Theory of the Fiduciary System

  • Roy Green
Part of the Studies in Political Economy book series (STPE)

Abstract

In the previous chapter, I have examined the development of eighteenth century monetary analysis. The period began with the inflationary collapse of Law’s System and ended with Smith’s succinct presentation of classical doctrine in the Wealth of Nations. The suspension of cash payments by the Bank of England in 1797 following the outbreak of the Napoleonic war opened a new phase of price inflation — or, more precisely, several distinct phases — and rekindled theoretical debate. This inflation was accompanied by a rise in the market price of bullion over its mint price, i.e., a depreciation of paper currency in terms of the monetary standard, a phenomenon which could not have existed when convertibility was enforced by law. The central problem was to explain the appearance of a premium on bullion, and to find a principle whose practical implementation would restore and maintain ‘economic convertibility’, thus ensuring that the bank notes conformed to the laws of metallic currency I have already outlined. It was not surprising, therefore, that the first decade of the nineteenth century should have been, in Marx’s words, ‘hardly more prolific of war bulletins than of monetary theories’ (1859, p. 81).

Keywords

Assimilation Expense Dium Defend Mast 

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References

  1. 1.
    This point was to be developed later by the Banking School: ‘The authority issuing such paper money, can determine exactly the quantity that shall remain permanently in the hands of the public. The power of issue is unlimited, because there is no reflux...’ (Tooke, 1838/57, IV, p. 186).Google Scholar
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    Ricardo reiterated this proposition in his Reply to Bosanquet. ‘If an addition be made to a currency consisting partly of gold and partly of paper, by an increase of paper currency, the value of the whole currency would be diminished, or in other words, the prices of commodities would rise, estimated either in gold coin or in paper currency’. In a closed economy, once gold had been “wholly withdrawn” from circulating it would ‘rise above the value of paper, and would soon obtain that relative value to other commodities which subsisted before any addition had been made to the circulation by the issues of paper’. It would then become the function of the mine to supply the quantity of gold required, and the paper currency would continue to be permanently depreciated’, anticipating the case of a fiduciary system: ‘During this interval, the gold mines of a country... could not be worked, because of the low value of gold, which would have reduced the profits on capital employed in the mines below the level of other mercantile concerns. As soon as this equality of profit were established, the supply of gold would be as regular as before.’ In an open economy, on the other hand, ‘any excess of... currency would be counteracted by an exportation of specie, and if that excess did not exceed the amount of coin in circulation,... no depreciation of the currency would take place’ (1951/58, III, pp. 210–12). This interpretation was affirmed by Ricardo in his notes on Bentham’s unpublished manuscript, ‘Sur les Prix’ (ibid., pp. 269–70).Google Scholar
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    To Bosanquet, who took the opposite view, Ricardo responded: ‘The analogy seems to me to be complete, and not to admit of dispute. The issues of paper not convertible are guided by the same principle, and will be attended with the same effects as if the Bank were the proprietor of the mine, and issued nothing but gold. However much gold may be increased, borrowers will increase to the same amount, in consequence of its depreciation; and the same rule is equally true with respect to paper. If money be but depreciated sufficiently, there is no amount which may not be absorbed...’ (1951/58, III, p. 217). Marx commented that, ‘Ricardo confuses the circulation of banknotes or of credit money with the circulation of simple tokens of value. The fact which dominates his thought is the depreciation of paper money and the rise in commodity-prices that occurred simultaneously. The printing presses in Threadneedle Street which issue paper notes played the same role for Ricardo as the American mines played for Hume’ (1859, pp. 169–70). Tooke showed that very different effects would follow from a gold issue by the Bank, depending upon the ‘mode of issue’ (1838/57, IV, p. 200).Google Scholar
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    In his private notes on the minutes of evidence to the Bullion Committee, Ricardo referred to the reliance upon the real bills doctrine by the Bank of England directors as ‘the source of all the errors of these practical men’ (1951/58, III, p. 362). However, the facts were clearly against Ricardo, for, taking the period as a whole, the real bills doctrine operated as an effective principle of limitation (Tooke, 1838/57, I, p. 159 and passim). In his Reply to Bosanquet, Ricardo conceded that, given the Bank of England’s attachment to the real bills doctrine, ‘it is a matter of surprise that our circulation has been continued within such moderate bounds’ (ibid., p. 221). Clapham comments with some justice: ‘If the Bank witnesses showed up badly as economists, their critics showed up no better as politicians’ (1944, p. 28).Google Scholar
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    As Tooke pointed out in his History of Prices, it was ‘the coincidence... between the market value and the Bank rate of interest, that prevented the tendency through this medium to progressive increase and irremediable excess of issues, which might have been apprehended if the Bank rate had been for any length of time much below the market rate’ (1838/57, I, p. 162). But see Chapter 7.Google Scholar
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    In reality, ‘the excess of the advances by the Bank to the Government over and above the amount of Government deposits, from the period of the suspension of cash payments in 1797, to the year 1811, was actually smaller in amount than the same excess during the seven years preceding that event... This comparative smallness of the advances to Government completely negatives the supposition, so commonly entertained and reasoned upon as a point beyond doubt, that the Bank was rendered, by the restriction, a mere engine in the hands of Government, for facilitating its financial operations’ (Tooke, 1838/57, IV, pp. 94, 96; see also Cannan, 1919, p. xxxvi; Andréadès, 1935, pp. 208–9; Deane, 1979, p. 17).Google Scholar
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    Ricardo accepted that monetary contraction could have a damaging effect on individual borrowers. He observed in the letters to the Morning Chronicle which followed publication of the Bullion Report: ‘As the paper system, pushed to the extravagant length which it now is, affords great facilities to this description of persons, there can be no doubt that every measure which tends to correct that system, every material reduction in the quantity of paper, will greatly embarrass and cause much distress amongst those who depend upon its continuance; and though the misfortunes of every part of the community must be deplored, it is to the pernicious system which has lately prevailed, that it will be alone to be ascribed’. The contraction, however, would not affect the level of output, for capital was not destroyed but merely redistributed among the ‘channels of trade’. Hence, Ricardo continued: ‘[W]hatever may be lost in consequence of the difficulties to which the persons of whom we have been speaking may be exposed, cannot be regarded an national loss, as the capital which they could command by the credit which the abundance of circulating medium afforded them will revert to those hands which have been heretofore dispossessed of it, and where it will at least be as profitably employed as in those where this ruinous system has placed it’ (1951/58, III, pp. 135–36).Google Scholar
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    Ricardo’s analysis in his drafts of the Plan for the Establishment of a National Bank (1824) anticipated the functions of central banking: Arnon (1987).Google Scholar
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    The dubious advantages of ‘consistency’ were alluded to by William Blake in his rejoinder (prior to publication) to Ricardo’s marginal notes on his Observations on the Effects Produced by the Expenditure of Government during the Restriction of Cash Payments (1823). Blake denied any observable relationship between the amount of bank notes and the high price of gold: ‘[M]ay, so far from it, that for months together they are found to run in opposite directions. It was this want of connexion, between the amount of Bank notes and the price of bullion, that first led me to suspect the accuracy of the theory, that attributed the high price of gold to the overissues of the Bank....’ Ricardo commented: ‘“Overissues of the Bank” Is not every thing an overissue after the market price of gold rises above the mint price, whether caused by a real rise in the value of gold or a real fall in the value of paper?’ Blake responded: ‘[Y]es overissue in the sense in which it is used by consistent political Oeconomists but not in the sense in which the public use it — viz. that notes have been issued in such excess as to alter the value of currency in respect to all commodities: there is a material difference between “overissue” and “non-contraction”’ (Ricardo, 1951/58, IV, p. 335).Google Scholar
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    The importance of Tooke’s work lay in his discovery of “the positive evidence that these expansions of the circulation, and those operations of the Bank which are described as “occasioning” the fall of the exchange could not have had any such consequence, unless it can be shown, that the date of a cause may be subsequent to the date of its effect’ (Tooke, 1838/57, IV, p. 138). He was determined to correct Ricardo’s persistent ‘misapprehension of the facts’ (ibid., p. 104). More recent commentators, such as Viner, have since demonstrated in some detail that Ricardo and his group ‘were clearly wrong in their denial that extraordinary remittances would operate to depress the value of the English currency on the exchanges...’ (1937, p. 142).Google Scholar
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    While some interpreted it as a concession, Ricardo was right to impress upon his readers that he had never held that every increase in prices was due to monetary depreciation: ‘[W]here has it been disputed that there are not other causes besides the depreciation of money which may account for a rise in the prices of commodities? The point for which I contend is, that when such rise is accompanied by a permanent rise in the price of that bullion which is the standard of currency, then to the amount of that rise is the currency depreciated’ (Reply to Bosanquet, in 1951/58, III, p. 251). Since the price of bullion had risen, this apparent concession did not materially affect Ricardo’s assessment of the contemporary inflation.Google Scholar
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    Ricardo had earlier presented these causes as follows: ‘[T]here may be a great increase in the capital of a country, which may so increase the quantity of commodities to be circulated, that there may be required more circulating medium at one time than at another; there may be a great diminution in the value of gold and silver, generally, in Europe, which may make it possible, with the same commerce, to maintain an increased amount of circulation; I consider, in all cases, that the quantity of circulation must depend upon its value, and the quantity of business which it has to perform’ (1951/58, V, pp. 372–3). At the time, however, statistics were lacking on changes in the level of output and the production costs of gold and silver.Google Scholar
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    This assessment is confirmed by Deane, who deduces from the accumulated evidence that the real bills doctrine ‘provided a reasonably acceptable criterion on which to base a prudent credit policy’ (1979, p. 17).Google Scholar
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    Tooke drew upon the vast empirical detail of his History of Prices to argue that, ‘[t]he notes of the Bank of England, and of the private banks of this country, were, for two years after the restriction, of the same value as if they had been convertible, and never experienced any discredit’ (1844, p. 70 fn.), and that, during the subsequent phases of inflation, causation ran from prices to the money supply, not the other way round. Also, Tooke observed, the paper money of the Russian government ‘seems never to have suffered any discredit; and the variation of the exchanges beyond those produced by the mere excess of the paper, were such only as are incidental to variations in the state of trade’. By contrast, the American colonial currencies during the war of independence and the French assignats ‘became ultimately valueless, when all prospect of redemption had ceased’ (ibid.). In other words, economic convertibility had not only not been maintained but had actually slipped out of reach.Google Scholar
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    ‘[T]he Currency School were not on very strong ground when they argued that the equilibrium gold value of notes could depreciate significantly in the presence of gold convertibility’ (Laidler, 1972, p. 179). See further below, ch. 7.Google Scholar
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    ‘It is manifest that the quantity of such money depends on the necessities and caprice of the issuer, and its value must fall in proportion to its increase’: ‘A Scotch Banker’ (1868), p. 100. See Laidler, (1972), p. 177; Fetter (1965), pp. 190–91.Google Scholar
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    Marx noted that, ‘the opinion of Adam Smith... is repeated by Thomas Tooke. This erroneous conception of the ratio of the quantity of money required for the realisation of revenues to the quantity of money required to circulate the entire social product is the necessary result of the uncomprehended, thoughtlessly conceived manner in which the various elements of material and value of the total annual product are reproduced and annually replaced’ (1867/94, II, p. 479).Google Scholar
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    Quite separately, George Poulett Scrope, like Attwood a ‘brilliant rebel’ (Fetter, 1965, p. 140), had already made the case for ‘an inconvertible paper money to be preserved at par with bullion ordinarily, but to be left free to deviate from par for short periods during which temporary fluctuations of the price level would otherwise occur’ (Viner, 1937, p. 288).Google Scholar
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    Fullarton was adamant about the retention of convertibility: ‘Let my views, however, not be misunderstood. Let it not be supposed, for a moment, that I am indifferent to the expediency and importance of maintaining intact the metallic basis of our circulation, and providing by the most judicious means of security that can be devised, for the perfect and uninterrupted convertibility of our bank paper’ (1844, p. 20). Yet he also maintained that the suspension of cash payments ‘had nothing like the share which has been commonly supposed, in producing those violent alternations of price’ (ibid., pp. 20–1; also p. 7 fn.). He argued that all the functions of gold and silver coins could be performed ‘as effectually by a circulation of inconvertible notes, having no value but that factitious and conventional value which they derive from the law’, and, echoing Steuart, that such notes could ‘supersede even the necessity for a standard, provided only the quantity of the issues be kept under due limitation’ (ibid., p. 21). For Marx, this aspect of Fullarton’s presentation showed ‘want of clearness’; just because ‘the commodity that serves as money is capable of being replaced in circulation by mere symbols of value,... its functions as a measure of value and a standard of prices are decared [by Fullarton] to be superfluous!’ (1867/94, I, p. 129 fn.). As a result, Fullarton managed to identify three disadvantages of fiduciary money, which, in his view, would rule it out as a feasible system of currency. The first was the lack of any ‘regulating principle’ by which the quantity could be ‘kept in exact proportion to the transactions which the currency has to perform’; fluctuations in the market-price of bullion ‘would not be sufficient’. Second, the ‘power of creating money’ would most likely be ‘abused’ by the government. Finally, ‘[a] conventional currency is the creature of the law, and it is only within the range, in which the law which creates it prevails, that it can serve the purposes of money’; a metallic standard was required not just to provide a medium of exchange for domestic circulation, but also to ‘facilitate our commercial intercourse with all the other nations of the world’ (1844, pp. 22–6). Fullarton was thus ‘another Law’ only to the extent that he imagined that the adoption of a fiduciary system would mean the complete abandonment of a metallic standard.Google Scholar
  35. 35.
    ‘In the same way as the exchange value of commodities is crystallised into gold money as a result of exchange, so gold money in circulation is sublimated into its own symbol, first in the shape of worn gold coin, then in the shape of subsidiary metal coin, and finally in the shape of worthless counters, scraps of paper, mere tokens of value’ (Marx, 1859, p. 114).Google Scholar
  36. 36.
    A rise or fall in the price level which corresponded with a change in the supply of fiduciary money was thus, according to Marx, ‘merely a forcible assertion by the process of circulation of a law which was mechanically infringed by extraneous action; i.e., the law that the quantity of gold in circulation is determined by the prices of commodities and the volume of tokens of value in circulation is determined by the amount of gold currency which they replace in circulation’ (1859, p. 121).Google Scholar
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    ‘The quantity theory being rightly regarded as refuted, there is a reluctance to give due recognition to the influence of quantity on the value of money even where it really is the determining factor, as in the case of paper money and depreciated currency’ (Hilferding, 1910, p. 50). On the suggestion that money was ‘imbued with a magic power which was supposed to be capable of adjusting and regulating the process of production’, see Niebyl (1946), p. 98.Google Scholar
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    Kuhne suggests that Marx’s ‘opposition to the theory of the Currency School was but a continuation of the polemics directed at Proudhon and his school (Darimon and others), who saw in the manipulation of banking policy the lever whereby to control cyclical developments and even to overcome capitalism’ (1979, p. 351). This interpretation has some validity.Google Scholar

Copyright information

© Roy Green 1992

Authors and Affiliations

  • Roy Green
    • 1
  1. 1.University of NewcastleAustralia

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