Natural price of one ounce of gold bullion, in pesos;5 The adjustment to a change in the value of the standard
No country that used the precious metals as a standard, were exempted from variations in the prices of commodities, occasioned by a variation in the value of their standard.
(Speech in the House of Commons, 12 June 1822; V: 204)
In Chapter 4 above I already discussed the “analogy” made by Ricardo in the Bullion Essays between an increase in the quantity of money caused by the discovery of a new gold mine and one caused by an additional discretionary issue of inconvertible notes. I contended that the adoption in Principles of a theory of the value of commodities based on their cost of production with the portion of capital that pays no rent allowed Ricardo to understand that, in a monetary system regulated by a standard, it is not by its quantity that the standard affected permanently the value of money (as he believed in the Bullion Essays) but by its cost of production. However, Ricardo maintained that, as in the case of an excess issue of bank notes, the discovery of a new mine caused a fall in the value of money through an increased quantity of money:
If by the discovery of a new mine, by the abuses of banking, or by any other cause, the quantity of money be greatly increased, its ultimate effect is to raise the prices of commodities in proportion to the increased quantity of money.
(Principles; I: 298)
In the case of notes, an excess issue of them (consequent upon “abuses of banking”) caused a general rise in money prices because it induced a depreciation of money, that is, a market price of gold bullion paid for in notes above the legal price of gold in coin. The question should thus be raised: Did the discovery of a new gold mine also cause an excess quantity of money and thereby its depreciation? I will contend that while in 1810 Ricardo remained rather ambiguous about an interpretation of the effect of a newly discovered gold mine in terms of depreciation of money, his later insistence on the distinction between a depreciation of money caused by its excess quantity and a fall in the value of money caused by a fall in the value of gold bullion implied that the effect of the discovery of a new gold mine belonged to the latter case, not to the former. Paradoxically, this became clear when, during the debates in 1819‒1823 around the resumption of convertibility, Ricardo discussed another aspect of the behaviour of the Bank of England than its note issuing: the faulty management of its gold reserve that caused an increase in the value of bullion and thereby in the value of money. This effect was symmetrical, not about the depreciation of the currency caused by an excess issue of notes, but about the fall in the value of money caused by a fall in the value of bullion after the discovery of a new gold mine.
In the Bullion Essays Ricardo contended that the discovery of a new mine more productive than at least some of those previously worked led to a permanent fall in the value of gold-money:
If a mine of gold were discovered in either of these countries, the currency of that country would be lowered in value in consequence of the increased quantity of the precious metals brought into circulation.
(High Price; III: 54)
Here, the effect of the discovery of a new gold mine on the value of money was ascribed to an increase in the quantity of gold produced, which generated an increase in the quantity of coins (“in consequence of the increased quantity of the precious metals brought into circulation”). There was one step then to consider this quantity of money as being in excess, and one step more to conclude that money was not only “lowered in value” but in fact depreciated. Did Ricardo make these steps? As shown below, there is some ambiguity in his writings of that period. However, after he adopted a few years later a theory of value based on the concept of difficulty of production, this ambiguity disappeared: the discovery of a new mine did lower the value of money and hence raised the money prices of commodities, but the channel of transmission was not an excess quantity and a depreciation of money. A reduction in the cost of production of gold – consequent upon the discovery of a new highly productive mine or the introduction of a new cost-reducing technique – was henceforth translated into a fall in the value of money through a fall in the value of bullion in terms of all other commodities, and not through a depreciation of money caused by an excess quantity (Section 5.1). This explanation of the effect of a newly discovered gold mine on the value of money was permitted by the extension of Ricardo’s theory of rent from land to mines (Section 5.2). There was, however, a specificity of gold bullion in respect to corn, which affected the adjustment process of the natural price to the discovery of a new gold mine (Section 5.3). This adjustment may be analysed in two steps: in the gold-producing country (Section 5.4) and in the gold-importing country where bullion was coined (Section 5.5). A symmetrical case was the adjustment to an increased demand for gold bullion, as that implemented by the Bank of England in the perspective of the resumption of the convertibility of its note into coin (Section 5.6). Both cases illustrate the relevance of the Money–Standard Equation (Section 5.7).
5.1 From an ambiguity in the Bullion Essays to a clarification in Principles
Criticising Bentham on the cause of the general rise in prices
At the time of the Bullion Essays, Ricardo sometimes interpreted the discovery of a new gold mine as causing a depreciation of money. This was implied in Reply to Bosanquet by the “analogy” between the discovery of a new gold mine and the additional discretionary issuing of inconvertible notes, and illustrated by his manuscript comments on the minutes of evidence before the Bullion Committee in 1810. On someone being asked about “an excessive currency, though not forced”, and answering “I do not conceive the thing possible”, Ricardo commented:
This seems to be the source of all the errors of these practical men. A paper currency cannot be excessive, according to them, if no one is obliged to take it against his will. They must be of opinion that a given quantity of currency can be employed by a given quantity of commerce and payments, and no more, – not reflecting that by depreciating its value the same commerce will employ an additional quantity. Did not the discovery of the American mines depreciate the value of money, and has not the consequences been an increased use of it. By constantly depreciating its value there is no quantity of money which the same state of commerce may not absorb.
(III: 362)
And contradicting a Director of the Bank of England:
The bank during the suspension of Cash payments, with its present excessive issues produces the same effect as the discovery of a new mine of gold which should materially depreciate the value of money.
(ibid: 376‒7)
Speaking of the relative redundancy of money in two countries, Ricardo wrote in a letter to Malthus of 18 June 1811:
This relative redundancy may be produced as well by a diminution of goods as by an actual increase of money, (or which is the same thing by an increased economy in the use of it) in one country; or by an increased quantity of goods, or by a diminished amount of money in another. In either of these cases a redundancy of money is produced as effectually as if the mines had become more productive.
(VI: 26)
Elsewhere at the same time, however, Ricardo seemed to discard such interpretation in terms of depreciation, as in his manuscript “Notes on Bentham’s ‘Sur les prix’”, written at the very end of 1810 (for the history of these notes on Bentham’s manuscript “Sur les prix” and a comparison between the two writings see Deleplace and Sigot 2012). Although Ricardo acknowledged that an increase in the quantity of coins and an increase in the quantity of notes would both cause a general rise in prices, he noticed a difference between the two cases:
The argument in this chapter [by Bentham] is that an increase of paper money has the same effects in increasing prices as an increase in metallic money. This is no doubt true, but we should recollect that paper money cannot be increased without causing a depreciation of such money as compared with the precious metals.
(III: 269)
The depreciation of the notes being “as compared with the precious metals”, it was reflected in a rise of the market price of bullion paid for in notes. An increase in the quantity of notes thus caused a rise in all prices of commodities paid for in notes, including that of gold bullion. In contrast, an increase in the quantity of coins, although it also raised the prices of all other commodities paid for in coins, did not raise the price of gold bullion (provided the coins were full-bodied) since an ounce of gold bullion always exchanged for an ounce of gold in coin (see Chapter 6 below). This excerpt shows that, at the time of the Bullion Essays, Ricardo already made a distinction between a general rise in prices (including that of bullion), caused by a depreciation of money, and a general rise in prices (excluding that of bullion), caused by a fall in the value of gold. This distinction was, however, obscured by the fact that, at that time, Ricardo understood this fall in the value of gold as being caused by an increase in its quantity produced, so that, as in the case of notes, the rise in price of all other commodities was explained by an increase in quantity – of gold as of notes. This explanation allowed Ricardo to express his agreement with Bentham on the general rise in price of commodities having been caused by an increase in the quantity of money, and his disagreement with him on the kind of money that was responsible for that rise. On Bentham saying: “The value of money is at present [in 1801] only half of what it was forty years ago: in forty years it will only be half of what it is at present”1 Ricardo commented with a phrase preceding the previous excerpt:
As I attribute the fall in the value of money during the last 40 years to the increase of the metals from which money is made, I cannot anticipate a similar fall in the next 40 years unless we should discover new and abundant mines of the precious metals.
(ibid)
By “increase of the metals” Ricardo meant an increase in the quantity produced of them. He had in view the long-term phenomenon (“40 years”) of “the fall in the value of money”, which he explained by the discovery of “new and abundant mines” that had increased the quantity produced of precious metals, hence reduced their value in terms of all other commodities. It was this fall in the value of gold which had provoked a fall in the value of money made of gold, and consequently a general rise in prices. On the contrary, Bentham attributed this rise to an overissue of notes. For Ricardo, such overissue did explain the depreciation of money – also responsible for a general rise in prices – although not at the period considered by Bentham (the 40 years before 1801) but more recently, after the suspension of convertibility in 1797 had produced its effects.
This critique addressed by Ricardo to Bentham anticipated the distinction made by him later (see Chapter 4 above) between a general increase in prices due to a fall in the value of gold in terms of all other commodities, and one due to a depreciation of money, measured by a rise in the price of gold in terms of money (that is, a fall in the value of money in terms of gold). The discovery of gold mines provoked a general rise in prices through the first channel and exclusively through it. The overissue of paper provoked a general rise in prices through the second channel and exclusively through it. However, when, in the above quotation from Principles, Ricardo mentioned “the discovery of a new mine” and “the abuses of banking”, he stressed that in both cases the prices of commodities were raised while the quantity of money increased, but he abstracted from the difference between coins and notes as to the transmission channel associated with an increase in the quantity of money. This point should, however, be clarified.
When in Reply to Bosanquet Ricardo made his “analogy” between an increased quantity of money caused by the discovery of a new gold mine “on the own premises” of the Bank of England and one caused by an additional discretionary issue of inconvertible notes, he supposed that gold was immediately coined by the Bank of England itself:
Now supposing the gold mine to be actually the property of the Bank, even to be situated on their own premises, and that they procured the gold which it produced to be coined into guineas, and in lieu of issuing their notes when they discounted bills or lent money to Government that they issued nothing but guineas; could there be any other limit to their issues but the want of the further productiveness in their mine? In what would the circumstances differ if the mine were the property of the king, of a company of merchants, or of a single individual? In that case Mr. Bosanquet admits that the value of money would fall, and I suppose he would also admit that it would fall in exact proportion to its increase.
(Reply to Bosanquet; III: 216‒17)
If the Bank of England itself issued coins, there would indeed be no difference with its issuing of notes: the exogenous increase in the quantity of gold bullion would immediately mean an increase in the quantity of money, as when the Bank of England discretionarily issued an additional quantity of notes. But would it be so “if the mine were the property of the king, of a company of merchants, or of a single individual”? It would for the king, who enjoyed the privilege of issuing coins. But it would not in the case “of a company of merchants, or of a single individual”, who needed to carry the gold bullion to the mint to have it coined. And so was it actually for that particular “company of merchants” called the Bank of England. However, all these private owners of the gold bullion produced by a new mine had also the possibility of selling it in the market against existing coins or notes, rather than carry it to the mint to get new coins. As already noted in Chapter 3 above, Ricardo was well aware that gold bullion could only be converted into money if its market price was below the legal price of gold in coin, which was the same as saying that the value of money was above the value of bullion. As he would write five years later in Proposals:
It is the rise in the value of money above the value of bullion which is always, in a sound state of the currency, the cause of its increase in quantity; for it is at these times that either an opening is made for the issue of more paper money, which is always attended with profit to the issuers; or that a profit is made by carrying bullion to the mint to be coined. To say that money is more valuable than bullion or the standard, is to say that bullion is selling in the market under the mint price.
(Proposals; IV: 56‒7)
Two inferences might be drawn from this necessary condition for an increased quantity of money to follow on an increased quantity of bullion. First, any interpretation of such situation in terms of depreciation caused by money being in excess should be discarded, in contrast with what happened in the case of an additional discretionary issuing of notes. The increase in the quantity of money after the discovery of a new gold mine was the consequence of a fall in the market price of bullion below the legal price of gold in coin; the increase in the quantity of money discretionarily decided by an issuing bank was the cause of a rise in the market price of bullion above the legal price of gold in coin. We will see that, “in a sound state of the currency”, the final outcome of the adjustment was in both cases the return of the market price of gold bullion to the level of the legal price of gold in coin, but in the case of the mine it was from below (through coining) while in the case of the bank it was from above (through melting).
The second inference is that, to explain how the quantity of money increased after the discovery of a new gold mine, one should understand what happened to the market price of gold bullion. Why did Ricardo in his “analogy” make the simplifying assumption that the Bank of England itself issued coins, thus bypassing the adjustment in the bullion market? One may suggest two reasons, one on the side of money the other on the side of gold bullion as commodity.
On the side of money, the “analogy” was at the time of the Bullion Essays explicitly made by Ricardo with the discretionary issuing of inconvertible bank notes. Ricardo considered that, in a situation where Bank of England notes had been made inconvertible and gold and silver coins had disappeared from circulation, money was no longer regulated by the standard:
That gold is no longer in practice the standard by which our currency is regulated is a truth. It is the ground of the complaint of the [Bullion] Committee (and of all who have written on the same side) against the present system.
(Reply to Bosanquet; III: 255)
In his writings of 1819‒1823 Ricardo would again emphasise this absence of regulation of the note issue by the standard during the period of inconvertibility:
It is also forgotten, that from 1797 to 1819 we had no standard whatever, by which to regulate the quantity or value of our money. Its quantity and its value depended entirely on the Bank of England, the directors of which establishment, however desirous they might have been to act with fairness and justice to the public, avowed that they were guided in their issues by principles which, it is no longer disputed, exposed the country to the greatest embarrassment. Accordingly, we find that the currency varied in value considerably during the period of 22 years, when there was no other rule for regulating its quantity and value but the will of the Bank.
(Protection to Agriculture; IV: 222‒3)
The value of money not being regulated by the standard meant that it was detached from the value of the latter. What happened to the market price of bullion only indicated by how much money departed from a situation in which it would be so regulated: this price was only “a proof of the depreciation of bank notes”. When in 1816 Ricardo developed in Proposals the plan of note convertibility into bullion outlined in 1811 in the Appendix to the fourth edition of High Price, he explicitly considered “a sound state of the currency”, that is, “the reverting from a currency regulated by no standard, to one regulated by a fixed one” as he would say in the “Draft on Peel” of 1821 (V: 519). Abstracting from the bullion market was thus no longer possible since its working was at the heart of this regulation, hence a central piece of the theory of money.
On the side of gold bullion as commodity, in the Bullion Essays its market price reflected its scarcity, like that of any commodity (see Chapter 4 above). The increased quantity of bullion produced after the discovery of a new mine was the only element to be taken into account in the adjustment of the quantity and the value of money, whether the owner of the new mine carried himself its production to the mint or sold it in the market, thus depressing the price of bullion so that its buyers carried it to the mint. Things changed when in Principles Ricardo adopted the view according to which “it is not quantity that regulates price, but facility or difficulty of production” (Letter to Maria Edgeworth of 13 December 1822; IX: 239). A corollary was that the market price of any competitively produced commodity varied temporarily with the quantity supplied but was ultimately regulated by the natural price, determined by the cost of production. Of course the increased quantity of bullion consequent upon the discovery of a new mine immediately depressed its market price, but since it was produced in competitive conditions one should inquire about what happened to its natural price before drawing a conclusion on the permanent change in the value of money. The adjustment in the market for gold bullion had henceforth to be made explicit: the simplifying assumption that the owner of the new mine bypassed the market was no longer acceptable – and neither was the “analogy”. The production of gold bullion was now to be compared with the production of corn, not with the issuing of inconvertible bank notes. A preliminary step was to extend the theory of rent from land to mines.
5.2 The extension of the theory of rent from land to mines
As with every commodity produced with capital in competitive conditions, gold had a natural price allowing any portion of capital advanced in its production to earn the same general rate of profit as in any other employment. Being produced in mines of different qualities, its natural price was determined by the cost of production with that portion of capital which was the least productive and paid no rent. According to Ricardo, the theory of differential rent applied to mines: after having exposed it for land in Chapter II of Principles “On rent”, Ricardo extended it in Chapter III “On the rent of mines”:
Mines, as well as land, generally pay a rent to their owner; and this rent, as well as the rent of land, is the effect, and never the cause of the high value of their produce.
If there were abundance of equally fertile mines, which any one might appropriate, they could yield no rent; the value of their produce would depend on the quantity of labour necessary to extract the metal from the mine and bring it to market.
But there are mines of various qualities, affording very different results, with equal quantities of labour. The metal produced from the poorest mine that is worked, must at least have an exchangeable value, not only sufficient to procure all the clothes, food, and other necessaries consumed by those employed in working it, and bringing the produce to market, but also to afford the common and ordinary profits to him who advances the stock necessary to carry on the undertaking. The return for capital from the poorest mine paying no rent, would regulate the rent of all the other more productive mines. This mine is supposed to yield the usual profits of stock. All that the other mines produce more than this, will necessarily be paid to the owners for rent. Since this principle is precisely the same as that which we have already laid down respecting land, it will not be necessary further to enlarge on it.
(Principles; I: 85)
As for land, the theory of rent applied to mines raises two distinct questions: first the effects of a change in the demand for the commodity produced in the mines; second, the effects of a change in the supply of that commodity, whether it be a consequence of the discovery of new mines or of the introduction of new production techniques. It seems that Ricardo himself and the subsequent Ricardian theory of the rent of land have mostly concentrated on the effect of changes on the side of demand, as part of a dynamic analysis of the interrelations between the determination of prices, the distribution of income, and the accumulation of capital. The cultivation of new lands and the introduction of new techniques are indeed considered, but as a response to a change in demand, not as an independent change on the supply side.2 In contrast, since the analysis of the relation between the quantity and the value of money was approached by Ricardo from the point of view of an exogenous change in the quantity of money issued, he concentrated his attention on changes occurring on the supply side. Typically, Ricardo considered the effects of the discovery of a new mine, which illustrated the analytical case of an exogenous increase in the quantity of gold-money issued and the historical fact of the large inflow of precious metals in Europe having followed the conquest of America.
It should be emphasised that, as for the analysis of the rent on land, Ricardo’s reasoning was in terms of portions of capital rather than in terms of mines or pieces of land. Capital is what should earn the general rate of profit in the natural state, and portions of capital are added or withdrawn according to whether more or less than the general rate of profit may be earned, no matter a new mine (piece of land) be opened (cultivated) or an old one be closed down (left fallow).3 This point was stressed by Ricardo in Principles as an answer to Say and Malthus who contended, as a matter of fact, that every land paid a rent. In Chapter XXXII “Mr. Malthus’s opinions on rent”, Ricardo wrote:
It is not necessary to state, on every occasion, but it must be always understood, that the same results will follow, as far as regards the price of raw produce and the rise of rents, whether an additional capital of a given amount, be employed on new land, for which no rent is paid, or on land already in cultivation, if the produce obtained from both be precisely the same in quantity. See p. 72. M. Say, in his notes to the French translation of this work, had endeavoured to shew that there is not at any time land in cultivation which does not pay a rent, and having satisfied himself on this point, he concludes that he has overturned all the conclusions which result from that doctrine. […] But before M. Say can establish the correctness of this inference [on the effect of taxes on corn] he must also shew that there is not any capital employed on the land for which no rent is paid (see the beginning of this note, and pages 67 and 74 of the present work); now this he has not attempted to do. In no part of his notes has he refuted, or even noticed that important doctrine.
(ibid: 412‒13)4
On p. 72 of Principles to which Ricardo referred, a numerical example ends with: “In this case, as well as in the other, the capital last employed pays no rent.” Leaving aside questions of facts, it might seem that Ricardo’s assumption according to which the least productive land or mine pays no rent contradicts his repeated insistence that individuals are driven by interest alone: why would the owner of a land or a mine agree to lease it if it does not afford any rent? The other references made by Ricardo to pages of his Chapter II “On rent” suggest that reasoning in terms of portions of capital allowed answering this logical objection, as it did to Malthus’s and Say’s factual objection. The reference to p. 67 in the above quotation is to the definition of rent, based on the distinction between “that portion of the produce of the earth, which is paid to the landlord for the use of the original and indestructible powers of the soil”, and what is paid “for the improved farm”. Only the former is properly rent, “in the strict sense to which I am desirous of confining it”, while the latter is in the nature of profit, even if it is like rent paid to the landlord (since it is not the farmer but the landlord who in the past advanced the capital responsible for the improvement of the land for which the lease is contracted). When a portion of capital is added to an existing land, it yields an additional profit – as every previous portion of capital that improved the land in the past – but no rent is paid since there is no change in “the original and indestructible powers of the soil”. Rent consequently did not enter the determination of the cost of production with the last portion of capital, and this was of the utmost importance for Ricardo’s theory of distribution:
By getting rid of rent, which we may do on the corn produced with the capital last employed, and on all commodities produced by labour in manufactures, the distribution between capitalist and labourer becomes a much more simple consideration.
(Letter to McCulloch, 13 June 1820; VIII: 194)
Reasoning in terms of last portion of capital invested and not in terms of last land cultivated was justified by Ricardo as follows, in a speech on Agricultural Distress Report in the House of Commons on 7 May 1822:
It was not that cultivators were always driven by the increase of population to lands of inferior quality, but that from the additional demand for grain, they might be driven to employ on land previously cultivated a second portion of capital, which did not produce as much as the first. On a still farther demand a third portion might be employed, which did not produce so much as the second: it was manifestly by the return on the last portion of capital applied, that the cost of production was determined.
(V: 167)
Keeping then in mind that Ricardo’s proper reasoning was in terms of portion of capital and not in terms of land or of mine, I will nevertheless use these expressions indifferently as Ricardo often did himself:
My argument respecting rent, profit and taxes, is founded on a supposition that there is land in every country which pays no rent, or that there is capital employed on land before in cultivation for which no rent is paid. You answer the first position, but you take no notice of the second. The admission of either will answer my purpose.
(Letter to Say, 11 January 1820; VIII: 149‒50)
The extension of the theory of rent from land to mines now raises the question of the comparison between Ricardo’s treatment of corn and that of gold bullion.
5.3 The specificity of gold bullion in respect to corn
The adjustment to a new land growing corn with a higher productivity
The situation created by the discovery of a new gold mine may be compared with that of a new technique of production of corn which allows a land previously lying fallow to become cultivated with a higher productivity than at least the land of the lowest quality already cultivated (“If a large tract of rich land were added to the Island [England]”, letter to Malthus, 21 April 1815, VI: 220; one may think of a new technique of draining a marsh, making it useful for cultivation with a high yield). In such a case, the increase in the total production of corn sinks its market price below the natural price determined by the cost of production on the previously cultivated land of the lowest quality, and the capital advanced on this land is withdrawn and transferred to another employment. This has two consequences: first, the production of corn is lowered by the amount produced previously on the land abandoned; second, the natural price declines because it is now determined by the cost of production on a land more productive than before. Capital goes on being withdrawn until the market price and the natural price of corn equalise, that is, until every portion of capital advanced on the still cultivated lands (including the one where the new technique has been applied) earns the general rate of profit. On the land which is henceforth of the lowest quality, no rent is paid, and differential rents are paid to the proprietors of the lands of better qualities, according to their respective productivity. In the final situation, the total quantity of corn produced is the same as in the initial situation, the quantity produced by the newly cultivated land having substituted for that produced by the abandoned ones. The total quantity of corn in the final situation is again equal to the natural demand, and it is produced at a lower natural price than in the initial situation.
This adjustment process has an important effect, which is the reverse of the well-known increase in natural wages consequent upon the new cultivation of less productive lands. Here, since the natural price of corn declines when less productive lands are abandoned, natural wages are lowered and the natural rate of profit increases accordingly. Answering a question by Malthus on this point, Ricardo quoted literally his friend’s supposition of his view of the subject:
You have correctly anticipated my answer: ‘Capital will’ I think ‘be withdrawn from the land, till the last capital yields the profit obtained (by the fall of wages) in manufactures, on the supposition of the price of such manufactures remaining stationary’.
(Letter from Ricardo to Malthus, 9 November 1819; VIII: 130; the quotation is from a letter from Malthus to Ricardo, 14 October 1819; ibid: 108)
This “supposition” was, however, contradicted by the effect of a change in distribution on relative prices (see Chapter 3 above) and, as shown in Sraffa (1960), the ranking of the lands was also altered by this change in distribution, creating a major difficulty for the theory of rent.
In Principles, Ricardo gave two examples of such an adjustment process “in consequence of permanent abundance” of corn (Principles; I: 268). In Chapter II “On rent”, an improvement in cultivation techniques does not lead to the withdrawal of the whole capital advanced on the least productive land but only to the transfer of the least productive portion of capital advanced on that land. In the initial situation, four “successive portions of capital” (ibid: 81) yield respectively 100, 90, 80, and 70 quarters of corn, so that the whole rent is equal to 60 quarters out of a total production of 340. After an improvement in cultivation applied equally to each portion of capital, these respective yields become 125, 115, 105, and 95, so that total production on the land mounts to 440 quarters:
But with such an increase of produce, without an increase in demand, there could be no motive for employing so much capital on the land; one portion would be withdrawn, and consequently the last portion of capital would yield 105 instead of 95, and rent would fall to 30, […] the demand being only for 340 quarters.
(ibid: 81‒2)
The increased production of corn consequent upon the improvement in cultivation faces an unchanged demand for the reproduction of the population,5 so that the market price falls below the natural price determined by the least productive portion of capital which becomes unprofitable (at the general rate of profit) and is withdrawn from the production of corn. The total production on the land is brought back approximately to its initial level (345 quarters instead of 340), in line with the unchanged natural demand for corn.
In Chapter XIX “On sudden changes in the channels of trade”, Ricardo considered “a revulsion of trade” (ibid: 265) such as a war which interrupts the importation of corn. The diminution of the quantity supplied, while the demand remains unaltered, pushes the market price of corn upwards, so that the cultivation of less fertile lands becomes profitable. The balance between the supply and the demand is then re-established, although at a higher natural price than before the war. When the war terminates and importation of corn resumes, the opposite movement occurs: the excess quantity of corn available sinks its market price, and the less fertile lands cannot be profitably cultivated any longer:
In examining the question of rent, we found, that with every increase in the supply of corn, capital would be withdrawn from the poorer land; and land of a better description, which would then pay no rent, would become the standard by which the natural price of corn would be regulated. At 4l. per quarter, land of inferior quality, which may be designated by No. 6, might be cultivated; at 3l. 10s. No. 5; at 3l. No. 4, and so on. If corn, in consequence of permanent abundance, fell to 3l. 10s., the capital employed in No. 6 would cease to be employed; for it was only when corn was at 4l. that it could obtain the general profits, even without paying rent: it would, therefore, be withdrawn to manufacture those commodities with which all the corn grown on No. 6 would be purchased and imported.
(ibid: 268)
In this example, the fall in the market price of corn, due to its “permanent abundance”, makes capital advanced on land No. 6 unprofitable (at the general rate of profit) so that it is withdrawn from the production of corn and transferred to an employment in manufactures. The total quantity of corn supplied is again equal to the unchanged natural demand, since the production of the land abandoned is replaced by imported corn produced at a cost consistent with the diminished market price. This foreign corn is itself purchased by the export of the commodities now produced by the capital transferred from the abandoned land.
In both examples, when corn becomes permanently abundant for an exogenous reason (an improvement in cultivation, the resumption of importation at the end of a war), the adjustment process occurs solely on the side of the quantity supplied, not on the side of demand, because there is a natural demand which must be satisfied, neither less nor more:
If the natural price of bread should fall 50 per cent. from some great discovery in the science of agriculture, the demand would not greatly increase, for no man would desire more than would satisfy his wants, and as the demand would not increase, neither would the supply; for a commodity is not supplied merely because it can be produced, but because there is a demand for it. Here, then, we have a case where the supply and demand have scarcely varied, or if they have increased, they have increased in the same proportion; and yet the price of bread will have fallen 50 per cent. at a time, too, when the value of money had continued invariable.
(ibid: 385)6
When it is in excess, the quantity of corn produced is adjusted to the natural demand through the successive withdrawal of the less productive portions of capital (on the same land or on different lands), until the balance between supply and demand is re-established through the equalisation of the market price with the natural price. It should be observed that in both examples, the withdrawal of capital is just enough to ensure this equalisation and thus to bring the supply of corn in line with the natural demand. Although there are discontinuities in production – “successive portions of capital” provide successive yields – its reduction through the withdrawal of one or more of these portions does not overshoot the excess, so that the market price never becomes higher than the natural price. Two reasons may explain this assumption. First, the successive withdrawal of portions of capital is nothing else as the reverse of their previous successive application to the production of corn when it was in short supply; if this process had been implemented smoothly7 – as Ricardo himself assumes by stating that the increase in production may not necessarily require the cultivation of new lands but only the inflow of new portions of capital applied to the same lands – its reverse may follow the same route. Second, corn is produced in competitive conditions, and if for any reason the production of corn were cut by more than what is required to match the natural demand, the market price would rise above the natural price, and abnormal profits would induce an inflow of capital into the production of corn until they disappear. This adjustment is the one which occurs when, because of a domestic increase in population or a higher foreign demand, an increase in the demand for corn raises its market price above its natural price.8
Two differences between gold bullion and corn
In Chapter XIII of Principles “Taxes on gold”, Ricardo emphasises two differences between corn and gold bullion, one on the supply side the other on the demand side. They both affect the adjustment process triggered by an increase in the quantity of the commodity produced.
On the supply side, the speed at which the market price adjusts is greater for corn than for gold, due to a difference in durability:
The agreement of the market and natural prices of all commodities depends at all times on the facility with which the supply can be increased or diminished. In the case of gold, houses, and labour, as well as many other things, this effect cannot, under some circumstances, be speedily produced. But it is different with those commodities which are consumed and reproduced from year to year, such as hats, shoes, corn, and cloth; they may be reduced, if necessary, and the interval cannot be long before the supply is contracted in proportion to the increased charge of producing them.
(ibid: 196)
The difference in durability manifests itself in a high or low ratio of the flow of new production to the existing stock. In the case of corn, the annual production is totally consumed in the period as wage-good or seeds, and no stock is carried from one period to the other. In the case of “gold, houses, and labour”, the stock is large in comparison with annual production, so that a change in the latter affects only slowly the market price (on the importance of the durability of gold in Ricardo’s theory of the value of money, see Takenaga 2013). This is particularly the case with gold used as money:
The metal gold, like all other commodities, has its value in the market ultimately regulated by the comparative facility or difficulty of producing it; and although from its durable nature, and from the difficulty of reducing its quantity, it does not readily bend to variations in its market value, yet that difficulty is much increased from the circumstance of its being used as money. If the quantity of gold in the market for the purpose of commerce only, were 10,000 ounces, and the consumption in our manufactures were 2000 ounces annually, it might be raised one fourth, or 25 per cent. in its value, in one year, by withholding the annual supply; but if in consequence of its being used as money, the quantity employed were 100,000 ounces, it would not be raised one fourth in value in less than ten years.
(Principles; I: 193‒4)9
Nevertheless, in the numerical example which illustrates the effects of taxes on gold, Ricardo supposes that the market price of gold-money increases in the same proportion as its quantity produced decreases (see Appendix 5 below); this amounts to neglecting the difference in durability between corn and gold bullion and considering only the initial and the final situations. As will be seen below, this does not mean, as Ricardo is often blamed for in the literature, that he gives no indication about the forces at work during the adjustment process. This simply means that this difference in durability, while affecting the speed of adjustment, does not affect its modus operandi.
On the demand side, the difference between gold and corn is that, in contrast with necessaries which must be consumed if the population is to be reproduced, there is no natural quantity of money made of gold:
The demand for money is not for a definite quantity, as is the demand for clothes, or for food. The demand for money is regulated entirely by its value and its value by its quantity. If gold were of double the value, half the quantity would perform the same functions in circulation, and if it were of half the value, double the quantity would be required. If the market value of corn be increased one tenth by taxation, or by difficulty of production, it is doubtful whether any effect whatever would be produced on the quantity consumed, because every man’s want is for a definite quantity, and, therefore, if he has the means of purchasing, he will continue to consume as before: but for money, the demand is exactly proportioned to its value. No man could consume twice the quantity of corn, which is usually necessary for his support, but every man purchasing and selling only the same quantity of goods, may be obliged to employ twice, thrice, or any number of times the same quantity of money.
(ibid: 193)
The aggregate value of the commodities to be circulated being given, any quantity of money will do.10 A small quantity of money performs the same circulating office as a large one: the commodities “would be circulated with a less quantity, because a more valuable money” (ibid: 196). Already in his “Notes on Bentham’s ‘Sur les prix’” in 1810, Ricardo had observed that the specificity of the demand for gold used as money prevented a gold-importing country from being benefited by an improvement in its production abroad, in contrast with any other commodity:
If in a foreign country new means of improving the production of commodities be discovered it will be attended with real advantage to all countries which consume that commodity. – If the article were french cambrics for example England would import the quantity of cambrics she required at a less sacrifice of the produce of her own industry: – but when gold and silver are the commodities that become cheap in consequence of improved means of working the mine or the discovery of new mines no such advantage will accrue to England because the quantity of money she requires is not a fixed quantity but depends altogether on its value.
(III: 305‒6)
One may now examine the consequences of the specificity of gold bullion for the adjustment process triggered by the discovery of a new mine. For the time being I will leave aside the question of whether gold bullion is produced in the country that transforms it into money or in a foreign country before it is imported and coined. This amounts to considering that the adjustment is triggered by an increase in the supply of gold bullion that lowers its market price, whether this increased supply is consequent upon the discovery of a new mine or upon importation. The justification for this assumption is that, contrary to what is usually said of the price of internationally traded commodities being determined in Ricardo by supply and demand, the price of imported goods is regulated by their cost of production in the exporting country. This was repeated by Ricardo in Principles and elsewhere:11
All that I contend for is, that it is the natural price of commodities in the exporting country, which ultimately regulates the prices at which they shall be sold, if they are not the objects of monopoly in the importing country.
(Principles; I: 375)
The difference between domestically produced and imported bullion is thus here only in the intervention of the exchange rate (see below Section 5.5). However, we will see in the conclusive section of Chapter 7 that the specificity of the market for bullion in the country where it is the standard of money logically implies that it should be produced abroad. This is what happened in the circumstances of the time: gold was produced outside England in competitive conditions. It was then exported as bullion (no matter whether in the form of merchandise or of coins taken by weight) to England, where it was coined at the mint, with the monopoly power of issuing coins belonging to the State. When a new mine was discovered, more productive than some or all previous ones, the adjustment process thus operated successively in the gold-producing country and in the gold-importing one.
5.4 The adjustment in the gold-producing country: a new “distribution of capital”
A fall in the value of gold bullion
As mentioned above, in the case of the discovery of a new mine, a fall in the value of money occurred because of a fall in the value of gold bullion in terms of all other commodities, not of a depreciation of money in terms of gold bullion. The question is now: how did this transmission channel work? The answer required a condition that Ricardo had not yet mastered at the time of the Bullion Essays: the appropriate link between the discovery of a new mine and the fall in the value of gold bullion in terms of all other commodities. In 1810, Ricardo understood this link through the scarcity principle: the discovery of a new mine increased the total quantity of gold bullion produced and an increased supply lowered its value. This led to an adjustment described in the sequel of the quotation from High Price given above:
If a mine of gold were discovered in either of these countries, the currency of that country would be lowered in value in consequence of the increased quantity of the precious metals brought into circulation, and would therefore no longer be of the same value as that of other countries. Gold and silver, whether in coin or in bullion, obeying the law which regulates all other commodities, would immediately become articles of exportation; they would leave the country where they were cheap, for those countries where they were dear, and would continue to do so, as long as the mine should prove productive, and till the proportion existing between capital and money in each country before the discovery of the mine, were again established, and gold and silver restored every where to one value.
(High Price; III: 54)
Here Ricardo explained that the immediate consequence of the discovery of a new mine would be a fall in the value of gold in the producing country, lowering it below its value in the other countries and leading to its exportation. The final outcome was to be a new equalisation of this value across all countries, presumably at a lower level than the initial one, because of the increased quantity of bullion. But Ricardo would soon feel dissatisfied by this scarcity approach to the value of commodities. As he would write to Mill on 30 December 1815: “I know I shall be soon stopped by the word price” (VI: 348). On 5 October 1816 he would confess to Malthus: “I have been very much impeded by the question of price and value, my former ideas on those points not being correct” (VII: 71).12 This difficulty was to be overcome with the theory of value contained in Principles, which determined the relative value of competitively produced commodities by their cost of production with the portion of capital that pays no rent.
In contrast with corn for which, as seen above, Ricardo explained how the adjustment operated, he did not do the same for gold bullion and contented himself with observing that the discovery of a new rich mine or an improvement in the technique of production caused a fall in the value of gold bullion:
By the discovery of America and the rich mines in which it abounds, a very great effect was produced on the natural price of the precious metals. This effect is by many supposed not yet to have terminated. It is probable, however, that all the effects on the value of the metals, resulting from the discovery of America, have long ceased; and if any fall has of late years taken place in their value, it is to be attributed to improvements in the mode of working the mines.
(Principles; I: 86)
The discovery of a new mine of a better quality than all or some of the mines previously worked increased the quantity produced of bullion, so that its market price fell below its natural price. What happened to the value of gold bullion thus depended on the adjustment process triggered by this gap.
The closure of existing mines as a consequence of the discovery of a new one
To capture how Ricardo understood the adjustment to the new value of gold bullion, one may consider his treatment of another issue that raised the same question of the market price of gold being lower than its natural price because of an exogenous change on the supply side, although another kind of change: the imposition of a tax levied on the production of gold, the effects of which were analysed in Chapter XIII “Taxes on gold” of Principles. When each existing mine was taxed a uniform quantity of gold, the cost of production in each mine increased – and so did the natural price of bullion, determined in the least productive one – while the market price remained the same. The market price of bullion being below the natural price, some mines were forced to close down because the capital invested in them no longer earned the general rate of profit. The same situation occurs in the case of the discovery of a new mine, although for different reasons: the market price of gold falls below the natural price, and here also this gap forces some mines to close down. One can thus transpose Ricardo’s argument about the adjustment process triggered by such a gap from the effect of taxes on gold to the effect of the discovery of a new mine (for a detailed analysis of Ricardo’s argument on the effects of taxes on gold, see Appendix 5 below).
Such transposition leads to the following adjustment. In the initial situation, the market price of gold bullion produced in competitive conditions by mines differing in the quantity produced with the same capital is equal to the natural price, determined by the cost of production with the least productive portion of capital that pays no rent. Suppose now that a new mine is discovered, which is at least more productive than the least productive one previously worked. Since that discovery increases the total quantity of gold bullion brought to market, the new market price falls below the initial natural level. Consequently the portion of capital that initially determined this level no longer earns the general rate of profit and is withdrawn, with two consequences: the cost of production with the least productive portion of capital (the initial next-to-last one) decreases, and the quantity of gold brought to market diminishes, making its market price rise. This process goes on until the rising market price and the falling natural price of gold bullion equalise again at a level that is necessarily lower than the one before the discovery of the new mine. In other words, the value of gold bullion in terms of all other commodities falls because of this discovery.
On the supply side, this adjustment is the same as that for corn, since both commodities are produced in competitive conditions, so that the driving force in the adjustment is the equalisation of the rate of profit earned on each portion of capital invested in the production of bullion at the general rate of profit. The difference is on the demand side: while in the final position the total quantity of corn produced is the same as the initial one – equal to the natural quantity required to reproduce the population – there is no such constraint for gold. The demand for bullion to be transformed into money is not for a definite total quantity but, with a given aggregate value of the commodities to be circulated, for an aggregate value. To any fall in the value of gold bullion consequent upon the discovery of a new mine corresponds a proportionate increase in the total quantity demanded because, as quoted above, “for money, the demand is exactly proportioned to its value” (ibid: 193). When gold bullion is imported to be coined as money, the quantity demanded also adjusts to its value (see below Section 5.6):
While money is the general medium of exchange, the demand for it is never a matter of choice, but always of necessity: you must take it in exchange for your goods, and, therefore, there are no limits to the quantity which may be forced on you by foreign trade, if it fall in value; and no reduction to which you must not submit, if it rise.
(ibid: 194‒5)
The adjustment described by Ricardo after the imposition of taxes on gold is also instructive about how a new “distribution of capital” (ibid: 198) among the mines and between the production of gold and other employments of capital is implemented. Since after the discovery of a new mine the market price of gold bullion falls in the first place, it may only increase later to agree with the natural price if the total quantity of gold brought to market is reduced. Ricardo’s reasoning is that this reduction is obtained by the closure of one or more of the previously existing mines. This assumption is consistent with an analysis of production in which, when the market price of gold is equal to the natural price, portions of capital advanced in mines of different qualities earn the same general rate of profit, the one advanced in the mine of the lowest quality paying no rent. When the market price falls, this particular portion of capital ceases to be profitable (at the general rate of profit) and is withdrawn from that mine, which closes down. The only mines remaining in operation are those where the capital advanced may still earn the general rate of profit, by cutting part – or all, in the case of the mine becoming of the lowest quality in the final situation – of the rent it paid previously.
Ricardo’s description of the adjustment process is such that the reduction of the quantity of gold produced occurs successively, one mine closing down after the other in the order given by the comparative cost of production, until the portions of capital advanced in the remaining mines earn the general rate of profit. Because gold is not a wage-good, a change in its natural price does not modify the level of the general rate of profit. The ranking of the mines by their physical productivity is thus exempt from the effect of a change in the distribution of income (in contrast with corn-producing lands), and the order in which they should close down successively is hence unaffected by the adjustment consequent upon the discovery of a new mine.13
Moreover, assuming that the total quantity of gold produced is not reduced because each mine lowers its production but because some mines completely close down while others keep their initial level of production implies that no assumption about constant returns is necessary: each mine eligible to go on being worked produces the same quantity of gold with the same capital as before, hence at the same cost. As is well known, the question of whether it is necessary to assume constant returns is a sensitive one in classical economics. According to Piero Sraffa:
[T]his standpoint, which is that of the old classical economists from Adam Smith to Ricardo, [is such] that no question arises as to the variation or constancy of returns. The investigation is concerned exclusively with such properties of an economic system as do not depend on changes in the scale of production or in the proportion of ‘factors’.
(Sraffa, 1960: v)
The adjustment process thus conforms to this “classical standpoint”. It may now be formalised as follows.
A formalisation of the adjustment
Let me call:
Natural price of one ounce of gold bullion, in pesos;
Market price of one ounce of gold bullion, in pesos;
Cost of production (in pesos) of one ounce of gold bullion in mine h, including profit at the general rate, with 
ranked according to their decreasing productivity;
Quantity of gold bullion produced by capital advanced in mine h, in ounces.
Supposing that the same amount of capital is advanced in each mine where it produces a different quantity of gold bullion, the cost of production of one ounce of gold in mine h is given by:
(5.1) |
The initial natural situation 0 is such that, with all k mines being worked, the market price of gold bullion is equal to its natural price, determined by the cost of production in mine k:
(5.2) |
Since the totality of gold produced is sold at its natural price, the demand 
expressed in money price, is given by:
(5.3) |
Let me now suppose that a new mine z is discovered, the productivity of which is higher than that of at least mine k: with a capital equal to the one advanced in each of the previous mines, it produces 
To simplify, I will also assume that the productivity of mine z is higher than that of any mine previously worked, so that 
14 Equations (5.2) and (5.3) state that, in the initial natural situation, the total quantity of gold produced by the existing mines allowed its market price being just equal to the cost of production in mine k, and that made this mine profitable (at the general rate of profit). Now, with an unchanged effective demand for gold bullion, expressed in money – as implied by the specificity of gold bullion noted above – the addition of 
sinks the market price below its initial level. Calling 
this new market price, equal to the ratio of 
to the new quantity of bullion, one gets:
(5.4) |
The capital invested in mine k having ceased to be profitable (at the general rate of profit), it is withdrawn. Depending on the level of 
and so on, other portions of capital may also become unprofitable at this market price 
and become eligible to be withdrawn. However, the closure of mine k makes the total production of gold decrease, and its market price consequently rise, so that a given portion of capital may be unprofitable before mine k closes down and become again profitable after its closure. The actual path of adjustment thus depends on the assumption made on the conditions under which the portions of capital are withdrawn. Ricardo’s assumption is that the withdrawal occurs successively, one portion after the other, that is, after the total production of gold has adjusted to the withdrawal of the last portion.15
The final new natural position is such that, with b of the previous mines closing down 
the new final market price 
is equal to the new natural price 
equal to the cost of production in mine 
It is thus given by:
(5.5) |
As in the initial situation (equation (5.2)), the condition of the existence of a new permanent natural position is the equality of the market price and the natural price of gold bullion, the latter being determined by the least productive portion of capital that pays no rent:
(5.6) |
Competition ensures that the market price of gold bullion equalises with the natural price, and each portion of capital advanced in its production except the least productive one pays a differential rent, after as before the discovery of the new mine.
Combining (5.1), (5.5), and (5.6), the condition of the existence of a new permanent natural position reads:
(5.7) |
Since by construction the productivity of the least productive mine in the new permanent natural position is higher than that in the initial situation 
condition (5.7) means that the total production of gold bullion is now permanently greater than before the discovery of the new mine, that is, the production of the newly discovered mine is greater than the combined previous production of the abandoned mines. Condition (5.7) is necessarily fulfilled because the demand for gold bullion (expressed in money) has remained unchanged. Since the new natural price (determined in mine 
) is lower than the initial one (determined in mine k which has been abandoned), the total quantity produced at the new natural price and facing this unchanged money demand is necessarily higher. As emphasised in the above comparison between corn and gold, this greater quantity will be absorbed in the circulation of the gold-importing country at a lower value to circulate the unchanged aggregate value of commodities. Before examining how this occurs, it may be useful to illustrate the consequences of the discovery of a new mine with a numerical example derived from that used by Ricardo when he analysed the effect of taxes on gold.
Let me assume an initial situation in which three mines 1, 2, 3 are worked 
, where the same capital invested in each produces respectively 
A new mine z is then discovered, which by assumption produces 
The question is asked of the conditions under which a new permanent natural position may exist such that, with mine 3 being closed, mines 1 and 2 plus mine z produce together a quantity of gold which sells at a market price equal to the new natural price, equal to the cost of production in mine 2. This new natural position exists if the quantity produced by the newly discovered mine z is such that, in application of equation (5.7):
The quantity of gold being measured in ounces, suppose that 
In the initial natural position, the total production of gold is 250, and 
in pesos, the cost of production of one ounce of gold in the least productive mine (including a profit at the general rate). The demand for gold, expressed in price, is consequently equal to 250 
and the cost of production in the two other mines is (70/80) 
in mine 2 and (70/100) 
in mine 1. A new mine z is then discovered, which, with the same capital as that advanced in each of the previous mines, produces 
hence at a cost of production of (70/105.7) 
Tables 5.1 and 5.2 sum up the natural positions before and after the discovery of the new mine.
After the discovery of mine z, the four mines produce together 355.7 ounces, and the market price of gold falls consequently to 
Capital invested in mine 3 at a cost 
ceases to be profitable and is withdrawn. One observes that capital invested in mine 2 is also unprofitable at this level of the market price, since it produces at a cost equal to 
higher than the market price 0.7 
However, assuming the successive withdrawal rule, mine 2 remains worked if, after the closure of mine 3, capital invested in it is still profitable. After the closure of mine 3, the total production falls to 285.7 and the market price rises again at 
equal to the cost of production in mine 2, which consequently sets the new level of the natural price of gold. By comparison with the initial natural position, the total production of gold has increased from 250 to 285.7 ounces and the natural price has fallen from 
Table 5.1 Natural position before the discovery of a new gold mine
|
Mine 1 |
Mine 2 |
Mine 3 |
Together |
Production of gold (in ounces) |
100 |
80 |
70 |
250 |
Cost of production per ounce (in pesos) |
|
|
|
|
Market and natural price per ounce (in pesos) |
|
Table 5.2 Natural position after the discovery of a new gold mine
Mine 1 |
Mine 2 |
Mine z |
Together |
|
Production |
100 |
80 |
105.7 |
285.7 |
Cost |
|
|
|
|
Price |
|
5.5 The adjustment in the gold-importing country: minting
From the foreign mine to importation
Importing goods produced abroad is an activity in which, as in any other, capital invested requires the natural rate of profit. This means that it may only be implemented permanently if the commodity imported is sold at a market price equal to its cost, including a rate of profit at the general level. In the gold-producing country, this condition is fulfilled if bullion sells at a natural price equal to the cost of production with the portion of capital that pays no rent. In the gold-importing country, the condition is that bullion sells at a natural price equal to the cost of importing it, including the rate of profit at the natural level in this country.
Let me call:
Natural price of an ounce of bullion in the gold-producing country, in pesos;
Market price of an ounce of bullion in the gold-producing country, in pesos;
Natural price of an ounce of bullion in the gold-importing country, in pounds;
Market price of an ounce of bullion in the gold-importing country, in pounds;
Legal price of an ounce of gold in coin in the gold-importing country, in pounds;
e: exchange rate of £1 against pesos;
r: Natural rate of profit in the gold-importing country during the time capital is invested in the importation and sale of bullion, in percentage;
parametric cost of transfer of bullion from the gold-producing to the gold-importing country, in percentage.
The condition for gold bullion to be imported in England is that the cost of its purchase in Spanish America and of its transfer to England (including the natural rate of profit in England) should be inferior or equal to the price at which it is sold in the London market:
(5.8) |
As seen above, in the gold-producing country the natural position (in which every portion of capital earns the natural rate of profit in this country) is characterised by the equality between the natural price and the market price of gold bullion:
(5.2) |
Similarly, the existence of a natural position in the gold-importing country is characterised by such equality:
(5.9) |
To simplify, let me suppose that the only currency circulating in the gold-importing country is composed of full-bodied gold coins minted without seignorage and being legal tender for 
per ounce of gold in coin.16 The condition of conformity of money to the standard (gold bullion) has been defined in Chapter 3 above as:
(3.9) |
“In a sound state of the currency” condition (5.9) may thus be rewritten as:
(5.10) |
Let me suppose that, before the discovery of a new mine in Spanish America, condition (5.10) is not fulfilled, so that gold bullion is not imported in England. This means that, given the natural price of bullion in Spanish America, the monetary conditions and/or the cost of transfer to England do not allow bullion to be profitably exported to this country (while it may be to others). The natural situation in time 0 is thus such that:
(5.11) |
The question is now: do things change after a new highly productive gold mine has been discovered in time 1? As indicated above, the increase in the total production of bullion sinks its market price 
and I will assume that at this level the cost of imported bullion falls below its price in the London market, so that importation begins:
(5.12) |
However, this importation will only become permanent if, after the adjustment has been completed in Spanish America (through the closure of some mines) and in England (as a consequence of the import), it is consistent with the new natural position in both countries. As noted above, since gold bullion is not directly or indirectly a wage-good, the natural rate of profit r in England is not affected. The import in England has only two effects: in the gold market the price 
is lowered, and in the foreign exchange market the demand for pesos against pounds by the importers to finance their purchases of bullion or by the exporters to return the proceeds of their sales lowers the exchange rate e of the pound in pesos. This double adjustment is all the more active since with inequality (5.12) capital invested in the importation of gold earns extra profits and additional capital is diverted to it from other employments. This adjustment at both ends stops when (5.9) applies to the new natural price in Spanish America, given by (5.6) above:
(5.13) |
In this new natural position, gold bullion is permanently imported in England from Spanish America, as would any foreign commodity experiencing a reduction in its cost of production after the introduction of a new technique. Equation (5.13) simply applies Ricardo’s already mentioned contention that the price of a commodity in an importing country is regulated by its natural price in the exporting country.
However, gold was not any commodity.
Being the standard of money in England, gold was there the only commodity which besides its market price in bullion had also a legal price in coin. In contrast with any other commodity, equation (5.13) generated by the international adjustment is not the end of the story, as long as the resulting market price 
is below the legal price 
Another arbitrage then exists for the owners of imported bullion, between the market and the mint: finding that it is profitable to have it coined, they carry it to the mint, and the reduction of the supply in the bullion market raises its price until it equalises with 
and accordingly fulfils the condition of conformity (3.9). Practically, both arbitrages occurred simultaneously, the importers of bullion having the choice of selling it in the market or to the mint. The outcome of the complete adjustment was that the whole quantity of bullion imported nourished an increased quantity of money, because coining only stopped when the difference between 
and 
was eliminated.
The new natural position corresponding to a permanent import of bullion converted into money is thus given by:
(5.14) |
Comparing (5.14) with (5.11) shows that, after the discovery of a new highly productive mine in Spanish America, the natural price of gold bullion there has declined 
and the exchange rate of the pound in pesos has proportionately fallen 
while the quantity of money in England has increased. One should note that the fall in the exchange rate of the pound is not a consequence of the increase in the quantity of money: both are effects of the import of gold bullion in England. In fact, the fall in the exchange rate e in the final position as compared with the initial one is what in (5.14) reconciles the fixed legal price of gold 
in the gold-importing country (England) with the fall in its natural price 
in the foreign gold-producing country (the Spanish colonies).
There remains an apparent difficulty. In (5.14) as in (5.11), the left-hand side of the equation is the natural price of gold bullion in England, which is consequently at the same level (equal to the legal price of gold in coin) before and after the discovery of the new mine in Spanish America. This raises two riddles. First, one should expect that this discovery would lower the value of gold bullion in terms of all other commodities, not only in the gold-producing country but in the gold-importing country too. Since, speaking of gold bullion, Ricardo contended that “its market value in Europe is ultimately regulated by its natural value in Spanish America” (ibid: 195), the fall in the latter should give rise to a fall in the former. This is how international trade was usually described by Ricardo: a fall in the value of any commodity in a country below its level in other countries made it profitable to export this commodity to them, before its value in these importing countries was lowered to its level in the exporting one. Second, the question arises of what becomes of the increased quantity of money consequent upon the coining of the imported bullion. Given the unchanged circulation of commodities in England, it may only enter this circulation if the value of coined money has itself fallen. One is thus led to look at the fall in the value of money as being what reconciles the fall in the value of gold bullion in England after a new mine has been discovered abroad with the constancy of its natural price in pounds.
This is precisely what is stated by the Money–Standard Equation exposed above in Chapter 4: the fall in the value of the standard (gold bullion) in terms of all other commodities causes a proportionate fall in the value of money in terms of all commodities except the standard, while the market price of the standard remains unaltered. A constancy of the natural (and market) price of gold bullion – at the level of the legal price of gold in coin – is thus consistent with a fall in its natural (and market) value because it goes with a fall in the value of coined money, that is, a proportional rise in money prices of all commodities except gold bullion. A change in the world value of the standard of money was thus reflected in an opposite and proportional change in the domestic prices of all other commodities:
The value of gold as a commodity must be regulated by the quantity of goods which must be given to foreigners in exchange for it. When gold is cheap, commodities are dear; and when gold is dear, commodities are cheap, and fall in price.
(Principles; I: 169)
When a new highly productive mine was discovered, the foreign value of bullion fell (“gold is cheap”) and domestic prices rose (“commodities are dear”). When mines were being exhausted, the foreign value of bullion rose (“gold is dear”) and domestic prices fell (“commodities are cheap, and fall in price”). The only commodity that did not change in price although its value might change was the standard of money. As Ricardo summed-up in a compact form before the Commons’ Committee on Resumption on 4 March 1819:
In a sound state of the currency the value of gold may vary, but its price cannot.
(V: 392)
This provided a rational foundation to what Ricardo only hinted at in 1810 in his “Notes on Trotter”:
The discovery of the American mines though they had quadrupled the amount of gold would not have sunk its price, whilst the mint price has not altered, and whilst it was measured by gold coin.
(III: 391)
Among the “many causes which might operate on the value of gold” (V: 204), the discovery of a new mine or of a new technique of producing gold was on the supply side, but there might also be causes on the demand side, particularly in relation to the behaviour of the note-issuing bank.
5.6 The effect of an increased demand for bullion by the issuing bank
The case of the Bank of England from 1819 to 1821
As mentioned in Chapter 2 above, the Bank of England started to enlarge its metallic reserve through purchases of gold bullion immediately after Peel’s bill was adopted in 1819. Although the resumption of the convertibility of Bank of England notes into coin was only scheduled for 1823 by the bill, the Bank wished to speed up such resumption in order to discontinue the circulation of its small notes (£5 and under), which could thus be replaced by specie. The official reason was that these small notes were easily forged, but the real motive was the conception held by the Bank of England of its role as an issuing bank for the circle of traders and not for people at large. It should be noted that the increased demand for bullion by the Bank of England had nothing to do with its management of the note issue. At a time when this issue was to be contracted, so as to lower the market price of gold bullion in 1819 (
2s.; see the letter to McCulloch of 3 January 1822 in Appendix 4 above) to the pre-war level of the legal price of gold in coin (£3.17s. 10½d) there was no reason to enlarge the metallic reserve to back the issue. Such enlargement was decided by the Bank of England in relation to a shift from a monetary regime in which inconvertible Bank of England notes (including small ones) had totally substituted for specie to the pre-war mixed regime of coins and high-denomination notes, disregarding the regime of exclusive circulation of notes convertible into bullion which was planned by Peel’s bill until 1823.
Designed to prepare for a change in monetary regime, this demand for bullion by the Bank of England was consequently once and for all. In contrast with the discovery of a new highly productive mine which had the permanent effect of increasing the total production of bullion, such demand had a temporary effect: after it had been satisfied, the world demand for gold bullion was to return to its previous level. There would only be an increase in the value of bullion until the metallic reserve of the Bank of England reached the desired level. Nevertheless, even temporary, the consequent rise in the value of money – that is, a general fall in money prices – was to be badly felt: taxation increased in real terms and the depressive situation of many sectors (particularly agriculture) deepened. This was the critique addressed by Ricardo to the Bank of England: its demand for gold could have been wholly dispensed with, had convertibility into bullion fairly been tried. As he wrote to McCulloch on 3 January 1822:
They [the Bank of England] have, from ignorance, made the reverting to a fixed currency as difficult a task to the country as possible.
(IX: 140)
The increased demand for bullion by the Bank of England raised the value of bullion and hence the value of money, that is, lowered money prices. As Ricardo exposed before Parliament on 12 June 1822:
It was undeniable, that the manner in which the Bank had gone on purchasing gold to provide for a metallic currency, had materially affected the public interests. It was impossible to ascertain what was the amount of the effect of that mistake on the part of the Bank, or to what precise extent their bullion purchases affected the value of gold; but, whatever the extent was, so far exactly had the value of the currency been increased, and the prices of commodities been lowered.
(V: 199)
The Bank had done exactly the opposite of what Ricardo had recommended during the discussion of Peel’s bill: it had purchased gold bullion instead of selling it. During his speech of 24 May 1819 before the House of Commons, in which he supported Peel’s bill that embodied his Ingot Plan, Ricardo had declared:
If he might give them [the Bank] advice, he should recommend to them not to buy bullion, but even though they had but a few millions [of gold in reserve], if he had the management of their concerns, he should boldly sell.
(V: 13)
Selling gold would have depressed the value of bullion, hence of money, at a time when the programmed return to the pre-war parity of the pound and the transition from a war to a peace economy had deflationary effects. On the contrary, the purchases of gold by the Bank raised the value of money and accelerated deflation. Two years later, during the debate in the House which would bury the experiment of the Ingot Plan, Ricardo recalled on 9 April 1821 his former advice and again blamed the Bank:
He [Ricardo] was not answerable, he said, for the effect which the present measure [the resumption of convertibility into coin at pre-war parity] might have upon particular classes; but he contended that if the advice which he had given long ago had been adopted – if the Bank, instead of buying, had sold gold, as he recommended – the effect would have been very different from what it was at present. […] If the Bank had not bought gold, contrary to his opinion and recommendation, gold would not have risen.
(ibid: 105‒6)
Although temporary, the demand for bullion by the Bank of England operated on the value of money as the discovery of a new gold mine did: through a change in the value of bullion. In the speech of 12 June 1822 Ricardo declared:
He fully agreed with the hon. member for Essex that there were various causes operating, also, on the value of gold, some of which were of a permanent, and others of a temporary nature. The more or less productiveness of the mines were among the permanent causes; the demands for currency, or for plate, in consequence of increased wealth and population, were temporary causes, though probably of some considerable duration. A demand for hats or for cloth would elevate the value of those commodities, but as soon as the requisite quantity of capital was employed in producing the increased quantity required, their value would fall to the former level. The same was true of gold: an increased demand would raise its value, and would ultimately lead to an increased supply, when it would fall to its original level, if the cost of production had not also been increased. No principle was more true than that the cost of production was the regulator of value, and that demand only produced temporary effects.
(ibid: 212)
This argument should be qualified. According to Ricardo, an increased “demand for hats or for cloth” had only temporary effects on the value of these commodities, because he assumed (as often in Principles) that manufactured goods were produced with constant returns. On the basis of his own analysis, this would not be the case for goods produced with land (such as corn) or in mines (such as bullion), since “an increased supply” required the employment of less productive portions of capital. In these cases, the value of the commodity would permanently increase as a consequence of a permanent increase in demand. This is accounted for in the above quotation by the phrase “[its value] would fall to its original level, if the cost of production had not also been increased”. In the case of the Bank of England after 1819, what made the rise in the value of bullion temporary was something else: the increased demand for bullion was itself temporary, until all small notes had been exchanged for coins at the Bank.
As in the case of the discovery of a mine, one should now analyse the adjustment in response to this increase in the demand for bullion by the Bank of England. It was in two ways symmetrical about that described above. First, the initial shock was no longer abroad – the discovery of a new gold mine – but domestic – a once-for-all demand for gold by the Bank of England. Second, its outcome was no longer a fall in the value of gold bullion accompanied with a fall in the value of money but a rise in the former accompanied with a rise in the latter.
In England, for reasons which will be detailed below in Chapter 7, this adjustment could not operate through a demand by the Bank of England in the London market without it being preceded by a corresponding import of bullion. When Bank of England notes were convertible (as was the case after Peel’s bill of 1819), the rise in the market price 
that followed an increased demand immediately triggered an arbitrage between the market for bullion and the Bank of England: coins obtained at 
at the Bank of England against notes were melted and the bullion sold back to the Bank of England in the market at 
The metallic reserve of the Bank of England could not increase because it was depleted as quickly as bullion was purchased at a loss by the Bank. The only way for the Bank to stop these losses was to contract its issues: as will be explained in Chapter 7, the reduction in the quantity of money lowered the market price of bullion and accordingly raised the value of money (in application of the Money–Standard Equation; see Chapter 4 above). The exchange rate e of the pound rose while at the same time 
was raised again to the level of 
through coining. When 
by a difference equal to 
imports of gold bullion began (see below Chapter 8). The increased supply in the London market matched the demand by the Bank of England at a market price equal to and filled its metallic reserve. The return of 
to its level before the demand by the Bank illustrated what Ricardo contended in the Bullion Essays to disqualify Thornton’s explanation of a high price of bullion by another cause of demand – to pay for an adverse foreign balance (see Chapter 8 below):
No demand for gold bullion, arising from this or any other cause, can raise the money price of that commodity.
(High Price; III: 60)
By symmetry with the case of the mine, the increase in the value of gold bullion in terms of all other commodities was made consistent with the constancy of its market price in terms of money through a fall in the money prices of all commodities except gold bullion – that is, an increase in the value of money.
In Spanish America, the higher demand for bullion raised the market price 
above the natural price 
making less productive mines profitable; the cost of production in the mine paying no rent rose and so did 
The “world value” of gold bullion was consequently increased, in line with its increased value in England: in contrast with what happened in the case of a newly discovered mine, the change in the value of bullion in the gold-producing country was here the consequence – and not the cause – of its change in the gold-importing one.
This adjustment was illustrated for its domestic part by what Ricardo wrote in 1821 in the “Draft on Peel” (for details see Appendix 4 above), keeping in mind that “a rise of paper in its comparative value to gold” is the same as a fall in the market price of gold bullion paid for in notes below the legal price of gold in coin (see Chapter 3 above about the condition of conformity):
He [Ricardo] could not contemplate [in 1819] that the Bank would so narrow the circulation of paper as to occasion such a rise in its comparative value to gold and the currencies of other countries as to make the influx of gold into this unexampled in amount.
(V: 519)
This argument was used in April 1822 in the pamphlet On Protection to Agriculture:
Their [the Bank of England] issues were so regulated, that the exchange became extremely favourable to this country, gold flowed into it in a continued stream, and all that came the Bank eagerly purchased at 3l. 17s. 10½d. per ounce. Such a demand for gold could not fail to elevate its value, compared with the value of all commodities. Not only, then, had we to elevate the value of our currency 5 per cent., the amount of the difference between the value of paper and of gold before these operations commenced, but we had still further to elevate it to the new value to which gold itself was raised, by the injudicious purchases which the Bank made of that metal.
(IV: 225)
This quotation emphasises the distinction between two contractions in the note issue. The contraction required by the increase in the metallic reserve of the Bank of England raised the value of money by lowering the market price of bullion below the legal price of gold in coin 
It added to that intended by Peel’s bill to lower the market price of bullion from its level at that time to the legal price (from 
). This was Ricardo’s critique to the Bank of England: it had contracted its issues more than was required by the stabilisation of the market price of bullion at the pre-war level of the legal price of gold in coin (£3. 17s. 10½d.) because, refusing convertibility into bullion advocated by Ricardo, it had favoured convertibility into coin, which called for a bigger metallic reserve. Ricardo clearly distinguished between the welcome contraction of the issue to eliminate the 5 per cent depreciation of paper that still existed in 1819 (the difference between £4. 2s. and £3. 17s. 10½ d. per ounce standard) and the unnecessary contraction of the issue aiming at enlarging the metallic reserve.
The charge against the Bank of England of having contracted its issues too much was not contradictory with the contention by the Bank of having increased them. The point was not the absolute level of the issues but the level that would have ensured the conformity of the value of money with the value of gold bullion. As argued by Ricardo in the same pamphlet:
At a late Court of Proprietors of Bank Stock, the Directors said that, so far from having reduced the amount of the circulation since 1819, they had considerably increased it. […] If the Directors were quite correct in this statement, it is no answer to the charge of their having kept the circulation too low, and thereby caused the great influx of gold. My question to them is, ‘Was your circulation so high as to keep the exchange at par?’ To this they must answer in the negative; and therefore I say, that if in consequence of the importation of gold, that metal is enhanced in value, and the pressure on the country is thereby increased, it is because the Bank did not issue a sufficient quantity of notes to keep the exchange at par. This charge is of the same force whether the amount of banknotes has, in point of fact, been stationary, increasing, or diminishing.
(ibid: 231‒2)17
The same argument is to be found in the letter to McCulloch of 3 January 1822:
If indeed during the operation of limiting the amount of paper, I make immense purchases of gold, and lock it up in a chest, or devote it to uses to which it had not before been applied, I raise the value of gold, and thereby lower the prices of goods, both in gold and in paper, which latter must conform to the value of gold; and this is precisely what the Bank have done.
(IX: 140)
As for the foreign part of the adjustment – the increase in the world value of gold as a consequence of its increased value in England – it was difficult to quantify it precisely. Echoing with his inquiry at the time into an invariable standard, Ricardo was very cautious in doing that and relied on estimates made by Thomas Tooke:
It is a question exceedingly difficult to determine what the effect has been on the value of gold, and consequently on the value of money produced by the purchases of bullion made by the Bank. When two commodities vary, it is impossible to be certain whether one has risen, or the other fallen. There are no means of even approximating to the knowledge of this fact, but by a careful comparison of the value of the two commodities, during the period of their variation, with the value of many other commodities.
Even this comparison does not afford a certain test, because one half of the commodities to which they are compared may have varied in one direction, while the other half may have varied in another: by which half shall the variation of gold be tried? If by one it appears to have risen, if by the other to have fallen. From observations, however, on the price of silver, and of various other commodities, making due allowance for the particular causes which may have specially operated on the value of each, Mr. Tooke, one of the most intelligent witnesses examined by the Agricultural Committee, came to the conclusion that the eager demand for gold made by the Bank in order to substitute coin for their small notes, had raised the value of currency about five per cent. In this conclusion, I quite concur with Mr. Tooke. If it be well founded, the whole increased value of our currency since the passing of Mr. Peel’s bill in 1819, may be estimated at about ten per cent.
(Protection to Agriculture; IV: 227‒8)18
Ricardo had used the same argument before Parliament on 18 February 1822:
If the affairs of the Bank had been conducted with skill, the directors, instead of forcing so great an importation of gold, should have kept the exchange as nearly as possible at par. He [Ricardo] repeated then, that the consequence of the law [Peel’s bill], if skilfully acted upon, was only to cause a rise of 5 per cent. But the Bank had acted very differently, and had imported a great quantity of gold; as much perhaps as twenty millions. This, of course, had created a change in the price of commodities, in addition to the apparent difference between paper and gold. The buying up of this quantity of gold must have affected a change in the value of it (as compared with other commodities) throughout Europe. What the amount of this change was, it was impossible to say – it was mere matter of conjecture. But when they took the quantity of gold in circulation in Europe into the calculation, and all the paper also, for that too must be reckoned, he did not conceive that it could be great, and he should imagine that 5 per cent would be an ample allowance for the effect.
(V: 135‒6)
And again on 12 June 1822:
Remarks had frequently been made upon an opinion which he (Mr. Ricardo) had given of the effect which had been produced on the value of gold, and therefore on the value of money, by the purchases made by the Bank, which he had computed at five per cent, making the whole rise in the value of money ten per cent. He confessed that he had very little ground for forming any correct opinion on this subject. By comparing money with its standard, we had certain means of judging of its depreciation, but he knew of none by which we were able to ascertain with certainty alterations in real or absolute value. His opinion of the standard itself having been raised five per cent in value, by the purchases of the bank, was principally founded on the effect which he should expect to follow, from a demand from the general stock of the world of from fifteen to twenty millions worth of coined money. If, as he believed, there was in the world twenty times as much gold and silver as England had lately required to establish her standard on its ancient footing, he should say that the effect of that measure could not have exceeded five per cent.
(ibid: 209‒10)
5.7 Conclusion: the Money–Standard Equation and a real shock on the value of money
A change in the value of money, but no depreciation or appreciation
When a new mine was discovered in a gold-producing country, the final position in England was that described by Ricardo in the quotation from Principles given at the beginning: the quantity of money increased, and its value fell with the value of gold bullion. But the increase in the quantity of money was not the cause of the fall in its value: both were the effects of the discovery of the mine and it was the fall in the value of the standard that caused the fall in the value of money and the increase in its quantity. In other words the currency fell in value but did not depreciate. Another striking conclusion emerges from this analysis: there could never be an excess of coins – hence their depreciation – following an increase in the quantity produced of gold bullion, simply because coining required the market price of gold bullion to be below the legal price of gold in coin, while an excess of the currency and its corresponding depreciation only occurred when the market price of gold bullion was above the legal price of gold in coin. Coining thus did start when the increase in the quantity of bullion lowered its market price, but it stopped when the latter again equalised with the legal price of gold in coin, preventing any excess from occurring. The increase in the quantity of money simply went with the fall in its value, but did not imply any excess.
The conclusion of this analysis is that, after the discovery of a new mine in the gold-producing country, the fall in the value of gold bullion in terms of all other commodities caused in the gold-importing country a fall in the value of money but had no permanent effect on the market price of gold bullion. Ricardo would often repeat that a change in the value of bullion affected the value of money in the same direction but had no influence on the price of bullion. The same reasoning applied when an increased demand for bullion by the issuing bank to enlarge its metallic reserve raised the value of gold bullion and hence the value of money, while arbitrage ensured the equality between the market price of gold bullion and the fixed legal price of gold in coin (money was not appreciated). As explained by the Money–Standard Equation, any change in the value 
of gold bullion in terms of all other commodities was combined with a constancy of its market price 
in any country where gold bullion was the standard of money. The addition of these two aspects resulted in a proportional change in the value of money 
in the same direction as 
– that is, a proportional change in the money prices of all commodities except the standard in the opposite direction.
The effect of a real shock on the value of money was the outcome of several adjustments implying different markets, each one having its own duration. In the case of the discovery of a new gold mine, the fall in the market price in the gold-producing country after the total quantity produced had increased might occur rapidly, while the subsequent equalisation of this market price with the new natural price only occurred after enough time had elapsed to close down the mines becoming unprofitable. In the world market for bullion, the speed at which a fall in the market price in the gold-producing country was translated into a fall in the market price in the gold-importing ones depended on the ratio of the flow of new production of gold to the existing stock of the metal in whatever form – an element emphasised by Ricardo to explain the slowness of the adjustment for commodities like houses, labour, and precious metals. In contrast, the domestic adjustment triggered by such a fall in the market price of bullion was quick, since arbitrage between the market and the mint was immediate and at a trifling cost. Finally, the fall in the value of money – hence the proportional rise in the money prices of all commodities except bullion – which reconciled a fall in the value of gold bullion with a constancy of its price took the time required by the adjustment in the markets for all commodities, thanks to the mobility of capital that ensured the uniformity of the rate of profit at higher money prices.
In the case of the demand for gold bullion by the Bank to enlarge its metallic reserve, the timing of the adjustment depended in the first place on the time it took for the Bank to understand that it could not achieve this goal without reducing its issues. Then there was the time necessary to trigger the import of bullion to satisfy the demand by the Bank at a market price equal to the legal price of gold in coin; this time might be expected to be short since it only required arbitrage between the market for bullion, the foreign-exchange market, and the mint. Finally, there was the time of the adjustment of the rising price of bullion in the world market and the time of the adjustment of its rising natural price (through the employment of capital in less productive mines) in the gold-producing country.
Although a precise pattern of adjustment durations in the case of a real shock on the value of money would probably imply arbitrary assumptions, one may nevertheless contrast, on the one hand, the short duration of the adjustment triggered by domestic arbitrage between the market for bullion and the mint or international arbitrage between the market for bullion and the foreign-exchange market, with on the other hand the longer duration of the respective adjustments in the production of bullion, in the world market for bullion, and in the domestic markets for all other commodities.
Symmetrical real shock versus asymmetrical monetary shock
A real shock on the value of money was produced either by a permanent change on the supply side of the market of the standard – the discovery of a new gold mine – or by a temporary change on the demand side of this market – a once-for-all demand by the issuing bank to accommodate a change in the monetary regime. In both cases, this real shock affected the value of money through a change in the value of the standard. The discovery of a new highly productive gold mine lowered permanently the value of bullion, hence the value of money. A new demand for gold by the issuing bank – namely the Bank of England in 1819–1821 to enlarge its metallic reserve raised temporarily the value of bullion, hence the value of money. Although in the second case the issuing bank was involved, it was nevertheless a real shock, not a monetary one: the new demand for metallic reserve was not motivated by an increase in the quantity of notes issued. On the contrary, it went along with a reduction in the new issues and was motivated by the wish of the Bank to substitute gold coins for the stock of small notes in circulation – a change in the working of the domestic payments system.
Affecting the value of money through the channel of the value of the standard, such a real shock was symmetrical: it concerned all the currencies having gold as standard and consequently left the exchange rates between these currencies unaltered. The variation in the value of a particular currency was an inconvenience in itself, but it did not change the respective positions of this currency in respect to the others. Examined on 26 March 1819 by a Secret Committee of the House of Commons, Ricardo answered to questions on this subject as follows, keeping in mind that “a sound state of the currency” is that of convertibility of the bank note into the standard:
Question: |
Do you recollect whether within these last eight years we have not frequently seen the circulating medium of the country undergo much more formidable changes with respect to value than 4 per cent., within a shorter period than six months, judging of the value of the circulating medium by the price of gold? |
Answer: |
In my opinion it has undergone much greater variations than 4 per cent.; and in the soundest state of our currency, it would be liable to such variations. |
Question: |
From what causes could it undergo variations, exceeding that amount, if the currency were restored to its soundest possible state? |
Answer: |
It would not undergo any variation, as compared with the standard; but I mean, that the standard itself might undergo variations exceeding that amount; the whole currency is of course subject to all the variations of the standard. |
Question: |
In that case, would not the currency of other countries, in an equally sound state, undergo similar variations? |
Answer: |
Certainly; the inconvenience, as far as regarded England, would not be less on that account; I consider any variation in the value of the currency as an evil, from producing a variation in the prices of all articles. |
(V: 441‒2)
According to Ricardo, the inconvenience of subjecting the value of money to any change in the value of the standard was the unavoidable counterpart of the self-regulating adjustment of the quantity of money permitted by the existence of a standard of money, which prevented any permanent variation in the value of money produced by a monetary shock. Such a monetary shock took the form of an exogenous change in the quantity of money, whether produced by the debasement of the circulating coin or a discretionary change in the note issue. The monetary shock was asymmetrical: it was restricted to the currency of the country where it occurred. The channel of transmission to the value of money was now a change in the price of the standard – instead of its value when the shock was real. The object of the next two chapters is to analyse the self-adjustment of the value of money generated by the standard in the case of a monetary shock.
The case examined by Ricardo in Chapter XIII of Principles analytically differs from that considered above in Chapter 5 in two respects. First, instead of being only lowered in the newly discovered mine, the cost of production of gold bullion is increased in all mines by the imposition of a tax at a uniform rate. Second, instead of being produced in competitive conditions, so that the market price cannot be raised permanently above the natural price, gold bullion is considered by Ricardo as “a monopolised commodity” (Principles; I: 197), because the King of Spain is supposed “to be in exclusive possession of the mines” (ibid: 195). However, in both cases all portions of capital invested in the mines of different quality require the same rate of profit, and they are withdrawn from the production of gold bullion when they fail to do so. This is what matters to allow transposing Ricardo’s analysis from the effect of taxation to the effect of the discovery of a new gold mine on the value of gold bullion.
1. The case examined by Ricardo
In Ricardo’s analysis of the effects of taxes on gold, the adjustment process starts when a negative gap between the market price and the natural price of gold – provoked by an increase in the cost of production due to taxation, while the market price remains unchanged – forces one or more existing mines to close down. The final outcome is a sharp decline in production, without any harmful consequence for the users of gold-money because, as noted in Chapter 5 above, any quantity produced in the Spanish colonies may satisfy the European circulation. After the adjustment, the market price of gold not only rises to the level of the natural price determined by the cost of production in the least productive mine still worked, but above that level. It is so because, in Ricardo’s example, the only mine still worked in the final situation produces a lower quantity of gold than what would be required to prevent the market price from overshooting the natural price. The absence of a smooth adjustment of supply allows the excess of the market price remaining permanent and the proprietor of that mine earning a rent. This, according to Ricardo, is due to the assumption that gold is “a monopolised commodity”:
Its [market] value might be higher, but it could not be lower [than its natural value], or even this mine would cease to be worked. Being a monopolised commodity, it could exceed its natural value, and then it would pay a rent equal to that excess; but no funds would be employed in the mine, if it were below this value.
(ibid: 197‒8)
The situation considered by Ricardo is as follows:
If then the King of Spain, supposing him to be in exclusive possession of the mines, and gold alone to be used for money, were to lay a considerable tax on gold, he would very much raise its natural value; and as its market value in Europe is ultimately regulated by its natural value in Spanish America, more commodities would be given by Europe for a given quantity of gold. But the same quantity of gold would not be produced in America, as its value would only be increased in proportion to the diminution of quantity consequent on its increased cost of production. No more goods then would be obtained in America, in exchange for all their gold exported, than before; and it may be asked, where then would be the benefit to Spain and her Colonies? The benefit would be this, that if less gold were produced, less capital would be employed in producing it; the same value of goods from Europe would be imported by the employment of the smaller capital, that was before obtained by the employment of the larger; and, therefore, all the productions obtained by the employment of the capital withdrawn from the mines, would be a benefit which Spain would derive from the imposition of the tax, and which she could not obtain in such abundance, or with such certainty, by possessing the monopoly of any other commodity whatever. From such a tax, as far as money was concerned, the nations of Europe would suffer no injury whatever; they would have the same quantity of goods, and consequently the same means of enjoyment as before, but these goods would be circulated with a less quantity, because a more valuable money.
(ibid: 195‒6)
This case is characterised by two aspects. First, gold is produced only in the Spanish American colonies, so that the King of Spain may impose a tax, however great, on the production of gold, without having to fear the competition of gold produced elsewhere. This assumption does not mean that the gold mines are publicly owned: capital is advanced in the privately owned mines and must earn the general rate of profit. Second, gold is the only money used in Europe, which has to import it against commodities exported to the Spanish kingdom. In application of Ricardo’s theory of international prices, the exchange rate of Spanish gold against European commodities is regulated by the natural price of each, so that the imposition of a tax on Spanish gold increasing its natural price, this exchange rate itself increases: “more commodities would be given by Europe for a given quantity of gold”. This however does not mean that more European commodities will be obtained by Spain against gold, since the quantity of gold produced and exported will be lower, as a consequence of some mines closing down because the cost of production of gold has been increased by taxation. An additional quantity of European commodities is therefore obtained by Spain, not against gold, but against the commodities produced by the capital withdrawn from the closed-down mines. This benefit derived by Spain from the imposition of the tax has no counterpart in a diminution of the value obtained by Europe from her trade with Spain: she obtains a smaller quantity of gold but of the same total value as before, and the value of the additional commodities she exports to Spain is balanced by the value of the additional Spanish commodities imported besides gold. The reduction in the quantity of gold imported in Europe has no harmful consequence whatsoever, since this reduced quantity has the same aggregate value – hence circulates the same value of domestic commodities – as the higher quantity before: “these goods would be circulated with a less quantity, because a more valuable money”.
2. Ricardo’s numerical example
Ricardo illustrates these conclusions with a numerical example. The initial situation is such that three mines 1, 2, 3 are worked and produce a total quantity of 250 pounds (of weight) of gold; the same capital is advanced in each mine, but the quality being different from one mine to the other, it produces respectively 100, 80, and 70 pounds of gold. According to the general law of value, the natural price of gold is determined in such a way that each capital earns the general rate of profit, hence by the cost (profit included) of gold produced with the capital advanced in mine 3 and paying no rent. The capital advanced in mines 1 and 2 consequently pays to their proprietors a rent equal to 30 and 10 pounds of gold respectively. The whole production of gold is exported and exchanged for (by supposition) 10,000 yards of European cloth. A new situation occurs when the King of Spain imposes a uniform tax of 70 pounds of gold on each mine. The comparison between the initial and the final situations is made by Ricardo as follows:
The account of Spain would stand thus:
Formerly produced: |
|
Gold 250 pounds, of the value of (suppose) |
10,000 yards of cloth. |
Now produced: |
|
By the two capitalists who quitted the mines, the same value as 140 pounds formerly exchanged for; equal to |
5,600 yards of cloth. |
By the capitalist who works the mine, No. 1, thirty pounds of gold, increased in value, as 1 to 2½ and therefore now of the value of |
3,000 yards of cloth. |
Tax to the King seventy pounds, increased also in value as 1 to 2½ and therefore now of the value of |
7,000 yards of cloth. |
|
15,600 |
(ibid: 198)
This numerical example raises three questions: (1) Why has gold “increased in value, as 1 to 2½”? (2) How does Spain obtain more cloth from Europe after taxation? and (3) Who pays the tax?
The first question concerns the determination of the value of gold after taxation. The “market value in Europe” of gold-money before taxation was such that the quantity of gold imported from the Spanish colonies circulated the aggregate market value of commodities in Europe. Since the latter remains unchanged, the market value of gold-money after taxation depends on the new quantity of gold imported, that is, produced by the mines remaining in operation.19 This in turn depends on the cost of production of each mine after taxation. Now mine 3 ceases obviously to be worked, since its whole production of 70 pounds of gold would be taken away by the tax, and the capital advanced in it could no longer earn the general rate of profit. Ricardo assumes that mine 2 also closes down, although it produces more than the tax.20 Only mine 1 remains operated, and the total quantity of gold produced in the Spanish colonies and imported in Europe is now equal to the production of this mine: 100 pounds. The quantity of gold-money circulating the unchanged value of commodities in Europe having fallen from 250 to 100 pounds, it is there “increased in value, as 1 to 2½”. This increase is that of the market value of gold in Europe, not of the “natural value” in the Spanish colonies. Ricardo analyses the increase in the natural value as follows:
The value, then, of what remains to the capitalist of the mine No. 1, must be the same as before, or he would not obtain the common profits of stock; and, consequently, after paying seventy out of his 100 pounds for tax, the value of the remaining thirty must be as great as the value of seventy was before, and therefore the value of the whole hundred as great as 233 pounds before.
(ibid: 197)
Before the imposition of the tax, the natural value of gold was determined by the cost of production in mine 3, including profit at the general rate. Now that mines 2 and 3 have closed down, it is determined in mine 1, and it is affected by two factors. First, mine 1 being of a better quality than mine 3, the cost of production per unit of gold produced (tax excluded) should decrease; second it increases after taxation since the tax is added to the previous costs. The new level of the natural value should be such that it still allows the unchanged capital advanced in mine 1 to obtain the unchanged general rate of profit. Before taxation, it was so when the capitalist exploiting mine 1 sold 70 pounds of gold (the production of 100 pounds minus 30 pounds paid to the owner of the mine as rent) at the natural value (determined by the cost of production in mine 3). After taxation, the natural value is determined in the only mine still exploited, mine 1, and if gold is sold at its natural value, so that no rent is paid any more to the owner of the mine since this is the mine in which this value is henceforth determined, the same capitalist now sells 30 pounds of gold (the unchanged production of 100 pounds minus 70 pounds paid to the King of Spain as tax). The natural value has thus been multiplied by 
As seen above, however, after taxation gold is sold at a market value multiplied by 2.5 (as compared with the situation before taxation) and not at its initial natural value multiplied by 2.33. To be sold at a market value equal to its natural value, gold should be produced by mine 1 in a quantity equal to 
pounds. But this mine only produced 100 pounds of gold in the initial situation, and its production – henceforth the total production of gold – is supposed by Ricardo to remain at this level. The rationing of the quantity of gold brought to market allows the market value of gold after taxation remaining permanently above its natural value. The capitalist exploiting mine 1 does not however benefit from the excess of the market on the natural value of gold, because he has to transfer it to the owner of the mine as rent. Using the same reasoning as Ricardo in the last quotation, one can calculate the level R of that rent: 
pounds of gold sold at a market value multiplied by 2.5 should bring to the capitalist exploiting mine 1 the same profit at the general rate than 70 pounds before taxation, so that 
pounds of gold.
The second question raised by Ricardo’s numerical example is: How does Spain obtain more cloth from Europe after taxation? By supposition, 10,000 yards of European cloth were previously exchanged against 250 pounds of Spanish gold, the exchange rate being thus 40 yards of cloth per pound of gold. After taxation, the market value of gold is multiplied by 2.5 and so does its exchange rate, which is raised to 100 yards of cloth per pound of gold. The 100 pounds of gold exported exchange for the same 10000 yards of European cloth as the 250 did before. As mentioned by Ricardo in his numerical table, 3000 out of these 10000 yards exchange for the 30 pounds of gold kept by the capitalist operating mine 
after payment of the tax (but it should be noticed that 200 out of these 3000 exchange for the 2 pounds of gold paid to the owner of the land as rent, so that the capitalist actually obtains 2800 yards of cloth for his gold), and 7000 exchange for the 70 pounds of gold levied by the King of Spain as tax.
Tables 5.3 and 5.4 sum up the situations before and after taxation.
Table 5.3 Initial situation (before taxation) in Ricardo’s numerical example in Chapter XIII “Taxes on gold” of Principles
|
Mine 1 |
Mine 2 |
Mine 3 |
Total |
Production of gold (in pounds of weight) |
100 |
80 |
70 |
250 |
Quantity of gold earned by the capitalist |
70 |
70 |
70 |
210 |
Rent in gold |
30 |
10 |
0 |
40 |
Quantity of foreign cloth exchanged against gold (in yards) |
10000 |
|||
Ditto: by the capitalist |
2800 |
2800 |
2800 |
8400 |
Ditto: by the owner of the mine |
1200 |
400 |
0 |
1600 |
Table 5.4 Final situation (after taxation) in Ricardo’s numerical example in Chapter XIII “Taxes on gold” of Principles
|
Capital invested in mine 1 |
Capital withdrawn from mine 2 |
Capital withdrawn from mine 3 |
Total |
Production of gold (in pounds of weight) |
100 |
0 |
0 |
100 |
Quantity of gold earned by the capitalist |
28 |
0 |
0 |
28 |
Rent in gold |
2 |
0 |
0 |
2 |
Tax in gold |
70 |
0 |
0 |
70 |
Quantity of foreign cloth exchanged against gold and commodities newly produced (in yards) |
15600 |
|||
Ditto: by the capitalist |
2800 |
2800 |
2800 |
8400 |
Ditto: by the owner of the mine |
200 |
0 |
0 |
200 |
Ditto: by the sovereign |
7000 |
After taxation, the capitalist of mine 1 obtains a smaller quantity of gold (28 instead of 70 pounds), but since the market price of gold has been multiplied by 2.5, his returns in value remain the same as his returns measured in foreign cloth. As for the capital withdrawn from mines 2 and 3, it has moved to other employments. Before taxation, it exchanged 140 pounds of gold – the 150 pounds produced minus the 10 pounds paid as rent to the proprietor of mine 2 – for 5600 yards of foreign cloth, at the ruling exchange rate of 40 yards of cloth per pound of gold. To earn the unchanged general rate of profit it should now sell whichever commodities it produces for the same value as before, that is, the equivalent of the same 5600 yards of cloth. After as before taxation, each equal capital formerly advanced in one of the three mines exchanges what it keeps of the value of its production against the same 2800 yards of European cloth.
The capitalists together obtain 8400 yards – the same as before taxation – the proprietors of the mines 200 yards – instead of 1600 –and the King of Spain exchanges the proceeds of the tax against 7000 yards. On the whole, the same capital as that previously invested in gold mines allows Spain receiving now 15600 yards of European cloth instead of 10000.
The third and last question is: Who pays the tax? In the Spanish colonies, the burden of the tax falls entirely on the proprietors of the mines who lose most of their rents (divided by 20 in terms of gold and by 8 in value or in foreign cloth), no change occurring for the profits on capital. This loss represents however only a part of the tax, a small one if measured in foreign cloth (1400 out of 7000 yards); most of it is “pure gain”. Ricardo comments on his numerical table as follows:
In return for one third of the labour and capital employed in the mines, Spain would obtain as much gold as would exchange for the same, or very nearly the same quantity of commodities as before. She would be richer by the produce of the two thirds liberated from the mines. If the value of the 100 pounds of gold should be equal to that of the 250 pounds extracted before; the King of Spain’s portion, his seventy pounds, would be equal to 175 at the former value: a small part of the King’s tax only would fall on his own subjects, the greater part being obtained by the better distribution of capital. […] Of the 7000 [yards of foreign cloth] received by the King, the people of Spain would contribute only 1400, and 5600 would be pure gain, effected by the liberated capital.
(ibid: 198‒9)
What is the nature of this “pure gain” of 5600 yards of cloth? It is indisputably wealth: the quantity of use-values obtained by Spain through foreign trade is greater than before taxation. Is it a creation of additional value? The same quantity of labour is embodied in the commodities now produced with the capital withdrawn from mines 2 and 3 than in the gold produced previously in these two mines; as for mine 1, it produces the same quantity of gold with the same labour as before. No creation of value has therefore occurred in the Spanish colonies, only a transfer of value from the proprietors of the mines to the King of Spain. It is true however that the same aggregate value created by labour in the Spanish colonies now exchanges for more value created by labour in Europe (embodied in 15600 yards of cloth instead of 10000, while no change occurred in its conditions of production); but this results simply from the fact that the relative price of gold in cloth has been multiplied by 2.5, because taxation has increased the cost of production of gold and monopoly sustains its market price above its natural price.21
In terms of wealth (use-values), Ricardo may rightly speak of “pure gain”, since the gain of the Spanish colonies (5600 yards of European cloth) is not associated with a loss for Europe – the 100 pounds of gold imported are as useful to circulate commodities in Europe than the 250 pounds were before, and the additional 5600 yards of cloth are exchanged against additional Spanish commodities. This “pure gain” is thus entirely to be explained by “the better distribution of capital” in the Spanish colonies, resulting from the imposition of the tax: a smaller capital – that advanced in the only still-operated mine 1 – produces the smaller quantity of gold required as money, and “the liberated capital” may be invested in the production of other commodities:
A part of the tax would be paid by the people of the Spanish colonies, and the other part would be a new creation of produce, by increasing the power of the instrument used as a medium of exchange.
(ibid: 199)
The value of a pound of gold – its “power” – has been multiplied by 2.5, and the quantity of it used “as a medium of exchange” has been accordingly divided in the same proportion, allowing “a new creation of produce” by the capital transferred to other employments.
Nevertheless, in terms of value, the origin of the gain is crystal-clear: by imposing a tax on gold, Spain is in a position to exchange the same aggregate quantity of her labour for a greater aggregate quantity of European labour than before. This explains why, out of the 7000 yards of imported cloth which will be used to dress soldiers of the King of Spain, 1400 yards only are diverted from dressing servants of the Spanish proprietors of mines, and the greater part is obtained for free from European labour. The following sentence should be read in this light:
If gold were the produce of one country only, and it were used universally for money, a very considerable tax might be imposed on it, which would not fall on any country, except in proportion as they used it in manufactures, and for utensils; upon that portion which was used for money, though a large tax might be received, nobody would pay it.
(ibid: 194; emphasis added)
Not only – as acknowledged by Ricardo – the Spanish proprietors of mines would indeed pay part of the tax, but Europe also would greatly contribute to paying it. This in no way violates the principles which determine international prices, since it is merely the consequence of the increase in the Spanish price of gold consequent upon taxation. Europe cannot however avoid submitting to the rise in the relative price of gold in order to obtain her circulating medium because of the monopolistic character of gold-money: it may not be replaced by something else – “it [is] used universally for money” – and the Spanish colonies monopolise its production – “gold [is] the produce of one country only”.
Ricardo’s general favour for taxation (rather than public debt) to finance the unavoidable government expenses is here all the more justified since the burden of most of the tax falls on foreign countries. This practical conclusion is however of no use in the case of Britain, because it only applies to countries enjoying a monopoly in the production of gold-money. Although the argument does not seem to have been used by Ricardo, this analysis provides a further reason for adopting a gold-economising monetary system such as Ricardo’s Ingot Plan, which would prevent Britain from being subject to the obligation of increasing the part of her labour and her capital devoted to the purchase of foreign gold when the countries enjoying the monopoly of its production decide to impose a tax on it.
In order to generalise Ricardo’s analysis of the effect of taxation on the value of gold, his numerical example may be formalised as follows. Let me call:
|
Natural price of one ounce of gold bullion, in pesos; |
|
Market price of one ounce of gold bullion, in pesos; |
|
Cost of production (in pesos) of one ounce of gold bullion in mine h, including profit at the general rate and excluding the tax, with |
|
Quantity of gold bullion produced by capital advanced in mine h, in ounces; |
T: |
Uniform tax imposed on each mine operated, in ounces of gold. |
The initial natural situation 0 has been described in Chapter 5 above and is summed-up by:
(5.1) |
(5.2) |
(5.3) |
In time 1, taxation is introduced in the form of a given quantity T of gold to be paid by each mine, whatever its cost of production. This tax increases the cost of production in each mine by the value of the tax levied on every ounce of gold produced by that mine. With 
the market price of gold after taxation, this tax in money terms is thus equal to T 
and with an unchanged quantity 
produced in mine h it increases the cost of production per ounce by T 
(5.15) |
According to (5.1), 
may be rewritten as:
(5.16) |
If after taxation b mines cease to be profitable at the general rate of profit 
, so that 
of them remain worked, 
is equal to the ratio of the unchanged demand 
given by (5.3) to the new total quantity of gold produced:
(5.17) |
The condition for mine h to remain profitable after taxation is that 
at least covers the cost of production 
According to (5.16) and (5.17) this condition is thus:
(5.18) |
For any combination of the parameters transforming (5.18) into a strict equality, 
the market price of gold is equal to its natural price determined by the cost of production in mine h, and all rent disappears. This may however only happen by chance; in the general case the market price of gold is higher than its natural price, and this excess generates an absolute rent.
The example given by Ricardo is: k = 3; qG(1)=100; qG(2)= 80; qG(3)= 70; T = 70. If the three mines which were profitable before taxation are to remain so after, condition (5.18) is 
for mine 1, 
for mine 2, and 
for mine 3; with 
this condition is fulfilled for none of them. As explained in Chapter 5 above, Ricardo assumes that, instead of the three mines closing down altogether, the mine of the lowest quality closes down first, and so on until the reduction in the quantity produced allows at least one mine to be profitable. Mine 3 is thus the first to close down, so that the total quantity of gold produced decreases from 250 to 180 and the market price of gold increases accordingly in the proportion of 1 to 1.39. Condition (5.18) becomes 
for mine 1 and 
for mine 2; with 
this condition is not yet fulfilled for any of the two remaining mines. Mine 2 then closes down, and condition (5.18) becomes 
for mine 1; now this mine may be worked with profit at the general rate.
If gold were sold at its natural price, so that 
(5.16) would give 
; the natural price would be increased by taxation in the proportion of 1 to 2.33 mentioned by Ricardo in the above quotation (ibid: 197). But since the total quantity of gold produced is not enough to ensure the equality between the market and natural prices, (5.17) gives 
(gold is “increased in [market] value, as 1 to 2½”), and (5.16) gives 
(the natural price is increased in the proportion of 1 to 2.45 and not 1 to 2.33, as would be the case if the market and natural prices of gold were equal, because the tax is now paid at a market price higher than the natural one). Consequently the capital advanced in mine 1 earns an extra-profit of 0.05 
per ounce of gold which is paid as rent to the owner of the mine, who gets 
ounce of gold per ounce of gold produced. On the 100 ounces of gold produced by the only mine still worked, 70 go to the King of Spain as tax, 2 to the owner of the mine as absolute rent, and 28 are kept by the capitalist as profit at the general rate. The tax could be increased to 72 ounces of gold – making the market price of gold be equal to its natural price and all rent disappear – but not more, otherwise mine 1 would close down and any production of gold would vanish.
Notes
1 Bentham’s manuscript is in French and reads as follows: “La valeur de l’argent n’est à présent que la moitié de ce qu’elle étoit il y a 40 ans; elle ne sera dans 40 ans que la moitié de ce qu’elle est à présent” (III: 269).
2 See Bidard (2014) for an evaluation of this “dynamic approach which consists in following the transformations of a long-term equilibrium when demand increases” (Bidard 2014: 3).
3 In Chapter II “On rent” of Principles, Ricardo gives a numerical example of the withdrawal of a portion of capital from a land, which ends as follows:
But with such an increase of produce, without an increase in demand, there could be no motive for employing so much capital on the land; one portion would be withdrawn, and consequently the last portion of capital would yield 105 instead of 95, and rent would fall to 30. (I: 81‒2)
4 Say was mentioned in a chapter of Principles devoted to “Mr. Malthus’s opinions on rent” because, in Ricardo’s opinion, Malthus was guilty of the same error as him. Ricardo pointed out in a letter to James Mill on 22 December 1818:
He [Malthus] read to me some more of his intended publication [Principles of Political Economy, 1820]. He has altered his opinion you know about there being land in every country which pays no rent, and appears like M Say to think that when that is proved, my doctrine of rent not entering into price is overthrown – they neither of them advert to the other principle which cannot be touched, of capital being employed on land, already in cultivation, which pays no rent. I have entered my protest against his omitting the consideration of this important fact. (VII: 372)
For Ricardo’s critique of Say, see also the letter to McCulloch of 3 January 1819:
He [Say] attempts to shew that there is no land which does not pay rent, and then thinks that I am confuted – never noticing the other point on which I lay most stress, that there is in every country a portion of capital employed on land already in cultivation for which no rent is paid, or rather that no additional rent is paid in consequence of the employment of such additional capital. (VIII: 4)
5 “The demands for the produce of agriculture are uniform, they are not under the influence of fashion, prejudice or caprice. To sustain life, food is necessary, and the demand for food must continue in all ages, and in all countries” (Principles; I: 263).
6 This quotation is from Chapter XXX “On the influence of demand and supply on prices”, where Ricardo criticises:
[T]he opinion that the price of commodities depends solely on the proportion of supply to demand, or demand to supply, [an opinion which] has become almost an axiom in political economy, and has been the source of much error in that science. (ibid: 382)
In the new final position, the supply has “scarcely varied” as compared with the initial one, since the increase in the supply of corn resulting from “some great discovery in the science of agriculture” has been followed by its nearly equal reduction when the less productive lands have been abandoned. The fall in the price of bread, consequent upon the fall in the price of corn, is thus entirely due to the fall in its money cost of production, which is itself the consequence of a diminution in its difficulty of production since by assumption the value of money has not changed.
7 Analysing the case of the supply being adjusted to a change in demand, Bidard emphasises that “the smooth adaptation of activity levels is a universal property which reduces the core of the dynamics to the identification of the outgoing marginal method and the incoming marginal method at critical moments; we call that phenomenon the law of succession of methods” (Bidard 2014: 5‒6). According to him, “Ricardo’s views […] assumed a smooth physical transition at breaking points and the progressive introduction of one new method” (ibid: 12).
8 “This is in fact the mode in which the cultivation of corn is always extended, and the increased wants of the market supplied” (Principles; I: 306; see also 301‒2, 312).
9 This inconvenience could be eliminated with paper money, even if convertible into gold. The quotation goes on:
As money made of paper may be readily reduced in quantity, its value, though its standard were gold, would be increased as rapidly as that of the metal itself would be increased, if the metal, by forming a very small part of the circulation, had a very slight connexion with money. (ibid: 194).
10 Another question is what happens when there is a change in the aggregate value of the commodities to be circulated; see below Chapter 7.
11 See also in Principles:
It may, however, be again remarked, that unless the monopoly of the foreign market be in the hands of an exclusive company, no more will be paid for commodities by foreign purchasers than by home purchasers; the price which they both will pay will not differ greatly from their natural price in the country where they are produced. England, for example, will, under ordinary circumstances, always be able to buy French goods, at the natural price of those goods in France, and France would have an equal privilege of buying English goods at their natural price in England. (ibid: 340‒1)
This was repeated in Ricardo’s speech in Parliament on 22 May 1823 about East and West India Sugars:
In the speech [of Mr. K. Douglas], however, it was stated, that the price of any commodity did not depend on the cost of cultivation, but on the relation of the supply to the demand. Now, nothing was more unsound. In all cases, the cost of cultivation was sure to regulate the price which any commodity must bear in the markets of the world. As, therefore, the cost of production was acknowledged to be less in the East Indies in the production of sugar, the price of that article in the markets of the world must in the long run be regulated by that cost. (V: 300)
The same applied to gold bullion: “its market value in Europe is ultimately regulated by its natural value in Spanish America” where it is produced (Principles; I: 195).
12 See also: “I have been beyond measure puzzled to find out the law of price. I found on a reference to figures that my former opinion could not be correct and I was full a fortnight pondering on my difficulty before I knew how to solve it” (Letter to James Mill, 14 October 1816; VII: 83‒4). The solution was “the curious effect which the rise of wages produces on the prices of those commodities which are chiefly obtained by the aid of machinery and fixed capital” (ibid: 82). Ricardo’s correction of “former ideas not being correct” is echoed in a letter by Hutches Trower of 19 November 1816, answering to a wanting letter by Ricardo:
The detection of error is as important as the discovery of truth; and therefore I cannot allow, that those two months were useless to you, by the labors of which you were enabled to ascertain the fallacy of the theory you were endeavouring to establish. (VII: 95)
13 The adoption in a Sraffian framework of Ricardo’s assumption about the closure of mines would consequently require gold bullion to be a non-basic good. See also the conclusive section of Chapter 7 below.
14 The argument is the same if the productivity of mine z is lower than that of some of the previous mines, the formalisation being only more complex, since it is then possible that the new natural price is determined by the cost of production in mine z, and not in one of the previous mines.
15 A more complex assumption would be that all portions of capital that become unprofitable after the discovery of the new mine are withdrawn at once. The fall in the total production would push the market price upwards, making it overshoot the cost of production with the least productive portion of capital still earning the general rate of profit. An extra profit would occur, which would induce portions of capital that had been withdrawn to be invested again in the production of gold, till the new natural position is established. The production of gold being competitive, there is no obstacle to capital flowing in after having flown out: provided the adjustment is strictly reversible, the final new natural position would be the same.
16 At the time of Ricardo, the Bank of England was not compelled to buy gold bullion at a fixed price against its notes and only purchased it in the market to replenish the metallic reserve. In his Ingot Plan, Ricardo recommended introducing such legal obligation (see Chapter 9 below) but he was not followed on this point when convertibility into bullion was adopted in 1819. Starting in 1828 the Bank of England committed itself to buy any bullion at the price of £3. 17s. 9d., that is, 0.16 per cent below the legal price of gold in coin. This was later officially introduced in the Bank Charter Act of 1844.
17 Ricardo also objected that the absolute increase had been in fact lower than claimed by the directors of the Bank of England (IV: 232‒3).
18 Quoting the “Minutes of Evidence” before the Agricultural Committee of 1821, Sraffa observes in a footnote that “Tooke actually said ‘About six per cent’” (IV: 228n).
19 As mentioned in Chapter 5 above, Ricardo emphasised that, by contrast with corn which is totally consumed during the circulation period, gold may be used as money during a long time, so that the adjustment process of its market value is slower. He assumed here by simplicity that the total quantity of gold used as money had again to be produced (in the Spanish colonies) and imported (in Europe) after the imposition of the tax.
20 See the model below for the reason why Ricardo is right in supposing that mine 2 must also close down.
21 Dome (2004) interprets the consequences of a tax on gold in the usual terms of the price-specie flow mechanism: “The money supply would diminish, and the general price level would fall. The balance of trade would become favourable to this country. However, such a trade surplus would disappear in the long run because of the specie-flow price mechanism” (Dome, 2004: 125). As the numerical example given by Ricardo makes clear, the adjustment to the tax entirely takes place in the domestic gold industry and in no way implies any other international change than an increase in the real price of gold in cloth. The “pure gain” consequent upon this change is permanent.
ranked according to their decreasing productivity;
