Introduction
The period of the 1840s in the history of the economic thought is characterized by a significant controversy observed between the Currency School and Banking School. The debate influenced not only the British monetary system but also the approaches to the monetary policies in the United States (Block 15; Skaggs 361). As a result, the historians and monetary economists discuss the Currency-Banking debates as the most influential event in the history of developing the Western monetary systems (O’Brien 593; Smith 106). The debates originated from the active discussion of the necessity to reform the British currency system in the 1840s. The representatives of the Currency School were active proponents of the reform, and they focused on the ideas previously proclaimed by David Ricardo.
The advocates of the Currency School with Robert Torrens as a leader stated that in order to overcome crises in the British monetary and banking systems, it was necessary to focus on the metallic standard as the guarantee to back the national money and avoid issues associated with the circulation of paper bank notes (Daugherty 140). The secret was in focusing on the nation’s gold reserves to back money, and as a result, the money fluctuations were caused by changes in the gold reserves (Hortlund 217; Skaggs 362). The representatives of the Banking School with Thomas Tooke as a leader supported the contradictory visions that the changes were caused by shifts in the demand for money with the focus on the idea of general liquidity in contrast to the discussion of the role of the metallic standard (Daugherty 140-146; Skaggs 364). This point played the key role in developing the debate.
These two theoretical approaches to discussing the functions and regulations of the monetary systems can be discussed as influential while focusing not only on decisions of policy-makers in the 19th century but also on the decisions of modern economists and bankers. The purpose of this paper is to examine the nature of the debate between the Currency School and the Banking School; to analyze the differences in the ideas and visions of the schools’ proponents; and to analyze the role of the debates for the development of the monetary policies not only in the 19th century but also today. In spite of the fact that the active debate between the Currency School and the Banking School developed in the 19th century, it is important to point at the importance of this debate for the modern discussion of the monetary systems and policies because the representatives of these two schools formulated the principles of regulating the monetary systems which are followed in the Western economies today.
Theoretical Views
The Currency School
The period of the 1820s-1830s was characterized by many crises experienced by the Bank of England. The problem was in the fact that the Bank’s reserves fell to “levels at which drastic action was required to prevent complete exhaustion” several times (Daugherty 141). As a result, economists and theorists became to focus on developing strategies in order to overcome crises that influenced the economy of the state dramatically (Hortlund 219). From this point, it was not enough to discuss the issue of the currency convertibility. The experts noted that it was necessary to adopt more radical measures for “safeguarding the Bank’s reserves” (Daugherty 141). The economists who proclaimed the necessity of reforming the bank and monetary system were the advocates of the Currency School, the representatives of which developed their ideas with the focus on Ricardo’s visions (Hortlund 218).
According to these ideas, it was necessary to focus on revising the vision of the guarantee and gold standard in the economic world. The main notions discussed by the theorists were the idea of convertibility, the problem of paper overissue, and the focus on the metallic currency (O’Brien 596). Therefore, it is possible to state that the Currency School “took as axiomatic the desirability of the gold standard” in order to back notes in Britain (Daugherty 143). Following this axiom, the representatives of the Currency School formulated two main views that led their vision and discussion of the reform necessary for the Bank in England. From this point, the definition of money adopted by the Currency School was associated with the idea that paper bank notes are not money till they are supported with the gold in the Bank in England (Hortlund 218). This definition was taken as the basis of the Currency School’s theory.
The followers of the Currency School noted that the changes associated with the issue of the legal convertibility were not appropriate in order to overcome the problem of the paper overissue in England completely. Furthermore, the effective currency reform needed to be realized with the attention to shifting the focus from the “existing mixed currency” to the “purely metallic currency” (Daugherty 143). These ideas pointing at the necessity of using bank notes supported with the gold were the main postulates proclaimed by the supporters of the reformation, who developed their views in the context of the Currency School (Skaggs 361). The implications of this principle were seen after the adoption of the Bank Charter Act of 1844, when the economy of Britain began to stabilize because of the directly regulated monetary system.
Thus, Torrens and the other writers focused on the advantages of the reform stated that “the note issues would be correctly regulated if they were made to fluctuate in volume exactly as a purely metallic currency would have done” (Daugherty 145). The main reason to concentrate on the idea of importance of metallic currency was in the fact that the approach could guarantee the increase in the value of currency (Hortlund 218; Skaggs 361). This aspect was discussed by the representatives of the Currency School as crucial in order to influence the overall economic situation in Britain.
The Banking School
In spite of the fact that Thomas Tooke is discussed today as the leader of the Banking School, his views presented in the early writings did not differ significantly from the ideas proclaimed by the Currency School. Tooke paid much attention to the idea of convertibility of the currency, as the representatives of the Currency School did (Smith 109). However, Tooke also focused on the “forces of self-interest” connected with the convertibility of the currency in order to discuss these aspects as “sufficient to maintain an orderly monetary system” (Daugherty 151). The representatives of the Banking School rejected the idea that only bank notes can be discussed as money.
Bank notes were not considered as only one form of possible credits represented in paper (Smith 110). The other forms of paper equivalents of money were checks and bills, as it was stated by the Banking School’s representatives (Skaggs 363). These views explain why the representatives of the Banking School chose to focus on restrictions of the currency circulation. The main argument to restrict the bank note circulation was in the fact that the currency “regulated by demand could never be overissued because, if the public had a free choice as to the amount of currency they would circulate, they would never put so much into circulation as to cause a rise of prices” (Daugherty 152). From this point, the Banking School proclaimed the idea that the quantity of bank notes circulated in the country was determined by the public’s demand.
In addition, the Banking School also “rejected the view that changes in the whole volume of the circulating medium would cause changes in the general price level” (Daugherty 151). They also developed a price theory according to which general prices were primarily influenced by incomes in contrast to the idea that they could be influenced by the “total quantity of money in circulation” (Daugherty 151). This argument was one more idea manipulated by Tooke and his followers in order to accentuate the necessity to focus on the overall quantity of bank notes circulated in Britain (Humphrey 56). The decrease in the quantity of bank notes was expected to be realized with the focus on the “‘law of reflux’ whereby unwanted notes would be returned to banks in exchange for deposits or coin or in the repayment of loans” (Skaggs 366). Thus, that money that was of no value to the citizens would be inevitably returned to the financial institutions that issued these bank notes (Hortlund 219). This statement was discussed as rather provocative by theorists and economists because of the lack of procedures and systems in order to effectively control such circulation of bank notes in the country.
Thomas Tooke, John Fullarton, and other theorists of the Banking School also developed the Real Bills Doctrine that implied that banks could offer short-term credits in cases where there were needs to support trade or other profitable projects (Timberlake 208). In this case, the loans were not discussed as inflationary. From this point, to promote the creation of money in the country, it was possible to provide short-term loans because they were considered as non-inflationary in their nature. This doctrine was actively criticized because only gold loans can serve as a successful basis for the money creation (Timberlake 206). That is why, this doctrine was adopted in the United States was followed only till the 1940s.
Analysis of Differences in the Approaches
In order to understand the nature of the Currency-Banking debate, it is necessary to analyze the points and aspects according to which the ideas of representatives of two schools were different. In the 1830s, the representatives of the Currency School and the adherents of the British banking system proposed two plans in order to overcome the monetary crisis in Britain. According to the Banking School, “the Bank’s total liabilities (including deposits) were to be regulated by the fluctuations in the metallic reserves”, and according to the Currency School representatives, “only the notes were to be so regulated” (Daugherty 145). It was the start of the further Currency-Banking debates.
The main difference in the ideas of the theorists was associated with the approaches to regulating the stability of the monetary system in Britain. According to Hortlund, “While the Currency School denied any need for an elastic currency and favored quantitative restrictions on banks’ right to issue notes, the Banking School advocated perfect discretion for banks to issue notes to accommodate demand” (Hortlund 217). The theorists of the Currency School focused on the necessity to regulate the aspects of the monetary systems while referring to regulating the paper overissue (Daugherty 142).
On the contrary, the developers of the Banking School ideas noted that the public’s demand for money needs to be the main aspect to which it is necessary to pay attention while proposing the effective strategy of regulating the monetary system and bank notes circulation in the country (O’Brien 598). From this perspective, the Currency School supported the quantitative restrictions on the supply of bank notes in the country in order to “stop the banks from over-issuing” (Hortlund 219). The representatives of the Banking School had no the developed approach to addressing the issue of the monetary system’s stability, and they were often discussed as weak theorists regarding the discussion of the quantity and monetary theories.
It is possible to state that the approach proposed by the Currency School was more convincing and well-grounded because it was based on the idea of the gold standard. However, the approach proposed by the representatives of the Banking School was also supported by many economists because the idea of banks’ competition was recognized by researchers who discussed the approaches to balance the supply and demand in relation to the British monetary system (Hortlund 219). Summing up differences between the views of the Currency School and Banking School, it is possible to state that differences were associated with the approaches to the principle of monetary system and bank operations. According to the Currency School, circulated bank notes mattered if they were supported with the Bank of England’s gold. In contrast, the representatives of the Banking School did not pay much attention to the issue of money, and they focused on real bills and on the law of reflux as the approaches to control banks. The other difference was in definitions of money. The Currency School supported the idea that only note issues backed with the gold can be considered as money, when the Banking School developed the idea that money was all bank notes, bills, and checks included in the money exchange system.
The Bank Charter Act of 1844
In 1844, Sir Robert Peel formulated and supported the Bank Charter Act of 1844 in Britain. The principles reflected in the Act were previously proclaimed by the followers of the Currency School. It is important to state that the Act passed with comparably little opposition (Skaggs 362). The reason was in the fact that many economists and promoters of the Act advocated the principles of the Currency School in the middle of the 1840s because of Torrens and followers’ convincing arguments (Block 16). One of the first steps adopted by the promoters of the 1844 Bank Charter Act and the banking reform was the discussion of the maximum of bank notes regulated in the monetary system and supported with the gold and silver in the bank’s reserves. The Bank of England “established a marginal gold reserve requirement of 100 percent behind note issues” (Humphrey 67). As a result, the Bank of England limited the maximum quantity of bank notes that participated in circulation in the country.
The Bank of England was reformed not only in relation to the principles of its activities but also in relation to its structure and divisions. According to Daugherty, there should be two main divisions in the reformed Bank of England (Daugherty 148). These divisions were planned to be “the Banking Department which would receive deposits and make loans and the Issue Department which should have no function other than that of issuing notes in exchange for gold and paying out gold on demand for its notes” (Daugherty 148). The main postulates that served as the fundament for the development of the bank reform were the focus on the necessity to “retain the economies of a paper circulation” and the focus on the idea that “the variable part of the issue should be backed by gold” (Daugherty 148).
The proposed strategies were discussed as effective in order to maximize the control over the monetary system in Britain in the 19th century (Humphrey 56). However, the representatives of the Currency School did not achieve the goal to maintain the complete control over the monetary base in the country in order to additionally stabilize the price levels (O’Brien 596). On the one hand, the representatives of the Currency School succeeded to promote their views and influence the reformation of the monetary system in the country. On the other hand, all the goals of the Currency School representatives were not realized, while discussing the idea of the full control over the convertibility and balance of money and gold reserve in the country.
The Role of Debates in Forming the Modern Monetary Policies
Discussing the importance of the Currency and Banking Schools and the role of the developed debate, it is significant to note that many questions discussed by the representatives of different schools are not resolved yet. Hayek and Friedman are also among those economists who discussed different monetary policies with the focus on differences in the visions of the Currency and Banking Schools (Block 15). Furthermore, the theoretical ideas developed by the economists and theorists of the 19th century also influence the decision of modern policy makers in relation to the stability of the monetary system in the western countries (Smith 107). The impact of the Currency School’s visions on the modern monetary system is significant because modern banks in many Western countries follow the principle proclaimed with the British Bank Charter Act in 1844 (Block 18). According to this principle, central or national banks state their monopoly of bank notes in the country because of the necessity to support banknotes with the gold supply in the bank’s reserves. This strategy works to support the financial stability in the country and avoid inflation.
The other contributions of the Currency School proponents to the modern vision of the monetary system are the focus on the money creation and the development of the definition of the demand deposit multiplier as the function used to correlate the change in reserves with the changes in the demand deposits (Skaggs 362). Referring to the money creation approach, the Currency School proponents formulated the principle that is actively followed today (Skaggs 368). Thus, the creation of money cannot be free in order to avoid the creation of inflationary money supply and further economic crisis. This principle is followed while creating the new currency and stabilizing the national money supply.
Much attention should be paid to discussing the relation of the Real Bills Doctrine to the Western monetary policies, as it was formulated by Tooke and Fullarton who developed the idea of the ‘real-bills doctrine’. It is important to state that the Real Bills Doctrine was followed in the United States till the 1940s, and the principle of the money reflux affected the visions of the economists in the 20th century significantly (Timberlake 196). However, the focus on the maturity of credits to support printing banknotes appeared to be a weak strategy which led to crises (Timberlake 206). The principle of the real demand for money could not serve effectively to support the developed economists of the Western countries, including Britain and the United States.
From this point, the visions shared by the representatives of the Currency School influenced the modern policy makers in the sphere of banking and monetary systems control more significantly because their ideas were empirically relevant and supported. In spite of the fact that the economists of the 20th century also used the principles promoted by the Banking School as the basis for their strategies, the flux/reflux principle was discussed as opposing the developed quantity and monetary theories (Humphrey 56). From this point, the modern theory of the endogenous money resulted from the Banking School representatives’ discussion is considered as highly provocative.
Conclusion
The debate between the Currency and Banking Schools is the important phenomenon in the economic world of the 19th century because it influenced not only the economic thought of the 20th century but also the approach to controlling the monetary systems. Although the Currency and the Banking Schools’ visions were quite different, these opposite frameworks were developed by proponents and they influenced the monetary systems’ formation in the Western world equally. Pointing at the differences between the views of the two schools, it is possible to mention differences in the definition of the money; differences in the approaches to backing up banknotes; differences in approaching the money demand; differences in stabilizing prices; and differences in the discussion of the banks’ monopoly regarding the money creation issue. Thus, the Currency School stated that the circulated banknotes needed to be supported with the gold reserves. Still, the Banking School focused on the idea of real bills and on the law of reflux while discussing the monetary system and money issues. As a result, both approaches found their followers among the theorists and economists of the 20th and 21st centuries.
The ideas developed by the proponents of the Currency and Banking Schools influenced the further development of the economic theories in the western countries because of the discussion of such main issues as the money demand, risk of inflation, and stability of the national monetary system. In spite of the fact that today there are no single idea regarding the credibility of the visions of this or that school representatives, it is possible to state that both schools contributed to the progress of the economic thought significantly, and there are still followers of opposing views in the banking systems of the Western countries.
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