During the 18th century England was nominally on a bimetallic standard (consisting of silver and gold), however, the mint price of silver was intentionally undervalued to keep it out of circulation and thus a de facto gold standard functioned: banknotes issued both by the Bank of England and country banks were convertible into gold upon request. Thus, the circulating medium consisted of paper currency and gold coin, while bills of exchange and deposits were widely used means of payment in wholesale transactions. Since the Bank of England had the monopoly on note issue in the London area and the monetary system's reserves consisting of gold bullion were concentrated in its vaults, it operated in fact as a central bank.
Due to the Napoleonic Wars (1793-1815) and the ensuing growing debt that the BoE was obliged to undertake on behalf of the British Government to finance war campaigns, the banking system's gold reserves started to decrease through both an external and internal drain, deterioration that peaked with a run on the banks in 1797 created by the fear of a French invasion. The French who actually did land in Wales were quickly captured, but the suspension of convertibility of BoE notes into gold was about to last 24 years. The events following the suspension act, notably two rounds of inflation in 1798-1803 and 1808-1811 and the issue of restoring convertibility itself later on, gave rise to numerous debates with respect to the monetary policy, if any, to be followed by the BoE to ensure the stability of the system.
The bullionist controversy, as the first of the British monetary controversies is called, was centered on the issue of whether the pound was depreciated and the extent to which the BoE was responsible for inflation in the context of convertibility suspension. In the absence of a theory of flexible exchange rate regimes or central banking, with some progress made by David Hume in what later became the quantity theory of money, the controversy proved to be the ground of significant developments in the area of monetary theory, such as the stabilizing role of a central bank, foreign exchange theory and the relationship between currency phenomena and prices, exchange rates and international balances.
The Bullionist camp argued that the pound was depreciated due to an overissue of BoE notes, depreciation that would not have been possible if the banks were required to convert their liabilities into gold upon demand, and thus made a case for convertibility to curb inflation and overissue. Stemming from this view, money was created in excess if it exceeded the amount that could have been sustained under similar conditions by a metallic standard. The mechanism through which convertible currency prevented overissue was the price-specie mechanism described by Hume in 1752:
Overissue Increase home prices relative to foreign Increase purchases of foreign goods loss of specie contraction of notes issue.
Furthermore, the bullionist camp took the premium on bullion over paper currency to measure the extent of depreciation, and thus the extent of excess issue. In general, evidence of depreciation consisted of a premium on bullion, a low rate of exchange and high prices of commodities.
The Anti-Bullionists mainly defended the BoE, and contended that overissue had nothing to do with the BoE but mainly was a problem created by the country banks. The high price of commodities that the bullionists took as evidence of depreciation was argued to be a result of poor harvests, while the low exchange rate was considered to be the result of a transfer problem. Moreover, some anti-bullionists were unwilling to accept that the optimal amount of currency was that which would circulate under a metallic standard and argued even against the possibility of overissue itself. The Real Bills Doctrine contended that bank notes issued in exchange for merchants' bills of exchange, under the credibility of repayment, would be demand driven and limited by the "needs of trade", thus preventing overissue. In case there would be an accidental excess that would be extinguished upon liquidation of the bills of exchange, the so called "reflux principle".
Due to the Napoleonic Wars (1793-1815) and the ensuing growing debt that the BoE was obliged to undertake on behalf of the British Government to finance war campaigns, the banking system's gold reserves started to decrease through both an external and internal drain, deterioration that peaked with a run on the banks in 1797 created by the fear of a French invasion. The French who actually did land in Wales were quickly captured, but the suspension of convertibility of BoE notes into gold was about to last 24 years. The events following the suspension act, notably two rounds of inflation in 1798-1803 and 1808-1811 and the issue of restoring convertibility itself later on, gave rise to numerous debates with respect to the monetary policy, if any, to be followed by the BoE to ensure the stability of the system.
The bullionist controversy, as the first of the British monetary controversies is called, was centered on the issue of whether the pound was depreciated and the extent to which the BoE was responsible for inflation in the context of convertibility suspension. In the absence of a theory of flexible exchange rate regimes or central banking, with some progress made by David Hume in what later became the quantity theory of money, the controversy proved to be the ground of significant developments in the area of monetary theory, such as the stabilizing role of a central bank, foreign exchange theory and the relationship between currency phenomena and prices, exchange rates and international balances.
The Bullionist camp argued that the pound was depreciated due to an overissue of BoE notes, depreciation that would not have been possible if the banks were required to convert their liabilities into gold upon demand, and thus made a case for convertibility to curb inflation and overissue. Stemming from this view, money was created in excess if it exceeded the amount that could have been sustained under similar conditions by a metallic standard. The mechanism through which convertible currency prevented overissue was the price-specie mechanism described by Hume in 1752:
Overissue Increase home prices relative to foreign Increase purchases of foreign goods loss of specie contraction of notes issue.
Furthermore, the bullionist camp took the premium on bullion over paper currency to measure the extent of depreciation, and thus the extent of excess issue. In general, evidence of depreciation consisted of a premium on bullion, a low rate of exchange and high prices of commodities.
The Anti-Bullionists mainly defended the BoE, and contended that overissue had nothing to do with the BoE but mainly was a problem created by the country banks. The high price of commodities that the bullionists took as evidence of depreciation was argued to be a result of poor harvests, while the low exchange rate was considered to be the result of a transfer problem. Moreover, some anti-bullionists were unwilling to accept that the optimal amount of currency was that which would circulate under a metallic standard and argued even against the possibility of overissue itself. The Real Bills Doctrine contended that bank notes issued in exchange for merchants' bills of exchange, under the credibility of repayment, would be demand driven and limited by the "needs of trade", thus preventing overissue. In case there would be an accidental excess that would be extinguished upon liquidation of the bills of exchange, the so called "reflux principle".
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