5. Monetary and Banking Thought, I: The Early Bullionist Controversy (continued)

0:005. Henry Thornton, Anti-Bullionist in Sheep's Clothing Although the bullionist controversy has been studied at length, historians of economic thought have had great difficulty identifying and analyzing the various different doctrines held in the bullionist camp. Generally, they have grouped the bullionists into an extreme or RIDGID camp, consisting of John Wheatley and David Ricardo to appear later on, and the others, including Henry Thornton, ranked as more sophisticated moderates. The issue supposedly centers on Wheatley and Ricardo's extreme devotion to long-run factors, leading them to deny any role to real factors in determining prices, exchange rates or balances Professor Joseph T. Salerno has recently made a notable advance by providing a far superior framework of analysis of the various thinkers.

1:23He notes that Boyd, as we have seen, and Lord King, another leading bullionist, were really extreme rather than moderate, and that they can be classified as such because they realized that monetary factors were always predominant, even though real factors could exert temporary influence. Thus the extreme bullionist camp now includes, A. Ricardo and Wheatley, who ignore all temporary and real factors, as well as short-term processes, and concentrate exclusively and mechanistically on the long run, And B. Boyd and later Lord King, who analyze short run processes and real factors, but realize that long run monetary factors predominate at all times.

2:18Then there are C. Moderate bullionists like Thornton, who are agnostic about whether real or monetary factors predominate at any given time. and D. anti-bullionists who ignore all underlying monetary causes. It is clear that Professor Salerno properly gives the accolade to Group B as having the correct analysis. But Salerno, it seems to the present author, does not quite go far enough. While he sees fully and lucidly the crucial differences between Groups A and B, it is is still confusing to classify these two as dwelling in the same camp, for it would clarify matters further if we totally dropped the extreme versus moderate distinction.

3:12Let Group B be termed complete bullionists and Group A, rigid or mechanistic bullionists. As for Group C, men like Henry Thornton do not really deserve the term bullionist at all. They are surely moderate, though confused might be a better term. Mired in their ad hoc approach, they could just as well end up in any given situation as anti-bullionist rather than bullionist. And indeed, Henry Thornton began his career of monetary theorist as a moderate anti-bullionist, which was his position in the course of his famous contribution of 1802. Later on, as depreciation and inflation continued, Thornton concluded that the preponderance of forces had moved the other way, and he changed his mind, gaining his undeserved historiographical reputation as a bullionist by signing the famous Bullion Committee Report of 1811, which recommended resumption of the gold standard.

4:21But Thornton remained a moderate. Placing on Thornton's later stance and conflating it with his theoretical work of a decade earlier, only misled historians into extravagantly overpraising Thornton and into placing him unequivocally in the bullionist camp. During the 20th century Thornton revival, it was said that earlier historians were unfair Here in attributing Henry Thornton's 1760-1815 pro-Bank of England bias to his being a director of the bank. It is true that he himself was not a board member of the bank, but his elder brother Samuel was director and deputy governor of the bank, and his grandfather Robert Thornton, as well as Robert's brother, Godfrey, was also a director of the Bank of England.

5:17Henry Thornton was a descendant of a long line of prominent merchants. Great Grandfather John was a merchant in Hull, in what was then Yorkshire, in the late 17th and early 18th centuries. John's sons moved to London to become important merchants there, particularly engaged in trade with Russia and the Baltic. Murray's father, also named John, continued the line of Russia merchant in London, was a senior partner in the firm of Thornton Cornwall and Company, and was also a leading member and financial supporter, beginning around 1750, of the first generation of evangelicals, low-church Puritan Anglicans under the influence of John Wesley.

6:06and gave enormous sums to charity, especially for the distribution of countless Bibles and prayer books abroad. Since the Thornton family and several of the other leaders of the movement resided in the wealthy London suburb of Clapham, they were eventually to become known as the highly influential Clapham Sect. Henry Thornton received only a sparse education. In early age he began working in the counting houses of his relatives and then of his father. Soon in 1784 he left the family firm to become a partner in the banking house of Down, Thornton and Free, where he remained as an active partner until his death.

6:53Thornton was able to build the small banking house into one of the largest in the city of London. In 1788, Thornton joined his father and several other family members as a director of the Russia Company. Meanwhile, in 1782, he had been elected a member of parliament and was soon joined by his brothers Samuel and Robert. Henry was to remain in parliament, too, for the rest of his life. Not only was Henry Thornton a distinguished banker, member of parliament, and closely William Wilberforce III became a member of Parliament at about the time of his death. He was also a dedicated leader and patron of the Clapham sect, and his home at Clapham was to serve as a virtual organizing headquarters for the evangelical movement.

7:46One of Henry's closest friends, William Wilberforce III, belonged to a powerful family, long friendly and Communications. Wilberforce became a member of Parliament at about the same time as Thornton, and it was characteristic of their earnestness, personal austerity and moral fervour that they soon came to form an independent Party of the Saints in Parliament. There, Wilberforce became the leading force in the eventually successful agitation for the abolition of the slave trade in the British West Indies. In 1796, Thornton married Marianna Sykes, daughter of another Russian merchant from Hull and also a lifelong family friend.

8:34The couple had nine children. Most of Thornton's intellectual energies were expended on evangelical religion. Though considered a distinguished expert on banking and finance, he wrote only his famous This work of 1802 on paper credit and participated in writing the Bullion Committee Report. The remainder of his voluminous writings were devoted to family prayers, family commentaries on the Bible, and scores of articles on politics, literature and religion for the Clapham Sect journal which he helped to found, The Christian Observer. After Thornton's death in 1815, his place as senior partner in the bank was taken by Sir Peter Pole.

9:22The bank prospered greatly for a while, but soon it turned out to be under-capitalized and over-expanded, and in 1825 it, along with lesser country banks, was plunged into crisis. It soon failed, despite a friendly £300,000 emergency loan from the Bank of England. Ironically, in view of Thornton's monetary views, there is some evidence that the two men most responsible for the mismanagement were Sir Peter Pohl and Henry Thornton. In particular, Thornton appears to have led the way in lax practices to induce Yorkshire country banks to keep their deposits in his London bank.

10:08Bank failure was no stranger to Thornton. Indeed, it was the temporary failure of his bank in the crisis of 1793 that turned his thoughts to problems of banking and led him to conclude that it was necessary for the Bank of England to play a supporting expansionist role in monetary affairs. As the banking theorist Thomas Joplin was to put it in his Analysis and History of the Currency Question, 1832, on the Financial Crises of 1793, Mr. Thornton, being a banker, a partner, it is curious to remark, of the House that failed on this occasion, had his attention particularly called to this subject, and a very considerable portion of his work on public credit is devoted to show that in a period of panic, the bank ought to lean to the side of enlarging than contracting its issues.

11:09When the restriction came in early 1797, Henry Thornton was honored by being the only London banker asked to give testimony before the committees of the Houses of Lords and of Commons investigating the suspension of specie payment. Thornton's influence was magnified by the lifelong friendship of Wilberforce and Prime Minister William Pitt, and Pitt's brother-in-law was the first tenant of one of the houses on Thornton's estate. The results of his pondering are scarcely surprising for someone of Thornton's status and background. Taking an inflationist and establishment line, Thornton opined that in times of crisis, paper money could not be limited or suppressed, since that would constitute a shock to commerce.

12:02On the contrary, the Bank of England must suspend specie payment in order to avoid the spectre of monetary contraction and general business failure. Indeed, Thornton undoubtedly gladdened the hearts of the bank by criticizing it for not being expansionist enough. Thornton's testimony won him the accolade of being the foremost authority on monetary Affairs and he was appointed to several parliamentary committees on money, expenditures and foreign exchange. Thornton indeed became one of the leading parliamentary defenders of the restriction and of expanded paper credit. We can easily imagine Henry Thornton's sentiments toward Walter Boyd's letter to Pitt when that tract hit the world of English opinion like a thunderbolt at the turn of 1800 to 1801.

13:00Here was this well-connected fellow banker, but an unsound adventurer, this rogue whom his own brother had brought to ruin by persuading the Bank of England to cut off his credit. And now, only months after this man had met his deserved fate, here was Boyd again, trying Trying to gain revenge by discrediting the noble banking and credit system of England. Thornton was stung to try to refute the dangerous Boyd, and it was in the service of this goal that he published his Inquiry into the Nature and Effects of the Paper Credit of Great Britain a year after Boyd's tract in February or March of 1802.

13:46At first, Thornton hit out at Boyd in Parliament in December 1800. As in his book, his words exerted all the more impact for the eminence of their author, combined with their seeming judiciousness and moderation. For there are always a host of people who will hold firmly that the more qualified and tentative the judgment, the more well balanced and sound it must therefore be. The mushiness of mind, especially in an eminent man, is all too often mistaken for wisdom. In this early phase of the bullionist debate, Thorntonian mushiness tended inexorably in the wrong direction. The depreciation of the pound in foreign exchange was caused, he opined in his speech in parliament, not by the increase of paper money, but by the unfavorable balance of trade, and specifically by the heavy imports of provisions. Typical of the anti-bullionist view, imports and exports were assumed to have ad hoc lives of their own and not to be determined by relative prices or by the supply and demand for money. But Thornton's anti-bullionism was nothing if

15:07not moderate, that is, he conceded the theoretical possibility that increased money supply could would bring about higher prices. As to the assertion that the increased issue of bank paper was the cause of the dearness of provisions, he, Thornton, would not deny that it might have some foundation, but he would contend that its effect was far from being as great as was being alleged. Henry Thornton's book on paper credit was a considerable expansion of his parliamentary speeches, and it was paper credit that took its place as not only the leading work on behalf of anti-bullionism, but also the most influential on either side of the debate.

15:57The timing was right, since the restriction was in particular need of defense in 1802. A peace with France was signed in March, and yet the British government persisted in extending the restriction another year. Soon after that year was up, war with France broke out again, but in the meantime the seeming end of the wartime emergency had taken away the apparent reason for the suspension of specie payments. Other anti-bullionist tracts appearing in 1802 were scarcely rivals for Thornton, ranging from Jasper Atkinson's anonymous pamphlet, Consideration on the Propriety of the Bank of England Resuming its Payments in Specie, denying that inflation had taken place, to another anonymous tract applying Adam Smith's erroneous theory of an automatic limit to to Excess Bank Credit to a situation Smith would never have applied it to, fiat money, the utility of country banks considered.

17:05Thornton disarmed many of his critics by conceding the theoretical possibility that excess issues of paper money can cause price increases, outflow of gold, higher prices of gold bullion and Depreciation of the Pound, but maintaining that the situation did not now apply, and that the problems of the day were due to such particular real factors as unusual demand for gold and for the importation of food and unusual blockages to exports. Thornton cleverly loaded the dice by spending the bulk of the book on the alleged horrors of Monetary Deflation and the Contraction of Bank Credit.

17:53Deflation would lead to trade depression, unemployment and bankruptcies. Furthermore, he claimed, deflation would not even accomplish an export surplus or an inflow of gold, since it would so exceedingly distress trade and discourage manufacturers as to impair are those sources of returning wealth to which we must chiefly trust for the restoration of our balance. Thornton neglected to realize that if times were really that bad, Englishmen would scarcely earn enough income to sustain a heavy excess of imports. As in all modern agitation against deflation, he also failed to realize that deflation only Money causes losses and bankruptcies if it is unexpected, revealing an excessive bidding up of wage rates and other business costs. Deflation, in addition to having the healthy impact of purging unsound investments and unsound banks from the economy, would have strictly limited and temporary effect. First, because while inflation is technically unlimited until the value of the currency is totally destroyed, deflation must necessarily be limited to the amount of bank expansion over specie, and second, deflation will cease having a

19:22depressionary effect as soon as excessive costs are brought down to pre-inflated levels. In fact, Thornton acknowledged that the fall in price and the depression brought about by Monetary Deflation would be unusual and temporary, but he anticipated Keynes in focusing on allegedly sticky wage rates. For a fall of prices arising from temporary distress will be attended probably with no correspondent fall in the rate of wages. For the fall of price and the distress will be understood to be temporary, and the rate of Wages we know is not so variable as the price of goods. There is reason, therefore, to fear that the unnatural and extraordinarily low price arising from the sort of distress of which we now speak would occasion much discouragement of the fabrication of manufacturers.

20:25There are two problems here. First, while the economic distress due to faulty forecasting Dealing and excess bidding up of wage rates and other costs will indeed be temporary. There is no reason why the fall in prices should not be permanent. Prices had previously been artificially raised by monetary and credit expansion. Their decline simply reflects the contraction of credit down to more realistic levels. The knowledge that the decline is permanent should greatly speed up the adjustment mechanism. Second, if workers persist in keeping their wage demands higher than the market, they have only themselves to blame for their unemployment.

21:13Keeping any price, including a wage rate higher than market equilibrium, will always lead to an unsold surplus of the good or service. In the case of labor, unsold labor time or unemployment. If laborers wish to change their unemployed status, they need only lower their wage demands to clear the market and allow themselves to be hired. We should also recognize that in this situation, with prices falling and wage rates constant, Workers are thereby insisting on higher real wage rates than they had enjoyed before. Why should workers holding out for higher real wage rates be able to induce an inflationist policy in the central government?

22:05So worried about deflation was Thornton that he actually urged the Bank of England to neutralize and his outflows of gold so as to obstruct the price-specie flow mechanism from bringing about equilibrium in the balance of payments. Instead, he would have the bank inflate banknotes to replace gold outflows and then hope that his vague long-run real principles of economy and exertion of expenditure and income would and eventually work to equilibrate imports and exports. Thus Thornton writes that, it may be true policy and duty of the bank to permit for a time and to a certain extent the continuance of that unfavorable exchange which causes gold to leave the country and to be drawn out of its own coffers, and it must in that case necessarily increase its loans to the same extent to which its gold is diminished.

23:09Thornton's work has been excessively hailed by von Hayek and other historians as being theoretically excellent if unfortunate in its political anti-bullionist conclusions. But his theoretical weakness did not only consist of his excessive horror of deflation and his stress on the alleged empirical dominance of real factors in his analysis of inflation and depreciation. For this stress itself reflected a grave if subtle theoretical flaw in Thornton's entire monetary and balance of payments analysis. His entire analysis lingered disproportionately on the real and short-term factors to the almost is the most complete neglect of the tendency of the economy towards long-run equilibrium.

24:04And even Thornton's perfunctory discussion of long-run equilibrium is divorced from short-run processes and also from its monetary nature. It goes without saying that Thornton therefore also neglects the monetary supply and demand nature of the short-run processes leading towards that equilibrium. Thus, Professor Salerno, who has given us a notable critique of Thornton, writes,

24:51This is in sharp contrast to the extreme bullionists and their 18th century forebears, who invariably began their analyses of balance of payments phenomena with a discussion of the nature and necessity of international monetary equilibrium, and then explained the tendency to balance of payments equilibrium as a logical implication of the necessary tendency to an equilibrium dividend. and distribution of the world stock of money. Indeed, the entire structure and organization of the book tilted Thornton heavily towards short-term real factors and away from any monetary approach towards analyzing inflation or the balance of payments.

25:41To sum up, the correct analysis of complete bullionism, such as presented by Boyd and by Lord King, stresses monetary factors leading to monetary equilibrium, while showing that real factors can only have temporary effects. The analysis of real factors is integrated with, and at all times subordinated to, the monetary factors, and short-run and long-run monetary processes are integrated as well. In Thornton's moderate anti-bullionist position, often miscalled moderate-bullionist, however, both real and monetary causal factors and processes are presented as separate and independent of each other, with real factors presented as empirically more important.

26:36Short-run factors are similarly stressed, to the neglect of long-run forces. Henry Thornton has been extravagantly praised by Schumpeter and other historians for adding velocity of circulation to the quantity of money as a determinant of overall prices. But in the first place, we have seen that ever since the scholastics, the demand for money, the inverse of the velocity, had always been integrated with the supply of money in Thornton analyzing the determination of general prices. It is true that Thornton analyzed the different influences on, and different variabilities of, velocity in considerable and pioneering detail.

27:25For example, frequency of payments, development of clearing systems, confidence in the money, and variations of the same stock of money over time. But unfortunately Thornton ruined this contribution by not realizing that velocity of circulation is simply the inverse of the demand for money, and by treating the velocity as somehow different and independent of demand in helping determine the money relation of supply, demand and price. Thornton has been lauded by von Hayek and others for including bank deposits as well as well as bank notes in the supply of money. True enough.

28:10But as we have seen, Walter Boyd preceded him in this insight by a year. But not only that, Boyd also demonstrated that bills of exchange and treasury bills are decidedly not part of the money supply, that they are objects of circulation rather than the circulator. But Thornton restored the older error of lumping bills of exchange in with notes and deposits as part of the supply of money. Henry Thornton did make some important contributions in the last two chapters of paper credit, particularly in the long-deferred paper money as cause of inflation sections that rested uneasily with the separate and contrary earlier chapters.

29:01Most of the anti-bullionist writers applied Adam Smith's dictum that bank credit cannot inflate the currency if confined to short-term, self-liquidating, real bills. The difference is that Smith had applied it only to a specie standard, whereas the anti-bullionists extended it to a fiat money system. Thornton replied that this criterion will not work since an increased quantity of bank notes will also indefinitely inflate the monetary value of the real bills, so that the Smith anti-bullionist limit is an indefinitely elastic one that will in practice only provide an open channel for bank credit inflation.

29:50Thornton further pointed out that the current usury law in Britain of 5% will aggravate the problem, for the free market interest rate or profit rate will rise higher than that in wartime or in any boom situation. Consequently, the artificial holding down of the bank loan rate below the profit rate will stimulate an excessive borrowing, artificially high levels of investment and a continuing monetary and price inflation. Thus, holding Setting the bank rate of interest below the profit rate stimulates an increase in the demand for borrowing and the continuing increase in the supply of money allows that demand to be fulfilled.

30:39In setting forth the inflationary consequences of artificially lowering the rate of interest on bank loans, Henry Thornton anticipated the later Austrian theory of the business Cycle, set forth by Ludwig von Mises and F. A. von Hayek, and in turn, based on the analysis of the Swedish-Austrian economist, Newt Wichsel, at the end of the 19th century. Thornton also hinted at the Austrian analysis of forced saving, pointing out that if excessive issues of paper money raise prices of goods more rapidly than wage rates, there will be be some increase of capital investment, but that this increase will be at the expense of the laboring classes and will therefore be attended with a proportionate hardship and injustice.

31:31Unfortunately, Thornton did not press on to the Austrian business cycle point, that since the public's time and saving preferences are not sufficient to sustain these forced Investments, a recession is bound to liquidate those investments when the artificial credit expansion stops and the true savings consumption preferences of the public are thereby revealed. It is very possible that despite the author's prominence in the world of banking, paper credit might have sunk quickly into obscurity. It was very long, several hundred pages, badly written and organized, unsystematic, muddled, and what its greatest admirers have called pro-licks.

32:20Even von Hayek, Thornton's biggest modern booster, concedes that his exposition lacks system and, in places, is even obscure. Even his greatest disciple and popularizer, Francis Horner, admitted that Thornton had little management in the disposition of his materials, that he frequently was much embarrassed in the explanation of arguments, that his reasonings are not to be trusted and are sometimes defective, that he was not trained in theorizing, that his style was poor and that the various discussions are so unskillfully arranged that they throw no light on each other and And we can never seize a full view of the plan.

33:07In short, the prolixity and the obscurity of the work oppress the reader. And yet, ironically, it was this very Francis Horner who rescued paper credit from these grave defects and put the work on the map. The form Horner used was a great stroke of luck for granting Thornton's work its maximum impact. We have noted in an earlier chapter on the influence of the Smithian Movement, Chapter 17, Volume 1, that Francis Horner was one of a scintillating group of young Scotsmen who studied under Dugald Stewart at the turn of the 19th century and went on to conquer the British intellectual climate for Smithian doctrine.

33:53It was in 1802 that these young pupils of Stewart founded the Edinburgh Review, which which struck the British intellectual world with enormous impact and quickly vaulted to the status of one of the leading journals. And it was precisely in the first October 1802 issue of the Edinburgh Review that Francis Horner wrote his famous review essay of Thornton's paper credit. In this 30-page tour de force, Horner systematized Thornton's work, made as much sense of it as was possible and, as von Hayek admits, gave an exposition of the main argument of the book in a form which was considerably more systematic and coherent than the original version.

34:43Horner beat the drums for paper credit, trumpeted it as the most valuable unquestionably of all the publications which the momentous event of the bank restriction had produced. The great fame and influence of paper credit was unquestionably Thornton mediated through Francis Horner. It was also important to realize that Horner, though chairman of the later Bullion Committee of 1810 and 1811, which recommended resumption of the gold standard, agreed with Thornton in his anti-bullionist stance of 1802. While Horner hailed Thornton's work as decisive, he paved the way for his and Thornton's later change of mind politically by writing that he was not sure which factors, the monetary or the real, had been more decisive in the inflation and the depreciation of the pound.

35:43He expressed his fundamental theoretical confusion, along with Thornton's, by declaring himself Agnostic on the Causal Issue, the matter to be decided later by more empirical data. In short, while Thornton, in his paper credit, carved out the new moderate anti-bullionist position, his follower, Horner, was what might be called a moderate-moderate, squarely in the middle of the issue. We might also note that Horner took his stand squarely with Thornton against Boyd on the The issue of defining the money supply. Rejecting Boyd's lucid circulator versus objects of circulation, Horner perpetuated Thornton's unfortunate and fuzzy view that there is no definite boundary between commodities and means of Exchange, so that everything is a mishmash of degrees of convertibility.