7.4 The crisis of 1837 and the currency school controversy

For the first time, the law of 1826 had allowed joint-stock banking (except for the Bank of England) to exist in England. But various remaining restrictions had held the number of joint-stock banks down to 14; the act of 1833 had removed these restrictions, and the result was a veritable orgy of joint-stock banks formed in England. Forty-four new banks were added from 1831 to 1835, topped by no less than 59 in 1836 alone, 15 of them established between 1 May and 15 June of that year. A powerful joint-stock bank, the London and Westminster Bank, was even established in London itself in 1834, although of course it was banned from issuing notes.

Along with the increase in the number of banks came an expansion in bank money. Thus the circulation of country bank notes rose from £10 million at the end of 1833 to over £12 million in mid-1836. Of this growth, almost all came from the issue of the new joint-stock banks: from £1.3 million to £3.6 million in the same period.

Although the Bank of England and the private country banks complained at the new competition, the expansion of credit by the bank fuelled this new burgeoning of banks and bank notes. Discounts of the bank expanded from £1.0 million in April 1833 to £3.4 million in July 1835, and rose to over £11 million by the end of the latter year. Total bank credit, in turn, rose from £24 million in 1833 to over £35 million at the beginning of 1837. This expansion took place in the teeth of the bank's loss of specie reserves from £11 million in 1822 to less than £4 million at the end of 1836. So much for the currency principle, and for its modified ‘Palmer rule’, which the bank's governor, John Horsley Palmer, had explained to the bank charter committee in 1832 that the Bank of England had been following. There is no way that such a practice -of expanding credit while specie reserves were falling – could be tortured into even an approximation of the currency ideal that the money supply should move as if it were the stock of specie in the country.

To top it off, the bank credit expansion led, in what was becoming the usual way, to a financial crisis and panic at the end of 1836 and the beginning of 1837, replete with bank runs, especially in Ireland. There followed the typical signs of recession: contraction of bank credit, decline of production, collapse of stock prices, numerous bankruptcies of banks and other businesses, and a swelling of unemployment.

It is not surprising that the new boom-bust cycle gave rise to parliamentary inquiries – by committees on joint-stock banks in 1836, 1837, and 1838, and even more so to vigorous debates on the banking situation in pamphlets and in the press. Indeed, more than 40 pamphlets were published on the banking system in 1837 alone, and a large number continued the following year.

The pamphlet war was touched off by a remarkable pamphlet by Colonel Robert Torrens,¹⁴ remarkable not only for being the best presentation of the currency school, but also because it signified a sudden conversion of Torrens into the currency ranks. For Torrens, though a distinguished political economist, a friend of Ricardo, and a founder and leading member of the Political Economy Club, had been an ardent, almost wild, inflationist and anti-bullionist during the bullion Report struggles. Indeed, Torrens's inflationism had continued at least into 1830.

Then, in the course of confused and bewildering speeches in Parliament in the critical year of 1833, Torrens continued his old bitter anti-deflationist attacks on the resumption act of 1819, but in the midst of them, also inconsistently enunciated the currency principle in clear form:

Extensive and calamitous experience had established the fact, that a currency, consisting of precious metals, and of paper convertible into these metals on demand, was liable to sudden and very considerable fluctuation, between the extremes of excess and of deficiency... A mixed currency... would suffer a much more considerable contraction... than a purely metallic... Unless our present system of currency were amended by the timely interference of the Legislature, it would go on to occasion periodical and aggravated distress, until, in a national bankruptcy it would find its euthanasia.¹⁵

In another speech on rechartering the Bank of England, Torrens warned that ‘the adoption of the measures proposed by Government for continuing and increasing the exclusive privileges of the Bank of England would inflict upon the country a periodic recurrence in aggravated forms of revulsions of trade, and of panics in the money market...’.

In his notable Letter to Lord Melbourne, all hesitation finally fell away, and Colonel Torrens joined the leadership of the currency school ranks. He began by pointing out, in contrast to most of his currency colleagues, that bank deposits were money equally with bank notes, paying tribute to James Pennington for pointing this out. Torrens explained the nature of deposits as money very clearly, showing that a shift of bank liabilities from notes to deposits or vice versa would not change the amount of bank money by which merchants and others can make purchases. He also noted that while most people have learned how an increase in coin and bank notes raises prices and depreciates foreign exchanges, neither the government nor the directors of the Bank of England understand how loans and deposits do the same thing. But tragically, Torrens then inconsistently dismissed deposits as unimportant, apparently on the ground that the bank, not the public, decides whether to keep its liabilities in notes or deposits, and on the further erroneous assumption that country and joint-stock banks pyramid at a fixed ratio upon bank notes as their reserves but not upon bank deposits. From then on, Torrens wrote and acted as if deposits were irrelevant to the money supply.

Torrens also unfortunately conceded that the bank must function as a lender of last resort to banks in distress, but then confined his attack on the bank to its stoking the fires of inflationary credit and not conforming to the currency principle from the beginning. In order to force the currency principle upon the bank, Torrens, for the first time in print, urged that Parliament rigidly separate the bank into an issue department and a banking department. The issue department would be forced to limit its note issues to its actual supply of gold, so that bank notes could only fluctuate to the extent that the bank's stock of gold increases or decreases. In that way, wrote Torrens, ‘the circulation [of bank notes] would always remain in the same state, both with respect to amount and to value, in which it would exist were it wholly metallic’.

The problem is that the banking department, in Torrens's and hence the currency plan, would be left totally free and unregulated, on the assumption that the bank could issue credits and deposits, and that those loans and demand deposits would be totally irrelevant to the money supply. The neglect of deposits was the tragic flaw in the currency plan.

Colonel Torrens's assault on the bank was in effect, though not by name, answered in a pamphlet by bank director and former governor John Horsley Palmer.¹⁶ As in the case of bank apologists for decades, Palmer put the blame for the inflation and recession on every institution but the bank: on shipments of funds abroad, on bank runs, and on reckless credit expansion by private and joint-stock English and Irish banks. He concluded that the solution – a particular favourite of the bank – was that the bank must have a monopoly of all note issue. Ironically, the currency school, so hostile to the bank, proposed the same plan for different reasons: so that the government could have but one central bank to regulate.

In his Letter to Lord Melbourne, Torrens had given credit to the banker Samuel Jones Loyd for originating the idea of the separation of the Bank of England into issue and banking departments. Loyd now weighed in with a pamphlet attack on Palmer, in which he assumed the leadership of the currency camp.¹⁷ Far more simplistic than Torrens, Loyd dogmatically but fatally asserted that notes and deposits are forever absolutely different and therefore can and must be treated totally differently. Professor Fetter offers an amusing and accurate explanation of the triumph of Loyd's simple-minded stance:

He [Loyd] stated as a fundamental that no man in his right mind could question that note issuing and deposit business were completely separate and that a mixed circulation of coin and notes should fluctuate exactly as would an all-metallic circulation. Despite its theoretical vacuity, there was no denying the effectiveness of Loyd's argument... Loyd's prestige as a successful banker undoubtedly made his words carry conviction to many who... felt that something ought to be done about the Bank of England and that a man who made money in banking must understand banking.¹⁸

Throughout 1837 and 1838, the currency principle was advocated in highly influential pamphlets – again by Loyd, by David Ricardo's brother Samson, and – in a particularly important pronouncement – by long-time Bank of England director George Warde Norman. Like Loyd, Torrens and Pennington, Norman was a member of the Political Economy Club. His pamphlet of 1838 was a revision of a pamphlet that he had privately printed five years earlier.¹⁹ Norman agreed with Loyd that notes and deposits are totally different, and also suggested granting to the Bank of England a monopoly of all bank notes. Since Norman was a powerful bank director, it would seem that his adoption of the allegedly ‘anti-bank’ currency principle was akin to B'rer Rabbit urging not to be thrown into the briar patch!

Another economist lending his prestige as one of the last of the Ricardians to the currency principle was the prolific John Ramsay McCulloch, both in a review of some of the year's pamphlets in the Edinburgh Review for April 1837, and again in a new edition of Smith's Wealth of Nations, which he published the following year. In 1840, at the next stage of the debate, another leading economist joined the fray on behalf of the currency principle: S. Mountifort Longfield, in a notable four-part article, ‘Banking and Currency’, in Dublin University Magazine, an article influenced heavily by McCulloch's writings.