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CHAPTER XXIV.

Or THE REGULATION OF A CONVERTIBLE PAPER CURRENCY.

§ 1. The frequent recurrence during the last half century of the painful series of phenomena called a commercial crisis, has directed much of the attention both of economists and of practical politicians to the contriving of expedients for averting, or at the least, mitigating its evils. And the habit which grew up during the era of the Bank restriction, of ascribing all alternations of high and low prices to the issues of banks, has caused inquirers in general to fix their hopes of success in moderating those vicissitudes, upon schemes for the regulation of bank notes. A scheme of this nature, after having obtained the sanction of high authorities, so far established itself in the public mind, as to be, with general approbation, converted into a law, at the renewal of the Charter of the Bank of England in 1844: and the regulation is still in force, though with a great abatement of its popularity, and with its prestige impaired by two temporary suspensions, on the responsibility of the executive, the earlier of the two little more than three years after its enactment. It is proper that the merits of this plan for the regulation of a convertible bank note currency should be here considered. Before touching upon the practical provisions of Sir Robert Peel's Act of 1844, I shall briefly state the nature, and examine the grounds, of the theory on which it is founded.

It is believed by many, that banks of issue universally, or the Bank of England in particular, have a power of throwing their notes into circulation, and thereby raising prices, arbitrarily; that this power is only limited by the degree of moderation with which they think fit to exercise it; that when they increase their issues beyond the usual amount, the rise of prices, thus produced, generates a spirit of speculation in commodities, which carries prices still higher, and ultimately causes a

reaction and recoil, amounting in extreme cases to a commercial crisis; and that every such crisis which has occurred in this country within mercantile memory, has been either originally produced by this cause, or greatly aggravated by it. To this extreme length the currency theory has not been carried by the eminent political economists who have given to a more moderate form of the same theory the sanction of their names. But I have not overstated the extravagance of the popular version; which is a remarkable instance to what lengths a favourite theory will hurry, not the closet students whose competency in such questions is often treated with so much contempt, but men of the world and of business, who pique themselves on the practical knowledge which they have at least had ample opportunities of acquiring. Not only has this fixed idea of the currency as the prime agent in the fluctuations of price, made them shut their eyes to the multitude of circumstances which, by influencing the expectation of supply, are the true causes of almost all speculations and of almost all fluctuations of price; but in order to bring about the chronological agreement required by their theory, between the variations of bank issues and those of prices, they have played such fantastic tricks with facts and dates as would be thought incredible, if an eminent practical authority had not taken the trouble of meeting them, on the ground of mere history, with an elaborate exposure. I refer, as all conversant with the subject must be aware, to Mr. Tooke's History of Prices. The result of Mr. Tooke's investigations was thus stated by himself, in his examination before the Commons Committee on the Bank Charter question in 1832; and the evidences of it stand recorded in his book: "In point of fact, and historically, as far as my researches have gone, in every signal instance of a rise or fall of prices, the rise or fall has preceded, and therefore could not he the effect of, an enlargement or contraction of the hank circulation."

The extravagance of the currency theorists, in attributing almost every rise or fall of prices to an enlargement or contraction of the issues of bank notes, has raised up, by reaction, a theory the extreme opposite of the former, of which, in scientific discussion, the most prominent representatives are Mr. Tooke and Mr. Fullarton. This counter-theory denies to bank notes, so long as their convertibility is maintained, any power whatever of raising prices, and to banks any power of increasing their circulation, except as a consequence of, and in proportion to, an increase of the business to be done. This last statement is supported by the unanimous assurances of all the country bankers who have been examined before successive Parliamentary Committees on the subject. They all bear testimony that (in the words of Mr. Fullarton*) "the amount of their issues is exclusively regulated by the extent of local dealings and expenditure in their respective districts, fluctuating with the fluctuations of production and price, and that they neither can increase their issues beyond the limits which the range of such dealings and expenditure prescribes, without the certainty of having their notes immediately returned to them, nor diminish them, but at an almost equal certainty of the vacancy being filled up from some other source." From these premises it is argued by Mr. Tooke and Mr. Fullarton, that bank issues, since they cannot be increased in amount unless there be an increased demand, cannot possibly raise prices; cannot encourage speculation, nor occasion a commercial crisis; and that the attempt to guard against that evil by an artificial management of the issue of notes, is of no effect for the intended purpose, and liable to produce other consequences extremely calamitous.

* Begulatiorl of Currencies, p. 85.

§ 2. As much of this doctrine as rests upon testimony, and not upon inference, appears to me incontrovertible* I give complete credence to the assertion of the country bankers, very clearly and correctly condensed into a smalt compass in the sentence just quoted from Mr. Fullarton. I am convinced that they cannot possibly increase their issue of notes in any other circumstances than those which are there stated. I believe, also, that the theory, grounded by Mr. Fullarton upon this fact, contains a large portion of truth, and is far nearer to being the expression of the whole truth than any form whatever of the currency theory.

There are two states of the markets: one which may be termed the quiescent state, the other the expectant, or speculative state. The first is that in which there is nothing tending to engender in any considerable portion of the mercantile public a desire to extend their operations. The producers produce and the dealers purchase only their usual stocks, having no expectation of a more than usually rapid vent for them. Each person transacts his ordinary amount of business and no more, or increases it only in correspondence with the increase of his capital or connexion, or with the gradual growth of the demand for his commodity, occasioned by the public prosperity. Not meditating any unusual extension of their own operations, producers and dealers do not need more than the usual accommodation from bankers and other money lenders; and as it is only by extending their loans that bankers increase their issues, none but a momentary augmentation of issues is in these circumstances possible. If at a certain time of the year a portion of the public have larger payments to make than at other times, or if an individual, under some peculiar exigency, requires an extra advance, they may apply for more bank notes, and obtain them; but the notes will ne more remain in circulation, than the extra quantity of Bank of England notes which are issued once in every three months in payment of the dividends. The person to whom, after being borrowed, the notes are paid away, has no extra payments to make, and no peculiar exigency, and he keeps them by him unused, or sends them into deposit, or repays with them a previous advance made to him by some banker: in any case he does not buy commodities with them, since by the supposition there is nothing to induce him to lay in a larger stock of commodities than before. Even if we suppose, as we may do, that bankers create an artificial increase of the demand for loans, by offering them below the market rate of interest, the notes they issue will not remain in circulation; for when the borrower, having completed the transaction for which he availed himself of them, has paid them away, the creditor or dealer who receives them, having no demand for the immediate use of an extra quantity of notes, sends them into deposit. In this case, therefore, there can be no addition, at the discretion of bankers, to the general circulating medium: any increase of their issues either •comes back to them, or remains idle in .the hands of the public, and no rise takes place in prices.

But there is another state of the markets, strikingly contrasted with the preceding, and to this state it is not so obvious that the theory of Mr. Tooke and Mr. Fullarton is applicable; namely, when an impression prevails, whether well founded or groundless, that the supply of one or more great articles of commerce is likely to fall short of the ordinary consumption. In such circumstances all persons connected with those commodities desire to extend their operations. The producers or importers desire to produce or import a larger quantity, speculators desire to lay in a stock in order to profit by the expected rise of price, and holders of the commodity desire additional advances to enable them to continue holding. All these classes are disposed to make a more than ordinary use of their credit, and to this desire it is not denied that bankers very often unduly administer. Effects of the same kind may he produced by anything which, exciting more than

usual hopes of profit, gives increased briskness to business: for example, a sudden foreign demand for commodities on a large scale, or the expectation of it; such as occurred on the opening of Spanish America to English trade, and has occurred on various occasions in the trade with the United States. Such occurrences produce a tendency to a rise of price in exportable articles, and generate speculations, 'sometimes of a reasonable, and (as long as a large proportion of men in business prefer excitement to safety) frequently of an irrational or immoderate character. In such cases there is a desire in the mercantile classes, or in some portion of them, to employ their credit, in a more than usual degree, as a power of purchasing. This is a state of business which, when pushed to an extreme length, brings on the revulsion called a commercial crisis ; and it is a known fact that such periods of speculation hardly ever pass off without having been attended, during some part of their progress, by a considerable increase of bank notes.

To this, however, it is replied by Mr. Tooke and Mr. Fullarton, that the increase of the circulation always follows, instead of preceding, the rise of prices, and is not its cause, but its effect. That in the first place, the speculative purchases by which prices are raised, are not effected by bank notes but by cheques, or still more commonly on a simple book credit: and secondly, even if they were made with bank notes borrowed for that express purpose from bankers, the notes, after being used for that purpose, would, if not wanted for current transactions, be returned into deposit by the persons receiving them. In this 1 fully concur, and I regard it as proved, both scientifically and historically, that during the ascending period of speculation, and as long as it is confined to transactions between dealers, the issues of bank notes are seldom materially increased, nor contribute anything to the speculative rise of prices. It seems to me, however, that this can no longer be affirmed when speculation has proceeded so far as to reaoh the producers. Speculative orders given by merchants to manufacturers induce them to extend their operations, and to become applicants to bankers for increased advances, which, if made in notes, are not naid away to persons who return them into deposit, but are partially expended in paying wages, and pass into the various channels of retail trade, where they become directly effective in producing a further rise of prices. I cannot but think that this employment of bank notes must have been powerfully operative on prices at the time when notes of one and two pounds value were permitted by law. Admitting, however, that the prohibition of notes below five pounds has now rendered this part of their operation comparatively insignificant, by greatly limiting their applicability to the payment of wages, there is another form of their instrumentality which comes into play in the later stages of speculation, and which forms the principal argument of the more moderate supporters of the currency theory. Though advances by hankers are seldom demanded for the purpose of buying on speculation, they are largely demanded by unsuccessful speculators for the purpose of holding on; and the competition of these speculators for a share of the loanable capital, makes even those who have not speculated, more dependent than before on bankers for the advances they require. Between the ascending period of speculation and the revulsion, there is an interval, extending to weeks and sometimes months, of struggling against a fall. The tide having shown signs of turning, the speculative holders are unwilling to sell in a falling market, and in the meantime they require funds to enable them to fulfil even their ordinary engagements. It is this stage that is ordinarily marked by a considerable increase in the amount of the bank note circulation. That such an increase does usually take place, is denied by no one. And I think it must be admitted that this increase tends to prolong the duration of the speculations; that it 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 a 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.

§ 3. To prevent this retardation of the recoil, and ultimate aggravation of its severity, is the object of the scheme for regulating the currency, of which Lord Overstone, Mr. Norman, and Colonel Torrens, were the first promulgators, and which has, in a slightly modified form, been enacted into law.*

* I think myself justified in affirming that the mitigation of commercial revulsions is the real, and only serious, purpose of theAct of 1844. I am quite aware that its supporters insist (especially since 1847) on its* supreme efficacy in "maintaining the convertibility of the Bank note." But I must be excused for not attaching any serious importance to this one among its alleged merits. The convertibility of the Bank note was maintained, and would have continued to be maintained, at whatever cost, under the old system. As was well said by Lord Overstone in his Evidence, the Bank can always, by a sufficiently violent action on credit, save itself at the expense of the mercantile public. That the Act of 1844 mitigates the violence of that process, is a sufficient claim to prefer in its behalf. Besides, if we suppose such a degree of mismanagement on the part of the Bank, as, were it not for the Act, would endanger the continuance of convertibility, the same (or a less) degree of mismanagement, practised under the Act, would suffice to produce a suspension of payments by the Banking Department; an event which the compulsory separation of the two departments brings much nearer to possibility than it was before, and which, involving as it would the probable stoppage of every private banking establishment in London, and perhaps also the non-payment of the dividends to the national creditor, would be a far greater immediate calamity than a brief interruption of the convertibility of the note; insomuch that, to enable the Bank to resume payment of its deposits, no Government would hesitate a moment to suspend payment of the notes, if suspension of the Act of 1844 proved insufficient.

According to the scheme in its original purity, the issue of promissory notes for circulation was to be confined to one body. In the form adopted by Parliament, all existing issuers were permitted to retain this privilege, but none were to be thereafter admitted to it, even in the place of those who might discontinue their issues: and, for all except the Bank of England, a maximum of issues was prescribed, on a scale intentionally low. To the Bank of England no maximum was fixed for the aggregate amount of its notes, but only for the portion issued on securities, or in other words, on loan. These were never to exceed a certain limit, fixed in the first instance at fourteen millions.* All issues beyond that amount must be in exchange for bullion; of which the Bank is bound to purchase, at a trifle below the Mint valuation, any quantity which is offered to it, giving its notes in exchange. In regard, therefore, to any issue of notes beyond the limit of fourteen millions, the Bank is purely passive, having no function but the compulsory one of giving its notes for gold at 31. 17s. 9d., and gold for its notes at 32. 17s. 10^d., whenever and by whomsoever it is called upon to do so.

The object for which this mechanism is intended is, that the bank note currency may vary in its amount at the exact times, and in the exact degree, in which a purely metallic currency would vary. And the precious metals being the commodity that has hitherto approached nearest to that invariability in all the circumstances influencing value, which fits a commodity for being adopted as a medium of exchange, it seems to be thought that the excellence of the Act of 1844 is fully made out, if under its operation the issues conform in all their variations of quan

• A conditional increase of this maximum is permitted, but only when by arrangement .with any country bank th« issues of that bank are discontinued, and Bank of England notes substituted; and even then the increase is limited to two-thirds of the amount of the country notes to be thereby superseded. Under this provision, the amount of notes which the Bank of England is now at liberty to issue against securities, is rather under fourteen and a half millions.

tity, and therefore, as is inferred, of value, to the variations which would take place in a currency wholly metallic.

Now, all reasonable opponents of the Act, in common with its supporters, acknowledge as an essential requisite of any substitute for the precious metals, that it should conform exactly in its permanent value to a metallic standard. And they say, that so long as it is convertible into specie on demand, it does and must so conform. But when the value of a metallic or of any other currency is spoken of, there are two points to be considered; the permanent or average value, and the fluctuations. It is to the permanent value of a metallic currency, that the value of a paner currency ought to conform. But there is no obvious reason why it should be required to conform to the fluctuations too. The only object of its conforming at all, is steadiness of value; and with respect to fluctuations the sole thing.desirable is that they should be the smallest possible. Now the fluctuations in the value of the currency are determined, not by its quantity, whether it consist of gold or of paper, but by the expansions and contractions of credit. To discover, therefore, what currency will conform the most nearly to the permanent value of the precious metals, we must find under what currency the variations in credit are least frequent and least extreme. Now, whether this object is best attained by a metallic currency (and therefore by a paper currency exactly conforming in quantity to it) is precisely the question to be decided. If it should prove that a paper currency which follows all the fluctuations in quantity of a metallic, leads to more violent revulsions of credit than one which is not held to this rigid conformity, it will follow that the currency which agrees most exactly in quantity with a metallic currency is not that which adheres closest to its value; that is to say, its permanent value, with which alone agreement is desirable.

Whether this is really the case or not we will now inquire. And first,

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