8  The international adjustment to a monetary shock

It appears to me, that the balance of payments is frequently the effect of the situation of our currency, and not the cause.

(Evidence before the Commons’ Committee on the Resumption of Cash Payments, 4 March 1819; V: 395)

Among the many paradoxes that plague the evaluation of Ricardo in the literature, his treatment of international economics does not give rise to the least. On the one hand, modern economic textbooks frequently only mention Ricardo for his contribution to the analysis of international trade, the exchange of English cloth for Portuguese wine being one of the favourite landmarks in basic economic knowledge. On the other hand, his contention that an excess note issue was in all circumstances the sole cause of a fall in the exchange rate has nourished the recurrent accusation of theoretical extremism, in contrast with someone like Thornton who acknowledged that exogenous factors affecting the balance of payments could also be responsible for such unfavourable exchange. It is not difficult to explain why in the same field of economic analysis universal praise may coexist with utmost indignity. The fame of the Ricardian model of international specialisation owes much to its reformulation in neo-classical terms by the so-called Heckscher–Ohlin–Samuelson theorem, which abstracts from money. And the question of whether an excess quantity of money is a necessary and sufficient condition for a fall in the exchange rate is usually understood as a short-term macroeconomic problem, distinct from the long-term microeconomic selection (based on comparative costs) of the pattern of international trade. The supposed absence of linkage between the two questions makes it easy to applaud Ricardo for the one and blame him for the other.

Along the path opened by Viner (1937: 138‒7, 295‒6) and Rist (1940 [1938]: 159‒70), modern literature has discussed the role of international adjustment in Ricardo’s monetary theory, although with diverse and often conflicting interpretations (see, for example, Mason 1957, Grubel 1961, O’Brien 1975, Peake 1978, Hollander 1979, Chipman 1984, Perlman 1986, Marcuzzo and Rosselli 1987, 1991, Deleplace 2001, 2008, Davis 2005, de Boyer des Roches 2007, 2008, 2013, Rosselli 2008). Most – but not all – of this literature attributes to Ricardo a crude version of the price-specie flow mechanism, originating in Hume (1752) (see Chapter 1 above), which relies on changes both in the quantity of money and in the balance of trade. In this literature the story of the international adjustment in Ricardo usually goes like this. The only possible cause of a country’s foreign deficit is the excess in the domestic quantity of money. Starting by assumption from an equilibrium situation, characterised by a given distribution of the precious metals amongst the nations of the world, an increase in the domestic quantity of money above the natural level corresponding to that distribution lowers the value of the currency in terms of commodities, a corollary being that the money prices of all commodities proportionally increase. Goods produced domestically become dearer in comparison with the same goods produced abroad; exports are reduced and imports increased, so that the balance of trade is against the country. By the same token, the depreciated domestic currency becomes cheaper in terms of the foreign ones. The coin and bullion are exported, paying for the trade deficit, and the quantity of money is consequently reduced. This process goes on as long as the currency remains in excess, and stops only when the natural level of the quantity of money is restored. Domestic prices regain their equilibrium level and so do exports and imports, bringing the trade balance back to even and the exchange rate at its equilibrium level.

Following the demonstration, made in Chapter 7 above, that the usual attribution to Ricardo of a quantity theory of money is erroneous, the object of the present chapter is to show that this usual story does not fit Ricardo’s analysis of international adjustment to a monetary shock. So doing, it is in keeping with a trend of research opened by Marcuzzo and Rosselli (1991) and complementing the old question of real versus monetary causes of gold flows and of variation in the exchange rate with the new question of how these changes were implemented (for the most recent and compact exposition of this shift in perspective, see Rosselli 2008). The chapter is divided into five sections. First, I will show that Ricardo used notions widely accepted at the time – such as the real par of exchange and the bullion export and import points (Section 8.1). He used them to explain how international adjustment operated in two successive steps, implying gold bullion and other commodities (Section 8.2). The much-criticised proposition according to which a fall in the exchange rate could only be explained by a redundancy of currency appears then, with appropriate qualification, as a necessary outcome of his monetary theory (Section 8.3). In Ricardo’s view, international adjustment was not to be expected from the effect of hydraulics of money on the balance of trade – the so-called price-specie flow mechanism – but from an active management of the quantity of money (Section 8.4). This analysis fits Ricardo’s general approach to money, as it is illustrated by the Ingot Plan, and includes the foreign balance in the policy rule to be applied to the monetary system – what will later be called the gold-exchange standard (Section 8.5).

8.1 Real par of exchange and bullion points

The legal par of exchange

The notion of par of exchange is as old as the trade in foreign bills of exchange. In the sixteenth century, at the peak of the European network of exchange by bills centred on the fairs of Lyons, Italian merchant-bankers were accustomed to calculate the “parità” on the basis of the legal values of the coins accepted to discharge the balance after clearing of their credits and debts. Knowing the intrinsic weight of pure metal legally contained in the gold coins of the various countries between which they traded bills, and the values in each monetary unit at which these coins were legal tender, they could calculate for any pair of these monetary units the level of the exchange rate that equalised the quantities of gold contained in the corresponding coins. This benchmark – the par of exchange – could then be used by the merchant-bankers collectively – when the list of exchange rates (“conto”) was voted at the end of each of the four yearly Lyons fairs – or individually – when a particular bill was negotiated – to determine the actual exchange rates written in the bills. Since at that time the best gold coins of the major continental coinages (France, Spain, Florence, Genoa, Venice) were legal tender in the countries linked by the network of bills of exchange, there was not one but several legal pars according to the coin on which they were calculated. The “art” – as it was then called – of merchant-banking was to take advantage of this variety for the calculation of the exchange rates written in the bills, so as both to generate profit and to comply with the legal values of the currencies fixed by the States (see Boyer-Xambeu, Deleplace and Gillard 1986, 1994a).

Things changed in the seventeenth century, for two reasons. First an institutional one: in most countries foreign coins were prohibited from circulating and had to be exchanged for domestic coins at the counters of money-changers. There existed now one single legal par of exchange for each pair of monetary units, equal to the ratio of the legal prices of a given weight of pure metal coined by each of the two mints. Secondly there was a theoretical reason: it was more and more recognised that the divergence between the actual exchange rate, quoted regularly in the foreign-exchange market, and the legal par of exchange, was an indicator of the state of the balance of trade between the two corresponding countries. When the aggregate value (measured in any of the two monetary units) of the exports from country A to country B was equal to the aggregate value (measured in the same unit) of the imports of A from B, bills issued in A on B to pay for the imports exactly balanced bills issued in B on A to pay for the exports. The foreign-exchange market cleared the payments between the two countries without any transfer of precious metal being necessary. Neither exporters nor importers were in a position to obtain in this market more of the foreign money than what was indicated by the par. In contrast, when the aggregate value of the exports from A to B was greater (lower) than the aggregate value of the imports of A from B, competition among exporters (importers) to sell (buy) the foreign money increased (decreased) the exchange rate of the domestic money above (below) the par. By comparing the actual exchange rate with the par it was thus possible to infer the state of the balance of trade between the two countries.

This was not just a matter of diagnosis; the cure of the illness was also involved. When the balance of trade of A with B was adverse, it had to be paid one way or another. If A had a positive balance with C, credits on C could be used to pay for the deficit with B. It was the job of traders in bills of exchange to implement such international arbitrage between foreign-exchange markets – with profit. But if the foreign balance of A – that is, the consolidated balance with all foreign countries – was adverse, precious metals (gold and silver) had to be transported abroad in order to pay for the deficit. Here also, this operation was implemented by private arbitragers, and, in addition to the foreign-exchange markets, it involved the markets for bullion. By bullion one meant exportable gold or silver, whether in the form of bars or coins taken by weight, since, because foreign coins were not legal tender, a debt could only be discharged abroad through the coining of the exported bullion at the local mint. This exportation of bullion consequent upon an adverse foreign balance was not only a source of profit for private arbitragers. From a mercantilist point of view, in which precious metals were considered as a privileged form of wealth, it meant that the country impoverished itself: it was an illness to be cured.

Again, both an institutional and a theoretical question were raised by international arbitrage on bullion. First, a market for bullion had to be organised in each main centre where bills of exchange were traded, with regular quotations advertised publicly. In London, John Castaing, “brooker at his office, Jonathans Coffee House”, started in 1698 to publish every Tuesday and Friday (the days of quotation) The Course of Exchange, which contained quotations of the exchange rates of the pound against various foreign currencies, as well as the prices of gold and silver bars and of some foreign coins taken by weight. Second, the observed practice of arbitrage on foreign exchange and bullion raised the question of the conditions of arbitrage. When, because of an adverse balance of trade, the exchange rate of the pound against a given foreign currency (say, French livres) fell, there came a moment when traders in the London market for bullion discovered that a profit could be made with the following operations: they sold at a high price a bill of exchange in livres payable in Paris, purchased gold bullion with the proceeds in pounds, exported it to Paris where it was sold for livres used to pay the bill. Alternatively, they could advance their own money to purchase in London gold bullion to be sold in Paris, and reimburse themselves by buying in Paris at a low price a bill of exchange in pounds payable in London. In both cases, the profit by arbitrage was equal to the difference between the arbitrated price of bullion in Paris – that is, its market price in livres converted into pounds at the ruling exchange rate – and its price in the London market, taking into account the cost of transportation of gold bullion from London to Paris.

This international arbitrage on foreign exchange and bullion had an effect on the exchange rate of the pound against livres: since arbitragers sold in London a bill in livres payable in Paris or bought in Paris a bill in pounds payable in London, an upward pressure was triggered on the pound, which counteracted the downward pressure consequent upon the adverse balance of trade. If arbitrage was powerful enough – thanks to the organisation of the bullion markets – it stopped the fall of the pound. Arbitrage itself stopped when the rise of the pound triggered by it cancelled the profit made. The level at which the exchange rate then settled was the export bullion-point: exportation of bullion by arbitrage started when the falling exchange rate of the pound hit this point. Symmetrically, a rise in the exchange rate of the pound consequent upon a favourable balance of trade with France triggered an import of gold when it hit the import bullion-point, and this prevented the pound from rising further.

The main conclusion was that international arbitrage on bullion stabilised the exchange rate within limits which depended on the magnitudes entering the calculation of the arbitragers. These magnitudes were of two kinds: the various costs involved by the transfer of bullion from, say, London to Paris (at the export) and Paris to London (at the import) and the price of gold in each of the two financial centres. In the same manner as the deviation of the exchange rate from the legal par was an indicator of the state of the balance of payments between two countries, the addition (subtraction) of the parametric cost of transfer of bullion to (from) the legal par of exchange gave the import (export) bullion-point at which international arbitrage started and stopped the rise (fall) of the exchange rate. At the end of the seventeenth century, these notions of par of exchange and of bullion points were common knowledge among international arbitragers and authors discussing the state of the exchange.

The real par of exchange according to Steuart

The use of the legal par of exchange to infer whether the balance of payments with a given foreign country was favourable or adverse and to calculate the import and export bullion points by which the variations in the exchange rate were constrained was convenient because the legal price of gold in coin in each country was a given magnitude which was left unchanged by the State, except in extraordinary circumstances. But it nevertheless opened a margin of error, both for the diagnosis of the balance of payments and the calculation of the bullion points. The reason for this error was to be found in the inaccuracy of the circulating coins for calculating the par of exchange that equalised the quantities of gold contained in them. This was obvious when circulating coins were debased, that is, when wear and tear or clipping made them contain less pure gold than they legally should. The real par of exchange, as it was called – that is, the par that equalised the actual quantities of gold contained in the domestic and the foreign coins – then differed from the legal par of exchange – calculated on the basis of the legal quantities. More generally, international arbitragers on gold bullion purchased and sold it in its domestic and foreign markets, where the price – hence the conditions of arbitrage – could differ from the legal price of gold in coin. The diagnosis of the balance of payments and the understanding of the limits between which the exchange rate could vary required the analysis of the factors which could make the market price of gold bullion diverge from the legal price of gold in coin – hence the real par of exchange diverge from the legal par.

The author who in the second half of the eighteenth century most attracted attention on this question was Sir James Steuart, of whom Ricardo said that “[his] writings on the subject of coin and money are full of instruction” (Proposals, IV: 59). In his Principles of Political Oeconomy (1767), Steuart criticised Cantillon¹ for calculating “the par of exchange according to the common rule”, that is, the legal par:

Mr. Cantillon, in his Analysis of Trade, which I suppose he understood by practice as well as by theory, has the following passage in his 99th page: “The course of exchange between Paris and London since the year 1726, has been at a medium price of 32 pence sterling for the crown of three livres; that is to say, we pay for this French crown of three livres, 32 pence sterling, when calculated on gold, when in fact it is worth but thirty-pence and three farthings, which is giving four pounds in the hundred for this French money; and consequently, upon gold, the balance of trade is 4 per cent. against England in favour of France.” In this place, Mr. Cantillon calculates the par of exchange according to the common rule, to wit, gold bullion against gold bullion in the coins of both nations, where both are supposed to be of legal weight; and he finds that there has been, these thirty-four years past, a balance of 4 per cent. against England. Now, according to my theory, it is exactly what the coinage in France ought to produce, supposing on an average that the trade had been at par.

(Steuart 1767, II: 17; III: 35)²

What was Steuart’s “theory”, which attributed the alleged unfavourable exchange of 32 pence per French crown (above the legal par of 30.75) to the characteristics of coinage in France, and not to an adverse English balance with France as supposed by Cantillon? It was based on the notion of “real par of exchange”:

The general rule, therefore, I think, is, to settle the real par of different coins, not according to the bullion they contain, but according to the bullion they are worth in their own market at the time.

(ibid, II: 23; III: 41; Steuart’s emphasis)

One should thus determine the par by calculating, not the ratio of the respective quantities of gold legally contained in the full-bodied coins of both nations, but the ratio of the respective market prices of the same quantity of gold bullion. An analysis based on the legal par of exchange did not reflect the “complicated operations” of merchants and precluded the understanding of “the principles upon which they are founded”:

To calculate, as every body does, the par of the French crown, either by the gold or the silver in the English standard coin, when no such standard coin exists; and to state all that is given for the crown above 29½d., if you reckon by the silver, or 30¾d. if you reckon by the gold, for the price of a wrong balance, is an error which may lead to the most fatal consequences.

(ibid, II: 320; III: 344)

In contrast with the legal par of exchange which was fixed, the real par of exchange might take a maximum or a minimum value according to the possible deviation of the market price of gold bullion from the legal price of gold in coin in each country:

But suppose two cases which may happen, viz. 1. That gold bullion at Paris should be at the price of coin, while at London it may be at mint price; or, 2. That at Paris it may be at mint price, when at London it is at 4l. 0s. 8d. what will then the real par of exchange be? I answer, that on the first supposition, it will be […] the crown of 3 livres equal to 30.076 pence sterling. In the other, [it will be] for the crown of 3 livres 33.728. A difference of no less than 8.9 per cent. Is it not evident that these variations must occur in the exchange between London and Paris? And is it not also plain, that they proceed from the fluctuation of the price of bullion, not from exchange?

(ibid, II: 319; III: 343)

In the first case, the market price of gold bullion was at its maximum in Paris (equal to “the price of coin”) and at its minimum in London (equal to “mint price”); the real par of exchange of the French crown in English money – equal to the ratio of the market price of gold bullion in London to that in Paris³ – was at its minimum, viz. 30.076 pence sterling per crown. In the second case, the market price of gold bullion was at its minimum in Paris (equal to “mint price”) and at its maximum in London (equal to £4. 0s. 8d., giving a melting cost of 3.6 per cent);⁴ the real par of exchange was at its maximum, viz. 33.728 pence sterling per crown. An observed exchange rate of 32 pence per crown, which, compared to the legal par of 30.75, seemed to indicate a balance with France of 4 per cent against England, really revealed a favourable balance for England when compared to a real par of 33.728 (for more details, see Deleplace 2015d).

The bullion points in Ricardo

At the time of Ricardo, all that was well-known, and the gold-points mechanism, as it would be called later in the literature, was disputed by no one. This of course included Ricardo.⁵ The two factors constraining the variations in the exchange rate – the cost of transferring bullion from one country to the other, and the real par of exchange – were mentioned by him on various occasions, in the Bullion Essays or in later writings.

In addition to the profit at the general rate, the transfer cost included transportation and the interest rate during the length of the operation:

Your remark that if no expences whatever attended the transmission of the metals from one country to another the exchange might nevertheless deviate from par on account of the time necessary to transmit them is quite correct, I consider the loss of interest for the time occupied in transmitting them as a part of the expence.

(Letter to McCulloch, 18 December 1819; VIII: 141)

In peacetime, the cost of transferring bullion was low, viz. less than 1 per cent with Paris in 1822:

Mr. Ricardo wished to set the hon. baronet right, as to the state of the exchange, which was now, he could assure him, very nearly at par; and it was impossible it could be far otherwise, because with a metallic circulation in this country and in France, the exchange could never vary more than from ½ to ¾ per cent.

(Speech in Parliament on 16 May 1822; V: 186‒7)

However, during the Napoleonic wars, this cost was equal to several percentage points (Ricardo mentioned 4 or 5 per cent between London and Hamburg in 1809 and 7 per cent in 1811; III: 24 and 198 respectively), especially after the Milan decrees implemented a blockade of all trade between Britain and the Continent:

The exchange in my opinion is, even in these turbulent times, rarely operated upon but by two causes: one, and that by far the most common is an alteration, or an apprehended alteration, in the relative prices of commodities in the two countries between which the exchange is estimated, and is in most cases to be traced to some augmentation or diminution in the amount of the currency of one of them. The other is an increased or diminished difficulty and expence, (or the anticipation of such) attending the transmission of money. The exchange with the continent has, I believe, for a length of time, not only been unfavourable to this country to the amount of the depreciation of our currency but considerably more, as much more probably as to 10 to 15 pc^t. This real difference in the price of money, (for the exchange expresses nothing more than the relative price, and not the relative value of money) as well as the real difference in the price of sugar or coffee, may be attributed to the difficulties which our enemy has interposed in the way of exportation. If then these difficulties should diminish, or should be expected to diminish, from the pacific disposition of one or more of the continental Powers the relative price of money as well as of all other commodities would be raised in England, – or in other words, the exchange would become less unfavourable to England by the whole amount of the diminished risk and expence attending the exportation of money.

(Letter to Horner, 4 January 1812; VI: 79‒80; Ricardo’s emphasis)

When the domestic currency was neither depreciated nor appreciated, the market price of gold bullion was equal to the legal price of gold in coin and, supposing the same in the foreign country, the real par of exchange was consequently equal to the legal par. The exchange rate could then only diverge from the par in the limit set by the cost of transferring bullion:

If the trade in the precious metals were perfectly free, and money could be exported without any expense whatever, the exchanges could be no otherwise in every country than at par. If the trade in the precious metals were perfectly free, if they were generally used in circulation, even with the expenses of transporting them, the exchange could never in any of them deviate more from par, than by these expenses. These principles, I believe, are now no where disputed.

(Principles; I: 230)⁶

When the domestic currency was depreciated, the discount on the bank notes paying for the bills of exchange opened an additional margin of variation in the exchange rate:

While the circulating medium consists, therefore, of coin undebased, or of paper-money immediately exchangeable for undebased coin, the exchange can never be more above, or more below, par, than the expences attending the transportation of the precious metals. But when it consists of a depreciated paper-money, it necessarily will fall according to the degree of the depreciation.

(High Price; III: 72)

This meant that to determine the actual limits set to the variations of the exchange rate by the transfer costs one had to substitute the market price of gold bullion in each of the two countries for the legal price of gold in coin. Instead of calculating the bullion points by adding to (subtracting from) the legal par the cost of importation (exportation) of bullion, one should calculate them on the basis of the real par of exchange, that is, the ratio of the market prices of gold bullion. This is what Ricardo explained to McCulloch in a letter dated 2 October 1819:

Double the quantity of currency in England and commodities will rise to double their former price in England, and twice the quantity of the money of England will be given for the former quantity of the currency of France. This is undoubtedly a mere nominal alteration, the real value both of commodities and bills will be the same as before. In fact the real par is altered, and nothing else. Instead of ascertaining the par by a consideration of what the pound sterling was formerly worth, it should be computed with reference to its present value, which is to be known by the value of the bullion which a pound can command. […] The real par is justly estimated by the current value of the pound sterling – that current value is depreciated, hence a new real par is, or ought to be, established.

(VIII: 87‒8, 91)⁷

The associated notion of real exchange rate was also present in Ricardo, as in the same letter:

If the exchange be 5pc^t against Rio Janeiro and money therefore comes to England,⁸ I agree with you that it is to that amount relatively depreciated in Rio Janeiro, 105 ounces of silver in one place is really paid to obtain 100 ounces in the other, but the exchange which is the consequence of this relative depreciation should I think be called real and not nominal.

(ibid: 92‒3)

Suppose that gold bullion may be transported from Rio to London at no cost. Because of arbitrage triggered by competition in the world market for bullion, 100 ounces of bullion purchased in Rio would exchange in London for 100 ounces of bullion, meaning that the price of 100 ounces in Brazilian money would be equal to the price of 100 ounces in English money, at the ruling exchange rate of the two currencies. If, however, the cost of transferring bullion from Rio to London is 5 per cent, 105 ounces of bullion purchased in Rio are necessary to exchange in London for 100 ounces of bullion, because 5 ounces cover the transfer cost. This circumstance is real – it applies to the market of any commodity, the level of the transfer cost depending on the characteristics of the commodity – and the 5 per cent unfavourable exchange of the Brazilian money may consequently be called real, in contrast with an unfavourable nominal exchange which would reflect a domestic depreciation of the currency due to its redundancy. The real exchange rate of the Brazilian money in terms of the English pound is here 0.95, that is, the quantity of gold bullion obtained in London against an ounce purchased in Rio.

The two notions of real par of exchange and of real exchange rate put the market for gold bullion centre-stage in international adjustment. This is at odds with the frequent contention in modern literature that the real par of exchange was only a proxy of the purchasing power parity over all commodities. This contention should be disclaimed, as was in Chapter 3 above the related statement that the market price of gold bullion was only a proxy of the general price level.

The real par computed on gold bullion, not the purchasing power parity over commodities

“I know I shall be soon stopped by the word price” (VI: 348): we saw in Chapter 3 above that in 1815 Ricardo became conscious of the necessity, when the money price of a commodity changed, to disentangle what was caused by a change on the side of money and by a change on the side of the commodity. This question was crucial for the theory of value and distribution developed two years later in Principles, as emphasised in Chapter VII “On foreign trade”. In both cases the money price of the commodity would change, but a change in the value of money would not affect the general rate of profit, while a change in the difficulty of production of the commodity would affect it, if this commodity was a wage-good or used to produce a wage-good (see the long quotation from I: 145‒6 in Chapter 6 above).

After having considered in the previous chapters the effect of the conditions of production of a commodity on its relative value and on the distribution of income, Ricardo concentrated in Chapter VII of Principles on their effect on the value of money, as might be expected in a chapter devoted to the analysis of foreign trade. The case was the following: a country (England) enjoying a particular advantage increased her exports of some commodities and, the exchange rate of her money having consequently risen to the bullion import point, it received bullion that was coined. This increase in the quantity of money acted as a monetary shock which ended up in a general rise in prices:

When any particular country excels in manufactures, so as to occasion an influx of money towards it, the value of money will be lower, and the prices of corn and labour will be relatively higher in that country, than in any other.

This higher⁹ value of money will not be indicated by the exchange; bills may continue to be negociated at par, although the prices of corn and labour should be 10, 20, or 30 per cent. higher in one country than another. Under the circumstances supposed, such a difference of prices is the natural order of things, and the exchange can only be at par, when a sufficient quantity of money is introduced into the country excelling in manufactures, so as to raise the price of its corn and labour. If foreign countries should prohibit the exportation of money, and could successfully enforce obedience to such a law, they might indeed prevent the rise in the prices of the corn and labour of the manufacturing country; for such a rise can only take place after the influx of the precious metals, supposing paper money not to be used; but they could not prevent the exchange from being very unfavourable to them. If England were the manufacturing country, and it were possible to prevent the importation of money, the exchange with France, Holland, and Spain, might be 5, 10, or 20 per cent. against those countries.

Whenever the current of money is forcibly stopped, and when money is prevented from settling at its just level, there are no limits to the possible variations of the exchange.

(Principles; I: 146‒7)¹⁰

In this extract Ricardo distinguished between two cases. If there was no obstacle to the international transfer of gold bullion, prices in England rose and the exchange rate of the pound, which had previously risen with the additional exports, was lowered till it was brought back to par. The ensuing situation was thus characterised by the coexistence of higher prices in England and an exchange rate at par: this was “the natural order of things”. If there were obstacles (for example, of a legal nature) to the international transfer of gold, which prevented it from being imported in England, prices did not rise and the exchange of the pound remained above par, that is, against the other countries (“France, Holland, and Spain”) who imported the English commodities.

One observes that in “the natural order of things” – when there was no obstacle to the international transfer of gold bullion – the exchange was at par while the value of money (which, it should be recalled, was its purchasing power over all commodities except the standard; see Chapter 3 above) would differ in each country. In other words, money prices would differ, except for the standard:

When each country has precisely the quantity of money which it ought to have, money will not indeed be of the same value in each, for with respect to many commodities it may differ 5, 10, or even 20 per cent., but the exchange will be at par. One hundred pounds in England, or the silver which is in 100l. will purchase a bill of 100l., or an equal quantity of silver in France, Spain, or Holland.

In speaking of the exchange and the comparative value of money in different countries, we must not in the least refer to the value of money estimated in commodities, in either country. The exchange is never ascertained by estimating the comparative value of money in corn, cloth, or any commodity whatever, but by estimating the value of the currency of one country, in the currency of the other.

(ibid: 147)

When the exchange was at par (here computed on silver) between England and France, Spain, or Holland, £100 purchased in the London bullion market the same quantity of silver which exchanged in Paris, Madrid, or Amsterdam for a bill of £100 on London. In other words, the price of this quantity of silver was in England £100, and its price abroad was also £100, since it could exchange for a bill of £100 on London. This was the definition of the exchange of the pound against the French, Spanish, or Dutch currency being at (the real) par. But the price of a given quantity of any other commodity, which was in England £100, could be £80 or £120 abroad, meaning that it exchanged for a bill of £80 or £120 on London. One cannot be clearer: the exchange being at par – that is, the purchasing power of money over the standard being equalised across countries – did not imply that the value of money was the same in these countries – in other words that the purchasing power parity over commodities held.¹¹

This analysis leads to an important conclusion: what in Chapter VII “On foreign trade” of Principles Ricardo called “the equilibrium of money”¹² was such that the value of money in terms of the standard was the same in all countries (the exchanges were at par), not that the value of money in terms of all other commodities was the same. His emphatic distinction between the real par of exchange (computed on gold bullion) and the ratio of the respective values of money in terms of all commodities except the standard was the direct consequence of his distinction between the depreciation of money and a fall in the value of money, a distinction in which his theory of money – as illustrated by the Money–Standard Equation – was grounded (see Chapter 4 above). It is noteworthy that this chapter was the first occasion when this distinction was introduced in Ricardo’s writings, before it became so important in his papers of 1819‒1823:

Some indeed more reasonably maintained, that 130l. in paper was not of equal value with 130l. in metallic money; but they said that it was the metallic money which had changed its value, and not the paper money. They wished to confine the meaning of the word depreciation to an actual fall of value, and not to a comparative difference between the value of money, and the standard by which by law it is regulated.

(ibid: 149)

The notion of par of exchange being now clarified,¹³ the relations between the magnitudes involved in international adjustment may be formalised.

The limits to the variations of the exchange rate

Let me suppose that gold is the monetary standard in the two countries – for example England and France – for which the exchange is quoted. During the Napoleonic wars, the exchange between London and Paris was quoted irregularly, and the examples given by Ricardo in the Bullion Essays concerned the exchange with Hamburg, more complicated since England was on a de facto gold standard while Hamburg was on a de jure silver standard (see Appendices 1 and 8). In his later writings Ricardo referred mostly to the exchange with Paris. The French monetary system was on a double standard, and the par of exchange could consequently be calculated on the basis of the common standard, gold. London (L) and Paris (P) thus quoted the nominal exchange rate e of the pound (£) in terms of French francs (F)¹⁴ and the respective market prices and of gold bullion. With and the respective legal prices of gold in coin, the legal par of exchange of the pound in francs was defined as the level of the exchange rate which equalised the quantity of coined gold legally contained in one pound and in francs:

(8.1)

The real par of exchange of the pound in francs was defined as the level of the exchange rate which equalised the quantity of gold bullion purchased by one pound in the London market and by francs in the Paris market:

(8.2)

The real exchange of the pound in terms of French francs was the quantity of gold bullion (in ounces) purchased in Paris exchanging at the ruling nominal exchange rate for an ounce purchased in London. If an ounce was purchased in London , hence e in French francs at the ruling nominal exchange rate e of the pound in francs, it exchanged in Paris for e ounces, with the price of the ounce in Paris. In other words, the real exchange rate of the pound in terms of French francs was the price of bullion in London relative to its price in Paris, the numerator and the denominator being both expressed in francs:¹⁵

(8.3)

From (8.2) and (8.3) one derives the relation between the real exchange rate and the real par:

(8.4)

It was thus equivalent to say that the exchange was favourable (unfavourable) to England when the nominal exchange rate of the pound was above (below) the real par or when the real exchange rate of the pound was above (below) one.

International arbitrage constrained the nominal exchange rate e between an upper limit at which importation of gold bullion started and a lower limit at which its exportation started. Gold bullion purchased in Paris at was transferred to London at a percentage cost and sold in the London market at ; the import bullion point was thus the quantity of francs that should be given in Paris to obtain one pound in London by such operation. The same bullion purchased in London at was transferred to Paris at a percentage cost and sold in the Paris market at ; the export bullion point was thus the quantity of francs that could be obtained in Paris against one pound in London by such operation. The limits of variation of e thus depended on the real par of exchange and the cost of transferring bullion both ways:

(8.5)

In Chapter 6 above, inequalities (6.1) expressed the limits between which the market price of gold bullion could vary when bullion was converted into coin at the mint at a cost and coin was converted into bullion in the melting pot at a cost :

(6.1)

Applying (6.1) to England and France, one may use Steuart’s method and calculate the maximum level of the real par , which according to (8.2) obtained when was at its upper limit and at its lower limit:

(8.6)

Hence, according to the definition of the legal par of exchange given by (8.1):

(8.7)

Symmetrically, the minimum level of the real par obtained when was at its lower limit and at its upper limit:

(8.8)

Hence:

(8.9)

From (8.5), (8.7), and (8.9) one may deduce the upper and lower limits of variation of the exchange rate e of the pound:

(8.10)

Another expression of the bullion points was given by the limits that constrained the real exchange rate . When , the price of gold bullion in London, converted in francs at the ruling nominal exchange rate, was equal to the price in Paris: there was no incentive to move gold between the two centres either way. When , an ounce of gold bullion was dearer in London than in Paris: it paid to import it in London from Paris, provided the percentage difference with 1 covered the percentage cost of this importation. When , an ounce of gold bullion was cheaper in London than in Paris: it paid to export gold bullion from London to Paris, provided the percentage difference with 1 covered the percentage cost of this exportation. From (8.4) and (8.5), one may deduce:

(8.11)

As mentioned by Ricardo in the letter to McCulloch dated 2 October 1819:

The expence of sending it [money] from one country to the other […] is always the range within which the real exchange varies.

(VIII: 93)

Ricardo could then use the notions of real par of exchange and of real exchange rate to explain how international adjustment operated through the transfer of gold bullion.

8.2 A two-stage international adjustment process

A double condition on the exchange rate

Whatever the commodity (including gold bullion) the profitability of exporting or importing it was computed by comparing its domestic and its foreign price. Since the latter was denominated in a foreign currency, it should be expressed in the domestic currency thanks to the exchange rate. As mentioned above, at the time of the Bullion Essays the exchange rate significant in expressing the foreign value of the pound was against the Flemish schilling, the monetary unit used to quote the exchange in Hamburg (see Appendix 1 above). The market price of commodity i in London was thus to be compared with its arbitrated price in Hamburg, with the market price in Flemish schillings and e the exchange rate of the pound sterling in Flemish schillings. If the domestic price differed from the foreign arbitrated price by at least the cost of transferring i (including the ordinary profit) one direction or the other, it was profitable to export or import it, according to the sign of the difference.

One of the objects of Ricardo’s inquiry in the Bullion Essays was to analyse the effect of a depreciation of the English currency – defined as the excess of the market price of gold bullion above the legal price of gold in coin – on the terms of such comparison, when it was made for gold bullion. In other words, the question was whether the observed exportation of gold bullion was caused by the domestic depreciation of the pound or by other (non-monetary) factors. Ricardo defended the former explanation – as it was also contended by the Bullion Report. It was thus necessary for him to demonstrate how the depreciation of the pound led to the exportation of gold bullion.

However, this was not enough. It was contended by some participants to the Bullion debates that the causality between the excess of the market price of gold bullion above the legal price of gold in coin and the exportation of bullion could be reversed: the deficit of the balance of payments – explained by non-monetary factors, such as abnormal imports of corn following a bad harvest, financial transfers caused by war, or impediments to exports – pulled the exchange rate of the pound downwards. When it reached the export bullion point, gold was exported to pay for the deficit, and in the London market the higher demand for bullion with a view to exportation pushed its market price above the legal price of gold in coin. With this reversed causality Ricardo consistently disagreed, in the Bullion Essays as in later writings:

The fall in the exchange, or the unfavourable balance of trade, is stated to be the cause of the excess of the market above the mint price of gold, but to me it appears to be the effect of such excess.

(High Price; III: 64)¹⁶

Question: Assuming that the balance of payments should be against this country, must the payment not necessarily be made, either in specie or in bullion?

Answer: It appears to me, that the balance of payments is frequently the effect of the situation of our currency, and not the cause.

(Evidence before the Commons’ Committee on Resumption of Cash Payments, 4 March 1819; V: 395)

It was thus necessary for Ricardo to show, not only that the depreciation of the English currency caused the exportation of gold bullion, but also that it was this exportation which triggered an additional importation of commodities, making the foreign balance apparently unfavourable, instead of the exportation of bullion paying for a pre-existing unfavourable foreign balance, as contended by some. The demonstration thus required a two-stage adjustment process.

Starting from an even trade balance – that is, a given pattern of exports and imports of commodities, excluding any transfer of gold either way – and for a given price of bullion in Hamburg , an export of gold bullion was to be implemented according to the respective variations in and e. If increased and e declined by the same percentage, the terms of the comparison between the domestic price and the foreign arbitrated price of gold bullion were similarly affected, and, as in the initial situation, no profitable export of it from London to Hamburg occurred. In Reply to Bosanquet, this conclusion was borrowed by Ricardo from Blake – to criticise it:

Many pages are employed [by Blake] in proving, that on every addition to the paper circulation, even when a great part of the currency consists of the precious metals, the price of bullion will be raised in the same proportion as other commodities; and as the foreign exchange will be nominally depressed in the same degree, no advantage will arise from the exportation of bullion.

(Reply to Bosanquet; III: 209)

The condition for gold to be exported in response to the depreciation of the currency was therefore that the price of bullion increased less than the prices of all other commodities, including the prices of the bills of exchange denominated in foreign currencies – that is, less than the exchange rate of the pound declined – so that the foreign arbitrated price of gold exceeded the domestic price by a margin covering the cost of the export.

Symmetrically, the condition for commodity i to be imported in response to the depreciation of the currency was that the domestic price of i increased more than the exchange rate of the pound declined. If both moved in the same proportion (in opposite directions), the gain on the sale in London of the commodity imported from Hamburg would be exactly compensated by the loss on the bill of exchange, and this import would not be more profitable than in the initial situation.

It appears then that the decline in the relative price of gold bullion in terms of commodities in England was not a sufficient condition to trigger an export of gold and an additional import of commodities. Since international trade was no barter but an exchange implemented through bills of exchange, the condition on the exchange rate of the pound was that it should decline more than the domestic price of bullion increased but less than the domestic price of importable commodities increased. Since all market prices (including prices of gold bullion and of the bills of exchange denominated in foreign currencies) were affected in the same proportion by the depreciation of the currency, this double condition implied that something special occurred, either in the market for gold bullion or the market for bills of exchange or both. Let me examine successively each part of this condition on the exchange rate.

The first stage: the exportation of gold bullion

We saw in Chapter 6 that the immediate consequence of the depreciation of the currency was that the increase in the money price of bullion was channelled in the same proportion to all prices of commodities. The same phenomenon occurred in the market for bills of exchange: in Hamburg, a buyer of a bill in pounds on London offered fewer Flemish schillings than when the exchange was at the legal par, since he knew that the bill would be paid to him in London in depreciated Bank of England notes:

When it is said that we may obtain 1l. 5s. for a guinea by sending it to Hamburg, what is meant but that we may get for it a bill on London for 1l. 5s. in bank-notes? Could this be the case if the bank paid in specie? Would any one be so blind to his interest as to offer me one guinea in specie and four shillings, for a guinea, when he might obtain the same at Hamburg at par, paying only the expenses of freight, &c.? It is only because he cannot get a guinea at the Bank for notes, that he consents to pay it with notes at the best price he can, or in other words he sells 1l. 5s. of his bank-notes for a guinea in specie.

(The Price of Gold ; III : 16‒17)

Ricardo described the situation in 1809, under inconvertibility. An arbitrager exported a guinea (of 21s.) from London to Hamburg. There he sold it in the bullion market against Flemish schillings (see Appendix 1 above) with which he bought a bill of exchange drawn on London where it was paid 25s. in Bank of England notes (the equivalent of “one guinea in specie and four shillings”). The seller of the bill in Hamburg agreed to give 25s. payable in London because he had no other way of obtaining for them in Hamburg the quantity of Flemish schillings necessary to purchase the guinea. If the Bank of England note had been convertible into coin (“if the bank paid in specie”), he could have obtained the guinea from the Bank against 21s. in notes and would only have paid “the expenses of freight, &c” from London to Hamburg to get it there. Supposing that this transfer cost was 1s., the seller in Hamburg of a bill on London would have agreed to give 22s. to get the guinea, not 25s. If, under inconvertibility, he agreed to pay 25s., it was not because the transfer cost had suddenly jumped from 5 to 20 per cent, but because the Bank of England note in which the bill of exchange was paid in London was depreciated by 15 per cent, as compared with what it would have been worth under convertibility. Under convertibility as inconvertibility, the quantity of English money equivalent to the quantity of Flemish schillings paying for a guinea in Hamburg could depart from 21s. in the limit set by the transfer cost (1s.), but under inconvertibility 3s. more were added to compensate for the depreciation of the Bank of England note, that is, for the difference between the market price of gold bullion and the legal price of gold in coin in London. This is an illustration of the right-hand side of inequalities (8.10), with accounting for this difference of 15 per cent and for the transfer cost of 5 per cent. The same argument may be found in Chapter VII “On foreign trade” of Principles (see Appendix 8 below).

The depreciation of money – that is, the excess of the market price of gold bullion above the legal price of gold in coin – thus raised in the London market the price of bills of exchange denominated in foreign currencies – and hence lowered the exchange rate of the pound below the legal par. I may now recall what was said in Chapter 7 about the relation between the rise in the market price of gold bullion and the rise in price of all other commodities. A specific phenomenon occurred in the market for bullion – and in that market only: convertibility of coin into bullion through the melting pot increased the supply of bullion, so that its domestic price rose less than the prices of all other commodities. This applied equally to the price of bills of exchange: the domestic price of gold bullion increased less than the exchange rate of the pound declined. In Reply to Bosanquet, referring to the period “when an ounce of gold was to be bought in this country at 3l. 17s. 10½d. [the mint price]” (III: 195), Ricardo observed (for more details see Appendix 1 above):

Gold has since that period risen in this country 18 per cent, and is now at 4l. 12s. per ounce, […] but the currency of England, on a comparison with the currency of Hamburgh, has fallen 23½ per cent.

(ibid: 196)

When this difference between the rise in the market price of gold bullion and the fall in the exchange rate of the pound reached the cost of transporting bullion abroad, its exportation began:

It appears, therefore, evident, first, that by the addition of paper to a currency consisting partly of gold and partly of paper, gold bullion will not necessarily rise in the same degree as other commodities; and, secondly, that such addition will cause depression not in the nominal but in the real exchange, and therefore that gold will be exported.

(ibid: 213)

In the expression of the real exchange rate given by (8.3) and now applied to London and Hamburg, increased less than e declined, and fell below 1. When it reached 1 – exportation of gold bullion began.

A contrario, in a monetary regime (such as in 1810) where inconvertible Bank of England notes had substituted for all circulating coins, the market price of gold bullion increased in the same proportion as all other commodities (including the price of bills of exchange), because no additional supply could make it increase less:

When the circulation consists wholly of paper, any increase in its quantity will raise the money price of bullion without lowering its value, in the same manner, and in the same proportion, as it will raise the prices of other commodities, and for the same reason will lower the foreign exchanges; but this will only be a nominal, not a real fall, and will not occasion the exportation of bullion, because the real value of bullion will not be diminished, as there will be no increase to the quantity in the market.

(High Price; III: 64; Ricardo’s emphasis).

This analysis clarifies the meaning of gold being “the cheapest exportable commodity”:

If I owed a debt in Hamburgh of 100l. I should endeavour to find out the cheapest mode of paying it. If I send money, the expence attending its transportation being I suppose 5l. to discharge my debt will cost me 105l. If I purchase cloth here, which, with the expenses attending its exportation, will cost me 106l. and which will, in Hamburgh, sell for 100l. it is evidently more to my advantage to send the money. If the purchases and expences of sending hardware to pay my debt, will take 107l. I should prefer sending cloth to hardware, but I would send neither in preference to money, because money would be the cheapest exportable commodity in the London market.

(ibid: 62; see also ibid: 57, 104‒5)

Here Ricardo insisted on the fact that, for exogenous reasons such as its great value per unit of weight and the developed organisation of its market, gold bullion was charged a lower parametric cost of transfer than any other commodity. When the exchange rate of the pound fell, it was the first additional commodity which became profitable to be exported, because it was the cheapest to transfer. But under convertibility there was another reason why gold bullion was more eligible to international arbitrage in response to a depreciation of the currency: its market price increased less than the market price of all other commodities did and than the exchange rate declined. It was cheaper to export than any other commodity, not only because of a lower exogenous transfer cost, but because of a lower endogenous rise in its domestic market price. And this characteristic was entirely explained by the fact that gold was the monetary standard, hence had a fixed legal price in coin whose difference with its market price in bullion triggered domestic arbitrage.

The second stage: the additional importation of commodities

As mentioned earlier, the fact that the market price of gold bullion increased less than the market price of all other commodities – so that the relative price of gold in terms of all other commodities decreased – did not guarantee that the export of gold was accompanied with the import of another commodity i: the exchange rate of the pound should also decline less than the domestic price of i increased. This was the second part of the condition on the exchange rate. At first sight, the proportional price-change in all markets (including that for bills of exchange) consequent upon the depreciation of the currency – with the exception of the market for gold bullion – prevented this part of the condition from being fulfilled. However, as in the market for gold bullion, something special occurred in the market for bills of exchange, as a consequence of the export of gold bullion itself.

Arbitragers who exported bullion from London to Hamburg needed to repatriate the proceeds of their sales in Hamburg, and to do that they demanded in that centre a bill of exchange in pounds on London; alternatively, they might finance their export of bullion by selling in London a bill in Flemish schillings on Hamburg. This means that, as in the market for bullion, the variation in the exchange rate of the pound against Flemish schillings resulted from the conjunction of two factors: a monetary one – the domestic depreciation of the English currency – which pulled the exchange downwards in the same proportion as it pushed the domestic prices of all commodities upwards – and a market one – the increased demand (supply) by arbitragers for bills denominated in pounds (Flemish schillings) – which exercised an upward pressure on the exchange. These opposite forces made the exchange rate of the pound consequently decline less than the prices of domestic commodities increased, and the commodities for which the difference compensated the transportation cost (including the ordinary profit) started to be imported.

This may be formalised by using again the notion of real exchange rate, now computed on any commodity other than gold bullion, as given by:

(8.12)

In (8.12) e fell less than increased, and rose above 1. When, with the percentage cost of importation of commodity i from Hamburg,reached , the importation of i began.

The upward pressure on the exchange rate of the pound consequent upon the exportation of gold bullion was of the same nature as what happened when any new commodity was exported, or when any previous importation of a commodity was discontinued, for reasons due to this or that commodity. This general effect was illustrated in Chapter VII “On foreign trade” of Principles by the famous example of the Portuguese wine and the English cloth. After having assumed that their respective cost of production made it profitable to import wine from Portugal to England and to export cloth from England to Portugal, Ricardo supposed that an improvement in making wine occurred in England and lowered its cost, so that the import of Portuguese wine ceased to be profitable and was discontinued. The export of English cloth to Portugal went on for a time, since “every transaction in commerce is an independent transaction” (Principles; I: 137). However, bills in pounds being no longer sold in Lisbon (or bills in Portuguese money being no longer bought in London) by importers of Portuguese wine, the exchange rate of the pound in Portuguese money rose. This premium on the pound reduced the profit of the importer of English cloth in Portugal, until this importation stopped. Describing how international trade was settled by bills of exchange, within the limits imposed by the bullion points, Ricardo compared the situation before and after the improvement in making English wine – hence before and after the importation of Portuguese wine was discontinued – as follows:

If the markets be favourable for the exportation of wine from Portugal to England, the exporter of the wine will be a seller of the bill, which will be purchased either by the importer of the cloth, or by the person who sold him his bill; and thus without the necessity of money passing from either country, the exporters in each country will be paid for their goods. Without having any direct transaction with each other, the money paid in Portugal by the importer of cloth will be paid to the Portuguese exporter of wine; and in England by the negotiation of the same bill, the exporter of the cloth will be authorized to receive its value from the importer of wine.

But if the prices of wine were such that no wine could be exported to England, the importer of cloth would equally purchase a bill; but the price of that bill would be higher, from the knowledge which the seller of it would possess, that there was no counter bill in the market by which he could ultimately settle the transactions between the two countries; he might know that the gold or silver money which he received in exchange for his bill, must be actually exported to his correspondent in England, to enable him to pay the demand which he had authorized to be made upon him, and he might therefore charge in the price of his bill all the expenses to be incurred, together with his fair and usual profit.

If then this premium for a bill on England should be equal to the profit on importing cloth, the importation would of course cease.

(Principles; I: 138‒9)

In this example, the link between two successive events connected by the rise in the exchange rate of the pound operated symmetrically with the case discussed previously: instead of an exportation of gold bullion from London to Hamburg causing an importation of commodity i from Hamburg to London, the interruption of an importation of wine from Portugal to England caused the interruption of the exportation of cloth from England to Portugal.

“The natural trade of barter”

It appears thus possible to reconstruct Ricardo’s analysis of the international adjustment to a monetary shock.¹⁷ Two conclusions emerge from this analysis. On the one hand, this adjustment required both markets for gold bullion and bills of exchange being subject to the combination of two factors of price variation, a monetary one (the effect of the depreciation of the currency) and a market one (an increase in the supply or in the demand, respectively). On the other hand, this combination of factors operated successively in the two markets, first in the market for bullion, and second, as a consequence, in the market for bills of exchange. This two-stage international adjustment process – the additional import of commodities occurring after the export of gold bullion – was the consequence of the fact that international trade was no barter but an exchange implemented through bills of exchange.

This conclusion may seem at odds with many instances where Ricardo literally wrote that trade in general, and international trade in particular, is barter, such as:

If any cause should raise the price of a few manufactured commodities, it would prevent or check their exportation; but if the same cause operated generally on all, the effect would be merely nominal, and would neither interfere with their relative value, nor in any degree diminish the stimulus to a trade of barter, which all commerce, both foreign and domestic, really is.

(ibid: 228)

All trade is in fact a trade of barter, and if money can by any laws be so distributed or accumulated as to raise the price of exportable commodities, it will also raise the price of imported commodities; so that whether money be of a high or of a low value, it will not affect foreign trade; for a given quantity of a home commodity in either case will be bartered for a given quantity of a foreign commodity.

(Notes on Malthus; II: 146‒7)¹⁸

All foreign trade finally resolves itself into an interchange of commodities; money is but the measure by which the respective quantities are ascertained.

(On Protection to Agriculture; IV: 214)

Referring to barter in international trade, Ricardo did not mean, as is often supposed in the literature, that commodities directly exchanged for one another or for gold bullion, but that transactions were settled exclusively through a multilateral clearing of bills of exchange, in contrast with a situation in which, in addition to bills of exchange, precious metals were also transferred. This “natural trade of barter” was “the equilibrium of money” discussed in Section 8.1 above:

Beside the improvements in arts and machinery, there are various other causes which are constantly operating on the natural course of trade, and which interfere with the equilibrium, and the relative value of money. Bounties on exportation or importation, new taxes on commodities, sometimes by their direct, and at other times by their indirect operation, disturb the natural trade of barter, and produce a consequent necessity of importing or exporting money, in order that prices may be accommodated to the natural course of commerce; and this effect is produced not only in the country where the disturbing cause takes place, but, in a greater or less degree, in every country of the commercial world.

(Principles; I: 141‒2; emphasis added)

This interpretation is consistent with Ricardo’s repeated statement that precious metals were distributed amongst the different countries in the proportions required by the domestic circulation in each of them, so that, once this distribution was implemented, international payments did not require any transfer of them and were exclusively settled through bills of exchange, as in “purely a trade of barter”:

Gold and silver having been chosen for the general medium of circulation, they are, by the competition of commerce, distributed in such proportions amongst the different countries of the world, as to accommodate themselves to the natural traffic which would take place if no such metals existed, and the trade between countries were purely a trade of barter.

(ibid: 137)¹⁹

Ricardo was aware of the theoretical and practical implications of the two-stage international adjustment process. On the level of theory, in contrast with the price-specie flow mechanism, the adjustment in international trade was not the engine of the restoration of the exchange but the consequence of arbitrage between the market for gold bullion and the market for bills of exchange.²⁰ This explains Ricardo’s often misunderstood claim that the export of gold did not pay for a previously existing foreign balance against England – explained by exogenous causes such as a bad harvest or war transfers – but was the condition – itself explained by the depreciation of the currency – for imports of other commodities being greater than their exports. Consequently, the issue was not whether the foreign balance was for or against England:

The fact of the balance of payments being for or against this country could be of little consequence, in my estimation, to the proof of the theory which I maintain.

(Reply to Bosanquet; III: 213)

On the level of practice, Ricardo’s awareness of the organisation of the market for bills of exchange led him to consider that the import of commodities being triggered by the export of gold bullion was a fact, not a doctrinal prejudice. In the example of the trade between London and Hamburg, the import of commodities in London was financed in Hamburg by the sale of long bills on London to exporters of gold bullion from England, and when, two and a half months later, these bills came due in London, the importers were in a position to pay for them with the proceeds of the sale of the imported commodities having occurred in the meantime in the English markets. The international adjustment process triggered by a domestic depreciation of the pound thus relied on three kinds of economic agents: arbitragers who exported gold bullion and repatriated the proceeds by purchasing long bills, merchants who financed the import of goods in England by the sale of these bills, and London banks who discounted the long bills supplied by the arbitragers.

A corollary of Ricardo’s understanding of the international adjustment process was the much-criticised proposition according to which a fall in the exchange rate could only be explained by a redundancy of currency.

8.3 The redundancy of money as the sole cause of fall in the exchange rate

Real and nominal variations in the exchange

At his time as in later literature, Ricardo has been often criticised for holding the “extreme Bullionist” position (Viner 1937: 106) according to which a fall in the exchange rate could only be explained by a redundancy of currency. When he was examined on 26 March 1819 by the Lords’ Committee on the Resumption of Cash Payments, the author of the following questions had probably this kind of critique in mind, and the answers given by Ricardo might be unexpected in their denial of such a position:

Question: Are not the rates of exchange affected by the balance of payments on all accounts?

Answer: Yes, within the limits of the expence attending the transmission of gold.

Question: Must not therefore a part of the depression of the exchange between any countries, be attributable to a cause independent of the amount of the circulating medium?

Answer: Very frequently, but the real exchange would be in favour of the country, while the nominal exchange is against it.

Question: Can you therefore conclude, from the degree to which the exchange is at any moment against any country, that the whole percentage of that unfavourable exchange is owing to the amount of its circulating medium?

Answer: A part may be owing to other causes.

(V: 448)

The possibility of a fall in the exchange to be explained by real causes – such as war transfers or extraordinary imports of corn following a bad harvest – as well as monetary ones had been contended in 1802 by Henry Thornton in An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (see Chapter 1 above), and Ricardo had emphatically rejected it in the debate around the Bullion Report in 1810 (see Chapter 2 above). It is thus surprising that, in the quoted evidence of 1819, he might have acknowledged that “a part” of the unfavourable exchange “may be owing to other causes” than the redundancy of the currency. As Ricardo’s second answer makes clear, his distinction between monetary and “other causes” had something to do with the distinction between the nominal and the real exchange rate.

His understanding of this distinction – hence of the question of the causes of an unfavourable exchange – is illustrated by correspondence raised at the end of the same year 1819 by the article “Exchange” written by John Ramsay McCulloch for the Supplement to the Encyclopœdia Britannica (letter by Ricardo of 2 October, answered by McCulloch on 2 November, with a reply by Ricardo on 18 December). In his view, Ricardo’s critiques were not of substance but of wording: “I think we agree in principle, I object to the language” (VIII: 93). They concerned McCulloch’s use of the expressions “real par of exchange” and “real exchange”.

On the real par of exchange, Ricardo objected to McCulloch’s inclusion of the cost of transferring bullion in its calculation, which was a source of confusion:

It is true that the expences of sending bullion from France to Poland may exceed the expence of sending it to England, but this circumstance will not alter the par, although it will allow of a greater deviation in the exchange from par between the more distant countries, before bullion moves to stop the rise or fall of the exchange. I cannot help thinking that the language of the Bullion Report is correct, and that it would introduce a new and less satisfactory definition if we were to allow of these expences in estimating the par of exchange between different countries. Suppose that the expence of sending silver from Poland to France or from France to Poland, to be 5 pct. it would in my opinion be correct to say that the exchange was at par when 100 ounces of silver in Poland would purchase a bill for 100 ounces of silver payable in France. According to your explanation I do not know whether you would estimate it to be at par when 105 ounces were given in Poland for a bill of 100 ounces payable in France or when 105 were paid in France for a bill of 100 ounces payable in Poland.

(VIII: 89)

Ricardo thus insisted that the two factors constraining the variations in the exchange rate – the cost of transferring bullion from one country to the other, and the real par of exchange – should be clearly distinguished.

On the real exchange rate, Ricardo also objected to McCulloch. In his first letter he expressed doubts about the usefulness of this notion, before changing his mind:

We mean the same thing, but I doubt whether there be any advantage in the distinction which is drawn between real and nominal exchange; by correcting the par, with every alteration in the bullion value of money, all would be clear.*

Note* On further reflection there may I think be real use in the distinction drawn between the nominal and real exchange, but the distinction should be clearly defined.

(ibid: 88)²¹

In his second letter Ricardo corrected McCulloch’s exposition of his own ideas:

If you substitute the words “real exchange” for “nominal exchange” you have exactly expressed my meaning, which I think agrees with the view I now entertain on this subject.

(ibid: 141)

How should the distinction between the two notions “be clearly defined” and what was this “view” which Ricardo entertained “now” (in 1819)? The above note* continued as follows:

The exchange may be said to be nominally affected to the amount of the difference between the market and mint prices of bullion, and be really affected by any deviation from par exceeding or falling short of this difference.

(ibid: 88)

This explanation is made crystal-clear by inequalities (8.10) formalised above in Section 8.1 and which constrain the variations of the exchange rate. Let me recall them:

(8.10)

The exchange rate e might deviate from the legal par of exchange from above or below by two magnitudes. The first was the ratio which reflected the monetary factors (the cost at which bullion was converted into coin at the mint and the cost at which coin was converted into bullion in the melting pot, in each country) that limited the deviation of the real par of exchange from the legal par produced by “the difference between the market and mint prices of bullion”. Since, according to Ricardo’s monetary theory (see Chapter 4 above), such difference (the depreciation or appreciation of money) was exclusively attributable to the state of the currency, “the exchange may be said to be nominally affected to the amount of” this difference: the cause of its fall (rise) was the redundancy (deficiency) of money. Second, the exchange rate e might also deviate from the legal par of exchange by the magnitudes in parentheses, that is, the cost or of transferring bullion either way. As mentioned above in Section 8.1, this factor was considered by Ricardo as “real”: it depended on the characteristics of bullion as commodity and was independent of the state of the currency in each country. Consequently, the exchange rate was “really affected” in the limit set by this transfer cost, that is, by “any deviation from par exceeding or falling short” of the other (monetary) factor. This made room for real causes of change in the exchange rate.

This explains why for Ricardo, as illustrated by his answers during his evidence before the Lords’ Committee, there was not one but two possible types of causes of deviation of the exchange rate from the legal par. One was “real”, and it might affect the exchange in the limit set by the cost of transferring bullion from one country to the other, since this cost determined the threshold that triggered international arbitrage between the bullion and foreign-exchange markets. The other was “nominal” (monetary), and it might affect the exchange in the limit set by the minting and melting costs, since these costs determined the threshold that triggered domestic arbitrage between coin and bullion. These two types of causes were not alternative but operated at different levels: the balance of payments explained the “real” variations of the exchange rate between the bullion points calculated on the basis of the legal par of exchange, and the state of the currency explained the “nominal” variations beyond them but within the bullion points calculated on the basis of the real par. When the proportion by which the exchange rate was below the legal par was greater than the percentage cost of transferring bullion, the whole of the difference should be ascribed to the depreciation of the currency (see in Appendix 8 Ricardo’s factual illustrations).

A matter of fact or of theory

It is thus inappropriate to blame Ricardo for ignoring the “real” causes of the fall in the exchange and contending that it could only be explained by the redundancy of the currency. His neglect for these real causes was rooted in the fact that, in normal times, the cost of transferring bullion from one country to the other was small and constant, so that the effect of the real causes on the exchange was insignificant and invariable. As Ricardo declared in a speech in Parliament on 24 May 1819:

His [Ricardo’s] own general opinion was, that an unfavourable state of exchange must always proceed from a redundant currency.

(V: 16)²²

But in extraordinary times such as the Napoleonic wars, Ricardo emphasised that the real causes could account for no less than 10 to 15 per cent of the fall in the exchange. The following extract of a quotation given in full in Section 8.1 above illustrates this point:

The exchange in my opinion is, even in these turbulent times, rarely operated upon but by two causes: one, and that by far the most common is an alteration, or an apprehended alteration, in the relative prices of commodities in the two countries between which the exchange is estimated, and is in most cases to be traced to some augmentation or diminution in the amount of the currency of one of them. The other is an increased or diminished difficulty and expence, (or the anticipation of such) attending the transmission of money. The exchange with the continent has, I believe, for a length of time, not only been unfavourable to this country to the amount of the depreciation of our currency but considerably more, as much more probably as to 10 to 15 pc^t.

(Letter to Horner, 4 January 1812; VI: 79)

This is the reason why the variation of the exchange rate was not as good an indicator of the state of the currency as the difference between the market price of bullion and the legal price of gold in coin: it could partly reflect a real cause which added to the monetary one.

Two conclusions about Ricardo’s much-discussed contention that a redundancy of money was the sole cause of fall in the exchange rate may be derived from this analysis. First this contention allowed for the acknowledgement of the fact that the existence of a cost of transferring gold bullion from one country to the other made room for real causes of change in the exchange rate. This was a matter of fact, not of theory, and it was “no where disputed” (Principles; I: 230). Second, any divergence between the nominal exchange rate and the legal par of exchange beyond this allowance for the transfer cost of bullion was necessarily caused by the state of the currency, which made the real par (on the basis of which the actual bullion points should be calculated) differ from the legal par. This affirmation was a direct consequence of Ricardo’s monetary theory, as embodied in the Money–Standard Equation, according to which the market price of gold bullion (the standard) could only be above (below) the legal price of gold in coin if the quantity of money was in excess (deficient). It was not a matter of fact but of theory.

Being grounded in his monetary theory, Ricardo’s analysis of international adjustment reflected the characteristics of this theory. This is illustrated by his rejection of the price-specie flow mechanism.

8.4 Price-specie flow mechanism versus active management of the currency

In the Appendix to the fourth edition of High Price, Ricardo mentioned three ways an adjustment of the exchange rate could be made:

An unfavourable exchange can ultimately be corrected only by an exportation of goods, by the transmission of bullion, – or by a reduction in the amount of the paper circulation.

(High Price, Appendix to 4th ed.; III: 125; Ricardo’s emphasis)

According to the price-specie flow mechanism, this correction occurred first “by the transmission [the export] of bullion”, followed by “an exportation of goods” rendered cheaper by the “reduction in the amount of the paper circulation” associated with the export of bullion. One may ask how the two-stage international adjustment process described above fits this sentence, and inquire accordingly about the existence of a price-specie flow mechanism in Ricardo, in the same manner as in Chapter 7 above in which the analysis of the regulation of the quantity of convertible notes by the standard raised the question of the existence in Ricardo of a quantity theory of money. The answer is in both cases in the negative, and there is a good reason for that: a quantity theory of money is an integral part of the price-specie flow mechanism. However, one cannot be simply content with removing the quantity theory of money to conclude that the price-specie flow mechanism falls apart. There is also an important question involved, which is central in international economics: does international adjustment rely on changes in the balance of trade, that is, in the difference between aggregate exports and imports of commodities? This is the case with the price-specie flow mechanism, in which the balance of trade adjusts in response to changes in prices triggered by changes in the quantity of money. One may ask whether this second pillar of that mechanism is also to be discarded from Ricardo’s theory. We will see that it should.

Already in the Bullion Essays Ricardo dissented with two common opinions on the balance of trade. First he objected to labelling “unfavourable” the balance of trade when gold bullion flew out:

In return for the gold exported, commodities would be imported; and though what is usually termed the balance of trade would be against the country exporting money or bullion, it would be evident that she was carrying on a most advantageous trade, exporting that which was no way useful to her, for commodities which might be employed in the extension of her manufactures, and the increase of her wealth.

(High Price; III: 54)

Not only a supposedly unfavourable balance of trade increased the wealth of the country (in terms of use-values) but also it did not correspond to any aggregate imbalance (in terms of values) between exports and imports: from the point of view of international trade, gold bullion was a commodity like any other, and when it flew out, aggregate exports were increased, causing an increase in aggregate imports, the balance between them remaining even. Second Ricardo also dissented with the idea that, after having flown out because it was in excess, gold money would again flow in when the ensuing fall in domestic prices would generate a “favourable” balance of trade. Although without mentioning Hume’s inference from the competitive advantage procured by the fall in domestic prices – “In how little time, therefore, must this bring back the money which we had lost” (Hume 1752: 311; see Chapter 1 above) – Ricardo ironically observed:

Is it to be contended that these results would not be foreseen, and the expence and trouble attending these needless operations effectually prevented, in a country where capital is abundant, where every possible economy in trade is practised, and where competition is pushed to its utmost limits? Is it conceivable that money should be sent abroad for the purpose merely of rendering it dear in this country [England] and cheap in another, and by such means to ensure its return to us?

(High Price; III: 103)

We saw in Section 8.1 above that when money was in excess and the market price of gold bullion consequently rose above the legal price of gold in coin, bullion started to be exported when the exchange rate fell to the export bullion point, and this prevented any further fall in the exchange rate. This bullion-points mechanism was generally acknowledged as a matter of fact, because it was the consequence of the practice of international arbitrage. As shown by inequalities (8.10) this mechanism constrained the exchange rate within limits, but did not imply the return to the level before the monetary shock (equal, by assumption, to the legal par). It did not provide in itself an answer to the question: what happened next? In other words, what became of the bullion exported and what was the final outcome of the process? To answer these questions, one needed to complement the factual bullion-points mechanism with a theory. Its combination with the Quantity Theory of Money and with the assumed sensitivity of exports and imports to changes in money prices gave the so-called price-specie flow mechanism, according to which gold bullion flew in after having flown out and the final outcome was the return to the initial position which had been disturbed by the monetary shock.

This was not Ricardo’s understanding of international adjustment. According to the two-stage adjustment process described above, gold bullion went abroad and did not come back. What flew in, as a consequence of this export of gold bullion, was another commodity (or several others). As for the final position, it depended on how the quantity of money adjusted and thus affected the market price of gold bullion. The international adjustment to an excess note issue was not implemented through the balance of trade but through the export of gold bullion: the structure of foreign trade was altered (bullion was exported and one or several new commodities were imported), but the balance of trade (the difference between aggregate exports and imports) remained even. Already in the bullion-points mechanism, the real par of exchange, defined as the ratio of the market prices of gold bullion in the two countries, was not a proxy of the purchasing power parity, as the market price of gold bullion was not a proxy of the general price level (see Chapter 3 above). But there was more: the return of the exchange rate e to the legal par was ensured by the return of the market price of gold bullion to the legal price ^£ of gold in coin, not by the return of the prices of all other commodities to their initial level before the monetary shock. As seen above when discussing the notion of par of exchange, the prices of the same commodity in any two countries, made comparable through the exchange rate, might permanently differ while the exchange was at par. The return to what Ricardo called “the equilibrium of money”, that is, the equality of the exchange rate with the par – hence the equality of the purchasing power of domestic and foreign currencies in terms of the standard – did not ensure the purchasing power parity in terms of all other commodities.

In a monetary system endowed with a regulation of the note issue by the standard – the only system also endowed with external monetary stability – the domestic market for gold bullion was central, first through international arbitrage with its foreign markets, second through domestic arbitrage with the bank issuing convertible notes, because a change in the quantity of money affected the value of the standard by changing its market price, as illustrated by the Money–Standard Equation. It is worthwhile noting that international adjustment rested only on the stabilisation of the market price of gold bullion, not on the adjustment of domestic price levels and corresponding changes in the balance of trade (as in the price-specie flow mechanism). In a nutshell, according to Ricardo, international adjustment to a monetary shock resulted from the combination of the bullion-points mechanism with the Money–Standard Equation, in contrast with the price-specie flow mechanism in which the bullion-points mechanism was combined with the Quantity Theory of Money and the adjustment of the balance of trade.

The exact role of the exportation of bullion required, however, an important qualification: the domestic market for bullion was central in the international adjustment, not necessarily the exportation of bullion. This calls for an explanation. We saw in Chapter 7 that the adjustment of the domestic quantity of money depended on the monetary system. The dividing line was between convertibility and inconvertibility of the note into gold – that is, between the existence and the absence of a regulation of the note issue by the standard. When notes were inconvertible, the exportation of bullion corrected their excess issue generated by a once-for-all monetary shock, but nothing could prevent the Bank from expanding its issues indefinitely – hence repeating the monetary shock – so that the corrective effect came to an end when all coins had disappeared from domestic circulation. The final outcome was consequently not a self-adjustment but a change of monetary system, from a mixed system of coins and inconvertible notes to a circulation exclusively composed of inconvertible notes. When notes were convertible, the adjustment of the domestic quantity of money depended on the working of the market for gold bullion. The quantity of money was first reduced by the conversion of notes into coins to be melted with a view to exporting the bullion but this exportation ceased when the Bank of England started to purchase bullion in order to replenish its metallic reserve and thus triggered the Penelope effect, until its losses forced the Bank to contract the issue, restoring the situation before the monetary shock. Such a system was thus self-adjusting, but the self-adjustment eventually relied on the domestic limitation of the quantity of money, not the exportation of bullion. And it occurred after a lag depending on the behaviour of the Bank; in the meantime the whole economy (and not only the Bank) suffered from depreciation. It is the reason why, according to Ricardo, it was better to anticipate this forced reduction with an active management of the note issue. This was the object of the Ingot Plan.

8.5 The Ingot Plan and the gold-exchange standard

Leaving aside the cost of transferring gold bullion from one country to the other – which in normal times was small and constant – the range of variation of the exchange rate, as shown by inequalities (8.10), depended on the two magnitudes – the minting and melting costs – which limited the divergence of the market price of gold bullion from the legal price of gold in coin, hence, for a given state of the currency in the foreign country, the divergence of the real par from the legal par of exchange. Consequently, the exchange rate was all the more stable since the domestic monetary regime ensured the stability of the market price of the standard: for Ricardo, international monetary stability was the outcome of domestic monetary stability. The effect of the Ingot Plan on international adjustment should be envisaged from this point of view. Chapter 9 below will detail the reasons why it improved domestic monetary stability by changing radically the monetary system, in comparison with the pre-1797 (and post-1821) one. One may here somewhat anticipate this analysis and so justify why, in contrast with the usual interpretation in terms of an automatic mechanism, Ricardo’s approach to international adjustment may rightly be inserted in the part of the present book devoted to policy. The institutional set-up and the policy rule that designed central banking à la Ricardo were also the ones which produced the best international monetary system in his view. Beyond the simple reduction of the range of variation in the exchange rate, they substituted, as driving force of adjustment, the domestic management of the note issue for international bullion flows, and they restricted to international payments the use of gold – what would later be called the gold-exchange standard.

The reduction of the range of variation in the exchange rate

As will be detailed in Chapter 9 below, the adoption in the Ingot Plan of convertibility both ways between money (the Bank of England note) and the standard (gold bullion) had the effect of stabilising as much as was desirable the market price of gold bullion, by narrowing its margin of variation around the legal price:

That regulation is merely suggested, to prevent the value of money from varying from the value of bullion more than the trifling difference between the prices at which the Bank should buy and sell [bullion], and which would be an approximation to that uniformity in its value, which is acknowledged to be so desirable.

(Proposals; IV: 67; Principles; I: 358)

Consequently, by comparison with the system in which the Bank of England note was convertible into coin and no obligation was imposed on the Bank to purchase bullion at a fixed price, the Ingot Plan eliminated the various costs associated with convertibility of bullion into coin and of coin into bullion, which, when the actual quantity of money differed from its conformable level, set the boundaries constraining the variations in the market price of gold bullion.

In the past, the extreme case had been obtained when, as at the time of the Bullion Report, the Bank of England note was inconvertible and had completely replaced coin in domestic circulation. As emphasised in Chapter 7 above, the absence of regulation of the note issue by the standard made the market price of gold bullion rise and the exchange rate of the pound fall without limit:

The same cause which has produced a difference of from fifteen to twenty per cent. in bank-notes when compared with gold bullion, may increase it to fifty per cent. There can be no limit to the depreciation which may arise from a constantly increasing quantity of paper. The stimulus which a redundant currency gives to the exportation of the coin has acquired new force, but cannot, as formerly, relieve itself.

(High Price; III: 78)

Since the domestic money – now the inconvertible Bank of England note – could not be converted into bullion with a view to exportation, in contrast with the situation when the note was convertible or when part of the domestic circulating money – the metallic one – was convertible into bullion, the situation was the same as if in a metallic regime rigorous laws had been enforced to prevent the exportation of the coin:

Whenever the current of money is forcibly stopped, and when money is prevented from settling at its just level, there are no limits to the possible variations of the exchange. The effects are similar to those which follow, when paper money, not exchangeable for specie at the will of the holder, is forced into circulation. Such a currency is necessarily confined to the country where it is issued: it cannot, when too abundant, diffuse itself generally amongst other countries. The level of circulation is destroyed, and the exchange will inevitably be unfavourable to the country where it is excessive in quantity: just so would be the effects of a metallic circulation, if by forcible means, by laws which could not be evaded, money should be detained in a country, when the stream of trade gave it an impetus towards other countries.

(Principles; I: 147)

This idea that “the level of circulation is destroyed” was reminiscent of a formula used by Ricardo in a letter to Malthus of 22 October 1811, when he referred to the former situation in which bullion could still be exported:

If in any country there exists a dearness of importable commodities and no corresponding cheapness of exportable commodities money in such country is above its natural level and must infallibly be exported in payment of the dear commodities, – but what does this state of things indicate but an excess of currency, and it may surely be correctly said that money is exported to restore the level not to destroy it.

(VI: 65)

Even when there were still coins in circulation, and also before 1797 when the Bank of England note was convertible into coin, the legal prohibition of melting and exporting the coin generated a cost that opened a margin of rise in the market price of gold bullion, hence of fall in the exchange rate. However this law was easily evaded and its effect was consequently weak; it is only under inconvertibility that the melting cost was significant but for another reason: the growing scarcity of the coins to be gathered in circulation. Symmetrically, the delay with which the coins were delivered by the mint against bullion was responsible for a minting cost that opened a margin of fall in the market price of gold bullion, hence of rise in the exchange rate.

The Ingot Plan eliminated these various costs which, according to (8.10), permitted the nominal exchange rate to vary when the quantity of money differed from its conformable level. The Bank of England note becoming convertible at no cost into exportable bullion, and bullion becoming convertible into the Bank of England note at a legal price only inferior by a slight margin covering the management costs of the Bank, the margin of variation of the exchange rate was reduced. The legal par of exchange became, with the legal price of gold bullion in England:

(8.13)

The inequalities constraining the exchange rate consequently became:

(8.14)

If the principles of the Ingot Plan were also adopted in the foreign country, these expressions became:

(8.15)

(8.16)

As emphasised by Marcuzzo and Rosselli, the Ingot Plan sped up international adjustment through gold flows, by narrowing the boundaries between which the exchange rate could vary before arbitrage was set in motion and stabilised it (for the distinction between “stable and unstable monetary regimes”, and the classification of stable regimes according to the velocity of the adjustment mechanism of the quantity of money, see Marcuzzo and Rosselli 1991: 123‒8). However, there was more than that, as shown by what happened if the same gold-standard system à la Ricardo was adopted in every trading nation: the stability of the international monetary system could be achieved without any international flow of gold. Not only would gold stop circulating inside each nation, but it would also stop moving from one nation to another, since the respective domestic quantities of paper money would endogenously adjust, without having to be corrected by the actual export or import of gold. The Ingot Plan radically changed the logic of the adjustment of the quantity of money – hence the monetary system itself – by substituting, as driving force of adjustment, the domestic management of the note issue for international bullion flows.

Domestic management of the note issue rather than international bullion flows

As was analysed in Chapter 7 above and recalled in the preceding section, in a system where the Bank of England note was convertible into coin, the adjustment to a monetary shock took the form of an exportation of gold bullion only as long as the Bank passively provided the coin demanded by arbitragers against its notes. As soon as the Bank purchased gold to replenish its reserves, the exportation of bullion was replaced by the Penelope effect. The adjustment of the quantity of money finally occurred when the Bank was compelled by its losses to contract its issues. Ricardo’s Ingot Plan aimed at by-passing the intermediate steps of the exportation of bullion and of the Penelope effect to produce the required adjustment in the quantity of money. When, for whatever monetary reason – a discretionary change in the note issue or a change in “the wants of commerce” that made the existing quantity of notes inappropriate – the quantity of money was in excess (deficient), the market price of gold bullion rose above (fell below) its legal level, and this signal triggered the application of the policy rule that reduced (increased) the note issue, before the exportation (importation) of gold even started. Consequently, the adjustment of the quantity of money, hence of the exchange rate, was expected by Ricardo from the active behaviour of the issuing bank, not from the mechanical effect of the exportation or importation of gold. Rather than relying on the delayed adaptation of their behaviour by the directors of the Bank of England, Ricardo preferred subjecting it to a policy rule that immediately corrected discrepancies between the quantity of money issued and the (unknown) quantity of money required by the “wants of commerce”.

It should be observed, however, that this active management of the currency, embodied in the Ingot Plan, only applied to such discrepancies, that is, to variations in the exchange having a domestic monetary origin. It did not apply to any variation in the exchange: according to Ricardo, the quantity of money should not be targeted by the exchange rate. During his evidence before the Lords’ Committee on 26 March 1819 quoted in Section 8.3 above, Ricardo had acknowledged that “a part” of the unfavourable exchange “may be owing to other causes” than an excess quantity of money, and he added:

There is no unfavourable exchange, which might not be turned in our favour, by a reduction in the amount of currency; it might not however be wise to make such a reduction.

(V: 448)

This affirmation was just the consequence of the contention that the balance of trade was the effect of the state of the currency, not its cause. Already in High Price Ricardo had mentioned this practical consequence of such causality:

It is only after a comparison of the value in their markets and in our own, of gold and other commodities, and because gold is cheaper in the London market than in theirs, that foreigners prefer gold in exchange for their corn. If we diminish the quantity of currency, we give an additional value to it: this will induce them to alter their election, and prefer the commodities.

(High Price; III: 62)²³

However, as testified by the last phrase in the evidence of 1819, this did not mean that, although possible, a monetary action on the balance of trade was desirable. If the quantity of money was in excess, its reduction should be implemented for its own sake – the elimination of domestic depreciation – the improvement of the exchange being a by-product. If the fall of the exchange was caused by real factors operating in the limit of the transfer cost of bullion, there was no reason to alter a situation of the currency which was not responsible for this fall: as quoted above, “it might not however be wise to make such a reduction”. On many occasions Ricardo showed some indifference to the level of the exchange rate:

The circumstance of the exchange being unfavourable, does not seem to me to be any disadvantage to us.

(Evidence before the Lords’ Committee, 26 March 1819; V: 442)

To your second question whether I can point out distinctly an example or instance whereby one country gains and the other country loses by the rate of exchange between them? I answer that I believe the rate of exchange quite unimportant as it affects the interests of the two countries. Inasmuch it is sometimes a symptom of subsidies being paid, of unprosperous commerce &c., it is a subject of regret when it is unfavourable. In our transactions with Hamburgh for example I believe we should neither gain nor lose by the exchange being at 28 or 33 the relative prices of commodities in the two countries being raised or lowered in proportion to the rise or fall of the exchange.

(Letter to Broadley, 14 June 1816; VII: 43‒4)

Consequently, when variations in the exchange rate had a real cause, it was not appropriate to vary the note issue: gold flows triggered by arbitrage were in charge of the adjustment. With the adoption of the policy rule embodied in the Ingot Plan, international bullion flows would only correct the effect on the exchange rate of these real causes, and no longer that of the monetary ones. The signal to be used by the issuing bank to determine whether it should vary its issues when the exchange rate varied was simple and it derived from Ricardo’s distinction between nominal and real effects on the exchange rate, as formulated in the quotation given earlier:

The exchange may be said to be nominally affected to the amount of the difference between the market and mint prices of bullion, and be really affected by any deviation from par exceeding or falling short of this difference.

(Letter to McCulloch, 2 October 1819; VIII: 88)

If the variation in the exchange rate was accompanied with a divergence between the market and the legal price of gold bullion, it had a monetary (“nominal”) origin and called for intervention. If it was not accompanied with such divergence (or in the measure that it varied more than the market price of bullion), it had a non-monetary (“real”) origin and the issuing bank should passively provide (absorb) the bullion demanded (supplied) by the arbitragers. Not being fuelled by the monetary shocks but only by real ones, these bullion flows would be small in importance:

The most perfect liberty should be given, at the same time, to export or import every description of bullion. These transactions in bullion would be very few in number, if the Bank regulated their loans and issues of paper by the criterion which I have so often mentioned, namely, the price of standard bullion, without attending to the absolute quantity of paper in circulation.

(Proposals; IV: 67; Principles; I: 357‒8)

The corrective role of international bullion flows to variations in the exchange rate was thus restricted to those (exogenous) variations having a real origin; for the variations (endogenously) caused by the absence of conformity of the quantity of money to “the wants of commerce”, they should be corrected by the adaptation of the quantity of money itself, thanks to the policy rule of varying the note issue inversely with the difference between the market price and the legal price of the standard.

This distinction between two answers to variations in the exchange rate amounted practically to restrict the role of convertibility to the sole international payments. The monetary system was made a gold-exchange standard one.

A prototype of the gold-exchange standard

In a monetary system where the bank note was convertible into coin, as was the case in England before 1797 and again after 1821, this convertibility meant exchanging at a legal parity one circulating medium (the note) for another (the coin). This had two consequences. First, such conversion could occur for reasons linked to the state of domestic circulation, for example the debasement of the coin (see Chapter 6 above): then there was an internal drain of the metallic reserves of the issuing bank. Second, conversion with a view to exporting bullion – an external drain – required the melting of the coin, with its associated cost. In a monetary system designed according to the Ingot Plan, the bank note was convertible into gold bars (ingots) wearing a legal stamp but deprived of legal tender, hence which could not be used as circulating medium. This convertibility meant exchanging at a legal price a circulating medium (the note) for a special commodity (gold bullion) which was both the domestic standard of money and an international means of settlement. This had two consequences. First, such conversion could still be triggered by the state of domestic circulation – an excess issue of notes, which raised the market price of gold bullion above its legal price and made arbitrage profitable – but no longer by the characteristics of the metallic currency or for the purpose of internal circulation. Second, the only use of the bars obtained from the issuing bank was their exportation: the bank had only to face an external drain, and this increased the security of the monetary system (see Chapter 9 below).

Convertibility was thus de facto restricted to foreign payments, a feature that would later define a gold-exchange standard, in which the domestic currency is convertible into a foreign currency (itself convertible into gold) that cannot legally be used in domestic payments. Ricardo’s paternity of the notion of gold-exchange standard was acknowledged by Keynes in his book Indian Currency and Finance:

Its theoretical advantages [of the gold-exchange standard] were first set forth by Ricardo at the time of the bullionist controversy. He laid it down that a currency is in its most perfect state when it consists of a cheap material, but having an equal value with the gold it professes to represent; and he suggested that convertibility for the purposes of the foreign exchanges should be ensured by the tendering on demand of gold bars (not coin) in exchange for notes – so that gold might be available for purposes of export only, and would be prevented from entering into the internal circulation of the country.

(Keynes 1913: 22; Keynes’s emphasis)

The relation with India was not fortuitous: the monetary system of this English colony had been reformed in the very first years of the twentieth century along the lines of the “Lindsay scheme” which explicitly referred to Ricardo’s Ingot Plan.

Alexander Lindsay, who was an English banker in the Bank of Bengal, had stressed that the fall in the relative price of silver in terms of gold had depressed the exchange rate of the Indian silver rupee in terms of the British gold pound and consequently increased production costs in India through higher import prices. He was thus looking for a monetary scheme which would allow India to continue using the silver rupee for her domestic payments, while reducing the negative effects on her economy of the adoption of the gold standard in most industrialised countries. The solution was to adapt Ricardo’s Ingot Plan to the situation of India. Mentioning Peel’s bill of 1819, he observed that “this short trial is the only one ever given to Ricardo’s scheme, and it passed through the ordeal satisfactorily” (Lindsay 1892: 6). For him, “in applying Ricardo’s proposals to India, little modification is necessary either of the proposals or of Indian currency arrangements. The only change in the proposals will be the substitution of sterling money for gold bars, and rupees for paper money” (ibid: 8). Rupees would be convertible in India against drafts in pounds remitted to England and payable at a fixed price in notes by the Bank of England. The main consequences of this scheme would be to link the rupee to gold, hence to stabilise the exchange with gold-standard countries, and to guarantee the convertibility of the rupee for external reasons without gold having to enter Indian domestic circulation. Hence “gold will be the standard of value, though it will not be used in the internal circulation” (ibid: 12); the system had “a gold standard without a gold currency on the footing recommended by Ricardo in his celebrated scheme for ‘A Secure and Economical Currency’” (ibid: 28).

In 1913 Keynes observed approvingly that “in the last ten years the gold-exchange standard has become the prevailing monetary system of Asia” (Keynes 1913: 25). As is well known, this system was extended to other countries in interwar years, and later institutionalised, with qualifications, at Bretton Woods.

Appendix 8: The boundaries constraining the exchange rate

As shown in Chapter 8, the evaluation of the state of the exchange required, according to Ricardo, a disentangling of the margin of variation in the exchange rate opened by the cost of transporting bullion abroad, and the effect of the monetary conditions that might depreciate or appreciate the currency. How to do that was illustrated by Ricardo with two examples, one in his early letters to the Morning Chronicle, the other in Principles. This question was made more complex if the two countries were on a different standard.

1. The proportions in which the transfer cost of bullion and the depreciation of the note accounted for a fall in the exchange rate

In his letters of 29 August and 20 September 1809 to the Morning Chronicle, Ricardo showed that the greatest part of the fall in the exchange rate of the pound should be ascribed to the depreciation of the Bank of England note. To do that, he compared a situation in which the currency would be undepreciated and the observed situation at the time.

The cost of transferring gold bullion being given, the export bullion point determined the lowest level of the exchange rate which could exist when the domestic currency was undepreciated:

If our circulation were wholly carried on by specie, I believe it would be difficult for this writer to convince us, that the exchange might be 20 per cent. against us. What could induce any person owing 100 l. in Hamburgh, to buy a bill here for that sum, giving 120 l. for it, when the charges attending the exportation of the 100 l. to pay his debt could not exceed 4l. or 5l.?

(The Price of Gold; III: 24)

Someone in London having to pay a debt of £100 in Hamburg had the choice between two means of implementing this operation: either he bought in London a bill of exchange on Hamburg of the equivalent in Mark banco of £100 at the ruling exchange rate of the pound, or he purchased £100 in gold bullion in London and sent it to Hamburg where he sold it for Mark banco to discharge his debt. Knowing that in the second case the cost of the exportation of bullion was 4 or 5 per cent, he would not agree to paying for the bill more than £104 or £105. If in the London foreign-exchange market the price of such bill was £120, the difference could only be ascribed to the depreciation of the Bank of England notes paying for the bill of exchange, which lowered the exchange rate of the pound beyond the 4 or 5 per cent limit set by the transfer cost below the legal par:

This is therefore the natural limit to the fall of the exchange, it can never fall more below par than these expences [of the transport of the metals]; nor can it ever rise more above par than the same amount. […] Thus then it appears, that the exchange may not only fall to the limits which I have before mentioned, but also in an inverse proportion to the rise of gold, or rather the discount of bank notes. But these are the limits within which it is even now confined. It cannot on the one hand rise more above par than the expence of freight, &c. on the importation of gold, nor on the other fall more than the expences of freight, &c. on its exportation, added to the discount on bank notes.

(ibid: 19‒20)

In Chapter VII “On foreign trade” of Principles Ricardo repeated the argument according to which an exchange rate of 30 per cent below par might only be explained by the depreciation of the currency (hence an excess issue of notes), not by an autonomous cause of fall in the exchange rate:

Those [like Ricardo] who maintained that our currency was depreciated during the last ten years, when the exchange varied from 20 to 30 per cent. against this country [England], have never contended, as they have been accused of doing, that money could not be more valuable in one country than another, as compared with various commodities; but they did contend, that 130l. could not be detained in England, unless it was depreciated, when it was of no more value, estimated in the money of Hamburgh, or of Holland, than the bullion in 100l.

By sending 130l. good English pounds sterling to Hamburgh, even at an expense of 5l., I should be possessed there of 125l.; what then could make me consent to give 130l. for a bill which would give me 100l. in Hamburgh, but that my pounds were not good pounds sterling? – they were deteriorated, were degraded in intrinsic value below the pounds sterling of Hamburgh, and if actually sent there, at an expense of 5l., would sell only for 100l. With metallic pounds sterling, it is not denied that my 130l. would procure me 125l. in Hamburgh, but with paper pounds sterling I can only obtain 100l.; and yet it was maintained that 130l. in paper, was of equal value with 130l. in silver or gold.

(Principles; I: 148‒9)

The first part of the quotation illustrates the contention that the value of money, estimated in “various commodities”, might differ from one country to the other. But this could not happen for the value of money estimated in bullion. Nobody would agree to “detain” £130 in England if their value in Flemish schillings were the same as £100 in bullion, unless the owner of the £130 knew that they had no more value than £100 in bullion, that is, that they were depreciated by 30 per cent. The exchange rate was a test of the depreciation, because it showed that the value of the £130 “detained”, measured in Flemish schillings (130 e, with e the exchange rate of the pound in Flemish schillings), was the same as the value of £100 in bullion, also measured in Flemish schillings (hence 100 , with the real par of exchange). It amounted to the same to say that the proof of a 30 per cent depreciation of the pound was that the value of £130 was £100 in bullion, or that the rate of exchange e was below the par by 30 per cent.

The second part of the quotation details what Ricardo meant in the first by “no more value, estimated in the money of Hamburgh, or of Holland, than the bullion in 100l”. By “the pounds sterling of Hamburgh” he meant the quantity of pounds one might obtain in London by purchasing in Hamburg a bill on London and paying it with the quantity of money previously sent from London to Hamburg. The reasoning was based on the rationale of arbitrage. If the arbitrager decided to transport £130 from London to Hamburg – by the cheapest way, that is, in the form of bullion, at a cost of £5 – he expected to get £125, that is, an amount of Flemish schillings allowing him to purchase a bill of £125 on London, if his £130 were “good English pounds sterling”. But then it did not make sense for him to purchase in London with £130 a bill payable in Hamburg a quantity of Flemish schillings that bought a £100 bill on London. Such operation did exist, however, as testified by the quotation of the exchange rate of the pound in Flemish schillings. This meant that the other operation was not more beneficial, hence that it did not produce £125 after deduction of the transport cost of bullion, but £100. In other words, this proved that the £130 were not “good English pounds sterling” but were “deteriorated”, “degraded”. The cause of this degradation was easy to find: the £130 pounds were not in metallic money but in depreciated paper.

2. The complications introduced by a difference in standard

As shown in Appendix 1 above, Ricardo criticised Vansittart in 1811 for wrongly ascertaining the state of the exchange in the year 1760, because Vansittart did not use the “real par of exchange” taking into account the difference in standard between London (gold bullion) and Hamburg (silver bullion). This real par obtained when, in the formula of the legal par computed on gold (), the lacking legal price of gold in coin in Hamburg was replaced by the price at which an ounce of gold bullion could be purchased or sold in the Hamburg market against silver bullion paid for at the legal price:

(1.3)

with the legal price of silver bullion in Hamburg, the legal price of gold in coin in London, and the relative price of gold bullion in terms of silver bullion computed in the London market as a proxy of its level in the Hamburg market (because of arbitrage in the international bullion market):

(8.17)

We saw that available historical data validate Ricardo’s calculation of , hence his critique of Vansittart.

In inequalities (8.5) of Chapter 8 above, which state the limits of variation of the exchange rate computed on the basis of the real par on gold, should now be replaced by the real par on gold and silver :

(8.18)

with e the exchange rate of one pound against Flemish schillings, and and the respective costs of importing or exporting bullion to (from) London from (to) Hamburg, supposed for simplicity to be identical for both metals.

From (1.3) and (8.18) one may deduce the boundaries constraining the exchange rate:

(8.19)

Applying (6.1) to the market price of gold bullion in London and to the market price of silver bullion in Hamburg gives their limits of variation:

(6.1)

(8.20)

with and respectively the melting and minting costs of the coin in London, and the commission charged by the Bank of Hamburg to pay accounts in Mark banco into silver bullion, the conversion of silver bullion into accounts in Mark banco being at no charge (see Chapter 1 above).

The upper boundary of the exchange rate e obtained when, in the first part of the definition of given by (8.17), was at its maximum, and the lower boundary obtained when was at its minimum, both given by (6.1). Inequalities (8.19) became then as follows:

(8.21)

In the second part of the definition of given by (8.17), e was also constrained by an upper boundary obtained when was at its minimum and by a lower boundary obtained when was at its maximum, making Inequalities (8.19) become as follows:

(8.22)

Inequalities (8.21) and (8.22) determine for either direction of variation of e two thresholds triggering international arbitrage, respectively on silver bullion (depending on its market price in London) and on gold bullion (depending on its market price in Hamburg). The exchange rate was effectively constrained from above by the lower threshold (which triggered the import to London of the corresponding metal) and from below by the higher threshold (which triggered the export of the corresponding metal). The boundaries of the exchange rate were consequently given by:

(8.23)

A comparison between (8.10) and (8.23) shows the similarities and differences that existed in the international adjustment between a system in which the two countries had a standard in common and a system in which they were on different standards. In the first case, the exchange rate was constrained by fixed boundaries depending on the legal price of the common standard in each country (which determined the legal par of exchange) and on given parameters reflecting the conditions of convertibility both ways between the currency and the standard in each country and of the transfer of the standard from one country to the other. In the second case, in addition to these magnitudes, the boundaries constraining the exchange rate also depended on the market price in each country of the metal that was the standard in the other country. Consequently, the boundaries were no longer fixed but moved with the relative price of one standard in terms of the other, a magnitude which varied with the conditions of production of the two metals at the world level. In other words, the exchange rate was no longer constrained by a fixed “tunnel”, exclusively determined by the monetary conditions in each country and the organisation of the world market of the metal acting as common standard, but by a “snake” which moved with changes in the production of gold and silver and whose “skins” were alternatively made of one metal or the other, as shown by the Min {…} and Max {…} operators in inequalities (8.23) (for a study of this “bimetallic snake” between London, Paris, and Hamburg from 1821 to 1873, see Boyer-Xambeu, Deleplace and Gillard 1997, 2013).

It should be observed that, although the boundaries constraining the exchange rate were not fixed in the case of two different standards, there were still boundaries: this was not a floating exchange-rate system. In contrast with the system based on a common standard, the price of the standard was not legally fixed in each country, the exchange rate adjusting to the legal par. Each of the two metals had now a fixed legal price in one of the two countries but only a variable market price in the other, where it was not the standard. However, this variable market price was itself constrained through arbitrage by the legal price of the same metal in the other country and by the level of the exchange rate. Inequalities (8.23) could be rewritten to show the boundaries constraining with and e being given, or with and e being given. A complex dynamics constrained thus e, , and together, thanks to arbitrage taking advantage of the monetary conditions in each country, the organisation of the world market of the two metals, and their conditions of production. This international bimetallism – which, it should be noted, did not require a legal domestic bimetallism in any country but simply a different standard in each – retained from the international monometallic standard the stabilising effect of the existence of a legal standard in each country and from domestic bimetallism the destabilising effect of the varying conditions of production of the metals, as had been emphasised by Ricardo (see Chapter 6 above).²⁴

Notes

1  Cantillon’s Essai sur la nature du commerce en général (Cantillon 1755 [1730]) was published in 1755 but probably written between 1728 and 1730. Cantillon disappeared mysteriously in 1734.

2  The first reference is to the 2015 edition of the original of Steuart (1767); the second reference is to the 1805 edition, reprinted in 1998. In both cases the roman figure indicates the volume in the edition.

3  At the time of Steuart, Paris quoted the exchange certain on London, while at the time of Ricardo London quoted the exchange certain on Paris. Leaving aside changes in the monetary units, the par of exchange was consequently at the time of Ricardo the reciprocal of that at the time of Steuart.

4  “How high the price of gold bullion may rise at London no man can say; but the highest it rose to, during the last war, was, I believe, 4l. 0s. 8d. per ounce standard” (Steuart 1767, II: 319; III: 343).

5  It is thus surprising to find in de Boyer des Roches (2007, 2008) the affirmation that the operation of the gold points was rejected by Ricardo. For a critique of this affirmation, see Rosselli (2008).

6  See also:

If there were no expences whatever in sending bullion from one country to another the exchange would never deviate from par. It would be as invariable as the price of bullion is in countries where money is freely exchangeable for bullion on demand.

(Letter to McCulloch, 2 October 1819; VIII: 93)

Without any alteration in the quantity of metal in either, the relative value of their currencies may undergo a change, within the range of the expences of sending the metal from one to the other. If 10000 guilder were of the same intrinsic value as £1000, and the expence of sending money 2 pct., £1000 might for a considerable length of time purchase a bill for 10200 guilders at one period, and at another, for a considerable length of time also, it might only purchase a bill for about 9800.

(Letter to Mill, 18 December 1821; IX: 129)

7  See also: “the par of exchange being calculated not on the value which the coin actually passed for in currency, but on its intrinsic value as bullion” (Reply to Bosanquet; III: 180).

8  As indicated by Sraffa in a footnote, “McCulloch assumes that the expense of conveying bullion from Rio Janeiro to London is 5 per cent”.

9  This obviously should read “lower”, although this mistake is not mentioned by Sraffa.

10  The incident phrase “supposing paper money not to be used” is explained by the fact that Ricardo here assumed a metallic circulation, so that a general rise in prices might only be produced by “an influx of money”. If inconvertible paper money was also taken into consideration, the effects on the exchange were the same as in the case of obstacles to the international transfer of bullion; see Section 8.5 below.

11  This conclusion is apparently contradicted by the following quotation:

It [the exchange] may also be ascertained by comparing it with some standard common to both countries. If a bill on England for 100l. will purchase the same quantity of goods in France or Spain, that a bill on Hamburgh for the same sum will do, the exchange between Hamburgh and England is at par; but if a bill on England for 130l., will purchase no more than a bill on Hamburgh for 100l., the exchange is 30 per cent. against England.

(Principles; I: 147‒8)

There is, however, no contradiction. The evaluation of the exchange concerned the English currency and the Hamburg currency, not the French or Spanish one. French or Spanish goods were only “some standard common to both countries” – any standard, not necessarily the standard of money – by which the parity of the pound and the Flemish schilling (Hamburg money) was ascertained. If one might pay in France for any given quantity of whatever commodity with a bill of £100 drawn alternatively on London or Hamburg, the exchange of the pound against Flemish schillings was at par. But if one had to draw a bill of £130 on London to be discharged of a payment one might do with a bill of £100 on Hamburg, the exchange of the pound against Flemish schillings was 30 per cent against the pound. This is no surprise: the fact that one might draw a £100 bill on Hamburg only meant that the bill in Flemish schillings drawn on Hamburg might purchase there a £100 bill on London. The exchange between the pound and the Flemish schilling was thus at par if it was indifferent to exchange French or Spanish money against pounds or against Flemish schillings then against pounds.

12  “Beside the improvements in arts and machinery, there are various other causes which are constantly operating on the natural course of trade, and which interfere with the equilibrium, and the relative value of money” (Principles; I: 141‒2). “Although taxation occasions a disturbance of the equilibrium of money, it does so by depriving the country in which it is imposed of some of the advantages attending skill, industry, and climate” (ibid: 145).

13  For a denial of the existence of the purchasing power parity theorem in Ricardo, see also Marcuzzo and Rosselli (1991).

14  For simplicity, I suppose that international arbitrage ensures that the exchange rate quoted in London is equal to that in Paris.

15  This definition of the real exchange rate and its formal expression in (8.3) resemble what may be found in any modern textbook in macroeconomics under the heading “real exchange rate”, with the general price level substituting for the price of gold bullion. As already emphasised in Chapter 3 above, this does not mean that for Ricardo the latter was a proxy of the former.

16  In the Appendix to the fourth edition of High Price, Ricardo quoted the author of the review of his book in the Edinburgh Review – Malthus – to criticise the contention that “the exportation of the ‘precious metals is the effect of a balance of trade, originating in causes which may exist without any relation whatever to redundancy or deficiency of currency’” (III: 101; Ricardo’s emphasis).

17  For a more sceptical view, and the suggestion that Ricardo in fact adhered to the description made by Thornton of the international transmission mechanism of an excess issue of notes, see Rosselli (2008: 77‒8):

Ricardo repeatedly states that it is a fall in the value of gold that determines its exportation, because he wants to stress that there is nothing that makes gold a special commodity, to be preferred to others to settle international debts. Yet, he does not feel the need to specify the sequence of steps by which an increase in the money supply determines the exportation of gold. Even in his later works, he will develop his theory of the value of gold, but will not feel the need for deepening this aspect of his analysis. A practical man, not particularly fond of putting in writing his thoughts, he stresses only the points where his opinions are at variance with those of the others. Thornton had “considered this subject very much at large” and there was no need to repeat what was now common ground.

18  See also: “All trade is at last a trade of barter and no nation will long buy unless it can also sell, – nor will it long sell if it will not also buy” (Letter to Malthus, 26 June 1814; VI: 109). Sraffa mentions that “the phrase is Malthus’s (Observations on … the Corn Laws, 1814, p. 24)” (VI: 109 n1).

19  It is the reason why in his Index Sraffa mentions at the entry “Foreign trade”: “principles of, in terms of barter, I, 133‒6, in terms of money, I, 137‒49; finally a trade of barter, I, 228, II, 154, IV, 214, VI, 109” (XI: 32). The pages in Principles are from Chapter VII “On foreign trade”; the other references are the ones quoted above in the text.

20  For a comparison of the various types of international adjustment in the literature on Ricardo, in the case of war transfers or abnormal importation of corn by Britain, see Marcuzzo and Rosselli (1991: 145‒8), including their own view of the subject.

21  This hesitation about the usefulness of the notion of real exchange is surprising, since Ricardo had used it eight years before in Reply to Bosanquet (III: 213) and also six months before when he was examined by the Lords’ Committee (see the above quotation from V: 448).

22  See also, in the first letter to McCulloch: “I cannot help thinking that in all cases an unfavourable exchange may be traced to a relative redundancy of currency” (VIII: 86).

23  This position was consistent with the affirmation, in Reply to Bosanquet, that the import of corn and the export of gold were voluntary – that is, governed by interest alone – even during a famine; they were not compulsory. Gold was exported neither because England was forced to import corn nor because foreigners refused to be paid in other English commodities:

Mr. Bosanquet speaks as if the nation collectively, as one body, imported corn and exported gold, and that it was compelled by hunger so to do, not reflecting that the importation of corn, even under the case supposed, is the act of individuals, and governed by the same motives as all other branches of trade. What is the degree of compulsion which is employed to make us receive corn from our enemy? I suppose no other than the want of that commodity which makes it an advantageous article of import; but if it be a voluntary, as it most certainly is, and not a compulsory bargain between the two nations, I do still maintain that gold would not, even if famine raged amongst us, be given to France in exchange for corn, unless the exportation of gold was attended with advantage to the exporter, unless he could sell corn in England for more gold than he was obliged to give for the purchase of it. Would Mr. Bosanquet, would any merchant he knows, import corn for gold on any other terms? If no importer would, how could the corn be introduced into the country, unless gold or some other commodity were cheaper here? As far as those two commodities are concerned, do not these transactions as certainly indicate that gold is dearer in France, as that corn is dearer in England? Seeing nothing in Mr. Bosanquet’s statement to induce me to change my opinion, I must continue to think that it is interest, and interest alone, which determines the exportation of gold, in the same manner as it regulates the exportation of all other commodities.

(Reply to Bosanquet; III: 207‒8)

These trade movements were consequent upon money being redundant in England, and gold rather than other commodities was exported because, as mentioned above in Section 8.2, it was “the cheapest exportable commodity”.

24  For any pair of currencies, it can be shown that, at a moment of time, the “width” of the “bimetallic snake” was smaller than the range of variation of the exchange rate permitted by an international monometallic standard, but through time changes in the relative price of the two metals made the “snake” oscillate, hence the exchange rate oscillated with it (see Boyer-Xambeu, Deleplace and Gillard 1997, 2013). The stabilising performance of international bimetallism thus depended on the respective force of these two effects. Econometric studies have shown that, on the period from 1821 to 1873, it was able to absorb several important shocks on the world gold / silver price, including the “gold rush” of the early 1850s; see Boyer-Xambeu et al. (2007a, 2007b).