The Bullionist Controversy
The Bullionist Controversy emerged in the early 1800s regarding whether or not paper notes should be made convertible to gold on demand. This metamorphosized later in the 1840s into the Banking-Currency School debate over the gold parity of the Bank of England notes.
In 1694, at the instigation William Paterson and the assent of the new Dutch king of England, William III, a new joint-stock company, the Bank of England, was formed to help finance the government's borrowing. In 1695, the Bank of Scotland was incorporated. In 1696, a proposal by John Briscoe and Hugh Chamberlain for a "National Land Bank", an equivalent note-issuing bank for the English provinces, with credit secured by land rather than gold, failed to get off the ground.
Besides lending to the government, the Bank of England's principal line of business was the London discount market - that is discounting commercial bills of exchange. The English currency crisis of 1695-98 lowered confidence in Bank of England notes. To shore up confidence, in 1704, government passed laws making promissory notes legally enforceable. This did not prevent a crisis and run on the Bank in 1707. So in 1708, parliament passed an act (7 Anne, c.7) prohibiting private companies with more than six partners from issuing promissory notes anywhere in England. In 1720, in the course of the South Sea Bubble, the Bubble Act (6 Geo. 1, c. 18) prohibited the formation of joint-stock companies without a royal charter. The banking act was clarified and reinforced in 1742 (15 Geo. 2, c.15). England was consequently reduced to a single, note-issuing joint-stock bank (Bank of England) and a myriad of small, private partnership banks which did not issue notes in London. Outside of London, there was a plethora of country banks which issued notes..
In early 1797, rumors that French soldiers had landed on English soil led to a widespread bank run in Britain. Customers hurried to their banks demanding immediate redemption of their notes in gold bullion. Several country banks failed, and on Saturday, February 25, 1797, the Bank of England reported its gold reserves were reduced to 1.1 million, and that it was likely to face a bank run when it opened on Monday. The Pitt government issued an order in council the next day suspending the convertibility of bank-notes to cash until Parliament could address the issue. After deliberation, Parliament, in early May, 1797, it passed the Bank Restriction Act (37 Geo III, c.45), extending Pitt's restriction until six months after the finalization of a stable peace treaty with France..
The crisis, then, was properly averted, but some commentators believed the government should have restored convertibility immediately after the invasion panic subsided. An intellectual debate proceeded immediately as lawyers, bankers and statesmen lined up for and against the maintenance of convertibility of notes into gold. On the one hand, there were the "Bullionist" group, which argued for convertibility; arrayed on the other side were the "Anti-Bullionist" who preferred the status quo of suspension. The Bullionist argument was straightforward. If banks are not required to convert notes into gold, then they will be tempted to issue notes in excess of the gold in their vaults. This will lead to an excess supply of money and hence, by their view, a cheapening of the price of money, i.e. inflation. They argued that to avoid inflation, required convertibility of notes into gold should be restored. Among the prominent spokesmen for the Bullionists were John Wheatley, David Ricardo, Sir Henry Parnell and Francis Horner.
In contrast, the Anti-Bullionists appealed to some form of the old Real Bills Doctrine of John Law (1705), Sir James Steuart (1767) and Adam Smith (1776). Given the peculiar, long experience of Scottish banking with inconvertibility, this authorship is not surprising. Banknotes, Smith had argued, were issued by banks in exchange for merchants' bills of exchange. As long as the repayment of these bills of exchange is credible (i.e. "Real Bills" as opposed to "Fictitious Bills"), then no more banknotes will be issued than what is required by merchants. In short, the demand for banknotes by commerce is itself limited by the "needs of trade", hence even without convertibility, the bank is not going to issue more notes than what commerce demands. Thus, there will never be excess note issue. If there happens to be excess issue by accident, however, this still would not cause inflation as it would return immediately to the banks upon the liquidation of the bills of exchange. This was called the "reflux principle" and was part of the Real Bills Doctrine. Among the Anti-Bullionists who espoused this doctrine in the early 1800s, we find Henry Boase, Nicholas Vanisttart, Charles Bosanquet, Robert Torrens and James Mill (although Mill subsequently converted to the Bullionist camp after his interaction with Ricardo).
Henry Thornton (1802) occupies a curious intermediary position. Although dismissing the Bullionist case for resumption at this stage, citing lack of evidence that excess issue caused the inflation, he also provided an admirable critique of the Real Bills doctrine. Namely, he asked, who guaranteed that the demands of commerce were limited? Suppose actual capital yields returns higher than the rate of interest (or discount) charged by the banks? Would not merchants' demand an interminable amount of notes - however "real"? Bills offered for exchange into notes, he argued, might not readily be "limited" as the Real Bills advocates argued. Inflation must thus ensue. Thornton's analysis formed the germ for the later "cumulative process" of Knut Wicksell (1898).
The Bullionist debate reached its climax in 1810, with the establishment of the "Bullion Committee" by parliament, chaired by Francis Horner, and including Parnell and Thornton, to inquire into Ricardo's allegations about excess issue. The Bullion Committee's report concluded that excess issue was indeed to blame for a recent bout of inflation, and recommended immediate resumption to convertibility (Thornton agreed with the report, with qualifications). However, the report came out too late in the parliamentary session to be considered, and would have to wait a year. In the interim, a veritable battle took place in the pages of the English press, attacking and defending the report. In the Spring of 1811, when the report was finally brought up for debate and vote on the parliamentary floor, the act of resumption was resoundingly defeated. Attention soon drifted, as the new problem facing Britain after 1812 was deflation rather than inflation, and economic debates focused on the Corn Laws.
The issue of resumption returned for a second round in 1818, with the establishment of new committee headed by the young Sir Robert Peel. It also recommended resumption, and this time it passed parliament in 1819. Convertibility of paper notes to gold was resumed by 1821.
The financial crisis of 1825-26 and the attendant wave of private bank failures had put monetary reform back on the table - this time focused on the banks. This had been agitated for by Thomas Joplin since 1822. Clearly a banking system reliant on a single gigantic Bank of England and a multitude of small, vulnerable, weakly-capitalized, private banks, was dangerous for the health of the financial and payments system so critical to Britain's commerce and prosperity. In an effort to strengthen the banking sector, the Bank Act of 1826 authorized the establishment of note-issuing joint-stock banks outside a radius of 65 miles from London. Under the new law, banking companies could have an unrestricted number of partners (previously it had been limited to six) but would not enjoy limited liability. To compensate for the loss of its privileges (and its profitable rediscount business), the Bank of England was allowed to open branches in the provinces.
But Joplin felt that was not enough, and noted that the current banking law did not forbid joint-stock banks to operate inside of London, provided they only took deposits and did not issue notes. The issue was take up in 1833, when the Bank of England's charter was up for renewal. Much to the Bank's protest, the government inserted an explicit declaratory clause concurring with Joplin, noting it was perfectly legal for deposit-taking joint-stock banks to establish themselves inside of London (3 & 4 William IV, c.98) It also inserted two other important changes - one making Bank of England notes "legal tender" in redemption of country bank notes, another exempting banks from usury laws.
Immediately, a series of joint-stock London banks were created - the London and Westminster (1834), the London Joint Stock (1836), the London and County (1839) and dozens more. But the Bank of England (in collusion with the small private banks) took a stance of unrelenting hostility towards the upstarts, refused to let them open accounts, or use their clearing facilities. The fledgling joint-stock banks responded as best they could, making up for their crippled means by offering high interest rates to their depositors - which could only be paid for, naturally, by a more reckless lending policy. Predictably, all this unleashed waves of speculation and spectacular failures, culminating in the Panic of 1837. In the aftermath, the pressure was on to tighten the system, a crusade launched by Samuel Loyd (Lord Overstone). It became known as the Banking school-Currency school debates
The eventual result was the Banking Acts of 1844, which came into two parts. The first (7 & 8 Vict c.32, also known as "Bank Charter Act" or "Peel's Act") prohibited the creation of any new note-issuing banks and restricted those already in existence from expanding. The Bank of England would henceforth have a de facto note-issuing monopoly. Moreover, the amount of issue would be strictly tied to gold reserves. The second act (7 & 8 Vict .c.113, "Joint Stock Banks Act") threw up so many restrictions and bureaucratic obstacles that made it practically impossible to create any new joint-stock banks. And very few were - only three were created over the next decade. These restrictions would be mildly relaxed in a series of acts 1857-62.
The debates leading up to the 1844 Banking Act pitted the "Currency School" (which supported the Act) against the "Banking School" (which preferred to retain the status quo), and resurrected some of the issues of the earlier Bullionist controversy. The "Currency School", argued that there needed to be a maximum amount of note issue (which the gold standard provided) or else inflation would result. They argued that the problems of the 1830s banking system resulted from the fact that the Bank of England's had conflicting objectives, that its note-issuing was tied to its private banking activities, and urged a strict separation between the two. Note-issuing should be "like currency", and follow a 100% gold reserve requirement, completely independently of the bank's other activities (a proposal already made by Joplin back in 1823). The Currency School after 1837 was led by Lord Overstone and counted among its proponents James R. McCulloch, Mountiford. Longfield and Robert Torrens.
Rallied against the act was the "Banking School", who argued that convertibility was enough, that imposing strict note-issuing restrictions and gold parity was unnecessary. Although not accepting the old Real Bills doctrine in its entirety, they resurrected some of its essentials, and argued there was little danger of excess. The new reflux principle was even simpler: excess note issue might induce inflation, but that would lead to a race to redeem notes in gold, thereby removing the excess money supply. As a more general point, and a little ahead of its time, the Banking School argued that note restrictions were pointless, since deposits and bills of exchange are effectively also money, and that concerns about inflation are better dealt with by focusing on the restriction of bank credit, rather than note-issue. The Banking School was led by Thomas Tooke, John Fullarton and the young John Stuart Mill.
As it happened, several circumstances during this period led to the suspension of the
Banking Act three times (1847, 1857, 1866), lending credibility to the position of the Banking School.
Nonetheless, the Currency School won the day and gold parity to note issue
introduced in 1844 was generally
maintained until the First World War.
Resources on the Bullionist Controversies
(most pamphlets are contained in their respective author profile pages; following just collects those without explicit profiles).
Early Bank of England
Bullionist debates to 1811
Banking-Currency School debates to 1844
History of the Bullionist Controversy
General histories of Banking and the Bank of England
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