History of Monetary and Credit Theory: From John Law to the Present Day

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Reprints

of Economic

HISTORY OF

MONETARY AND CREDIT THEORY

CLassics

Tila

One, OF

MONETARY AND CREDIT THEORY FROM JOHN LAW TO THE PRESENT DAY BY

CHARLES,

Bist

PROFESSEUR HONORAIRE A LA FACULTE DE DROIT DE PARIS MEMBRE DE L’INSTITUT

TRANSLATED

REPRINTS

Avucustus

BY JANE

DEGRAS

OF Economic

CLASsIcs

M. KeE.Liey: PuBLIsHERS

NEW YORK - 1966

The French original, “Histoire des Doctrines relatives au Crédit et a la Monnaie,”

was

first published in Paris in 1938 FIRST

PUBLISHED

IN

ENGLISH

Liprary oF Concress CaTraLocuE

IN

1940

Carp NuMBER

66-21371

PRINTED IN THE UNITED STATES OF AMERICA dy SENTRY PRESS, NEW YORK, N. Y. LOO1Q

DERE FASC E

Tuis is not a work of erudition. I have tried to give the history, not of books or of men, but of ideas. At all times the problems of credit and of money have excited controversies in which there have been apparent, from the first, the same theoretical conflicts. It is this permanence of the problems and of the points of view that it is interesting to bring into prominence; and, with the lapse of time, it is worth while to attempt once again to check the answers given at different periods by the facts relating to the matters at issue. Credit and money are human institutions. Like all human institutions, they may be regarded in different ways. Experience alone indicates the practical results to which these different conceptions lead. But neither the public nor even statesmen are familiar with more than a small part of that experience. In France, for example, it has no place in the teaching of history. It is not, therefore, inappropriate to bring it back to mind, and at the same time to remember that in such a subject there is neither “orthodoxy”’ nor “heresy.” The effects which the various methods employed have had on the well-being of nations will in the last resort be judged by the nations themselves. If to be orthodox means to favour those methods which have been hallowed by success, I accept the qualification. But let us beware of forgetting that in these matters nothing is simple. The truth of this will, I hope, be apparent to those who read this book. It would be a most serious error to believe that it is possible to summarise in a few brief precepts the totality of experience relating to credit, and to apply those precepts to daily life and politics. Man can never dispense with thought, but thought unsupported by experience is futile. And the experiences examined here are complex in their nature. “Whatever the activity under consideration,” wrote Marshal Foch, “whether it be history, literature, poetry, the novel, the study of social questions, arts of all kinds (including the art of war),

nobody can approach it without a body of knowledge, that is to say, without the knowledge of what has been done in the past, without having analysed, discussed and reflected upon it, without having elucidated the principles that governed and constituted different schools of thought at different times.” T5

History of Monetary and Credit Theory

In our subject the difficulty arises from the fact that the normal functioning of credit and money is constantly disturbed by wars and crises. The complex and delicate monetary mechanism of modern countries is periodically thrown out of gear by the extraordinary requirements of war, or by the abuses arising in times of peace from the collective psychosis born of economic booms and depressions. A great deal of ingenuity and courage is necessary to re-establish a workable monetary system. Equally great ingenuity and courage are required to recall to minds agitated by the monstrous consequences of:paper money or by the exaggerations of credit, the few essential ideas in the absence of which no monetary system can function. Rigidity is not less dangerous than the reckless pursuit of so-called originality. Monetary systems are always undergoing adaptation; but to adapt is not to destroy. I have sought, above all, to be clear. Indeed I have at times sacrificed brevity to clarity. With the same end in view I have grouped the principal theories discussed here around certain particularly representative writers. The penalty of this method— the only method that does not distract the attention of the reader— is the impossibility of quoting a large number of writers of distinction, who have frequently made important corrections and additions to fundamental theories. I apologise in advance to those of my contemporaries in Europe and America, and even in Asia, who are at the present time devoting so much ability and skill to the solution of these problems, and whose ideas it was practically impossible for me to present or to analyse in detail. It was not without regret that I was compelled to omit many names justly held in high esteem, and even famous. In Chapter VIII, I have tried,

more briefly than I would have wished, to do justice to the indisputable contributions they have made to the advance of monetary theory since the nineteenth century. The reader will, however, find in the footnotes references to

special books or articles containing detailed bibliographies. He will only have to consult them to discover the latest theories concerning one or another aspect of this vast subject.t 1 I should like to refer here to the excellent and comprehensive book by M. Valentin Wagner, of Basel: Geschichte der Kredittheorien, and to M. Baudin’s La Monnaie et la Formation des Prix. Both provide a masterly treatment of the problems

dealt with in this book. 16

Preface It will be seen that I have not used history as a means of evasion. In no instance have I concealed my views regarding the essence of the problems treated in this book. I have tried to justify my opinion by arguments whose value will be judged by the reader. But history is itself a critical instrument of the highest order. To bring back to mind the opinions expressed by the great thinkers of other times, the mistakes that they made, and the circumstances in which their views originated, is of great value in placing in their true perspective many theories of to-day, which their authors sincerely believe to be wholly new. It is well to remember that history repeats itself; but it should be added that it never repeats itself in exactly the same way. It is these variations which constitute the difficulty of the problems confronting the intelligence and the courage of the governments of to-day.

17

CONTENTS

CHAPTER

ONE

Confusion between Credit and Money in the Political Economy of the Eighteenth Century PAGE

ee Distinction between money and circulating credits—Commercial credit makes commodities circulate. Banking credit makes money circulate. The “margin of credit.’’ Bank-notes are deposit certificates. The banker’s issuing limit. The “virtual” circulation of the cash held by the bank. Banknotes do not increase the quantity of money; they are the material embodiment of the velocity of circulation . . .

34

. John Law.—Law and his “System’’ completely discredited among eighteenth-century writers. Curious revival of his popularity to-day. The origin of his ideas: compulsory transfer in operation at the Bank of Amsterdam and the saying: ““The good bank is the bank which does not pay.” Temporary difficulties of Bank of England and Bank of Scotland. The 1705 memorandum on trade and currency. Ways of increasing the quantity of money. Why Law, who opposed “augmentations,” advocated “‘diminutions.”’ Eighteenth-century attitude to augmentation. Bank of Scotland

operations in 1703 and their effect on Law’s subsequent policy. Comparison between the edict of March 1720 and gold purchases by the Bank of France in 1926. Law’s incorrect identification of credit with an increase in currency. Failure to distinguish between bank-notes and money. Erroneous idea that money is only a “voucher to purchase” goods. Indictment of hoarding. Low financial standing of the French State in the eighteenth century aggravated by Law’s experiments. False idea of basing bank-notes on land. The assignats. Galiani’s correct conception of circulating credits compared with that of Law § 11. Richard Cantillon —His book as it were an “anti-system.”’ Low estimate of the power of credit. Bank-notes as a means of making money circulate more rapidly. The Banker should

i?

43

History of Monetary and Credit Theory always be in a position to redeem his liabilities. Methods employed by the Bank of England to slow down repayments in times of difficulty. Identity of bank-notes and current account entries. Cantillon opposed to any change in the money standard. Faulty banking organisation of France in his time. Cantillon too conservative in this respect, Law too rasiioa ec . Adam

Smith—Familiar

with bank-notes

in Scotland and

the paper money used in the American colonies. Correctness of his practical ideas. Incorrectness of his theoretical conception of the bank-note, which he regards primarily as a less costly currency than coin, which it can replace. His famous comparison between credit and air transport based on an error. Incorrect idea that the number of notes which can circulate equal to the quantity of metallic currency which would exist in the absence of bank-notes. Erroneous idea of the process by which an excessive note issue is revealed. Thornton’s correction of this error. Identity of views held by Law and Smith about money, regarded as a “voucher to purchase.” Regrettable consequences of Smith’s idea that it is always advantageous to economise metallic currency. Smith’s correct ideas concerning the difference in the effect on prices between bank-notes and paper money. How convertible notes, if issued in large quantities, make the purchasing power of bullion vary. Thornton’s addition to Smith’s acs on this question . NT Oe Matias ai te tie x

77

~ Count Mollien Faithful disciple of Adam Smith. Admirer of England. Primarily a man of action. Special dangers of bank-notes in France. The discounting of commercial paper the basis of the note issue. Bank-notes merely replace commercial media of payment. Necessity of cash holdings. Uselessness of a capital stock. Mollien fails to see that notes “make cash holdings circulate.” He regards notes as “artificial money” which is cheaper than coin. Bank-notes regarded by Napoleon as a means of reducing the interest rate. Mollien’s opposition to this attitude; his faulty distinction between credit and money

gi

20

Contents CHAPTER

TWO

Eighteenth-Century Theories of the Action of the Precious Metals on the Price Level and on the Rate of Interest Src Contradictory Views on the Importance of Metallic Money.— Subsidiary role in economic life attributed by eighteenthcentury writers to money. Some regard its value as “‘fictitious,’ “imaginary” or “‘conventional.’”’ These ideas partly shared, partly rejected by Cantillon, Turgot, Galiani. Importance attached by statesmen in the eighteenth century and early nineteenth century to metallic currency and its stability. Galiani’s remarkable theory of the value of metallic currency and of value in general . . .

103

. General belief in the action of the precious metals on the price

level. Theory of the velocity of circulation—Unanimity from John Law to Adam Smith in recognising that an influx of bullion affects prices. Recognition that this influence is offset by increase in the volume of commodities. English and Italian writers introduce a third factor influencing the price level, the rapidity of circulation of money. Theories on this question of Thornton, Cantillon, Galiani, Verri. Erroneous

idea that the velocity of circulation always acts in a contrary direction to the quantity of money. All the elements in the “quantity” theory of money known to eighteenth-century writers. Conclusions drawn therefrom by Hume as to the distribution of the precious metals among different countries. Thornton’s theory of this distribution under a paper currency. Antiquity of the controversy as to the respective influence of the “quantity of money”’ factor and the “balance of trade” factor on exchange rates. No fear of an inadequate supply of the precious metals in the eighteenth century. Output of mines and price movements in this period § m1. Relation between abundance of the precious metals and the rate of interest.—Importance of the problem of the rate of interest in eighteenth-century economic literature. Prevailing idea that an abundance of the precious metals brings down the rate of interest. In criticising this idea Cantillon distinguishes between the price of savings and the purchasing power of money. His theory taken up by Hume, Turgot, 21

I1o

History of Monetary and Credit Theory Smith. The profit made by entrepreneurs, by determining the price which borrowers are prepared to offer, is the factor whose fluctuations have the greatest effect in determining fluctuations in the rate of interest. An abundance of bullion is therefore frequently accompanied by a rise and not a fall in the rate of interest. Remarkable observations of Cantillon and Turgot on this point. Conversely, an inadequate supply of the precious metals may lead to a fall in the rate of interest, not a rise. Important observation by Smith on this point. Similarity between these discussions and those at the end of the nineteenth century on this subject CHAPTER

123

THREE

Thornton, Ricardo, and the Bullion Report

§

. Peculiar characteristics of forced currency in England.— English paper money represents commercial discounts rather than loans to the State. Consequently English theory as a whole fails to grasp properly the difference between banknotes and paper money. English currency during theserie of the suspension of payment in specie 131 i=). Thornton’s book.—An Enquiry into the Nature and | Eifects A of the Paper Credit of Great Britain (1802), represents a defence of forced currency and a warning against excessive issue of paper money. His comparison of paper money in England and paper money in other countries is wholly favourable to the former, of the final redemption of which there'can be‘noidoubtia ieee ead eee 135 § m1. Ricardo and the identification ofbank-notes and paper money.— Ricardo “deflected” English theory. Polemical character of his pamphlets on currency. Explanation of his success. Lal

—

“Quantity” the only difference between bank-notes and paper money. Ricardo ignores the demand for money and attaches exclusive importance to supply; overlooks the differences between the value placed on a claim and the value placed on a good desired for its own sake; forgets the part played by speculation in determining the value placed on claims. Influence of changes in the value of the money standard on the distribution of expenditure in time . § Iv. Theory of purchasing power parity.—Excessive paper: issue compared to wear and tear of coinage. Regarded as the only 22

140

Contents cause of falling exchange rates. The question of confidence set aside by Ricardo. Modern revival of his theory by Cassel.

149

. The 1810 Palion Sees pethdienced ie iors snag more than by Ricardo. Differences between Ricardo’s theory and theory underlying the Report: a. uncertainty as to the character of the standard under a paper money regime; b. the part played by confidence in determining the value of the paper; c. influence attributed to balance of trade in exchange fluctuations. Ricardo persistently ignores this factor. Ricardo struck by the rapidity with which a scarcity of money affects the money market. Incidents in the history

of the Bank of England recorded by Smith and discussed 7 Ricardo . . - 153 § vi. Mechanism of the ald heen of the.eam fenls — _

A priori conception of equilibrium between currency requirements and the quantity of metallic money in each country, which can be disturbed only by a growth in requirements or an increase in the quantity of bullion. These changes reflected in divergent price levels. Money as a simple “commodity.” The terms “dear” and “cheap” applied to money as synonyms for “shortage” and “abundance.” Ricardo a cambist. Gold movements after the world war and Ricardian theory. Complex theory of equilibrium between the different

markets provides the only satisfactory explanation of the various causes determining gold movements. aka truths in Ricardo’s theory . § vil. Ricardian conception of ode Baers med, meanscr economising money. Money merely “‘voucher to purchase.”’

159

Metal standard useful only because it limits the quantity of money. Bank-notes, money created by the bankers, should be limited. The 1816 “Proposals for an Economical and Secure Currency” contain the essential features of the 1844

Act. Ricardo and the Gold Exchange Standard. The Baa s preference for coin a mere caprice. . : Appendix.—Ricardo’s 1823 plan for a ea seissue . CHAPTER

FOUR

Tooke the Historian and Ricardo the Logician . Problems created in England by the resumption of cash payments. Price fall and crises. The Birmingham School and

25

170 177

History of Monetary and Credit Theory the advocates of the devaluation of the pound. The Currency School and the explanation of crises as due to excessive banknotes. Tooke’s opposition . Tooke’s explanation of the price rise during forced currency.— Rise due chiefly to falling exchanges, not to excessive paper money. Persistence of Ricardo’s ideas in English doctrine. Goschen’s theory of the premium on gold

182

187

§ 1. The return of the pound to par in 1819.—Tooke shews ae this was done without diminishing the number of notes in circulation. Importance of this proof, and the oblivion into

which it subsequently fell 5, agi itne, e s £93 Paper money and bank-notes.—As against Ricardo, Tooke § Iv. differentiates sharply between forced paper currency and convertible bank-notes. He refuses to give the name of money to bank-notes; this name should be reserved for the money which serves as standard. Torrens’ objection CHAPTER

196

FIVE

Tooke, Creator of the Credit Theory. The Currency and Banking Principles Controversy

§ 1.

Fundamental identity of bank-notes and bank deposits ——This opinion held by Gilbart, MacLeod, Fullarton, and Mill. Forgotten by later writers. Revived by Ansiaux and Withers. Confirmed by the methods employed in France and the Anglo-Saxon countries to finance the world war. Irving Fisher’s recent proposal for a 100 per cent cover for bank deposits echoes Ricardo’s suggestion in regard to bank-notes 203 - Tooke’s theory of crises. Income created by credit and final income.—Speculative price rises always provoked by preceding demand for credit; not created by the issue of notes. These rises conflict with the general price level, which is determined by the final income of the public. Mr. Hawnrey’s s criticism of this theory, and the reply. 214 § 1. Different effect of an influx of gold on prices Porn oh to whether it coincides with a boom or slump.—Remarkable observations by Fullarton on this point . 219 § Iv. Influence of the rate of interest on prices—A low interest rate has never in itself caused a rise in prices; it merely provides a stimulus. It may affect stock exchange values without -_

24

Contents affecting the value of commodities. This observation confirmed by events in France in 1927 § v. Peel’s Act of 1844 and the Currency and Beatiag Principles Controversy— Why Peel agreed with Tooke’s opponents. Practical reasons determining the Bank of England’s monopoly of the note issue. Tooke accepts these reasons, but insists on elasticity in the note issue; opposed by Lord Overstone. Tooke’s ideas triumph in the post-war organisation of the Bank of ete Tooke’s criticism Ineo By

225

the 1847 crisis A