Abstract
The debate between the Currency and Banking Schools in the mid nineteenth century gave rise to important developments in the theoretical analysis of inflation and business cycles in the context of an increasingly sophisticated credit system. Indeed, Marx spoke of the ‘economic literature worth mentioning since 1830’ as resolving itself ‘mainly into a literature on currency, credit and crises’ (1867/94, III, pp. 492–3). The ‘bullion controversy’ in the early part of the century was addressed, as we have seen, almost exclusively to the operation of a fiduciary system; hence, the resumption of cash payments by the Bank of England in 1821 was the first occasion for any real advance in the theory of credit since Adam Smith. In this chapter, I shall begin with the concept of ‘fictitious capital’ and the determination of the rate of interest, and then attempt to deduce the laws governing the behaviour of credit instruments and their connection with economic activity and prices.
[W]ith the development of the credit system, capitalist production continually strives to overcome the metal barrier, which is simultaneously a material and imaginative barrier of wealth and its movement, but again and again it breaks its back on this barrier.
K. Marx, Capital, III (1867/94)
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Preview
Unable to display preview. Download preview PDF.
References
Some clarification of terminology may be required at this point. In the eighteenth century, for writers like Hume, all paper money was ‘fictitious’, whereas Smith confined the term only to credit instruments which lacked an equivalent counterpart in commodities or real assets of any kind. In other words, ‘fictitious’ was a description used either indiscriminately to cover all money and credit which had escaped from its golden prison, or, much more narrowly, to distinguish in practice commercial paper which did not furnish adequate security for bank lending from that which did, that is, ‘real bills’ (see above, ch. 5). The classification of fictitious capital in the nineteenth century, by contrast, included every instrument in the spectrum of credit, irrespective of its capacity for conversion into real assets; as Marx pointed out, the various kinds of interest-bearing paper ‘are not capital but merely debt claims. If mortgages, they are mere titles on future ground-rent. And if they are shares of stock, they are mere titles of ownership, which entitle the holder to a share in future surplus value. All of these are not real capital’ (1867/94, III, p. 457). Nevertheless, Smith’s distinction retained at least a practical validity in the operation of the Banking School’s ‘law of reflux’, a direct descendant of the real bills doctrine.
‘[T]he essence of the transaction is that the credit is based upon the actual or anticipated existence of real concrete goods, and that it is measured and limited by the value of those goods’ (Hobson, 1913, p. 76).
Thornton had already pointed out that real capital ‘cannot be suddenly and materially encreased by an emission of paper... [T]he rate of mercantile profit depends on the quantity of this bona fide capital and not on the amount of the nominal value which an encreased emission of paper may give to it....’ An expansion of bank lending might, however, ‘cause paper to be for a time overabundant, and the price paid for the use of it [that is, the money rate of interest: R. G.] consequently, to fall’ (1802, p. 255). See Wicksell (1936), pp. 81 ff.
Although Tooke was ready to criticise almost every aspect of the Currency School theory, there is no evidence for Schumpeter’s view that he ‘attacked Ricardo’s theory as theory’ (1954, p. 709). This view rests upon a confusion of long-run analysis with its short-run application.
Interest-bearing capital, according to Marx, was derived originally from ‘usurer’s capital’ and played a significant role in the dissolution of feudalism: ‘Both the ruin of rich landowners through usury and the improvement of the small producers lead to the formation and concentration of large amounts of money capital. But to what extent this process does away with the old mode of production, as happened in modern Europe, and whether it puts the capitalist mode of production in its stead, depends entirely upon the stage of historical development and the attendant circumstances’ (1867/94, II, p. 594). For usury to have this ‘revolutionary effect’, it was essential that it be subordinated to emergent industrial capital. In eighteenth century England, this took the form of a campaign — led by Sir Josiah Child, whom Marx called ‘the father of ordinary English private banking’ — against high interest rates and for their compulsory reduction by legislation: ‘This violent battle against usury, this demand for the subordination of interest-bearing capital to industrial capital, is but the herald of the organic creations that establish these prerequisites of capitalist production in the modern banking system, which on the one hand robs usurer’s capital of its monopoly of the precious metal itself by creating credit-money’ (ibid., p. 603). See Postan (1928).
Indeed, as Marx demonstrated, Massie ‘laid down more categorically than did Hume, that interest is merely a part of profit’ (1963/71, I, p. 373). Marx also suggested that, ‘Adam Smith’s discussion of the rate of interest is closer to Massie than to Hume’ (1972, p. 265). Even before Massie, Sir Dudley North, in his Discourses upon Trade (1691), determined interest by the supply and demand for ‘stock’ by which he meant not only money, but capital: ‘If there be more Lenders than Borrowers, Interest will... fall;... it is not low Interest makes Trade, but Trade increasing, the Stock of the Nation makes Interest low’ (1691, p. 4)
Massie noted the correspondence between the fall in the rate of interest in England and Holland over the preceding hundred years and the fall in the rate of profit, and inquired, ‘how it happens that... Profits are less now than they were when [Merchants and Tradesmen] first set out in the world’ (Massie, 1750, p. 49). This he attributed ‘either to an Increase of Traders or a Decrease of Trade, or to People in Trade lowering the Prices of their Commodities upon each other... through Necessity to get some Trade, or through Avarice to get most...’ (ibid.). While he was able to deduce, therefore, that, ‘the Profits of Trade in general, are governed by the Proportion which the Number of Traders bears to the Quantity of Trade’ (ibid., pp. 51–2), he made no attempt to analyse the production of a social surplus in the same way as Petty and his successors had done. As Marx put it, ‘Neither Massie nor Hume know or say anything at all regarding the nature of “profit”, which plays a role in the theories of both’ (1972, p. 263; also 1963/71, I, p. 377).
Earlier, Massie dismissed any attempt to derive the ‘natural’, or more accurately, average, rate of interest from the rate on government securities: ‘All Reasoning about natural Interest from the Rate which the Government pays for Money, is, and unavoidably must be fallacious; Experience has shown us, they neither have agreed, nor preserved a Correspondance with each other; and Reason tells us they never can; for the one has its Foundation in Profit, and the other in Necessity; the former of which has Bounds, but the latter none’ (Massie, 1750, p. 32–3, emphasis added).
Smith as usual, made no reference to Steuart, who had earlier shown how ‘property becomes transferred to a new set of men, once the monied interest, who... consolidate this quantity of money which is become superfluous to circulation’ (Steuart, 1767, II, p. 638).
Smith also showed how, just as a given amount of money could be used for a number of purchases — depending upon its velocity of circulation — so it could be employed in a number of different loan transaction. He concluded that, ‘the same pieces of money can thus serve as the instrument of different loans to three, or for the same reason, to thirty times their value’ (1776, p. 271). When Marx applied Smith’s example to deposits in the banking system, he found that, ‘everything in this credit system is doubled and trebled and transformed into a mere phantom of the imagination, [including] the ‘reserve fund’ where one would at last hope to grasp onto something solid’ (1867/94, III, p. 472).
In the Principles, Ricardo commented on Say’s argument, ‘that the rate of interest depends on the rate of profits; but it does not therefore follow, that the rate of profits depends on the rate of interest. One is the cause, the other the effect, and it is impossible for any circumstances to make them change places’ (1951/58, I, p. 300 fn.). This implied a sharp break with Hume’s more agnostic approach to the direction of causality.
‘If... the quantity of money be greatly increased, its ultimate effect is to raise the prices of commodities in proportion to the increased quantity of money; but there is probably always an interval, during which some effect is produced on the rate of interest’ (Ricardo, 1951/58, I, p. 298).
Tooke’s antagonists in the Currency School were largely responsible for this confusion. Marx ridiculed Overstone’s parliamentary evidence of 1857 on the record of the Bank Acts: ‘Overstone... confuses continually “capital” and “money”. “Value of money” also means interest to him, but insofar as it is determined by the mass of money, “value of capital” is supposed to be interest, insofar as it is determined by the demand for productive capital and the profit made by it’ (1867/94, III, p. 509).
This view had been put most uncompromisingly by Thornton in a House of Commons speech on the Bullion Report in May 1811. He maintained that the ‘danger of excess’, and hence of a rise in the price level in accordance with the quantity theory of money, ‘was aggravated in proportion to the lowness of the rate of interest at which discounts were afforded’ (Appendix to Thornton, 1802, p. 335). This would especially be the case if the current interest rate was ‘lower than that which was the natural one...’ (ibid., p. 339). Thornton’s view was widely shared, but, as Tooke was to demonstrate, it was contradicted by evidence (Tooke, 1838/57, IV, pp. 124–9).
Tooke had already argued in his History of Prices that, ‘If there exist grounds for speculation in goods, a coincident facility of credit may, but will not necessarily, extend the range of it’ (1838/57, III, p. 166). The key factor was the extent of demand (Fetter, 1965, p. 193; Schumpeter, 1954, p. 709).
Tooke spoiled this aspect of his case, however, by over-reaching himself. He cited J. W. Bosanquet’s observation in his Metallic, Paper and Credit Currency that: ‘Were the rate of interest reduced as low as one per cent, capital borrowed at that, or even a lower rate, should be considered nearly on a par with capital possessed, is a proposition so strange as hardly to warrant serious notice were it not advanced by a writer so intelligent, and, on some points of the subject, so well informed. Has he overlooked the circumstance, or does he consider it of little consequence, that there must, by the supposition, be a condition of repayment?’ (1844, p. 80). As Marx rightly pointed out, Tooke’s criticism of Bosanquet on this score was misconceived: “The nearer the rate of interest approaches zero, falling, for instance to one per cent, the nearer borrowed capital is to being on a par with owner’s capital (1867/94, III, p. 371).
In the History of Prices, Tooke found that even ‘given the motives for speculation’ and an ‘undue extension’ of credit, ‘the prices of commodities are little, if at all, affected by temporary alterations, in the rate of interest; whilst a permanent increase of the rate of interest would have effects on the prices of produce directly opposite to those which are commonly supposed’ (Tooke, 1838/57, III, p. 166). Fullarton, on the other hand, although prepared to accept that, ‘a depression of the market-rate of interest has no necessary or direct tendency to raise prices’, drew back from the proposition that it had no role at all in promoting speculative activity. He distinguished ‘sound or rational speculations’, in which interest rate movements might have very little part, from ‘speculation extravagant and monstrous’ which would be conducted ‘without the slightest regard to the state or prospects of supply’ (1844, p. 163 fn.). See Niebyl (1946) pp. 69–70.
There is also a significant discussion as ‘addenda’ to the third part of Theories of Surplus Value. Here interest-bearing capital is examined from the perspective of ‘revenue and its sources’ (1963/71, III, pp. 453–540).
Similarly, Steuart demonstrated not only that the rate of interest was generally ‘in proportion to the profits upon trade and industry’, but also that it was regulated by competition: ‘The borrowers desire to fix the interest as low as they can; the lenders seek, for a like principle of self-interest, to carry the rate of it as high as they can. From this combination of interests arises a double competition, which fluctuated between the two parties’ (1767, II, pp. 449, 452).
Marx distinguished between that portion of gross profit accruing as interest and the portion left to the ‘active capitalist’, which could be categorised as ‘profit of enterprise’. This derived ‘solely from the operations, or functions, which he performs with the capital in the process of reproduction...’ (1867/94, III, p. 374 and passim). Long before most observers, therefore, he recognised the growing separation between ownership and control under capitalism: ‘[S]tock companies in general — developed with the credit system — have an increasing tendency to separate this work of management as a function from the ownership of capital, be it self-owned or borrowed’ (ibid., pp. 387–8; also, pp. 436–40). See also Hilferding (1910, ch. 7).
‘The price of commodities is extremely fluctuating; they are every one calculated for particular uses; money serves every purpose. Commodities, though of the same kind, differ in goodness: money is all, or ought to be all of the same value, relatively to its denominations. Hence the price of money (which is what we express by the term interest) is susceptible of a far greater stability and uniformity, than the price of any other thing’ (Steuart, 1767, II, p. 450).
According to Kuhne, ‘That Marx set his face against the Currency School is curious, as the latter dates back to Ricardo...’ (1979, p. 349). It has been my contention that the Currency School represents a distortion of Ricardo’s theory of interest and prices and that the Banking School comes much closer to a ‘Ricardian’ position, on what might have been Ricardo’s view in the mid-nineteenth century. It is therefore not at all remarkable that Marx should ‘align himself’ with the Banking School.
As far as Marx was concerned, the money supply could have a ‘determining influence’ on the rate of interest ‘only in times of stringency’. Under normal circumstances, however, it would have no effect, ‘since — assuming the economy and velocity of currency to be constant — it is determined in the first place by commodity prices and the quantity of transactions..., and finally by the state of credit, whereas it by no means exerts the reverse effect upon the latter; and, secondly, since commodity prices and interest do not necessarily stand in any direct correlation to each other’ (1867/94, III, p. 530).
Panico (1980) also takes up Sraffa’s suggestion (1960, p. 33) that the rate of interest may be treated as an independent variable in the formation of prices of production, thus ‘closing’ the system outlined by Garegnani (see above ch. IV). I have reservations about this argument, but its assessment is beyond our present scope.
Fullarton dismissed the idea that simply by ‘operating on the interest-market’, the Bank of England ‘might succeed in arresting [a gold drain], without any material stock to credit or disturbance of mercantile affairs’. It might have been possible ‘if the Bank held at all times the control of the market-rate of interest in its own hands’, but ‘that power only accrues to the Bank, when the public has already to some extent become dependent on the Bank for its discount accommodations’ (1844, p. 160).
Although Fullarton and the Banking School recognised the dangers in the overaccumulation of money capital, they ignored its counterpart in the overaccumulation of real capital, expressed in an overproduction of commodities, and the role of credit, in promoting this overproduction. Marx, on the other hand, depicted the credit system as ‘the main lever of over-production and over-speculation in commerce... because the reproduction process, which is elastic by nature, is here forced to its extreme limits’. The further development of the credit system would therefore ‘constitute the form of transition to a new mode of production’ (1867/94, III, p. 441).
The argument for a separation of Bank of England functions derived its authority from David Ricardo’s posthumously published Plan for the Establishment of a National Bank (1824): ‘The Bank of England performs two operations of banking, which are quite distinct, and have no necessary connection with each other: it issues a paper currency as a substitute for a metallic one; and it advances money in the way of loan, to merchants and others. That these two operations of banking have no necessary connection, will appear obvious from this, — that they might be carried on by two separate bodies, without the slightest loss of advantage, either to the country, or the merchants who receive accommodation from such loans’ (1951/58, IV, p. 276). See Arnon (1987).
Andréadès, for example, found that, ‘the discussion of the merits and demerits of these two systems is... somewhat futile and very dull... whatever may in reality be the advantages of the Banking Principle,... it was very soon rejected in England. Hence it is more important to examine the practical form given by the exponents of the currency principle to their theory (1935, p. 277). The Banking School has received more attention as successive inquiries upheld their main conclusions (Macmillan, 1931; Radcliffe, 1959; du Cann, 1981).
The little headway Tooke was able to make initially against the prevailing orthodoxy of the Currency School was partly explained by Fullarton as follows: ‘Mr Tooke himself has been exceedingly slow in following out his original conclusions on the subject of price to all their consequences.... He adhered to [quantity theory] doctrines even after he had refuted them by his discoveries, and seems to have parted with them at last only by degrees and with reluctance, under the pressure of his growing convictions.... These slight appearances of wavering, which, rightly viewed, ought rather to be considered as proofs of the caution and deliberation with which he formed his judgements, have been charged against him as inconsistencies, and advantage has been taken of them to detract from the weight of his authority’ (1844, pp. 18–19). The chief ‘inconsistency’ as we shall see, lay in Tooke’s persistent failure to deal with Say’s law; nevertheless, he was later to ‘fully acquiesce’ in Fullarton’s ‘sketch... of the progress of my opinions’ (1838/57, IV, p. x).
‘The discussion between the two schools turned wholly... on short-run issues. On the question of what determined the quantity and value of a metallic currency in the long-run, both schools followed the “classical” or “Ricardian” doctrine’ (Viner, 1937, p. 221). See also Laidler (1972).
Although this section is concerned largely with gold drains, the same principles apply to a gold influx of the kind discussed in chs 4 and 7; such an influx also took place later in the nineteenth century, following the new discoveries in California and Australia. Upon the constant velocity assumption, Hobson pointed out, ‘hinges the whole of the theory that quantity of gold output is the sole ultimate regulator of prices, upon the money side of the equation of exchange’ (1913, p. 145).
Fullarton also discussed the issue in some detail. In the first stage postulated by the specie-flow doctrine, he pointed out that an influx of bullion need have no effect on the domestic money supply: ‘They never even allude to the existence of such a thing as a great hoard of the metals, though upon the action of the hoards depends the whole economy of international payments between specie-circulating communities, while any operation of the money collected in hoards upon prices must, even according to the currency hypothesis, be wholly impossible’ (1844, p. 140). In the second stage, a bullion outflow might be drawn entirely from available reserves: ‘I would desire, indeed, no more convincing evidence of the competency of the machinery of the hoards in specie-paying countries to perform every necessary office of international adjustment, without any sensible aid from the general circulation, than the facility with which France, when but just recovering from the shock of a destructive foreign invasion, completed within the space of twenty-seven months the payment of her forced contribution of nearly twenty millions to the allied powers, and a considerable proportion of that sum in specie without any perceptible contraction or derangement of her domestic currency, or even any alarming fluctuation of her exchanges’ (ibid., p. 141). Marx also maintained that, ‘the movements of a hoard concentrated as a reserve fund for international payments have as such nothing to do with the movements of money as a medium of circulation’ (1867/94, III, p. 453). See Viner(1937, pp. 222, 268).
Fullarton’s commonsense produced a distant echo: ‘We cannot regard as satisfactory a system under which so high a proportion of the gold stock is locked up in such a way as not to be available for export if the Central Bank should so desire’ (Macmillan, 1931, p. 139). Fullarton distinguished drains of bullion for purchases of corn and war expenditure from those in which ‘a foreign debt has been created by very extensive investments of capital in foreign securities’ and where ‘the mischief has originated in speculation and over-trading’. These latter categories ‘have no claim to be treated with the same tenderness’ (1844, p. 154). See also Tooke (1844), pp. 187–89 and below.
For Rist, the fact that, ‘[t]he beliefs of Peel and the Currency School were not weakened by Tooke’s arguments... provides a further striking example of the weight carried by great names and by over-simplified thought in the tradition of political economy’ (1940, p. 205).
It has been argued persuasively that, ‘the currency principle and monetary base control are almost identical in intention’ (Congdon, 1980, p. 2). See also du Cann (1981) ch. 9.
‘[I]t cannot surely be pretended for an instant, that this question as to the action of a credit circulation on prices can, in one way or the other, or in the slightest degree, be affected by any variation in the form of credit through which the payments are made...’: Fullarton (1844), p. 40. ‘It appears, then, that there is neither authority nor reasoning in favour of the definition which invests Bank notes with the property of money, or paper currency, to the exclusion of all other forms of paper credit’ (Tooke, 1838/57, IV, p. 163).
‘Though we do not regard the supply of money as an unimportant quantity, we view it as only part of the wider structure of liquidity in the economy’ (Radcliffe, 1959, p. 132; see also Sayers 1960, pp. 516–17; Kaldor and Trevithick, 1981, pp. 11–13; du Cann, 1981, pp. lxxxvi–lxxxviii).
Rist subscribed to the law of reflux in the following terms: ‘The banks’ creation of credit, in all its forms, and particularly in the form of bank-notes, takes place only because the public demand credit. Banks cannot create notes at will, anymore than they can create deposits’ (1940, p. 213). Similarly Kaldor and Trevithick: ‘Hence in a credit money economy... the outstanding “money stock” can never be in excess of the amount which individuals wish to hold; and this alone rules out the possibility of there being an “excess” supply of money which should be the cause (as distinct from the consequence) of a rise in spending’ (1981, p. 7). Others have taken a different view: ‘[A]s long as a bank could find borrowers and had sufficient reserves it could increase its note issues indefinitely by granting more and more loans’ (Daugherty, 1942/43, p. 151). The question which should have been asked is would the non-bank public have continued to demand credit, let alone ‘indefinitely’, if there were no further expectation of profit? This question is addressed below in the context of the business cycle.
Considerable confusion enters into the literature at this point, for which the Banking School itself is partly responsible. According to Fetter, ‘it is never quite clear whether... the fundamental idea was that changes in note issues alone had no effect on prices, or that a change in the total means of payment created by banks that loaned only on real bills had no effect on prices’ (1965, p. 191). My argument is that the reflux law contains both these aspects; however, some commentators, who find the first aspect congenial, recoil from the real bills dimension (e.g. Laidler, 1972, pp. 173–4).
The Banking School view has been cited in recent debate on credit control: ‘The Currency School was incorrect... to claim that excessive increases in the note issue were responsible for price inflation or the subsequent commercial crises which threatened convertibility. Rather it was commercial crises which were responsible for excessive increases in the note issue’ (Congdon, 1980, p. 4). Ironically, the opposite view is held by Kuhne, a Marxist economist. He claims that the Banking School must ‘surely’ have been wrong to assume ‘the improbability of an inflation of bank notes’ (1979, p. 350). He even suggests that, ‘in the area of regulations the ideas of the Currency School had some success’ (ibid.) It is now widely accepted that the banking legislation inspired by the Currency School only served to exacerbate subsequent crises (Clapham, 1944, II, pp. 211–16; Fetter, 1965, pp. 201–15).
‘The main constructive proposal made by the Banking School was that the Bank of England should maintain a larger average reserve’ (Daugherty, 1942/43, p. 153). See also Gregory’s introduction to Tooke (1838/57, p. 100); Viner (1937, pp. 264–70); Clapham (1944, II, p. 240).
Wilson’s argument is reinforced by the possibility of converting the notes into gold: ‘Their equilibrium price could never fall below their gold redemption value minus the cost of the redemption transaction... [I]t is hard to believe that [this cost] could have been a significant amount’ (Laidler, 1972, p. 179). Fetter regards Wilson’s articles compared with the writings of Tooke and Fullarton, as ‘a better statement of the theoretical case against the Act of 1844’ (1965, pp. 199–200).
Marx agreed, however, that ‘the demand for currency between consumers and dealers predominates in periods of prosperity, and the demand for currency between capitalists predominates in periods of depression. During a depression the former decreases, and the latter increases’ (1867/94, III, p. 450). See Kuhne (1979), p. 353; Harris (1979), p. 140.
‘Each demand originates in circumstances peculiarly affecting itself, and very distinct from each other. It is when everything looks prosperous, when wages are high, prices on the rise, and factories busy, that an additional supply of currency is usually required to perform the additional functions inseparable from the necessity of making larger and more numerous payments; whereas, it is chiefly in a more advanced stage of the commercial cycle, when difficulties begin to present themselves, when markets are overstocked, and returns delayed, that interest rises, and a pressure comes on the Bank for advances of capital’ (Fullarton, 1844, p. 96).
The issue was posed by Marx as follows: ‘[W]hich is it, capital or money in its specific function as a means of payment that is in short supply in periods of stringency? And this is a well-known controversy... It is not a contradiction here between a demand for money as a means of payment and a demand for capital. The contradiction is rather between capital in its money-form and capital in its commodity-form; and the form which is here demanded and in which alone it can function, is its money-form. Aside from this demand for gold (or silver) it cannot be said that there is any dearth whatever of capital in such periods of crisis.... On the contrary, the markets are overstocked, swamped with commodity capital. Hence, it is not in any case, a lack of commodity capital which causes the stringency’ (1867/94, III, pp. 459–60).
It should be kept in mind that this over-supply of capital was seen as an oversupply of money capital. Marx noted that, ‘this plethora of loanable money capital merely shows the limitations of capitalist production. The subsequent credit swindle proves that no real obstacle stands in the way of the employment of this surplus capital’ (1867/94, III, p. 507).
Stocks and shares, for example, did not transfer control over real capital, but ‘merely convey legal claims to a portion of the surplus value to be produced by it’ (Marx, 1867/94, III, p. 477). They could be seen as ‘duplicates’ of the capital; but, ‘as duplicates which are themselves objects of transaction as commodities, and thus able to circulate as capital-values, they are illusory, and their value may fall or rise quite independently of the movement of value of the real capital for which they are titles. Their value, that is, their quotation on the Stock Exchange, necessarily has a tendency to rise with a fall in the rate of interest — insofar as this fall, independent of the characteristic movements of money capital, is due merely to the tendency for the rate of profit to fall; therefore, this imaginary wealth expands, if for this reason alone, in the course of capitalist production...’ (ibid., pp. 477–8).
Thornton had long before in his Paper Credit insisted that the scope for speculation turned ‘principally on a comparison of the rate of interest taken at the bank with the current rate of mercantile profit’. His description of the nature of the demand brought by borrowers was perceptive: ‘It will not be the privation of that quantity of circulating medium which is necessary for carrying on the accustomed payments, for these will be very immaterially encreased; the cause of the extraordinary applications to the bank will be the temporary advantage which may be gained, or the loss which may be avoided, by borrowing, during the three months in question, at the rate of five per cent’ (1802, p. 257).
Hobson also attributed price fluctuations of this kind ‘to an increase in the quantity of credit which each unit of negotiable capital supports during a rise of prices’; he called this ‘a temporary and adventitious increase of supply of money’ and distinguished it from ‘that increased credit which is the natural financial result of enabling larger masses of wealth to figure as securities’ (1913, p. 93).
The mechanism of a credit inflation was explained by Fullarton: ‘It is true, that the prices of an extensive class of commodities may occasionally be affected for a time by speculation, and that such speculation may be more or less supported by extraordinary facilities of credit. But albeit bank-notes are nothing more than credit embodied in a particular shape, this indirect action of credit on prices is quite a different thing from the action on prices ascribed to bank-notes by the partisans of the currency theory.... The object of the speculative purchaser is to withdraw from consumption a portion of the stock of the commodity in which he speculates, and to hold it back from the market until he can sell it at a profit; his action is on the value, not of the money, but of the commodity; and he causes a rise of price by thus disturbing the natural course of supply and demand. He first creates an artificial demand, by entering into competition with the consumer for the possession of the commodity, and then he contracts the supply, by refusing for a time to sell it to any-one else. When he succeeds in his object, however, the rise rise of price is not nominal but real; when he at last brings his commodity to market, he obtains for it not merely a larger numerical amount of coin or notes than he paid for it, but a larger money value’ (1844, pp. 58–9).
As the crisis assumed an international dimension, it ‘becomes evident that all these nations have simultaneously over-exported (thus over-produced) and over-imported (thus over-traded), that prices were inflated in all of them, and credit stretched too far. And the same break-down takes place in all of them... prov[ing] precisely by its general character... that gold drain is just a phenomenon of a crisis not its cause’ (Marx, 1867/94, III, p. 492). Clapham has referred to the ‘commercial crisis of the autumn of 1857, in which all the feverish and gold-dazzled activity of the mid-fifties ended’, as ‘the first really world-wide crisis in history...’ (1944, II, p. 226).
It was not until 1931 that a firm recommendation was made to end the separation of departments and the associated fixed fiduciary issue: ‘This peculiar provision arose out of long-dead controversies which we need not revive; for the reasons which originally led to the separation of the departments have no interest or relevance to-day’ (Macmillan, 1931, p. 143).
Again, it was not until 1959 that the Banking School view was embodied in official policy: ‘The authorities thus have to regard the structure of interest rates rather than the supply of money as the centre-piece of the monetary mechanism’ (Radcliffe, 1959, p. 135). See also Sayers (1960).
The position was summarised by The Economist: ‘Practically, then both Mr Tooke and Mr Loyd would meet an additional demand for gold... by an early... contraction of credit by raising the rate of interest, and restricting advances of capital.... But the principles of Mr Loyd lead to certain [legal] restrictions and regulations which produce the most serious inconvenience’ (11 December 1847, p. 1418). Marx’s comment was apt: ‘That the greatest sacrifices of real wealth are necessary to maintain the metallic basis in a critical moment has been admitted by both Tooke and Loyd-Overstone. The controversy revolves merely round a plus or a minus, and round the more or less rational treatment of the inevitable’ (1867/94, III, p. 573).
On the relationship between Bank rate and the market rate of interest, see Cramp (1962) ch. 1.
Four years earlier, the third volume of his History of Prices, Tooke argued that, in response to a gold drain, ‘the Bank rate of discount should be kept so steadily above the market rate, as progressively to reduce the securities, through that channel, without increasing them by other investment’. The effect would be to replenish the Bank’s reserve — up to a predetermined amount — and to allow it to ‘preserve that amount on an average’, depending upon the circumstances where the drain was due to temporary factors, such as the purchase of corn, ‘the balance of payments would in all probability be satisfied by the export of that amount of bullion’. If the drain continued, however, the Bank would have ‘reason to apprehend the existence of more extensive and deeper-seated causes of demand for the metals’, namely a speculative boom. Under these circumstances, ‘measures might be taken for its counteraction, without producing alarm and disturbance of the money market on the one hand, or endangering an extreme and unsafe degree of reduction of the Bank treasure on the other’. Tooke concluded that regulating the securities in this way would be ‘more easily practicable than either that of maintaining the securities even, or of presenting the bullion in any given proportion to the liabilities’; and that, ‘the principle of limitation would operated less rigidly’ if the issue and deposit departments of the Bank were fused rather than separated (1838/57, III, pp. 187–9).
It is now possible to correct a widespread misinterpretation in the literature (Sweezy, 1970, p. 178 and passim) of Marx’s contention that, ‘The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit’ (1867/94, III, p. 484). Although it has been alleged that Marx was here elaborating an ‘underconsumptionist’ theory of crisis, the context — a discussion of credit — makes it clear that he viewed the ‘limits of consumption’ as being set by ‘the reproduction process itself (ibid., p. 482). The point he wanted to make was simply that it was ‘erroneous... to blame a scarcity of productive capital’ for conditions of economic stagnation. On the contrary, it was “precisely at such times that there is a super abundance of productive capital, partly in relation to the normal, but temporarily reduced scale of reproduction, and partly in relation to the paralysed consumption’ (ibid., p. 483, emphasis added). In other words, the ‘consuming power of society’ was a factor in the crisis only to the extent that it was restricted by the overriding need to maintain the rate of profit on capital. Nor was there any point in looking to a Malthusian ‘third party’ to ‘realise’ surplus value: ‘The incomes of the unproductive classes and of those who live on fixed incomes remain in the main stationary during the inflation of prices which goes hand in hand with over-production and over-speculation. Hence their consuming capacity diminshed relatively, and with it their ability to replace that portion of the total reproduction which would normally enter into their consumption. Even when their demand remains nominally the same, it diminishes in reality’ (ibid., p. 491).
Laidler concludes that, ‘Tooke’s emphasis on bank lending as a key variable in short-run business fluctuations surely put him closer to the truth than did the Currency School’s emphasis on the size of the note issue’ (1972, p. 183).
‘Ignorant and mistaken bank legislation, such as that of 1844/45, can intensify [a] money crisis. But no kind of bank legislation can eliminate a crisis’ (Marx, 1867/94, III, p. 490).
Rist pointed out that this argument ‘remains valid only so long as the banks really put the “law of reflux” into operation and confine themselves to making short-term loans and not advances which immobilise their funds for indefinite periods. Tooke makes this assumption throughout his argument’ (1940, p. 200). Tooke himself later notes: ‘It is certainly a striking fact, that for so long a period after the Restriction Act, so uniform a value of the currency and of the amount of the circulation should have been preserved... [N]o attempt has ever been made to explain it by the vast majority of those who, under the influence of the currency theory, or of the Birmingham school, write or talk of the period of the Bank restriction as having been characterised in its whole course by abundant or excessive issues of paper money, and consequent depreciation’ (1838/57, IV, pp. 92–3). See also Deane(1979,p. 17).
Author information
Authors and Affiliations
Copyright information
© 1992 Roy Green
About this chapter
Cite this chapter
Green, R. (1992). Theory of the Credit System. In: Classical Theories of Money, Output and Inflation. Studies in Political Economy. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-22388-6_7
Download citation
DOI: https://doi.org/10.1007/978-1-349-22388-6_7
Publisher Name: Palgrave Macmillan, London
Print ISBN: 978-1-349-22390-9
Online ISBN: 978-1-349-22388-6
eBook Packages: Palgrave Economics & Finance CollectionEconomics and Finance (R0)