Classical Economics, Lecture 3

The Bullionist Controversy and the Banking and Currency Schools

Rothbard on Monetary Controversies

• Rothbard’s chapters on monetary theory and history illustrate two important principles he uses in writing economics.

• In all cases, he judges writers by how close they come to the correct position. This favors the gold standard and 100% percent reserve banking.

• The enemy consists of anyone who wants to expand the money supply.

Rothbard Continued

• Rothbard does not just concentrate on a few people. Major writers are often responding to lesser known writers.

• Sometimes, lesser known writers express certain principles best.

• Rothbard was influenced by Quentin Skinner in this approach.

Suspension

• When Britain and France became involved in war in 1793, this led to a period of armed conflict that lasted almost without interruption until 1815.

• Britain increased spending during the wars. The Bank of England kept issuing more bank notes. Country banks, i.e, banks outside London, rapidly increased.

Suspension Continued

• Many of the country banks suspended specie payment. They issued so much money that they couldn’t meet all requests to redeem claims on them in gold.

• In 1797, the Bank of England also suspended specie payment. This bank was by far the most important English bank.

• Specie remained suspended until 1821. This long a suspension was unprecedented and generated controversy.

The Bullionist Controversy

• Prices increased during the war period.• The price increases led to a controversy between

those who said that prices had increased because of the expansion of the money supply and those who denied this.

• The former group were the bullionists and the latter group the anti-bullionists.

• It may seem obvious to us now that the bullionists were right, but many people contested this.

Walter Boyd

• One of the most important of the earlier bullionists was Walter Boyd, a failed banker who wrote A Letter to the Rt. Hon. William Pitt. This was published in 1801.

• Boyd argued that increase in the supply on money had led to higher prices, a decrease in the value of the pound compared to gold bullion, and lower value of the pound compared to foreign currencies.

Boyd on Inflation

• Boyd realized that an increase in the money supply didn’t affect all prices equally. People who got the new money earliest would be able to spend before prices had gone up much.

• People who came later would face rising prices.• Boyd was reviving the ideas on Richard Cantillon• He also realized the need to define money

carefully . Currency and bank notes were money, bills of exchange (e.g., checks) were not. Demand deposits were money.

Purchasing Power Parity

• Boyd realized that an increase in the supply of money would decrease its value relative to foreign currencies.

• He had the basics of the purchasing-power parity theory of money that can’t be converted into specie.

• We know from the Law of One Price that a commodity will tend to sell for the same price.

Parity Continued

• The purchasing-power parity theory applies this insight to foreign exchange.

• Units of different monies will tend to able to purchase the same goods in different countries. This enables a rate of exchange between the monies to be calculated.

Long-Run Versus Short Run

• Boyd and the other bullionists didn’t deny that particular prices could go up or down because of non-monetary factors.

• But in the long run, demand and supply of money determined the price level.

• In monetary economics, long-run trends are the most important ones. This isn’t the case in non-monetary economics.

Parties to the Controversy

• Rothbard distinguishes four positions in the bullionist controversy.

• 1) The complete bullionists. These included Boyd and Lord King. King said there was no way to determine a “safe” amount of monetary expansion, as the anti-bullionists thought. There is no way of calculating the optimum demand for money, apart from what the public wants.

Parties

• 2) The anti-bullionists. They including Francis Baring. They thought that prices had risen because of real factors, e.g., more imports than exports. They thought that increases in the quantity of money were reactions to price changes, rather than causes of the them.

Parties Continued

• 3) The moderates. They said it was an empirical question whether monetary or real factors produced price rises. Henry Thornton was first a moderate anti-bullionist . Then, he became a moderate bullionist.

• 4) The mechanical bullionists, such as John Wheatley. They said prices rise in fixed proportion to a rise in the quantity of money. They ignored demand.

Ricardo

• The bullionists gained the support of David Ricardo, the leading British economist.

• Most of his writings were about money.• He tended to favor the mechanical bullionists. He

thought that the quantity of money determines the price level, but money is neutral. Values are determined by real factors, mostly the quantity of labor required to produce a commodity.

Resumption of Specie

• In 1821, the Bank of England resumed redeeming money in gold.

• Sir Robert Peel, an influential Tory leader, had been converted to the bullionist position. Peel was the head of the committee of Parliament that recommended resumption.

• He had earlier been an anti-bullionist but changed his mind.

Crisis After Resumption

• Even after the 1821 resumption of specie, inflation continued.

• The problem was that banks, especially the Bank of England, issued a large number of bank notes.

• One solution was that issuing bank notes should be limited by the supply of gold on hand. The banks shouldn’t be able to issue notes as they pleased.

The Currency School

• Those who advocated this principle were called the Currency School.

• They included James Pennington and Robert Torrens.

• Torrens realized that demand deposits were part of the money supply. But he didn’t call for limiting money creation through these deposits. This was a weakness of the Currency School.

The Banking School

• The opponents of the Currency School were the Banking School. Members of this group included Thomas Tooke, who was an important collector of economic statistics.

• The Banking School said that banks can’t create money. It’s true that bank can lend out money through issuing notes or claims on deposits that exceed the gold the bank has available.

• But these increases will not be permanent.

Banking School Continued

• Why not? After a loan is paid off, the money that the bank created is extinguished.

• This is called the doctrine of reflux. It is related to the earlier real bills doctrine, held by Adam Smith.

• Rothbard says the problem with this view is that the money doesn’t all come back to the bank at the same time. Inflation can continue.

Peel’s Act

• Peel’s Act (1844) was a victory for the Currency School. The Act separated the note issue of the Bank of England from the lending and demand deposit sides of the Bank.

• The country banks were cartelized under the Bank of England.

Developments in America

• In America, there was an influential movement that went much further than the Currency School.

• Jefferson was suspicious of paper money altogether.

• His position was continued by Andrew Jackson and his followers, who wanted to do away with fractional reserve banking.

• Condy Raguet was an important writer who held this position.

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