7.7 Triumph of the currency school: Peel's Act of 1844

At the heart of the triumph of the currency principle in Peel's Act of 1844 was one man: the statesman and political genius Sir Robert Peel.²⁴ Peel has been habitually derided by historians as a confused middle-of-the-roader, a ‘flexible’ political opportunist, at best a transitional figure unwittingly performing the historical function of ushering in the Conservative and Liberal party system in England. But, as Professor Boyd Hilton has helped to point out, Peel was a far different figure: a statesman in the best sense, a Tory liberal who was consistent and even unyielding in principle and purpose, and flexible and ‘entrepreneurial’ only in attaining the best tactics to arrive at his fixed ideological goals. As Hilton has demonstrated, in every important sense, economic, financial and moral, Robert Peel was the John the Baptist, the founder, the ‘progenitor of Gladstonian liberalism’.²⁵

During the 1820s, Peel was for most years head of the Home Office in Tory governments. He had long been opposed to Catholic emancipation, and had even resigned his Cabinet post in 1827 in protest at the accession to the prime ministry of George Canning, head of Tory liberalism and champion of Catholic rights. Two years later, however, after the death of Canning, Peel, back as home secretary, was converted to Catholic emancipation as part of his ever-increasing devotion to the classical liberal, laissez-faire cause. At his conversion, Peel had the good grace to honour the prophets and warriors for Catholic emancipation whom he had opposed for so long: Fox, Grattan and Canning himself.

From 1831 on, Peel headed the Tory, now Conservative party, and also was the heart and soul of the liberal faction of the party. Peel's great prime ministry took place in 1841–46. Here he fought vigorously for a peaceful foreign policy, battling against the pro-war, imperialist Palmerston wing of the Liberal party, and managed to conclude peace with the United States in the menacing Oregon boundary controversy. Peel also managed to lower tariffs, but lost in his fight for all-out free trade. His great accomplishment on that front was victory over the furious opposition of the Tory agriculturalists led by Benjamin Disraeli, in the complete repeal of the infamous Corn Laws which had for decades established an enormous import tariff on wheat. In this fight against the artificially high price of food, Peel was spurred by the growing famine in Ireland. Again gracious in victory, Peel hailed his political opponent, the laissez-faire Liberal Richard Cobden, as the true architect of the repeal of the Corn Laws. For his success, Peel's government was toppled by Disraeli, and he died in a hunting accident four years later, in 1850.

Robert Peel's proudest achievement, however, was his banking reform, his Act of 1844. The Bank Charter Act of 1833 had provided for possible change in the charter during 1844, so that was the year of potential banking reform. As recent research has revealed, Peel's Act did not originate as a hostile 'strait-jacket, fastened on a reluctant (though subsequently complacent) Bank by the efforts of the Currency School’. Rather the Act came from within the bank itself, ‘as an attempt by the Bank to find for itself a short-cut to currency management’, as well as a means of obtaining its long-sought monopoly over bank note issue.²⁶ First, the ardent currency school leader, George Warde Norman, had, as a bank director, been promoting the plan since 1838. Although Norman lost within the bank on his currency proposal in 1840, he persisted, and the following year he became part of a five-man standing committee of the bank to discuss the scheme. By January 1844, William Cotton, the governor of the Bank of England, and a member of the standing committee, had been converted to the currency plan, and when, in early January, Peel asked Cotton and the deputy governor, J.B. Heath (also a member of the standing committee) to confer with him and Chancellor of the Exchequer Henry Coulburn about fundamental banking reform, Cotton was ready.²⁷ In response to these discussions, Cotton and Heath, on 2 February, submitted to Peel the complete outline of what was soon to become Peel's Act.

In essence, Peel's Act established the currency principle. It divided the Bank of England into an issue department, issuing bank notes, and a banking department, lending and issuing demand deposits. True to the rigid currency school separation of notes and deposits, deposits would be totally free and unregulated, while notes would be limited to a ceiling of £14 million matched by assets of government securities (roughly the extent of existing note issue). Any further notes could only be issued on the basis of 100 per cent reserve in gold. The second main provision was to grant the Bank of England its long-sought monopoly of the note issue. This was not done immediately, but to be phased in over a period of time. Specifically: no new banks were to issue any bank notes, existing banks were to issue no further notes, and the Bank of England might contract with bankers to buy out their existing notes and replace them with the bank's own. In this way, private bank notes were ‘grandfathered’ in, and the private (that is, joint-stock plus country) banks were neatly cartellized, under the direction of the bank, with the private banks able to keep out all further competition. This ‘grandfather’ cartel clause was not only designed to make the transition to the new order gradual; its main effect, and presumably its intent as well, was to bring the private banks – which might be expected to be the chief opponents of the new bill -around to become enthusiastic supporters.

In his manoeuvring within the Cabinet before publicly presenting Peel's Act, the prime minister made it clear that ‘if we were about to establish in a new state of society a new system of currency’, he would have preferred the Ricardian plan of government notes, with no Bank of England or any other bank notes allowed; but that this plan would be impracticable in the existing state of the real world, where a coalition must be built among such contending forces as the bank itself, Ricardians, free bankers and country bankers. The desideratum, Peel shrewdly advised, was to ‘determine to propose the course which they may conscientiously believe to reconcile in the greatest degree the qualities of being consistent with sound principle and suited to the present condition of society’.

News of Peel's coming bank charter bill had spread by the end of February, and the country banks, as expected, vigorously protested the bill during March and April. Finally, Peel introduced the bill to Parliament on 6 May. Shrewdly splitting his opposition, he applied the bill fully only to England. The ban on new banks issuing notes was extended to Scotland and Ireland, but the limitations on existing banks were applied to England alone. For the rest, Scotland and Ireland were left alone for the time being.

The introduction of Peel's bill touched off a flurry of controversy, including a pamphlet war over the Act. In particular, the new controversy gave rise to the banking school, which beforehand had been represented only by Tooke. Tooke weighed in with an Inquiry into the Currency Principle, and John Fullarton entered the fray with his aforementioned pamphlet, On the Regulation of Currencies, a widely circulated and influential tract even though it was published in August 1844, after the passage of Peel's Act. S.J. Loyd published a defence of the bill, while the formidable Colonel Torrens blasted Tooke in another pamphlet.

The new banking school was noteworthy for being more royalist than the king, more favourable to the Bank of England than the bank itself. In short, the banking school, along with most of the London bankers, favoured the vesting of a monopoly of bank note issue in the Bank of England. Its quarrel was solely with currency principle restrictions on the bank's issue of notes. This was surely the kind of opposition that the Bank of England could live with. While the banking school correctly spotted the main weakness of the currency school in not treating notes and deposits alike, this objection was scarcely directed to extending any sort of reserve requirements to bank deposits as well as notes. On the contrary, they would have been all the more outraged by, say, a consistent Peel's Act that would have placed a 100 per cent reserve requirement on all further bank liabilities, deposits as well as notes.

One bit of curiosa about the emergence of the banking school is the lateness of its arrival; coming as it did almost when the fight over Peel's Act was over, and flourishing for a while after, its importance was more for raising theoretical issues and for raising the interest of historians of economic thought than in actually influencing the political battle.

Another noteworthy aspect of the fray was the advent of a new and important star in the economic firmament: John Stuart Mill (1806–73), who joined the banking school side of the debate in an anonymous article, ‘The Currency Question’, in the radical Westminster Review. Actually, Mill had foreshadowed the banking school in an article written at the age of 20, ‘Paper Currency and Commercial Distress’, in the short-lived radical Parliamentary Review. Like so many others, Mill was first moved to turn his attention to banking and business cycles by the economic and financial crisis of 1825–26. But in contrast to many others, he abandoned instead of extending his basic Ricardianism in this area.²⁸ Instead of seeing the new phenomenon of business cycles as created by monetary disturbances, he saw them as caused by waves of ‘speculation’, presumably generated by over-optimism. Money and banks were purely passive respondents to fluctuations in the economy. From this there followed his conclusion that movements in the money supply, at least under a gold standard, had no effect on prices or trade. Within the framework of a gold standard, prices rose first, dragging the money supply upwards, and later fell, pulling the money supply down.

How could Mill square this odd doctrine with his overall Ricardianism and its thesis of the influence of the supply of money upon its value? He did so by an ingenious, though bizarre and fallacious, theory of what constitutes the supply of money. The money supply was made up, not only of coin, notes and demand deposits, Mill opined, but also of the ‘credit-worthiness’ of every member of the public. When a bank made loans to some member of the public, then, it might increase notes or deposits outstanding, but that increase is exactly compensated by a decrease in the ‘credit-worthiness’ of the borrowing citizens. Therefore, when banks lend money to individuals and businesses, the money supply does not increase at all. On the contrary, when banks purchase government securities or finance its deficit, they add directly to the total money supply by the same amount. In fact, they even add to the money supply when they lend to private citizens beyond the degree of their genuine credit-worthiness. How is such ‘credit-worthiness’ to be determined? By banks confining their loans to sound borrowers, and to the discounting of ‘real bills’, that are short-term, matched by inventories of goods in process, and are therefore self-liquidating in a short period of time. Bank credit then happily follows the ‘needs of trade’ upwards or downwards, and cannot raise prices. While completely fallacious, Mill's theory at least had the merit of providing some plausible, logical explanation for the banking school creed -one that was scarcely matched by any of his colleagues.

Furthermore, Mill's doctrine provided a good reason for his devotion to the gold standard, and for his bullionist denunciation of inconvertible fiat money. Within his theory, if government or the central bank issues inconvertible fiat paper, that paper adds directly to the money supply and to inflation rather than being neutralized by subtracting from credit-worthiness. And devoted to the gold standard he remained. We have already seen Mill's denunciation of Thomas Attwood's inflationary fiat paper scheme in 1833.

And what of the alleged free banking school, which Professor White has put forward as equally strong and vibrant to, and strictly separate from, the rival currency and banking schools? As White himself ruefully admits, they were nowhere to be found, their alleged devotion to free banking failing the most acid of all tests, when Peel's Act was about to bring all commercial banks under Bank of England control. For not only would the bank now have a virtual monopoly of note issue, but in order to obtain notes in exchange for cashed-in deposits, the other banks would now be obliged to keep the great bulk of their reserves at the Bank of England. White tries to explain away the defection of the free bankers as having been bought out by Peel's cartellization-‘grandfather’ clause: for the banks could continue to issue at their current level and no new competing banks would be permitted. But while this explanation is true enough, it raises the crucial question: how devoted were Professor White's heroes to free banking to begin with? Wasn't the free banking school simply a group devoted to the economic interests of the private commercial banks?

Take, for example, the newly founded The Bankers' Magazine, which had supposedly been a leading mouthpiece for free banking for the previous year. A writer in the June 1844 issue, while critical of the currency principle and the move towards monopoly issues for the bank, frankly approved the Peel Act as a whole for aiding profits of existing banks by prohibiting all new banks of issue.

And let us take in particular James William Gilbart (1794–1863), leading spokesman for the country bankers, manager of the London & Westminster Bank, and, according to Professor White, one of the main theoreticians of the free banking school. Gilbart, born in London and descended from a Cornish family, had worked all his life as a bank official and had written works on banking since the late 1820s. Since 1834, he had been manager of the London & Westminster Bank, continually clashing with the Bank of England. Despite Professor White's assurance that the free banking school men were even more fervent than the currency men in attributing the cause of the business cycle to monetary inflation, Gilbart held, typically of the banking school, that bank notes simply expand and contract according to the ‘wants of trade’, and therefore such notes, being matched by the production of goods, could not raise prices. Furthermore, the active factor goes from ‘trade’ to prices to the ‘requirement’ for more bank notes to flow in the economy. Thus Gilbart: ‘if there is an increase of trade without an increase of prices, I consider that more notes will be required to circulate that increased quantity of commodities; if there is an increase of commodities and an increase of prices also, of course you would require a still greater amount of notes.’ In short, whether prices rise or not, the supply of money must always increase! One wonders who the ‘you’ is who would have such requirements. On the free market, on the contrary, if there is an increase in the production of commodities, prices will tend to fall and not rise; furthermore, increased production of trade does not ‘require’ or call forth an increase in bank money. The causal chain is the other way round: increased bank note issue raises the money supply and prices, and also the nominal money value of the goods being produced.

All historians of economic thought except for Professor White have placed Gilbart squarely in the banking school camp as one of its leaders. Since White seems to agree with Gilbart's fallacious ‘wants of trade’ analysis, and since he admits that this creed is similar to that of the banking school, his creation of an important new school of ‘free banking’, challenging both of the others, appears all the more tenuous and artificial. The main difference seems to be marginal and political: while all the banking school hailed the banking system as useful and harmless, most of them laid special honours on the Bank of England, while Gilbart, as a joint-stock banker himself, placed most approval upon the commercial banks.²⁹

When it came to the test, then, Gilbart, like his colleagues on The Bankers' Magazine, caved in on what Professor White alleges to be his free banking principles. Thus White concedes:

He [Gilbart] was relieved that the act did not extinguish the joint-stock banks' right of issue and was frankly pleased with its cartellizing provisions: ‘Our rights are acknowledged – our privileges are extended – our circulation guaranteed -and we are saved from conflicts with reckless competitors’.³⁰

James Gilbart's open status as a banking school inflationist and Robert Peel's staunch devotion to hard money were both revealed in Peel's questioning of Gilbart when the latter testified that country bank notes are only issued in response to the wants of trade, and therefore that they could never be over-issued. He also claimed that the Bank of England could never over-issue so long as it only discounted commercial loans and did not buy government bonds.³¹ At this point, Sir Robert Peel unerringly zeroed in and drew forth Gilbart's apologia for the banking system. Peel: ‘Do you think, then that the legitimate demands of commerce may always be trusted to, as a safe test of the amount of circulation under all circumstances?’ To which Gilbart admitted: ‘I think they may.’ (Nothing about exempting the Bank of England from that trust.) Peel then asked the critical question. The banking school all claimed to be devoted to the gold standard, so that the ‘needs of trade’ justification for bank credit did not apply to inconvertible currency. Peel, suspicious of that devotion to gold, then asked: in the bank restriction days, ‘do you think that the legitimate demands of commerce constituted a test that might be safely relied upon?’ To which Gilbert evasively replied: ‘That is a period of which I have no personal knowledge.’ This was a particularly disingenuous point coming from the author of The History and Principles of Banking (1834). Moreover, the issue is of course a theoretical one, and no ‘personal knowledge’ is necessary to make a reply – a point made immediately by Peel. At which point Gilbart threw in the towel on the gold standard: ‘I think the legitimate demands of commerce, even then, would be a sufficient guide to go by...’. When Peel pressed Gilbart on the point, Gilbart began to vacillate, changing his views, returning to them, and then again falling back on his lack of personal experience.³²

Peel was right in being suspicious of the strength of the banking school's devotion to gold. Apart from Gilbart's damaging revelations, his colleague at the London & Westminster Bank, J.W. Bosanquet, kept urging bank suspensions of specie payment whenever times became difficult. And while Thomas Tooke often proclaimed his abhorrence of the Birmingham school, he wrote in 1844 that a crucial limit on any over-issue of bank notes was the needs of trade in addition to gold convertibility. The opening was sufficient to allow Robert Torrens to score a palpable hit:

After a careful examination of Mr. Tooke's recent publication, [1844] I cannot discover any very essential or practical difference between his principles and those of the Birmingham economists. Once deviate from the gold rule of causing the fluctuations of our mixed circulation to conform to what would be the fluctuations of a purely metallic currency and the flood-gates are opened, and the landmarks removed. Between the abandonment of a metallic standard as recommended by the Birmingham economists, and the adoption of arrangements hazarding the maintenance of a metallic standard recommended by Mr. Tooke, the difference in the practicable result might ultimately be nothing.³³

John Fullarton's admission was even more damaging than Tooke's, avowing, in his popular 1844 tract, that he wholeheartedly agreed with the ‘decried doctrine of the old Bank Directors of 1810’ – namely, the anti-bullionist position that so long as any bank sticks to short-term real bills ‘It cannot go wrong in issuing as many [notes] as the public will receive from it’. And of course 1810 was a year of inconvertible money. It is no wonder that Robert Peel considered all opponents of the currency principle as essentially Birmingham men.

Thus the opposition to Peel's Act, while theoretically important, was politically scattered and ineffective. The bill sailed through overwhelmingly, and became law on 19 July. A second Peel bill, designed to make it more difficult to establish new joint-stock banks, sailed through in September. The result of this tightening of bank control and monopoly as well as cartel privileges to existing banks, was, indeed, the creation of virtually no new joint-stock banks in England for the next eight years.

At this point, Peel completed his currency task by extending its sway to Scotland and Ireland in two bills that became law on 21 July 1845. Cautious in the face of regional traditions, Peel was not as tough on the Scottish and Irish banks as he had been on the English. Whereas the English commercial banks could issue no more bank notes period, the Scottish and Irish banks were treated as Peel's Act of 1844 treated the Bank of England: their further bank note issues were limited to 100 per cent gold reserves. Scotland had never had its banking restricted, having been free to establish joint-stock banks and issue notes and deposits throughout Scotland. The Scottish bankers, however, like Gilbart and the English bankers, were easily bought off by cartel privileges even more lucrative than in England. As White admits, ‘Peel in essence bought the support of all existing banks by suppressing potential entrants and competition for market shares’.³⁴ In addition, Peel shrewdly permitted the Scottish banks to keep the privilege, denied to English banks (including the Bank of England) since the 1820s, of continuing to issue their cherished small (£1) notes.

The only important development in the year between the two Peel's Acts was the highly belated entry into the great debate of a new leader of the banking school, James Wilson, founder and editor of the notable new journal, The Economist. Wilson (1805–60)³⁵ had founded The Economist for the express purpose of battling for free trade and laissez-faire. He criticized Peel's Act when it came up in 1844, but devoted most of his energies to free trade. Finally, in the Spring of 1845, Wilson wrote a famous series of nine articles on ‘Currency and Banking’ in The Economist, attacking the extension of Peel's Act to Scotland and Ireland. Wilson took an orthodox banking school approach, except that each of his positions was so emphatic that the inner inconsistencies and contradictions of the banking school were brought out particularly starkly. Thus Wilson was far more emphatic and militant than Tooke or Fullarton about the importance of preserving the gold standard, so much so that Torrens was later to call Wilson ‘the most able of the opponents of the act of 1844’,³⁶ And yet, of the Big Four of the banking school (Tooke, Fullarton, Mill and Wilson), Wilson was the only one who stated flatly and clearly that short-term, self-liquidating real bills would be sufficient to protect the banks from over-issue, even without specie convertibility. Thus, Wilson declared that

inconvertible paper notes might be issued to any extent that legitimate transactions required them, provided such issues were confined to the discount of good bills of exchange, and to loans for short periods, without any risk of depreciation, because a larger quantity never could be so issued than was again shortly returnable to the bank in payment of such loans.³⁷

In addition, of all the Big Four Wilson was the friendliest to free banking and desirous of saving the alleged free banking system in Scotland.³⁸ And yet he also claimed that the Bank of England could never over-issue in a convertible money system, which was quite the opposite of the free banking approach.