Chamber of Commerce, reported to the chamber in 1840 that the crisis of 1839 was caused by the Bank of England’s contraction, following inexorably from its own earlier ‘undue expansion of the currency’. Smith denounced the ‘undue privileges’ of the bank as the source of its control over the nation’s economic life. Testifying before Parliament that year, Smith endorsed the currency school by criticizing the fluctuations of note issues by all the banks as well as the Bank of England, and went on to state: ‘it is desirable in any change in our existing system to approximate as nearly as possible to the operation of a metallic currency; it is desirable also to divest the plan of all mystery, and to make it so plain and simple that it may be easily understood by all.’ Not only did he thus endorse the currency principle; he went further to endorse Ricardo’s scheme of creating a governmental national bank for the purpose of issuing bank notes.23

A similar course was taken by Richard Cobden, the shining prince of the Manchester laissez-faire movement. Attacking the Bank of England, and any idea of discretionary control over the currency, Cobden fervently declared:

I hold all idea of regulating the currency to be an absurdity; the very terms of regulating the currency and managing the currency I look upon to be an absurdity; the currency should regulate itself; it must be regulated by the trade and commerce of the world; I would neither allow the Bank of England nor any private banks to have what is called the management of the currency... I should never contemplate any remedial measure, which left it to the discretion of individuals to regulate the amount of currency by any principle or standard whatever...

Rejecting both private and central bank management, Cobden was perceptive enough to see that the goal was not free banking per se, but to have a currency that mirrors genuine market forces of supply and demand: i.e. the fortunes of gold or silver money. He saw that the currency principle aimed to do just that, and hence his endorsement. And while his support for a government national bank of issue was too much like leaping out of the frying pan into the fire, it was understandable in the light of his refusal to trust the Bank of England to cleave to the currency path: ‘I should be sorry to trust the Bank of England again, having violated their principle [the Palmer rule]; for I never trust the same parties twice on an affair of such magnitude.’

7.6   The renewed threat to the gold standard

Thus a consensus was building rapidly after the crisis of 1839 on behalf of the currency principle. But perhaps the precipitating factor in bringing Sir Robert Peel and the Establishment to enact the principle was a renewed threat to the gold standard. The gold standard had been the agreed-upon consensus of all parties since the 1820s and since the return to gold the assaults of inveterate statists and inflationists like Birmingham’s Attwood brothers had faded away. But now, under the stimulus of economic crisis, fiat paper agitation and other inflationist threats to the gold standard surfaced once again.

If Manchester was the home of laissez-faire and sound money, Birmingham, its sister manufacturing town in the North, had long been the home of state-sponsored inflationism. Economic recession struck the Birmingham area in 1841, and Birmingham moved once more to a powerful attack upon gold. Thomas Attwood himself had retired from Parliament two years before, but Birmingham’s representatives were more than willing to take up the old cause. Attwood had been replaced by merchant and manufacturer George Frederick Muntz, who agreed with the former’s currency views; and Richard Spooner, the Tory whom Muntz had defeated for the seat, was an inflationist and a banking partner of Attwood’s.

The following year, the Birmingham Chamber of Commerce, presided over by Richard Spooner, launched a furious campaign pressuring the prime minister, Sir Robert Peel, into going off gold. Muntz put out a new edition of an old anti-gold tract and, roaring back to the wars, Thomas Attwood, as might be expected, published articles and wrote numerous letters on his currency nostrums.

The most influential of this outpouring of Birmingham inflationism was the Gemini Letters, published anonymously by Thomas B. Wright and John Harlow of Birmingham, first as 35 letters in a country newspaper during 1843, and then in book form the following year as The Currency Question: The Gemini Letters. The Gemini plea was straight, proto-Keynesian, inflationism: inconvertible paper money should be issued by the government, in sufficient amount to stimulate consumer purchasing power and ensure full employment. In addition, the public debt should be inflated away. Thus, as Wright and Harlow put it:

The proper plan, it appears to us, is to raise the capacity of the consumer, by securing high wages and ample profits, and by these means making light the fixed national obligations of the people... The only limit they would affix to the issue of paper money would be the degrees of prosperity which the different amount of issues would produce...

There is every reason to believe that the Gemini Letters and the Birmingham agitation were influential throughout the country. Henry Burgess and his committee of country bankers used the interchanges between the Birmingham Chamber and Robert Peel to denounce the gold standard. Both the Times and the new weekly Economist were forced to expend a great deal of energy in defending the gold standard from its ‘unsound’ enemies. At any rate, it is known that Peel owned a copy of The Currency Question and marked key passages in the book.

The threat to gold was reinforced by a renewed agitation to dump gold for a bimetallic gold-silver standard. Heedless of the fact that bimetallism never works in practice (since Gresham’s law pushes the undervalued metal out of circulation and encourages the overvalued), the pro-silver forces found in bimetallism a way to support monetary inflation while remaining respectably in favour of precious metals as money. Silver supporters therefore began with a core from the fiat paper group, including Spooner, Matthias Attwood, George Muntz and Henry Burgess, and added numerous bankers and businessmen, such as Richard Page, Henry W. Hobhouse, chairman of the committee of country bankers, William D. Haggard, and the eminent banker Alexander Baring, now Lord Ashburton.

7.7   Triumph of the currency school: Peel’s Act of 1844

At the heart of the triumph of the currency principle in Peel’s Act of 1844 was one man: the statesman and political genius Sir Robert Peel.24 Peel has been habitually derided by historians as a confused middle-of-the-roader, a ‘flexible’ political opportunist, at best a transitional figure unwittingly performing the historical function of ushering in the Conservative and Liberal party system in England. But, as Professor Boyd Hilton has helped to point out, Peel was a far different figure: a statesman in the best sense, a Tory liberal who was consistent and even unyielding in principle and purpose, and flexible and ‘entrepreneurial’ only in attaining the best tactics to arrive at his fixed ideological goals. As Hilton has demonstrated, in every important sense, economic, financial and moral, Robert Peel was the John the Baptist, the founder, the ‘progenitor of Gladstonian liberalism’.25

During the 1820s, Peel was for most years head of the Home Office in Tory governments. He had long been opposed to Catholic emancipation, and had even resigned his Cabinet post in 1827 in protest at the accession to the prime ministry of George Canning, head of Tory liberalism and champion of Catholic rights. Two years later, however, after the death of Canning, Peel, back as home secretary, was converted to Catholic emancipation as part of his ever-increasing devotion to the classical liberal, laissez-faire cause. At his conversion, Peel had the good grace to honour the prophets and warriors for Catholic emancipation whom he had opposed for so long: Fox, Grattan and Canning himself.

From 1831 on, Peel headed the Tory, now Conservative party, and also was the heart and soul of the liberal faction of the party. Peel’s great prime ministry took place in 1841–46. Here he fought vigorously for a peaceful foreign policy, battling against the pro-war, imperialist Palmerston wing of the Liberal party, and managed to conclude peace with the United States in the menacing Oregon boundary controversy. Peel also managed to lower tariffs, but lost in his fight for all-out free trade. His great accomplishment on that front was victory over the furious opposition of the Tory agriculturalists led by Benjamin Disraeli, in the complete repeal of the infamous Corn Laws which had for decades established an enormous import tariff on wheat. In this fight against the artificially high price of food, Peel was spurred by the growing famine in Ireland. Again gracious in victory, Peel hailed his political opponent, the laissez-faire Liberal Richard Cobden, as the true architect of the repeal of the Corn Laws. For his success, Peel’s government was toppled by Disraeli, and he died in a hunting accident four years later, in 1850.

Robert Peel’s proudest achievement, however, was his banking reform, his Act of 1844. The Bank Charter Act of 1833 had provided for possible change in the charter during 1844, so that was the year of potential banking reform. As recent research has revealed, Peel’s Act did not originate as a hostile ‘strait-jacket, fastened on a reluctant (though subsequently complacent) Bank by the efforts of the Currency School’. Rather the Act came from within the bank itself, ‘as an attempt by the Bank to find for itself a short-cut to currency management’, as well as a means of obtaining its long-sought monopoly over bank note issue.26 First, the ardent currency school leader, George Warde Norman, had, as a bank director, been promoting the plan since 1838. Although Norman lost within the bank on his currency proposal in 1840, he persisted, and the following year he became part of a five-man standing committee of the bank to discuss the scheme. By January 1844, William Cotton, the governor of the Bank of England, and a member of the standing committee, had been converted to the currency plan, and when, in early January, Peel asked Cotton and the deputy governor, J.B. Heath (also a member of the standing committee) to confer with him and Chancellor of the Exchequer Henry Coulburn about fundamental banking reform, Cotton was ready.27 In response to these discussions, Cotton and Heath, on 2 February, submitted to Peel the complete outline of what was soon to become Peel’s Act.

In essence, Peel’s Act established the currency principle. It divided the Bank of England into an issue department, issuing bank notes, and a banking department, lending and issuing demand deposits. True to the rigid currency school separation of notes and deposits, deposits would be totally free and unregulated, while notes would be limited to a ceiling of £14 million matched by assets of government securities (roughly the extent of existing note issue). Any further notes could only be issued on the basis of 100 per cent reserve in gold. The second main provision was to grant the Bank of England its long-sought monopoly of the note issue. This was not done immediately, but to be phased in over a period of time. Specifically: no new banks were to issue any bank notes, existing banks were to issue no further notes, and the Bank of England might contract with bankers to buy out their existing notes and replace them with the bank’s own. In this way, private bank notes were ‘grandfathered’ in, and the private (that is, joint-stock plus country) banks were neatly cartellized, under the direction of the bank, with the private banks able to keep out all further competition. This ‘grandfather’ cartel clause was not only designed to make the transition to the new order gradual; its main effect, and presumably its intent as well, was to bring the private banks – which might be expected to be the chief opponents of the new bill -around to become enthusiastic supporters.

In his manoeuvring within the Cabinet before publicly presenting Peel’s Act, the prime minister made it clear that ‘if we were about to establish in a new state of society a new system of currency’, he would have preferred the Ricardian plan of government notes, with no Bank of England or any other bank notes allowed; but that this plan would be impracticable in the existing state of the real world, where a coalition must be built among such contending forces as the bank itself, Ricardians, free bankers and country bankers. The desideratum, Peel shrewdly advised, was to ‘determine to propose the course which they may conscientiously believe to reconcile in the greatest degree the qualities of being consistent with sound principle and suited to the present condition of society’.

News of Peel’s coming bank charter bill had spread by the end of February, and the country banks, as expected, vigorously protested the bill during March and April. Finally, Peel introduced the bill to Parliament on 6 May. Shrewdly splitting his opposition, he applied the bill fully only to England. The ban on new banks issuing notes was extended to Scotland and Ireland, but the limitations on existing banks were applied to England alone. For the rest, Scotland and Ireland were left alone for the time being.

The introduction of Peel’s bill touched off a flurry of controversy, including a pamphlet war over the Act. In particular, the new controversy gave rise to the banking school, which beforehand had been represented only by Tooke. Tooke weighed in with an Inquiry into the Currency Principle, and John Fullarton entered the fray with his aforementioned pamphlet, On the Regulation of Currencies, a widely circulated and influential tract even though it was published in August 1844, after the passage of Peel’s Act. S.J. Loyd published a defence of the bill, while the formidable Colonel Torrens blasted Tooke in another pamphlet.

The new banking school was noteworthy for being more royalist than the king, more favourable to the Bank of England than the bank itself. In short, the banking school, along with most of the London bankers, favoured the vesting of a monopoly of bank note issue in the Bank of England. Its quarrel was solely with currency principle restrictions on the bank’s issue of notes. This was surely the kind of opposition that the Bank of England could live with. While the banking school correctly spotted the main weakness of the currency school in not treating notes and deposits alike, this objection was scarcely directed to extending any sort of reserve requirements to bank deposits as well as notes. On the contrary, they would have been all the more outraged by, say, a consistent Peel’s Act that would have placed a 100 per cent reserve requirement on all further bank liabilities, deposits as well as notes.

One bit of curiosa about the emergence of the banking school is the lateness of its arrival; coming as it did almost when the fight over Peel’s Act was over, and flourishing for a while after, its importance was more for raising theoretical issues and for raising the interest of historians of economic thought than in actually influencing the political battle.

Another noteworthy aspect of the fray was the advent of a new and important star in the economic firmament: John Stuart Mill (1806–73), who joined the banking school side of the debate in an anonymous article, ‘The Currency Question’, in the radical Westminster Review. Actually, Mill had foreshadowed the banking school in an article written at the age of 20, ‘Paper Currency and Commercial Distress’, in the short-lived radical Parliamentary Review. Like so many others, Mill was first moved to turn his attention to banking and business cycles by the economic and financial crisis of 1825–26. But in contrast to many others, he abandoned instead of extending his basic Ricardianism in this area.28 Instead of seeing the new phenomenon of business cycles as created by monetary disturbances, he saw them as caused by waves of ‘speculation’, presumably generated by over-optimism. Money and banks were purely passive respondents to fluctuations in the economy. From this there followed his conclusion that movements in the money supply, at least under a gold standard, had no effect on prices or trade. Within the framework of a gold standard, prices rose first, dragging the money supply upwards, and later fell, pulling the money supply down.

How could Mill square this odd doctrine with his overall Ricardianism and its thesis of the influence of the supply of money upon its value? He did so by an ingenious, though bizarre and fallacious, theory of what constitutes the supply of money. The money supply was made up, not only of coin, notes and demand deposits, Mill opined, but also of the ‘credit-worthiness’ of every member of the public. When a bank made loans to some member of the public, then, it might increase notes or deposits outstanding, but that increase is exactly compensated by a decrease in the ‘credit-worthiness’ of the borrowing citizens. Therefore, when banks lend money to individuals and businesses, the money supply does not increase at all. On the contrary, when banks purchase government securities or finance its deficit, they add directly to the total money supply by the same amount. In fact, they even add to the money supply when they lend to private citizens beyond the degree of their genuine credit-worthiness. How is such ‘credit-worthiness’ to be determined? By banks confining their loans to sound borrowers, and to the discounting of ‘real bills’, that are short-term, matched by inventories of goods in process, and are therefore self-liquidating in a short period of time. Bank credit then happily follows the ‘needs of trade’ upwards or downwards, and cannot raise prices. While completely fallacious, Mill’s theory at least had the merit of providing some plausible, logical explanation for the banking school creed -one that was scarcely matched by any of his colleagues.

Furthermore, Mill’s doctrine provided a good reason for his devotion to the gold standard, and for his bullionist denunciation of inconvertible fiat money. Within his theory, if government or the central bank issues inconvertible fiat paper, that paper adds directly to the money supply and to inflation rather than being neutralized by subtracting from credit-worthiness. And devoted to the gold standard he remained. We have already seen Mill’s denunciation of Thomas Attwood’s inflationary fiat paper scheme in 1833.

And what of the alleged free banking school, which Professor White has put forward as equally strong and vibrant to, and strictly separate from, the rival currency and banking schools? As White himself ruefully admits, they were nowhere to be found, their alleged devotion to free banking failing the most acid of all tests, when Peel’s Act was about to bring all commercial banks under Bank of England control. For not only would the bank now have a virtual monopoly of note issue, but in order to obtain notes in exchange for cashed-in deposits, the other banks would now be obliged to keep the great bulk of their reserves at the Bank of England. White tries to explain away the defection of the free bankers as having been bought out by Peel’s cartellization-‘grandfather’ clause: for the banks could continue to issue at their current level and no new competing banks would be permitted. But while this explanation is true enough, it raises the crucial question: how devoted were Professor White’s heroes to free banking to begin with? Wasn’t the free banking school simply a group devoted to the economic interests of the private commercial banks?

Take, for example, the newly founded The Bankers’ Magazine, which had supposedly been a leading mouthpiece for free banking for the previous year. A writer in the June 1844 issue, while critical of the currency principle and the move towards monopoly issues for the bank, frankly approved the Peel Act as a whole for aiding profits of existing banks by prohibiting all new banks of issue.

And let us take in particular James William Gilbart (1794–1863), leading spokesman for the country bankers, manager of the London & Westminster Bank, and, according to Professor White, one of the main theoreticians of the free banking school. Gilbart, born in London and descended from a Cornish family, had worked all his life as a bank official and had written works on banking since the late 1820s. Since 1834, he had been manager of the London & Westminster Bank, continually clashing with the Bank of England. Despite Professor White’s assurance that the free banking school men were even more fervent than the currency men in attributing the cause of the business cycle to monetary inflation, Gilbart held, typically of the banking school, that bank notes simply expand and contract according to the ‘wants of trade’, and therefore such notes, being matched by the production of goods, could not raise prices. Furthermore, the active factor goes from ‘trade’ to prices to the ‘requirement’ for more bank notes to flow in the economy. Thus Gilbart: ‘if there is an increase of trade without an increase of prices, I consider that more notes will be required to circulate that increased quantity of commodities; if there is an increase of commodities and an increase of prices also, of course you would require a still greater amount of notes.’ In short, whether prices rise or not, the supply of money must always increase! One wonders who the ‘you’ is who would have such requirements. On the free market, on the contrary, if there is an increase in the production of commodities, prices will tend to fall and not rise; furthermore, increased production of trade does not ‘require’ or call forth an increase in bank money. The causal chain is the other way round: increased bank note issue raises the money supply and prices, and also the nominal money value of the goods being produced.

All historians of economic thought except for Professor White have placed Gilbart squarely in the banking school camp as one of its leaders. Since White seems to agree with Gilbart’s fallacious ‘wants of trade’ analysis, and since he admits that this creed is similar to that of the banking school, his creation of an important new school of ‘free banking’, challenging both of the others, appears all the more tenuous and artificial. The main difference seems to be marginal and political: while all the banking school hailed the banking system as useful and harmless, most of them laid special honours on the Bank of England, while Gilbart, as a joint-stock banker himself, placed most approval upon the commercial banks.29

When it came to the test, then, Gilbart, like his colleagues on The Bankers’ Magazine, caved in on what Professor White alleges to be his free banking principles. Thus White concedes:

He [Gilbart] was relieved that the act did not extinguish the joint-stock banks’ right of issue and was frankly pleased with its cartellizing provisions: ‘Our rights are acknowledged – our privileges are extended – our circulation guaranteed -and we are saved from conflicts with reckless competitors’.30

James Gilbart’s open status as a banking school inflationist and Robert Peel’s staunch devotion to hard money were both revealed in Peel’s questioning of Gilbart when the latter testified that country bank notes are only issued in response to the wants of trade, and therefore that they could never be over-issued. He also claimed that the Bank of England could never over-issue so long as it only discounted commercial loans and did not buy government bonds.31 At this point, Sir Robert Peel unerringly zeroed in and drew forth Gilbart’s apologia for the banking system. Peel: ‘Do you think, then that the legitimate demands of commerce may always be trusted to, as a safe test of the amount of circulation under all circumstances?’ To which Gilbart admitted: ‘I think they may.’ (Nothing about exempting the Bank of England from that trust.) Peel then asked the critical question. The banking school all claimed to be devoted to the gold standard, so that the ‘needs of trade’ justification for bank credit did not apply to inconvertible currency. Peel, suspicious of that devotion to gold, then asked: in the bank restriction days, ‘do you think that the legitimate demands of commerce constituted a test that might be safely relied upon?’ To which Gilbert evasively replied: ‘That is a period of which I have no personal knowledge.’ This was a particularly disingenuous point coming from the author of The History and Principles of Banking (1834). Moreover, the issue is of course a theoretical one, and no ‘personal knowledge’ is necessary to make a reply – a point made immediately by Peel. At which point Gilbart threw in the towel on the gold standard: ‘I think the legitimate demands of commerce, even then, would be a sufficient guide to go by...’. When Peel pressed Gilbart on the point, Gilbart began to vacillate, changing his views, returning to them, and then again falling back on his lack of personal experience.32

Peel was right in being suspicious of the strength of the banking school’s devotion to gold. Apart from Gilbart’s damaging revelations, his colleague at the London & Westminster Bank, J.W. Bosanquet, kept urging bank suspensions of specie payment whenever times became difficult. And while Thomas Tooke often proclaimed his abhorrence of the Birmingham school, he wrote in 1844 that a crucial limit on any over-issue of bank notes was the needs of trade in addition to gold convertibility. The opening was sufficient to allow Robert Torrens to score a palpable hit:

After a careful examination of Mr. Tooke’s recent publication, [1844] I cannot discover any very essential or practical difference between his principles and those of the Birmingham economists. Once deviate from the gold rule of causing the fluctuations of our mixed circulation to conform to what would be the fluctuations of a purely metallic currency and the flood-gates are opened, and the landmarks removed. Between the abandonment of a metallic standard as recommended by the Birmingham economists, and the adoption of arrangements hazarding the maintenance of a metallic standard recommended by Mr. Tooke, the difference in the practicable result might ultimately be nothing.33

John Fullarton’s admission was even more damaging than Tooke’s, avowing, in his popular 1844 tract, that he wholeheartedly agreed with the ‘decried doctrine of the old Bank Directors of 1810’ – namely, the anti-bullionist position that so long as any bank sticks to short-term real bills ‘It cannot go wrong in issuing as many [notes] as the public will receive from it’. And of course 1810 was a year of inconvertible money. It is no wonder that Robert Peel considered all opponents of the currency principle as essentially Birmingham men.

Thus the opposition to Peel’s Act, while theoretically important, was politically scattered and ineffective. The bill sailed through overwhelmingly, and became law on 19 July. A second Peel bill, designed to make it more difficult to establish new joint-stock banks, sailed through in September. The result of this tightening of bank control and monopoly as well as cartel privileges to existing banks, was, indeed, the creation of virtually no new joint-stock banks in England for the next eight years.

At this point, Peel completed his currency task by extending its sway to Scotland and Ireland in two bills that became law on 21 July 1845. Cautious in the face of regional traditions, Peel was not as tough on the Scottish and Irish banks as he had been on the English. Whereas the English commercial banks could issue no more bank notes period, the Scottish and Irish banks were treated as Peel’s Act of 1844 treated the Bank of England: their further bank note issues were limited to 100 per cent gold reserves. Scotland had never had its banking restricted, having been free to establish joint-stock banks and issue notes and deposits throughout Scotland. The Scottish bankers, however, like Gilbart and the English bankers, were easily bought off by cartel privileges even more lucrative than in England. As White admits, ‘Peel in essence bought the support of all existing banks by suppressing potential entrants and competition for market shares’.34 In addition, Peel shrewdly permitted the Scottish banks to keep the privilege, denied to English banks (including the Bank of England) since the 1820s, of continuing to issue their cherished small (£1) notes.

The only important development in the year between the two Peel’s Acts was the highly belated entry into the great debate of a new leader of the banking school, James Wilson, founder and editor of the notable new journal, The Economist. Wilson (1805–60)35 had founded The Economist for the express purpose of battling for free trade and laissez-faire. He criticized Peel’s Act when it came up in 1844, but devoted most of his energies to free trade. Finally, in the Spring of 1845, Wilson wrote a famous series of nine articles on ‘Currency and Banking’ in The Economist, attacking the extension of Peel’s Act to Scotland and Ireland. Wilson took an orthodox banking school approach, except that each of his positions was so emphatic that the inner inconsistencies and contradictions of the banking school were brought out particularly starkly. Thus Wilson was far more emphatic and militant than Tooke or Fullarton about the importance of preserving the gold standard, so much so that Torrens was later to call Wilson ‘the most able of the opponents of the act of 1844’,36 And yet, of the Big Four of the banking school (Tooke, Fullarton, Mill and Wilson), Wilson was the only one who stated flatly and clearly that short-term, self-liquidating real bills would be sufficient to protect the banks from over-issue, even without specie convertibility. Thus, Wilson declared that

inconvertible paper notes might be issued to any extent that legitimate transactions required them, provided such issues were confined to the discount of good bills of exchange, and to loans for short periods, without any risk of depreciation, because a larger quantity never could be so issued than was again shortly returnable to the bank in payment of such loans.37

In addition, of all the Big Four Wilson was the friendliest to free banking and desirous of saving the alleged free banking system in Scotland.38 And yet he also claimed that the Bank of England could never over-issue in a convertible money system, which was quite the opposite of the free banking approach.

7.8   Tragedy in triumph for the currency school: the aftermath

As the Jacksonians and other currency counterparts in the US might have predicted, the currency school harboured a tragic flaw, an Achilles’ heel that laid them low and turned their triumph into ashes: the neglect of bank deposits as a coordinate part of the money supply. And so, no sooner had Peel’s Act been passed, when the Bank of England, happily ensconced in its briar patch of monopoly, central control, and note restriction but deposit freedom, began to expand its loans and deposits ad libitum. At the end of 1844, bank discounts had been £2.1 million and total bank credit £21.8 million. By the end of February 1846, however, bank credit expansion had been so intense that its discounts totalled £13.1 million and total credits £35.8 million. In short, in only a little over a year, total bank credits had risen by 64 per cent, and discounts by a phenomenal 424 per cent. This expansion was aided by the bank’s drastically reducing its discount rate from 4 per cent to 2V2 per cent, not only a huge quantitative reduction, but also a lowering of the rate from its traditional ‘penalty rate’ above the market, to the market interest rate, thereby greatly stimulating borrowing from the bank by banks and other debtors.

Notes of the Bank of England increased only mildly during this period; the huge rise, as we might expect, took place in bank deposits. In September, 1844, bank deposits totalled £12.2 million; by the end of February, 1846, they had doubled to £24.9 million. In the course of this enormous expansion, bank gold reserves fell sharply.

Most of this expanded bank credit poured into a speculative mania of investing in questionable new domestic railroads. In the years 1845 and 1846, over £180 million of new railroad construction was authorized, about double the total of the entire previous decade. Looking back on the period a few years later, The Economist referred to the ‘mad scenes’ of 1845 and 1846, and to

the folly, the avarice, the insufferable arrogance, the headlong, desperate, and unprincipled gambling and jobbing, which disgraced nobility and aristocracy, polluted senators and senate houses, contaminated merchants, manufacturers, and traders of all kinds, and threw a chilling blight for a time over honest plod and fair industry.

The bank tried feebly to stem the tide during the first half of 1846, but no sooner did bank reserves increase, than the bank, which had raised its discount rate to 3 1/2 per cent in November 1845, dropped it back to 3 per cent the following August. Bank reserves then resumed their steep decline, falling from £10 million in August 1846, a ratio of specie to notes and bank deposits of 58 per cent, to only £3.0 million in April 1847, a ratio of only 20 per cent.

Again, the bank tried to check the tide it had created and continued to generate, but too little and too late. Interest rates rose with the inflationary boom, so that an increase of the bank discount rate to 4 per cent in January 1847 left the rate still under the market, and between 9 January and 10 April, total bank credits rose by £4.5 million and discounts by £3.8 million.

By April 1847, the Bank of England, as well as the entire financial and economic system, was in deep crisis: it increased its rate to 5 per cent, but market rates were now up to 7 per cent. Rejecting efforts by a minority of bank directors to raise the rate to 7 per cent, or even to 6, the bank made things much worse by keeping its rate at 5 and then rationing credit, suddenly cutting off discounts, calling in loans, and refusing to increase loans regardless of the credit quality of the borrower. The bank’s refusal to raise rates and instead discriminate in favour of certain borrowers did not, however, save the commercial bank owned by the bank’s own governor, W.R. Robinson, from stopping payments in July, or the bank of two other directors from going under in September.

The bank’s sudden contraction, cessation of loans and credit rationing caused a severe business and financial panic in April and May of 1847. This drastic therapy finally eased the bank’s own condition by the end of May, with the gold outflow temporarily reversing. By the beginning of July, the bank’s reserves had doubled from £3.0 million to £6.0 million, a reserve ratio to deposits of 32 per cent. But no sooner had the pressure eased than the bank began to expand again, in the meanwhile making things worse by keeping its discount rate below the market and indulging in selective credit rationing. In September, the second great crisis of 1847 broke, and mercantile failures spread throughout September and October. Thomas Tooke lamented that ‘These mercantile failures, in number and in the amount of property involved in them, were unprecedented in the commercial history of this country’. In October, the banks began to break, and bank runs began to spread through the provinces. As a result, the frightened banks began to contract their credit and deposits drastically, in order to increase greatly their percentage of reserves. The reserves of the Bank of England were down sharply once again, to less than 14 per cent of deposits. At that point, the Bank of England threw in the towel, and, for the first of many crises, requested the government to suspend the 100 per cent gold reserve restriction on notes imposed by Peel’s Act. Delegations from Liverpool and the North, London private bankers, and members from Scotland also pressed hard for suspension of Peel’s Act. The country bank organ, Circular to Bankers, charged that the London bankers were considering breaking the Bank of England by redeeming all their deposits. One wonders, in that case, how the commercial banks themselves could have avoided being broken in turn. At that point, the government predictably, and, for the first of many crises, itself threw in the towel by suspending the Peel Act provision of 100 per cent gold reserve restrictions on the issue of Bank of England notes.

The government saved the fractional-reserve system by obediently suspending Peel’s Act on 25 October, thereby of course saving the day for the banks and alleviating the immediate crisis – at the expense of, in effect, giving up the currency principle and any attempt to tie the monetary and banking system directly to, and to the same extent as, the behaviour of gold. From then on, Great Britain, and eventually the rest of the world, was stuck with a fractional-reserve banking system issuing demand deposits, pyramiding on top of a central bank monopolizing the issue of notes and centralizing the nation’s gold, and generating an endless round of boom-bust cycles of inflation and recession. Furthermore, with gold essentially centralized into the reserves of the central banks, it became easy for all these nations, even though allegedly committed to the gold standard, to go off that standard and on to fiat paper whenever any crisis – such as World War I – presented an alleged need for the rapid inflation of money to finance the war effort.

The heart and soul of the currency principle was a rigid tie of Bank of England note issue to 100 per cent gold reserve; but if this restriction was to be suspended whenever banks or businesses got into trouble, then the currency principle lay in shambles. As the prominent London banker George Carr Glynn correctly prophesied after the 1847 suspension, the public would expect another suspension in every future crisis. And sure enough, that is precisely what happened. In response to the 1847 crisis, there were committees of parliamentary inquiry in 1847 and 1848. The suspension of Peel’s Act during the crisis of 1857 was easier, and while there were parliamentary committees in 1857 and 1858, there was, in contrast to the 1847 crisis, no debate on the floor of Parliament. And the suspension of Peel’s Act in 1866 was considered so routine that there was not even the bother of a parliamentary committee of inquiry.

It is therefore remarkable that, from the time of the first suspension in 1847, the currency school, without exception, defended the suspension of Peel’s Act, giving no sign of realizing that they were thereby abandoning their entire doctrine.39 For not only did suspension in crises weaken the point of the Act, but also the knowledge that suspension would come to the rescue in any crisis emboldened the bank and banking system to expand credit as if the restrictions of Peel’s Act did not exist at all. As a result, all that was left of the currency principle was the monopolization of notes by the Bank of England.

7.9   De facto victory for the banking school

It is a cliché that people are often appalled at the consequences of achieving their long-cherished goals. Because of the neglect of deposits, the enactment of the currency principle in Peel’s Act in no way moderated bank credit expansion or the boom-bust cycle. Given the dashing of their dreams, the currency school, as in the case of all ideologues whose god has failed, could take several alternative courses of action. The most courageous would have been to admit that their principle was deeply flawed, to concede defeat, and to go back to the drawing board. Unfortunately, human beings are so constituted that they rarely opt for this noble course. Certainly none of the currency school distinguished themselves in this crisis. Instead, they took the route that all too many schools of thought, including the Marxists, have travelled: stoutly proclaiming that their theory is in excellent shape, while subtly but vitally redefining what the theory is all about.

For example, before 1844, the currency school, especially Colonel Torrens, adopted a monetary theory of the business cycle. Economic fluctuations were generated by bank credit expansion, led by the Bank of England, which led to inflation and booms, after which the inevitable contraction brought about bankruptcies and recessions. No sooner did the cycle of 1844—47 occur, however, when the currency men backtracked, virtually joining their old enemies of the banking school. The banking school had always proclaimed that banks and the money supply were merely passive respondents to boom-bust cycles generated by non-monetary forces in the ‘real’ economy. Usually the culprit was mysterious waves of ‘speculation’, presumably driven by waves of over-optimism and over-pessimism. Now, the currency school, even Colonel Torrens, proclaimed that they had never, ever promised an end to the business cycle, which is, after all, governed by such non-monetary forces as speculation and over-optimism and pessimism. The most that regulation of the currency could do, the currency school now opined, is to eliminate whatever part of the business fluctuations were caused by movements of the money supply. And this, they staunchly affirmed, Peel’s Act had indeed accomplished. The business cycle of 1844–47 might have been severe, but it would have been far worse if Peel’s Act and the currency principle had not been in effect.

Thus Colonel Torrens, in numerous apologies for Peel’s Act, put the blame for the boom of 1844–46 on ‘overtrading’ and railway speculation, as if this speculation had come out of the blue and was not the consequence of cheap, expanding bank credit. He also mentioned that one aspect of the inflationary boom was ‘rapid conversion of floating to fixed capital’, that is, a sinking of liquid capital into an excessive amount of fixed, long-range investment. Again, there was no hint that it was excessive bank credit that had generated this over-investment.

It is revealing to compare two critiques by Torrens of Mill’s contention that the currency school claimed to be able to cure all business cycles and ‘commercial revulsions’. In 1844, in reply to Mill’s essay in Westminster Review, Torrens pointed out that the currency school claimed to eliminate not all revulsions but only those originating ‘in a currency fluctuating alternately above and below the level to which a purely metallic currency would perform’. But in his point-by-point 1857 critique of the banking chapter in Mill’s Principles, Torrens shifted the emphasis. Instead of paring down monetary-based fluctuations to gold currency, Torrens now claimed that most fluctuations began, not in over-issue by banks, but in disturbances not caused by money, which left the money supply out of harmony with the gold supply. Furthermore, Torrens was now easily able to cite Loyd and Norman in support. Loyd, too, now focused on the alleged non-monetary causes of fluctuations. Focusing, as the banking school had long done, on optimism and speculation, Loyd declared that ‘so long as human nature remains what it is, and hope springs eternal in the human breast, speculations will occasionally occur, and bring their attendant train of alternate periods of excitement and depression’.

Thus, with the currency school coming to agree with the banking school on the primacy of non-monetary, and the passive dependence of monetary, causes of the cycle, the way was paved for a de facto consensus between the two schools. Since the currency school seemed content with the existing system so long as it enjoyed the label of the currency principle, the money supply was now deemed passive enough. At the same time, the Bank of England had enough real discretion and flexibility to satisfy the banking school and reconcile it rather easily to the status quo. Thus James Wilson, a leading banking school critic of Peel’s Act, was readily able to vote for its continuance in the parliamentary committee of 1857–58. The banking school was content, in the British banking system of 1844–1914, to achieve the substance of their own creed while allowing the proud currency men to bask in the name. For their part, the currency men enjoyed the laurels of an empty victory: Norman, Torrens and Loyd (after 1850 made Baron Overstone), enjoyed great prestige while proclaiming the status quo a triumphant embodiment of their principles. The Bank of England’s directors were happy to embrace the supposedly restrictive currency creed, and new currency epigones relayed what had become standard doctrine: misinterpreting the existing system as currencylike, and ignoring the entrenching of the boom-bust cycle in economic life.40

With the currency school now committed to the banking school’s non-monetary, ‘overtrading’ theory of the business cycle, and with such hard-money and free-banking writers as Robert Mushet and Henry Parnell gone from the scene, the currency analysis of the business cycle disappeared by default. Of the banking school analysts, the most important elaboration of the non-monetary cycle theory was that of James Wilson, in his Capital, Currency, and Banking (1847).41 Wilson developed what might be called a non-monetary over-investment theory, which foreshadowed the later Austrian cycle theory but lacked the crucial monetary causal element. He focused on railroad over-investment as the cause of the 1844–47 cycle, and persistently predicted a crisis based on his analysis from 1845 until the time of the crash.

In Wilson’s brilliant analysis, the boom begins with the excessive investment of savings in fixed capital. Savings are ‘floating’ or circulating capital, the wages fund that goes into the hiring of workers and buying of raw materials. But because of a sometime propensity to overtrade, businesses may invest in fixed capital beyond the annual supply of savings. Too many money savings are poured into the production of fixed capital, whereas too few are used to produce consumer goods. In short, the boom is characterized by an undue shift of resources from consumption goods to capital goods. The increased expenditure on fixed investment of capital – in the 1845 case heavy railroad investment – on the other hand, increases wages in the hands of consumers. But as the consumers come to spend their wages on a lower supply of consumer goods, the price of consumer goods will inevitably rise. In short, consumption and investment have become excessive in relation to the savings available. In response to the rising prices of consumer goods, consumer goods producers will attempt to expand output and thereby increase their demand for capital, i.e. their demand for loans. But the dearth of savings in relation to the demand for capital will bring about a rise in the rate of interest, and the sharp rise in interest rates will precipitate a recession. In short, the fixed investment-boom producers, in this case, the railways and suppliers of railway material, would be forced into a sharp scramble with the producers of consumer goods for suddenly scarce capital, and the resulting crisis and depression causes the abandonment or indefinite postponement of the excessive fixed investments. During the depression, excessive investment is abandoned, resulting eventually in recovery to a sound and normal condition.

Thus Wilson, in addition to seeing the unwise and excessive investment as well as the overconsumption and undersavings of the boom, demonstrated how the boom is the economic distortion that necessarily generates the unhappy but curative depression that finally restores a sound economy. He also saw how a rise in interest rates, as a signal of overconsumption and undersaving, brings about the restorative recession. In addition, he realized that a lack of savings was a key to the recession and concluded that greater savings would help speed the recovery.

While there is surely over-investment in the higher orders of capital goods during a boom, Wilson misfired when making his sharp distinction between floating and fixed capital. To Wilson, money savings going into fixed capital are somehow lost or ‘sunk’, and thus disappear from the payment of wages. The problem is not in fixed vs floating capital, however, but consumption as against over-investment of all types in the higher orders of capital – whether in fixed plant or greater inventory of raw materials.

But the greatest problem in Wilson’s discussion was his neglect of money. Money, he believed, was merely a device for facilitating exchanges, and therefore could never be a cause of economic fluctuations, but only an effect. And yet, if money was not involved, where do the railway firms get the new money to spend, even though savings have not risen? The only answer, which Wilson neglects, is an increase in money and bank credit loaned to those firms. And, if the money supply has not increased, why are the increases of wage payments by railway firms and other capital producers not offset by declines of wage payments in consumer industries? In short, why does the general level of prices increase from the beginning of the boom? Why don’t consumer prices at least initially fall? The answer, once again, is the increase in the supply of money and credit that generates and fuels the boom. And finally, why can’t the general run of businessmen, including the railway magnates, realize that their investments are outrunning savings, and why does the eventual critical rise in interest rates come as a shock? The answer, once more, is that the expansion of bank credit artificially lowers the interest rate, and lures business firms into the fatal over-investment.

Despite the fact that Wilson insisted that a quantity of money must not be confused with capital, he yet fell into the old Smithian trap of considering the supply of gold as ‘idle and unproductive’ capital, and so he believed that capital could be increased, and the depression greatly eased, by government issue of £20 million of small, £1 notes, which would replace the ‘idle and unproductive’ £20 million of gold in circulation. This huge issue, Wilson assured his readers, would not be inflationary because it would simply add to capital; and besides, he added smugly, no inflation could exist since the paper notes would continue to be convertible into gold. But what sort of gold convertibility, what sort of gold standard, exists when gold is supposed to disappear from circulation? The lesson is that, regardless how much devotion is professed to laissez-faire or the gold standard, at the heart of every banking school man, including those professing a free banking position, lies an unreconstructed inflationist.

In his Principles of Political Economy (1848), John Stuart Mill set forth a cycle theory that blended Wilson’s analysis with a Tookean emphasis on commodity speculation, and unfortunately brought in the Ricardian gloom about the alleged inevitable tendency toward a falling rate of profit as agriculture yields ever lower returns. Mill, in short, fused the standard Tooke-banking school emphasis on speculation, over-optimism, and overtrading with Wilson’s analysis of the conversion of circulating into fixed capital. Once again, the doctrine was non-monetary, with money playing a passive, non-essential, and at best secondary role. Thus Mill adopted Wilson’s railroad investment theory of the cause of the recent 1845–47 cycle. The Ricardian motif led Mill to anticipate Schumpeter and hail the inflationary boom as necessary and vital to the achievement of economic growth, by enabling a periodic escape from the falling rate of profit. As a result, Mill was among the first to develop the idea that business fluctuations tend to repeat as recurring cycles, a process which he considered beneficial. He was not worried about recessions, since the contraction and Say’s law ensured a rapid return to full employment and prosperity.

There was another important reason for the effective fusion of the currency and banking schools after the enactment of Peel’s Act. Both these groups, after all, were dedicated to retention of the gold standard as their top monetary priority, even though the banking school version tended to be highly attenuated. But as soon as the great crisis of 1847 occurred and brought monetary and banking controversy back to Britain, the ultra-inflationist opponents of the gold standard came on the attack, calling either for fiat money inflation or, at best, a bimetallic gold/silver standard. In the face of this onslaught, the currency and banking schools closed ranks, which largely accounts, for example, for James Wilson’s voting to retain Peel’s Act in 1858.

In fact, it took no more than the crisis of 1847 to encourage the men of Birmingham to resume their assault on gold. Matthias Attwood’s old fiat money pamphlet was promptly reprinted, a Birmingham delegation headed by George Frederick Muntz called upon the prime minister, and the Birmingham Currency Reform Association sent a memorial to the queen. The Times felt called upon to denounce the Birmingham men in an editorial and T Perronet Thompson warned a friend of an increasing flow of ‘half-mad pamphlets from Birmingham’. And other sectors in the north of Britain joined in the cry. The Liverpool Currency Reform Association was active enough to be denounced in two issues of The Economist, and Scotland revealed its inflationist bent by an anti-gold article in the Tory Blackwood’s Edinburgh Magazine. Furthermore, an organizing convention of the National Anti-Gold Law League was held in Glasgow and was attended by 3 000 people.

The threat of silver bimetallism also surfaced during the crisis of 1847. Particularly important was the powerful banker, Alexander Baring, now Lord Ashburton, always ready to ride his hobby horse of bimetallism, and a petition of a number of influential ‘Merchants, Bankers, and Traders of London against the Bank Act’. Wilson denounced the bimetallist doctrine of Ashburton and the London petitioners as ‘extraordinary’, and ‘most inexplicable and unreasonable’. So serious was the bimetallic threat considered that the two stalwarts of the currency school, Loyd and Torrens, collaborated in writing an anonymous pamphlet in a point-by-point rebuttal of the London petition.42 The telling thrust in the Torrens-Loyd polemic was to show that the logic of the bimetallist position pointed straight to the far more consistent, though far more dangerous, policy of Birmingham fiat money:

The Birmingham philosophers are consistent reasoners, and have the sagacity to perceive that an arbitrary extension of the paper circulation is incompatible with the maintenance of a metallic standard. The inferior logicians who have signed the London petition, while demanding the establishment of a double metallic standard, are unable to perceive that an extension of paper money through the exercise... of the relaxing power for which they pray would render impracticable the maintenance of any metallic standard.43

The high-water mark of the assault on gold came in votes in Parliament in 1848. In the Commons committee, the veteran radical leader Joseph Hume’s motion denouncing Peel’s Act for aggravating the crisis of 1847 was defeated by a vote of 13 to 11. The 11 supporters included a coalition of free banking remnants like Hume, inflationists and protectionists like the Birmingham Tory Richard Spooner, and bimetallists like Thomas Baring and Lord Bentinck. Furthermore, the report of the House of Lords committee criticized Peel’s Act and recommended watering down the restrictive provisions on bank notes. While the committees were deliberating, the veteran anti-bullionist John Charles Herries moved to repeal the limitations on bank notes of the Act of 1844 and all the Acts of 1845. Here was a rallying-point for all soft currency men of whatever stripe – Birmingham men, bimetallists, or soft gold men. Herries’s motion lost rather narrowly, by a vote of 163 to 142. The major speeches for the motion came not from the moderates, but from Birmingham men like Richard Spooner. In answer to Spooner, the great Robert Peel rose and pointed out that although Birmingham doctrine was in ‘a small minority’ within the House of Commons, outside the House ‘of those who talk about the currency, and write about the currency, the vast majority’, indeed ‘nine tenths’, agree with Spooner, that is, want ‘issues of paper without the check of convertibility’.

Whether Peel was over-reacting to what he considered expressions of evil, or whether his raising the spectre of Birmingham was a ploy to rally the troops, that tactic was successful, and Herries’s motion to consider the reports of the Lords and Commons committees, was defeated without even coming to a formal vote. From then on, for a decade, the spectre of Birmingham was enough to win the moderate gold men and the banking school to an all-out defence of the Peel Act status quo. During the mid-1850s, Wilson’s Economist followed this path, and the veteran currency man James Pennington wrote a worried letter to a friend that ‘There is just now a widespread clamour calling for repeal of that Act [the Bank Act of 1844] which clamour, if it prevails, will I think, be followed by a clamour, equally loud, for doing away altogether with the obligation of specie payments’.44

We may fittingly close our discussion of the aftermath of Peel’s Act by focusing on two important contributions, after the passage of the Act, by the wisest of the currency school, Colonel Robert Torrens. In the course of his critique in 1857 of the banking school chapter of Mill’s Principles, Torrens added another vital point in criticizing the view that banks, being passive, can have no power to increase their liabilities, and hence have no power to raise prices. Torrens trenchantly pointed out that Mill

excludes from his consideration the important fact, that banks possess in themselves the power of increasing and diminishing the demand for banking accommodation when they raise the rate of discount, the demand for accommodation contracts, and when they lower the rate it expands... and unless he is prepared to disprove the fact that banks can lower the rate of discount, he cannot consistently maintain that their power of increasing the issue is limited...

Amidst all the assaults on the Peel’s Act system, by Birmingham fiat money men, bimetallists, remnants of free bankers, and banking school adherents, it is remarkable that apparently not a single writer, parliamentarian, or man of affairs called for a tougher policy of plugging up the enormous hole in the currency system by extending the 100 per cent reserve principle to deposits as well as notes. Not a single currency man admitted any flaw in his previous position, nor advocated, like Jacksonians in the United States, pressing on to a full 100 per cent reserve position on all bank demand liabilities, including deposits. The closest that anyone came to this view was Colonel Torrens. In a poignant moment in the history of economic thought, in his last published work at the age of 77, Torrens wrote a review in the January 1858 issue of Edinburgh Review, of the collected Tracts and Other Publications on Metallic and Paper Currency by his old friend and ally Samuel Loyd, Lord Overstone, edited by John R. McCulloch. After eulogizing the contributions of Lord Overstone, and once again defending Peel’s Act, Torrens went on to try to explain the business cycle culminating in the recent crisis of 1857. In sharp contrast to his surrender a decade earlier to the banking school in blaming ‘overtrading’ for the crisis of 1847, Torrens now strongly affirmed that ‘Were there no overbanking, there could not be (except for brief periods) overtrading and excessive speculation’. And the overbanking, since Peel’s Act, clearly meant deposits. For Torrens could scarcely ignore the fluctuations that were occurring in the amount of bank deposits. Discussing deposit banking, Torrens emphasized that by creating new demand deposits through loans, the banks exerted ‘the same influence upon the markets as an increase in the numerical amount of the circulation [of notes]’. Torrens had always been the only currency man to understand the true monetary importance of deposits; now he pressed on to a vigorous condemnation of the commercial bankers and their expansion of deposits in the recent boom as well as their contraction and bankruptcy during the crisis. Thus, Torrens bitterly inquired:

Are the scales of justice held even, when a petty thief, or the forger of a five-pound note, is treated as a felon, and when the speculating banker... obtains from the Court of Bankruptcy a full liquidation of his debts, and receives from sympathising friends and half-ruined creditors the means of recommencing his disreputable and mischievous career?

Torrens went on to show how additional loans ‘from deposits produce effects upon prices, upon commercial credit and upon the exchanges, results analogous to those produced by additional issues of bank notes’. Virtually conceding that Peel’s Act suffered from not being applied to deposits, Robert Torrens now conceded that ‘even under a currency exclusively metallic [i.e. coins without notes] overbanking and the insolvency of discount-houses may occasion disasters as formidable as those which can result from an unrestricted use of bank notes and a suspension of cash payments’.

In his conclusion, Torrens expressed strong doubt whether ‘the advantages of discount [deposit] banking, even when conducted under a metallic currency, balance the evils it inflicts’. It seems that Torrens was on the brink of advocating the extension of the currency system to deposits, and perhaps if he had lived to write more on money and banking, he would have done so.

7.10   Currency and banking school thought on the Continent

The flowering of the currency and banking school debates in Britain, coupled with the later burgeoning of central banking on the Continent, led to similar controversies in France and Germany in the 1850s and 1860s. Generally, the results were the same: pseudo-currency triumph in the sense that the central bank acquired a monopoly of note issue, and de facto banking school victory in elastic, fractional-reserve banking and repeated increases and declines in the supply of money.

In France, laissez-faire thought flowered among economists, who proved themselves the true heirs of J.B. Say. Professors, journalists, the long-lasting Société d’Économie Politique, the Société’s Journal des Économistes, both launched in 1842, and several other scholarly and popular periodicals were dedicated to the free trade and laissez-faire cause. In that atmosphere, the French economists naturally plumped for free rather than central banking. Most of them, unfortunately, felt constrained to adopt banking school doctrine so as to maintain that freely competitive banking, like banks in general, can never issue excessive notes or bring about a business cycle. They were a far more genuine free banking group than the British who, as we have seen, were special pleaders for commercial banking interests rather than consistent advocates of free banking. Indeed, in this as in other areas, the French, in contrast to the hesitant, muddled and pragmatic British, were not afraid to be consistent, rigorous, militant, and therefore ‘extremist’ advocates of individual liberty and free exchange.

One of the leading, and one of the most interesting, of the French free banking theorists was Jean Gustave Courcelle-Seneuil (1813–92). Courcelle, as one historian writes: ‘was in favour of absolute freedom and unlimited competition and was the most uncompromising of all free bankers in France. The sole permissible regulation, in his view, was one aimed simply at the prevention of fraud’.45

I. Edward Horn (1825–75) was another notable French free banking theorist. In his La Liberté des Banques (1866), Horn went so far as to challenge the idea that the state must have a monopoly on coinage. He pointed out that private investment bankers could easily gain as much public confidence in the circulation of their coins as has the state. Horn noted that the state is far more likely to suspend the obligation of a central bank to redeem in specie than grant such a boon to the smaller, individual banks. In the paraphrase of Vera Smith:

Horn called attention to the greater possibility that the liability of such a [Central] bank to pay out specie on demand would be revoked with its consequence of pure paper money in place of notes convertible into coin. A bank under State patronage always counted on the Government to relieve of its obligation to pay when nearing insolvency, and its bankruptcy became legalised instead of its having to go into liquidation and suffer the usual penalties of insolvency. This history of privileged banks had undeniably been full of bankruptcies.

Horn went on to insist that, under free banking, any refusal whatever to pay in specie on demand must mean instant liquidation for the errant bank. Only then could a free banking system work. Horn notes: ‘If banks of issue were given to understand, however, that they were positively and irremediably responsible for their acts, and had themselves to bear the consequences, they would be as prudent in their policy as any other business concern’.46 The problem is how could government be trusted to enforce prompt specie payment on the banks, especially if many or most banks get into trouble at the same time?

Courcelle and Horn were both heavily influenced by James Wilson’s circulation into fixed capital analysis of the boom. But both men, while stressing with the banking school that banks cannot over-issue their notes, did admit, in contrast to Wilson, that banks could and did err in fuelling over-investment in fixed capital during the boom. Interestingly enough, Horn, Courcelle, and many of the French free bankers felt they had to deny, by legalistic quibbles, that even bank notes were ‘money’, since money, in the legalistic though not economic sense, must be strictly confined to the standard specie in which notes were convertible.

But the most fascinating theorists were the tiny intrepid band of Frenchmen who believed in free banking and at the same time were rigorous currency school ultras, who despised as fraudulent and inflationary all fiduciary media, all bank liabilities beyond 100 per cent specie reserve. They believed, quite plausibly, that neither a monopoly privileged bank, nor the government that backed it, could be long trusted to maintain 100 per cent gold reserve banking. The leader of this little band was Henri Cernuschi, who, writing two tracts in 1865, declared that the important question was not monopoly note issue vs plural or free banking, but whether bank notes should be issued at all. His answer was no, since ‘they had the effect of despoiling the holders of metallic money by depreciating its value’. If they were at all useful, they should no more than represent metallic money by 100 per cent; any uncovered notes, any fiduciary media, should be ended totally. Cernuschi favoured free banking because he held that, lacking any special privilege, encouragement, or acceptance by the state, and forced to close the minute banks refused any payment of liabilities, nobody would wish to hold bank notes. As Ludwig von Mises approvingly quoted from Cernuschi: ‘I want to give everybody the right to issue banknotes so that nobody should take banknotes any longer’.47

A follower of Cernuschi was Victor Modeste, whose policy conclusions were rather different, and brought him close to the hard-core Jacksonians in the United States. Modeste was a dedicated libertarian, who believed that the state is ‘the master..., the obstacle, the enemy’, and whose announced goal was to replace government by ‘self-government’. Modeste agreed with Courcelle and the banking school free bankers that commerce and trade must remain free. He also agreed with them that central monopoly banking was far worse and more damaging than freely competitive banking, and was also opposed to administrative control or regulation of banks. On the other hand, what is to be done about bank notes? In this category, Modeste explicitly included demand deposits, which he saw to be illicit, fraudulent, inflationary, generators of the business cycle, and bearers of ‘false money’. His answer was to point out that ‘false’ demand liabilities which pretend to but cannot be converted into gold, since they go beyond the value of the gold stock, are in reality equivalent to fraud and theft. Modeste concluded that false titles and values are at all times ‘equivalent to theft; that theft in all its forms every-where deserves its penalties..., that every bank administrator... must be warned that to pass as value where there is no value,... to subscribe to an engagement that cannot be accomplished... are criminal acts which should be relieved under the criminal law’. The answer, then, is not administrative regulation but prohibition of tort and fraud under general law.48

In Germany, there were few writers influenced by the banking school; most were currency men. In the rigorous currency tradition was Philip Joseph Geyer. Writing in his tract Banken und Krisen (Banks and Crises) in 1865, and in another book two years later, Geyer declared that ideally the amount of money in circulation should always remain constant. The money supply is not in fact constant largely because continuing issues of bank notes are not covered by specie. At this point, Geyer contributed one of the first outlines of the Austrian theory of the business cycle, as he pointed out that uncovered bank note issues inject an ‘artificial capital’ (kunstliches Kapital) into the economy, and when this artificial capital exceeds the amount of available ‘real’ (naturliches) capital, over-investment and over-production bring about a crisis. However, Geyer then blundered into an inconsistent underconsumption theory while trying to develop his analysis.

An academic hard-line currency man in Germany was Johann Louis Tellkampf (1808–76). A young Prussian with a doctorate from the University of Gottingen, Tellkampf emigrated to the United States, where he taught first at Union College in law and political economy, as well as history, German language and literature. Then, in 1843, he moved to Columbia College as professor of German language and literature. Three years later, Tellkampf returned to Prussia and became professor of political economy at the University of Breslau. He was later elected to the Prussian senate, where he took a leading part in bank legislation.

Tellkampf’s observations on the problems of decentralized banking in the United States led him to argue for strict 100 per cent specie reserves to bank notes, and for one monopoly central bank to put this plan into effect. Tellkampf aided in disseminating the currency principle by co-translating McCulloch’s defence of the principle into German in 1859. On the other hand, failing the adoption of his 100 per cent specie plan, Tellkampf was very willing to consider free banking as a second best.

The free bankers in Germany tended to be smaller in number than in France, and currency school rather than banking school men. A notable writer in this camp was Otto Hübner, a leader of the German Free Trade Party. His multi-volume work, Die Banken (1854), was largely an empirical survey of banks throughout the world, and argued that banks were soundest and least in danger where they were freest and least controlled. Privileged central banks tend to be wildly run and are in danger of insolvency, as note the suspension of specie payment of the Austrian national Bank, which had financed large deficits of the Austrian government. Hübner’s goal, like Cernuschi’s in France and like that of Geyer and Tellkampf in Germany, was 100 per cent specie reserve to bank notes. His ideal preference would have been for a state-run monopoly 100 per cent reserve in the bank, like the old banks of Amsterdam and Hamburg, but he recognized the problem of inherent mistrust of state banking. As Vera Smith paraphrases Hübner:

If it were true that the State could be trusted always only to issue notes to the amount of its specie holdings, a State-controlled note issue would be the best system, but as things were, a far nearer approach to the ideal system was to be expected from free banks, who for reasons of self-interest would aim at the fulfillment of their obligations.49

7.11   Notes

After his father’s death in 1833, Althorp succeeded to his father’s earldom as Lord Spencer, and withdrew from direct politics in the House of Commons. He continued to be influential, however, in favour of peace with France and repeal of the Corn Laws in the 1840s.

A Yorkshire landowner and cattleman, Althorp loved agriculture and hunting. He founded or helped to found the Yorkshire Agriculture Society, and the English Agricultural Society (1828), which later became the Royal Agricultural Society.

Norman was a liberal devoted to free trade, and a close friend of the great philosophical radical, banker, and classicist George Grote. Norman was widely read in English, continental, Latin, and Norwegian literature.

But both parts of this thesis are deeply flawed. On (b) White confines his evidence of superiority to the lower bank failure rate in Scotland. But bank failure is a minor way to gauge the workings of a banking system. White presents no data whatever on whether Scotland suffered any less economic inflation or recession than England. One suspects, then, in the absence of data, that the economic record was about the same for the two parts of the United Kingdom. On (a), the problem is that Scottish banking was scarcely ‘free’. Most Scottish bank reserves were kept, not in gold, but in deposits at the Bank of England, or in its surrogate, bills on London. Scottish banks, then, far from being free and independent of the Bank of England, pyramided on top of bank liabilities. Furthermore, the bank habitually bailed Scottish banks out in time of trouble. To top off the argument, the realities were that it was very difficult, both socially and legally, for anyone to actually obtain gold from the Scottish banks in exchange for their liabilities – especially in times of trouble when the gold, of course, was in particularly great demand.

On Scottish banking in this era, see in particular the definitive work of Sydney G. Checkland, Scottish Banking: A History, 1695–1973 (Glasgow: Collins, 1975). Checkland writes that ‘Requests for specie met with disapproval and almost with charges of disloyalty’, and ‘the Scottish system was one of continuous partial suspension of specie payments. No one really expected to be able to enter a Scots bank... with a large holding of notes and receive the equivalent immediately in gold or silver. They expected, rather, an argument, or even a rebuff. At best they would get a little specie and perhaps bills on London. If they made serious trouble, the matter would be noted and they would find the obtaining of credit more difficult in the future’. And finally, ‘This legally impermissible limitation of convertibility, though never mentioned in public inquiries, contributed greatly to Scottish banking success’. Ibid., pp. 184–6. Also: ‘the principal and ultimate source of liquidity lay in London, and in particular in the Bank of England’. Ibid., p. 432. Also see Charles W. Munn, The Scottish Provincial Banking Companies 1747–1864 (Edinburgh: John Donald, 1981), and Charles A. Malcolm, The Bank of Scotland, 1695–1945 (Edinburgh: R. & R. Clark, n.d.). On the Scottish free banking question, see Murray N. Rothbard, ‘The Myth of Free Banking in Scotland’, The Review of Austrian Economics, 2 (1988), pp. 229–45; Larry J. Sechrest, ‘White’s Free-Banking Thesis: A Case of Mistaken Identity’, Ibid., pp. 247–57.

• 1Frank W. Fetter, Development of British Monetary Orthodoxy 1797–1875 (Cambridge, Mass.: Harvard University Press, 1965), p. 122.
• 2In ‘Currency Juggle’, Tait’s Edinburgh Magazine (Jan. 1833). See Fetter, op. cit., note 1, pp. 14CM1.
• 3Lionel Robbins, Robert Torrens and the Evolution of Classical Economics (London: Macmillan, 1958), pp. 245–6.
• 4As we shall see below, the currency school was split on the issue of deposits as money: the simplistic insistence on notes as the only bank money being held by the majority led by George Warde Norman and Samuel J. Loyd (Lord Overstone), while the contrary and correct position was held by Sir William Clay and Colonel Robert Torrens.
• 5William Gouge’s main work was first published as A Short History of Paper Money and Banking (1833) in two separate parts, theoretical and historical. Most of the latter was reprinted in England, under the title The Curse of Paper Money and Banking, with an introduction, appropriately enough, by the great anti-bank radical, William Cobbett. Both parts were reprinted, virtually intact, in Gouge’s own Journal of Banking (1841—42).
• 6Henry Drummond was the eldest son of the banker Henry Drummond, and was born in Hampshire. He was raised by his maternal grandfather, Henry Dudas, Viscount Melville, and, during his childhood, became a favourite of William Pitt. Educated at Harrow and at Christ Church, Oxford, Drummond left college to become a partner at his father’s bank in London. The aristocratic Drummond was a Member of Parliament from 1810 until he retired for ill health three years later. In the meanwhile, Drummond was able to put through Parliament an act outlawing the embezzlement by bankers of securities kept in their safe-keeping. Drummond founded the chair of political economy as Oxford in 1825, and at about the same time became the main leader, prophet and evangelist of the rising movement of pre-millennial millenarianism in Protestant Christianity. Drummond returned to Parliament from 1847 until the end of his life, there serving as a highly independent Tory, favouring war, government, and the ecclesiastical establishment. Drummond wrote many pamphlets on financial and on evangelical themes.
• 7In his Letters to the Editor of the Times’ Journal on the Affairs and Conduct of the Bank of England (1826), cited in Elmer Wood, English Theories of Central Banking Control 1819– 1858 (Cambridge Mass.: Harvard University Press, 1939), p. 110. Another hard-money writer in 1826 was the pseudonymous ‘Benjamin Bullion’, Letters on the Currency Question.
• 8For an excellent discussion of the independent treasury programme and its two crucial parts, as well as of the Van Buren bankruptcy proposal, see Major L. Wilson, The Presidency of Martin Van Buren (Lawrence, Kan.: The University Press of Kansas, 1984), p. 73 and passim.
• 9For Mushet, see Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate, 1800–1845 (Cambridge: Cambridge University Press, 1984), p. 62.
• 10On Parnell, who has ben neglected by most historians, see ibid., pp. 62–3, and Jacob Viner, Studies in the Theory of International Trade (New York: Harper & Bros., 1937), pp. 24–241.
• 11George Poulett Scrope, An Examination of the Bank Charter Question (1833), p. 456. Also see Scrope, The Currency Question Freed from Money (1830), On Credit Currency (1830). The other articles in 1830 in the Quarterly Review were by Edward Edwards and H.A. Nilan. On Scrope, see Fetter, op. cit., note 1, pp. 137–8. White characteristically neglects the vital difference between Scrope’s inflationism and hard-money writers in the free banking camp. White, op. cit., note 9, passim.
• 12John Charles Spencer, Viscount Althorp (1782–1845), was born in London to an aristocratic family, the son of Earl Spencer. After studying at Harrow and Trinity College, Cambridge, Althorp received an MA from Trinity in 1802. Althorp was an MP for 30 years after 1804. First a supporter of Pitt, Althorp took a generally radical position in Parliament, battling against the leather tax and in favour of Catholic emancipation, and took his stand with the Whig opposition after 1815 in favour of reform, lower taxation, and cutting the budget. In 1830, Althorp refused the prime ministership, and took his place in the Grey ministry as chancellor of the Exchequer and leader of the House of Commons.
• 13In Alexander Mundell, The Danger of the Resolutions Relative to the Bank Charter... (London, 1833). Cited in White, op. cit., note 9, pp. 67–8.
• 14Robert Torrens, A Letter to the Right Honourable Lord Viscount Melbourne on the Causes of the Recent Derangement in the Money Market and on Bank Reform (London, 1837).
• 15Cited in Lionel Robbins, Robert Torrens and the Evolution of Classical Economics (London: Macmillan, 1958), p. 89. Robbins, Torrens’s biographer, admits his inability to explain Torrens’s complete about-face on money and inflationism. Ibid., pp. 73–4.
• 16The Causes and Consequences of the Pressure upon the Money-Market (London, 1837). Palmer (1779–1858), was the son of William Palmer of Essex, a London merchant, and mayor and high sheriff of Essex. An East India merchant and shipowner, John Horsley Palmer went into partnership with his brother in 1802. He was a director of the Bank of England from 1811 on.
• 17In his Reflections Suggested by a Perusal of Mr. J. Horsley Palmer’s Pamphlet (London, 1837). Loyd (1796–1883), later the first Baron Overstone, was the only son of a dissenting Welsh minister, the Rev. Lewis Loyd. Loyd’s mother was a daughter of a Manchester banker, John Jones. Educated at Eton, and then receiving a BA at Trinity College, Cambridge, at the top of the list, in 1818, Loyd gained an MA from Trinity in 1822. By this time, the Rev. Loyd had left the ministry to become a partner in his father-in-law’s bank, and then proceeded to found the London branch of Jones, Loyd & Co. In 1834, the bank merged into the new London & Westminster Bank. A successful banker, Samuel Loyd succeeded to his father’s leadership in London & Westminster in 1844. Loyd died one of the richest men in England. He was made Lord Overstone in 1850.
• 18Fetter, op. cit., note 1, p. 171.
• 19Norman, Remarks Upon Some Prevalent Errors with Respect to Currency and Banking (London, 1838). Norman (1793–1882) was born in Kent; his father, George Norman, was a merchant in the Norway timber trade, and a sheriff of Kent. George Warde was educated at Eton, and joined his father in the Norway trade, spending many years in Norway. After his father’s retirement in 1824, George Warde became sole owner of the business, until it was merged with another mercantile firm in 1830. George Warde Norman was a director of the Bank of England from 1821 until 1872, and was a member of the bank’s treasury committee during the 1840s. Norman was founding member of the Political Economy Club, and was its last surviving original member.
• 20The first two volumes were published in 1838, the third in 1840, and the fourth in 1848. Two later volumes appeared in 1857, near the end of Tooke’s life, but they were largely written by his co-author William Newmarch.
• 21John Fullarton, On the Regulation of Currencies (1844). Fullarton (1780–1849), son of a physician, went to India as a medical officer for the East India Company, and rose to become an assistant surgeon in Bengal for over a decade. While in India, he became a partner in the Calcutta banking house of Alexander and Co., and amassed a huge fortune, returning to London in the early 1820s. A founder of the Carlton Club, and author of several pro-Tory articles in the early 1830s, Fullarton, retired, now entered the fray on behalf of the banking school.
• 22For Torrens’s role in this and other economic discussions, including a full annotation of each one of his writings, see the delightful work by Lionel Robbins, Robert Torrens and the Evolution of Classical Economics (London: Macmillan, 1958), esp. Chapters IV, V, and the bibliographical appendix.
• 23Oddly, Professor White chides Marion Daugherty for putting Smith in the ranks of the currency school rather than of the free bankers, even though White himself concedes four pages later that ‘The testimony of Manchesterites J.B. Smith and Richard Cobden [1840] revealed the developing tendency for adherents of laissez-faire, who wished to free the currency school from discretionary management, to look not to free banking but to restricting the right of issue to a rigidly rule-bound state bank as the solution’. White, op. cit., note 9, pp. 71, 75. See Marion R. Daugherty, ‘The Currency-Banking Controversy, Part I’, Southern Economic Journal, 9 (October 1942), p. 147. In particular, see Fetter, op. cit., note 1, pp. 175–6.
• 24Years later, S.J. Loyd, the leader of the currency school, testified that he had never had any personal or political connection with Robert Peel. ‘I knew nothing whatever of the provisions of the Act until they were laid before the public. The Act is entirely so far as I know the Act of Sir Robert Peel.’ Torrens had no contact with Peel either, and indeed Peel turned down Torrens’s request for office based on his leadership in the currency school. Only after Peel’s death did Torrens receive a government pension ‘in consideration of his valuable contributions to the Science of Political Economy’. As for the veteran adviser James Pennington, his advice was only sought for technical details after the main provisions of Peel’s Act had already been determined. Fetter, op. cit., note 1, p. 182n.
• 25Boyd Hilton, ‘Peel: A Reappraisal’, Historical Journal, 22 (Sept. 1979), p. 614. Not that Hilton is sympathetic to Peel’s determined role on the behalf of laissez-faire and hard money. On the contrary, he is appalled at Peel’s ‘doctrinaire’ stance, an assessment unfortunately echoed by Professor White in his reference to Peel’s ‘little-recognized dogmatism’. White, op. cit., note 9, p. 77n.
• 26J.K. Horsefield, ‘The Origins of the Bank Charter Act, 1844’, in T.S. Ashton and R.S. Sayers (eds.), Papers in English Monetary History (Oxford: The Clarendon Press, 1953), pp. 110–11.
• 27William Cotton (1786–1866) was the son of a naval captain, merchant, and director of the East India Company. At the age of 15, young William entered the counting house of his father’s friend. By 1807, he had become partner in a London mercantile firm, and become general manager in that firm’s cordage manufacturing plant. Cotton was a director of the Bank of England for 45 years, from 1821 until his death, and eventually became known as ‘the father of the Bank of England’. Cotton was governor of the bank from 1843 to 1845, and was succeeded by Heath. Cotton also invented a successful automatic machine for weighing gold sovereigns, and was a distinguished philanthropist in the Church of England. Cotton was born, and lived most of his life, in the county of Essex, where he became justice of the peace, judge and sheriff.
• 28Morris Perlman has pointed out that James Mill, in a book review in 1808, developed an extreme version of the real bills banking school doctrine. In that case, James Mill was never a Ricardian in this area, and John Stuart may have been exercising his filio-pietism in bringing back his father’s monetary views, as well as Ricardianism in the rest of economics. Morris Perlman, ‘Adam Smith and the Paternity of the Real Bills Doctrine’, History of Political Economy, 21 (Spring 1989), pp. 88–90.
• 29See White, op. cit., note 9, pp. 122–6.
• 30Ibid., p. 79.
• 31So much for James Gilbart’s alleged devotion to free banking, years before his surrender to Peel’s Act.
• 32See the interchange in Hilton, op. cit., note 25, pp. 593–4. It is characteristic of Professor Hilton’s lack of insight into economic theory that he brands Peel’s questioning as ‘inept’ and faults him for scoffing at the importance of Gilbart’s ‘personal knowledge’ when judging inconvertible flat money.
• 33Cited in Fetter, op. cit., note 1, p. 193.
• 34White, op. cit., note 9, p. 80. Thus the Scottish devotion to their vaunted free banking system turned out to be mainly special pleading. Much of White’s book is devoted to the thesis (a) that until Peel’s Act of 1845, Scotland enjoyed a regime of free banking uncontrolled by the Bank of England, with liabilities convertible into gold; and (b) that this free system worked far better than England’s central bank-dominated one.
• 35Wilson, son of William Wilson, a prosperous woollen manufacturer, was educated in a Friends’ school and, at the age of 16, was apprenticed to a hat manufacturer. Soon, his father bought the firm for James and his brother. In 1824, Wilson came to London, and became a partner in a mercantile firm which, after 1831, became James Wilson & Co. After losing a great deal of money in indigo speculation, Wilson retired from business in 1844. In the meanwhile, he had become interested in economics and free trade, and had published several tracts on commerce and the Corn Laws. Wilson’s writings strongly influenced such later free trade stalwarts as Peel and Gladstone. Finally, Wilson founded The Economist in 1843, writing almost all of the copy himself, and forged it rapidly into a highly influential journal. Wilson became an MP from 1847 to 1859, and was also financial secretary to the Treasury during the 1850s. Under the Palmerston regime in 1859, Wilson became vice-president of the Board of Trade, paymaster-general, and a Privy Councillor, and then, just before his death, was sent to India as finance minister, where he proceeded, ironically enough, to increase taxes and to issue a great quantity of government paper.
• 36Fetter asserts that Torrens ‘never could have said of Wilson’s ideas, as he did of Tooke’s, ‘that the flood-gates are opened, and the landmarks removed’.’ Fetter, op. cit., note 1, p. 200.
• 37See Lloyd Mints, A History of Banking Theory in Great Britain and the United States (Chicago: University of Chicago Press, 1945), p. 90.
• 38A few years later, in his Principles of Political Economy, Mill became sympathetic to freedom of bank note issue, but on general laissez-faire rather than specific monetary and banking grounds.
• 39William Cotton, of the Bank of England, thought that the suspension came too soon, and John R. McCulloch thought it of doubtful value, but no currency man attacked the suspension, or even gave any sign of comprehending the significance of the suspension question.
• 40These epigones included Charles Neate, a professor at Cambridge who published his lectures, Two Lectures on the Currency (1850); R.H. Mills, a professor at Trinity College, Dublin, in his The Principles of Currency and Banking, in the mid-1850s; John Inchbald’s The Price of Money (1862), and the popular tract by George Combe, The Currency Question Considered (1856), which was hailed by the London Times and went through six editions within one year.
• 41The book consisted of the nine 1845 articles on Peel’s Act, plus later essays.
• 42The Petition of the Merchants, Bankers and Traders of London Against the Bank Charter Act: with Comments on Each Clause (London, 1847).
• 43Quoted in Fetter, op. cit., note 1, p. 208.
• 44Ibid., p. 216. Fetter wittily describes the feelings of the Banking School and the other anti-Peel Act gold men vis-à-vis the threat from the Birmingham school: ‘The situation is suggestive of the attitude that tradition associates with the Duke of Wellington – he had no fear of the enemy, but the very thought of his allies filled him with terror’. Ibid.
• 45Vera C. Smith, The Rationale of Central Banking (1936, Indianapolis: Liberty Press, 1990), p. 94.
• 46Ibid., p. 108.
• 47From Henri Cernuschi, Contre le Billet de Banque (1866), Cernuschi’s testimony before the massive French government’s bank inquiry of 1865–66. Translated by Ludwig von Mises, Human Action (New Haven: Yale University Press, 1949), p. 443.
• 48Victor Modeste, ‘Le Billet Des Banques D’Emission Est-Il Fausse Monnaie?’ (‘Are Bank Notes False Money?’), Journal des Économistes, 4 (Oct. 1866), pp. 77–8. (Translation mine.)
• 49Smith, op. cit., note 45, pp. 115–16.