Thomas Tooke

Archive for October, 2012|Monthly archive page

Repayment of the government debt and contraction in 1819 and its consequences.

In Uncategorized, United Kingdom Bank restriction from February 27th 1797 to May 1st 1821 on October 29, 2012 at 11:07 pm

Thomas Tooke wrote to Lord Grenville in MDCCCXXIX (1829)

” But it has been urged, that the provisions of Mr. Peel’s Bill, by directing a repayment to the Bank of a certain amount of its advances to Government, necessarily occasioned the withdrawal of bank-notes from circulation to that extent. I am quite prepared to admit that the repayments by Government to the Bank would have the effect of diminishing the circulation, if there were no other channels through which the bank-notes cancelled by such repayment, admitted of being re-issued. But it is evident that, if the authority which I have quoted is to be relied upon, there were other channels_, including the purchases of gold, by which the sums,repaid by Government, were re-issued ; and the main question is as to the total amount of the Bank circulation, and not the manner in which the issues were made.”

“When the provisions of Mr. Peel’s Bill, directing the repayment of 10 millions to the Bank, were discussed in Parliament, it was proposed by some members, that the time of repayment should be strictly prescribed. But this was objected to by ministers as being liable to inconvenience; and it was objected to by Mr. Ricardo, because he considered,and, as the event proves, justly, that such repayment might not be necessary, or even desirable. The time, therefore, of repayment, was left open to arrangement between the Bank and Government.”

COMMENT:

Interestingly today Mr. Dalio is more concerned by Austerity than by deficit spending. I think there is an echo with Mr. Ricardo. A repayment of debt in a middle of a deflationary environment just does not help. Evidently the event considered was the repayment of debt by the Government which would contract the circulation. The contraction can force the prices down but the expansion of the bank notes is by no means creates an automatic revival of the level of the circulation on its own. Also a redeemable regime is not comparable with a conventional system or a pure metallic standard, a pure mettalic system shares more similarities with a conventional irredeemable system than with a system of bank notes convertible in bullion with a bid-ask system for Gold. This system is equivalent in some ways to a currency board where the monetary anchor is the bullion (Hong Kong Dollar). As a pure exercise it seems that Hong-Kong would have the least issues of all countries to shift to a mettalic monetary standard. It would just peg with a bid-ask system against bullion(s).

A small annoying detail for monetary policy: Quantity of money theory is very imperfect and velocity is just an accounting “plug”.

In Uncategorized, United Kingdom Bank restriction from February 27th 1797 to May 1st 1821 on October 26, 2012 at 10:41 pm

It has been maintained by Ricardo that the plunge of prices was due to the Peel bill, which forced a contraction of the quantity of money in circulation and forced a plunge in price. The Peel bill restored the convertibility of Gold and bank of England notes.

The Peel bill really restored the convertibility of Gold, the plunge of price really happened, but there is a small annoying detail for monetarist, which is that the quantity of notes in circulation actually expanded.

Here what Thomas Tooke wrote:

” The question, whether any contraction at all took place subsequently to the passing of Mr. Peel’s Bill, is confined to the six months following August, 1819 ; for, according to the following declaration of the Governor of the Bank of England, at a Court of Proprietors, held on the 21st March, 1822, the issues of the Bank were greatly extended in the two years following March, 1820 :—” If,” said he, ” the Bank had erred, it was not on the side of a reduction of the circulating medium ; for, on looking at the amount of their issues, he found that, on the 9th March, 1822, their issues exceeded, by the sum of 3,859,000P., those of the same date in the preceding year ; and that the latter, viz. the 9th March,1821, exceeded the issues of the 9th March, 1820,by the sum of 3,440,000P. It was, therefore, quite clear that the repayment of the Government debt, called for in July, 1819, did not induce the Bank to diminish their issues, for they had been increasing them in the years which had since followed.” In answer to a question from a Proprietor the Governor added : ” That the amount of issues from which he had quoted, of course, included the sovereigns issued by the Bank.”
According  to this declaration, the amount of the circulation, as emanating from the Bank of England, and forming the basis of the Currency, stood thus:

Now, this authority is quite sufficient to establish the fact, that, as far as regards the Bank issues, constituting the basis of the circulation, there was a considerable increase of the amount,notes and sovereigns together, (and from the state of the exchanges the whole of the sovereigns must have remained in the country,) between March, 1820, and March, 1822, as compared with the amount at the time of the passing of Mr. Peel’s Bill ; and this interval of two years being that ill which the principal phenomena of the fall of
prices, and the general depression ascribed to the operation of Mr. Peel’s Bill, occurred, it is of no consequence to the general argument, whether there was or was not a small reduction in the amount of the Bank issues in the six months between August, 1819, and March, 1820. It appears, then, from this statement, that, as far as regards the Bank of England issues, there was not only no contraction of the circulation following the passing of Mr. Peel’s Bill, but an actual increase of the amount (with the trifling exception ofthe six months following August, 1819) down to1822. The mere amount of bank-notes was certainly diminished, but that diminution was more than compensated by the issue of a larger amount of coin ; and whatever coin was issued in that interval must, as already observed, have remained in circulation,because there would have been a heavy loss on its exportation.

COMMENT:

There is a striking similarity to the present conditions, a large extension of the number of Bank issues but no noticeable increase in prices in what is related to domestic basket of consumption driven itself by wages in the United States, in the case of 1819-1822 episode we have an expansion of the bank issues yet a fall in prices. It is historically interesting to observe that declining long bond yields have proven to be deflationary, so why the twist?

The Fall in applications for discount of mercantile bills post Feb 1819

In United Kingdom Bank restriction from February 27th 1797 to May 1st 1821 on October 10, 2012 at 1:13 am

Thomas Tooke in his letter to Lord Grenville wrote:

” From the fall in the market rate of interest, and the little inducement to speculation, the applications for discount of mercantile bills fell off rapidly: these stood at about eight to ten millions in Feb. 1819, and it is probable that they were reduced to half that amount by the end of the year; not from any disinclination on the part of the Bank to grant the accommodation, but from the want of inducement on the part of the merchants to give five per cent, when they could readily obtain discount through private channels at on or two percent less. As as Government, from the improved state of the finances, required no further advances from the Bank, (supposing that the latter had been disposed to grant them,) there remained no medium for maintaining the circulation of Bank notes but the purchase of bullion, and possibly a reduction of the Government balances. It is owing to these two channels for the issue of notes by the Bank, that the circulation was not more reduced*.

* It may be urged that the Bank might and ought to have reduced its rate of interest on mercantile bills, in order to keep up the amount of its issues through that channel, or to have bought Exchequer Bills in the market at a premium. How far it might have been expedient to adopt either or both of these modes, It will not now stop to discuss; to have done either would, at any rate, have involved a departure from their ordinary rules, and it would have been difficult for so unwieldy a body to abandon suddenly its established habits, without the risk that its efforts might be too great in the opposite direction. The event proves that they might have ventured upon a considerable effort for enlarging their issues; and Mr. Ricardo was entitled to contend that they ought to have made this effort, and that if they had, the alteration in the value of the currency would not have been so great as it proved to be. My own opinion is, that the Directors were right, under the circumstances, in not deviating from their regular course till after they had actually resumed cash payments. And I am not at all sure that any evil consequences did arise from their having adhered to their ordinary rules. If, at the close of 1819, they had forcibly, that is, by a departure from their ordinary rules, extended their issues, they would have hastened the fall in the rate of interest, and would so far only have hastened the inducement to Government to diminish its unfunded debt, and consequently to repay the Bank, as it eventually did. ”

COMMENT:

A few critical points mentioned back in the first half of the XIX century by Ricardo and others which are still relevant today. First we see the impact of  the Government repaying its debts during a revulsion of credit which would create a contraction. This is not viewed from a Keynesian perspective of diminished spending (austerity) but in terms of reduction of collateral to issuance of  Bank notes, so the circulation would contract . We have to remember that during this period we are not in a redeemable monetary regime (Gold or bimettallic standard) we are under a compulsory regime which is irredeemable (fiat if you will). Under a redeemable monetary regime there is little a central bank do to avert a contraction/ revulsion of credit. The flip side of the price stability is steep and absolute busts.

So to continue the commentary, it is mentioned that if the BoE wanted to avert the negative consequences of a contraction, it could have bought exchequer´s bills (the equivalent of today´s QEs), or it could have lowered its discount rate on commercial bills (it seems that we are repeating the same old recipe). This was not considered for fear of negative unintended consequences of going to far in the other direction (not new either!). In summary, the QEs and  the lower discount rates are same old recipes to a contraction under a non-redeemable monetary system (fiat). The discount mechanism of the BoE was blunt, 5% always, if the market rate is lower nothing goes to get discounted at the central bank but goes in the market, if there is over excitement of trade, the BoE provides discounting at a fixed rate. Eichengreen might be right, it is a bit pro-cyclical….

Now another important lesson is that the investor should always have an eye on what is going on with money markets versus Fed Funds rates.

The contraction following August 1819: passivity from the Bank of England

In United Kingdom Bank restriction from February 27th 1797 to May 1st 1821 on October 5, 2012 at 12:31 am

As Thomas Tooke mentioned, while it can not be reasonable to ascribe to Mr. Peel’s bill, there are certain factors to consider.

Here is what Thomas Tooke wrote:

“The average of February, 1820, was somewhat more than one million and a half below that of August, 1819. Whether this reduction of bank-notes was compensated by an equal issue of sovereigns, or whether the issue of sovereigns, to which the Governor of the Bank alluded in his speech at a Court of Proprietors, of 21st March, 1822, did not take place till after February, 1820, is immaterial to my present argument, viz., — that the reduction was not rendered necessary by the provisions of Mr. Peel´s Bill.”

The state of the exchanges in August, 1819, and the influx of gold which they insured, proved that no reduction of circulation was required for the eventual resumption of cash payments. The reduction, therefore, can only be accounted for on one of two suppositions: either that the Directors designedly and forcibly contracted the circulation with a view to prepare for paying in gold; in which case, as for the reasons stated, such contraction was unnecessary, and would involve the charge of mismanagement which Mr. Ricardo made against them* on that specific ground; or the Directors were simply passive in the regulation of their issues, following the routine by which they were guided previously to 1819. The latter was the fact.”

COMMENT: Ricardo once again lost an occasion to shut-up. While many are against the current printing of the Fed, they should consider seriously the impact of the Fed not printing currrently.That being said, the best idea would probably to have prudential regulation on deposits levels, and on loan to values as well as on the curbing total debt to GDP at a certain ratio. The impediment to that are political. In Singapore and Hong-Kong those prudential measures exist, and the paper currencies of those city-states are of utmost quality.  Now given that harm already done by the lack of regulations in the US, I think we would probably have something in the order of the price plunge which was witnessed post 1819 and which was very severe and disruptive.