The Bank and the Bullionists (Part II - The Bullionists)

This is the second in a two-part post. The first briefly described the banking system in England prior to the suspension of the gold standard in 1797 and the actions of the Bank of England after that suspension. It also summarized the argument of defenders of the Bank of England against accusations that the Bank issued too many banknotes, depreciating the paper money and raising prices. This post will outline the opposing camp, the bullionists, who argued that the Bank of England’s note issuance did cause depreciation and inflation. It ends with Britain’s return to the gold standard in 1821.

Bank of England

In 1797, the gold standard in Britain was suspended and would not be restored until 1821. During this period and especially in the first two-thirds of it, there was a growing difference between the value of banknotes and the gold into which the banknotes were previously convertible. Now that they were no longer linked, gold came to change hands at a premium to the paper money. There was also a rise in prices over the period and the controversies surrounding this prompted the creation of a ‘Bullion Committee’ to investigate.

Those who defended the Bank of England’s policy during the suspension period belonged to the ‘banking school’ and were called ‘anti-bullionists’. They assigned more blame for the reduced value of money to the irregular balance of payments and supply shocks occurring during the Napoleonic Wars. By contrast, the ‘bullionists’ thought the Bank of England was printing too many banknotes and advocated a return to the gold standard.

The Bullionist School

At the start of the 19th century, the bullionists believed that issuances of banknotes were causing prices to rise and the foreign exchange value of the pound to depreciate. To some, this was not believed to be an accident. Those particularly critical of the Bank of England argued that it stood to make more profit from an enlarged issuance of banknotes, because this allowed it to discount more bills, essentially lending money against these receivables, and advance more money to the government too.

The profits from this activity accrued to the Bank but the cost was to the entire country’s detriment since the resulting inflation affected everyone. They accused merchants of acquiescing to this because they also stood to benefit from a readier supply of money. In any case, the bullionists simply placed less emphasis on the balance of payments or supply shocks in explaining the value of money and more on the money supply which the Bank of England to a large extent controlled.

Some of them might concede that the supply shocks and the ‘imbalance of payments’ had some effect but they were temporary occurrences. Yet, at least for long periods during the era of inconvertible money, the inflation was persistent. That said, some did not even accept much of a temporary role for these shocks. Perhaps the most famous and rigid of the bullionists, David Ricardo, argued that a supply shock such as a bad harvest leading to imports of grain would be offset by more British exports, rather than an outflow of gold abroad, if only the Bank of England’s policy was restrictive enough. Further, he argued that financial assistance and lending to foreign allies would cause an increase in British exports, returning the gold to Britain and causing no major effect. Thus, he completely rejected the position of the banking school.

In Ricardo’s view, the factors to which anti-bullionists attributed the premium on gold and discount on paper money were not just insufficient but were altogether false. Ricardo also rejected the idea that an increase in the money supply could affect real output, namely increase it, in the manner some anti-bullionists argued.

For a while, as noted by another commentator, the bullionist politician and lawyer Francis Horner, the depressed exchange rate caused by the money issuance can cause the export of precious metal abroad since money in that form came to be worth more elsewhere. This reduced the money supply, somewhat offsetting the emission of paper money, but once so much metal has left circulation, this can offset the printing of paper money no longer. The lack of convertibility also eliminated a floor on the exchange rate, namely the point at which it was profitable to buy British gold and export it and this floor could have been helpful in keeping prices for imports down.

A key argument advanced by the bullionist side was that printing banknotes to discount bills arising in trade could merely reflect inflation in the price of goods, and thus an increase in the need for financing, rather than actual real economic growth. So, printing money to discount more bills would lead to more inflation. The anti-bullionists missed the possibility of inflation, rather than real demand, increasing the need for discounting of bills and therefore money creation. This is critical because a key argument of the anti-bullionists was that so long as the Bank of England was advancing money against ‘real bills’, or financial liabilities arising from genuine trade, then the growth in money would reflect the growth of the economy and no more, avoiding inflation and depreciation.

Indeed, over longer periods of time during the suspended convertibility, there does seem to be a correlation between banknote issuance and the premium on gold even if this correlation is not apparent in smaller time horizons. Recent research has also found that, in the context of the war, the action of the Bank of England mitigated the crowding out of private debts by public borrowing but in the process prevented a rise in interest rates but allowed a rise in prices. Bullionists argued that the Bank could have prevented the rise in prices by adopting a more restricting policy, namely by choosing to discount fewer bills than for which there was demand for discounting. This would have curtailed the money supply growth but also avoided inflation and depreciation of the paper pound.

The Bullion Report

The Bullion Committee produced a report in 1810 which largely supported the bullionist position. It was mostly written by committee member Henry Thornton who had staked out a bullionist position for himself even before the committee was established, though he was not as rigid a bullionist as David Ricardo.

The report attributed blame for the depreciation of banknotes as compared to gold to the Bank of England’s emissions of banknotes and advocated for a return to the gold standard. However, this did not happen quickly. In fact, after the report was released, in 1811 and 1812, Parliament passed the Gold Coin Acts which discouraged the use of gold payments in private contracts. The suspension of the gold standard would be extended longer as well.

Even after the report recommended a return to the gold standard, the difference between the value of the paper pound and gold continued to widen. This gap peaked at a 36% premium in favor of gold in 1813. That was also the year the price level peaked, or at least returned to 1801 levels after an earlier decline. Prices then dipped but the improvement lasted only until Napoleon’s return for the ‘Hundred Days’ when the brief resumption of war sent prices back up; this inflation would not dissipate until the end of 1818.

Restoration of the Gold Standard

The original Bank Restriction Act called for convertibility of banknotes to be restored within six months of peace but this was extended numerous times. Many, including some bullionists, advocated for convertibility but with caveats. Some argued in favor of a reduced exchange rate, some advocated for a silver or bimetallist standard, and others argued only to make the conversions of large amounts of money permissible rather than allow small banknotes to be converted.

In the end, the case for convertibility at the old rate was strengthened by the Bank of England contracting the money supply and speculation in foreign exchange markets. Both led to a strengthening of the pound. After the wars ended, in 1816 and 1817, the Bank of England even offered to voluntarily redeem some portions of its notes into gold once more. There were a few years of mild deflation in the late 1810s but not as much as opponents of convertibility feared. By now, the difference in the price of gold and the old exchange rate of £3 17s 6d per ounce had converged to nearly zero. The result was that restoring full convertibility at the old rate came to look very feasible by 1820.

Synthesis

Though the Bullion Committee’s report advocated a return to the gold standard, the experience of the suspension period was not exclusively damning of the Bank of England or supportive of the bullionists, especially the rigid bullionists. Some moderate bullionists, like Henry Thornton, did concede that factors like the balance of payments could affect the exchange rate and prices. Compared to many fellow bullionists and despite his report, Thornton was not actually particularly critical of the Bank. He argued that restricting the money supply to improve the balance of trade and the exchange rate was likely only to rectify the situation after a large interval of time and would cause considerably harm in the meantime.

Thornton also noted that some of the increased stock of banknotes was due to a reduced velocity of money as people sought to hold more cash on hand in a period of uncertainty, an inclination which also led to more discounting of bills afforded by the printed money. While this increased the stock of paper money beyond the gold it displaced, a result not always accepted by the banking school, it also conflicted with the view of many bullionists that there was an ideal static ratio of gold to paper money. Thornton argued this was not so static. Some may even argue that Thornton essentially accepted a bullionist position on the general effect on prices of the Bank of England’s policies without wholesale rejecting the Bank’s actions in these particular circumstances either.

Lesson

The setting of the Bullion Committee has some relevance today for countries abandoning a fixed exchange rate for a floating one. How they use or refrain from using that additional flexibility can be informed by the findings of the Bullion Committee more than two centuries ago. In fact, the debate between the bullionists and anti-bullionists has some relevance for all issuers of inconvertible paper monies. The bullionists, for example, contributed to an understanding on how to control the value of money in the absence of a precious metal standard even if they argued for a return to such convertibility. Though they may have been on the ‘losing’ side of the 1810 debate, even the banking school added to this understanding.

More from the Tontine Coffee-House

Read the first part of this post and about even more tortured efforts to restore the gold standard after another European war. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.

The Bank and the Bullionists (Part II – The Bullionists)