of gold bullion between two fixed limits given by:9 Central banking and the euthanasia of metal currency
A currency is in its most perfect state when it consists wholly of paper money, but of paper money of an equal value with the gold which it professes to represent.
(Principles; I: 361)
The link between money and central banking is usually provided in the literature on Ricardo by the Quantity Theory of Money: it concerns the effects of an exogenous quantity of notes – issued discretionarily by the Bank of England – on the value of money. The attribution to Ricardo of a price-specie flow mechanism – according to which there is a mechanical adjustment of the domestic quantity of money thanks to international bullion flows and changes in the balance of trade – restricts the question of central banking to the rules that prevent the Bank of England from raising obstacles to this adjustment.
The object of the present chapter is to show that Ricardo’s positions on central banking are better understood on the basis of the theory of money exposed in Chapters 3 to 7 above and of its consequences for international adjustment as analysed in Chapter 8. The starting point is Ricardo’s conception of the public nature of paper money (Section 9.1), which is embodied in the two plans he designed for the monetary system, the Ingot Plan (Section 9.2) and the Plan for a national bank (Section 9.3). These plans aimed at managing the quantity of notes issued (Section 9.4) and at increasing the security of the monetary system (Section 9.5). They were an application of Ricardo’s theory of money (Section 9.6). Appendix 9 compares five monetary systems endowed with a gold standard, the pre-1797 one, Ricardo’s Ingot Plan, Peel’s bill, Ricardo’s Plan for a national bank, and the 1844 Bank Charter Act.
9.1 The public nature of paper money
In a letter to Jean-Baptiste Say of 24 December 1814, Ricardo still considered that “justice” and “security” were at variance on the question of the ownership of the bank of issue: the former object pleaded for public ownership (by “Government”), the latter for private one (by “a company of Bankers or merchants”):
The plan for the currency of France which you have sent me to look over differs in no essential point from that which I recommended for our Bank of England [in the Appendix to the fourth edition of High Price], excepting that you propose Government to be the issuers, and to derive the advantages from the substitution of paper for metallic money. In all countries, I should think, there exists a repugnance to entrust to Government the power of issuing paper money, and when we consider that perhaps in no instance they have not abused such a power, it is not wonderful that such fears are prevalent. I am however so fully persuaded that the value of a currency depends on its quantity, and if your plan is adhered to there is such security against the quantity becoming excessive, that I cannot doubt of its success. My only doubt is whether Government will under all temptations rigidly abide by its own rules. In justice the public ought to derive the benefits which result from the substitution of a paper for a more valuable currency, but it has hitherto been given to a company of Bankers or merchants because they were more under the control of authority and could not with impunity use so formidable an engine to the injury of the public. At no time has the theory of money been so well understood as at present, and if the practice is conformable to it every thing respecting paper money will go on well.
(VI: 165‒6)
Eight months later, his commitment to justice was even greater, after the discovery of the “enormous profits” made by the Bank of England in its bargains with the government. At the request of Pascoe Grenfell, he was then completing the manuscript of Proposals (“late in September 1815”, according to Sraffa 1951e: 46), which was first conceived as an attack at the Bank to be mounted in Parliament on this question. But he had also imagined a way to reconcile justice and security: the appointment of “Commissioners […] independent of all ministerial control.” In a letter to Malthus of 10 September 1815, he wrote:
I think the Bank [of England] an unnecessary establishment getting rich by those profits which fairly belong to the public. I cannot help considering the issuing of paper money as a privilege which belongs exclusively to the state. – I regard it as a sort of seignorage, and I am convinced, if the principles of currency were rightly understood, that Commissioners might be appointed independent of all ministerial controul who should be the sole issuers of paper money. […] In looking over the papers which have from time to time been laid before Parliament I think it might clearly be proved that the profits of the Bank have been enormous, – I should think they must have a hoard nearly equal to their Capital. By their Charter they are bound to make an annual division of their profits, and to lay a statement of their accounts before the Proprietors, – but they appear to set all law at defiance. I always enjoy any attack upon the Bank and if I had sufficient courage I would be a party to it.
(VI: 268‒9)
The idea of independent commissioners made its way in Proposals, which ended with a half-page outline of a public bank of issue, substituting for the Bank of England (“a company of merchants”) when its charter would expire in 1833:
The Bank are secure of their charter for seventeen years to come; and the public cannot, during that time, deprive them of the most profitable part of their trade. If indeed the charter were about to expire, the public might question the policy of permitting a company of merchants to enjoy all the advantages which attend the supplying of a great country with paper money; and although they would naturally look with jealousy, after the experience furnished by other states, to allowing that power to be in the hands of government, they might probably think that in a free country means might be found by which so considerable an advantage might be obtained for the state, independently of all control of ministers. Paper money may be considered as affording a seignorage equal to its whole exchangeable value, – but seignorage in all countries belongs to the state, and with the security of convertibility as proposed in the former part of this work, and the appointment of commissioners responsible to parliament only, the state, by becoming the sole issuer of paper money, in town as well as in the country, might secure a net revenue to the public of no less than two millions sterling. Against this danger, however, the Bank is secure till 1833, and therefore on every ground publicity [of its profits] is expedient.
(Proposals; IV: 114)
It should be observed that the security of a public-note issue would not only be afforded by the political independence of the commissioners but also by “convertibility as proposed in the former part of this work”, that is, convertibility of the note into bullion. Ricardo explicitly envisaged coupling the Ingot Plan – outlined in 1811 in the Appendix to the fourth edition of High Price and developed in 1816 in Proposals as applying to the Bank of England – and the public note issue. One may think that, in Ricardo’s mind at that time, the Ingot Plan should be implemented for the Bank of England until the expiration of its charter (in 1833), and prolonged later under public ownership of the bank of issue. This conjecture is consistent with what may be found in Principles. In the first edition of 1817 and in the two subsequent editions of 1819 and 1821, the idea of a public bank was revived with the same arguments as in Proposals. After having shown that such bank would spare the interest on the loans made by the Bank of England to the government – hence the taxes levied on the public to pay for this charge of interest – he noted:
I have already observed, that if there were perfect security that the power of issuing paper money would not be abused, it would be of no importance with respect to the riches of the country collectively, by whom it was issued; and I have now shewn that the public would have a direct interest that the issuers should be the State, and not a company of merchants or bankers. The danger, however, is, that this power would be more likely to be abused, if in the hands of Government, than if in the hands of a banking company. A company would, it is said, be more under the control of law, and although it might be their interest to extend their issues beyond the bounds of discretion, they would be limited and checked by the power which individuals would have of calling for bullion or specie. It is argued that the same check would not be long respected, if Government had the privilege of issuing money; that they would be too apt to consider present convenience, rather than future security, and might, therefore, on the alleged grounds of expediency, be too much inclined to remove the checks, by which the amount of their issues was controlled. Under an arbitrary Government, this objection would have great force; but, in a free country, with an enlightened legislature, the power of issuing paper money, under the requisite checks of convertibility at the will of the holder, might be safely lodged in the hands of commissioners appointed for that special purpose, and they might be made totally independent of the control of ministers.
(Principles; I: 362)
In the perspective of the coming debate in Parliament on the resumption of cash payments by the Bank, Ricardo, on McCulloch’s suggestion in a letter of 6 December 1818 (VII: 353), inserted in the second (1819) edition of Principles a four-page extract of Proposals containing the Ingot Plan. This insert remained in the third edition of 1821. Thus, these two editions of Principles contained the complete scheme of a paper money convertible into bullion and issued by a public bank. However, after the Ingot Plan, partly adopted by Parliament in 1819 as a transition to the resumed convertibility of the Bank of England note into coin, had been torpedoed by the Bank and abandoned in 1821 on the occasion of the return to the pre-war parity of the pound, Ricardo stepped back on convertibility into bullion, although introducing in the manuscript (1823) of his Plan for a National Bank an “expedient” provision that resurrected it (see below).
This latter plan again illustrated Ricardo’s ongoing concern about the profits of the Bank of England, as shown in a letter to Malthus on 3 August 1823:
I have been writing a few pages in favor of my project of a National Bank, with a view to prove that the nation would lose nothing in profits by abolishing the Bank of England, and that the sole effect of the change would be to transfer a part of the profits of the Bank to the national treasury.
(IX: 325‒6)
But above all it reiterated the view, already expressed in Proposals and deriving from his theory of money (see Chapter 4 above), that “paper money may be considered as affording a seignorage equal to its whole exchangeable value” (IV: 114)1 and consequently should be issued by the State. In a letter to McCulloch on 8 August 1823 he wrote:
I have written a short essay on the Plan of a National Bank, in which I have endeavored to shew that no one would be injured by such an establishment, but the Bank of England and the other issuers of paper money in the country who have no claim whatever to a profit which may be compared to that which is derived from the seignorage of money.
(IX: 331)
The danger of “this great Leviathan, the Bank” for security
So far so good for justice. As for security, Ricardo did not only believe that a public power of issuing paper money could be prevented from being abused; he also contended that security was not on the side of “a company of merchants”. It is striking that in the above quotation from Principles he mentioned the same argument – “a company would, it is said, be more under the control of law” – he had used in his letter to Say in 1814, but now he objected to it. The reason was that, as early as Proposals, Ricardo had emphasised that it had been unsafe to entrust the Bank of England with the power of regulating the currency, in the sense that it could vary the quantity – hence the value – of money at will:
With the known opinion of the Bank directors, as to the rule for issuing paper money, they may be said to have exercised their powers without any great indiscretion. It is evident that they have followed their own principle with extreme caution. In the present state of the law, they have the power, without any control whatever, of increasing or reducing the circulation in any degree they may think proper: a power which should neither be intrusted to the State itself, nor to any body in it; as there can be no security for the uniformity in the value of the currency, when its augmentation or diminution depends solely on the will of the issuers. That the Bank have the power of reducing the circulation to the very narrowest limits will not be denied, even by those who agree in opinion with the directors, that they have not the power of adding indefinitely to its quantity. Though I am fully assured, that it is both against the interest and the wish of the Bank to exercise this power to the detriment of the public, yet, when I contemplate the evil consequences which might ensue from a sudden and great reduction of the circulation, as well as from a great addition to it, I cannot but deprecate the facility with which the State has armed the Bank with so formidable a prerogative.
(Proposals; IV: 68‒9; Principles; I: 359‒60)
In a speech before the House of Commons on 12 June 1822 Ricardo would speak of “this great Leviathan, the Bank” (V: 202). According to him, the danger of “so formidable a prerogative” did not lie in the Bank issues being driven by interest or recklessness – “they may be said to have exercised their powers without any great indiscretion” – but in the fact that discounting bills – the very act by which the Bank issued notes – was decided on the basis of the quality of the bills, and not of the effect on aggregate circulation. In his “Notes on the Bullion Report” of 1810 Ricardo had already emphasised this point:
The observations of Mr. Harman that the Bank never discount bills but for bona fide transactions cannot limit the quantity, – the same sum of money performs successively a great number of payments, – but a bill might be given for each of these payments for bona fide transactions and if the bank discounted them all we might have four or ten times the amounts of paper that is now actually in circulation.
(III: 363‒4)2
In modern parlance, the Bank’s approach to the note issue was microeconomic – it relied on the characteristics of the commercial bill which was discounted – while it should have been macroeconomic – taking into account the state of the aggregate circulation, as signalled by the market price of gold bullion. The fact that the directors of the Bank of England persistently denied that their issues had any effect on the price of gold and on the level of the exchange rate was a proof of the danger to which their incompetence exposed the public. Indeed, there was a corrective mechanism – convertibility of the notes into coin – which eventually admonished them for their error. But in the interval before they were forced to adapt, “great distress would be suffered”, as Ricardo observed before the House of Commons on 12 June 1822:
His hon. friend [Mr. Haldimand, a Member of Parliament] had said, that whilst the Bank was obliged to pay its notes in gold, the public had no interest in interfering with the Bank respecting the amount of the paper circulation, for if it were too low, the deficiency would be supplied by the importation of gold, and if it were too high, it would be reduced by the exchange of paper for gold. In this opinion he did not entirely concur, because there might be an interval during which the country might sustain great inconvenience from an undue reduction of the Bank circulation. Let him put a case to elucidate his views on this subject. Suppose the Bank were to reduce the amount of their issues to five millions, what would be the consequence? The foreign exchanges would be turned in our favour, and large quantities of bullion would be imported. This bullion would be ultimately coined into money, and would replace the paper-money which had previously been withdrawn; but, before it was so coined, while all these operations were going on, the currency would be at a very low level, the prices of commodities would fall, and great distress would be suffered. Something of this kind had, in fact, happened.
(V: 199‒200)
Ricardo’s solution to this problem was to adopt convertibility of the note into bullion instead of specie and to subject the Bank of England to the rule of varying its issues according to the spread between the market price of the standard and its legal price. This was the Ingot Plan.
Many modern commentators simply ignore the Ingot Plan, for example Ahiakpor (1985, 2003), Perlman (1986), Peach (1993), Blaug (1995, 1996), de Boyer des Roches (2007, 2008, 2013). When it is mentioned, it is often downplayed as being only a technical device – already to be found in Adam Smith – aiming at economising on gold by substituting paper money for metallic coins (see for example in the past Rist 1940 [1938]: 173, 176, and in modern times Laidler 1987: 293; Davis 2005: 155, 169, 194; Arnon 2011: 145; King 2013: 144). It is also often overlooked as a permanent system and reduced to a temporary device aiming at limiting the deflation involved by money supply contraction during the transition to convertibility at pre-war parity (see for example Hollander 1979: 494‒5, 536). The genesis of this plan and the analysis of its content suggest that it was far more than that.
The idea of convertibility of the Bank of England note into bullion appeared in 1811 in the Appendix to the fourth edition of High Price:
If the same benefits to the public, – the same security against the depreciation of the currency, can be obtained by more gentle means, it is to be hoped that all parties, who agree in principle, will concur in the expediency of adopting them. Let the Bank of England be required by Parliament to pay (if demanded) all notes above 20l. – and no other, at their option, either in specie, in gold standard bars, or in foreign coin (allowance being made for the difference in its purity) at the English mint value of gold bullion, viz. 3l. 17s. 10½d. per oz., such payments to commence at the period recommended by the Committee.
This privilege of paying their notes as above described might be extended to the Bank for three or four years after such payments commenced, and if found advantageous, might be continued as a permanent measure. Under such a system the currency could never be depreciated below its standard price, as an ounce of gold and 3l. 17s. 10½d. would be uniformly of the same value.
(High Price, Appendix to 4th ed.; III: 124‒5)
One observes that the general motive of this plan was to guarantee for the monetary system the “security against the depreciation of the currency”, by employing “more gentle means” which would:
[P]revent the useless labour, which, under our system previously to 1797, was so unprofitably expended on the coinage of guineas, which on every occasion of an unfavourable exchange (we will not enquire by what caused) were consigned to the melting pot, and in spite of all prohibitions exported as bullion.
(ibid: 125)
Ricardo did not take credit for this idea of convertibility into bullion, but had taken advantage of its implementation abroad for a long time, namely by the Bank of Amsterdam and the Bank of Hamburg (see Chapter 1 above).3 However, the novelty was to marry this type of convertibility, which ensured the security of the monetary system (see Section 9.5 below), with the issuing of notes by discounting commercial bills, as the Bank of England did, which ensured the fulfilment of “the demands of commerce” (neither the Bank of Amsterdam nor the Bank of Hamburg issued notes or discounted bills).4 Already in his “Notes on Bentham” written around Christmas 1810, Ricardo had mentioned these banks:
The Bank of England is certainly not quite secure as a bank of deposit such as Amsterdam and Hamburgh, – but is infinitely more useful in making the whole capital of the country available. […] In Holland and Hamburgh the advantages of the Banks is 1° in the use of paper instead of metals which has been admirably described by this author [Bentham], and 2° in having a uniform measure of value subject to no debasement or deterioration.
(III: 288; Ricardo’s emphasis)5
Ricardo’s plan thus combined the advantages of the two systems:
The plan here proposed appears to me to unite all the advantages of every system of banking which has been hitherto adopted in Europe. It is in some of its features similar to the banks of deposit of Amsterdam and Hamburgh. In those establishments bullion is always to be purchased from the Bank at a fixed invariable price. The same thing is proposed for the Bank of England; but in the foreign banks of deposit, they have actually in their coffers, as much bullion, as there are credits for bank money in their books; accordingly there is an inactive capital as great as the whole amount of the commercial circulation. In our Bank, however, there would be an amount of bank money, under the name of bank-notes, as great as the demands of commerce could require, at the same time there would not be more inactive capital in the bank coffers than that fund which the Bank should think it necessary to keep in bullion, to answer those demands which might occasionally be made on them. It should always be remembered too, that the Bank would be enabled by contracting their issues of paper to diminish such demands at pleasure. In imitation of the Bank of Hamburgh, who purchase silver at a fixed price, it would be necessary for the Bank to fix a price very little below the mint price, at which they would at all times purchase, with their notes, such gold bullion as might be offered to them.
The perfection of banking is to enable a country by means of a paper currency (always retaining its standard value) to carry on its circulation with the least possible quantity of coin or bullion. This is what this plan would effect. And with a silver coinage, on just principles, we should possess the most economical and the most invariable currency in the world. The variations in the price of bullion, whatever demand there might be for it on the continent, or whatever supply might be poured in from the mines in America, would be confined within the prices at which the Bank bought bullion, and the mint price at which they sold it. The amount of the circulation would be adjusted to the wants of commerce with the greatest precision; and if the Bank were for a moment so indiscreet as to over-charge the circulation, the check which the public would possess would speedily admonish them of their error. As for the country Banks, they must, as now, pay their notes when demanded in Bank of England notes. This would be a sufficient security against the possibility of their being able too much to augment the paper circulation. There would be no temptation to melt the coin, and consequently the labour which has been so uselessly bestowed by one party in recoining what another party found it their interest to melt into bullion, would be effectually saved. The currency could neither be clipped nor deteriorated, and would possess a value as invariable as gold itself, the great object which the Dutch had in view, and which they most successfully accomplished by a system very like that which is here recommended.
(High Price, Appendix to 4th ed.; III: 126‒7; Ricardo’s emphasis)
In spite of the rejection of the Bullion Report by Parliament (see Chapter 2 above), Ricardo tried to push his plan among political leaders. On 27 July 1811 he wrote to the Prime Minister and Chancellor of the Exchequer Spencer Perceval:
Let the Bank be obliged to sell gold bullion, for their own notes, to any purchaser that shall apply for a quantity not less than 5 ounces, at the rate of £4.15 pr oz for standard bullion, and whatever the bullion so delivered by the Bank may arise from, whether from foreign coin, or from light guineas, let it be freely exportable at the will of the purchaser. An enactment to this effect would secure the public against any depreciation of the currency beyond that to which it has already reached.
(VI: 43‒4)
As shown by the price chosen for the conversion of the notes into gold bullion – the ruling market price of the latter at the time, 22 per cent above the mint price – the purpose of the measure was to stop the acceleration of depreciation, not to restore the currency to its original value. Such a proposal could not “in any way be considered as a hardship on the Bank”, and “it would give the public complete security against the further depreciation of Bank notes” (ibid: 44‒5), because the Bank of England would prevent any rise in the market price of bullion – hence any threat on its metallic reserves – by adjusting the amount of the note issue:
Whilst the Bank have the power of limiting their issues of paper, they have the power of counteracting any tendency to a rise in the price of gold, whatever the demand for that article may be, either on the continent of Europe, or in any other part of the world.
(ibid: 45)
The proposal was turned down by the Prime Minister, as mentioned by Ricardo (“He politely declined to follow my suggestions”) on 11 December 1811 at the end of a letter to the Whig Opposition leader George Tierney, whom he also tried (unsuccessfully) to convince of the relevance of:
[T]he means which might be advantageously adopted, first, to arrest the progress of the depreciation of our currency, and secondly to restore it to its standard value.
(VI: 67)
The first object would be attained by the measure he had proposed to Perceval (the minimum quantity of bullion sold by the Bank “at a fixed price somewhere about the present market price” being now raised to “not less than 50, 100, or 200 ounces”; ibid: 67‒8), the second by the gradual lowering, beginning six months later, of this fixed price by 6 or 9 pence (less than one per cent) each month, until after four or three years it was reduced to the mint price (£3. 17s. 10½d.). The restoration of the currency “to its standard value” was put by Ricardo in a larger perspective: the adoption of a permanent system of a circulation exclusively composed of notes convertible into bullion:
When this desireable object should be attained it would be of little comparative importance to the public, whether the Bank were allowed to continue to supply the whole circulation, as they now do, with their notes, or whether they should be compelled to pay in specie. It is not money but money’s worth that the holders of notes require, and it can be of little consequence to any reasonable man whether he goes to market with 20 guineas or £21 in notes, provided he can purchase precisely as much with one as with the other. If the public were secured against depreciation by possessing the power of exchanging their notes for bullion at the mint value of gold, I should prefer a circulation, such as ours, consisting wholly of paper, to any other, even as a permanent measure, as being more economical and possessing other obvious advantages.
(ibid: 69)
Ricardo ended up by recalling the assumption on which his plan was based:
It need not be observed that the whole of the above plan proceeds on the supposition that the Bank have uncontrouled power of regulating the rise or fall in the price of gold bullion, a point which was most satisfactorily proved during the late discussion on the report of the Bullion Committee.
(ibid)
As shown in Chapter 7 above, Ricardo started with Proposals for an Economical and Secure Currency in 1816 to give a theoretical foundation to the assumption that the Bank regulated the price of gold bullion by its note issue. The pamphlet was originally conceived at the suggestion of Pascoe Grenfell as an attack at the Bank of England on the high level and the distribution of the profits made by the Bank in its operations with the Government. It also contained the full development of what Ricardo would call in a letter of 5 March 1822 his “Ingot plan of payment” (IX: 176) and which is known in the literature as the Ingot Plan.
The two aims of the plan announced in the title of the pamphlet were summarised in the sentence opening the long passage of Proposals which would be quoted later in the second and third editions of Principles:
To secure the public against any other variations in the value of the currency than those to which the standard itself is subject, and, at the same time, to carry on the circulation with a medium the least expensive, is to attain the most perfect state to which a currency can be brought.
(Proposals; IV: 66; Principles; I: 356‒7)
This passage continues with the proposed legal provisions which broke with the pre-1797 system:
[A]nd we should possess all these advantages by subjecting the Bank to the delivery of uncoined gold or silver at the mint standard and price, in exchange for their notes, instead of the delivery of guineas; by which means paper would never fall below the value of bullion, without being followed by a reduction of its quantity. To prevent the rise of paper above the value of bullion, the Bank should be also obliged to give their paper in exchange for standard gold at the price of 3l. 17s. per ounce. Not to give too much trouble to the Bank, the quantity of gold to be demanded in exchange for paper at the mint price of 3l. 17s. 10½d., or the quantity to be sold to the Bank at 3l. 17s., should never be less than twenty ounces. In other words, the Bank should be obliged to purchase any quantity of gold that was offered them, not less than twenty ounces, at 3l. 17s. per ounce, and to sell any quantity that might be demanded at 3l. 17s. 10½d. While they have the power of regulating the quantity of their paper, there is no possible inconvenience that could result to them from such a regulation. The most perfect liberty should be given, at the same time, to export or import every description of bullion.
(Proposals; IV: 66‒7; Principles: 357)6
The first two legal changes in respect to the pre-1797 system introduced convertibility both ways (at fixed legal prices slightly different) between the Bank of England note and the standard (gold bullion). On the one hand, there existed before 1797 convertibility of the note into gold, but it was gold in coin, not in bullion, which could thus be obtained only by melting fraudulently the coin. On the other hand, the Bank of England was not in the past obliged to purchase all bullion offered to it at a fixed price, and it did that only discretionarily and at the market price. Convertibility of the note into bullion ensured that by arbitrage the market price of bullion would not rise much above the mint price when notes were issued in excess and money was depreciated. Symmetrically, convertibility of bullion into the note prevented the market price of bullion from falling too much below the mint price when the note issue was deficient and money was appreciated. The third legal provision – “the most perfect liberty […] to export or import every description of bullion” – also broke with the pre-1797 system where melting and exporting the coin was prohibited. Here also, the object was to reduce the margin of variation of the market price of bullion triggering arbitrage, hence to facilitate the stabilisation of this price (see Section 9.5 below).
What may be called the ingot principle – convertibility of the note into bullion – was coupled by Ricardo with a provision which, although not legally binding, contributed, as quoted above, “to secure the public against any other variations in the value of the currency than those to which the standard itself is subject”. This concerned the regulation of the quantity of notes issued, and may be called the management principle.
In the pre-1797 system as under inconvertibility, the issues of the Bank of England had an effect on the market price of gold bullion. As Ricardo put it in the letter to Tierney of 11 December 1811 quoted above: “the Bank have uncontrouled power of regulating the rise or fall in the price of gold bullion” (VI: 69). He would always criticise the Directors of the Bank for exercising this discretionary power while being ignorant on monetary matters. During the debate in 1819 in the House of Commons on the resumption of cash payments, a Director of the Bank of England having “denied the assertion of an hon. gentleman opposite [Ricardo], that they were not competent to the conduct of their own affairs”, Ricardo bluntly replied:
He meant no personal hostility to them as individuals, or as a public body; but he was of opinion, that they had taken wrong steps, and that they did not understand the subject of the currency.
(V: 18)7
Being incompetent the Bank’s discretion was dangerous to the public and it should be replaced by an explicit “criterion” of issuing which was also in the interest of the Bank because, by adjusting the market price of gold bullion to the legal price, it prevented profitable arbitrages from draining or flooding its metallic reserves:
These transactions in bullion [at the Bank] 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: 357‒8)
The use of this “criterion” constituted “a judicious management of the quantity” of notes, which, by stabilising the market price of the standard at the level of the legal price, prevented money from being depreciated or appreciated:
Besides, then, all the other advantages attending the use of paper money; by the judicious management of the quantity, a degree of uniformity, which is by no other means attainable, is secured to the value of the circulating medium in which all payments are made.
(Proposals; IV: 57‒8)
Referring to the Ingot Plan, Keynes (1930: 14) would go as far as speaking of “managed money”: “If Ricardo had had his way with his ingot proposals, commodity money would never have been restored, and a pure managed money would have come into force in England in 1819.” An evaluation of this affirmation would require discussing what Keynes meant by “managed money”; it will be enough here to ask whether the management principle may be understood as a discretionary monetary policy or as a rule of conduct by the Bank (see Section 9.4 below).
Implementing an “economical currency” was also one of the objects of the plan, as was recalled in Principles:
The use of paper instead of gold, substitutes the cheapest in place of the most expensive medium, and enables the country, without loss to any individual, to exchange all the gold which it before used for this purpose, for raw materials, utensils, and food; by the use of which, both its wealth and its enjoyments are increased.
(Principles; I: 361)
But there was far more than that, as James Bonar would justly emphasise in his “centenary estimate”: “Ricardo had no idea of making his ingots masquerade as coins, ‘money of a larger denomination’, in the common meaning of the words. His complete Plan was to be the euthanasia of metal currency” (Bonar 1923: 298). Thirty years later, Richard Sayers also understood that Ricardo advocated external convertibility into gold rather than a domestic one: “Ricardo perceived that the essential condition of a gold standard is not gold coinage but convertibility into gold for international transactions” (Sayers, 1953: 38).
Although stamped to guarantee their weight and fineness, the bullion “ingots” in which notes were convertible were not money, because they were not legal tender: one could not legally pay in ingots. Convertibility of the note into bullion was consequently not convertibility of a money into another money but of the only money (the note) into its standard. Ricardo emphasised this aspect, and his plan assumed that the ingots would be assayed and stamped by the Bank itself, not to confuse them with “money of a large denomination”. This was made clear in 1819 when, having not been followed on this point by the Commons’ and Lords’ Committees on the Resumption of Cash Payments, Ricardo resigned himself to this confusion because he thought it would damp the hostility of the Bank of England to the plan. In a letter to McCulloch of 8 May 1819 he wrote:
The Committee have deviated in two points from the plan as originally suggested – they think that the bars of bullion delivered by the Bank, in exchange for notes, should be assayed, and stamped, at the Mint; and they have advised that after 1823, at the latest, we should revert to the old system of specie payments. Perhaps, in both instances, they have done right, for the Bank persisting in the most determined opposition to them, they were under the necessity of having the bullion stamped that it might be legally called money of a large denomination, and that the Bank might not raise a clamour against them for having imposed upon that corporation the obligation of paying in Bullion, from which they said their charter protected them.
(VIII: 26‒7)
Ricardo’s wish to break with the old convertibility into coin was illustrated by his evolution about a provision which existed in the 1811 Appendix, leaving to the Bank the “option” of paying its notes “either in specie, in gold standard bars, or in foreign coin (allowance being made for the difference in its purity)” (III: 124). During the debates in Parliament in 1819 about his plan Ricardo first recommended such option before the Commons’ and Lords’ Committees (V: 379, 422) but he later opposed an amendment of this sort in the general debate in the House of Commons. According to Sraffa (1952b: 357):
[P]erhaps Ricardo at first took it for granted that, Bullion payments being more advantageous to the Bank, the latter would not normally exercise the option of paying in specie; and later, when the reluctance of the Bank Directors to operate the plan became apparent, he thought it necessary to make Bullion payments obligatory.
Not being available at the Bank, gold coins could still be obtained at the mint, if it remained open to the public. Proposals did not pronounce on this point, although it showed Ricardo’s preference for a circulation exclusively composed of notes. During the 1819 debates, he remained prudent and left the question open, only emphasising that the low-denomination notes (£1, 2, and 5), which had been issued by the Bank of England to substitute for the disappeared coins, should remain in circulation, and praising the 1816 reform having made silver coins a token currency. The logic of the Ingot Plan was, however, obvious: the gold coins still in circulation would progressively be carried to the Bank to be exchanged for notes, and the Bank of England note would become the sole currency. There was, however, a condition for that: the Ingot Plan should be made permanent and not just ensure the transition to the resumption of convertibility into coin.
The letter of 8 May 1819 to McCulloch quoted above mentioned a second concession by Ricardo, on the temporary character of the Ingot Plan. But this concession was only tactical; his state of mind appeared at the end of the letter:
In the second place they [the Committee] had to contend with public prejudice, and perhaps too with prepossessions which they themselves felt in favour of coin. If no inconvenience is suffered from the working of this plan for the next 5 years, the Bank will be amongst the foremost in contending that it should be adopted as a permanent system.
(VIII: 27)
After the plan had been discontinued in 1821, mainly under the pressure of the Bank of England,8 Ricardo retrospectively regretted that a chance had not been given to it for a fair try. In a letter to McCulloch of 3 January 1822 he wrote:
All the friends of that bill [of 1819] had a right to expect that the Bank would make no preparation for specie payments till 1822, one year before the period fixed, and I for one flattered myself that if from 1819 to 1822 it were found that the system of bullion payments was a safe and easy one, specie payments would be still further deferred.
(IX: 141)
This sentiment was publicly repeated in a speech before the House of Commons on 12 June 1822:
That bill [of 1819] he had always considered as an experiment, to try whether a bank could not be carried on with advantage to the general interests of the country, upon the principle of not being called upon to pay their notes in coin, but in bullion; and he had not the least doubt that, if the Bank had gone on wisely in their preliminary arrangements – if, in fact, they had done nothing but watch the exchanges and the price of gold, and had regulated their issues accordingly, the years 1819, 1820, 1821 and 1822 would have passed off so well with the working of the bullion part of the plan, that parliament would have continued it for a number of years beyond the time originally stipulated for its operation. Such, he was convinced, would have been the course, had the Bank refrained from making those unnecessary purchases of gold which had led to so many unpleasant consequences.
(V: 200)
Ricardo’s consistent position from 1811 to 1819 thus shows that Bonar’s evaluation was accurate: in Ricardo’s mind, the Ingot Plan should lead to “the euthanasia of metal currency”. In other words, it amounted to a demonetisation of gold in circulation: gold would remain the standard of money, but no longer money. Ricardo considered this achievement as a major progress in civilisation:
A well regulated paper currency is so great an improvement in commerce, that I should greatly regret, if prejudice should induce us to return to a system of less utility. The introduction of the precious metals for the purposes of money may with truth be considered as one of the most important steps towards the improvement of commerce, and the arts of civilised life; but it is no less true that, with the advancement of knowledge and science, we discover that it would be another improvement to banish them again from the employment to which, during a less enlightened period, they had been so advantageously applied.
(Proposals; IV: 65)
This new contribution to “the arts of civilised life” was, however, unfortunate.
The unhappy fate of the Ingot Plan
As adopted by Parliament on 25 June 1819 (and usually called Peel’s bill after the name of the chairman of the Commons’ Committee), the plan was incomplete and transitory. First, convertibility was only one way: the Bank of England was not obliged to buy any bullion offered to it at a fixed legal price. Second, Peel’s bill stipulated in its second article:
[T]hat it is expedient that a definite period should be fixed for the termination of the Restriction on Cash Payments; and that preparatory measures should be taken, with a view to facilitate and ensure, on the arrival of that period, the payment of the Promissory Notes of the Bank of England in the Legal Coin of the Realm.
(V: 7)
Consequently the application of the plan was limited in time: after 1 May 1822, the Bank of England would have the choice of paying its notes in coin or bullion, and on 1 May 1823 convertibility into coin would be resumed. However, even if this was as a transitory device, the adoption of convertibility into bullion was a subject of satisfaction for Ricardo because, as seen above, he thought that the success of the experiment would lead to its prolongation. There were other reasons for him to be satisfied: the bill introduced the notion of decreasing scale he had suggested for the return to the pre-war legal price at which notes were convertible. The market price of gold bullion being £4. 2s. at the time of the bill, the legal price would be £4. 1s. from 1 February 1820, £3. 19s. 6d. from 1 October 1820, and finally the mint price of £3. 17s. 10½d. from 1May 1821. As also suggested by Ricardo, the prohibition of melting and exporting the coin was repealed.
In spite of the ambiguities noted above, the adoption by law of “the Ricardo system”, as called in public by Alexander Baring (V: 92) and in private correspondence by Hutches Trower (VIII: 361), was considered by Ricardo as the “triumph of science and truth in the great councils of the Nation” (letter to Trower, 8 July 1819; VIII: 44). This triumph, however, did not last. The possibility for the Bank of England of choosing between paying its notes in coin or in bullion, programmed by Peel’s bill for 1 May 1822, was advanced to 1 May 1821 on the occasion of the return to the pre-war parity of £3. 17s. 10½d., putting the Ingot Plan experiment to an end. The Bank of England had been instrumental in this sabotage, purchasing gold bullion and having it coined, before asking Parliament for permission to substitute coins for its low-denomination notes (see Chapter 5 above). The last time Ricardo evoked the advisability of implementing again the Ingot Plan was in a letter to Trower of 5 March 1822:
If Cobbett’s recommendation should again endanger the safety of the Bank of England in consequence of an extensive practice of hoarding sovereigns, which I by no means apprehend, it might become necessary to adopt the Ingot plan of payment once more.
(IX: 176)
Even after his plan had been abandoned, Ricardo was accused of being responsible for the deflation that had occurred since 1819. He had to defend himself against this accusation, arguing that it was not his plan but the sabotage of his plan which had triggered an increase in the value of money – hence a general fall in prices – double what he had anticipated from the return to pre-war parity. The speech he delivered in the House of Commons on 12 June 1822 expressed his irritation:
He [Ricardo] hoped the House would pardon this personal reference to his own opinion: he was very averse from intruding on their patience; but he was as it were put upon his trial – his plan had not been adopted, and yet to it was referred the consequences which were distinct from it; and he was held responsible for the plan that had been adopted, which was not his, but was essentially different from it.
(V: 206)
I showed in Chapter 4 above that his defence on this occasion provided a factual illustration of his mature theory of money, as it is embodied in the Money–Standard Equation (see in particular my comments on the speech in the House of Commons on 11 June 1823 against Charles Western’s motion).
Having measured the hostility of the Bank of England to the Ingot Plan, Ricardo prepared in the last months of his life another plan, which developed an idea going back to 1815 and aiming at transferring the power of note issuance from the Bank of England to a public institution (see Section 9.3 below). Nevertheless, according to his brother Moses, he always considered the Ingot Plan as his best practical achievement:
In this pamphlet [Proposals], Mr. Ricardo suggested his plan for an economical currency. If there was any suggestion which emanated from him, upon which he seemed to pride himself more than any other, it was certainly this.
(Moses Ricardo 1824: 10)9
Ricardo’s Ingot Plan was resurrected by Alfred Marshall when he was examined by two Royal Commissions between 1886 and 1888, and in an article where he proposed a “currency scheme which […] differs from his [Ricardo’s] only by being bimetallic instead of monometallic” (Marshall 1887: 204), which was a puzzling difference, however (see Deleplace 2013b). As mentioned above in Chapter 8, Alexander Lindsay published in 1892 a pamphlet where he suggested to apply “Ricardo’s Exchange Remedy” to the monetary system of India, making it “a gold standard without a gold currency on the footing recommended by Ricardo in his celebrated scheme for ‘A Secure and Economical Currency’” (Lindsay 1892: 28). In his book Indian Currency and Finance, John Maynard Keynes credited Ricardo for having set forth the “theoretical advantages” of the gold-exchange standard which had in the meantime been adopted in India (Keynes 1913: 22). In the aftermath of World War I James Bonar observed that “in the winding up of the Treasury notes Ricardo’s help, a century after his death, may be of some use, for our problems are still his problems, with their factors much magnified” (Bonar 1923: 300). “Ricardo’s help” was finally welcome in 1925 when convertibility of the Bank of England note was resumed, not into coin but into bullion for the first time since 1819.
9.3 The plan for a national bank
The main provisions of the plan
In Section 9.1 above I described the genesis of this plan. Its main provisions were as follows. The note issue would be transferred from the Bank of England and the country banks to five independent commissioners having a monopoly all over England:
Five Commissioners shall be appointed, in whom the full power of issuing all the paper money of the country shall be exclusively vested.
(IV: 285)
The criterion for varying the issue would be the spread between the market price of gold bullion and the mint price:
Regulating their issues by the price of gold, the commissioners could never err.
(ibid: 293)
The method used to vary the note issue would no longer be discounting commercial bills – an activity left to non-issuing banks, including the Bank of England – but open-market operations on State securities (the term “open market” was used by Ricardo):
If the funds of the Commissioners became so ample as to leave them a surplus which might be advantageously disposed of, let them go into the market and purchase publicly government securities with it. If on the contrary it should become necessary for them to contract their issues, without diminishing their stock of gold, let them sell their securities, in the same way, in the open market.
(ibid: 284)
The other method used to vary the note issue was the purchase or sale of gold bullion:
If, on the contrary, the circulation of London were too low, there would be two ways of increasing it – by the purchase of Government securities in the market, and the creation of new paper money for the purpose; or by the importation, and purchase, by the Commissioners, of gold bullion; for the purchase of which new paper money would be created. The importation would take place through commercial operations, as gold never fails to be a profitable article of import, when the amount of currency is deficient.
(ibid: 297)
At the creation of the national bank, notes would be issued to discharge the government debt towards the Bank of England (equal to the capital of the Bank lent to the State plus part of the exchequer bills purchased by the Bank during the period of inconvertibility), sparing the taxes which had to be levied in order to pay the interest:
On the expiration of the charter of the Bank of England, in 1833, the Commissioners shall issue fifteen millions of paper money, the amount of the capital of the Bank, lent to government, with which that debt shall be discharged. From that time the annual interest of 3 per cent. shall cease and determine. On the same day, ten millions of paper money shall be employed by the Commissioners in the following manner. With such parts of that sum as they may think expedient, they shall purchase gold bullion of the Bank, or of other persons; and with the remainder, within six months from the day above mentioned, they shall redeem a part of the government debt to the Bank, on exchequer bills. The exchequer bills, so redeemed, shall thereafter remain at the disposal of the Commissioners.
(ibid: 285‒6)
The national bank would “act as the general banker to all the public departments” (and to no other corporation or individual) (IV: 289) but would not lend to the State: the purchase of securities by the national bank could never be made directly from the government, so as to avoid a monetary financing of this debt:
I propose also to prevent all intercourse between these Commissioners and ministers, by forbidding every species of money transaction between them. The Commissioners should never, on any pretence, lend money to Government, nor be in the slightest degree under its controul or influence. […] If Government wanted money, it should be obliged to raise it in the legitimate way; by taxing the people; by the issue and sale of exchequer bills, by funded loans, or by borrowing from any of the numerous banks which might exist in the country; but in no case should it be allowed to borrow from those, who have the power of creating money.
(ibid: 282‒3).
The latter provision ensured the independence of the national bank from the State.
The question of the independence of the national bank
This independence was a quality that did not exist with the Bank of England, although it was private:
Over Commissioners so entirely independent of them, the ministers would have much less power than they now possess over the Bank Directors. Experience shows how little this latter body have been able to withstand the cajolings of ministers; and how frequently they have been induced to increase their advances on Exchequer bills and Treasury bills, at the very moment they were themselves declaring that it would be attended with the greatest risk to the stability of their establishment, and to the public interest.
(ibid: 282)10
Ricardo had already answered in Principles to the objection that a public note issue would soon become beyond control:
Under an arbitrary Government, this objection would have great force; but, in a free country, with an enlightened legislature, the power of issuing paper money, under the requisite checks of convertibility at the will of the holder, might be safely lodged in the hands of commissioners appointed for that special purpose, and they might be made totally independent of the control of ministers. The sinking fund is managed by commissioners, responsible only to parliament, and the investment of the money entrusted to their charge, proceeds with the utmost regularity; what reason can there be to doubt that the issues of paper money might be regulated with equal fidelity, if placed under similar management?
(Principles; I: 362‒3)
This comparison with the sinking fund may be surprising in regard of the critique Ricardo made of the use of it, particularly in his article “Funding System” (1820):
They [the ministers] considered the commissioners as their trustees, accumulating money for their benefit, and of which they knew that they might dispose whenever they should consider that the urgency of the case required it. They seem to have made a tacit agreement with the commissioners, that they should accumulate twelve millions per annum at compound interest, while they themselves accumulated an equal amount of debt, also at compound interest.
(IV: 194)
According to Ricardo, “such pitiful shifts and evasions” (ibid: 195) were not the commissioners’ fault – they “have faithfully fulfilled the trust reposed in them” (ibid: 191) – but the consequence of “ready compliance from Parliament” to authorise a partial repeal of the law each time the ministers asked for it (ibid: 193). The conclusion of Ricardo was that it was better to dispense with the sinking fund:
It is, we think, sufficiently proved, that no securities can be given by ministers that the sinking fund shall be faithfully devoted to the payment of debt, and without such securities we should be much better without such a fund.
(ibid: 196)
One might think that the same legislature, be it “enlightened” as Ricardo wrote in Principles, would no more resist in the future the demands by ministers to authorise the use of the note issue to finance current expenditure than it resisted in the past when the sinking fund was diverted from its professed use of paying the debt. Even in the third edition of Principles, one year after the article “Funding System”, Ricardo did not change anything in the above passage, nor did he explain why a paper issue managed by commissioners would escape the evils denounced by him of a sinking fund also managed by commissioners. The question at stake was the possible interference between them and political power – whether Government or Parliament. On this point, as quoted above, Ricardo never suspected the commissioners of the sinking fund of any such interference (they “have faithfully fulfilled the trust reposed in them”; IV: 191) and it was for him legitimate to take them as an example for those who would manage the paper issue. This may explain why Ricardo did not think it necessary to refer to his previous article “Funding System” and to emphasise how his critique of that system did not disqualify commissioners for the management of the paper issue.
Nevertheless, even if the independence of its commissioners could be granted, this had not been enough to prevent the sinking fund from being diverted from its professed goal. One could hope that the legislature would be more “enlightened” in the future than in the past – Ricardo himself was busy in various attempts at reforming Parliament – but this was a bet which weakened the security of the proposed national bank. Although Ricardo did not mention it, there was, however, a substantial difference between the case of the sinking fund and that of a national bank, a difference that would prevent past evils of the former from being repeated with the latter. The independence of the commissioners was a necessary but insufficient condition for the sinking fund to work properly, while it was a necessary and sufficient condition in the case of a national bank – provided the commissioners were equipped with an appropriate criterion of note issuance.
In the case of the sinking fund, once it had been properly built by the commissioners, the later use of this dormant fund did not concern them, but ministers and Parliament; the independence of the commissioners in the building of the fund did not help in its later use. In the case of a national bank, the very act of issuing paper money was at the same time determining its use: purchasing gold bullion or government securities in the market. As explicitly stipulated in Plan for a National Bank, it could never be used to finance new government debt. The recent history of modern central banking, especially in times of liquidity crisis and/or sovereign debt crisis, suggests that, from a practical point of view, there is little difference for a central bank between purchasing securities directly from the government and purchasing them from banks in the secondary market, while it liberally furnishes banks with liquidity to purchase them in the primary market. In Ricardo’s plan, however, the last proposition did not apply, since the national bank did not provide money to banks as the Bank of England did before by discounting bills. Open-market operations required government securities having been previously purchased by banks with money borrowed from the credit market, not from a central bank. Moreover, as quoted above, “the purchase [by the Commissioners] of Government securities in the market, and the creation of new paper money for the purpose” would be effectuated only when “the circulation of London were too low” (IV: 297), as indicated by the market price of gold bullion being below the mint price, but never, as in modern times, to provide liquidity to banks and/or finance to government.
Of course, there was always the risk that, as had been the case with the sinking fund, Parliament might violate its own law under the pressure of ministers; but this could only be done by forcing the commissioners to breach their duty, and not by wrongly using a fund built by commissioners according to their duty. In the terms used in Principles, this could happen “under an arbitrary Government” but not “with an enlightened legislature”, all the more so since, as advised by Ricardo, “the commissioners should be appointed by government, but not removable by government” (IV: 290). An independent national bank strictly applying the management principle to the note issuance seemed to be enough for Ricardo to avoid “such pitiful shifts and evasions” as had been observed in the history of the sinking fund, even if his projects of reforming Parliament and making the legislature more “enlightened” were not to meet success.11
The role of the management principle in the Plan for a national bank suggests continuity with the previous Ingot Plan. This seems, however, not to be the case for the ingot principle, since convertibility of the notes into coin was enacted again:
From the moment of the establishment of the National Bank, the Commissioners shall be obliged to pay their notes and bills, on demand, in gold coin.
(Plan for a National Bank; IV: 289)12
It is not surprising that, after his Ingot Plan had been torpedoed by the Bank of England, Ricardo stepped back to convertibility into coin. This was, however, a tactical retreat only, because the new plan contained the following “expedient” provision:
It might be expedient to oblige them [the commissioners] to sell gold bullion at 3l. 17s. 9d.; in which case the coin would probably never be exported, because that can never be obtained under 3l. 17s. 101/2d. per oz. Under such a system, the only variations that could take place in the price of gold, would be between the prices of 3l. 17s. 6d. and 3l. 17s. 9d.; and by watching the market price, and increasing their issues of paper, when the price inclined to 3l. 17s. 6d., or under; and limiting them, or withdrawing a small portion, when the price inclined to 3l. 17s. 9d., or more; there would not probably be a dozen transactions in the year by the Commissioners in the purchase and sale of gold; and if there were, they would always be advantageous, and leave a small profit to the establishment.
(ibid: 293‒4)
This was the same scheme as in the Ingot Plan: the market price of bullion was constrained by arbitrage between two legal boundaries (see Section 9.5 below), the one at which the national bank sold bullion (£3. 17s. 9d.) and the one at which it purchased it (£3. 17s. 6d.). The variations in the market price of the standard – hence in the value of money, for a given value of the standard – were thus limited to 0.3 per cent. As for the mint price of £3. 17s. 10½d., it concerned gold in coin, not in bullion, the difference with the bank selling price of bullion (£3. 17s. 9d.) being enough to prevent arbitragers from demanding the coin with a view at its exportation (“the coin would probably never be exported”) – the same effect as that expected from “a moderate seignorage” (see Chapter 6 above). As in the Ingot Plan, increasing (reducing) the note issue when the market price of bullion tended to its lower (upper) boundary stabilised this price even before arbitrage was implemented, so that “there would not probably be a dozen transactions in the year by the Commissioners in the purchase and sale of gold”.
By prudence – and also because, as seen in Chapter 8 above, there might be variations in the exchange rate which had a real origin and should not give rise to a corrective change in the note issue – a metallic reserve should be kept by the national bank to satisfy demands by arbitragers for exportation and hence correct the exchange rate. The above quotation continued:
As it is, however, desirable to be on the safe side, in managing the important business of a paper money in a great country, it would be proper to make a liberal provision of gold, as suggested in a former regulation, in case it should be thought expedient occasionally to correct the exchanges with foreign countries, by the exportation of gold, as well as by the reduction of the amount of paper.
(ibid: 294)
The idea of separating domestic circulation and foreign payments, inherited from the Ingot Plan, was preserved in the Plan for a national bank that separated the management of the metallic reserve of the bank for its relations with foreign countries – which relied on the purchase and sale of gold bullion at fixed prices, as in the Ingot Plan – from its management for domestic circulation – which also relied on the purchase of gold bullion at a fixed price but on the sale of gold in coin at the mint price. This separation made the monetary system more secure (see below Section 9.5) and hence more economical because, according to Ricardo, it required a limited metallic backing of the note issue: at the creation of the bank the ratio of the reserve in bullion or in coin to note circulation would be between 17 and 28 per cent.13
9.4 The management of the note issue
The revolutionary character (theoretically and practically) of the Ingot Plan, fully recognised in old literature (see the above references to Marshall 1887, Lindsay 1892, Keynes 1913, 1930, Bonar 1923, Sayers 1953) has nearly disappeared in the modern one. When convertibility into bullion (as distinct from convertibility into coin) is not simply absent, it is considered as a technicality of secondary importance, aiming at economising on gold or at facilitating the return to convertibility into coin. The Plan for a national bank fares better, probably because it seems more appealing about the management of the note issue. However, in the recent literature on Ricardo, one may find on this question everything and the contrary, on the existence or not of a central bank, on the implementation or not of a discretionary monetary policy, on the presence or not of the lending-of-last-resort function. Some examples may illustrate this heterogeneity.
Davis (2005: 197) contends that:
Ricardo’s case for discretionary monetary policy appears in Secure Currency (1816) and in Plan for a National Bank (1824). By ‘discretion’ I refer to a central bank’s role in stabilizing prices and correcting financial crises. The bank acts by altering its discount rate or by trading bullion and government bonds. […] Discretion in this sense does not require a full-fledged countercyclical policy.
However:
[D]oubts about Ricardo’s ability as a monetary theorist have arisen because of the absence of any reference in his Plan for a National Bank to the role of the central bank as lender of last resort. […] I submit that Ricardo never attributed to the central bank the role of lender of last resort because the Bank of England did not perform this function.
(ibid: 208‒9)
Diatkine (2008, 2013) argues that Ricardo advocated flexibility of the money supply but, even in the Plan for a National Bank, “this was not a discretionary policy, because the Bank’s objective to regulate the value of money by only watching the price of gold, and not looking at other variables, was still at work” (Diatkine 2013: 139). Moreover, “the public bank was not a lender of last resort; it did not have to provide liquidity to banks. […] In this respect, Ricardo’s National Bank is not a central bank” (ibid: 141).
Arnon (2011) develops the idea, already put forward in a former publication, that, until nearly the end, Ricardo adhered to a Smithian notion of competitive banks and to an “anti-central banking position” (Arnon 1987: 275) – namely, a “free-banking position” (Arnon 2011: 260). However, in the last two months of his life (when he drafted his Plan for a National Bank), he converted himself to discretionary central banking, “in clear contradiction to Ricardo’s earlier views” (ibid: 382). To sum up:
Thus, in 1823, and for the first time since Ricardo started writing on monetary issues, he clearly rejects competition in issuing notes. […] In his 1824 text, Ricardo discusses not only the responses to developments in the gold market, but also interventions aimed at influencing the quantity in circulation according to overall macroeconomic circumstances. […] He openly recommends discretion.
(ibid: 382‒3; see also 149‒50)
For King (2013: 142):
[H]e [Ricardo] was a forceful critic of government policy in this area [money], and especially antagonistic towards the Bank of England. This led him to deny any role for active (counter-cyclical) monetary policy, and to anticipate twenty-first century political orthodoxy in his advocacy of an ‘independent’ central bank.
King “finds convincing […] the standard Keynesian interpretation”, as:
[S]et out by R.S. Sayers, who regards Ricardo’s strong support for the Quantity Theory of money as ‘a major disaster’ that committed him to the doctrine of the neutrality of money and hence forced him to deny any role for discretionary monetary policy. Sayers also attributes to Ricardo an unchanging refusal to advocate a lender of last resort function for the Bank, which is entirely consistent with his advocacy of Say’s Law.
(ibid: 147)
Sato (2013: 65) finds in Ricardo a “‘discretionary’ policy [which] means open-market operations that are performed considering the market price of bullion as a policy target and an active discount policy”. In this sense, Ricardo advocated “a national bank independent of the government that could pursue a countercyclical policy” and perform “a central bank ‘lender of last resort’ function” (ibid: 66).
According to Otomo (2013: 170), “the idea of making the government the issuer of paper money was suggested in Secure Currency, further developed in Principles, and embodied in the Plan [for a National Bank]”. In the latter, “the first measures for stabilizing the value of paper money – fixing the price of gold – remained unchanged, but the National Bank’s management was changed through the control of securities and gold in the open market” (ibid).
Such heterogeneity in the evaluation of Ricardo’s position on the management of the note issue, however, proceeds from a common conception of what may properly be called a central bank. For most of the commentators on this question, one may speak of a central bank if the bank of issue implements a monetary policy which: (a) is discretionary (in contrast with the mere application of a pre-determined rule), (b) takes into account “real” objectives (in contrast with monetary stability as the only concern), and (c) aims at influencing the interest rate (in contrast with varying the quantity of money). The differences between commentators then arise from the weight attributed to each of these characteristics and from various interpretations of Ricardo’s writings in respect to them. The figure of Henry Thornton is often called for as a model of what at Ricardo’s time a vision of a central bank could be: an institution which had to appreciate the situation before stepping in, considered the various threats faced by the general level of activity, particularly in the credit market, and varied the discount rate accordingly. Raising in this way the question of the management of the note issue in Ricardo inevitably exposes someone to difficulties, if not disappointment.
One reason is that the above features (a) and (b) do not necessarily overlap. As mentioned in Chapter 1 above, for Thornton the Bank of England had to appreciate the situation because the nature of its intervention should be different according to whether the cause of the disequilibrium was exogenous (a bad harvest or war transfers, both generating an adverse foreign balance) or endogenous (an excess note issue) to the monetary system: in the former case it should expand its issues, acting as a lender of last resort, while in the latter case it should restrict them. But this did not mean that Thornton favoured a monetary policy that would stimulate aggregate output: discretion was required only in times of crisis provoked by exogenous circumstances. To borrow the expression from Arnon (2011: 371), it was “defensive central banking” (note that Arnon attributes to Thornton an “active” central banking; ibid: 373). For Ricardo, as shown in Chapter 8 above, the bank of issue had nothing to do, when the cause of the variation in the exchange rate was “real”, except providing or absorbing passively gold bullion. It should only intervene when the quantity of money was inappropriate, as testified by the divergence between the market price of gold bullion and its legal price. The bank of issue had consequently only to watch the price of gold: although, by difference with Thornton, there was no room in Ricardo for an appreciation of the situation, for both authors the objective was only monetary stability (extending in Thornton this notion to the credit market, because of a larger definition of money). In neither case was there discretion applied to boosting the economy.
Another reason why the above-mentioned definition of a central bank is misleading is that its features (a) and (c) do not overlap: a discretionary monetary policy is not necessarily one that aims at influencing the interest rate. As seen in Chapter 2 above, Thornton acknowledged in 1811 that the situation at the time called for the application of a note-issuing rule – the same as Ricardo’s: “the Bank should regulate the issues of its paper with a reference to the price of Bullion, and the state of the Exchanges” (Thornton 1811: 327). This was not contradictory with the theoretical framework exposed in Paper Credit (1802): altering the discount rate was appropriate when the cause of the crisis was exogenous (as in 1795‒1797), not endogenous to the monetary system (as in 1810‒1811). However, even in the exogenous case, the discount rate should be raised, in order to attract foreign capital, domestic relief coming from enlarged discounts, not from lowering the discount rate. A rise in the discount rate certainly did not suit Ricardo, for whom bullion internationally traded was a commodity, not capital. But he had no difficulty in advocating enlarged discounts in cases of “embarrassed credit”, since in such cases one did not have to fear a depreciation of money, as he emphasised in the letter to Tierney of 11 December 1811:
If a greater circulation were required from the operation either of increased commerce, or of embarrassed credit, the bank might augment their issues without producing any effect whatever on the price of bullion, and consequently without exposing the Bank to any inconvenience, or depriving the merchants of that increased accommodation, which might be essential to their operations.
(VI: 68)
Ricardo’s conception of the management of the note issue thus raises the question of his understanding of the relation between bank issues and the rate of interest.
Bank issues and the rate of interest
The necessity to enlarge discounts by the Bank of England when credit was failing was evoked by Ricardo in reference to the crisis of 1793. Commenting on an extract of the Bullion Report,14 he wrote:
If the Bank had been more liberal in their discounts at that period, they would have produced the same effect on general credit as was afterwards done by the issues of Exchr. bills. It would appear that the bank would buy the exchr. bills but would not discount the merchants bills, – or rather they would not advance money to the merchants without the guarantee of Parliament. If the bank bought the bills it was then by an increase of circulating medium that public credit was ultimately relieved. If the public and not the bank purchased the bills then was a portion of the circulating medium of the country which had been withdrawn from circulation again brought forth by the credit of government being pledged for the parties requiring relief. Perhaps after all that confidence was on the point of being restored at the very moment that recourse was had to this boasted measure.
(III: 349)
Here Ricardo acknowledged that in 1793 “more liberal” discounts by the Bank of England – in modern parlance lending of last resort – would have helped restoring confidence as the issuing of exchequer bills had done. But such “boasted measure” could have been dispensed with since confidence was “perhaps […] on the point of being restored” by itself. That the issuing of bank notes could fill the void occasioned by a want of confidence between merchants in the credit market was emphasised by Ricardo in Proposals, and he stressed that notes could play this role quicker than metallic currency, and above all without harmful consequence for the value of money:
Whenever merchants, then, have a want of confidence in each other, which disinclines them to deal on credit, or to accept in payment each other’s checks, notes, or bills; more money, whether it be paper or metallic money, is in demand; and the advantage of a paper circulation, when established on correct principles, is, that this additional quantity can be presently supplied without occasioning any variation in the value of the whole currency, either as compared with bullion or with any other commodity; whereas, with a system of metallic currency, this additional quantity cannot be so readily supplied, and when it is finally supplied, the whole of the currency, as well as bullion, has acquired an increased value.
(Proposals; IV: 58)
“More liberal” discounts by the Bank did not mean, however, lending at a discount rate below the market rate of interest. Indeed, Ricardo advised the Bank of England to discount its notes at a variable rate, provided it varied with the market rate, as he declared in Parliament on 19 March 1821:
The rate of interest in the market had been invariably under 5 per cent since 1819. It would be a great advantage to the mercantile interests, that the Bank of England should discount the notes presented to them, not at one invariable rate of interest, but varying according to the alteration of the rate of interest in the market.
(V: 97)15
According to Ricardo, the level of the market rate of interest could be approximated by the rate usually charged by the London discount banks, provided the Usury Laws did not interfere. Being examined on 30 April 1818 by a Commons Committee on the Usury Laws and asked “What is the criterion by which you judge the market rate of interest, or is there any criterion at all?” Ricardo discarded the discount rate when it was at the maximum level allowed by the Usury Laws (5 per cent) but added:
When the market rate of interest is below 5 per cent, then I think that the discount given on a bill is a very good criterion of the market rate of interest.
(ibid: 345)
During the discussion of the budget in the House of Commons on 1 July 1822 Ricardo rejoiced at the behaviour of the Bank of England which had decided to lower its discount rate, only regretting that it “should have done so long before”, because of the then distressed state of the British economy. He observed that it was in the interest of the Bank itself:
The country only required, and could only bear, a certain circulation; and when that amount of circulation was afloat, the rate of interest would find its wholesome and natural level. He [Ricardo] was glad that the Bank had determined to reduce its rate of interest to four per cent.; indeed, they would have done wrong in declining to do so, as by that means only could they bring their notes into circulation. If the Bank had not reduced its interest to four per cent. the country must necessarily resort to a metallic currency, or else notes must be issued from some other quarter, as it would be impossible for the Bank of England to put a single pound note into circulation.
(ibid: 222‒3)16
It appears thus that Ricardo always considered that the Bank had to adapt its discount rate to the market rate of interest and not to try to influence it. He criticised the Bank for having discounted bills at a lower rate than the market in order to “force” the circulation of its notes:
The reason, then, why for the last twenty years, the Bank [of England] is said to have given so much aid to commerce, by assisting the merchants with money, is, because they have, during that whole period, lent money below the market rate of interest; below that rate at which the merchants could have borrowed elsewhere; but, I confess, that to me this seems rather an objection to their establishment, than an argument in favour of it.
(Principles, I: 364)
The Bank of England had done wrong because its forced issues had depreciated the currency, without having a positive effect on the accumulation of capital:
In another part of this work, I have endeavoured to shew, that the real value of a commodity is regulated, not by the accidental advantages which may be enjoyed by some of its producers, but by the real difficulties encountered by that producer who is least favoured. It is so with respect to the interest for money; it is not regulated by the rate at which the Bank will lend, whether it be 5, 4, or 3 per cent, but by the rate of profits which can be made by the employment of capital, and which is totally independent of the quantity, or of the value of money.
(ibid: 363)
Ricardo thus contended that a variation in the bank issues – whether through discount lending by the Bank of England or open-market operations by the national bank – affected the market price of gold bullion (see Chapter 7 above) and not the market rate of interest. His monetary theory explained that any attempt by the Bank of England at forcing the circulation of its notes by lowering its discount rate below the market rate, or by the national bank at forcing by its open-market purchases the rate of interest on government securities below the ordinary level of the market rate, would raise the market price of gold bullion. In such a situation, if the Bank of England did not voluntarily follow what I called the management principle, convertibility of its notes constrained it to contract its issues (because of the Penelope effect). If the Ingot Plan or the Plan for a national bank was implemented, the Bank of England or the commissioners would apply the management principle, so that they would voluntarily contract the note issue whenever they observed a rise in the market price of gold bullion and were consequently warned of their error. In any case, no increase in the quantity of money above its conformable level could have a permanent effect on the market rate of interest.17
Nevertheless, does this mean that Ricardo discarded any management of the note issue? Being most of the time depicted as advocating a rule that would restrict the quantity of money, he seems to do so. However, watching the market price of the standard with a view at correcting the note issue was not only useful to detect an excess of notes but also their deficiency – a situation about which Ricardo was also concerned, particularly during the 1821‒1823 debates on the depression.
Avoiding an undue contraction of the note issue
One thing was to contend that a monetary expansion could have no permanent effect on aggregate output and the accumulation of capital – a proposition that Ricardo certainly held – another to deny that an undue monetary contraction might have depressive effects. Avoiding such contraction was the second reason to compel the bank of issue to purchase at a fixed price any bullion offered to it – the first reason being to set a lower boundary to the variations in the market price of gold bullion (see Section 9.5 below). This provision guaranteed that, if the market price of bullion fell – which, according to Ricardo’s theory, could only happen because the quantity of notes issued was deficient – bullion would be offered by arbitragers to the bank of issue, which could not refuse to purchase it with additional notes. This safeguard against a too restricted money circulation was already provided by the mint, where owners of bullion carried it to have it coined whenever the market price of bullion fell below the mint price. But the mint answered the need for money with a delay of two months for the fabrication of the coins, and in the interval general activity would be impaired. In contrast, the issuing of additional notes would be immediate, all the more so if, watching the fall in the market price of bullion, the bank applied the management principle and increased its issues even before bullion was carried to it.
This argument was exposed by Ricardo before the House of Commons on 24 May 1819 when he regretted that this provision had not been introduced in Peel’s bill, because it would have prevented the Bank of England from reducing its issues too much:
The Bank should reduce their issues cautiously; he only feared they would do it too rapidly. […] He was only sorry that the Bank was not to be obliged by the resolutions to buy all the bullion offered to them at 3l. 17s. 6d. lest through excessive caution they might starve the circulation. The Mint, it was true, was to remain open to the public, who might coin the bullion which they obtained from the Bank. Mr. Mushett […] had stated, that with a capital of 300,000l. the Mint could supply the public with 12,000,000l. a year. Yet a year was a long time to wait for twelve millions, and it might easily happen, that in the interim between the reduction of the Bank issues and the supply afforded from the Mint, the country might seriously feel the deficiency. It was on that account that he should have wished a resolution inserted, to compel the Bank to give its notes for bullion (at 3l. 17s. 6d.) on demand. With the exception of this omission, the plan was, in his opinion, perfectly safe and gentle.
(V: 13)
As shown in Chapter 5 above, Ricardo’s fear was justified, and on many occasions in Parliament in 1822 and 1823 he would retrospectively blame the Bank of England for having contracted its issues too much between 1819 and 1821 (to prepare for the return to convertibility of its notes into coin) and thus deepened the depression. This danger was eliminated both in the Ingot plan and in the Plan for a national bank. When general activity contracted or expanded, while the bank of issue did not change its issuing behaviour, the consequence was respectively an excess or a deficiency in the quantity of money, which was reflected by a positive or a negative spread between the market price of gold bullion and the legal price. One thus needed an instrument that linked real general activity and the note issue. In the Ingot Plan – which preserved the existence of the Bank of England as bank of issue – this link was provided by discount lending, in which the issuance of notes originated in commercial transactions. In the Plan for a national bank, the issuing bank no longer discounted commercial paper and there was a need for another kind of link between the real and the monetary sphere. This link was provided by open-market operations, at the initiative of the national bank. Open-market operations then substituted for discount lending as the appropriate instrument of monetary policy, with the same object in view: varying the note issue with the quantity of money needed by the real economy, as reflected by the sign of the spread between the market price of gold bullion and the legal price.
To conclude on Ricardo’s “judicious management of the quantity” of notes, one may observe that the usual reading key “rules versus discretion” does not apply. The management principle did not fit this opposition in which both terms assume the exogeneity of the quantity of money, either fixed by a rule or discretionarily decided by the bank of issue. As quoted above, Ricardo’s non-quantitative approach implied that “the Bank regulated their loans and issues of paper […] without attending to the absolute quantity of paper in circulation” (Proposals; IV: 67; Principles; I: 357‒8): as shown in Chapter 7 above, the quantity of notes should not be determined from outside but resulted endogenously from the fulfilment of the condition of conformity of money to the standard, that is, the equalisation of the market price of gold bullion with its legal price. In modern parlance, Ricardo was not a “verticalist” – the quantity of money on the horizontal axis being exogenously given by a vertical line – but a “horizontalist” – a horizontal line intersecting the vertical axis and expressing the given level of an independent variable.18 Of course, contrary to modern “horizontalists”, this independent variable was not in Ricardo the rate of interest fixed by the monetary authorities but the legal price of the standard.
Of the two pillars of the Ingot Plan – the ingot principle and the management principle – it is as expected the latter, left unchanged in the Plan for a national bank, which was central for the question of the management of the note issue. The ingot principle, which, as seen above, was resurrected in a slightly modified form in Plan for a National Bank, was central for another question, illustrated by the title of Proposals for an Economical and Secure Currency: the security of the monetary system.
9.5 Increasing the security of the monetary system
The ingot principle and the management principle
The pamphlet Proposals for an Economical and Secure Currency was a turning point in Ricardo’s theory of money, which was the outcome of two changes in Ricardo’s inquiry about money. First, with the end of the Napoleonic wars in June 1815, the historical perspective was now the resumption of the convertibility of the Bank of England note. Consequently the question on the agenda was no longer the understanding of a monetary regime deprived of any standard but of one endowed with a standard. Second, this line of inquiry, formulated in 1816 in Proposals, now ran parallel to another line of inquiry on exchangeable values and the rate of profit, inaugurated in 1815 with the Essay on Profits. As a turning point Proposals designed what Ricardo’s monetary programme would be until his death seven years later: the search for what he called “a perfect currency” that should fulfil three conditions:
A currency may be considered as perfect, of which the standard is invariable, which always conforms to that standard, and in the use of which the utmost economy is practised.
(Proposals; IV: 55)
The rationale of the first two conditions – the invariability of the standard and the conformity of money to this standard – has been analysed above in Chapters 3 to 7. It remains to study how Ricardo’s plans for “a perfect currency” fulfilled these conditions, while adding the property that “in the use of [it] the utmost economy is practised”.
As seen above, there were two principles on which the Ingot Plan was founded. First the ingot principle: the Bank of England notes had to be convertible into bullion (bars), instead of specie (coins) as they were prior to 1797. Symmetrically, these notes could be obtained from the Bank against bullion at a fixed legal price, slightly below the price of £ 3.17.10½ per standard ounce at which they were convertible. Second, the quantity of bank notes issued had to vary inversely with changes in the observed market price of bullion, instead of being left to the discretion of the Bank, as before. This provision constituted a “judicious management of the quantity” of paper money (Proposals, IV: 57); it was the management principle.
The specificity of both principles should be underlined. The ingot principle makes sense of the sentence in Principles (I: 354), that “it is not necessary that paper money should be payable in specie to secure its value”: Ricardo was against the inconvertibility of notes, but he favoured another kind of convertibility than the one usually put forward before (and also after) him. The management principle meant that the issue of notes had to be modified according to an objective criterion – the market price of bullion – which in no way implied any judgement on the level of the stock of circulating notes or of the metallic reserves of the Bank. The object of these two principles was twofold: stabilising the market price of the standard, thus preventing the currency from being depreciated or appreciated; and preventing the drain of the Bank’s metallic reserve. Let us look successively at these two goals.
Stabilising the market price of the standard
With convertibility of notes into bullion as into specie, arbitrage made the market price of bullion fluctuate with supply and demand between two fixed limits depending on the monetary regime; but the width of this margin was consequently not the same. As shown above in Chapter 6, the regime prior to 1797 was based on convertibility both ways between bullion and the gold coin and convertibility one way of the Bank of England note into full-bodied gold coin. This regime thus constrained the market price of gold bullion between two fixed limits given by:
(6.1) |
with 
the legal price of an ounce of gold in coin, 
the melting cost of the coin (obtained at no cost from the Bank of England against its notes) into bullion, and 
the minting cost of bullion into coin, equal to the rate of interest until the mint delivered the coins. Inequalities (6.1) illustrate the maxim enunciated by Ricardo in his letter to Grenfell of 19 January 1823:
We all know that it is the melting pot only which keeps all currency in a wholesome state.
(Deleplace, Depoortère and Rieucau 2013: 4)
Let me now call 
the legal price of an ounce of gold bullion, which in the Ingot Plan substituted for the legal price 
of an ounce of gold in coin. The condition of conformity of money to the standard analysed in Chapter 3 above becomes:
(9.1) |
which may be rewritten as:
(9.2) |
Equations (7.3) to (7.5) and (7.7) to (7.10) apply. Instead of (7.6), the combination of (7.5) and (9.1) determines the conformable quantity of money:
(9.3) |
The limits imposed to the variations in the market price of gold bullion were modified. With convertibility of notes into freely exportable bullion, the cost of melting fraudulently the coins obtained from the Bank disappeared, so that arbitrage ensured that could not be permanently higher than the legal price. Symmetrically, the Bank was substituted for the mint in the issuing of the currency: notes were to be obtained from the Bank against bullion at a trifling cost b for the management of the issue, and this settled the lower limit to the variation of thanks to arbitrage. In Ricardo’s view, the application of a policy rule – the management principle – was preferable to actual conversion of notes into bullion or of bullion into notes by arbitragers. One way or the other the following inequalities applied:
(9.4) |
The comparison of (6.1) and (9.4) shows that the range of variation of the market price of gold bullion was reduced by the elimination of the melting cost (the Bank substituting for the melting pot to ensure the conversion of the currency into bullion) and the limitation of b to a level as low as was consistent with the private character of the Bank.19 In Ricardo’s terms:
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, 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)
One object of the Ingot Plan was thus to ensure a higher stabilisation of the market price of bullion in normal times, hence, for a given value of the commodity chosen as the standard, a higher stabilisation of the value of money itself. Moreover, as mentioned above in Chapter 7, the circulation of notes could endogenously increase to accommodate the “wants of commerce” without the size of the reserve having to increase, while preserving the equality between the market price of bullion and its legal price (as quoted above, the Bank would not have to bother about “attending to the absolute quantity of paper in circulation”). Consequently, the working of the monetary system did not alter the world demand for gold bullion. The changes in the value of the standard were then limited to real causes. One may here recall the Money–Standard Equation established in Chapter 4 above in its simplified form:
(4.8) |
with 
the rate of change in the value of the pound in terms of all commodities except gold bullion, 
the rate of change in the value of an ounce of gold bullion in terms of all other commodities, and 
the rate of change in the market price of an ounce of gold bullion. In (4.8), not only the margin of variation in 
induced by a change in 
was limited to b but any domestic monetary cause of variation in 
was eliminated.
There was an even more important object of the Ingot Plan: preventing the drain of Bank’s reserves in case of monetary shocks.
Preventing the drain of the Bank’s metallic reserve
Inequalities (9.4) were ruling in the normal course of events; but when the pressure on the currency became hard, the two sides of the inequalities were exposed to different threats. Whenever the Bank remained open to the public, it could absorb all the bullion which depressed the market; the only drawback imposed on the Bank by the Ingot Plan was to force it to accumulate a sterile asset. On the contrary, when the market price of bullion tended to increase, signalling a depreciation of the currency, this movement was hindered by arbitrage as long as the Bank had enough bullion reserves to ensure the convertibility of its notes. The suspension of cash payments decided in 1797 had shown that this could not always be guaranteed. The issue here at stake was no longer the range of variation in the value of the currency in normal times, but the security of the monetary system, which could be jeopardised by a drain of the Bank’s metallic reserve. As the title of the 1816 pamphlet made explicit, convertibility into bullion was supposed to increase this security, as compared with convertibility into specie – but in precisely what way?
With convertibility into specie, one had to distinguish between three types of drain.
The panic
The first type of drain of the metallic reserve of the Bank of England was one caused by a panic, when notes were brought back to the Bank, not to melt the coin and export the bullion with profit, but to hoard the metal itself as a store of value:
Against such panics, banks have no security, on any system; from their very nature they are subject to them, as at no time can there be in a Bank, or in a country, so much specie or bullion as the monied individuals of such country have a right to demand. Should every man withdraw his balance from his banker on the same day, many times the quantity of Bank notes now in circulation would be insufficient to answer such a demand.
(Proposals, IV: 68; Principles, I: 358‒9; Ricardo’s emphasis)
This kind of run could then jeopardise the monetary system because notes issued through discounting of commercial bills were not backed by corresponding metallic reserves. This was the price to pay for issuing money to the benefit of owners of capital and not only of precious metals. For this kind of drain the Ingot Plan could not improve upon convertibility into specie because the threat to security was consubstantial with banking activity itself.
According to Ricardo, it was a panic which had forced suspension of the convertibility of the Bank of England note in 1797. The above quotation continues:
A panic of this kind was the cause of the crisis in 1797; and not, as has been supposed, the large advances which the Bank had then made to Government. Neither the Bank nor Government were at that time to blame; it was the contagion of the unfounded fears of the timid part of the community, which occasioned the run on the Bank, and it would equally have taken place if they had not made any advances to Government, and had possessed twice their present capital. If the Bank had continued paying in cash, probably the panic would have subsided before their coin had been exhausted.
(ibid)
This “probable” conjecture, made by Ricardo in 1816, about the outcome of the prolongation of convertibility, had it been decided in 1797, was at odds with the one he had made in 1810 in his manuscript notes on the Bullion Report:
It has been contended, by some intelligent men, that in the year 1797 when there was a run upon the Bank for specie, – that the Directors would have upheld public credit and have put a stop to the demand for guineas by increasing their discounts, rather than by diminishing them. I am of opinion that the run upon the Bank in 1797 proceeded from political alarm, and a desire on the part of the people to hoard guineas. I was myself witness of many persons actually exchanging bank notes for guineas for such purpose, – therefore it is probable that the Bank could not have prevented the stoppage of payments to which they were obliged to have recourse. But a demand upon the bank for specie from fears of the solidity of its resources, or from political alarm, are very different from a demand arising from a high price of bullion and a low rate of exchange and must be differently treated. In the latter case it can proceed only from an excessive issue of paper, if the gold coin is not debased and can only be checked by calling in the excess. In 1797 the exchange was at 38 with Hamburgh and gold bullion at £3. 17. 6. – In 1810 the exchange is at 29 and gold bullion at £4. 13 –
(III: 364‒5)
Ricardo then commented on the answer given before the Bullion Committee by the Governor of the Bank of England to a question concerning the advisability of increasing the discounts “in order to support public credit” at a time when the market price of bullion was high and the exchange low. The Governor had given his “own opinion” according to which the discounts should neither be increased nor diminished, and he availed himself of “the experience of the years 1796 and 1797”.20 With this opinion Ricardo disagreed at two levels. First, at a factual one, he considered that the situation in 1796 and 1797 was not characterised by a failing public credit but by a panic; consequently, contrary to what “some intelligent men” (Henry Thornton, Walter Boyd) had contended in evidence, increasing the discounts would have been useless: “it is probable that the Bank could not have prevented the stoppage of payments to which they were obliged to have recourse”. Second, at a theoretical level, the assumption made in the question – of a high price of bullion and a low exchange – disqualified the example of 1796‒1797 (when the market price of bullion was below the mint price and the exchange with Hamburg high) and above all implied that the hypothetical situation was neither that of a panic or of a failing public credit, but of an excess note issue. In that case, according to Ricardo, discounts should be contracted. This was in fact the case in 1810, and the Governor of the Bank of England was consequently twice wrong, about the past and about the present.
Ricardo’s attitude towards the panic gives rise to what John King calls a “residual question […] more theoretical than factual” (King 2013: 119), which he borrows from Peach. For Peach, “to the extent that he [Ricardo] could make any sense of it [the distress] at all, its severity was attributed to blind irrationality on the part of the capitalist class” (Peach 1996: 30), and he quotes Ricardo’s letter to Malthus of 9 October 1820:
Men err in their productions, there is no deficiency of demand […] we are guilty of some such folly now, and I can scarcely account for the length of time that this delusion continues.
(VIII: 277‒8)
King points to a contradiction in Ricardo: “Protracted episodes of ‘great folly’ and ‘delusion’ are indeed difficult to reconcile with Ricardo’s belief that most people, in all social classes, are normally engaged in the rational pursuit of their own self-interest” (King 2013: 120). There is a contradiction only if one assumes, as King does, that there lies a “more theoretical than factual” question. But, as shown in what he wrote about the panic, Ricardo considered irrationality as a matter of fact, not of theory. For him, theory explained what should happen if people were rational, that is, behaved according to their interest, but he did not deny that it might happen that they were not. Theory was unable to explain that because it was out of its scope.
This does not mean that Ricardo neglected the role of confidence when he considered the design of the monetary system. As seen above, he acknowledged that the Bank of England might increase its discounts – hence the note issue – when in the credit market a lack of confidence resulted in difficulties for the borrowers. About money proper, when in 1811 he was pushing his plan of convertibility into bullion among political leaders, he stressed that such plan would improve confidence in the Bank of England note, at a time when it was envisaged to make it a legal tender, by guaranteeing against any further depreciation. Knowing that the Bank would be prevented by its own interest from issuing in excess, the public would be confident in the constancy of the future value of money, with a positive effect on contracts:
If, Sir, you should deem it necessary, at the expiration of the bill which has just received the Royal assent, to make Bank notes a legal tender, a provision to the effect which I have suggested, would I am confident deprive such a measure of almost all its terrors, as it would give the public complete security against the further depreciation of Bank notes; without which they would have too much reason to fear, from their observations on the past, that the paper currency would continue progressively to sink in value. It is not necessary to point out the effects which will follow from such a conviction on all future leases and contracts.
(Letter to Perceval, 27 July 1811; VI: 45)
This would secure the public against any further depreciation of Bank notes, as the Bank would be obliged for their own safety to keep the amount of their circulation within the present limits whilst commerce and credit continued in its present state, to prevent such a rise in the price of bullion as would make it profitable to individuals to purchase it of them for exportation. […] If no further measures were taken to approximate the currency to our ancient standard, the adoption of the one here recommended would alone give complete security as to the future: – the depreciation of our currency would be effectually checked, and the bank deprived of the alarming power which they at present possess, of diminishing, at their pleasure, the value of the monied property of every man in the kingdom. It would afford leisure too for the consideration of such further measures as might be necessary, without pledging Parliament to any particular course of proceeding. And if it should be thought expedient to make bank notes a legal tender, the knowledge which the public would have that though already depreciated more than 20 pct., the depreciation of Bank notes would go no further, and that their value would no longer depend on the caprice or false theory of Bank Directors, would deprive that measure of all the alarm which without such security it is so much calculated to produce.
(Letter to Tierney, 11 December 1811; VI: 68)
The design of the monetary system could thus affect positively the confidence of the public in money inasmuch as expectations about the rational – that is, interest-driven – behaviour of its issuer were concerned. It could do nothing against a panic generated by circumstances outside the monetary system itself.
The internal drain
A second type of drain was caused by the coexistence of coins and notes in the domestic monetary system; it was thus an internal drain. Old coins becoming light through debasement in one way or another while keeping their nominal legal value, the market price of bullion increased, and new full-bodied coins were demanded from the Bank (against notes) to be melted and sold in the market to pocket the difference (see Chapter 6 above). Facing a drain of its metallic reserve, the Bank had to purchase bullion in the market to have it coined, thus sustaining the market price above the legal price; this process (the Penelope effect analysed in Chapter 7 above) would go on, imposing losses on the Bank. In the Ingot Plan, notes convertible into bullion did not aim at complementing coins but at eliminating them altogether (as Ricardo wrote in Principles: “A currency is in its most perfect state when it consists wholly of paper money”; I: 361). The elimination of the metallic currency radically prevented this internal drain from occurring, by suppressing the defects which were attached to that kind of currency and caused the drain. There was an additional advantage: having no longer to guard itself against an internal drain, the Bank could hold a smaller reserve. The system was then more “economical” because it was more “secure”.
The external drain
A third type of drain remained: the external one, when gold was obtained from the Bank to be exported. The security of the monetary system required that the metallic reserve of the Bank might not be threatened by an external drain. The second principle of the Ingot Plan – the management principle – was put to contribution to attain this goal. We saw in Chapter 8 above that, according to Ricardo, the monetary cause of a fall in the exchange rate – which led to an external drain when the exchange rate hit the export bullion point – should be handled by a contraction of the note issue, before the external drain even started. The management of the note issue was thus substituted for bullion flows as driving force of the international adjustment, and this eliminated the threat of external drain for this (monetary) type of causes. The corrective role of international bullion flows only subsisted for those variations in the exchange rate having a real origin – a type of cause which was acknowledged by Ricardo but could only generate small demands for bullion at the Bank, as compared with the demands triggered by a mismanagement of the note issue. As quoted above:
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.
(Proposals; IV: 67; Principles; I: 357‒8)
In the Ingot Plan, a small metallic reserve of the Bank would be amply sufficient to face this kind of real external drain, provided the ingot principle eliminated the risk of internal drain caused by the coexistence of coins and notes, and the management principle eliminated the risk of external drain caused by an excess issue of notes. In the Plan for a national bank, as seen above, “a liberal provision of gold” (between 17 and 28 per cent of the note issue) would be made “in case it should be thought expedient occasionally to correct the exchanges with foreign countries, by the exportation of gold, as well as by the reduction of the amount of paper” (Plan for a National Bank; IV: 294).
Both the Ingot plan and the Plan for a national bank aimed at increasing the security of the monetary system by limiting the need for a metallic reserve of the issuing bank to the occasional demand for bullion raised by non-monetary circumstances affecting relations with foreign countries.
9.6 An application of Ricardo’s theory of money
On the question of central banking, the literature on Ricardo usually emphasises quantity rationing of the note issue and independence of the central bank. This is consistent with the attribution to Ricardo of a quantity theory of money. In contrast, his position on central banking is better understood as an application of his non-quantitative monetary theory (the Money–Standard Equation), in which the quantity of money is regulated by the standard.
According to Ricardo, two conditions were necessary and sufficient to achieve a “sound” (that is, “secure”) state of the currency: convertibility of bank notes into bullion (ingot principle) and regulation of their issue so as to maintain the market price of bullion equal to its legal price (management principle). The first principle prevented an internal drain of the gold reserves of the issuing bank (except in the case of a panic, which no monetary system could guard from), and the second principle prevented an external drain for monetary reasons. These two principles ensured that the currency conformed to the standard (to eliminate monetary causes of instability in its value), although it was not issued through the monetisation of the standard but of capital (to ensure the fulfilment of the needs of trade). They testified to the fact that money was not subject to physical constraints: in Ricardo’s system, the monetary standard is a specific commodity, but money is no commodity at all. No natural law explains changes in the value of money: such laws apply to one of their determinants (changes in the value of the standard), but not to the other (changes in the price of the standard, which entirely depends on the institutions ruling the monetary system). The quantity of money is not restricted by the available quantity of gold (whether at the level of the world as a whole or in the reserve of the issuing bank) but is adjusted to “the wants of commerce”. The soundness of money only depends on the soundness of the plan designed for it.
The standard and the paper currency were thus two complementary but distinct features of Ricardo’s ideal monetary system, and this complementarity is in no way trivial in the history of monetary thought and in the history of money as well. On the one hand, the Ingot Plan led to the demonetisation of gold in domestic circulation: gold was the standard of money but no longer money. On the other hand, Ricardo was the first to theorise the gold-exchange standard, by separating domestic circulation (of convertible notes) and foreign payments (in bills of exchange), though preserving a link through gold (which acted as domestic monetary standard and international means of settlement).
As seen above, Proposals was a turning point in Ricardo’s theory of money, by stating the three conditions for “a perfect currency”:
A currency may be considered as perfect, of which the standard is invariable, which always conforms to that standard, and in the use of which the utmost economy is practised.
(Proposals; IV: 55)
The Ingot Plan and the Plan for a national bank were the outcome of these conditions. Although the literature on Ricardo mostly emphasised the third one – the “economical” character mentioned in the title of the 1816 pamphlet – Ricardo was mainly interested by the first two, which gave the currency a “secure” character. The design of the monetary system could not do much for the invariability of the value of the standard, apart from avoiding any unnecessary demand for gold bullion by the bank of issue. But it was crucial to ensure the conformity of the currency to the standard, that is, the stabilisation of the market price of gold bullion at the level of its legal price.
The theoretical foundation of the Ingot Plan was not yet complete at the time of Proposals: as shown in Chapter 4 above, it would require the theory of value and distribution contained in Principles. But it was ready when the plan was discussed in Parliament in 1819 with a view to restoring the convertibility of the Bank of England note. The basis of the Ingot Plan was what I called the Money–Standard Equation, that is, the distinction between the two channels of variation in the value of money: variations in the value of the standard and variations in its market price. By eliminating gold from domestic monetary circulation and restricting its role to the function of standard of paper money, the ingot principle – convertibility both ways between the note and the standard – avoided the interference between the value and the price of the standard produced by the circulation of coins. As shown in Chapter 7 above, the demonstration that the quantity of money did not affect its value directly but indirectly, through the market price of the standard, gave a theoretical basis to the policy rule which Ricardo had advocated for long, namely varying the note issue inversely with the spread between the market price and the legal price of the standard. This was the management principle which allowed stabilising the value of money thanks to the stabilisation of the market price of gold bullion; this second pillar of the Ingot Plan was the second application of Ricardo’s monetary theory.
Ricardo’s conception of a monetary system based on a central bank was present as early as his Bullion Essays,21 but it only acquired a theoretical foundation with Proposals and Principles. When in 1819 time came for a discussion and experimentation of “Ricardo’s system”, he was fully equipped both with a monetary theory and the applied institutions and rules deriving from it. This was not enough to overcome obtuse prejudices and vested interests.
Appendix 9: The Ingot Plan in perspective
Table 9.1 compares: (a) the monetary system as it existed before 1797 and was resumed from 1821 to 1844, (b) the Ingot Plan as embodied in Proposals for an Economical and Secure Currency (1816), (c) the transitory system adopted in Peel’s bill in 1819 and discontinued in 1821, (d) the Plan for a national bank, as embodied in Ricardo’s Plan for the Establishment of a National Bank (written in 1823 and published posthumously in 1824), and (e) the system embodied in the Bank Charter Act of 1844. Ricardo considered that, from 1797 (when the convertibility of the Bank of England note was suspended) to 1819 (when it was resumed), the monetary system had no standard (see Chapter 7 above); this period is consequently not included in Table 9.1.
Most of the legal provisions of the pre-1797 system were present in the system ruling from 1821 to 1844, with the exceptions of the Bank of England note becoming legal tender (in parallel with the gold coin) from 1833 on, and of melting and exporting the coin being authorised, as was the case since 1819. Discretion in the Bank of England issuance of notes evolved around 1830 (outside any legal provision): from 1828 on, the Bank committed itself to buy any bullion offered to it at a fixed price, and in the early 1830s it adopted the “Palmer rule” (after the name of the Governor of the Bank) for varying the issues (see Clapham 1944).
The provisions of the Ingot Plan, of Peel’s bill and of the Plan for a national bank are detailed in Chapter 9 above.
The 1844 Bank Charter Act divided the Bank of England in an Issue department and a Banking department. The existing stock of notes at the time was backed around one half by the metallic reserve and one half by government securities. As for the additional issue, it was to be backed 100 per cent by an increase in the metallic reserve. The Banking department could lend the notes (by discounting bills) in the limit of the quantity issued by the Issue department (see Clapham 1944).
Table 9.1 Monetary systems with a gold standard
Notes
1 See also:
It is on this principle that paper money circulates: the whole charge for paper money may be considered as seignorage. Though it has no intrinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of coin, or of bullion in that coin.
(Principles; I: 353)
2 On 9 April 1810 Mr. Harman, a Director of the Bank of England, had declared before the Bullion Committee: “I think if we discount only for solid persons, and such paper as is for real bona fide transactions, we cannot materially err” (III: 375).
3 When examined in 1819 on “Mr. Ricardo’s plan” by the Commons’ Committee on the Resumption of Cash Payments, the financier Alexander Baring confirmed this link with the Bank of Hamburg:
The plan in question is, in fact, no other than that of the bank of Hamburgh, only substituting a currency of paper in lieu of a transfer of book debt; and the bank of Hamburgh has always been found, from long experience, the best institution for preserving the standard of value; the payments of the bank of Hamburgh are solely in silver bullion.
(quoted in Sraffa 1952b: 358)
4 See Gillard (2004) on the Bank of Amsterdam and Achterberg and Lanz (1957‒1958) on the Bank of Hamburg.
5 On Ricardo’s notes on Bentham’s manuscript “Sur les prix” see Deleplace and Sigot (2012).
6 As he explained in a footnote, Ricardo mentioned “uncoined gold or silver” because at the time of Proposals the pound was still legally on a double standard and the question of the choice of the standard was not yet settled. He himself opposed the double standard and at that time favoured the silver one; he would later prefer gold (see Chapter 2 above). In another footnote Ricardo observed that the Bank buying price could be fixed “a little above, or a little below” £3. 17s. and the minimum quantity of bullion to be obtained from or sold to the Bank could be made “ten or thirty” instead of twenty ounces. These were details: he wished only “to elucidate the principle” (Proposals; IV: 66n; Principles; I: 357n).
7 See the letter to Malthus on 9 July 1821: “they [the Directors of the Bank of England] are indeed a very ignorant set” (IX: 15).
8 One objection to the plan was that, aiming at eliminating the circulation of gold coins, it implied the issuance of low-denomination notes. The problem of forgery was put forward but the reluctance of the Bank of England to enlarge the circulation of its notes beyond the circle of merchants also played a role.
9 When in 1832 the question of the renewing of the charter of the Bank of England was raised, Moses Ricardo suggested to Ricardo’s publisher, John Murray, to re-issue Plan for a National Bank with “a concise account of his plan for a secure and economical currency”, that is, the Ingot Plan of 1816. As Sraffa observes, “nothing came of this suggestion” (Sraffa 1951f: 273).
10 See also the letter to Mill of 7 August 1823: “I have devoted a few days to the writing of a short tract to prove the practicability of the Government becoming the sole issuers of paper money. I feel fully assured that Commissioners might be appointed on such a plan, to manage the whole concern, that ministers would have much less influence over them, to make them swerve from their duty, than what they have possessed, and have indeed exercised over the Bk. of Engd” (IX: 329).
11 In the final version of his plan, Ricardo strengthened the independence of the commissioners from Parliament, as compared with the original MS in which they “should not be removable but in consequence of an address to his majesty by the House of Commons, or by both Houses of Parliament” (IV: 290n).
12 The bills were used for the relations between the London office of the national bank and its agents in the country.
13 The commissioners would issue £29 millions in notes, that is, 15 to reimburse the capital of the Bank of England, 10 to purchase gold or exchequer bills from the Bank of England, and 4 exchanged for the sums (in Bank of England notes) deposited by public departments at their bankers, for which the national bank would henceforth substitute. Ricardo envisaged two cases (IV: 291): £5 or 8 millions could be devoted to buy gold and respectively £9 or 6 millions to buy exchequer bills, giving a ratio of 17 or 28 per cent respectively.
14 “In this crisis, Parliament applied a remedy, very similar, in its effect, to an enlargement of the advances and issues of the Bank; a loan of Exchequer Bills was authorized to be made to as many mercantile persons, giving good security, as should apply for them; and the confidence which this measure diffused, as well as the increased means which it afforded of obtaining Bank Notes through the sale of the Exchequer Bills, speedily relieved the distress both of London and of the country” (III: 349).
15 Sraffa gives in a footnote the conclusion of the speech as it appeared in the British Press. It read:
If I might advise the Bank, they would, instead of discounting at the invariable rate of 5 per cent. alter the rate of interest according to the changes of the market. During the war those merchants who could discount at the Bank, raised money at 5 per cent. whilst those who were not so favoured paid 7 per cent. for it. That was the case in the war, but at present it would be wise for the Bank to lower the rate of interest to 4 per cent.
(V: 97n)
16 Sraffa gives two alternate reported versions of this part of Ricardo’s speech; this is the second one, which is more detailed.
17 On the rate of interest in Ricardo see also Ahiakpor (1985), Panico (1988), Diatkine (2013), Pivetti (2015).
18 The distinction between “Horizontalists” and Verticalists” is borrowed from Moore (1988). For its role in modern post-Keynesian and Circulation approaches, see Deleplace and Nell (1996a).
19 In Proposals as in the extract of this pamphlet quoted in Principles, Ricardo mentioned £3. 17s. as a legal buying price of bullion by the Bank of England, which for a legal price of £3 17s. 10½d. at which bullion was provided by the Bank against notes gave for b a little more than one per cent. While the mint remained open to the public, b should be fixed a little lower than the rate of interest until the mint delivered the coins:
The price of 3l. 17s. here mentioned, is, of course, an arbitrary price. There might be good reason, perhaps, for fixing it either a little above, or a little below. In naming 3l. 17s. I wish only to elucidate the principle. The price ought to be so fixed as to make it the interest of the seller of gold rather to sell it to the Bank, than to carry it to the mint to be coined.
(Proposals; IV: 66n; Principles; I: 357n)
In his speech of 24 May 1819 before the House of Commons, Ricardo recommended £3 17s. 6d. as Bank buying price (V: 13), which gave for b a little less than 0.5 per cent.
20 This evidence reads as follows:
[Question]: Suppose a case in which no demands were made upon the Bank by Government for unusual accommodations, but an unusual demand was made by merchants for increased facilities of discount, would the Bank in such a case consider itself as bound, in order to support public credit, to grant that increase of discounts, although there was a run upon it for Gold occasioned by the high price of Bullion and the unfavourable state of the exchange?
[Answer by John Whitmore, Governor of the Bank of England]: I now consider my answer as my own opinion, not having the opportunity of consulting the Bank upon the question; in my opinion the Bank would not increase their discounts, nor on the other hand would it, I think, after the experience of the years 1796 and 1797, do well materially to diminish them.
(III: 364‒5)
21 This is testified by Ricardo’s critique (around Christmas 1810) of Bentham’s manuscript “Sur les prix”. Comparing this manuscript and Ricardo’s critique, Deleplace and Sigot (2012: 759‒60) conclude:
The confrontation of Bentham and Ricardo, as it appears in Ricardo’s notes on Bentham’s manuscript, highlights two lines of thought which coexist in classical monetary theory after Smith. In Bentham, a microeconomic theory of money focuses on the solidity of banks, whose primary role is to grant credit to private activity. In Ricardo, a macroeconomic theory of money focuses on a central bank, whose primary role is to regulate the aggregate quantity of money according to the value of the standard. Classical monetary theory, as illustrated by Bentham and Ricardo, then appears to be split in two variants: a banking system based on prudence and confidence versus a monetary system based on institutions and rules.
On Bentham on money see Sigot (2001) and Sigot and Deleplace (2012).
