An Outline of International Price Theories

CHAPTER III

FROM DAVID HUME TO J. S. MILL: THE DEVELOPMENT OF THE CLASSICAL THEORIES

1. David Hume

While mercantilism was popular in the period described in the preceding chapter, in the latter half of the eighteenth century it gradually came to be considered as a hindrance to economic progress. About the year 1750 many of the mercantilist doctrines were criticized and new systems of thought were advanced in their stead. The most important of the thinkers, who were responsible for the downfall of the mercantilistic system of thought, are David Hume, the French Physiocrats, and Adam Smith. The contribution of Hume lies mainly in his theory of international price relationships, which served the purpose of a refutation of the theoretical foundations of mercantilism. In the writings of the Physiocrats and Adam Smith are reflected the existing economic and social conditions of France and England respectively. They attacked the mercantilists mainly on practical grounds.

Economic conceptions underwent partial change in the hands of Hume. While retaining the mercantilist preconception that the interests of the State and of its subjects were not always in harmony,1 he brought forward the view that the growth of commerce (both domestic and foreign) was a common interest of both, because it had the effect of “augmenting the power of the State as well as the riches and happiness of the subjects”.2 On the subject of commerce among nations, he rejected the view that a State could make progress only at the expense of other states and ventured to assert “that the encrease of riches and commerce in any one nation . . . commonly promotes the riches and commerce of all its neighbours; and that a state can scarcely carry its trade and industry very far, where all the surrounding states are buried in ignorance, sloth, and barbarism”.3 He saw the real source of wealth in labour4 and thought that money was but an instrument of trade.5 He accepted the view that a state would be at an advantage in wars and negotiations with foreign states if it possessed plenty of money6 and that in the transitional or intermediate period between the acquisition of money and the rise of prices, “the encreasing quantity of gold and silver is favourable to industry,”7 but he did not attach the same importance to those arguments as the mercantilists.

It was his theory of international price relationships which made him a critic of mercantilism. His theory was based on a rigid quantity theory of money. He considered “a maxim almost self-evident that the prices of everything depend on the proportion between commodities and money”, but he limited the money side to “the money which circulates” and the commodity side to the “commodities which come or may come to market”.8 He then applied the quantity theory beyond the limits of any one country and formulated what is sometimes known as the classical theory of international price adjustments. The main point of the theory is that there was a natural distribution of money among nations and that, if that natural distribution was disturbed, it would be automatically corrected mainly by changes in the income and price structures of the trading nations. For instance, he said:—

Suppose four-fifths of all the money in Britain to be annihilated in one night . . . what would be the consequence? Must not the price of all labour and commodities sink in proportion. . .? What nation could then dispute with us in any foreign market, or pretend to navigate or to sell manufactures at the same price, which to us would afford sufficient profit? In how little time, therefore, must this bring back the money which we have lost, and raise us to the level of all the neighbouring nations? Where, after we have arrived, we immediately lost the advantage of the cheapness of labour and commodities; and the farther flowing in of money is stopped by our fulness and repletion.9

Thus a country could not continue to maintain an inflow or outflow of specie for a very long time, and the mercantilists would defeat their own end by advocating an increase of the national stock of money. That led him to the conclusion that trade must be mutual and that a country that trades must buy as well as sell.

It should be noted that the mechanism described by him in the passage quoted in the preceding paragraph was not limited to the correction of disturbances originating from the money side. It was applied by Hume also to the adjustment of deficits in the balance of trade that originated on the commodity side.10 Thus, in justifying the proposition that trade must be mutual, he showed that if the exports and imports of a country were not equal, the mechanism, which corrected disturbances arising from the relative excess of metallic money, would work to bring about an equality in exports and imports. He said that there was “a happy concurrence of causes in human affairs, which check the growth of trade and riches and hinder them from being confined entirely to one people; as might naturally at first be dreaded from the advantages of an established commerce”. If a state had a favourable balance of trade, it would naturally have its money increased and the prices of its commodities raised so that the poorer states were enabled “to undersel the richer in all foreign markets”.11 He drew attention, moreover, to another factor, which helps to bring international price relationships into equilibrium:—

There is another cause, though more limited in its operation, which checks the wrong balance of trade, to every particular nation to which the kingdom trades. When we import more goods than we export, the exchange turns against us, and this becomes a new encouragement to export; as much as the charge of carriage and insurance of the money which becomes due would amount to. For the exchange can never rise higher than that sum.12

Upon the basis of those considerations, he came to the conclusion that there was a natural distribution of money among trading nations:—

The same causes, which would correct these exorbitant inequalities . . . must prevent their happening in the common course of nature, and must for ever, in all the neighbouring nations preserve money nearly proportionable to the art and industry of each nation.13

We shall designate that doctrine as “Hume’s Law” in honour of its ingenious author. It is true that the essential features of the doctrine are found in the writings of the later mercantilists, but it is only in the hands of Hume that the inevitability of a tendency towards equilibrium and the automatic character of the working of the correctives take definite form. Furthermore, he was the first economist to point out that the rate of exchange is also a corrective of disturbances.

Hume made another important contribution to the theory of international price relationships, that was his description of the chains of events connecting money and price. His analysis is so excellent that it is worth quoting in full:—

To account, then, for this phenomenon we must consider that, though the high price of commodities be a necessary consequence of the encrease of gold and silver, yet it follows not immediately upon that encrease; but some time is required before the money circulates through the whole state, and makes its effect felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom. In my opinion, it is only in this interval or intermediate situation between the acquisition of money and rise of prices, that the enhancing quantity of gold and silver is favourable to industry. . . . When any quantity of money is imported into a nation, it is not at first dispensed into many hands; but is confined to coffers of a few persons, who immediately seek to employ it to the best advantage. Here are a set of manufacturers or merchants, we shall suppose, who have received returns of gold and silver for goods which they send to Cadiz. They are thereby enabled to employ more workmen than formerly, who never dreamed of demanding higher wages, but are glad of employment from such good paymasters. If workmen become scarce, the manufacturer gives higher wages, but at first requires an encrease of labour; and this is willingly submitted to by the artisan, who can now eat and drink better, to compensate his additional toil and fatigue. He carries his money to market, where he finds everything at the same price as formerly, but returns with greater quantity and of better kinds, for the use of his family. The farmer and gardener, finding that all their commodities are taken off, apply themselves with alacrity to the raising more; and at the same time can afford to take better and more clothes from their tradesmen, whose price is the same as formerly, and their industry only whetted by so much new gain. . . . There is always an interval before matters be adjusted to their new situation; and this interval is as pernicious to industry, when gold and silver are diminishing, as it is advantageous when these metals are encreasing.14

It will be observed that he (a) called attention to the importance of the time element; (b) put the doctrine that money stimulates trade in its right place, that is, by considering it to be true “only in this interval or intermediate situation”; and (c) presented an analysis of the mechanism connecting money and prices.

2. The Physiocrats and Adam Smith

Although Hume furnished us with a theory of international price relationships which, to some economists, had “at a single stroke wrecked the balance of trade theory”, yet he established no new school of economic thought to take the place of that of the mercantilists. That task was left to the Physiocrats in France and Adam Smith in England.

The Physiocratic system was the outcome of the economic and financial conditions in France in the first half of the eighteenth century. In those days costly military expeditions abroad, ruinous extravagance, and a corrupt financial administration at home combined to impose upon the French people, especially the farmers, an unbearable burden of taxation. That, together with the fall of the prices of agricultural products, forced the farming populations to live below the standard of subsistence. The sharp contrast between widespread poverty, misery, and starvation on the one hand, and the luxurious life of the nobles on the other, could not fail to evoke criticisms against the existing conditions. The Physiocrats were a group of those critics who thought that the prosperity of agriculture was essential to the opulence of the state. The agrarianism of the Physiocrats can best be shown by their conception of wealth and productiveness. They declared that agriculture alone was productive and that the land alone produced a produit net and hence was the only form of true wealth. The mercantilistic dogma that the precious metals were wealth and wealth par excellence was entirely rejected by them. Money was defined as merely a kind of richesse relative ou seconde. Commerce and industry, to which the mercantilists and the Colbertists had attached great importance, were described as being sterile or non-productive. International trade was considered as at best a pis aller.

As the Physiocrats concentrated their attention on agriculture and other internal economic activities, they naturally did not say very much about the problem of international trade. Yet, negatively, we find in the writings of many of them some very severe criticisms of the mercantilistic theory of foreign commerce. The ablest writer on this subject is le Mercier de la Rivière.15

He started with a refutation of the mercantilistic conception that the wealth of a nation rested on its foreign trade. He said that “commerce is an exchange of values for equal values” and hence there could be no increase of wealth by foreign trade.16 Yet foreign trade might be beneficial to a country if it lacked within itself a sufficient number of consumers to ensure a bon prix for agricultural products and if foreign lands could furnish it with consumers and hence the best possible price for its products. The highest possible price would, in turn, enable it to accelerate the reproduction of the country and maintain its population by agriculture. It was because a country must sell to foreign countries what it could not consume, and buy from them their products which it could not produce, that international trade was both necessary and beneficial.17 Trade, therefore, must be considered as une multitude de ventes et d’achat. One could not buy unless one sold, and one could not sell unless one bought. “Every seller must also be a buyer.”18 Hence the ambitions of the mercantilists to obtain a favourable balance of trade, that is to be a seller but not a buyer, was illusory. Moreover, even if a country succeeded in getting a large quantity of money it would not be able to keep it. He said:—

Well, I will drown the clamour of all your blind and stupid policies. Suppose that I gave you all the money which circulates among the nations with whom you trade. Imagine it all in your possession. What would you do with it? You must lose so many foreign consumers that you would be ruined by it. . . . A part [of your production] must remain unsold and become superfluous. From that moment your cultivators will not only sell in a less quantity, but also at a lower price, because the result of over-abundance is a diminution of price.19

At the same time the excessive dearth of everything at home gave a chance for the inflow of a great quantity of foreign merchandise.20 That was clearly very near to the theory of Hume. He also held a doctrine of free trade. His reason for freedom of trade was simply the belief that it was only through freedom of commerce that good prices could be secured for agricultural products.21

The conditions which were responsible for the anti-mercantilistic views in England were entirely different from those in France. By the time mercantilism was challenged industries in England had been developed to such a stage that they were in general superior to those of other countries, did not fear competition from abroad and consequently no longer needed the support of the state. Intervention of the state had become a hindrance instead of a help. Therefore, unlike the Physiocrats, who were more agrarians than free traders, the English school was purely a free-trade school. Adam Smith was its founder. His principal contribution to the theory of international trade was his doctrine of the reciprocal advantages of the international division of labour. It is true that we can find that doctrine in the writings of some liberal mercantilists and of many Physiocrats, but no one before him had demonstrated the soundness of the doctrine with such a wealth of fact and argument or formulated it with so much clarity.22 In accordance with his doctrine he advocated freedom in international trade, because free trade would ensure the best division of labour among nations.23 In regard to the theory of international price relationships he merely said:—

When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation. . . . If, on the contrary, in any particular country their quantity fell short of the effectual demand, so as to raise their price above that of the neighbouring countries, the government would have no occasion to take any pain to import them.24

The real implication of that passage is the same as Hume’s doctrine, although Smith said nothing about the intermediate mechanism and although the passage might mislead the reader on some points. As Smith was intimately acquainted with the work of Hume and once in his Lectures had approvingly presented an abstract of the latter’s view,25 he could hardly have omitted entirely Hume’s doctrine from his celebrated essay.26 Let us now turn to his doctrines concerning money. Like the Physiocrats, he attacked the mercantilistic preconception that money was wealth par excellence. To him money was merely a commodity which served as an instrument to facilitate the circulation of goods and commodities.27 It was the “great wheel of circulation”, but it formed no part of the net revenue of the nation. “The revenue of the society consists altogether in those goods and not in the wheel which circulates them.” Moreover, it required no small expense for its erection and support. Therefore, “the gold and silver money which circulates in any country may very properly be compared to a highway which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either.” If so, in case we could find “a new wheel, which it costs less both to erect and to maintain than the old one”, we must make an improvement of the net revenue of the community. It was on that ground that he considered paper money as a useful institution, for paper money would perform the same work as metallic money and cost very little. According to him, the effect of the introduction of paper money was as follows: When a certain quantity of paper money was issued the total volume of national currency was increased by the same amount. If the original sum of metallic money was just sufficient to answer the “effectual demand” for a circulating medium in the country, its currency would, by the introduction of bank notes, “exceed” the effectual demand of the nation. According to the doctrine laid down above, the excessive part must flow out. As the paper cannot go abroad, gold alone will be exported.28 With regard to the problem of the value of money his position was not definite. Generally speaking, he was of the opinion that the real value of gold and silver depended on the quantity of labour embodied in it.29 That is a labour-cost theory. He said very little, if anything, which constituted a quantity theory of money. One thing is made clear by his writings. That is that the value of a coin was determined by its metallic content, regardless of its nominal designation. He was, however, of the opinion that it was possible to have small occasional fluctuations in the market prices of gold and silver bullion. “But when, under all those occasional fluctuations, the market price either of gold or silver bullion continues for several years together steadily and constantly, either more or less above, or more or less below the mint price: we may be assured that this steady and constant, either superiority or inferiority of prices, is the effect of something in the state of the coin, which, at that time, renders a certain quantity of coin either of more value or of less value than the precise quantity of bullion which it ought to contain. The constancy and steadiness of the effect, supposes a proportionable constancy and steadiness in the cause.”30

3. The Bank Restriction Controversy

More than two decades elapsed after the publication of the Wealth of Nations without any important contribution to the theory of international price relationships. Then came the wars between France and England, which started in the spring of 1793. The abnormal financial and monetary conditions caused by those wars, especially the suspension of specie payments by the Bank of England from 1797, naturally evoked much speculation both inside and outside political circles. That led to many important developments in the theory.31 Among the causes responsible for the suspension of the convertibility of the note issue of the Bank of England were the following—

(a) the continuous heavy remittances of the Government to foreign powers;

(b) the growing demands of the Government on the Bank for the extension of credit (which the Bank could not resist);

(c) the adoption by the Bank of a policy of excessive contraction of its note issue and of the accommodation it afforded merchants as a result of its advances to the Government;

(d) the general loss of confidence and the increasing demand for guineas, as a result of the general anxiety about the issue of the war and the contraction of credit; and

(e) the bad harvests.

Those causes combined to depress the exchanges, which reached in May, 1795, the point at which it was profitable to export bullion and thus increase the internal as well as the external drain upon the metallic resources of the Bank of England and thus to bring about the final suspension of specie payments in 1797. So grave and far-reaching an event could not fail to arouse much controversy. People who were unable to obtain credit that they needed from the Bank and those who were opposed to the Bank on general grounds united in attributing the difficulties of the time to the monopoly of the Bank and saw the explanation of the currency crisis in the policy of excessive contraction of credit. The apologists of the Bank, in replying to the criticisms, called attention to the expanding demands of the Government on the Bank for credit and pointed out that its directors were not the real masters of their own policy. They held that the Bank had rendered very valuable services to the progress of the nation and that its monopoly should not be violated.

For the first few years under the Bank Restriction Act everything went on smoothly. The public avowal of the vast majority of bankers and business men of their decision to support the credit of the Bank and the acceptance of the notes of the Bank by the Government in payment of taxes at par reinforced the confidence of the public. The directors acted with great caution and their policy of contracting credit, which had been in operation all through the year 1796, gradually made itself felt. In the years 1797 and 1798, moreover, government remittances abroad were much less than in the preceding years. Those circumstances, together with the unusually good harvests in the years 1797 and 1798 could not fail to produce good monetary conditions. The exchanges soon rose high in favour of England, specie began to flow in and the cash reserve of the Bank continued to increase. By the middle of the year 1799, however, adverse conditions began to set in. The exchanges declined all through the summer of 1799; and in May, 1800, gold began to be quoted at a premium in London. Prices, which had been climbing steadily since 1794, rose sharply. All those developments furnished new grounds for an attack upon the Bank. Walter Boyd based his case against the Bank upon those facts. In December, 1801, he sent a letter to Pitt, denouncing the policies of the Bank.32 He called attention to three facts: First, an increase in the prices of almost all articles of necessity, convenience, and luxury, and indeed of almost every species of exchangeable value “has been gradually taking place during the last two years, and has recently arrived at so great a height”;33 second, gold in home markets had a premium of about 9 1/8 per cent34; and third, the exchange with Hamburg was about 9 per cent against England.35 He thought that the existence of those three conditions was a sufficient proof of the existence of a state of depreciation in the currency.36 That was the first proposition that he wished to prove. It was simply an extension of Smith’s principle concerning the debasement of coins to the sphere of paper money. But to what extent that principle was applicable to the conditions in England at the time is very doubtful. As pointed out by Mr. Hawtrey, at that time, both the gold market and the exchange market were in an artificial condition and could not afford an unquestionable measure of depreciation.37 As to the relationship between money and prices, although the increase of the volume of notes must ceteris paribus cause a rise in prices, a rise in prices is only a possible symptom and not a sufficient proof of the existence of depreciation of paper.38 The rise in prices might be due to some particular causes such as a bad harvest or to some general causes, such as the relative scarcity of commodities, arising out of the general reduction of production caused by the war and to a general increase of the demand for all goods. Boyd argued convincingly that the former was not possible, because “partial causes never can produce general effects” and hence a scarcity of grain could not raise the price of all commodities,39 but he said nothing on the latter point. The second proposition that he presented was that the depreciation of paper money “proceeds chiefly from the addition to the circulation medium . . . made by the issue of Banknotes, uncontrolled by the obligation of paying them, in specie, on demand”.40 In other words, the depreciation was caused by an excessive circulation of banknotes and an excessive circulation of banknotes could arise only in the event of the suspension of specie payments. He then went on to compare the differences between the conditions under a convertible paper currency and those under an inconvertible one.41 Two important differences were pointed out by Boyd. First, under a convertible system, should there be a premium on gold or an unfavourable rate of exchange, so that specie was drained out, the Bank must, at least for its own sake, try its best to correct those unfavourable conditions; but in case the Bank was no longer required to redeem its notes, it “is not compelled to any exertions to remedy the evil of an unfavourable exchange, or to restore the equilibrium between coin and bullion”.42 Second, in the case of a metallic standard, if the quantity of money possessed by a nation was excessive, “that surplus quantity would have soon found its way into other countries, to seek that employment which it could not readily have found in this.”43 But in the case of an inconvertible currency the paper money could not be exported and, therefore, the full effect of excessive currency must fall entirely upon the prices at home.44 In other words, in the case of a metallic standard the effect of an excess of money on prices would be spread all over the world, while in the case of an inconvertible paper standard, the effect was limited to a country. With those differences in mind, he said that in a country with an inconvertible paper currency, “circulation is not only carried on by a new wheel, but the wheel is altogether of a different sort of material from those of which such wheels used to be made.” That to him meant “a positive degradation of the standard”.45 The third proposition was that the excess of paper currency could be traced to the Bank of England and that the country banks were entirely innocent. He said: “The circulation of Country Bank-notes must necessarily be proportioned to the sums, in specie or Bank of England notes, requisite to discharge such of them as may be presented for payment; but the paper of the Bank of England has no such limitation. It is itself now become (what the coin of the country only ought to be) the ultimate element into which the whole paper circulation of the country resolves itself. The Bank of England is the great source of all the circulation of the country; and, by the increase or diminution of its paper, the increase or diminution of that of every Country-Bank is infallibly regulated.”46 Finally, we find in his Letter a suggestive fragment of theory concerning the beneficial effects of an increase in the quantity of money. That is contained in the following passage:—

If the increase of prices in the home-market should fortunately not keep pace with the depression of the exchange, all our articles of exportation must feel the effects of the increased demand in the foreign markets, in consequence of the diminished value of British money abroad. . . . Trade may be greatly extended in consequence of the increased demand which the diminished value of British money in foreign countries necessarily tends to create.47

That anticipated an important doctrine of the effect of depreciation on the course of foreign trade.

Boyd’s work was widely read and succeeded in exerting a great influence upon his contemporaries. His first three propositions were at once accepted by the anti-Restriction group and soon became the orthodox view of the group.

The apologists of the Bank were naturally quick to take up its defence. Immediately after the appearance of Boyd’s work Francis Baring published his Observations on it.48 His arguments are rather vague. He conceded that—

a considerable portion of Mr. Boyd’s Letter contains facts and principles which are indisputable: no intelligent person can doubt but that when paper circulation is pushed much beyond reasonable and proper bounds and that bullion disappears in a comparative degree, the price of all commodities (including provisions) must feel the effects. This is no new discovery. It has been the alphabet or first principle of every financier and merchant for about a century.49

What he questioned was the interpretation of the facts. He thought that the increase in the volume of notes was very small and relatively inconsiderable and argued that as banknotes were circulating at par, there could be no depreciation.50 The Bank of England also found other defenders. Most of them were of the opinion that if currency and credit inflation existed, the country banks were at least as responsible as the Bank of England.

In the following year (1802), there appeared another important work, Thornton’s treatise on paper credit.51 His work is much superior to that of Baring in every respect. Like the latter, however, he accepted “a considerable part” of the principles laid down by Boyd and defended the policy of the Bank mainly on the ground of facts. First of all, he agreed with Boyd that the Bank of England was the controlling element in the country’s credit circulation. When the Bank expanded its issues and discounted them it directly increased the reserve of the country banks and hence of their issues of notes. When, however, their issues were expanded independently, the rise in local prices and the consequent increase in country purchases in London would cause a great demand for bills on London, reduce the reserves of the country banks and thus force a diminution in the volume of their notes.52 Moreover, he agreed with Boyd that an increase in inconvertible paper money would lead to a rise in prices of both commodities and bullion and to a fall in the exchanges. He came to a similar conclusion, that is, that it was necessary for the Bank itself to limit its note issues. When he turned to consider the facts of the controversy he differed radically from Boyd. He contended that, in point of fact, since the suspension of specie payments, the Bank had limited its note issues and had not raised the number of its notes. Hence the Bank’s policy was not wrong. The causes of the rise in prices and the fall in the exchanges should, therefore, be looked for elsewhere. Among the causes he mentioned the abnormal conditions of war, the accumulated taxes, the bad harvests in 1799 and 1800 (which had combined to raise the price of all commodities); the immense importations of corn and the heavy governmental remittances to foreign countries (which turned the exchanges against England and thus led to a rise in the market price of gold).53

Regarding the allegation that the excessive contraction of credit by the Bank was responsible for the conditions of 1797, he took the same line. He agreed in principle that, however effective the deflationary policy might be in rendering the balance of trade favourable, it was a very dangerous weapon, because it would so “distress trade and discourage manufacture as to impair . . . those sources of our returning wealth to which we must chiefly trust for the restoration of our balance of trade and for bringing back the tide of gold into Great Britain”.54 When he came to explain the cause of Restriction he emphasized the first, fourth, and last causes stated on an earlier page and declared that it was due to the state of alarm that had arisen “at a period in which the stock of gold should have been reduced by the other great cause of its reduction, namely, that of a call having been recently made for gold to discharge an unfavourable balance of trade In such circumstances, “the power of any bank, however ample its general provision [of gold] should have been, may easily be supposed to prove insufficient for this double purpose.”55

But his treatise is much more than a mere defence of the Bank’s policy on the basis of facts or a mere refinement of his opponents’ doctrines in the domain of theory. His contributions both to the theory of money and that of international trade are important. In connection with the former, he noticed the following points. Firstly, unlike most of his predecessors, he included all negotiable papers in the category of circulating media,56 and excluded uncoined metals from the same.57 Secondly, he called attention to the importance of the rapidity of the circulation of money. “It is on the degree of the rapidity of the circulation of each [money and goods], combined with the consideration of quantity, and not the quantity alone, that the value of the circulating medium of any country depends.”58 His treatment of the velocity of the circulation is, in effect, a combination of Petty’s approach and Locke’s approach to the question. Velocity of circulation was sometimes viewed by him as a question of the number of times money changes hands in a given period of time and at other times discussed in connection with the “motive for holding it”.59 Thirdly, he gave an account of how an increase in notes would work out its effect on prices, and that is the most important of all his contributions to the theory of money. He said:—

Let us suppose, for example, that an encreased number of Bank of England notes to be issued. In that case the traders in the metropolis discover that there is a more than usual facility of obtaining notes at the bank by giving bills for them, and that they may, therefore, rely on finding easy means of performing any pecuniary engagement into which they may enter. Every trader is encouraged by the knowledge of this facility of borrowing, a little to enlarge his speculations; he is rendered, by the plenty of money, somewhat more ready to buy, and rather less eager to sell. . . . Thus an inclination to buy is created in all quarters, and an indisposition to sell. Now, since the cost of articles depends on the issue of that great conflict between the buyers and sellers . . . it follows, that any circumstance which seems to communicate a greater degree of eagerness to the mind of one party than to that of the other, will have an influence on price.60

In that passage are implied two important propositions: (a) that an increase of banknotes would affect prices through an increase of borrowing and (b) that an increase of the volume of the note circulation would increase the velocity of its circulation.61 In another place,62 he elucidated the former proposition and showed how and why an increase of notes would cause an increase of borrowing. He started by explaining the cause governing the willingness of the merchants to borrow:—

In order to ascertain how far the desire of obtaining loans at the Bank may be expected at any time to be carried, we must enquire into the subject of the quantum of profit likely to be derived from borrowing there under the existing circumstances. This is to be judged of by considering two points: the amount, first, of interest to be paid on the sum borrowed; and, secondly, of the mercantile or other gain to be obtained by the employment of the borrowed capital. The gain which can be acquired by the means of commerce is commonly the highest which can be had; and it also regulates, in a great measure, the rate in all other cases. We may, therefore, consider this question as turning principally on a comparison of the rate of interest taken at the bank with the current rate of mercantile profit.63

Thus, an extension of note issues by furnishing additional money capital and by lowering the terms of loans would facilitate borrowing and increase the buying-power of the community. Now, “the extraordinary emission of paper causes no immediate difference in the total quantity of articles belonging to the kingdom. This is self-evident. But it communicates to the new borrowers at the bank a power of taking to themselves a larger share of the existing goods than they would otherwise have been able to command. If the holders of the new paper thus acquire the power over a larger portion of the existing stock of the kingdom, the possessors of the old paper must have the power over a smaller part. The same paper, therefore, will purchase fewer goods or, in other words, commodities will rise in their nominal value.”64 That rise in prices itself would in turn encourage further borrowing and a further rise in prices:—

While paper is encreasing, and articles continue rising, mercantile speculations appear more than ordinarily profitable. The trade, for example, who sells his commodity in three months after he purchased it, obtains an extra gain, which is equal to such advance in the general price of things as the new paper has caused during the three months in question: he confounds this gain with the other profits of his commerce; and is induced, by the apparent success of his undertakings, to pursue them with more than usual spirit. The manufacturer feels the same kind of encouragement to extend his operations; and the enlarged issue of paper supplies both him and the merchant with the means of carrying their plans into effect.65

Those conditions would be perpetuated until the Bank stopped increasing its note issues. “As soon, however, as the circulating medium ceases to encrease, the extra profit is at an end,”66 and the price structure would become stationary after having produced its full effect in raising the prices of goods. “The temptation to borrow . . . will be exactly the same as before; for the existing paper will then bear only the same proportion to the existing quantity of goods, when sold at the existing prices, which the former paper bore to the former quantity of goods, when sold at the former prices; the power of purchasing will, therefore, be the same; the terms of lending and borrowing must be presumed to be the same; the amount of circulating medium will have altered, and it will have simply caused the same goods to pass for a larger quantity of paper.”67

That leads us immediately to his attitude towards the doctrine that money stimulates trade. That doctrine was explicitly “admitted to be just”.68 Furthermore, he said:—

It must be also admitted that, provided we assume an excessive issue of paper to lift up, as it may for a time, the cost of goods though not the price of labour, some augmentation of stock will be the consequence; for the labourer, according to this supposition, may be forced by his necessity to consume fewer articles, though he may exercise the same industry. But this saving, as well as any additional one which may arise from a similar defalcation of the revenue of the unproductive members of the society, will be attended with a proportionate hardship and injustice.69

Thereby he anticipated what is now known as the doctrine of “forced saving”, i.e. the doctrine that an increase of money brings about an increase of capital—a doctrine which is so closely connected with the general doctrine that money stimulates trade and production that it may be considered as a part or a particular version of the latter doctrine.70 He limited, however, the application of the doctrine to the transitional period and gave it its rightful place in the theory of money. He clearly connected the doctrine with his analysis of the mechanism connecting money and prices. He showed that it was because of the very fact that industry was encouraged that the willingness of people to borrow became greater, that the demand both for goods and labour became more intense than before and that consequently the prices of goods and the wages of labour rose higher.71 Thus the doctrine that money stimulates trade was reconciled with, or subordinated to, the quantity theory of money.

In the theory of international trade he considered “as a general truth that the commercial exports and imports of a state . . . naturally proportion themselves in some degree to each other; and that the balance of trade, therefore . . . cannot continue for a very long time to be either highly favourable or highly unfavourable to a country. For that balance must be paid in bullion, or else must constitute a debt. To suppose a very great balance to be paid, year after year in bullion . . . [or] to suppose large and successive balances to be formed into a debt . . . is almost equally incredible”.72 The reason for the establishment of an equality of imports and of exports was found, partly at least, in the disposition of people to adapt their individual expenditure to their incomes. He accordingly declared that the “equality between private expenditures and private incomes tend ultimately to produce equality between the commercial exports and imports”.73 Thereby he anticipated one of Wicksell’s doctrines of international trade. There must be not only an equality of imports and exports but also an equilibrium in currency conditions among the trading nations. Equilibrium would be established when the quantity of money in a country relative to the quantities in other countries was proportionate to its relative needs in comparison with those of other countries.

Before we take up the problem of disturbance and its correction, it is best, first, to describe his theory of international price relationships, which was based on the doctrine described in the preceding paragraph. He said:—

Bullion necessarily bears that value, or nearly that value, in each country, in exchange for goods, which it bears in all, allowance being made for the expense of their transmission, inclusive of export and import duties, ordinary profit of the merchant, freight, insurance, and other customary charges. The expense of the transportation of commodities from the several places of their growth or manufacture, an expense which is greater in some cases and small in others, is the measure of the difference subsisting between the bullion prices of the same articles, at the same time, in different parts of the world.74

The next problem is that of the possible causes of a disturbance and how disturbances are adjusted. Thornton was of the opinion that the initiating cause might originate either on the money side or on the commodity side. If it originated from the former, Hume’s Law would operate to restore the equilibrium. He went, however, beyond Hume and extended the latter’s doctrine to a depreciated currency:—

[First] in a country in which coin alone circulates, if, through any accident, the quantity should become greater in proportion to the goods which it has to transfer than it is in other countries, the coin becomes cheap as compared with goods, or, in other words, that goods become dear as compared with coin, and that a profit on the exportation of coin arises. This profit, indeed, soon causes the actual exportation of the article which is excessive. . . .

[Secondly] in a country in which coin and paper circulate at the same time, of the two taken together should, in like manner become in the same sense of the term, excessive, a similar effect will follow. There will, I mean, be a profit on sending away the coin, and a consequent exportation of it. . . .

[Thirdly] in a country in which paper alone circulates, if the quantity be in the same time excessive, supposing the credit of the banks which issued it to be perfect, the paper will fall in value in proportion to the excess, on an exactly similar principle; or, in other words, that goods will rise; and . . . a necessity will exist for granting, in the shape of exchange, a bounty on the exportation of them equal to that which would have been afforded in the two former suppositions, assuming the quantity of circulating medium to be excessive in an equal degree in all the three cases.75

His doctrine concerning a depreciated currency, as presented here, is substantially what is now known as the “purchasing power parity doctrine”.76

The disturbance might be initiated from the commodity side, that is, it might spring from an unfavourable balance of payments. Thornton saw clearly that specie would be exported only if the currency of the country were “redundant”, but he insisted that “it is very possible . . . that the excess of paper, if such it is to be called, is merely an excess above that very low and reduced quantity to which it is necessary (at the time of a very unfavourable balance of trade) that it should be brought down, in order to prevent the existence of an excess of the market price above the mint price of gold. I conceive, therefore, that this excess, if it arises on the occasion of an unfavourable balance of trade, and at a time when there has been no extraordinary emission of notes, may fairly be considered as an excess created by that unfavourable balance, though it is one which a reduction of notes tends to cure”.77 How is such a disturbance corrected? In answering that question Thornton advanced a double doctrine.78 One part of his double doctrine was found in the following passage:—

At the time of a very unfavourable balance (produced, for example, through a failure of the harvest), a country has occasion for large supplies of corn from abroad: but either it has not the means of supplying at the instant a sufficient quantity of goods in return, or, which is much the more probable case, and the case which I suppose more applicable to England, the goods which the country having the unfavourable balance is able to furnish as means of cancelling its debt, are not in such demand abroad as to afford the prospect of a tempting or even of a tolerable price. . . . The country, therefore, which has the favourable balance, being, to a certain degree, eager for payment, but not in immediate want of all that supply of goods which would be necessary to pay the balance, prefers gold as part, at least, of the payment; for gold can always be turned to a more beneficial use than a very great overplus of any other commodity. In order, then, to induce the country having the favourable balance to take all its payments in goods, and no part of it in gold, it would be requisite not only to prevent goods from being dear, but even to render them excessively cheap. It would be necessary, therefore, that the bank should not only not encrease its paper, but that it should perhaps very greatly diminish it, if it would endeavour to prevent gold from going out in part payment of the unfavourable balance. And if the bank do this . . . [then it may so] exceedingly distress trade and discourage manufacturers as to impair . . . those sources of our returning wealth to which we must chiefly trust for the restoration of our balance of trade, and for bringing back the tide of gold into Great Britain. It is also necessary to notice in this place, that the favourable effect which a limitation of bank paper produces on the exchange is certainly not instantaneous, and may, probably, only be experienced after some considerable interval of time; it may, therefore, in many cases, be expected that the exchange will rectify itself before the reduction of bank paper can have any operation. . . . For this reason it may be the true policy and duty of the bank to permit, for a time, and to a certain extent, the continuance of that unfavourable exchange, which causes gold to leave the country, and to be drawn out of its own coffers.79

The process of adjustment of a disturbance caused by an unfavourable balance of payments, according to the passage quoted above, was as follows—

(a) disturbance caused by an unfavourable balance of payments,

(b) an unfavourable exchange rate,

(c) contraction of the note issue or exportation of gold,

(d) changes in the relative prices of the trading nations,

(e) an increase of exports and a decrease of imports, and

(f) a restoration of equilibrium.

The most important point is the fourth one, that is a shift in relative prices. The shift may be brought about either by a contraction of currency or by an export of gold. To Thornton, however, the former had depressing effects and required a certain time to work out those effects, and he, therefore, preferred the latter. The doctrine, which implies a shift in the relative prices as the essential part of the mechanism of adjustment was in effect a restatement of Hume’s Law, which is generally known as the “classical theory”. That theory implicitly assumed that the conditions of international demand in the trading countries would remain unaffected, in spite of bad harvests or other causes that might disturb the balance of payments. There is an “alternative” theory concerning the mechanism of adjustment, which has sometimes been called the “modern” theory. Briefly stated, the advocates of that so-called “modern” theory questioned the validity of the assumption of unchanged demand conditions and argued that a bad harvest or a transfer of capital itself would alter the demand condition to such an extent that equilibrium in the balance of payments would be restored. Thus, they denied the shift of relative prices as a necessary part of the mechanism of adjustment. We shall call that theory “the Wicksellian theory of transfer”, for the following reason: The theoretical foundation for that theory is to be found in the doctrine that individuals always adapt their expenditures to their incomes and that, as a bad harvest or an export of capital would diminish the income or income available for expenditure of the people, their demand curves for all goods would be shifted. That doctrine, as we shall see, is most clearly expounded by Wicksell. Therefore, although Wicksell was not the first to advance that so-called “modern” theory of transfer, we think that there is sufficient justification for associating it with his name. The Wicksellian theory of transfer is usually considered—we think wrongly—as not only irreconcilable with the classical theory, but also explicitly or implicitly opposed by Thornton. In reality Thornton very clearly and and emphatically stated the Wicksellian view:—

There is in the mass of the people, of all countries, a disposition to adapt their individual expenditure to their income. Importations conducted with a view to the consumption of the country into which the articles are imported (and such, perhaps, are the chief importations of a poor country), are limited by the ability of the individuals of that country to pay for them out of their income. Importations, with a view to subsequent exportation, are in like manner limited by the ability to pay which subsists among the individuals of the several countries to which the imported goods are afterwards exported. The income of individuals is the general limit in all cases. If, therefore, through any unfortunate circumstance, if through war, scarcity, or any other extensive calamity, the value of the annual income of the inhabitants of a country is diminished, either new economy on the one hand, or new exertions of individual industry on the other, fail not, after a certain time, in some measure, to restore the balance. And this equality between private expenditures and private incomes tends ultimately to produce equality between the commercial exports and imports. But though the value of the commercial exports and imports of a country will have this general tendency to proportion themselves to each other, there will not fail occasionally to arise a very great inequality between them. A good or a bad harvest, in particular, will have a considerable influence in producing this temporary difference. . . . The two principles of economy and exertion are always operating in proportion to the occasion for them. But the economy and exertion follow rather than accompany the evil which they have to cure. If the harvest fails and imports are necessary, in order to supply the deficiency, payment for those imports is almost immediately required; but the means of payment are to be supplied more gradually through the limitation of private expenditures, or the encrease of individual industry. Hence a temporary pressure arises at a time of any unfavourable balance. . . .80

Thus, he recognized that in the long run a disturbance might be adjusted by the following sequence of events:—

(a) disturbance,

(b) changes in individual incomes,

(c) “the limitation of private expenditure, or the encrease of individual industry,” that is, to put it in modern terminology, a shift in demand and supply, and

(d) the supply of the means of payment and the restoration of equilibrium.

That is substantially the same as the Wicksellian theory. Thornton insisted, however, that that was only the ultimate mechanism of adjustment that took time to work out its effects and that for the correction of the difficulty or of the pressure which arose immediately after the disturbance the mechanism described in the classical theory should be relied on.

Thornton’s work was reviewed at length by Francis Homer in the Edinburgh Review.81 With respect to the theory Homer made some minor adjustments in the position of Thornton, and in regard to contemporary conditions he took the anti-Bank view first laid down by Boyd.

According to the Restriction Act, the suspension of cash payments should have expired in September, 1802, but, in spite of the conclusion of the Treaty of Amiens early in March and of the declaration of the Bank of its readiness to resume specie payments, Addington, the then Chancellor of the Exchequer, brought in a bill on the 9th April to continue the restriction till the 1st March, 1803. His argument in favour of that measure was contained in the following passage in his speech before Parliament:—

It cannot be necessary for me to inform the House that the rate of exchange between this country and foreign parts is disadvantageous to ourselves—that the export trade has been for some months at a stand, that while the rate is disadvantageous to us, an augmentation of the circulating cash would create a trade highly injurious to the commerce of this country. For several months past there has been a trade carried on for purchase of guineas with a view to exportation. It is on these grounds that I submit to the House the expediency of continuing the restriction with regard to the cash payments of the Bank.82

Addington’s statement, whatever might be its merits or demerits, represented the view of the Government and of business circles during the period. In February, 1803, for practically the same reason, Addington again asked Parliament for another renewal of restriction. The motion was granted but on this occasion not without some opposition. Charles James Fox was the first to raise an objection in the House of Commons:—

Perhaps even it might happen that the unfavourable turn of the exchange against this country might be owing to the very restriction on the Bank. . . . In 1772 to 1773, when there was a great quantity of bad money in the country, the course of exchange was then also much against us. . . . As long as our currency continued bad, the exchange was against us; so is it now, because paper is not much better than bad gold; or it is attended with the same inconvenience. May it not therefore be expected that as in the former case, when our currency was ameliorated, the course of exchange turned in our favour, so also if the Bank now resumed its cash payments the same favourable circumstances might attend the change?83

That is nothing but rather a poor statement of a part of the first proposition advanced by Boyd two years before. That view was expanded with much skill and clearness by Peter King in the House of Lords on 22nd February.84 His arguments might be summarized in a single sentence: a rise of the market price of bullion (in terms of paper currency) and a fall of the rate of exchange below the limits of the “real” exchange was the proof and the measure of the depreciation of paper money. Debates on the Restriction problem disappeared with the declaration of war against France on 18th May, 1803.

4. Foster and the Report on Irish Currency

Between 1803 and 1810 the problems of currency and trade did not attract much attention. Nevertheless, there appeared no less than three important works in those fields, namely the essays of Foster, Wheatley, and Blake. Foster’s work was connected with the problem of the Irish currency. In the last quarter of the year 1797 the exchange in Dublin (on London) began to decline steadily with a corresponding rise in the price of bullion. The exchange reached an extremely bad condition early in 1804. On a motion of Foster, a committee was immediately appointed “to inquire into the cause of the present high rate of exchange between Great Britain and Ireland and the state of the Currency in the latter kingdom”. Foster himself was appointed a member of the committee. It was in connection with his appointment to the committee that he published his famous essay on commercial exchanges.85

Foster’s general position was similar to that of the anti-Restriction group. He began by making a distinction between the balance of trade, that is “the difference between commercial exports and imports,” and the balance of debt, that is “the difference between money to be paid and money to be received”.86 He pointed out that, while exports might exceed imports, the balance of debt could not be permanently favourable or unfavourable. That was the first condition of equilibrium in international trade that he laid down in his essay. There was also another condition, namely that each country should maintain an equalization of the value of the money metals with other nations. For instance, he said:—

The precious metals, like every other commodity, seek a market where they are dear, and retire from one where they are cheap. The trade of the bullion-merchant for ever prevents their value becoming permanently less or greater in any one country than in the rest; and distributes their quantity to each, in such a proportion to its demand, that their value continues everywhere nearly equal. . . . Their intrinsic value is least in those countries which have the most direct communication with the mines; in all, it is compound of their value at the mines, and of the expense of their carriage.87

Like Thornton, Foster thought that disturbances might arise either from the commodity side or from the monetary side.88 If disturbances arose from the latter cause, then, under a metallic standard, Hume’s law would operate to restore equilibrium. In connection with that point he also gave an analysis of how an increase of the volume of money would raise the prices of commodities. That analysis was made in connection with his attempt to refute the proposition that “the Bank issues cannot be excessive according to the present mode in which they are made”, that is, issued solely on good security so that “the supply follows and does not precede the demand Foster presented his argument so excellently that it is worth quoting in full here:—

Without looking farther than the impolitic laws against usury, we may discover the source of a demand on the Bank discounts, which, if complied with, might at length reduce the value of their notes to that of the paper on which they are engraved, and yet without those notes ever being issued except on perfect security. By law the Bank are obliged to discount at 5 per cent: but during war it is almost always possible to make more than 5 per cent of money. If a merchant, under such circumstances, could obtain discounts to the amount of the security he could give, the issues of notes would soon amount to all the security that could be given [if the country is off the gold standard]. . . .89

Certainly if a country maintained a gold standard, the issues of notes could not continue very long, because the consequential rise of prices would turn the balance of debt against the country, cause gold to flow out of it, and hence serve as a check to further expansion of issues of notes. But no such check existed in the case of a paper standard.

That brings us to the problem of prices and rates of exchange under a paper standard. It should be noted at the outset that Foster understood clearly that an excess of the circulating medium does not necessarily follow a restriction of the operation of the gold standard or the abolition of the gold standard. “The restriction permits excess but does not compel it.”90 When depreciation did exist it is due to one or both of the following causes:—

(a) discredit, and

(b) excess.

In connection with the latter he, like Thornton, advanced a purchasing-power-parity doctrine:—

If the currency of any country become less valuable than formerly, it becomes exchangeable for a less quantity of the currency of any other country, which continues as valuable as formerly.91

Although he held the view that no balance of debt could continue permanently against a country, Foster thought that disturbances might arise from the commodity side. He said:—

The balance of debt may be for or against any one country with the whole world, for a limited time: great foreign expenditure, bad harvests, sudden emigrations of the proprietors, may all make the value that must be sent out greater than the value immediately to be received; the difference in this case must be paid in the precious metals.92

The last clause is rather misleading. What Foster really meant was simply that there might be temporarily an outflow of specie if the balance of debt, for a short time, turned against the country under consideration, that was Ireland. But he was of the opinion that “an increase of Irish produce must be sent out to recover specie to an equal amount, as indispensable to the circulation of Ireland”.93

As to the Irish exchange, his conclusions were the same as those embodied in the Report of the Select Committee on Irish Currency and Exchange to which we shall now turn. That report was presented in about the middle of 1804.94 The principles laid down by the report were exactly the same as those of Boyd and King. Its four main conclusions were as follows: first, that the variations of the exchanges could not exceed the expense of transporting and insuring the precious metals from one place to another and that, in case there was an excess of that kind in the exchange rate, it would be a proof of the existence of depreciation; second, that the price of gold bullion could not long exceed the mint price, unless the currency in which it was paid was depreciated below the value of gold; third, that there did exist in the case under consideration a state of unfavourable exchange much beyond the export point and a high price of bullion and that those facts constituted a sufficient proof of the existence of the depreciation of the paper; and, fourth, that the cause of unfavourable exchanges and a high price of bullion was the suspension of specie payments and not the balance of payments, because the latter was said to be favourable, instead of unfavourable.

The minutes of evidence taken by the Committee were published, and from them we learn the views of the directors of the Bank of Ireland, Colville and D’Olier. Three of their arguments might be given here. First, they argued that the sole cause of the unfavourable exchange was the unfavourable balance of payments and that “the mere buying of gold at an advanced price beyond that of the Mint, is the effect, and not the cause, of the exchange, and, therefore, no proof of the depreciation of the paper itself In other words, the causal sequence ran from the balance of payments to the exchanges and then to the price of gold and not in the reverse order. Second, they declared that it was inaccurate to speak of “depreciated paper money”. The paper had not depreciated, but the price of gold had risen. Third, they were of the opinion that the issues of convertible notes by a bank should be governed by totally different principles from the principles which govern the issues of inconvertible notes. The issue of the former ought to be regulated according to the price of guineas and the rate of exchange, while in the issue of the latter the public demand was the sole criterion.95

5. Wheatley and Blake

In the first decade of the nineteenth century there appeared some important non-controversial works on the theory of the exchanges, namely the essays of Wheatley96 and Blake. Wheatley started with an extreme quantity theory of money97 and applied it unreservedly to paper currency.98 “The increase of currency by paper,” he said, “must cause the same reduction in the value of money, in proportion to the activity of its circulation as an increase of currency by specie. But a reduction in the value of money and an advance in the price of produce, are synonymous terms; one effect cannot take place without the other; and if paper depreciate money, it must advance in a similar proportion the prices of articles of subsistence and luxury.”99 He denied in his earlier writings the doctrine that an increase of currency gave a stimulus to industry and argued (rather weakly) that “as the wages of labour are augmented only in proportion to the increase, and purchased no great quantity of produce after the addition than before it, no greater stimulus can in reality exist, and therefore no greater effect is likely to be produced by the deception”.100 In his later writings, however, he clearly presented the proposition that a hasty reduction of currency would bring about a decay of trade.101

He next presented the doctrine that prices tend to have an international “equalization”. Within a nation, nobody “would submit to a material depression in the estimate of his labour or produce in any instance where he could procure a better market”. The same regard for individual interests prevented any particular produce, the cost of conveyance being taken account of, from exchanging at one place for more value than it did at another place either inside or outside the same country. “The facility with which the reciprocal communication of nations is carried on, has a necessary influence on the markets of all and approximates the price of their produce to a general level.”102 That doctrine of international equalization of prices was, however, applied only to product prices and not to factor prices. To him the existence of inequality of wages between two countries, say France and England, was not inconsistent with the doctrine of international price equalization. For the inferiority of the wages of labour, say, in France, to the wages of labour in England “only proves that the commonalty of France are compelled to submit to a proportionate inferiority of subsistence, and by no means authorizes the inference, which the variation in the market prices of the two countries might at first view appear to justify, that the same sum measured in one country a greater value than it measured in the other”.103 What maintained an international equalization of the purchasing power of money, therefore, was the equalization of product prices but not factor prices. If those two propositions were granted, that is, if the product prices were a function of the quantity of money and at the same time the prices of the products were consequently everywhere on a level of equality, it logically followed that the quantity of money each nation could have was limited and that “no one nation can possess a greater relative currency than another But how could an equilibrium of international prices be maintained? He pointed out that “the course of exchange constituted the practical means by which the equivalency is maintained”.104 Whenever it happened that every country employed such an amount of currency as to establish an international equalization of prices, the exchange between nations “would be invariably at par”. Otherwise, a relative excess of currency would occasion a premium on a foreign bill and a relative scarcity a discount. “The course of exchange, therefore, affords an accurate criterion of the relative value of money over the whole world, and constitutes the instrument, by which the interchanges of trade between nation and nation are exclusively estimated.”105 That is what is now known as the purchasing power parity doctrine. He applied it to both metallic and paper standards. Under a metallic or under a convertible paper currency the variations of exchange could not exceed the specie points, because whenever the exchange fell below the specie exporting point, bills “would be purchased by the bullion merchant, and invested in its surplus specie for the profit of exporting it to the state whose proportion of currency was relatively less”.106 By that movement of specie equilibrium would soon be restored. Under an inconvertible paper currency, however, there would be no such limit. He said:—

When the paper of a country is not convertible into specie at the option of the holder, and a relative excess of currency ensures from its over-issue, as it is not like specie qualified for exportation, nor like paper convertible into specie obnoxious to a forced contraction, the course of exchange has no other means of causing the same sum to express in that country the same value which it expresses in others, than to reduce it to a discount in proportion to its excess.107

Although there are many points on which Wheatley comes very near to Hume, the position of the former was different from the latter. It is true that they both stood for an equilibrium theory and that both had a conception of an optimum amount of currency for a country. They also both agreed that there was a tendency towards a balance in a country’s international accounts. They differed, however, on the question how equilibrium in a country’s accounts, if disturbed, is restored. To Hume, as indicated above, when the balance of payments of a country is not in equilibrium, gold moves from one country to another to settle the debts and the movement of gold means changes in the volumes of currencies and leads to changes in prices. As a result of the changes in prices, the balance of trade is affected and the international accounts will once more be balanced. To Wheatley disturbances arising from the balance of payments automatically adjusted themselves without any effect on the prices of the countries concerned, and equilibrium in international price relationships was consequently not occasioned by the state of the balance of payments. Or, in other words, disequilibrium in international price relationships was occasioned only by monetary factors. Wheatley himself explicitly recognized that his doctrine differed from that of Hume,108 and tried to defend his own position by attempting to refute the latter’s doctrine. First he denied that there was any necessary connection between international balances of payments and international movements of specie. He wrote at length for the purpose of proving the proposition that gold could flow into the country, in spite of an adverse balance of trade and flow out, in spite of a favourable balance. His main argument was simply this: “By a due compression of our currency,” whatever might be the international balance of payments, specie would necessarily flow in.109 That argument is certainly very vague. The question is whether there will be an international movement of gold if a country has to pay a debt or a subsidy to a foreign country while other things remain unchanged. Deflation is one thing and a payment abroad is another. We cannot prove that the latter dynamic factor is ineffective simply because it might be counteracted by the former dynamic factor. More acceptable is another of his arguments, to which he failed to give due emphasis, namely that the balance of payments has in itself a tendency to adjust itself without the help of monetary changes. Of that, he said:—

All commerce with independent states consists in the equal interchange of produce for produce. It is impossible that a nation could fulfil the relations of commerce, and drive an export trade to the amount of many millions, without importing to a similar extent. The power of buying depends upon the power of selling; and unless the countries, to whom the produce was exported, were capable of vending an equivalent in return, they would be deficient in means to maintain the intercourse. . . . It may be said, indeed, that according to this principle, the exports and imports should have a reciprocal action on each other, and that the extent of the one should be implicitly governed by the extent of the other; nor can there be any doubt but that a perfect correspondence would be fully established, did not the payment of a foreign expenditure intervene to obstruct it. . . . If no demand has subsisted in this country from 1793 to 1797 for corn and naval stores, the countries that furnished the supply would have possessed so much less means of expanding our exports, as an inability to sell would, of course, have created an inability to buy.110

If we consider that that passage represents the ideas of Wheatley,111 we can say that what divides Hume from Wheatley is that the former holds to the classical theory of transfer, while the latter holds to what we call the Wicksellian theory of transfer.

Finally, Wheatley made an examination of the relationship between the Bank of England and the country banks. He adopted the view just opposite to that advanced by Boyd, and he attacked the country banks instead of the Bank of England. If the latter had the monopoly of issuing notes, certainly the whole responsibility of inflation rested on it. The country banks had, however, also issued notes. As their paper was also “made to answer the purpose of money, it necessarily depreciates the value of money, exactly in the same proportion as an addition of so much coin”, unless it could be proved that country issues “either led to a corresponding contraction of Banknotes or a corresponding contraction of specie”. Neither of those conditions existed. As a matter of fact, the country bank-notes had increased excessively in times of security and became in times of distress the main source of the difficulties that were being experienced at the time.112

Blake’s Observations exerted a greater contemporary influence than Wheatley’s work. Blake began by pointing out that “the price of bills will depend . . . first, on their abundance or scarcity in the market compared with the demand for, them; and secondly on the value of the currency in which they are to be paid, compared with the value of that with which they are bought”.113 He called the problems of exchange arising from those two causes respectively as those of “real exchange” and “nominal exchange” and investigated them separately.

He first assumed the coins of all trading nations to be “in a perfect state as to purity and weight” and presented a theory of real exchange. In that case the exchange rate depended on the demand and supply of foreign bills which, in turn, depended on the state of the balance of payments. In the long run, as international accounts had to be balanced, the exchange was inevitably at par. “At any particular period of time, however, it may happen that a nation may have imported to a greater amount than it has exported, and consequently have more payments to be made than to receive.”114 Thus conditions became deviated from the equilibrium, and demand and supply no longer remained equal if the exchange was at par. His description of the mechanism which corrects the disturbance was essentially the same as that of Hume. The only difference was that he laid greater emphasis on the variations of the rate of exchange itself than on the international movement of specie.115

He then turned on the problem of nominal exchange, that is, the problem of the effects of monetary changes on the rates of exchange, if other things remained unchanged. His theory was simply a purchasing-power-parity doctrine like that advanced by Thornton and Wheatley.116

6. The Bullion Report: Ricardo and Bosanquet

In 1808 a sharp change occurred in the monetary situation. The price of gold had become so high and the foreign exchange so unfavourable that it was manifest to everyone that the state of the national currency was becoming critical. The conditions naturally revived the currency controversy and led to the appointment of the Bullion Committee. The Committee presented its Report in 1810.117 It embodied the view that the Bank of England was solely responsible for the cause of the trouble and all the principles laid down in the Report of 1804. It was, however, much more radical in its recommendations than the latter. It recommended the adoption of a policy of severe contraction and the abolition of the restriction of specie payments within two years, in spite of war conditions. Its views were strongly opposed by both business circles and the Government. The arguments given by those opponents of the Report were practically the same as those given by the directors of the Bank of Ireland before the Committee of 1804, and we need not, therefore, repeat them here. The recommendations of the Report were finally rejected. It was not until 1819, when the war was over, that the Bank of England began to take steps to resume cash payments.

Among the innumerable participants in this new phase of the Bank Restriction Controversy we need consider only Ricardo and Bosanquet. Ricardo was both an instigator of the anti-Bank view and a supporter of the Bullion Report. His conclusions with respect to the contemporary conditions were essentially the same as those found in the Bullion Report.118 Like most of the other supporters of the anti-Bank view, he considered money as a commodity and its value as governed by the same law which governed the value of other commodities. “Gold and silver, like other commodities, have an intrinsic value, which is not arbitrary, but is dependent on their scarcity, the quantity of labour bestowed in procuring them, and the value of the capital employed in the mines which produced them.”119 As to the market value of the money metals he seemed to believe it to be governed according to the quantity theory of money.120 Paper money was considered by him as “a piece of money on which the seignorage is enormous, amounting to all its value”. “Though it has no intrinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of coin, or of bullion in that coin.”121 But when paper money was not convertible into cash there was always the danger that the issue might be excessive, that is to say, its quantity was no longer limited to that sum which would be employed if the paper money “were to regain its bullion value”.122 In such a case, specie would have a premium and the exchanges would fall.

Like Thornton and others Ricardo also made efforts to prove that “the circulation can never be over full”; and in doing so he demonstrated how an increase of money would affect prices through changes in the money rates of interest:—

If the Bank were to bring a large additional sum of notes into the market, and offer them on loan, . . . they would for a time affect the rate of interest. The same effects would follow from the discovery of a hidden treasure of gold or silver coin. If the amount were large, the Bank, or the owner of the treasure, might not be able to lend the notes or the money at 4, nor perhaps above 3 per cent; but having done so, neither the notes, nor the money, would be retained unemployed by the borrowers; they would be sent into every market, and everywhere raise the price of commodities, till they were absorbed in the general circulation. It is only during the interval of the issues of the Bank, and their effect on prices, that we should be sensible of an abundance of money; interest would, during that interval, be under its natural level; but as soon as the additional sum of notes or of money became absorbed in the general circulation, the rate of interest would be high, and new loans would be demanded with as much eagerness as before the additional issues. The circulation can never be over full. If it be one of gold and silver, any increase in its quantity will be spread over the world. If it be one of paper, it will diffuse itself only in the country where it is issued. Its effects on prices will then be only local and nominal, as a compensation by means of the exchange will be made to foreign purchasers.123

That leads us to his theory of international price relationships. Following Hume and others, he said: “The precious metals employed for circulating the commodities of the world . . . have been divided into certain proportions among the different civilized nations of the earth, according to the state of their commerce and wealth, and therefore according to the number and frequency of the payments which they had to perform.”124 “While so divided,” he continued, “they preserve everywhere the same value.” But what is meant by “the same value”? Ricardo did not give any cut and dried answer to that question. In order to understand his position fully, we must turn first to his analysis of price relationships. To him the cost of conveyance being taken account of, the prices of “exportable” commodities or “commodities common to both countries” would be internationally equalized.125 But as all commodities are not “exportable” or “common to both countries”, all prices are not equalized. Accordingly, he said that the “value” of money in terms of many commodities “may differ 5, 10, or even 20 per cent”.126 It follows that if we measure the value of money in terms of the prices of all commodities taken together it cannot be the same in all countries. In the following passage he clearly showed why the value of money in terms of all commodities could not be internationally equal and how the relative price levels in the trading nations were determined:—

In the early stages of society, when manufactures have made little progress, and the produce of all countries is nearly similar, consisting of all the bulky and most useful commodities, the value of money in different countries will be chiefly regulated by their distance from the mines which supplied the precious metals; but as the arts and improvements of society advance, and different nations excel in particular manufactures, although distance may still enter into the calculation, the value of the precious metals will be chiefly regulated by the superiority of those manufactures. . . . These I believe to be the only two causes which regulate the comparative value of money in the different countries of the world.127

In other words the differences in the cost of obtaining gold for different countries—which are due either to differences in the expense of conveying goods or to the qualitative and quantitative differences in the efficiency of factors of production—determine the differences in the average prices in different countries. That point was later taken up by Senior to form the basis of what we shall call the Seniorian doctrine of international price relationships. It remains for us to interpret Ricardo’s proposition that money preserves “every where the same value” and to see how that proposition could be reconciled with the idea contained in the passage just quoted. In order that the value of money might be comparable among nations, it had to be expressed in terms of something, which was “common” to all countries. The idea of a commodity “common” to all nations was, however, conceivable only when we arbitrarily supposed the existence of “exportable products” as a class distinguished from “non-exportable products” and assumed that in the case of the former the expense of conveyance might be ignored. Upon that assumption, all “exportable products” were commodities “common” to all nations. They would command, if trade were free, the same prices in all countries; or what was the same thing, the value of money in terms of them would be everywhere the same. As a “non-exportable product” in one country and a “non-exportable product” of an identical constitution in another country were not commodities “common to both countries”, their prices would not be the same. In spite of that, as pointed out by Senior and Mises, the value of money would remain the same for both countries, because those differences in the prices of the respective “non-exportable products” should be explained by differences in the quality of the commodities offered and demanded but not by the differences in the value of money itself. Hence there would be differences in prices though not a difference in the value of money. It was to explain that divergence of prices that Ricardo presented what we call the Seniorian doctrine. There is then no contradiction between the Seniorian doctrine and the proposition that the value of money is everywhere the same.

Next we may examine his view on the possible causes of disturbance and on the mechanism of adjustment. Here his view is, in the main, similar to that of Wheatley. He said:—

The temptation to export money in exchange for goods, or what is termed an unfavourable balance of trade, never arises but from a redundant currency.128

In other words, a monetary cause was the only possible cause of disturbance. If such a cause arose to disturb the equilibrium, Hume’s law would, according to Ricardo, operate to correct it in the case of a metallic standard. In the case of a paper standard, the purchasing-power-parity doctrine would apply. He denied that equilibrium in international price relationships could be disturbed by changes in the balance of payments. He said:—

Mr. Thornton has not explained to us why any unwillingness should exist in the foreign country to receive our goods in exchange for their corn; and it would be necessary for him to show, that if such an unwillingness were to exist, we should agree to indulge it so far as to consent to part with our coin. If we consent to give coin in exchange for goods, it must be from choice, not necessity. We should not import more goods than we export, unless we had a redundancy of currency, which it therefore suits us to make a part of our exports. The exportation of the coin is caused by its cheapness, and is not the effect, but the cause of an unfavourable balance: we should not export it, if we did not send it to a better market, or if we had any commodity which we could export more profitably. . . . If, which is a much stronger case, we agreed to pay a subsidy to a foreign power, money would not be exported whilst there were any goods which could more cheaply discharge the payment.129

Ricardo’s position here may be summarized in two propositions—

(a) an exportation of gold is always the cause, never the effect, of an unfavourable balance of trade; and

(b) a failure of the harvests, or the grant of a subsidy or a loan to a foreign country, does not create a redundancy of currency, and therefore does not result in the export of gold.

The latter proposition in turn implied that a failure of harvests would immediately and automatically cause a proportionate change in the reciprocal demands of countries for each other’s products. That, as pointed out by Dr. Iverson, pre-supposes “that, consciously or unconsciously, he has based his reasoning upon the idea that a transfer of capital means eo ipso a transfer of an equal amount of buying power”, or in other words upon what we call the Wicksellian theory of transfer. If Ricardo’s position is interpreted in that way the only difference between Ricardo and Thornton is that, while to the latter the mechanism of adjustment, as described in the Wicksellian theory, took time to work out its effects, to Ricardo the mechanism was immediately effective. In fact, the doctrine Ricardo implied in his criticism was the classical theory of transfer as expounded by Hume.

That view was strongly criticized in the Edinburgh Review by Malthus. He, siding with the classical theory, said:—

The great fault of Mr. Ricardo’s performance, is the partial view which he takes of the causes which operate upon the course of Exchange. Independently of the wearing or the adulteration of the coin, the effects of which are readily intelligible, there are, we conceive, two causes, perfectly distinct in their origin, though nearly similar in their effects, by which the exchange is affected. The first, and the most ordinary, is the varying demand for different sorts of produce arising from the varying desires and necessities of the nations connected with each other by commerce: The second is a comparative redundancy or deficiency of currency, in whatever way it may be occasioned. . . . [In the first case], the exportation of bullion was the effect of a balance of trade, originating in causes which may exist without any relation whatever to redundancy or deficiency of currency. In other cases, a redundancy or deficiency of currency is the exciting cause of the balance of trade and payments, and of the exportation or the importation of bullion. . . . Mr. Ricardo, however, instead of directing his attention to both these causes, confines it to only one of them. He attributes a favourable or unfavourable exchange exclusively to a redundant or deficient currency, and overlooks the varying desires and wants of different societies, as an original cause of a temporary excess of imports above exports, or exports above imports.130

That criticism was immediately answered at length by Ricardo. His argument was essentially the same as before, but he disclosed one of his underlying reasons for rejecting the classical theory of transfer, even as a transitional mechanism, namely that gold would not be exported if it were soon to be re-imported.131 He conceded, however, that a bad harvest itself might create a redundancy of currency and thus cause an outflow of gold. He said:—

If the circulating medium of England consisted wholly of the precious metals, and were a fiftieth part of the value of the commodities which it circulated . . . [and if] England, in consequence of a bad harvest, would come under the case mentioned—of a country having been deprived of a part of its commodities, and therefore requiring a diminished amount of circulating medium. The currency, which was before equal to her payments, would now become super-abundant, and relatively cheap, in the proportion of one-fiftieth part of her diminished production; the exportation of this sum, therefore, would restore the value of her currency to the value of the currencies of other countries.132

As pointed out by Professor Viner, that was not the sort of gold movement posited by the advocates of the classical theory. What Ricardo had in mind was that the outflow of gold was a consequence of a change in the proportion of commodities and money and that its purpose was the maintenance unaltered of the original relation between the price levels, whereas the outflow of gold, as described in the classical theory, was the cause of an alteration of the proportion between commodities and money, and hence a change in the price and income structures.

In his private correspondence with Malthus, Ricardo defended his main position, although he admitted that his theory would be applicable only to a society without friction and needed some modification when applied to the actual world.133 He consistently maintained the proposition that gold would not be exported if it would speedily return.134 He also elucidated the proposition that the varying demand for different sorts of produce could not be the cause but the effect of the state of currency. The demands for particular commodities, he said,

are in my opinion regulated by the relative state of the currency; they are not causes but effects. You appear to me not sufficiently to consider the circumstances [which] induce one country to contract a debt to another. [In] all the cases you bring forward you always suppose the debt already contracted, forgetting that I uniformly contend that it is the relative state of the currency which is the motive to contract itself. The corn, I say, will not be bought unless money be relatively redundant; you answer me by supposing it already bought, and the question to be only concerning the payment.135

The same, however, cannot be said of subsidy or similar payments. Ricardo seemed to have found it necessary to concede that a subsidy payment might affect the rate of exchange and international price relationships. It had that effect, “because a demand for bills arising from such a cause would not be in consequence of the natural commerce of the country. Such a demand would therefore have the effect of forcing the exports of commodities by means of the bounty which the exchange would afford.”136 In connection with his discussion of the payment of subsidy, he recognized that the rate of exchange did play a very important role in the process of adjustment, precisely in the way described by Hume and Foster.137

Bosanquet138 was probably the best critic of the Bullion Report and a strong opponent of Ricardo.139 He tried to refute one by one the main propositions of the anti-Restriction group. With regard to the problem of exchange rates, he said that the proposition that exchange rates could not long vary beyond the specie points unless the currency had been depreciated was true only when the following condition was fulfilled: “The country by which the balance of payment is due shall possess bullion or specie sufficient to liquidate it” and at the same time did not prohibit, or at least effectually prohibit, the export of their currency.140 But that condition was not fulfilled. Moreover, like other defenders of the Bank, he declared that “the usual cause of variations in the foreign exchanges and price of bullion” was “the fluctuations in the balance of payments, due to or by Great Britain”.141 As to the problem whether the paper currency of the Bank was issued to excess, he rightly pointed out that the opinion of the Report was founded on the two following propositions. First the Bank possessed the power of adding to the amount of their notes in circulation beyond the absolute demand for paper, as a circulating medium. Second the issues of the Bank regulated those of the country banks and were dependent upon and proportionate thereto.142 He thought that both propositions were untrue. In his attempt to refute the second proposition, there was very little which was worth notice.143 His argument against the first proposition was, however, suggestive. He said:—

Mr. Ricardo has assimilated the Bank of England during the restriction, so far as relates to the effects of its issues, to a gold-mine, the produce of which . . . has the acknowledged effect of depreciating the value of the existing medium, or, in other words, of raising the prices of commodities for which it is usually exchanged. . . . But Mr. Ricardo has not stated, what is essential to the comparison, why it is that the discovery of a gold-mine would produce this effect. It would produce it, because the proprietors would issue it, for whatever services, without any engagement, to give an equal value for it again to the holders, or any wish, or any means, of calling back and annihilating that which they have issued. By degrees, as the issues increase they exceed the wants of circulation; gold produces no benefit to the holder as gold; he cannot eat it, nor clothe himself with it; to render it useful, he must exchange it either for such things as are immediately useful or for such as produce revenue. The demand and consequently the prices of commodities and real properties, measured in gold, increase; and will continue to increase so long as the mine continues to produce. And this effect will equally follow whether . . . the issue be gold from a mine or paper from a government-bank. . . . [But] there is not one point of analogy to the issues of the Bank of England. The principle on which the Bank issues its notes is that of loan. Every note is issued at the requisition of some party, who becomes indebted to the Bank for its amount, and gives security to return this note, or another of equal value, at a fixed and not remote period, paying an interest proportioned to the time allowed. . . . In the case of an excess of bank-paper the remedy is more simple: the surplus . . . would revert to us by a diminished application for discounts and advances on government-securities.144

Thereby he anticipated the main argument of the banking school of the Bank Charter Act controversy in the middle of the nineteenth century.

* * * *

The literature of the Bank Restriction controversy had thus pushed the theory of international price relationships another great step forward. The main problem in that controversy was what caused the unfavourable exchange and the high price of bullion. There were three possible explanations: first the excessive issues of bank-notes; second the unfavourable balance of payments; and third discredit or the loss of confidence. The last cause had not been advanced as an independent explanation of the situation. The issue was, therefore, limited chiefly to the question whether it is an excessive issue of currency or an unfavourable balance of payments which was responsible for the situation. In connection with the problem of excessive issue as a cause of disturbance there arose two important theoretical questions. First, was there any assignable limit for the circulation of the Bank of England notes? Bosanquet, in defence of the Bank, gave a positive answer and argued that if the Bank issued its notes on the principle of loans, they could not be excessive. That view anticipated the so-called Banking Principle which we are going to discuss in a later section. The anti-Bank theorists showed that if the Bank’s rate of interest was kept low enough, its circulation could expand beyond all assignable limits. In that connection they presented a valuable analysis of the “indirect” mechanism connecting money and prices (that is, via changes in borrowing). Moreover, if there was an excessive note circulation, what would be the effect of it on prices and the exchanges? It was in the answering of that question that the purchasing-power-parity doctrine was advanced and Hume’s law was re-stated. In connection with the problem of an unfavourable balance of payments as a cause of disturbance in international price relationships, the transfer problem was much discussed. Malthus and others claimed that an unfavourable balance could be a cause of disturbance in the international price relationships and thought that Hume’s law would work to restore equilibrium. Foster was of the opinion that while an unfavourable balance might be a cause of disturbance, changes in the rate of exchange would, in most cases, be able to correct it without resort to the international movement of gold. Wheatley and Ricardo denied that an unfavourable balance of payments was a cause of disequilibrium in international price relationships and came near to what we call the Wicksellian theory of transfer. Thornton, though often misinterpreted, was really midway. He had presented, probably for the first time, the Wicksellian theory of transfer in an elaborate and clear-cut form, but he limited it to being an ultimate mechanism of adjustment and thought that during a short period of time the classical theory of transfer was correct.

* * * *

After the resumption of cash payment by the Bank and the return to the gold standard at the old par, there was a long period of deflation. The fall of prices and the economic distress, which ensued, aroused much discussion of the problem whether the resumption of cash payment was responsible for the situation. While Ricardo continued to defend the return to gold at the old par, most economists thought that the return to gold at the old par was a mistake. They emphasized more and more the doctrine that falling prices reduced the volume of trade and retarded production and rising prices stimulated trade and production.145

7. Nassau Senior

In the three decades which elapsed between the last phase of the Bank Restriction controversy and the controversy concerning the Bank Charter Act of 1844, there appeared among other works the Principles of Ricardo (1817) and the Lectures of Senior.146 With the former the theory of international trade took a new departure because in it was found one of the first formulations of the doctrine of comparative costs. As that doctrine was primarily one concerning the real aspects of the problem, it seems better to examine it in the next chapter where those aspects are fully treated.

The Lectures of Senior are mainly concerned with the monetary aspects of the problem. Let us first describe his theory of money under a metallic standard. He began with an attack on the quantity theory of money, because it usually suggested the idea “that the value of money is decided by causes differing from those which decided the value of other commodities”.147 The value of money, according to him, should follow the general law of value. “The value of the precious metals, as money, must depend ultimately on their value as materials of jewellery and plate; since, if they were not used as commodities, they could not circulate as money.”148 Furthermore, the causal sequence did not run from quantity to the value of money as supposed by the quantity theory of money, and he remarked “that whilst the fertility of the mines is unaltered, every increase of the total amount of silver is preceded by an increase of its value, indeed, could not take place, unless so preceded; and that every diminution of the value of silver is followed by a miminution of the whole quantity”.149

The general law of the value of money in his analysis was that the value of money would be such that the quantity supplied was equal to the quantity demanded, and it had, in the long run, to equal its cost of production. To begin with, let it be assumed that the production of gold was subject to the law of constant cost. Then the value of gold would become fixed and the quantity of money produced was determined mainly by the demand conditions. In that case, if there were no foreign commerce “the quantity of gold produced would depend partly on the quantity wanted for plate, including under that word all use of gold except as money, and partly on the quantity wanted for money”.150 The quantity wanted for plate “would, of course, depend on the prevailing fashions of the country”, and called for no further observations. The quantity wanted for money was much more complicated. It was in connection with the explanation of the latter point, that is, the causes determining the quantity of money, which a community should possess, that Senior advanced a clear-cut “cash-balance doctrine”:—

It is obvious, in the first place, that the whole quantity of money in a community must consist of the aggregate of all the different sums possessed by the different individuals of whom it is constituted. And what this quantity shall be must depend partly on the number of those individuals; partly on the value in money of the aggregate of their respective incomes; and partly on the average proportion of the value of his income which each individual habitually keeps by him in money. . . . What proportion of the value of his income each individual shall habitually retain in money . . . may be said to depend, first, on the proportion to his income of his purchases and sales for money; and secondly, on the rapidity with which they succeed one another.151

Thus, while the number of individuals and their money incomes remained the same, the demand for money depended on the proportion in which each individual kept his income in cash, which in turn depended on the rapidity of its circulation.

In that connection Senior developed the theory first suggested by North that there was a definite relationship between the monetary and the non-monetary uses of the precious metals. He said:—

Any increase or diminution of the demand for plate occasions an increase or diminution of the demand for silver in the same direction, and a diminution or increase in the demand for money in an inverse direction. An increased demand for money must, in a similar manner, increase the demand for silver and diminish the demand for plate and vice versa.152

The demands for plate and money are antagonistic demands, and, in a great measure, neutralize one another: that an increased consumption of plate, by raising the value of silver, occasions less money to be necessary; and . . . that a diminished demand for plate, by sinking the value of silver, makes more money necessary. . . .153

It was the resultant of the two antagonistic uses of the precious metals that constituted the aggregate demand for the precious metals. But of the two Senior considered the non-monetary uses as the more fundamental. “Ultimately and principally [is] the demand for them as commodities; as the material of plate, gilding, and jewellery; and through the intervention, and as a consequence of that demand, the demand for them as money.”154 Although upon the assumption of constant costs in gold production, the quantity of gold produced depended solely upon its demand, demand did not affect the value of gold except for short intervals. He said:—

I say, except during comparatively short intervals, because though the causes which limit the supply of gold are supposed to be unalterable, those which give it utility, or, in other words, which create the demand for it, might be increased or diminished; and during the interval between the diminution or increase of the demand, and the increase or diminution of the supply in the market, the value might rise above, or sink below, the cost of production.155

Thus, ultimately the value of money was determined by its cost of production. He then removed the assumption of constant costs and demonstrated how the value of money was determined by the cost of production “under the least favourable circumstances”.156

In the next place he discussed the problem of the effects of bank credit on prices. He pointed out that by diminishing the use of money in exchange the introduction or expansion of bank credit would cause “a rise in the price of every commodity except plate, and in the wages of all labourers except the gatherers of gold”.157 He also demonstrated the functioning of the doctrine “that the demands of commerce for loans and discounts at a rate below the usual rate are insatiable”.158

One more point should be noted before we go to his theory of international price relationships. The cost of production theory of the value of money, as advanced by Senior, is not irreconcilable with the quantity theory of money. The best way to reconcile the two theories is to use, as Cantillon did, the cost of production theory to explain the intrinsic value of the money metal and to use the quantity theory to explain the market value of the metal. That is the way, as we shall see, in which J. S. Mill tried to reconcile the two theories.

Senior’s contributions to the theory of international price relationships were even more valuable. In his doctrine concerning the comparative values of money in different countries he pointed out, like all the other classical economists, that in equilibrium the exchanges would be at par and that the value of money everywhere would be the same. He considered it as “a peculiar and important attribute of the precious metals when used as money: that their value was almost entirely independent of locality”.159 He was the first economist to give a clear explanation of the meaning of the classical doctrine that the value of money was everywhere the same and to demonstrate that differences in the prices of goods of similar composition in different places were perfectly reconcilable with the assumption of an equality of the value of money. His description of those matters was so excellent that it is worth quoting in full:—

Because 1,000 sovereigns will purchase 200 acre of land in Wales and not one in London, Mr. [James] Mill considers money estimated in land of greater value in Wales than in London. But 1,000 sovereigns in London will purchase just as much Welsh land as 1,000 sovereigns in Wales. If there are two purchasers in an auction room at Carmarthen, one of whom has his bag of sovereigns in his hand, and the other Bank of England notes of equal amount (which are only an authority to receive a given amount of sovereigns in London), we shall find that the notes purchase just as much land as the sovereigns. To take another example, 1,000 sovereigns will purchase 1,000 chaldrons of coal in Newcastle, and only 500 in London, but it does not follow that 1,000 sovereigns in Newcastle are of more value, estimated in coal, than 1,000 sovereigns in London. The fact is that a person in Newcastle having 1,000 sovereigns in London will be able to purchase with them just as much Newcastle coal as if he had the sovereigns with him. The only inference from all the facts is that 1,000 sovereigns in London, Wales, or Newcastle, though of precisely equal value themselves, exchange for different quantities of what are in fact different commodities: exchange in a different proportion for coal in Newcastle and for (what is a different commodity) coal in London; just as they exchange in different proportions for coal and diamonds.160

Senior accounted for the uniformity in the value of money as follows:—

This uniform value of money . . . [is] partly without doubt from its portableness. But a bar of gold weighing 20 pounds is as portable as 1,000 sovereigns, and yet such a bar in Liverpool would not exchange in the London market for as much as a similar bar in London. The purchaser would deduct from its price the expense of transport. In the case of the sovereigns he would make no such reduction. The principal cause is that in the case of the sovereigns he does not expect the expense of transport to be incurred. Every day many purchases are made in London by persons whose money is at Liverpool, and in Liverpool by persons whose money is in London. But the payments are not made by a transport of money, but by an exchange of debts, or in commercial language by bills of exchange. . . . As long as the debts between London and Liverpool are capable of being adjusted without the transport of money, either by a direct exchange of bills or by an exchange of their respective debts and credits at third places, the exchange between them is said to be at par. And equal sums of money in each place are of precisely the same value. . . . The reciprocal value of the moneys of different countries using different coins or, as it is usually termed, the foreign exchange, is governed by the same principles although their application is more complex.161

His opinion of the causes of disturbance and its correction was mainly “classical”. He presented an excellent exposition of Hume’s law as a correction of an adverse balance of payments or of an excessive circulation of money.162

He examined how wages and prices were determined in countries which possessed mines of the precious metals as well as in countries into which the precious metals constantly flowed. In the former, all prices ultimately depended on the cost of producing the precious metals and all the wages of labour on the money wages of the miners. “Though the remuneration paid to the miner is not identical with that received by other producers, yet . . . it affords the scale by which the remuneration of all other producers is calculated.”163 In countries which possessed no mines of the precious metals “the mine . . . is the general market of the world: the miners are those who produce those commodities by the exportation of which the precious metals are obtained, and of the amount of the precious metals, which by a given exertion of labour, and advance of capital, they can obtain, must afford the scale by which the remuneration of all other producers is calculated”.164 In other words the wages obtained by the labourers of the exporting industries, for whose produce the precious metals were imported, “regulate the wages of all other labourers in the same country.”165 The wages of the labourers in the exporting industries in turn were proportionate to the amount of the precious metals obtained by a certain quantity of labour; and the amount of the precious metals obtained (or the cost of obtaining money) depended on the efficiency of the labour itself. It followed, therefore, that the more efficient its labour, the higher the level of wages a country had.166 He declared that this—the relative efficiency of labour—was chiefly responsible for the discrepancies in the wages of labour (in terms of gold or silver) in different countries at the same period.167 Finally he came to commodity prices in countries which did not mine the precious metals. His conclusion was that the price (that is the value in gold or silver) of all commodities depended upon “the gold and silver which can be obtained by exporting the result of a given quantity of labour, the current rate of profit, and in each case, the amount of the wages which have been paid, and the time for which they have been advanced”.168 If the cost of obtaining gold was relatively small, the general level of prices would be relatively high. If the difficulty of obtaining it increased, there would be a general fall in prices.169 That doctrine concerning discrepancies in wages and prices among trading nations we shall designate as the Seniorian doctrine of international price relationships.

8. The Bank Charter Act Controversy

In the decade following the crisis of 1836–7 the long-discussed problem of what was the best form of organization for the Bank of England insistently called for a solution and thus a new controversy arose.170 Although the controversy was mainly concerned with banking and credit, it had a bearing on the theory of international price relationships, because in discussing the relations of the exchanges to the note issue, credit, and other connected matters, the participants in the controversy went into many departments of the problem of international price relationships. The controversy has been known as the Bank Charter Act controversy. The two opposite parties to the controversy have come to be known as the “currency school” and the “banking school The main proposition of the currency school, or what has also been called “the currency principle”, was that there is always a danger of an over-issue of bank-notes, which therefore should be strictly regulated—so regulated that the notes might become mere tokens for metallic money. The Banking School, on the contrary, denied the possibility of an over-issue of banknotes and regarded “elasticity” as the essential characteristic of the note issue. The theoretical foundation of the currency principle was provided by Thornton and the anti-Bank writers in the Bank Restriction controversy. However, the first writer to advance the currency principle as a banking policy was Thomas Joplin, who is sometimes called “the inventor of the currency principle”.171 As Joplin dealt primarily with the banking structure, it is best that we turn at once to Norman, Loyd, and Torrens, the three most important champions of the currency principle.

Norman started with the classical theory of the value of money, that is that while the value of money was ultimately regulated by the costs of production, its market value depended upon demand and supply.172 Then, like the classical economists, he carried the theory beyond the frontiers of a single nation and came to the conclusion that “the whole mass of coin and bullion is distributed according to the respective wants of the several countries upon the principle of competition”.173 While so distributed, there would be “general equality of value in the precious metals over the whole globe”.174 Like Senior, he pointed out that differences in local prices could exist without invalidating the doctrine that the value of money was internationally uniform. He said:—

One, two, twenty, nay, it is possible, though highly improbable, that all the commodities would fall in money price, without any appreciation of the currency, that is to say, without the existence of any change affecting the precious metals themselves. If such an event should take place without any derangement in the exchanges, or should continue when, after a derangement, the equilibrium had been restored, we might be sure that the cause was to be sought in some circumstance extrinsic to the currency, unless at the same period a corresponding fall, of an exactly similar amount, could be traced in the money prices of all other countries. Then, indeed, it might be fairly assumed, though not with absolute certainty, that the phenomenon was referable to some alteration of the precious metals themselves.175

The key to the question whether the relative values of moneys were equal or not was not the prices of commodities but the rates of exchange. As long as the rate of exchange was at par the value of money at home was equal to that abroad, whatever might be the local prices of commodities. Again, like the classical economists, he pointed out that “an issue of paper money produces precisely the same effect on general prices as would follow from an augmentation in the quantity of the precious metals—it lowers their value”.176 Hume’s law would operate to restore the “general equality of value in the precious metals over the whole globe”. There the exchange rate was also “the sole guide” to the question whether a country’s circulation was excessive or not.

That was the theoretical foundation of Norman’s opinion on banking policy, which might be summarized in two propositions. First, since the value of the precious metals was ultimately determined by the cost of production and since “there is every reason to believe that during a long course of years, no considerable change has occurred in the cost of producing the precious metals”,177 he came to the conclusion that “the precious metals afford the best and only safe standard”. Secondly, although a paper currency was more convenient than a metallic currency, it always involved the danger of an over-issue. Therefore he proposed to establish “a single issuing body”, the only business of which “would be to issue notes for gold and gold for notes”, so that the mixed circulation of coin and paper would approach “to what would be the amount of coin in case there was no paper”. Under such a system, he thought, the country would have all the advantages of a pure metallic standard and at the same time retain many of the advantages of a paper currency.178

The main arguments and conclusions of S. J. Loyd (known in his later years as Lord Overstone) were the same as those of Norman, though they were not systematically stated. He conceived a metallic currency as an ideal currency, because it “will adjust itself”.179 Under a purely metallic currency, “no danger of total exhaustion of the gold could arise. As a portion of the metallic money was exported, the quantity of that remained being diminished, the value of it would be proportionately increased; and consequently a limited proportion only of the gold in circulation could be drawn out of the country by any foreign demand.”180 Under a “mixed circulation” of coin and paper, however, there was always the danger of over-issue.181 Contraction of the currency was generally not coeval with a loss of bullion and the amount of the contraction did not coincide with the extent of the diminution of the bullion. Notes were often issued in place of the metallic money exported and thereby prevented a fall in internal prices and retarded the restoration of equilibrium. “There can then be no certainty that the value of currencies will be thus equalized; and, consequently, there can be no security that the bullion may not be entirely drained out. . . . Bullion, equal to the amount of the whole circulation may be drained out, if its place be continually supplied by paper issues, and the total amount of the circulation be thus kept diminished.”182 In order to prevent that danger, a mixed circulation of paper and coin should be so regulated that its amount was “equal to what would have been the amount of a metallic circulation”. The best measure of what should be the amount of the currency was “the influx or efflux of bullion”.183

Torren’s184 view was similar to that held by Norman and Loyd. He also started from the classical doctrines of the value of money, natural distribution of the precious metals among the trading nations and international price adjustments.185 Like Norman and Loyd, he insisted on the gravity of the danger of the over-issue of notes in the case of a mixed circulation of coins and convertible paper in the absence of proper control. The danger of an excessive issue would arise from a failure to make the necessary contraction when bullion was lost as well as in the temptation to expand the note issue in such a situation. To him convertibility was no safeguard, for “the effect of convertibility is not to prevent the occurrence of excess and depreciation but, on the contrary, to limit and to check excess and depreciation after they have occurred”.186 Therefore in order to ensure a timely limitation against the excess it was necessary to rely upon other regulations. The proposal of Torrens was “to cause our mixed circulation of coin and banknotes to expand and contract, as it would have expanded and contracted under similar circumstances, had it consisted exclusively of coin” and to make the bank-notes mere tokens of metallic coins.

The Currency School relied, on the whole, chiefly upon the classical doctrine of the natural distribution of the precious metals among trading nations and Hume’s law as the theoretical foundation of its banking policy proposals. The term “power of over-issue” was employed by its members as implying, in the words of Torrens, “that banks of issue may cause a temporary expansion beyond the metallic equilibrium until the level is restored by the expulsion of bullion.”187 Thus the term “excessive issue” was explained in terms of international price relationships. In doing so they failed to give due emphasis to another of their reasons in support of the proposition that convertible paper was liable to over-issue. That was the reason generally brought forward by the anti-Bank group, namely that if the banks kept their interest rates low enough, the demand for their notes would be insatiable. All of them, particularly Loyd, had presented that argument in one form or another,188 but none of them had given it sufficient emphasis.

Another defect in the arguments of the currency school lay in its definition of money or currency. They held that both coins and central bank notes should be included in the category of “money” but that cheques should not be so included, because cheques did not possess the power of closing transactions. Starting from that position they came to the erroneous conclusion that the volume of cheques could not create a state of “redundancy” in the currency and hence could not have any bearing on the international movement of bullion.189 That view was certainly incorrect. In reality, banknotes and bank deposits are both fiduciary media and produce essentially similar effects on internal prices and on international price relationships. But, as pointed out by Mises, “the doctrine of the Currency School does not stand or fall on the nature of cheques and deposits. It is enough to correct it on this point,—to take its propositions concerning the issue of notes and apply them also to the opening of deposit accounts. . . . Its mistake on this point is of small significance in comparison with that made by the Banking School. . . . And in any case it does not seem an inexcusable mistake to have made if we take into account the relatively backward development of even the English deposit system at the time when the foundations of the classical theory of banking were being laid and if we further consider the case with which the legal differences between payment by note and payment by cheque might give rise to error.”190

The best spokesmen of the opposite view, that is the Banking Principle, were Thomas Tooke and John Fullarton.191 According to that principle, under a metallic standard, only coins could be classed as money, whether convertible notes were circulating or not. Banknotes and other forms of paper credit, they contended, were essentially the same. It was a mistake to distinguish between them and to say that banknotes had an effect upon prices that was different from the effect produced by deposits and cheques. Only when notes were inconvertible did they become money, for convertibility, they argued, demonetized banknotes, while inconvertibility monetized them.192

The next issue which divided the Banking School from the Currency School was the mode of the operation of a pure metallic currency. The members of the former declared that it was necessary to distinguish between the precious metals and money. According to them a great error of the Currency School was that the latter assumed “that the precious metals, gold, and silver, and bullion are synonymous with currency and money, and are convertible terms Generally the elasticity of a country’s bullion reserve in the form of hoards and in the form of commodity made it possible to transmit precious metals from one country to another “to a considerable amount (five or six millions at least), without affecting the amount or value of the currency of the country from or to which the transmissions were made; and without being a cause or a consequence of alternation in general prices”.193 It was not until the increase in the precious metals was extraordinary that the volume of money would be affected. That point will be further discussed in connection with their criticism of Hume’s law. Thirdly, they differed from the currency school, as to the mode of operation of a mixed circulation of coin and convertible notes. To them there were important differences between coins or inconvertible notes (money) and convertible notes both in the volume of issue and in the effects on prices. Of the volume of an issue they said:—

There is this broad and clear distinction between all currencies of value [coins] and currencies of credit [convertible notes], that the quantity of the former is in no degree regulated by the public demand, whereas the quantity of the latter is regulated by nothing else. The gold, which is once melted and converted into coin, can never be returned again into the mine; there it is, a permanent and irrevocable addition to the stock of money in the world; the people among whom it is circulated have no voice in directing its destination.194

When a government issues paper money, inconvertible and compulsorily current, it is usually in payment for (a) the personal expenditure of the Sovereign or the governing power, (b) Public works and Buildings, (c) Salaries of Civil Servants, (d) Maintenance of Military and Naval Establishments. It is quite clear that paper created and so paid away by the Government not being returnable to the issuer, will constitute a fresh source of demand, and must be forced into and permeate all the channels of circulation.195

Banknotes, on the contrary, are never issued but on loan, and an equal amount of notes must be returned into the bank whenever the loan becomes due. Banknotes never, therefore, can clog the market by their redundance, nor afford a motive to anyone to pay them away at a reduced value in order to get rid of them. The banker has only to take care that they are lent on sufficient security, and the reflux and the issue will, in the long run, always balance each other.196

That doctrine of the impossibility of the over-issue of convertible notes is sometimes called the Principle of Reflux. The way in which that principle chiefly works is a return of notes to the bank for cancellation of debts. It follows from that principle that, while coins and fiat money might be increased to the extent that prices will be affected, banknotes can never be issued in excess or in deficit relative to the “needs” of trade. In the latter case, the rise of prices is not preceded, but followed by an increase in the amount of their circulation. In other words, an increase in the amount of the circulation of notes is the effect, and not the cause of a rise in prices.197

To the principle laid down in the preceding paragraph one may raise the objection that the demands of commerce for loans and discounts at a rate below the equilibrium rate are insatiable. That objection, as already pointed out, was a common asset of the anti-Bank group in the Bank Restriction controversy. Tooke, in his Considerations, written some two decades previously, had held the same view. To him a new supply of money was bound to have effects on the rate of interest, “since it cannot enter into circulation otherwise than by reducing the rate of interest, other things remaining the same; as it must inevitably at the time it is issued increase the number of lenders or diminish the number of borrowers. The additional currency, in whatever way it comes into circulation, and whether it is in the form of gold or paper or mere credit, must eventually raise the price of commodities and labour.”198 When they attempted to explain the banking principle both Tooke and Fullarton were conscious of the contradiction between the banking principle and the classical doctrine of the market rate of interest as a connecting link between money and prices. Fullarton tried to escape the difficulty by limiting the classical doctrine to the case of changes in the volume of legal money. He recognized that an extraordinary influx of gold would work out its effects on prices through changes in the interest rate:—

The inevitable results [of an influx of bullion and its consequent increase in funds available for productive investment] would be, first, a decline of the market rate of interest; next, a rise in the value of land, and of all interest-bearing securities; and, lastly, a progressive increase in the prices of commodities generally.199

Quite illogically, Fullarton insisted that an increase of the note issue did not have a similar result. Tooke, on the contrary, entirely rejected in his Inquiry the classical doctrine. He started by pointing out the empirical fact that rising prices very rarely coincide with low or falling rates of interest but much more frequently with rising or high rates. He then drew the conclusion that “a reduced rate of interest has no necessary tendency to raise the prices of commodities. On the contrary, it is a cause of diminished cost of production, and consequently of cheapness”.200 That view of Tooke’s, though plausible, was incorrect. What affected prices, according to the classical doctrine, was not the absolute rate of interest in the market but the deviation of the market rate from the “equilibrium rate Whenever the “equilibrium rate” rose or fell, and the market rate did not rise or fall, or did not rise or fall immediately, to a similar extent, there was a deviation of the market rate from the equilibrium rate and prices were affected. The empirical fact, which had been discovered by Tooke, did not, therefore, invalidate the classical doctrine. Tooke was not right, furthermore, in drawing the conclusion, given above, namely that a fall in the rate of interest would, by reducing costs, lower the prices of commodities. As Wicksell rightly pointed out, “the argument is based on the inadmissible, not to say impossible, assumption that wages and rent would at the same time remain constant, whereas in reality a lowering of the rate of interest is equivalent to a raising of the shares of the other factors of production in the product. Indeed, as Ricardo (and more recently Böhm-Bawerk) proved, and as experience has often shown, a rise in wages or rent constitutes ceteris paribus just the necessary condition for the profitable employment of more capital in the service of production. A fall in loan rates caused by increased supplies of real capital (increased savings) should thus in itself cause neither a rise nor a fall in the average price level.”201 Tooke also objected to the doctrine “that a low, and especially a declining, rate of interest operates necessarily as a stimulus to speculation, not only in government stocks and shares both at home and abroad, that is in both British and foreign public and private securities, but also in the markets for produce He said:—

There are, doubtless, persons who, upon imperfect information and upon insufficient grounds, or with too sanguine a view of contingencies in their favour, speculate improvidently; but their motive or inducement so to speculate is the opinion which, whether well or ill founded, or whether upon their own view or upon the authority or example of other persons, they entertain of the probability of an advance of price. It is not the mere facility of borrowing, or the difference between being able to discount at 3 or at 6 per cent, that supplies the motive for purchasing, or even for selling. Few persons of the description here mentioned ever speculate but upon the confident expectation of an advance of price of at least 10 per cent . . . but the utmost difference the rate of discount of 3 per cent and 6 per cent, namely 3 per cent per annum for three months, would on a quarter of wheat [at an average price of about 50s.] amount only to 4 1/2d. per quarter, a difference which, I will venture to say, never induced or deterred a single speculative purchase. But, given the force of the motive, the extent to which it can be acted upon is doubtless affected as regards persons who can buy only on credit, or who must borrow in order to be able to buy, by the greater or less facility of borrowing.202

That argument, correct so far as it goes, did not invalidate the classical doctrine. The classical doctrine did not require that a fall in the discount rate should arouse “speculation” in the sense employed by Tooke. What it required was only that the availability of loanable capital at cheaper rates than usual should stimulate those businesses, which were on the point of expanding their activities, and fully maintain those which were about to restrict their activities or to close down altogether. Thus a moderate lowering of the discount rate was sufficient to produce a tendency to increased enterprise, to increased demand for goods and services, and therefore to rising prices.203

Closely connected with the question of the rates of discount and prices was a valuable contribution that Tooke made. He probably produced the first clear statement of how the bank rate could be used as a means of protecting a country’s gold reserve by influencing the rate of foreign lending.204 Thereby he anticipated Goschen’s doctrine, which will be discussed later.

As already explained, the classical doctrine of prices was questioned by Tooke and Fullarton. What was the theory they offered in its stead? They came near to what is now called “the income theory of prices”. Tooke said:—

The prices of commodities do not depend upon the quantity of money indicated by the amount of banknotes, nor upon the amount of the whole of the circulating medium; but . . . it is the quantity of money, constituting the revenues of different orders of the State, under the head of rents, profits, salaries, and wages, destined for current expenditure, that alone forms the limiting principle of the aggregate of money prices, the only prices that can properly come under the designation of general prices. As the cost of production is the limiting principle of supply, so the aggregate of money incomes devoted to expenditure for consumption is the determining and limiting principle of demand.205

Tooke did not go a step forward to see how the “aggregate of money incomes” might be increased or diminished. Had he done so, he would have discovered that in the long run the aggregate of money incomes was proportional to the quantity of the circulating medium and that an increase of the volume of banknotes due to easier terms of lending meant an expansion of enterprise, an increase of money incomes, and consequently a rise in prices.

Finally, let us examine their criticism of Hume’s law. Four propositions can be distinguished. First, based upon their distinction between bullion and money and their doctrine of the elasticity of a country’s bullion reserve, they declared that a flow of the precious metals did not necessarily, and generally did not, bring about a contraction of the currency of the country exporting the precious metals or an expansion of the currency of the country, to which the precious metals were exported. Thus the causal relationship between the movement of specie and the changes in the volume of currency was explicitly denied. “Consequently, the doctrine by which it is maintained that every export or import of bullion in a metallic circulation must entail a corresponding diminution of, or addition to, the quantity of money in circulation, and thus cause a fall or rise of general prices, is essentially incorrect and unsound.”206 Second, they pointed out that since the practice of investing capital in foreign securities had become general, the capital required for the liquidation of a foreign debt could be transmitted in the form of investment (as well as in gold) and that that formed a new instrument for the regulation of the exchanges and for the control of the international movements of specie. That point, however, was more important to Tooke than to Fullarton. Third, as to the initial cause of the movements of specie, they were of the opinion that it was governed almost exclusively by the state of the balance of payments.207 Fourth, a more serious mistake was the extension of Hume’s law to the banknote circulation. As convertible notes could never be excessive and could have no effect upon prices, they could not cause any movement of gold or silver. Both the third and the fourth points were obviously erroneous. There was, however, an important element of truth in the first two propositions.208

9. The Restatement by J. S. Mill

The equilibrium theory of international price relationships, which was first advanced by Hume and was later modified, refined or attacked by the participants of the Restriction and the Bank Act controversies in England, was restated by John Stuart Mill209 in the form in which it came to be known as the classical theory. The position of Mill was an eclectic one. He wanted to reconcile the antagonistic views of as many of his predecessors and contemporaries as possible and to fuse their conflicting doctrines into an organic whole.

In order clearly to understand his theory of international price relationships, it is necessary to know his theory of money and credit. In those fields also his position was an eclectic one. His definition of money meant that coins and inconvertible notes alone were money. “It seems to be an essential part of the idea of money that it be legal tender.”210 Therefore, convertible notes did not fall into the category of money. On the contrary, notes, like book credits, bills of exchange, and cheques, were but one form of credit.211

He next examined how the value of money, that is the purchasing-power of money, was determined and made an excellent attempt to combine the doctrines of the authors of the quantity theory, of Ricardo, and of Senior. Like Ricardo and other classical economists, he pointed out:—

The value of money, then, conforms permanently and, in the state of freedom, almost immediately, to the value of the metal of which it is made; with the addition, or not, of the expenses of coinage, according as those expenses are borne by the individual or by the state.212

Now, “since gold and silver bullion are commodities,” their natural or permanent value, like that of any other commodity, “is in the long run proportional to their cost of production in the most unfavourable existing circumstances, that is at the worst mine which it is necessary to work in order to obtain the required supply.”213 The cost of production doctrine was applied by Mill only to the places in which the precious metals were actually produced. In most countries money, or the material of which it was composed, was a foreign commodity. In the latter case the value of money was subject to the doctrine of international value, and we had to substitute for the cost of its production the cost of obtaining it.214 The cost of obtaining money was not, however, the same in all countries. As to the causes determining the cost of obtaining money, he combined the doctrine of Ricardo and that of Senior with his own doctrine of international values. His position was summed up in the following passage:—

The countries whose exportable productions are most in demand abroad, and contain greatest value in smaller bulk, which are nearest to the mines, and which have least demand for foreign productions, are those in which money will be of lowest value or, in other words, in which prices will habitually range the highest. If we are speaking not of the value of money, but of its cost (that is the quantity of the country’s labour which must be expended to obtain it) we must add to these four conditions of cheapness a fifth condition, namely “whose productive industry is the most efficient”, This last, however, does not at all affect the value of money estimated in commodities: it affects the general abundance and facility with which all things, money and commodities together, can be obtained.215

That is the Seniorian doctrine in a modified form. Senior, as it will be recalled, emphasized only the fifth condition mentioned by Mill. Mill went a step further in taking other factors into consideration and giving them due emphasis. In that connection, it should be noted, the term “value of money” referred to the general level of prices and the doctrine advanced concerned the second, and not the first, problem of the theory as defined in our first chapter.

But “the adjustment takes a long time to effect in the case of a commodity [so small in its annual supply], so generally desired [so largely used], and at the same time so durable as the precious metals”.216 Hence the market or the short-run value of money was more important. There again it followed the general law of value, according to which “the temporary or market value of a thing depends on the demand and supply”. Demand and supply in relation to money needed some explanation: “The supply of money . . . is all the money in circulation at the time. The demand for money, again, consists of all the goods offered for sale. . . . We are comparing goods of all sorts on one side, with money on the other side, as things to be exchanged against each other.”217 He then followed Ricardo and other classical economists in turning the demand-and-supply theory into a quantity theory:—

The value of money, other things being the same, varies inversely as its quantity; every increase of quantity lowering the value, and every diminution raising it, in a ratio exactly equivalent.218

He called attention to the rapidity of the circulation of money and gave it the right place in the quantity theory.219 He discussed the problem of liquidity preference, i.e. the problem of the willingness to hold money instead of other commodities. He pointed out that if “persons in general . . . liked to possess money more than any other commodity”, there would be a rise in the value of money and a general fall in prices.220

On the subject of inconvertible paper money, he said that “an inconvertible paper which is legal tender is universally admitted to be money Its value depended on its quantity which was arbitrarily fixed by the issuing authority. If its quantity was increased, all prices would rise and among them the price of gold bullion. The nominal exchange would then fall proportionately.221 In regard to the relationships between credit and prices, Mill, like Tooke and Fullarton, declared that after the introduction of credit, credit occupied in the determination of market prices a more important position than currency.222 Credit economized the use of money and was itself a purchasing-power like money.223 The grant of facility for the multiplication of credit transactions might, however, lead to one form of credit having a greater effect on prices than others. For instance, banknotes as well as cheques were more powerful instruments in raising prices than bills.224 It did not follow, however, that although credit had the power of raising prices it would be freely created for that purpose. Nor was it true that one form of credit would be more used than another, because it could be more used. “When the state of trade holds out no particular temptation to make large purchases on credit, dealers will use only a small portion of the credit power.”225 “The inclination of the mercantile public to increase their demand for commodities by making use of all or much of their credit as a purchasing-power depends on their expectation of profit.”226 It was only when the circumstances of the markets and the state of the mercantile mind were such as to make the dealers willing to use their credit that credit was actually extended. There he implied that the initial cause of an increase in prices was on the demand side and not on the supply side of credit. That leads us immediately to his opinion on the banking and the currency principles. Like Tooke and Fullarton, Mill pointed out that the difference between banknotes and other forms of credit was only a difference in degree and not in kind. He also agreed with them in their doctrine of the impossibility of the banks increasing the circulation of banknotes “except as a consequence of, or in proportion to, an increase of the business to be done”, and of the impossibility of convertible banknotes raising prices—so far as those doctrines were applied to a quiescent state, that was one “in which there was nothing tending to engender in any considerable portion of the mercantile public a desire to extend their operations”, or, in an expectant or speculative state, so far as “it is confined to transactions between dealers”.227 But he thought (a) “that this can no longer be affirmed when speculation has proceeded so far as to reach to producer”, and in that case, the “employment of banknotes must have been powerfully operative on prices at the time when notes of one and two pounds’ value were permitted by law”228; and (b) that the increase of banknotes in the duration between the ascending period of speculation and the revulsion necessarily “tends to prolong the duration of the speculation . . . enables the speculative prices to be kept up for some time after they would otherwise have collapsed; and therefore prolongs and increases the drain of the precious metals for exportation, which is the leading feature of this stage in the progress of a commercial crisis: the continuance of which drain at last endangering the power of the banks to fulfil their engagement of paying their notes on demand, they are compelled to contract their credit more suddenly and severely than would have been necessary if they had been prevented from propping up speculation by increased advances, after the time when the recoil had become inevitable”.229 Unlike Tooke and Fullarton, Mill recognized, once at least, that the project of the currency school did have the advantages of preventing the retardation of the recoil and the ultimate aggravation of its severity.230 He, nevertheless, opposed the Bank Charter Act of 1844, because he thought that those advantages were “purchased by still greater disadvantages”.231

His attempt to reconcile the banking principle with the currency principle apparently did not prove a successful one. We entirely agree with him that the actual volume of credit demanded depends largely upon the expectation of profit. Is it not true, however, that the central bank can, by diminishing the market rate of interest and exciting expectation of profit, increase the quantity of credit demanded and thus expand its issue of notes excessively? Mill himself, in another connection, explicitly recognized the classical doctrine that the bank could throw additional notes into the circulation if it lowered the market rate of interest.232 The classical doctrine being accepted, was Mill consistent in partially accepting the banking principle?

Having presented his doctrine of money and credit, we can now turn to his doctrine of international price relationships. His theory was “an equilibrium theory”. The equilibrium was established when the precious metals “distribute themselves in such proportions among the different countries of the world, as to allow the very same exchanges to go on, and at the same values, as would be the case under a system of barter”, and when the exchange rate was at par.233 The exchange rate was at par when imports and exports balanced. In regard to the problem of the comparison of general levels of prices in different countries his doctrine was, as already indicated, the Seniorian doctrine in a modified form. He said: “The currencies of all countries had come to a level; by which I do not mean . . . money became of the same value everywhere, but . . . the differences were only those . . . which corresponded to permanent differences in the cost of obtaining it.”

As to the mechanism which corrects disequilibrium he, like other classical theorists, stood by Hume’s law. On that question, too, his attitude was an eclectic one. He embodied in his views many of the arguments of the critics of the doctrine and made many refinements of his own. We shall now describe what his position was separately with respect to each of the following four sets of relationships which must be included in any version of Hume’s law:—

(a) Initial causes of disturbance—flow of specie;

(b) Flow of specie—volume of currency;

(c) Volume of currency—prices of commodities;

(d) Prices of commodities—rate of exchange (and the restoration of equilibrium).

First, as to the initial causes of specie flow, he gave us four alternatives: (i) alternations in the state of money and credit; (ii) alternations in the state of trade; (iii) international payments of a non-commercial character; and (iv) the state of the money market.234 Mill had thus held a view which was much wider than either the doctrine of Wheatley and Ricardo or the doctrine of Bosanquet, Tooke, and Fullarton. His view was also more comprehensive than the view of Hume and Thornton, for he gave a fourth possible cause. Of that cause, he said:—

It frequently happens that money, to a considerable amount, is brought into the country, is there actually invested as capital, and again flows out, without having ever once acted upon the markets of commodities, but only upon the market of securities, or, as it is commonly though improperly called, the money market. Let us return to the case already put for illustration, that of a foreigner landing in the country with a treasure . . . . He might very probably prefer to invest his fortune at interest, which we shall suppose him to do in the most obvious way, by becoming a competitor for a portion of the stock, exchequer bills, railway debentures, mercantile bills, mortgages, etc., which are at all times in the hands of the public. By doing this he would raise the prices of those different securities, or in other words would lower the rate of interest; and since this would disturb the relation previously existing between the rate of interest on capital in the country itself, and that in foreign countries, it would probably induce those who had floating capital seeking employment, to send it abroad for foreign investment rather than buy securities at home at the advanced price. As much money might thus go out as had previously come in, while the prices of commodities would have shown no trace of its temporary presence. This is a case highly deserving of attention: and it is a fact now beginning to be recognized, that the passage of the precious metals from country to country is determined much more than was formerly supposed by the state of the loan market in different countries, and much less by the state of prices.235

So much for the disturbance arising from the fourth cause. Let us turn now to disturbance arising from the first cause. His view was similar to that of Hume, Thornton, and others. Under a metallic standard Hume’s law would operate to restore equilibrium and under an inconvertible paper standard the purchasing power parity doctrine was correct. Disturbance might be due to an adverse balance of payments (the second and the third causes). In regard to such a disturbance he agreed with Hume and Malthus and differed from Ricardo.236 He also recognized that there could be temporary causes of disturbance which did not cause any movement of specie. In that case Mill, like Hume, considered the exchange itself as a sufficient corrective.237

Would the gold or silver exported for the purpose mentioned be drawn from the circulation of the country exporting it? If the exportation of gold was due to the state of the currency, the answer would be in the affirmative. If it was due to the second or the third causes, the answer depended upon circumstances. In case the variations were not permanent, Mill thought that Tooke and Fullarton were right in giving a negative answer. “The gold or silver exported for the purposes in question . . . would be drawn from hoards, which under a metallic currency always exist to a very large amount; in uncivilized countries, in the hands of all those who could afford it; in civilized countries, chiefly in the form of bankers’ reserves.”238 It was when the variations were permanent that the volume of circulation would be eventually affected. If the initial cause was the fourth one, the movement of specie would not necessarily, or even probably, bring about a change in the volume of circulation.239

In case the volume of currency was affected, would the prices of commodities be affected accordingly? Mill’s position implied adherence to the most rigid form of the quantity theory.240 How could a change in prices restore equilibrium? Like other classical writers, he declared that the change in prices would work out its effects through a change in the state of trade or the balance of payments.

10. Summary

This chapter covers mainly the period of the Industrial Revolution in England from about 1770 to about the middle of the nineteenth century. The spirit of that period might be summarized in two words, “Free trade.” One of the most important theoretical foundations for free trade was found in the classical theory of international price relationships. It was only natural, therefore, that from the standpoint of the theory of international price relationships, the period was chiefly notable for the rise and the development of the classical equilibrium theory.

The classical economists had given a solution for each of the four problems posed by the theory of international price relationships. In solving the problem of the relation between the value of money in one country and the values of money in other countries, they started with a doctrine of the natural distribution of money, as a result of which the precious metals were distributed in certain proportions among the different trading nations according to the respective needs of the nations. “While so divided they preserved everywhere the same value.” That doctrine of the international equality of the value of money was first advanced by Foster, Ricardo, and others, and very ably expounded by Senior and Norman. It was also shown that when the international equality of the value of money was established, rates of exchange were at par. The views of the classical economists on the problem of the relation of the price level of one country to the price levels in other countries are embodied in the Seniorian doctrine. That doctrine was first found in Ricardo. It was very ably stated by Senior and vigorously expounded by Mill, who modified it. As to the problem of the price relations of goods of identical technological composition among trading countries, the classical economists demonstrated that there was a tendency of the prices of all traded goods to reach international equalization. That proposition was most ably explained by Thornton, who was, however, surpassed by Wheatley. Finally, Senior gave the classical explanation of the differences in wages in different countries.

The contribution of the classical economists was not limited to the static aspects of the subject. They also discussed how equilibrium might be disturbed and restored. All of them agreed that disturbance might be caused by the currency. If that happened under an international metallic standard, Hume’s law would operate to restore equilibrium. If it happened under an inconvertible paper standard, prices and exchanges would be adjusted according to the purchasing power parity doctrine. Hume’s law was first advanced by Hume, la Rivière, and others. In its most general form, the causal sequence according to that law runs as follows:—

Initial disturbance of equilibrium—flow of specie—changes in the volume of circulation—changes in prices—restoration of equilibrium.

The most important set of relations is that between the volume of the circulation and the changes in prices. According to the classical theory, an increase of the former necessarily brings about a rise in the latter. Hume brilliantly demonstrated how an increase of money would work out its effects on prices through purchases and gave one of the best descriptions of what is known as the “direct” mechanism connecting money and prices. In that connection, Thornton made two other important contributions. First, he called attention to the importance of the velocity of circulation in the problem of money and prices and gave an ingenious account of its effects. Moreover, in his hands the doctrine that money stimulates trade was reconciled with, and subordinated to, the quantity theory of money. Hume’s law had its critics. Tooke and Fullarton, for example, pointed out that it was not so “automatic” as it was supposed to be. That criticism was accepted by Mill and incorporated by him in the classical theory.

Hume’s law was applicable only to the case of an international metallic standard. When the countries under consideration were under an inconvertible paper standard, the classical economists had a more general doctrine, namely, the purchasing power parity doctrine. Among the ablest exponents of that doctrine were Boyd, Thornton, Wheatley, Foster, Blake, and Ricardo.

The question whether the expansion or contraction of bank credits (notes and cheques) would be an initial cause of disturbance was also raised during the period under review. The banking school gave a negative and, we think, an erroneous answer. The currency school successfully refuted the doctrine of the banking school but made an illogical distinction between cheques and notes and contended that cheques could not be considered as an initial cause of disturbance.

The economists of the classical school all agreed that in a state of equilibrium a country’s accounts of international indebtedness must be balanced. They differed on the question how an adverse balance of payments was to be adjusted and whether disequilibrium in the international balance of payments might be an initial cause of disturbance of the equilibrium in international price relationships. Hume, Malthus, and Mill were of the opinion that Hume’s law was also applicable to this case and that equilibrium was restored by changes in the price and income structures of the trading nations. That view was known as “the classical” view. In opposition to the classical view, Wheatley and Ricardo advanced what we call the Wicksellian doctrine that disequilibrium in the balance of payments always adjusted itself and produced no changes in international price relations. Thornton stood midway: he accepted the Wicksellian doctrine as valid in the long run but sided with Malthus and others when temporary effects were considered.

For many classical economists the rate of exchange itself was a sufficient corrective mechanism for a disturbance of a temporary character. Hume, Foster, Blake, and Mill were the ablest writers who expounded that view.

Both Tooke and Mill gave expositions of how the bank rate could be used as a means of protecting a country’s gold reserve by its effect upon the rate of interest on foreign loans. They thus anticipated a doctrine of Goschen.

In this and the preceding chapters we have dealt exclusively with the monetary aspects of the theory of international price relationships. The appearance of the Principles of Ricardo, however, drew attention to the real aspects of the problem and in the next chapter we deal with the latter aspects of the problem.

“Croit-on de bonne foi que cette situation serait durable, et que cet État absorberait peu à tout l’argent qui existe dans le monde? Non, sans doute. L’augmentation de la quantité d’argent en diminuerait le prix; le luxe croîtrait et avec lui la consommation des denrées soit nationales, soit étrangères. Il en résulterait donc que cet État transporterait aux autres une moindre quantité de denrées et en retirerait une plus grande quantité. Ainsi il serait obligé à son tour de payer en argent et la circulation se rétablirait.”

See his “Paradoxes philosophiques sur la liberte du commerce entre les nations”, MS., 1764, first published in F. Sauvaire-Jourdan, Isaac de Bacalan et les idees libre-echangistes en France, Paris, 1903. The reference is to p. 43.

“The effect of forced frugality is also produced by the creating of paper money by government, or the suffering of the creation of paper money by individuals. In this case, the effect is produced by a specie of indirect taxation. . . . The effect of every increase of money . . . is to impose an unprofitable income tax on the incomes of all fixed incomists. . . . If, on the introduction of the additional money into circulation, it pass in the first instance into hands which employ it in the way of unproductive expenditure, the suffering from this tax remains altogether uncompensated; if before it come into any hands of that description, it have come into hands by which it has been employed in the shape of capital, the suffering by the income tax is partly reduced and partly compensated. It is reduced by the mass of things vendible produced by means of it: a mass by the amount of which, were it not for the corresponding increase in the mass of money, the value of the mass of money would pro tanto have been increased, and the prices of things vendible decreased. It is in a certain degree, though in a very inadequate degree, compensated for by the same means, viz. by the amount of the addition made to the quantity of sensible wealth—of wealth possessing a value in the way of use. Here . . . national wealth is increased at the expense of national comfort and national injustice.”

The above passage is quoted from Professor Hayek’s article, “A Note on the Development of the Doctrine of Forced Saving,” Q.J.E., 1932, pp. 124 f.

• 1It is the practice of some economists to divide economic analysis into three departments, viz., statics, comparative statics, and dynamics. Economic statics deals with the conditions of equilibrium, if they exist at all. By conditions of equilibrium we mean those positions in which the price system will remain at rest, once it reaches them, provided that there is no fresh disturbance. That, however, does not imply that conditions of equilibrium must necessarily be reached ultimately by the price system. Comparative statics is concerned with the differences in the conditions of equilibrium in two or more price systems that are due to differences in the given data in the different systems. Economic dynamics deals with the problem, how a change in the fundamental data disturbs the price system and how the disturbances are corrected. It shows us, as Professor Robbins has pointed out, “the actual process of change—the path followed through time between one equilibrium position and the other.” In economic dynamics we have to see whether it is necessary or likely that the original change in data would lead to secondary changes in data. It is mainly because of those secondary changes in data that we have to differentiate between a doctrine of dynamics and one of comparative statics. In the latter we always suppose that when the original data change all other things will remain the same. In dynamics, however, we are not allowed to make the assumption of ceteris paribus.
• 2In dividing history into periods, we find it convenient to use certain dates, but the selected dates are only approximately accurate indicators. Nobody can point to a certain date as marking the exact point of time at which a historical stage or period either terminated or began. Nevertheless, we have to draw some lines of demarcation, however inexact they may be.
• 3The term, quantity theory of money, is sometimes defined as the theory that, in a given period of time, the product of the total volume of goods bought and sold multiplied by the average price of those goods is equal to the volume of the circulation of the medium of exchange. In such general terms, the theory does not indicate whether an increase in the circulation of money would lead to an increase in the volume of the goods or to a rise in their average price. The causal sequence may run either from the volume of the circulation to the average price of the goods transacted, or from the circulation to the volume of those goods. In the strict sense of the term, however, the quantity theory of money assumes the causal relation to run only from the circulation to the average price. We shall, in this essay, use the term in that strict sense. As to the theory that an increase (or decrease) of money would lead to an increase (or decrease) of the volume of goods and transactions, we shall call it “the doctrine that money stimulates trade and production”.
• 4Ibid., p. 34.
• 5Ibid., p. 69.
• 6Ibid., p. 105.
• 7For example, St. Thomas Acquinas, Nicholas Oresme, and Molinæus had developed, or at least indicated, a similar theory.
• 8Hales, op. cit., pp. 87, 115 f.
• 9That “theory of the store of value”, as it might be called, has been wrongly credited to Petty by Suviranta (The Theory of the Balance of Trade, 1923, pp. 52 f.). That theory is the natural outcome of the financial conditions in the sixteenth century and the greater part of the seventeenth century when gold and silver were alone easily exchangeable values, because foreign investment was practically unknown in those days and goods were not so easily exportable as at later periods.
• 10People having “plentie of things” and wanting to store up the surplus would naturally be willing to exchange these things for such wares as would lie in lesse Romes, and contineweth longest with out perishinge, and be carried to and fro with lesse charge, and be most currant at all times and at all places”. Gold and silver were “most of that sort” (Hales, op. cit., p. 72). See also p. 73.
• 11Discourse, Lamond’s ed., pp. 86–7; see also p. 113.
• 12Ibid., p. 35.
• 13That is in essence what has been called after Thomas Mun the balance of trade theory. The theory, in fact, had a long process of development. As early as the last quarter of the fourteenth century we find very definite statements of it in English by one of the officers of the Mint in his evidence before Parliament. The statement is as follows: “. . . As to the fact that gold and silver come not to England, whilst that which is in England is carried abroad, . . . if the merchandise exported from England be well and justly governed, the money which is in England will remain, and great plenty of money will come from abroad. It must be ascertained that no more foreign merchandise come within the realm than the value of the merchandise of this country that goes out of the realm.” However, the exact term balance of trade itself seems to have been coined in 1615 and the term favourable balance of trade in as late as 1767. See W. H. Price, “The Origin of the Phrase ‘Balance of Trade’,” Quarterly Journ. of Economics, xx (1905), pp. 157–167.
• 14Hales, op. cit., p. 102.
• 15Discourse, Lamond’s ed., pp. 88, 65.
• 16Ibid., pp. 47, 51 passim.
• 17Ibid., p. 40, see also pp. 43 ff., 47 f.
• 18It should be noted that the domestic demand for imported goods could not be permanently inelastic. When the balance of payments of the country turns unfavourable and specie flows out, then, other things being equal, the total income of consumers falls. The fall in consumers’ income will sooner or later lead to a reduction in the total value of its imports.
• 19Seigneur de Malestroit (second half of the sixteenth century) was a “member of the royal council of France and comptroller of the Mint”.
• 20“Lon ne peut dire qu’vne chose soit maintenant plus chere qu’elle n’estroit il y a trois cens ans, sinon que pour l’achepter il faille maintenant bailler plus d’or ou d’argent que l’on n’en bailloit alors. Or, est-il que pour l’achapt de toutes choses, lon ne baille point maintenant plus d’or n’y d’argent que Ion en bailloit alors. Doncques puis ledict temps rien n’est encbery en France. Les maxims sont clairs.” (Les Paradoxes sur le faict des Monnyes, Paris, 1578 ed. used, p. 4). Compare Paul Raveau, Précédé d’un Étude sur le Pouvoir d’Achat de la Livre, Paris, 1926.
• 21Les Paradoxes sur le faict de Monnyes, Paris, 1578, p. 15.
• 22Other writers, especially Spanish writers, must have more or less noticed the effects of the influx of the American treasure in raising prices. But there can be no doubt that Bodin is entitled to the credit for first giving due emphasis to the importance of the supply of the money metals and that it was from Bodin and not from others that later writers got that explanation of the price revolution. For that reason we feel ourselves justified in choosing Bodin as the representative exponent of that view. See Earl J. Hamilton, American Treasure and the Price Revolution in Spain, 1501–1650 (Cambridge, Mass., 1934), pp. 283–306 and Bernard W. Dempsey, “The Historical Emergence of Quantity Theory,” Q.J.E., 1935.
• 23Jean Bodin (1530–1596) was bora and educated at Angers. He spent his college days in studying law; became, after his graduation, a lecturer on jurisprudence and later practised law in Paris. Not being very successful at the bar, he entered government service. In 1568 he published his famous Reponse aux paradoxes de M. de Malestroit touchant l’encherissement de toutes les choses et des monnaies, which was followed in 1578 by his Discours sur le rehaussement et diminution des monnaies, pour reponse aux paradoxes de sieur de Malestroit. It is, however, as political philosopher that he is chiefly noted. In political theory he was sometimes considered as “one of the most important figures after Aristotle”. His famous work, Les six livres de la République, was published in 1576. In it he incorporated the substance of his Réponse. The Réponse has an English translation in A. E. Monroe’s Early Economic Thought. The reference is to Monroe’s edition, pp. 123–6.
• 24Ibid., p. 127.
• 25Ibid., pp. 128–131.
• 26Ibid., p. 131.
• 27As early as the Saxon coinage controversy around 1530, the opponents of depreciation put forward arguments suggestive of the quantity theory.
• 28By the Quantity Theory of Money we mean the doctrine according to which, to use the words of Wicksell, “the value or purchasing power of money varies in inverse proportion to its quantity, so that an increase or decrease in the quantity of money, other things being equal, will cause a proportionate decrease or increase in its purchasing power in terms of other goods, and thus a corresponding increase or decrease in all commodity prices.” One may, of course, use the term, quantity theory of money in a broader sense, viz. in the sense that
• 29Réponse (Monroe’s ed.), pp. 138 ff.
• 30Bernardo Davanzati (1529–1606), A Discourse upon Coins (1582). We have used the English translation by John Toland (London, 1696), p. 18.
• 31Ibid., p. 15.
• 32Antoyne de Montchrétien, Traicté de l’économie politique, 1615, Funck-Brentano ed. (Paris, 1889) used, p. 257.
• 33See Professor R. H. Tawney, Introduction to a new edition of Thomas Wilson’s “Discourse upon Usury” (London, 1925).
• 34Ibid., p. 60.
• 35See Memorandum prepared for the Royal Commission on the Exchanges, London, 1564, reprinted in Tudor Economic Documents (edited by Tawney and Power, London, 1924), vol. iii, pp. 346–359.
• 36Ibid., p. 350.
• 37“The Exchange is the gouernere of prices of all warres enterchangablye vented betweene this Realme and the Low Contreyes, because the greateste quantetye of wares transported ether outeward or inwarde is boughte by money taken vppe by Exchange, and also because, althoughe the wares he boughte with his owne moneye, in sellinge of his hondred poundes worthe of wares he Consydered what gaynes he myght have made by Exchange of so muche moneye, and he maketh the price of his wares accordingly or to some Convenyent overpluse.” (Ibid., p. 347.)
• 38See Tawney, op. cit., pp. 138–154.
• 39“Protest against the State Control of Exchange Business,” 1576, reprinted in Tudor Economic Documents, vol. ii, pp. 169–173.
• 40Tudor Economic Documents, p. 172.
• 41See Thomas Milles, The Customers Replie or Second Apologie (London, 1604); The Customers Apologie (London, (1601) 2nd ed., 1609); An out-port-Customers Accompt (London, 1609); and especially Customers Replie, pp. 4–5; ch. x, pp. 14–32.
• 42Thomas Gresham went even so far as to say: “As the exchainge is the thinge that eatts ought [eats out] all princes, to the wholl destruction of ther common well [weal], if itt be nott substantially looked unto, so likewise the exchainge is the cheffest [chief] and richest thinge only above all other, to restore your Majestie and your reallme to fine gowld and sillvar . . .” (“Letter to Queen Elizabeth on the Fall of the Exchanges,” 1558—quoted from Tudor Economic Documents, ii, p. 148). Gresham, it may be noted, has been known for his excellent exposition of the doctrine that bad money drives out good. The doctrine was given the name “Gresham’s Law” by H. D. Macleod in 1858. It had, however, been formulated also by other writers.
• 43Gerrard de Malynes (fl. 1586–1641), the son of an English Mint-master, himself became an Assay Master of the Mint and in 1609 was appointed commissioner on Mint affairs. He had wide experience in trade and was frequently employed by Elizabeth and James I as an adviser on commercial questions. His writings, which bear on the present section, are: A Treatise of the Caker of England’s Commonwealth (London, 1601) and England’s View in Unmasking of two Paradoxes (by De Malestroit) with a Replication unto the answer of Jean Bodin (London, 1603). For his later writings see Sec. 5.
• 44Treatise of the Caker, p. 2.
• 45Ibid., p. 3.
• 46To him the causal sequence ran as follows: “Foreign exchanges—money—commodities.” See also The Maintenance of Free Trade, p. 2.
• 47See Lex Mercatoria, p. 415; The Maintenance of Free Trade, pp. 14–15; The Center of the Circle, pp. 41 f.
• 48Caker, p. 35; see also The Maintenance of Free Trade, p. 61.
• 49Caker, p. 18.
• 50Caker, p. 34.
• 51Ibid., pp. 38–9.
• 52Ibid., pp. 42–3.
• 53Ibid., p. 99.
• 54Ibid., p. 10.
• 55Ibid., p. 11.
• 56England’s View, pp. 55, 60.
• 57“The property of the money . . . is, that plentie of money maketh generally things deare, and scarcitie of money maketh likewise generally things good cheape. Whereas things particularly are also deare or good cheape, according to plentie or scarcitie of the things themselves, or the use of them” (Caker, p. 10). See also England’s View, pp. 7 and 9. In discussing the value of “money” Malynes and his contemporaries (e.g. Mun) had used the term “money” in two senses: firstly in the modern sense, and secondly in the sense of money delivered to (or taken from) foreign countries, i.e. bills of exchange. But in the quotation cited the word “money” is unmistakably used in the modern sense.
• 58Professor J. W. Angell has said of Malynes that he was one who considered the value of money as “something absolute and unchanging” (The Theory of International Prices, p. 18). That is certainly incorrect.
• 59England’s View, p. 65.
• 60Ibid., pp. 65 f.
• 61Caker, p. 35.
• 62England’s View, pp. 65–6.
• 63Ibid., p. 70.
• 64Although he recognized that an inflow of specie could produce opposite results, he was of the opinion that a high rate of exchange did not necessarily cause an inflow of specie. He said that “it would be so, were it not for the tolleration of the monies to go currant farre above their value beyond the seas” (Caker, p. 48). In other words, his theory would apply to countries, the value of whose coins were identical with their metallic contents.
• 65Caker, pp. 117–118.
• 66See, for example, ibid., pp. 106 f.
• 67Discorso intorno allieffett. . . . (1605). See A. E. Monroe, Early Economic Thought (Cambridge, U.S.A., 1927), p. 154. De Santis also stood for an embargo on the exportation of money and for some legal tarif. See Luigi Cossa, An Introduction to the Study of Political Economy (London, 1893), p. 180.
• 68A Brief Treatise on the Causes which can make Gold and Silver Plentiful in Kingdoms where there are no mines (1613, Naples). We have used the English translation in A. E. Monroe, op. cit., pp. 143–167.
• 69Ibid., p. 154.
• 70Ibid., p. 156.
• 71Ibid, pp. 146–153.
• 72It follows that such remedies as the regulation or prohibition of the movement of gold would, according to him, be useless or even harmful. See p. 161.
• 73See P. J. Thomas, Mercantilism and the East India Trade (London, 1926), pp. 8–16.
• 74The following are the most important works in connection with that controversy:—
• 75Edward Misselden (fl. 1608–1654), a prominent merchant, was connected with the East India Company at about the time during which he wrote on economic matters. His economic writings were primarily called forth by the appointment of the standing commission on trade in 1622 and were published, as shown in the preceding note, between 1622 and 1623. In October, 1623, he left England, and “the East India Company invited him to act as one of their commissioners at Amsterdam to negotiate a private treaty with the Dutch”. It is believed that during these negotiations he “must have been brought into close relations with” Thomas Mun. Misselden became deputy-governor of the Merchant Adventurers’ Company at Delft in 1623. He held that post until 1633.
• 76Thomas Mun (1571–1641) “appears to have been early engaged in mercantile affairs in the Mediterranean, especially in Italy and the Levant”. He was very successful and gained a high reputation among merchants. In July, 1615, he was elected a member of the committee or a director of the East India Company, and “he spent his life in actively promoting its interests”.
• 77See, however, Mun, England’s Treasure, ch. xviii, especially pp. 189–190.
• 78Ibid., p. 130 and passim. See also Lewes Roberts, The Treasure of Traffike, 1641 (E.E.T. reprint), p. 110; England’s Great Happiness, 1677 (E.E.T. reprint), p. 262.
• 79Raising of money would have the advantages, he said, of “plenty of money and quickening of Trade in euery mans hand” (Free Trade, p. 106). And when Trade flourisheth, the King’s Revenue is augmented, Lands and Rents improoued, Navigation is encreased, the poor employed” (p. 4).
• 80See The Circle, p. 116, and passim.
• 81In this respect Misselden’s view is not so consistent a balance of trade theorist as Serra and Mun. See Free Trade, chs. i and ii.
• 82The Circle, p. 97.
• 83The Circle, p. 98.
• 84Ibid., p. 100.
• 85Free Trade, p. 104. Too much importance should not be attached to that quotation, significant as it might be, because the term “monies” is here rather ambiguously used.
• 86The Circle, p. 21.
• 87Mun, England’s Treasure, p. 157. See also pp. 143–6, 186, 208, and passim.
• 88Ibid., ch. iii (pp. 127 ff.). It is interesting to note that he had taken into consideration the factor of fishing (p. 130) and that of freight charges (p. 129). That is one of the earliest, if not the earliest, instance of the recognition of the invisible items.
• 89Discourse of Trade, pp. 7–41.
• 90England’s Treasure, chs. 4, 6.
• 91Ibid., ch. 8.
• 92Ibid., ch. 9.
• 93England’s Treasure, p. 158.
• 94“As plenty or scarcity of money [in exchange] do make the price of the exchange high or low, so the over or under balance of our trade doth effectively cause the plenty or scarcity of money.” (Ibid., p. 159.)
• 95Ibid., pp. 128, 133.
• 96Ibid., p. 141 (and also passim).
• 97Ibid., p. 138.
• 98That is not a question of opinion but simply a question whether the elasticity of demand for imports at home and that for exports abroad are greater or less than unity.
• 99Rice Vaughan (fl. 1650), legal writer, son of Henry Vaughan of Machynlleth, Montgomeryshire, barrister of Gray’s Inn from 1638, etc. He died in or shortly before 1672. A Discourse of Coin and Coinage, which “was written while Charles I, Louis XIII, and Ferdinand II reigned and before certain Dutch and French proclamations were repealed”, was published posthumously in London in 1675.
• 100Discourse of Coin, p. 101.
• 101Ibid., p. 19 and passim.
• 102Discourse of Coin, pp. 148–9.
• 103Ibid., pp. 58 f.
• 104The Economic Writings of Sir William Petty, ed. by C. H. Hull (Cambridge, 1899). He held to the mercantilistic doctrine that “the great and ultimate effect of Trade is not Wealth at large, but particularly abundance of Silver, Gold and Jewels, which are not perishable, nor so mutable as other Commodities, but are Wealth at all times, and all places”. (Political Arithmetick, ca. 1676, Writings, pp. 259 f.) For an account of the life of Petty (1623–1687) see Hull’s edition of his works, pp. xiii-xxxiii.
• 105A Treatise of Taxes and Contribution, 1662 (Writings, p. 35). See also Writings, pp. 113, 446.
• 106Ibid. (Writings, p. 36).
• 107Verbum Sapienti, ca. 1664 (Writings, pp. 112–13).
• 108Two of the other earliest statements were found in the works of G. Montanari and Pierre de Boisguilbert. The contributions of Boisguilbert will be described in a footnote below. Other contributions of Montanari may be noted here. Firstly, his statement of the quantity theory was as follows:—
• 109Implicitly, Petty’s doctrine means the recognition of the relation that
• 110“If the largeness of a public Exhibition should leave less money then is necessary to drive the Nations Trade, then the mischief thereof would be the doing of less work, which is the same thing as lessening the people, or their Art and Industry; for a hundred pounds passing a hundred hands for Wages, causes a 10000 1. worth of Commodities to be produced, which hands would have been idle and useless, had there not been this continual motive to their employment” (Writings, p. 36). He agreed, however, with the view that “to prohibit the Exportation of Money . . . is a thing almost impracticable . . . and vain” (ibid., p. 57).
• 111A Treatise of Taxes, Writings, p. 36; see also Writings, p. 446.
• 112Quantulumcunque (1682), Writings, p. 446.
• 113Treatise (Writings, p. 48).
• 114The meaning of the term “specie-points mechanism” or “gold-points mechanism” can be given in the words of George Clare. “By buying gold in one country or shipping it for sale in another, a certain rate of exchange is yielded, which is called a gold-point—the rate produced by buying at home and selling abroad being the export-point, and that produced by buying abroad and selling at home being the import-point. . . . It is of course obvious that, if the price of London paper rises to the export gold-point, and if the remitter is free to export gold, it is immaterial to him whether he buys a draft or sends gold, but that he would never think of paying more; on the other hand, if the price falls to the import point . . . the seller of a bill . . . would certainly refuse to take less; and, provided that the import and export of gold is free, the gold points thus mark the highest level to which an exchange may rise, and the lowest to which it may fall” (The A.B.C. of the Foreign Exchanges, 9th ed., London, 1931, pp. 25–6).
• 115William Potter (fl. 1656) was appointed in 1656 registrar of debentures on “the act for the sale of the late king’s lands”. He was one of the earliest writers on paper currency. He recommended the issue, by means of a land bank, of bills payable at sight to the bearer, under a guarantee of land mortgages. It was to give an account of his scheme that he published the works mentioned in this essay.
• 116Potter, The Key of Wealth (London, 1650), p. 2.
• 117“Let it be supposed, that there is a people amongst whom there is now, ten times as much money as formerly. . . then I say the consequence will be, that both trading and riches will encrease amongst them, much more than proportionable to such increase of money” (ibid., p. 6).
• 118“The Advancement of Trade, consisteth chiefly in the great and quick Revolution of Commodity from Sea or Land, through the hands of Tradesmen, to each particular person for his private life. This Revolution of Commodity, is proportionable to the Revolution of Money, or that which goeth for such. Such Revolution of Money is according to the plenty thereof not hoarded up” (The Tradesmen’s Jewel, London, 1650, p. 5).
• 119Ibid., p. 7.
• 120See The Key, p. 13.
• 121Ibid., p. 14.
• 122See P. J. Thomas, Mercantilism and the East India Trade (London, 1926), especially chaps. 1 and 4.
• 123John Cary (?-c. 1720) was a prominent Bristol merchant. He was engaged in the West Indian sugar trade and took a political interest in commercial matters. The most important of his economic writings is An Essay on the State of England in relation to its Trade, its Poor, and its Taxes, for carrying on the Present War against France, 1695. That essay attracted attention and brought him into correspondence with Locke, who wrote that it “is the best discourse I ever read on that subject”. Its second edition was published in 1719 under the title An Essay towards regulating the Trade and employing the Poor of this Kingdom; and its third edition, after his death, in 1745 as A Discourse on Trade and other matters relative to it. The latter editions differ considerably from the first one. In that work is found his plan for providing workhouses for the poor, which through his efforts was brought into operation in Bristol by an Act in 1697. Although his scheme was a financial failure, it was the model for several local experiments in the eighteenth century. His other economic writings include On the Coin and Credit of England, 1696, and A Proposal for paying off the Publick Debts by erecting a Nation Credit, London, 1719. The former was reprinted along with the second and third editions of his essay on trade. In the latter is found the proposal for a national bank, from which, he claimed in the second edition, “the famous Mr. Laws’ drew his scheme.”
• 124John Pollexfen (fl. 1697), an English merchant, was born about 1638. He became a member of the committee of trade and plantations in 1675 and was elected a member of the Board of Trade in 1696 (which he held up to 1705). In the following year (1697) he published his A Discourse of Trade and Coyn, in which he agitated for the withdrawal of the privileges of the East India Company. When Davenant published his essay in defence of the East India Company Pollexfen produced a reply, entitled England and East India Inconsistent in their Manufactures (London, 1697).
• 125Cary, A Discourse on Trade (London, 1695), p. 1. See also Pollexfen, A Discourse of Trade and Coyn (London, 1697), p. 5.
• 126Pollexfen, Discourse, p. 55.
• 127Ibid., p. 54.
• 128Ibid, p. 55.
• 129Pollexfen, Discourse, p. 62. “Trade governs Interest, and not Interest Trade” (p. 64).
• 130His remarks on paper credit also deserve notice. He said:—
• 131Josiah Child (1630–1699), “the wealthiest Englishman of his time and the most prominent figure in finance and foreign trade,” began his career as a merchant’s apprentice. He rapidly made his way in business and made a fortune. By the fifties he became Mayor of Portsmouth and was M.P. for Petersfield 1659, Dartmouth 1673–8, and Ludlow 1685–7. He was a director from 1677, deputy-governor from 1684 to 1686 and again from 1688 to 1690, and Governor of the East India Company from 1681 to 1683 and from 1686 to 1688 and “for a rule he ruled over the company absolutely”. The most important of his economic writings is New Discourse of Trade, which passed through several stages before it reached its final form. “The first draft was his Brief Observations concerning Trade and Interest of Money (London, 1668), followed the same year by A Short Addition to the Observations concerning Trade. In 1669–1670 he wrote ten additional chapters and the complete work was issued as A Discourse about Trade (London, 1690). In 1693 the same work with little variation, except for an introduction of twenty pages and the name of Child on the title page, appeared as A New Discourse of Trade.” His other writings include The Great Honour and Advantage of East India Trade (London, 1697).
• 132Charles Davenant (1656–1714) was a member of Parliament and an influential Tory politician. He held the office of commissioner of excise from 1683 to 1689. In 1705 he was appointed inspector-general of exports and imports, which office he held until his death. His economic writings are all reprinted in The Political and Commercial Works of Charles Davenant, edited by C. Whitworth (London, 1771).
• 133See Child, A New Discourse of Trade, London, 1693, pp. 137 ff.; Davenant, Works, i, p. 147. They considered the criterion of a general balance as “doubtful and uncertain”, because they had found that since the exportation of bullion to India had begun to increase, especially towards the close of the century, the usual calculations of the balance of trade had ceased to justify the operations of their company.
• 134Child, Discourse, pp. 148–9.
• 135One of the most important reasons given by Davenant is that since large quantities of the imported Indian textiles were re-exported to the Continent, any limitation imposed by England would divert the trade to the Dutch.
• 136Davenant, Works, i, p. 98; see also i, p. 429.
• 137Ibid., i, p. 97.
• 138Ibid., i, p. 100; Child, Discourse, p. 19.
• 139Child, Discourse, Preface (p. A 6).
• 140Ibid., p. 159 and passim. See also Child, Brief Observations.
• 141Davenant, Works, i, p. 382.
• 142Ibid., pp. 440 ff.
• 143Dudley North (1641–1690), a leading Tory of his time, made his way in business so early that when twenty-one years of age he was the leading merchant in Constantinople of the Turkey Company. Having made a large fortune, he returned to England in 1680. In 1683 he became one of the commissioners for the customs and carried out important reforms. His chief work is Discourses of Trade, published posthumously (London, 1691). We have used the reprint in Early English Tracts on Commerce, edited by J. R. McCulloch (London, 1856).
• 144Discourses of Trade, Early English Tracts, p. 513 (or Original, p. viii). See also p. 528 (Original, p. 14).
• 145“The Proposition I chiefly aim to prove . . . is, that Gold and Silver, and, out of them, Money are nothing but the Weights and Measures, by which Traffick is more conveniently carried on, then could be done without them: and also a proper Fund for a surplusage of Stock to be deposited in” (Discourse of Trade, p. 530 of E.E.T.).
• 146Ibid., E.E.T., p. 525 (Original, p. 11).
• 147Ibid., E.E.T., p. 539.
• 148Ibid., E.E.T., p. 513.
• 149Ibid., E.E.T., p. 527.
• 150Discourse of Trade, E.E.T., p. 539.
• 151Ibid., E.E.T., p. 531.
• 152Ibid., E.E.T., p. 518. The author of Considerations on the East-India Trade (1701) and other upholders of the East India Company bad also free trade ideas. But it would be too generous an interpretation to say, as an authority recently did, that they anticipated the doctrine of comparative costs.
• 153See W. Lowndes, An Essay for the Amendment of the Silver Coins (London, 1695). Lowndes, being the Secretary of the Treasury, was in the controversy a more important opponent of Locke than Barbon. But from the point of view of the theory of international price relationships the contributions of Barbon were of much more importance. For that reason we shall deal only with the views of Barbon. For the conditions of currency that were responsible for this controversy, see A. E. Feavearyear, The Pound Sterling (London, 1931), ch. 6.
• 154John Locke (1632–1704) was the son of John Locke of Pensford in Somersetshire, who took great care in the education of his son. The younger Locke took his B.A. degree at Oxford in 1655 and M.A. in 1658. He later spent some time in studying medicine “not with any design of practicing as a physician, but principally for the benefit of his own constitution, which was but weak”. Yet he was very successful in that line. He was known mainly as a great English philosopher. His famous Essay on the Human Understanding was written between 1670 and 1687 and published in 1689. After having served as one of the “commissioners of trade and plantation” and filled other posts, he retired, spending the last fourteen or fifteen years of his life at Oates. He died in the 73rd year of his life. His economic writings are:—
• 155Some Considerations, p. 53.
• 156Ibid., p. 53.
• 157Ibid., p. 60; see also p. 70.
• 158“The Value of Money in respect to those [Commodities] depends only on the Plenty or Scarcity of Money in proportion to the Plenty or Scarcity of those things.” Ibid., p. 45.
• 159Some Considerations, pp. 29, 32.
• 160Ibid., p. 32.
• 161Ibid., pp. 16–17.
• 162Ibid., p. 32. For his calculation of the average cash balance required by each of the several groups of people such as labourers, landlords, tenants, and brokers, see pp. 33 ff.
• 163Some Considerations, pp. 75–6. It follows that money is “not of the same value at the same time, in several parts of the World, but is of most worth in that Country where is the least Money, in proportion to its Trade” (p. 78).
• 164Some Considerations, p. 78. Note that the implicit assumption of this statement is international mobility of labour. Note also that he said nothing about the possibility of “too much” money.
• 165Ibid., pp. 14–15.
• 166Ibid., p. 81.
• 167Although the honour of having given the first descriptions of the specie-point mechanism must be shared by Petty, Locke, and Simon Clement, the description of Clement is the most elaborate of the three. The principal work of Clement is A Discourse of the General Notions of Money, Trade, and Exchanges (London, 1695), from which we may quote a few passages to show the essence of his theory of foreign exchanges:—
• 168Nicholas Barbon (1640?-1698) was the son of Praisigod Barbone. “He studied medecine at Leyden, received a medical degree at Utrecht in 1661, and was admitted as an honorary fellow of the College of Physicians in 1664. After the great fire of 1666 he established the first insurance office in London and participated actively in rebuilding the city. He was a member of Parliament in 1690 and again in 1695; he founded and conducted a land bank in 1695–6.” His writings are mainly concerned with the economic events of the period in which he lived. “He defended his scheme of fire insurance; he advocated building extensions in London; he discussed the possibilities of land-banking,” and he wrote also on money and trade. His contribution to the currency controversy under consideration is A Discourse Concerning Coining the Neiv Money Lighter (London, 1696), and that to the general problem of trade is A Discourse of Trade (London, 1690).
• 169“The Value of all Things, arises from their Use” (Discourse concerning Coining, p. 1). See also ibid, pp. 5, 7, and passim; Discourse of Trade, pp. 13 ff. It is interesting to note, furthermore, that he clearly pointed out that the “Use of all Wares” depended on scarcity:—
• 170Discourse concerning Coining, p. 6; see also p. 10 and passim.
• 171Ibid., p. 8.
• 172Ibid., p. 13.
• 173Discourse concerning Coining, p. 34.
• 174Discourse of Trade, pp. 20–2. He recognized, however, that moneys “change their Value in those Countries, where the Law has no Force, and yield no more than the Price of the Metal that bears the Stamp” (ibid., p. 22). See also Discourse concerning Coining, pp. 21–8.
• 175That is that there is no free coinage.
• 176Discourse concerning Coining, p. 89.
• 177Discourse concerning Coining, pp. 40 and 53. See also Discourse of Trade, p. 77.
• 178Discourse concerning Coining, p. 36.
• 179Ibid., p. 36.
• 180Ibid., pp. 56–9.
• 181Ibid., pp. 56 f.
• 182Discourse concerning Coining, p. 85.
• 183Cf. Angell, The Theory of International Prices, p. 211.
• 184The doctrine that money stimulates trade was closely connected with the concept of money as a circulating medium. Most mercantilists, even Mun and his followers, had the idea that money stimulates trade. But it was in the hands of the writers, with whom we shall deal in the present section, that the idea was not only emphatically developed but also clearly connected with the problems of international trade and international price relationships.
• 185As indicated above, Bodin and his followers had a very simple theory of money, viz. that a change in the volume of Money would lead to a change in the general price. In the hands of Petty, Locke, and others, both the velocity of the circulation of money and the volume of trade were introduced. Thenceforth, we have the formula:
• 186John Law (1671–1729) a Scotch financier, was the son of James Law, an Edinburgh goldsmith. He was “active in all the controversies arising in England at the time of the creation of the Bank of England in 1694”, and elaborated many financial and monetary projects. In 1705 he submitted to the Parliament of Scotland a proposal for the establishment of a national bank on the lines indicated in his famous Money and Trade considered with a proposal for supplying the nation with money, published in the same year. His scheme was to establish a national bank for the issue of paper currency which would be secured by the value of the nation’s land. After the public had gradually become accustomed to this new money, the bank was to extend its activities by engaging in profitable commercial operations in the colonies, in redeeming public debts, etc. The most important precursors of Law were, besides Potter, Hugh Chamberlain, who brought forward a rival scheme to the Bank of England in 1693, John Briscoe, one of the chief promoters of the Land Bank in 1696, and J. Asgill, who in his Several Assertions Proved (London, 1696), an essay of little merit, had presented a doctrine somewhat similar to those of Potter and Law. That project of Law’s was rejected. He then appealed to various European governments to adopt his plan. In 1716 he finally succeeded in winning the confidence of the French Government. In May of that year he was given the patent to establish a Banque Générale. After he had achieved a brilliant success during four years in the issue of paper money and such supplementary activities as redemption of public debts and the conduct of colonial trade, his system collapsed in consequence of a collapse of the confidence of the public. He died in 1729.
• 187That is based upon his use theory of value: “Goods have a Value from the Uses they are apply’d to; and their Value is Greater or Lesser, not so much from their more or less valuable, or necessary Uses; as from the greater or lesser Quantity of them in proportion to the Demand for them. Example. Water is of great use, but of little Value; Because the Quantity of Water is much greater than the Demand for it. Diamonds are of little use, yet of great Value; because the Demand for Diamonds is much greater than the Quantity of them.” (Money and Trade Considered, Glasgow, 1705, p. 3.) He then extended that theory of value to the value of silver: “Silver was Barter’d as it was valued for its Uses as a Mettal, and was given as Money according to its Value in Barter. The additional Use of Money Silver was apply’d to would add to its Value, because as Money it remedied the Disadvantages and Inconveniencies of Barter, and consequently the demand for Silver encreasing, it received an additional Value equal to the greater demand its Use as Money occasioned.” (Ibid., p. 10; see also p. 72.)
• 188Money and Trade Considered, p. 13. Note that the proposition was founded either on the implicit assumption that there was unemployment formerly or that labour was internationally mobile. Thus, in another connection he said: “As Trade depends on Money, so the encrease or decrease of the People depends on Trade. If they have Employment at Home, they are kept at Home: And if the Trade is greater than serves to Employ the People, it brings more from places where they are not Employ’d” (p. 19). Mr. J. M. Keynes, in his recent work The General Theory of Employment, Interest, and Money, gives an excellent demonstration of the connection between the quantity of money and the volume of employment. He seems to have thought that his doctrine is a development of what he calls “the element of scientific truth in mercantilist doctrine”. Although we cannot agree with all his interpretations of the mercantilist doctrines, yet we think that his doctrine may be correctly considered as a continuation of the doctrine of Law.
• 189Money and Trade Considered, p. 117; see also pp. 74 ff.
• 190Ibid., p. 75; see also p. 20.
• 191Money and Trade Considered, pp. 14–15.
• 192Ibid., pp. 115 f.; see also pp. 59 f., 101.
• 193“If Money were given to a People in greater Quantity than there was a Demand for, Money would fall in its value; but if only given equal to the Demand, it will not fall in value.”—Money and Trade Considered, p. 117. See also p. 76.
• 194Money and Trade Considered, p. 89; see also p. 102.
• 195Ibid., p. 19.
• 196Money and Trade Considered, pp. 6 f.
• 197Ibid., p. 104.
• 198Jean François Melon, Essai politique sur le commerce (Paris? 1734); English translation as A Political Essay upon Commerce, translated by David Bindon, Dublin, 1738; (nouvelle édition, augmentée de sept chaptres, Paris?, 1763). Melon was at one time a secretary of John Law.
• 199François Véron de Forbonnais (1722–1800), son of a merchant of Mans, went into trade at the age of 16. By the time that he was about thirty years of age he had collected so much valuable information on maritime and colonial trade that he began to write on economic subjects. In 1753 he published his Théorie et pratique du Commerce et de la Marine, which was soon followed by the Considerations sur les Finances d’Espagne relativement à celles de France. His important Recherches et considérations sur les finances de France depuis 1595 jusqu’a 1721, printed at Basle, 1758, in 2 vols., “experienced the most distinguished reception both in France and other countries” and made Forbonnais well known in his days. In the next year he was appointed inspector of the dépôt of the general financial comptrol. The most important of his economic writings is his Principes Economiques (Amsterdam, 1767).
• 200Principes (1767). We have used the reprint in the Collection des Principaus Economists, ed. by E. Daire and G. de Molinari, Paris, 1843–7, Mélanges, vol. i, pp. 165–240. The reference is to p. 223.
• 201Principes, p. 224.
• 202Ibid., p. 226.
• 203Principes, p. 225.
• 204“Le balance générale du commerce d’une nation, est la difference du montant de ses achats au montant de ses ventes au-dehors. Cette différence doit être nécessairement payée en argent, puis que c’est le seul équivalent qui puisse suppléer au défaut des échanges en nature.” (Elemens, 2nd ed., ii, p. 310.)
• 205Elemens, 2nd. ed., pp. 151 ff.
• 206See also the work of a later writer, An Inquiry into the Principles of Political Economy (2 vols., London, 1767) by James Denham Steuart (1712–1780).
• 207Before we go to the semi-equilibrium theory we may note the contributions of two French economists, viz. Boisguilbert and Montesquieu. Boisguilbert’s views of money were not mercantilistic. Firstly he asserted that money was a means and not an end in itself. Secondly unlike Law, Boisguilbert was of the opinion that trade was not stimulated by money but that the circulation of money was stimulated by the movement of trade. He accepted the doctrine that the general price level varies directly with the quantity of money, but he considered the problem of general price level as unimportant. What was important was the quantity of goods exchanged and not the quantity of money or the resultant price level. For it was the volume of transactions which determined the circulation and not the circulation which determined the volume of transactions. When commerce was active the velocity of the circulation of money increased; when commerce was not active the velocity decreased. Or, as Boisguilbert often put it, money “stops, dislodges, and runs along with consumption”. Where there was very much consumption, “a little silver on account of its frequent appearances, passes for a very large quantity of specie”; but when consumption was diminishing “silver stops immediately”. In short, it was consumption “that leads the march” of money. Boisguilbert’s important works were printed, under the title, Le détail de la France (1697, 1707, 2nd edition, 1712, reprinted with a critical note in D. Daire’s Economistes financiers du xviiie siècle, Paris, 1843). Montesquieu is known as one of the early advocates of the quantity theory of money. (See his The Spirit of Laws, published first in French, Geneva, 1748, English edition tr. by Thomas Nugent, new edition by J. V. Prichard, London, 1909. The reference is to the 1909 edition, pp. 54–6.) He also advanced the doctrine that money stimulates trade. (See 1909 ed., p. 56.)
• 208Before them there were only some fragmentary statements of a certain part of this theory. See, for example, John Houghton, A Collection of Letters . . . vol. ii (London, 1683), pp. 97–9, 115; William Wood, A Survey of Trade, pp. 329–373.
• 209Vanderlint, Money Answers All Things (London, 1734), p. 3.
• 210Ibid., pp. 52–3.
• 211Ibid., p. 46 and passim.
• 212Money Answers All Things, p. 94.
• 213Ibid., p. 6 and passim.
• 214Money Answers All Things, p. 5.
• 215Ibid., p. 95 n.
• 216Richard Cantillon (1680?—1734), Essai sur la Nature du Commerce en Général, written about 1734, first published in French in 1775. We have used the edition issued with an English translation by Henry Higgs (London, 1931). Cantillon was a great banker and speculator of his time. For a detailed account of his life, see Higgs’s ed. of the Essai, pp. 331–389.
• 217Essai, Higgs’s edition, part i, ch. x.
• 218Ibid., p. 97.
• 219Ibid., p. 117.
• 220Ibid., part ii, ch. i; see also p. 161.
• 221Ibid., p. 161. See also part ii, ch. iii, and ch. iv. His treatment of rapidity of circulation is the same as that of Petty.
• 222Ibid., p. 301.
• 223Essai, Higgs’s edition, pp. 163–5.
• 224“By doubling the quantity of money in a State the prices of products and merchandise are not always doubled. A River which runs and winds about in its bed will not flow with double the speed when the amount of the water is doubled.” Essai, p. 177.
• 225Essai, Higgs’s edition, p. 179.
• 226Ibid., p. 181.
• 227Ibid., pp. 181, 191, 195.
• 228Essai, Higgs’s ed., pp. 163–7.
• 229Ibid., p. 167.
• 230Ibid., p. 169. For the relationship between the rate of interest, on the one hand, and the quantity of money and the balance of trade, on the other, see part ii, ch. ix and x, especially pp. 215, 219.
• 231But when a country, for any reason whatever, has a constant balance due to another country, the prices and the money in circulation cannot be equal in those two countries, and “the inequality is always relative to the balance or debt The prices in the receiving country would ultimately be higher to the extent that the paying country would be able to pay its debts in commodities. Therefore the receiving country would be benefited in two ways: first it has a constant income to receive; and second, owing to its high level of prices, it “will exchange a smaller amount of Land and Labour with the Foreigner for a larger amount so long as these circumstances continue.” (Essai, Higgs’s edition, p. 159.) See pp. 151–9.
• 232Essai, p. 235.
• 233Ibid., pp. 189, 235.
• 234Ibid., p. 185.
• 235Essai, pp. 305, 307, 311, 319.
• 236Joseph Harris (1702–1764) is said “to have been a working blacksmith at his native place, but to have removed at an early age to London”. In London he became known as a writer on navigation, trigonometry, optics, and astronomy. He probably held some subordinate post in the Mint before 1748. In that year he was appointed assay master of the Mint. An Essay upon Money and Coins was written by him probably about 1750, and was first published in 1757–8 in London.
• 237Essay (written c. 1750, published London, 1757–8 in two parts). We have used the reprint in McCulloch’s A Select Collection of Scarce and Valuable Tracts on Money, etc., London, 1856. The reference is to p. 350.
• 238Ibid., pp. 391, 396–8.
• 239Ibid., pp. 406, 407.
• 240Ibid., p. 402.