"The Bullionist Controversy" 1810,

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.

The Bullionist Debate of the 1810s

In the 18th Century, there was a clearing-house system of banking in the United Kingdom. Banknotes, which circulated as money, were issued by private banks. These bearer notes were claims on gold held by the bank - hence the common preamble which still persists in modern Bank of England notes, "I promise to pay the bearer on demand X pounds." In that time period, that promise was actually true: a person could take a note to the bank which issued it and ask for it to be exchanged for gold. Thus, for a long time, all paper notes were issued by private banks on the basis of the gold they had in their vaults.

In Scotland, however, there was a slight exception: banknotes often had a clause that allowed the bank to suspend convertibility. Although banks were legally required to pay the bearer in gold bullion, they could temporarily suspend that conversion should they find that necessary. The suspension clause in Scottish banks was the way that system responded to clearing house "bullying" trick - whereby several banks would surreptitiously hold back notes issued by bank Z and then, one day, they would all collectively unload the notes upon bank Z and demand redemption. Naturally, as it was a fractional reserve banking system, bank Z would not be able to redeem them all. If convertibility was required by law, then bank Z would have to declare bankruptcy. This sort of ruination by a clearing house cartel against a loner bank was not uncommon in Europe and North America. Thus, Scottish law allowed for a temporary suspension of convertibility. This clause, however, was banned in 1765 and henceforth Scottish banks were required to pay the full amount on demand.

However, in 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. The British government, realizing the dangerous consequences of the run allowed banks to suspend convertibility of the notes issued by the Bank of England.

The crisis, then, was properly averted, but the government did not quickly restore convertibility. Rather, they permitted banks to continue issuing notes without necessarily respecting their convertibility into gold. 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 spokesmen for the Bullionists were Henry Thornton and, a bit later, John Wheatley and David Ricardo (1810, 1811).

In contrast, the Anti-Bullionists appealed to some form of the Real Bills Doctrine of John Law (1705), Sir James Steuart (1767) and Adam Smith (1776). Given the afore-mentioned 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 Richard Torrens, Bosanquet and James Mill.

The Bullionist Henry Thornton (1802) 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).

Who was proved right? In fact, as Jacob Viner (1937) documents, there was indeed a period of inflation in the early 1800s, peaking in 1814. Bullionists argued that this supported their position. Anti-Bullionists explained it away by the rationing effects of government purchases during the Napoleonic Wars. A report by a parliamentary committee in 1810 supported a moderate view of the Bullionist position and argued for a phased and partial resumption of convertibility. David Ricardo (1810, 1811), however, was more more forceful - arguing for immediate and full-par resumption of convertibility.

However, the end of the Napoleonic Wars seemed to swerve the argument towards the Anti-Bullionists. From about 1815 until 1830, there was a prolonged period of deflation as opposed to inflation. Certainly, this went against the Bullionist argument? The verdict is confused however. The Resumption Act was passed in 1819 and convertibility came into effect in 1821. Hence, although there had already been about six years of deflation with suspension, the extra nine years of deflation might have resulted from the contractionary effects of the resumption of convertibility.

The Banking-Currency School Debates of the 1840s

The Bullionist debate (with slight differences) re-emerged in the 1840s and 1850s after the Banking Act of 1844 giving the Bank of England a monopoly on note issue. While not requiring convertibility, the Bank of England was required to maintain a specific par between note issue and gold reserves held at the Bank. Should that gold parity be respected or not?

Supporting the Banking Act was the so-called "Currency School". They argued that there needed to be a maximum amount of note issue (which the gold standard provided) or else inflation would result. They thus resurrected the Bullionist arguments of a few decades earlier. The Currency School was led by Lord Overstone and counted among its proponents James R. McCulloch, Thomas Joplin, Samuel M. Longfield and, now converted, Richard Torrens.

Rallied against the act was the "Banking School", who argued against gold parity -- although not accepting the old Real Bills doctrine in its entirety and arguing for some degree of convertibility. 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. 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, lending credibility to the position of the Banking School. Nonetheless, the Currency School won the day and gold parity to note issue was generally maintained until the First World War.

Bullionists/Currency School

Henry Thornton,1760-1815.
David Ricardo,1772-1823.
John Wheatley, 1772-1830.
Remarks on Currency and Commerce, 1803.
Essay on the Theory of Money and Principles of Commerce, 1805.
One of the major Bullionists. Developer of idea of an "optimum" quantity of money.
Lord Samuel Jones Loyd Overstone, 1796-1883.
Tracts and Other Publications on Metallic and Paper Currency, 1858.
Main leader of the Currency School in Parliament and the whose ideas were drafted into the 1844 Banking Act.
Thomas Joplin, 1790-1847. - (1)
Essay on Money and Bullion, 1818
Outlines of a System of Political Economy, 1823.
Developed the "currency principle" - effectively, 100% gold reserve currency - behind the Currency School's position. His notice that the Bank of England's royal charter prevented only the formation of other note-taking but not deposit-taking banks led to explosion in the 1830s of joint stock banks in London. Joplin was the founder of the National Provincial Bank.
James R. McCulloch, 1789-1864.
Samuel Montiford Longfield, 1802-1884.
Amasa Walker, 1799-1895.
Anti-Bullionists/Banking School

Colonel Robert Torrens, 1780-1864.
James Mill, 1773-1836.
Thomas Tooke, 1774-1858. - (1), (2), image
Thoughts and Details on the High and Low Prices, 1823.
Considerations of the State of the Currency, 1826.
On the Currency in Connection with the Corn Trade, 1829.
History of Prices and the State of the Circulation, with W. Newmarch, 1838-57.
An Inquiry into the Currency Principle, 1844.
On the Bank Charter Act of 1844, 1856.
One of the main figures of the Banking School, he rejected the Quantity Theory without actually developed a clear monetary theory of his own. Also compiled many economic statistics.
John Fullarton, 1780-1849.
On the Regulation of Currencies
Banking School advocate.
John Stuart Mill, 1806-1873.
On the Bullionist Controversies

Thomas Moore's Poems on Bullionism
Jacob Hollander's "The Development of the Theory of Money from Adam Smith to David Ricardo", 1910-1, QJE
Neil Skagg's "Changing Views: Twentieth-Century Opinion on the Banking School-Currency School Controversy", forthcoming, HOPE, 1999.
Allan Sproul's review of the Real Bills Doctrine
"Resumption of Specie Payments", 1838, US Democratic Review
"The Myth of Free Banking in Scotland" by Murray Rothbard, Rev of Austrian Econ
"White's Free-Banking Thesis: A Case of Mistaken Identity" by Larry Sechrest, Rev of Austrian Econ
"The Option Clause in Free-Banking Theory and History: A Reappraisal" by Parth Shah, 1997, Rev of Austrian Econ
"The Poet as Economist: Shelley's Critique of Paper Money and the British National Debt", by Paul Cantor, 1997, JLS
The Bullion Committee at the Peel Web