The Power of Gold: The History of an Obsession
Page 24
Let us step back for a moment, in order to gain better perspective on these dramatic events. Some brief history and overview of the mechanics of the English monetary system might be helpful.
It is important to recognize that the English monetary system-like the English political system-had evolved by trial and error, without the rigidities of legal stipulations and regulations that characterized the French system of government and that Napoleon and his successors did nothing to diminish. Public and private money circulated together and reinforced each other. The government's money was the coinage, most of which consisted of the golden guinea, although silver coins and token coins of smaller denominations also circulated.; More than one hundred years before the crisis of 1797, however, private paper money had begun to substitute for coins in large transactions. Bills of exchange, as we have already seen, were often endorsed over from one holder to another and thereby became a kind of paper money. In addition, many people who owned gold coins would deposit them with a goldsmith for safekeeping, accepting in exchange a receipt for the gold that could then be used as a means of payment because it was redeemable in gold on demand. Indeed, the total output of gold during the century as a whole averaged only twenty tons a year.'
More important, banking grew at a rapid rate throughout the eighteenth century, and it was customary for banks to pay out the proceeds of their loans in the form of promissory notes to customers; these notes, in a variety of denominations and engraved and watermarked to defy forgers, would then circulate from hand to hand as money. When the Bank of England was established in 1694 and made the original loan of £1.2 million to the government, part of the proceeds paid out to the government was in the form of Bank notes, which the government used to purchase supplies for its campaign against Louis XIV. Those notes circulated among businesses and the public as money but were also held by other banks as a reserve to cover withdrawals of deposits.
The consequences of this unplanned structure were profound. As the volume of banknotes replaced the coinage of government in daily circulation, the supply of money in daily use was now joined directly to the volume of credit provided by the privately owned banking system. In essence, the private sector overtook the public sector as the primary engine of money creation. Although most money in use today is in the form of checking accounts rather than paper currency, the basic eighteenth-century relationship between bank credit and money supply remains intact. By the end of the eighteenth century, in fact, a rising share of money was already being held in the form of checks and deposits much as we know them today.
These developments do not mean that gold coins or bullion ceased to be important because their hand-to-hand circulation declined. English money was clearly defined by its weight in gold-the 129.4 grains of gold in the guinea that worked out to an ounce of gold being equal to £3 17s 10%d. Even though guineas resided for the most part in the safes of goldsmiths or the faithfully guarded vaults of the Bank, the assurance that they were there was what appeared to make the system work. The various forms of private paper-bills of exchange, goldsmiths' receipts, and banknotes issued by commercial banks throughout the countrycould always be exchanged for the notes of the Bank of England, and Bank notes could always be exchanged for gold, or specie as it was often called in those days. For example, before February 26, 1797, anyone with £210 in notes could go to the Bank at any time and receive two hundred golden guineas in exchange.
Most of the time, nobody bothered. Yet when business was boom ing and the price of gold in the marketplace was rising, or when sterling was losing value in the foreign exchange markets, two hundred golden guineas could command more than £210 in the City markets or the equivalent of more than £210 in foreign financial markets. At that point, it would be profitable to convert £210 in notes into two hundred guineas and then exchange the guineas for some larger amount in the financial markets.
In 1783, after the end of the American Revolution, the Bank had made an energetic effort to halt such a process before it had much opportunity to begin. Private business activity was expanding rapidly, with prices about 10 percent higher than they had been four years earlier, and the Bank's stock of gold coins began to shrink.' In response, the Directors of the Bank of England refused additional credits to merchants and other borrowers, who had to turn elsewhere for credit. The result was a sharp rise in interest rates, a cooling of speculative fevers, an immediate improvement in the exchange rate between sterling and continental currencies, and a return flow of guineas to the vaults of the Bank.9 Thus, the staunch faith in gold had transformed the shiny metal that most people viewed as the ultimate form of wealth into a powerful vehicle of checks and balances (a role that gold would continue to play, in one form or another, and not just in Britain, for the next 174 years). What everyone considered to be the riskless asset seemed to subdue the risks in the entire economy.
The crisis of 1797 and the Restriction Bill that sundered the linkage between Bank notes and gold tore apart this unofficial but powerful system of controls. With the golden counterweight no longer operative, the economy was now operating completely on paper currency.* Hien Tsung's inadvertent innovation, which, with "continentals" and assignats, had caused disasters in financing the American and the French revolutions just a short time back, was now about to make its debut on the more conservative shores of Great Britain. In the words of Lord Lansdown, contemplating the consequences of the Restriction Bill, "A fever is as much a fever in London as in Paris or Amsterdam; the fall will be slow perhaps, and gradual for a time; but it will be certain.""'
The original issue of the assignats in December 1790 had amounted to eight hundred million livres; on October 23, 1795, over twenty billion were outstanding. The Paris riots that ensued paved the way for Napoleon's rise to power and forced the government to abandon the worthless assignats for a metallic-based system based on gold and silver.
Where did the French gold come from? Much of it was a return of capital that had fled the country during the assignat regime. In fact, the events in France were the main reason that the Bank of England's gold reserves were so low when the Fishguard adventure occurred: gold that had earlier been transferred to England by frightened Frenchmen now began to return to France, driving the Bank of England's gold reserve from C6 million in early 1795 to only £2 million in early 1797. Napoleon had inadvertently laid the groundwork for the panic that ensued from the Battle of Fishguard."
In addition, however, acting in the tradition of the great conquerors of the past, Napoleon lost no time in launching his career as a ruthless accumulator of monetary treasure (among other things) from vanquished nations. In a note to the Directoire Executif on June 1, 1796, he informed his colleagues that "Two millions of gold are en route [from Italy]. They leave tomorrow with a hundred carriage horses, the most beautiful one can find in Lombardy. They will replace the mediocre horses that pull our carriages."12
Napoleon remained steadfast as a "hard-money" man throughout his reign. He had no choice. If he had even whispered the possibility of issuing an inconvertible paper currency, the nightmare of the assignat experience would have provoked an immediate flight of all the gold in France to safer havens abroad. Thus, Napoleon's keen monetary management skills enabled him to succeed where every other leader had failed. This was probably the only major war in history to be conducted without currency depreciation in one form or another.i3
Lord Lansdown was right: the fall was slow and gradual, but inflation ultimately took hold in Britain. Prices in 1802 were lower than they had been in 1800, but they climbed 30 percent between 1802 and 1807 and by another 15 percent over the next three years. Prices had doubled from their 1797 level when Napoleon succumbed at Waterloo in 1815.'
The inflation was associated with a substantial increase in money and credit. No longer constrained by the gold supply, the Bank's loans to business-so-called commercial bills under discount-more than quadrupled between 1797 and 1810. The Bank has never supplied the financial markets with such
an explosion of credit except during the extraordinary conditions of the two World Wars of the twentieth century. By no coincidence, the Bank's note issue expanded from approximately £10 million to k25 million over the same period of time, with half the increase having occurred just since 1807, while deposits at the Bank were increasing at about the same pace. The Bank's holdings of coin and bullion fluctuated with the fortunes of war but were at no point equal to as much as 50 percent of the Bank notes outstanding; in 1794, before all these troubles began, the gold reserve had been equal to 70 percent of the outstanding notes.15
Beginning in 1808, the price of gold began a rapid ascent. By 1809, the gold in a guinea was fetching k4 10s an ounce in the marketplace, well above the price of £3 17s 1 OV2d that had defined the value of gold when Isaac Newton was pondering the matter back in 1717. Sterling was also losing value relative to the currencies of other nations-toward the end of 1809, the pound was exchanging in Hamburg, Amsterdam, and Paris from 16 percent to more than 20 percent below its official par values.16 The result was a 50 percent decline in the Bank's holdings of gold coins and bullion between February 1808 and August 1809, even though these holdings had been replenished since the low point at the enactment of the Bank Restriction Act in 1797. The restoration of convertibility appeared further off than ever.
The financial community was outraged." On August 29, a 38-yearold stockbroker as spokesman for this community submitted the first of three letters on this matter to the Morning Chronicle, complaining that the public "do not seem to be sufficiently impressed with the importance of the subject, nor of the disastrous consequences which may attend the further depreciation of the paper."" His name was David Ricardo, and this was the first time his name had appeared in print. The letters and additional commentary subsequently appeared as a tract titled "The High Price of Bullion."
Ricardo was born in 1772, when Adam Smith was fifty years old and Thomas Malthus, Ricardo's beloved friend and unremitting intellectual opponent, was six years old; Ricardo first met Malthus in 1809 at the very moment he was sending in his letters to the Morning Chronicle.19 Ricardo's father was a Jewish merchant banker and stockbroker jobber, as the English call it-who took his son in as an employee when the boy was only fourteen. The firm prospered, even though it had to limit its trading activity to a section of the Royal Exchange known as Jews Walk. Ricardo remained in business with his father for seven years, until he fell in love with a Quaker girl. At the age of 21, he broke with his family, married Miss Wilkinson, adopted the Quaker religion, went into business at the Exchange on his own, and, more than most people, lived happily until he died suddenly at the age of 51.
Ricardo scored an enormous success as a stock jobber, years before he had any idea that he would become one of the most famous theoretical economists of all time with the publication of The Principles of Political Economy and Taxation in 1817. His brother once observed that "Perhaps in nothing did Mr. R. more evince his extraordinary powers than he did in business. His complete knowledge of all its intricacies ... his capability of getting through, without any apparent exertion, the immense transactions in which he was concerned-his coolness and judgment-enabled him to leave all his contemporaries at the Stock Exchange far behind."20
As the English government debt climbed ever higher during the course of the Napoleonic conflict, Ricardo became one of the major underwriters of those government securities each time they were issued to the public. Like investment bankers today who like to take care of their friends, Ricardo would occasionally allot a small cut of these deals to his chum Malthus, a parson and academic of modest means whose fame as an economist would in time rival Ricardo's. In 1815-at the moment when the battle of Waterloo was approaching-Malthus could not stand the strain of being exposed to what might happen to his little nest egg if Wellington were to lose. He pleaded with Ricardo "to take an early opportunity of realizing a small profit on the share you have been good enough to promise me."21 Ricardo obliged but held on to his own much more substantial position. For Malthus, Napoleon's defeat at Waterloo was good news and bad news: good news as it was for all Englishmen but bad news for the enormous opportunity missed. For Ricardo, it was 100 percent stupendous news. Just two years later, he published his magisterial work, The Principles of Political Economy and Taxation. The remarkable friendship with Malthus survived these events unscathed. After Ricardo's death, Malthus declared that "I never loved anybody out of my own family so much. "222
Ricardo's letters to the Morning Chronicle about Britain's shrinking gold reserve and the depreciation of the pound in the foreign exchange markets attracted much attention. About six months after the publication of Ricardo's letters, and after extended debate in Parliament and the press, a little-known member of Parliament named Francis Horner moved for the establishment of a parliamentary committee to look into the whole matter in detail, to examine expert witnesses, and to prepare a report and recommendations for the House of Commons upon the completion of their task. Eighteen days later, the House announced the appointment of "The SELECT COMMITTEE to enquire into the Cause of the High Price of GOLD BULLION, and to take into consideration the State of the CIRCULATING MEDIUM, and of the EXCHANGES between Great Britain and Foreign Parts."2i
What came to be known as the Bullion Committee numbered 22 members, most of whom were experts from the world of finance; some, such as the joint Paymaster of the Forces, were civil servants. The hearings ran for a total of 31 days between February 22 and May 25, 1810, during which the Committee took testimony from 29 witnesses from business, finance, academia, and government. The Committee's report provides the full identity of all the witnesses, except on page 19, where it refers to a "very eminent Continental Merchant," who, according to further commentary on page 25, was "intimately acquainted with the trade between this Country and the Continent"; Ricardo's testimony refers to this gentleman simply as "Mr. -." Edward Carman, who wrote an authoritative commentary on the whole matter in 1919, concludes that "An obvious conjecture is that this modest Mr. Blank was the great N. M. Rothschild."24
The report never indicates which members asked the questions of the witnesses, on the theory that the questions were being raised by the committee "as a body."25 The most active members, and the primary authors of the Committee's final report, were Francis Homer, Henry Thornton, and William Huskisson. A barrister, Homer was one of the founders of the Edinburgh Review, to which he had contributed several articles on banking. Like Adam Smith before him, he had been born and educated in Edinburgh but had spent two years in England "to rid himself of the disadvantages of a provincial dialect."26 Thornton, a banker; had written an early textbook on banking theory that had issued dire warnings about the abuses of paper credit. Huskisson had earlier been associated with some of the leaders of revolutionary France and had publicly expressed his disapproval of their plan to issue the assignats. He subsequently became President of the Board of Trade (equivalent to Secretary of Commerce in the United States) and, as the economist Glyn Davies phrased it, "suffered the final dubious distinction of being killed by a train at the ceremonial opening of the Liverpool to Manchester Railway in 1830."27
In June, while the report was still in the hands of the printer, Horner wrote the following to a friend:
The Report is in truth very clumsily and prolixly drawn; stating nothing but very old doctrines on the subject it treats of, and stating them in a more imperfect form than they have frequently appeared before.... One great merit the Report, however, possesses; that it declares in very plain and pointed terms, both the true doctrine and the existence of a great evil growing out of the neglect of that doctrine.... We shall in time (I trust) effect the restoration of the old and only safe system.28
Despite Homer's demurrer about its literary quality, the report was a best-seller for its time; it was out of print three months after its appearance in August. For someone who encounters it nearly two hundred years after its publication, the report is an extraordinary document. Homer's letter indic
ates that there was nothing wishy-washy about the effort: the conclusions and recommendations are indeed plain and pointed. A reader could disagree with the hard line taken by the authors and still be startled by the sophistication of the economic analysis. At its best, the report accurately reflects the most important economic ideas developed by David Hume and Adam Smith even while anticipating concepts that would appear in theory books only years in the future, especially in relation to the theory and practice of the gold standard system that would develop over the course of the nineteenth century. Indeed, the clarity and thoroughness of the presentation of monetary theory matches Milton Friedman at his best. A document of equivalent quality written by today's members of Parliament or the U.S. Congress would be inconceivable.
The issues confronted by the Bullion Committee were essentially the same as the arguments between Lowndes and Locke in the period before the Great Recoinage of 1695. The Committee's report builds on the basis of an overarching assumption that was never open to question at any point-that gold is the paramount asset. The authors refer at the outset to "the sound and natural state of the British currency, the foundation of which is gold. "29 A few pages later, echoing Ricardo's affirmation in his third letter to the Morning Chronicle that "Gold Coins are now become, in the practice and opinion of the people, the principal measure of property, 11311 the report asserts, "In this Country, Gold is itself the measure of all exchangeable value, the scale to which all money prices are referred."31 And, finally, "Gold in Bullion is the standard to which the Legislature has intended that the coin should be conformed and with which it should be identified as much as possible. ... It is most desirable for the public that our circulating medium should again be conformed, as speedily as circumstances will permit, to its real and legal standard, Gold Bullion. "32