 [In a former work, Ricardo's theory on the value of money as related to commodity-prices has been analysed; we can, therefore, confine ourselves here to the indispensable. According to Ricardo, the value of metallic money is determined by the labour-time incorporated in it, but only as long as the quantity of money stands in correct relationship to the amount and price of commodities to be exchanged. If the quantity of money rises above this ratio, its value falls and commodity-prices rise; if it fails below the correct ratio, its value rises and commodity-prices fall assuming all other conditions equal. In the first case, the country in which this excess gold exists will export the gold whose value has depreciated and import commodities; in the second case, gold will flow to those countries in which it is assessed above its value, while the under-assessed commodities flow from these countries to other markets, where they command normal prices. Since under these circumstances "gold itself may become, either as coin or bullion, a token of metallic value of greater or smaller magnitude than its own value, it is self-evident that convertible bank-notes in circulation must share the same fate. Although bank-notes are convertible, and therefore their real value corresponds to their nominal value, the aggregate currency consisting of metal and of convertible notes may appreciate or depreciate in accordance with its aggregate quantity, for reasons already stated, rising above or falling below the level determined by the exchange-value of circulating commodities and the metallic value of gold.... This depreciation, not of paper as compared with gold, but of gold and paper taken together, or of the aggregate currency of a country, is one of Ricardo's principal discoveries which Lord Overstone and Co. pressed into their service and made a fundamental principle of Sir Robert Peel's bank legislation of 1844 and 1845." (Zur Kritik der Politischen konomie, p.155.) We need not here repeat a demonstration of the incorrectness of this Ricardian theory which is given in the cited work. We are merely interested in the way Ricardo's theses were elaborated by that school of bank theorists who dictated Peel's above-mentioned Bank Acts. "The commercial crises of the 19th century, especially the great crises of 1825 and 1836, did not result in any new developments in the Ricardian theory of money, but they did furnish new applications for it. These were no longer isolated economic phenomena, such as the depreciation of precious metals in the 16th and 17th centuries according to Hume, or the depreciation of paper money in the 18th and early 19th centuries according to Ricardo; these were instead the violent storms in the world-market wherein the conflict of all elements of the capitalist production process discharges itself, and whose origin and cure were sought in the most superficial and abstract sphere of this process, the sphere of money circulation. The actual theoretical assumption from which the school of economic weather prophets proceeds, is actually reduced to the dogma that Ricardo discovered the laws governing the purely metallic currency. The only thing remaining for them to do was to subordinate credit and bank-note circulation to these laws. "The most general and palpable phenomenon in commercial crises is the sudden general decline in prices following a prolonged overall rise. The general decline in commodity-prices may be expressed as a rise in the relative value of money with respect to all commodities, and the general price rise as a decline in the relative value of money. In either expression the phenomenon is described but not explained.... The different wording leaves the problem as little changed as would its translation from German into English. Ricardo's theory of money was therefore exceedingly opportune, because it lends to a tautology the semblance of a statement of causal relationship. Whence comes the periodic general fall in commodity-prices? From the periodic rise of the relative value of money. Whence the general periodic rise in prices? From the periodic decline in the relative value of money. It might have been stated with equal truth that the periodic rise and fall of prices is due to their periodic rise and fall. ...Once the tautology is admitted as a causal relationship, the rest follows easily. A rise in commodity-prices is caused by a decline in the value of money and a decline in the value of money is caused, as we know from Ricardo, by an over-supply of currency, i.e., a rise in the volume of currency over the level determined by its own intrinsic value and the intrinsic value of commodities. Similarly, a general decline in commodity-prices is explained by a rise in the value of money above its intrinsic value in consequence of under-supply of currency. Thus, prices rise and fall periodically, because there is periodically too much or too little money in circulation. Should a price rise happen to coincide with contracted money circulation, and a fall in prices with expanded circulation, it may be asserted despite this that the quantity of money in circulation has, though not absolutely, yet relatively increased or declined in consequence of a contraction or expansion of the volume of commodities in the market, even if this cannot be statistically proved. We have seen that according to Ricardo these general price fluctuations must take place even with a purely metallic currency, but that they alternatively balance one another; thus, e.g., an under-supply of currency causes a fall in prices, the export of commodities abroad, but this export causes an import of gold from abroad, which in turn brings about a price rise; the opposite movement taking place in the case of an over-supply of currency, when commodities are imported and gold is exported. But, since despite these general price fluctuations which are in perfect accord with Ricardo's metallic currency, their turbulent and violent form, their crisis form, belongs to the period of developed credit system, it is crystal clear that the issue of bank-notes is not exactly regulated by the laws of metallic currency. Metallic currency has its remedy in the import and export of precious metal, which immediately enters circulation as coin and thus, by its inflow or outflow, causes commodity-prices to fall or rise. The same effect on prices must now be exerted artificially by banks through imitating the laws of metallic currency. If gold is coming in from abroad it proves that currency is in under-supply, that the value of money is too high and commodity-prices too low, and, consequently, that bank-notes must be put into circulation in proportion to the newly imported gold. On the other hand, notes must be withdrawn from circulation in proportion to the gold exported from the country. The issue of bank-notes, in other words, must be regulated by the import and export of precious metal or by the rate of exchange. Ricardo's false assumption that gold is only coin, and, therefore, all imported gold swells the currency, causing prices to rise, while all exported gold reduces the currency, leading to a fall in prices this theoretical assumption is here turned into the practical experiment of putting an amount of coin in circulation equal in every case to the amount of gold available. Lord Overstone (banker of Jones Loyd), Colonel Torrens, Norman, Clay, Arbuthnot and a host of other writers, known in England as advocates of the 'Currency Principle', have not only preached this doctrine, but succeeded in 1844 and 1845 with the aid of Sir Robert Peel's Bank Acts in making it the basis of English and Scottish bank legislation. Its ignominious failure, both theoretical as well as practical, following upon experiments on the broadest national scale, can be treated only in connection with the theory of credit." (Loc. cit., pp. 165-68.) The critique of this school was furnished by Thomas Tooke, James Wilson (in the Economist of 1844 to 1847) and John Fullarton. But we have seen on several occasions, particularly in Chapter XXVIII of this book, how incompletely they, too, saw through the nature of gold, and how unclear they were about the relationship of money and capital. We quote here merely a few instances in connection with the transactions of the Committee of the Lower House of 1857 concerning Peel's Bank Acts (B. C. 1857). F.E.] J. G. Hubbard, former Governor of the Bank of England, testifies: He presents two tables covering the years 1834 to 1843, and 1845 to 1853, which show that the price variations of fifteen major commercial articles were quite independent of the export and import of gold and the interest rate. On the other hand, they show a close connection between the export and import of gold, which is, indeed, the "representative of our uninvested capital," and the interest rate. The fifteen major articles on which the following tables of Hubbard are based include cotton, cotton yarn, cotton fabrics, wool, woollen cloth, flax, linen, indigo, pig-iron, tin, copper, tallow, sugar, coffee, and silk. I. 1834-1843 Price changes on 15 major items II. 1844-1853 Price changes on 15 major items Hubbard comments in this regard: Since the demand and supply of commodities regulate their market-prices, it becomes evident here how wrong Overstone is in identifying the demand for loanable money-capital (or rather the deviations of supply therefrom), as expressed by the discount rate, with the demand for actual "capital." The contention that commodity-prices are regulated by fluctuations in the quantity of currency is now concealed by the phrase that discount rate fluctuations express fluctuations in the demand for actual material capital, as distinct from money-capital. We have seen that before the same Committee both Norman and Overstone actually contended this, and that the latter especially was compelled to resort to very lame subterfuges, until he was finally cornered (Chap. XXVI). It is indeed an old humbug that changes in the existing quantity of gold in a particular country must raise or lower commodity-prices within this country by increasing or decreasing the quantity of the medium of circulation. If gold is exported, then, according to this Currency Theory, commodity-prices must rise in the country importing this gold, and thereby the value of exports from the gold-exporting country on the gold-importing country's market; on the other hand, the value of the gold-importing country's exports would fall on the gold-exporting country's market while it would rise on the domestic market, i.e., the country receiving the gold. But, in fact, a decrease in the quantity of gold raises only the interest rate, whereas an increase in the quantity of gold lowers the interest rate; and if not for the fact that the fluctuations in the interest rate enter into the determination of cost-prices, or in the determination of demand and supply, commodity prices would be wholly unaffected by them. In the same report, N. Alexander, head of a large firm doing business with India, expresses the following views on the heavy drain of silver to India and China in the mid-fifties. This was partly due to the Chinese Civil War, which checked the sale of English fabrics in China, and partly due to the disease among silkworms in Europe, which sharply reduced silkworm breeding in Italy and France: In other words, silver, the money metal of that continent, was sent to Asia instead of commodities, not because commodity-prices had risen in the country which produced them (England), but because prices had fallen, as a result of over-imports in the country which imported them; and this despite the fact that the silver was received by England from France and had to be paid for partly in gold. According to the Currency Theory, prices should have fallen in England and risen in India and China as a result of such imports. Another illustration. Before the Lords' Committee (C. D. 1848/57), Wylie, one of the first Liverpool merchants, testifies as follows: This shows the self-interest of Overstone's sagacity according to which money should be "dear" because capital is "scarce." On March 3, 1844, the bank interest rate stood at 3%; in October and November of 1847 it rose to 8 and 9%, and was still 4% on March 3, 1848. The prices of cotton were depressed far below the price which corresponded to the state of supply by the complete stoppage of sales and the panic with its ensuing high rate of interest. As a result, there was an enormous decrease in imports in 1848, on the one hand, and, on the other, a decrease in production in America; hence a new rise in cotton prices in 1849. According to Overstone, the commodities were too dear because there was too much money in the country. How nicely Overstone confuses prices, or the value of commodities, with the value of money, that is, the interest rate. In his reply to Question 2026, Wylie sums up his general judgement of the Currency Theory, based on which Cardwell and Sir Charles Wood, in May 1847, He says, furthermore, concerning the effects of this Bank Act on business in general: We see, then, that the suspension of this Bank Act was received with relief in the provinces as well. [The crisis of 1837 with its protracted aftermath, followed in 1842 by a regular post-crisis, and the self-interested blindness of industrialists and merchants, who absolutely refused to see any over-production for such a thing was absurd and impossible according to vulgar economy had ultimately achieved that confusion of thought which enabled the Currency School to put its dogma into practice on a national scale. The bank legislation of 1844 and 1845 was passed. The Bank Act of 1844 divides the Bank of England into an issue department and a banking department. The former receives securities principally government obligations amounting to 14 million, and the entire metal hoard, of which not more than one-quarter is to consist of silver, and issues notes to the full amount of the total. In so far as these notes are not in the hands of the public, they are held in the banking department and, together with the small amount of coin required for daily use (about one million), constitute its ever ready reserve. The issue department gives the public gold for notes and notes for gold; the remaining transactions with the public are carried on by the banking department. Private banks in England and Wales authorised in 1844 to issue their own notes retained this privilege, but their note issue was fixed; if one of these banks ceases to issue its own notes, the Bank of England can increase its unbacked notes by two-thirds of the quota thus made available; in this way its issue was increased by 1892 from 14 to 16 million (to be exact, 16,450,000). Thus, for every five pounds in gold which leave the bank treasury, a five-pound note returns to the issue department and is destroyed; for every five sovereigns going into the treasury a new five-pound note comes into circulation. In this manner, Overstone's ideal paper circulation, which strictly follows the laws of metallic circulation, is carried out in practice, and by this means, according to the advocates of the Currency Theory, crises are made impossible for all time. But in reality the separation of the Bank into two independent departments deprived its management of the possibility of freely utilising its entire available means at critical times, so that situations could arise in which the banking department might be on the verge of bankruptcy while the issue department still had intact several millions in gold and, in addition, its entire 14 million in securities. And this could take place so much more easily since there is a period in almost every crisis when heavy exports of gold take place which must be covered in the main by the metal reserve of the bank. But for every five pounds in gold which then go abroad, the domestic circulation is deprived of a five-pound note, so that the quantity of circulating medium is reduced precisely at a time when the largest quantity is most needed. The Bank Act of 1844 thus directly induces the entire commercial world forthwith to hoard a reserve fund of bank-notes at the outbreak of a crisis; in other words, to accelerate and intensify the crisis. By such artificial intensification of demand for money accommodation, that is, for means of payment at the decisive moment, and the simultaneous restriction of the supply the Bank Act drives the rate of interest to a hitherto unknown height during a crisis. Hence, instead of eliminating crises, the Act, on the contrary, intensifies them to a point where either the entire industrial world must go to pieces, or else the Bank Act. Both on October 25, 1847, and on November 12, 1857, the crisis reached such a point; the government then lifted the restriction for the Bank in issuing notes by suspending the Act of 1844, and this sufficed in both cases to overcome the crisis. In 1847, the assurance that bank-notes would again be issued for first-class securities sufficed to bring to light the 4 to 5 million of hoarded notes and put them back into circulation; in 1857, the issue of notes exceeding the legal amount reached almost one million, but this lasted only for a very short time. It should also be mentioned that the 1844 legislation still shows traces recalling the first twenty years of the 19th century, the period when specie payments were suspended and notes devaluated. The fear that notes may lose their credit is still plainly in evidence. But this fear is quite groundless, since even in 1825 the issue of a discovered old supply of one-pound notes, which had been taken out of circulation, broke the crisis and proved thereby that the credit of the notes remained unshaken even in times of the most general and deepest mistrust. And this is quite understandable; for, after all, the entire nation backs up these symbols of value with its credit. F.E.] Let us now turn to a few comments on the effect of the Bank Act. John Stuart Mill believes that the Bank Act of 1844 [In the German 1894 edition this reads: 1847. Ed] kept down over-speculation. Happily this sage spoke on June 12, 1857. Four months later the crisis broke out. He literally congratulated the "bank directors and the commercial public generally" on the fact that they The sagacious Mr. Mill thinks that if one-pound notes are issued Does Mr. Mill assume, then, that manufacturers will pay higher wages because they pay them in paper instead of gold? Or does he believe that if a manufacturer receives his loan in 100 notes and exchanges them for gold, these wages would constitute less demand than if paid immediately in one-pound notes? And does he not know that, for instance, in certain mining districts wages were paid in the notes of local banks, so that several labourers together received one five-pound note? Does this increase their demand? Or will bankers advance money to manufacturers more easily and in larger quantities in small notes than in large ones? [This singular fear which Mill has for one-pound notes would be inexplicable if his whole work on political economy did not reveal an eclecticism which shows no hesitation in the face of any contradiction. On the one hand, he agrees on many points with Tooke as opposed to Overstone; on the other, he believes that commodity-prices are determined by the quantity of available money. He is thus by no means convinced that, all other conditions being equal, a sovereign will find its way into the coffers of the Bank for every one-pound note issued. He fears that the quantity of circulating medium could be increased and thereby devaluated, that is, commodity-prices might rise. This and nothing more is concealed behind the above-mentioned apprehension. F.E.) Tooke expresses the following views before the C. D. 1848/57 concerning the division of the Bank into two departments and the excessive precautions taken to safeguard the cashing of notes: Before the Committee on B. A. 1857, Newmarch testifies: Of special interest is the testimony of Palmer, a Director of the Bank of England since 1811 and for a while its Governor, before the Lords' Committee on C. D. 1848/57: The purpose was to make money dear; aside from the Currency Theory, the separation of the two bank departments and the requirement for Scottish and Irish banks to hold gold in reserve for backing notes issued beyond a certain amount had the same purpose. This brought about a decentralisation of the national metal reserve, which decreased its capability of correcting unfavourable exchange rates. All the following stipulations aim to raise the interest rate: that the Bank of England shall not issue notes exceeding 14 million except against gold reserve; that the banking department shall be administered as an ordinary bank, forcing the interest rate down when money is plentiful and driving it, up when money is scarce; limiting the silver reserve, the principal means of rectifying the rates of exchange with the continent and Asia; the regulations concerning the Scottish and Irish banks, which never require gold for export but must now keep it under the pretence of ensuring an actually illusory convertibility of their notes. The fact is that the Act of 1844 caused a run on the Scottish banks for gold in 1857 for the first time. Nor does the new bank legislation make any distinction between a drain of gold abroad or for domestic purposes, although it goes without saying that their effects are quite different. Hence the continual large fluctuations in the market rate of interest. With reference to silver, Palmer says on two separate occasions, 992 and 994, that the Bank can buy silver for notes only when the rate of exchange is favourable for England, i.e., silver is superfluous; for: In his opinion, the Bank did not have to raise the interest rate above its old level of 5% in times of stringency, so long as unfavourable exchange rates do not drain gold to foreign countries. Were it not for the Act of 1844, the Bank would be able to discount all first-class bills presented to it without difficulty. [1018-20.] But under the Act of 1844 and in the state in which the Bank found itself in October 1847, And this high interest rate was precisely the purpose of the Act. So speaks a man who has occupied a post for 39 years in the administration of the Bank of England. Let us now listen to a private banker, Twells, an associate of Spooner, Attwood & Co. since 1801. He is alone among the witnesses before the B. C. 4857 who provides us with an insight into the country's actual state of affairs and who sees the crisis approaching. In other respects, however, he is a sort of little-shilling man from Birmingham, like his associates, the Attwood brothers, who are the founders of this school. (See Zur Kritik der pol. Oek., S. 59.) He testifies: 4494. He declares that business is not profitable now. The following remarks of his are important because they show that he saw the latent existence of the crisis when none of the others had even an inkling of it. 4495. He relates the following case: A Frenchman sends a broker in Mincing Lane commodities for 3,000 to be sold at a certain price. The broker cannot obtain the requested price, and the Frenchman cannot sell below this price. The commodities remain unsold, but the Frenchman needs money. The broker therefore makes him an advance of 1,000 and has the French man draw a bill of exchange of 1,000 for three months on the broker against his commodities as security. At the end of the three months the bill becomes due, but the commodities still remain unsold. The broker must then pay the bill, and although he possesses security for 3,000, he cannot convert it into cash and as a result faces difficulties. In this manner, one person drags another down with him. This man, then, is by no means of Overstone's opinion that a high rate of interest is the same as dear capital. The following shows how business is now conducted: We have seen that the credit of Bank of England notes is considered beyond question by all experts. Nevertheless, the Bank Act completely ties up nine to ten million in gold for the convertibility of these notes. The sacredness and inviolability of this reserve is thereby carried much farther than among hoarders of olden times. Mr. Brown (Liverpool) testifies, C. D. 1847/57: The building contractor E. Capps, already cited earlier, whose testimony is also used to illustrate the modern building system in London (Vol. II, Ch. XII), sums up his opinion of the Bank Act of 1844 as follows [B. A. 1857]: As mentioned before, the Scottish banks were forced by the Bank Act of 1845 into a system resembling that of the English. They were obliged to hold gold in reserve for their note issue beyond the limit fixed for each bank. The effect of this may be seen from the following testimony before the C. D. 1848/57. Kennedy, Director of a Scottish bank: The sum of about 900,000 in gold, which the Scottish banks are compelled to keep since 1845, can only be injurious in his opinion and Furthermore, Anderson, Director of the Union Bank of Scotland: Finally, we quote an article from the Economist (Wilson): This system was disturbed by the Act of 1845: [And what does the father of the Bank Act, banker Samuel Jones Loyd, alias Lord Overstone, say to all this? Already in 1848 he repeated before the Lords' Committee on Commercial Distress that in spite of the fact that the mere authority to increase the note issue, given by the Government's Letter of October 25, 1847, had sufficed to take the edge off the crisis. He holds to the view that And yet the depressed condition of the manufacturing industry had for months consisted in material commodity-capital filling the warehouses to overflowing and being actually unsaleable; so that for precisely this reason, material productive capital lay wholly or partly idle, in order not to produce still more unsaleable commodity-capital. And before the Bank Committee of 1857 he says: To this song of praise by Overstone before the Committee on July 14, the antistrophe was given on November 12 of the same year in the shape of a letter to the Bank's management, in which the government suspended the miracle-working law of 1844 to save what could still be saved. F. E.] 
Economic Manuscripts: Capital, Vol.3, Chapter 34