RIVAL NOTIONS OF MONEY Thomas M. Humphrey Introduction Bullionist Controversy (1797-1821) The rise of Milton Friedman’s version of mone- Monetarism did not begin with Friedman nor did tarism in the 1960s and early 1970s provoked an antimonetarism originate with Kaldor or Keynes’s antimonetarist backlash culminating in the late General Theory. Those doctrines clashed as early as Nicholas Kaldor’s The Scourge of Monetarism (1982). the Bank Restriction period of the Napoleonic wars Friedman stressed the ideas of exogenous (i.e., when the Bank of England suspended the converti- central bank determined) money, money-to-price bility of its notes into gold at a fixed price on de- causality, inflation as a monetary phenomenon, and mand. The suspension of specie payments and the controllability of money through the high-powered resulting move to inconvertible paper was followed monetary base. He traced a chain of causation run- by a rise in the paper pound price of commodities, ning from open market operations to bank reserves gold bullion, and foreign currencies. A debate be- to the nominal stock of money and thence to aggre- tween strict bullionists, moderate bullionists, and an- gate spending, nominal income, and prices. tibullionists then arose over the question: Was there By contrast, Kaldor postulated the opposite notions inflation in England and if so what was its cause? of endogenous (i.e., demand-determined) money, reverse causality, and inflation as a cost-push or Strict Bullionists: the classical monetarists supply-shock phenomenon. He denied the possibility Led by David Ricardo, the strict bullionists argued of base control given the central bank’s responsi- that inflation did exist, that overissue of banknotes bility to guarantee bank liquidity and the financial by the Bank of England was the cause, and that the sector’s ability to engineer changes in the turnover premium on gold (the difference between the market velocity of money via the manufacture of money and official mint price of gold in terms of paper substitutes. Kaldor’s transmission mechanism runs money) together with the pound’s depreciation on from wages (and other factor costs) to prices to the foreign exchange constituted the proof. Price money and thence to bank reserves. Wages deter- index numbers not then being in general use, the mine prices, prices influence loan demands, and loan bullionists used the gold premium and depreciated demands via their accommodation in the form of new exchange rate to measure inflation. checking deposits created by commercial banks The bullionists arrived at their conclusions via the determine the money stock, with central banks following route: The Bank of England determines the passively supplying the necessary reserves. quantity of inconvertible paper money. The quan- Kaldor claimed his attack on monetarism was in tity of money via its impact on aggregate spending the tradition of Keynes’s General Theory. So much so determines domestic prices. Domestic prices, given that he labeled it “a Keynesian perspective on foreign prices, determine the exchange rate so as to money. ” In so doing, he contributed to the standard equalize worldwide the common-currency price of textbook tendency to treat the monetarist- goods. Finally, the exchange rate between incon- antimonetarist debate as a post-Keynesian develop- vertible paper and gold standard currencies deter- ment. This article shows that the debate long mines the paper premium on specie so as to equalize predates Keynes, that it is rooted in classical everywhere the gold price of goods. In short, causality monetary tradition, and that it traces back at least runs unidirectionally from money to prices to the ex- to the bullionist-antibullionist and currency school- change rate and the gold premium. It followed that banking school disputes in England in the nineteenth the depreciation of the exchange rate below gold century. More precisely, the following paragraphs parity (i.e., below the ratio of the respective mint demonstrate that the arguments of Friedman and prices of gold in each country) together with the Kaldor were fully anticipated by their classical premium on specie constituted evidence that prices predecessors. were higher and the quantity of money greater in FEDERAL RESERVE BANK OF RICHMOND 3 England than would have been the case had con- Moderate Bullionists vertibility reigned. Here is a straightforward applica- Moderate bullionists, led by Henry Thornton, tion of the monetarist ideas of exogenous money, Thomas Malthus, and William Blake, modified the money-to-price causality, inflation as a monetary strict bullionists’ analysis in one respect: they argued phenomenon, and purchasing power parity. On these that it applied to the long run but not necessarily to grounds the strict bullionists attributed depreciation the short. They held that in the short run real as well of the internal and external value of the pound as monetary shocks could affect the exchange rate solely to the redundancy of money and reproached such that temporary depreciation did not neces- the Bank for having taken advantage of the suspen- sarily signify monetary overissue. In the long run, sion of convertibility to overissue the currency. however, real shocks were self-correcting and only The strict bullionists also enunciated the monetarist monetary disturbances remained. Their position is notion of control of the money stock through the best exemplified by Blake’s distinction between the high-powered monetary base. With respect to base real and nominal exchanges. The real exchange or control, they argued that the Bank of England could, barter terms of trade, he said, registers the impact through its own note issue, regulate the note issue of nonmonetary disturbances-crop failures, unilateral of the country (non-London) banks as well as other transfers, trade embargoes and the like-to the privately issued means of payment (bills of exchange balance of payments. By contrast, the nominal ex- and checking deposits). Two circumstances, they change reflects the relative purchasing powers of said, worked to ensure base controllability. First, foreign and domestic currencies as determined by country banks tended to hold in reserve Bank of their relative supplies. Both components contribute England notes (or balances with London agents to exchange rate movements in the short run. In the transferable into such notes) equal to a relatively fixed long run, however, the real exchange is self-correcting fraction of their own note liabilities. This estab- (i.e., returns to its natural equilibrium level) and lished a constant relationship between the Bank note only the nominal exchange can remain permanently base and the country note component of the money depressed. Therefore, persistent exchange deprecia- stock. Second, a fixed-exchange-rate regional balance tion is a sure sign of monetary overissue. On this of payments or specie-flow mechanism kept coun- point the moderate bullionists agreed with their strict try bank notes in line with the Bank’s own issues. bullionist colleagues. Country bank notes were fully convertible into Bank of England notes but did not circulate in London. Antibullionists: the classical nonmonetarists Should country banks overissue, the resulting rise Opposed to the bullionists were the antibullionist in local prices over London prices would lead to a defenders of the Bank of England. They denied that demand to convert local currency into Bank of the Bank had overissued or that domestic monetary England notes to make cheaper purchases in Lon- policy had anything to do with the depreciating don. The ensuing drain on reserves would force exchange rate and rising price of gold. Such infla- country banks to contract their note issue, thus tionary symptoms they attributed to real rather than eliminating the excess. For these reasons, the quan- monetary causes. In so doing, they contributed two tity of country notes was tied by a rigid link to the key ideas that today appear in Kaldor’s work. volume of Bank notes and could only expand and First was their supply-shock or cost-push theory contract with the latter. The implication was clear: of inflation. They argued that crop failures and war- Bank of England notes drove the entire money stock. time disturbances to foreign trade had raised the price Country banks were exonerated as a source of of wheat and other staple foodstuffs that constituted inflation. the main component of workers’ budgets. These The strict bullionists displayed another monetarist price increases then passed through into money trait in prescribing rules rather than discretion in wages and thus raised the price of all goods pro- the conduct of monetary policy. Their rule called duced by labor. Ricardo, however, convincingly for the Bank of England to contract its note issue replied that this explanation confused relative with upon the first sign of exchange depreciation or rise absolute prices. For without excessive money growth, in the price of gold. This rule derived from the a rise in the relative price of wheat that required famous Ricardian definition of excess according to which workers to spend more on that commodity would if the exchange was depreciated and gold was com- leave them with less to spend on other goods whose manding a premium the currency was by definition prices would accordingly fall. In that case the rise excessive and should be contracted. in wheat’s price would be offset by compensating falls 4 ECONOMIC REVIEW, SEPTEMBER/OCTOBER 1988 in other relative prices leaving general prices below the expected rate of profit on the use of the unchanged. borrowed funds. In this case loan demands will be Second, the antibullionists enunciated the notion insatiable and the resulting rise in money and prices of an endogenous, demand-determined money stock. will be without limit. This came in the form of their real bills doctrine, which Bullionists, especially Henry Thornton, advanced they employed to assert the impossibility of an ex- exactly this same argument against the antibullionists’ cess supply of money ever developing to spill over real bills doctrine.