Introduction of Paper Currency

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


After the ‘price revolution’ of the sixteenth and seventeenth centuries, the next major episodes of British monetary history had as their central focus the role of fiduciary money and credit. The first of these, the ‘bullion controversy’, took place as a result of the Napoleonic war inflation at the end of the eighteenth and beginning of the nineteenth centuries; and the second, the ‘currency-banking debate’, was motivated by the increasingly cyclical character of economic activity towards the middle of the nineteenth century. These disputes were no longer between a pure exchange quantity theory of money on the one hand and classical value theory on the other. The law of monetary circulation had by this time been firmly established. Monetary requirements were determined by the ‘supply side’ of the equation of exchange, i.e., by the level of output and prices. The questions now raised were whether in a credit or fiduciary system the money supply could exceed (or fall short of) the normal requirements, and, if so, how this excess (or deficiency) was to be measured and what would be the consequences. The answers to these questions implied specific sets of policies.


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  1. 1.
    ‘Name and substance, nominal weight and real weight, begin their process of separation. Coins of the same denomination become different in value, because they are different in weight. The weight of gold fixed upon as the standard of prices, deviates from the weight that serves as the circulating medium, and the latter thereby ceases any longer to be a real equivalent of the commodities whose prices it realises. The history of coinage during the middle ages and down into the eighteenth century, records the ever renewed confusion arising from this cause’ (Marx, 1867/94, I, p. 126). See also Feavearyear (1931, p. 157 ff.).Google Scholar
  2. 2.
    Ricardo was later to sharpen the distinction between an increase of money and an increase of capital. In his Notes on Bentham he commented: ‘No sum of money carried into Switzerland would enable the possessor to drain a marsh and render it productive. The money must first be exchanged with some other country for those commodities which would increase the capital and revenue of the country. The same observation is applicable to Scotland. It was not by money, but by capital that Scotland has been improved’ (1951/52, III, pp. 286–87 emphasis added).Google Scholar
  3. 3.
    Despite his hostility to the development of credit, Hume, at least in his later essays, recognised the benefits which could flow from its ‘right use’. He saw the discounting of bills of exchange by Scottish banks as ‘favourable’ to industry and loans upon collateral as ‘one of the most ingenious ideas that has been executed in commerce’ (1752, pp. 190–1). The systematic issue of bank notes in Glasgow, for example, permitted ‘a stock of £5 000... to perform the same operations as if it were six or seven; and merchants were thereby enabled to trade to a greater extent, and to require less profit in all their transactions’ (ibid., p. 191). Hume concluded, remarkably, that this acceleration in turnover, ‘renders the commodity cheaper, causes a greater consumption, quickens the labour of the common people, and helps to spread arts and industry throughout the whole society’ (ibid., p. 209). Financial conservatism was by no means a consistent virtue on Hume’s part.Google Scholar
  4. 4.
    A less than successful aspect of Steuart’s classification was his distinction between banks ‘which issue notes payable in coin to bearer’ and those ‘which only transfer the credit written down in their books from one person to another’ (1767, II, p. 476). The former he called ‘banks of circulation’, the latter ‘banks of deposit’. It was an artificial distinction, and one that contributed later to the confusion between money and credit in the ‘currency-banking debate’. At the time Steuart was writing, however, it happened to be an accurate description of the practice of the Bank of Amsterdam on the one hand (a bank of deposit), and the Bank of England and Bank of Scotland on the other (banks of circulation).Google Scholar
  5. 5.
    In this context, Davenant, the seventeenth century mercantilist, became a counterfoil to Steuart’s promotion of deficit financing: ‘Men, at that time, had a terror upon them in contracting debts for the public: they considered the nation as they would a private man’ (1767, II, p. 607). The real target, however, was the fiscal orthodoxy of Hume and Montesquieu: ‘It is no objection to this representation of the matter, that the persons from whom the money is taken, would have spent it as well as the state’ (ibid., pp. 725–6).Google Scholar
  6. 6.
    According to his biographer, William Ainsworth, this was how Law explained his system to Lord Godolphin: ‘On reflecting profoundly on the matter, I am satisfied that precious metals are improperly employed as agents of circulation. By means of paper money, and a system of credit, such as I propose, the circulation would immediately be quadrupled, and since every branch of trade and industry must be immensely stimulated and encouraged, so the prosperity of the country will infallibly be increased in the same ratio’ (Ainsworth, 1874, p. 45).Google Scholar
  7. 7.
    ‘During the year and a half following its institution, Mr Law’s Bank continued to rise in credit and importance, and was constantly extending its operations. Received as cash at all the public offices, its notes were eagerly sought after, and preferred to specie — thus realising Law’s prognostications. Moreover, the large deposits of gold and silver continually made at the Bank, under the eye of the public, removed all doubts as to the solvency of the establishment. Distrust, in fact, had long since disappeared, and given way to the blindest confidence. In eighteen months, Mr Law had changed the whole aspect of affairs, had immensely increased the circulation, restored credit, revived trade, and given a new and strong impulse to every kind of industry’ (ibid., p. 167).Google Scholar
  8. 8.
    ‘During all this time Law’s efforts to uphold the System had been incessant but ineffectual. Decree after decree was issued, but with no other result than to aggravate the difficulties of the position. Specie was almost entirely banished, but though the billets de banque maintained their nominal value, the price of provisions and of all other necessaries was trebled, so that in effect the notes were depreciated to that extent. The shares of the Compagnie des Indes, which was now united to the bank, had undergone a rapid and continuous fall, and were now not worth a twentieth part of price to which they had been raised by the manoeuvres of the Realisers. Moreover, there was every prospect that they would sink still lower, while it appeared equally certain that the billets des banque must be further depreciated’ (ibid., p. 369). As soon as it became clear that a ‘terrible financial crisis’ was at hand, ‘Law at once lost the wonderful popularity he enjoyed’ (ibid.).Google Scholar
  9. 9.
    Schumpeter, who placed Law ‘in the front rank of monetary theorists of all times’, regarded his ‘gigantic enterprise’ as ‘not simply a swindle and it may well be doubted whether France was the worse off for it...’ (1954, p. 295). Less extravagantly, Clapham has argued that Law’s central ideas were ‘neither fantastic nor fraudulent; and this plan for a banque de France with its provincial succursales was obviously sensible’ (1944, I, p. 106). Whereas Rist dismissed Law as an ‘intelligent crank’ (1940, p. 65), Schumpeter was surely closer to the mark when he described him as the ‘ancestor of the idea of a managed currency’ (1954, p. 322).Google Scholar
  10. 10.
    Once again, Hume was here simply repeating the view of Vanderlint and Montesquieu: ‘I believe our paper-effects have contributed as much to this decay of trade as all the rest put together, by enhancing the price of everything among us, above the rates our real specie would have supported them at, in such proportion as the paper-effects amongst us are greater than the real specie we have circulating; for this is the natural and unavoidable effect of any thing operating as cash, which is not such’ (Vanderlint, 1734, pp. 164–5).Google Scholar
  11. 11.
    Steuart was prepared to allow this ‘money of society’ to become ‘legal tender in every payment of domestic debts’, confining the metals to the discharge of the ‘grand balance’, or balance of payments. He advocated unrestricted convertibility, however, ‘as long as some persons of the most acute understanding in many things, consider all money, except coin, to be false and fictitious’ (1767, II, p. 485). Thus, unlike his predecessor Law, Steuart conceded the necessity of a proportional metallic reserve to meet both international obligations and domestic withdrawals (see p. 000).Google Scholar
  12. 12.
    ‘It is this circumstance, above all others, which distresses banks of circulation. Were it not for this, the obligation to pay in coin might easily be discharged; but when in virtue of this pure obligation, a heavy national balance is demanded from the bank, which has only made provision for the current and ordinary demand at home, it requires a little combination to find out, at once an easy remedy. This combination... is by far the most intricate, and at the same time the most important in whole doctrine of banks of circulation’ (Steuart, 1767, II, p. 488).Google Scholar
  13. 13.
    ‘Credits of this kind are, I believe, commonly granted by banks and bankers in all different parts of the world. But the easy terms upon which the Scotch banking companies accept of repayment are, so far as I know, peculiar to them, and have, perhaps, been the principal cause, both of the great trade of those companies, and of the benefit which the country has received from it’ (Smith, 1776, p. 226).Google Scholar
  14. 14.
    Many commentators, as we have seen, could not understand why Smith failed to adopt explicitly Hume’s specie-flow mechanism. The reason, quite simply, lay in Smith’s opposition to the pure exchange quantity theory and in his attempt, however, inadequate, to establish ‘the forces determining the normal amount of a country’s money supply’ (Hollander, 1911, p. 436). It is perhaps not surprising therefore, to find the following assessment of the real bills element in maintaining a paper currency equivalent to the value of the commodity money it replaced: ‘Beside Hume’s performance, this was a pretty weak one and indeed a puzzling one... [Smith] may have preferred to evade the issue [of quantity theory] in the Wealth of Nations rather than enter into lengthy public controversy with his friend’ (O’Brien, 1975, p. 147).Google Scholar
  15. 15.
    In this context, Smith unequivocally rejected Hume’s account of the rise in prices in mid-eighteenth century Scotland; this was due ‘to the badness of the season, and not to the multiplication of paper money’ (1776, p. 249). It should be borne in mind that Smith was here writing about bank notes, a species of credit, not fiduciary money. As Rist has pointed out, ‘he does not confuse bank-notes with paper money, as Ricardo did later... He saw that in the long-run credit does not affect prices. Their level depends at bottom on the long-period relationship between the quantity of goods [Rist should have said ‘value of output’: R. G.] and that of the precious metals’ (1940, p. 89).Google Scholar
  16. 16.
    Andréadès describes the fiasco of the South Sea Company and the many other ‘projects’ launched in Change Alley (1935, pp. 127–45). He cites an example of the contemporary verse: A wise man laughed to see an ass Eat thistles and neglect good grass, But had the sage beheld the folly of late transacted in Change Alley, He might have seen worse asses there Give solid gold for empty air. (Ibid., p. 135)Google Scholar

Copyright information

© Roy Green 1992

Authors and Affiliations

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

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