Byzantine Debasement

In the eleventh century a.d. the Byzantine Empire began debasing its gold coinage. For seven centuries Byzantium had maintained the purity of a gold coinage inherited from the reforms of the Roman emperor Constantine I.

Until the eleventh century, Byzantine gold coins show a gold content ranging between 22 and 24 carats fine, probably the highest standard of purity obtainable with the technical processes of the time. The Byzantine emperor Michael IV (r. 1034–1041) had practiced the money-changing profession before his elevation to emperor, and under his rule the Byzantine mints turned out coins varying between 12 and 24 carats. The purity of the gold coins continued to decline. Under Nicephorus III Botaneiates (r. 1078–1081), gold coinage averaged about 8 carats. By 1090 gold coins consisted of an alloy containing a bit of gold, more silver, and much more copper.

In 1092 Alexius I (r. 1081–1118) introduced a reformed coinage based upon four metals. A standard gold coin was struck with a fineness of 20.5 carats, a silver/gold alloy coin was struck with a fineness of 5 and 6 carats, a billon coin was struck containing 6 to 7 percent silver with the remainder of copper, and two copper coins were struck. This system provided the Byzantine Empire with a stable coinage throughout the twelfth century.

In 1204 Constantinople fell to Latin crusaders in the Fourth Crusade, and the gold coinage of Byzantium began a downward slide toward debasement. In 1253 William of Rubruck recorded an incident that occurred when the Tartars of Crimea were handed Byzantine gold coinage: “When our servants offered them ipperpera they rubbed them with their fingers and held them to their noses to sense by smell whether they were copper (utrum essent cuprum)” (Hendy, 1985). Apparently the Tartars were trying to detect a sour smell associated with copper, and the Byzantines debased their gold coinage with copper. It was said that India produced a copper that was bright, clean, corrosion resistant, and virtually indistinguishable from gold. Supposedly, Darius had drinking cups of gold and of copper, and these cups could not be distinguished except for smell.

In 1261 the Byzantine Empire was restored under a new dynasty, but the new government continued to strike debased gold coinage. In the fourteenth century debased gold coins ranged between 11 and 15 carats and a reformed silver coinage began to displace gold coins. The final blow to Byzantine gold coinage came when Constantinople fell to the Turks in 1453. Leonard of Chios, archbishop of Mitylene, gave the following account of monetary affairs during the siege:

But the troubled emperor did not know what he was to do; he consulted his chief men; They advised that the citizens should not be disturbed through the exigencies of the occasion, but that recourse should be had to ecclesiastical property. He therefore ordered the holy vessels of God to be taken from the sacred churches, just as we have read the Romans to have done on account of the needs of the moment, to be melted down and struck into coin (in pecuniam insigniri), and to be given to the soldiers, the ditch-diggers, and the builders, who were concerned with their own interest, not those of the public, and who refused to work unless paid.

(Hendy, 1985)

Byzantium’s monetary disorder mirrored the deterioration of Byzantine society. Travelers and diplomats at the time noted the palaces, churches, and monasteries that were in ruins, and the destroyed houses and neglected fields.

The Byzantine shift from a gold coinage to a silver coinage marked a geographical shift in metallic coinage. Between the seventh century and the twelfth century, the Eastern world depended primarily on a gold-based coinage and the Western world depended on a silver-based coinage. During the thirteenth and fourteenth centuries a reversal occurred, and the Eastern world shifted to a silver-based coinage and the Western world to a gold-based coinage

Bronze Standard of Ancient Rome

Early Romans replaced a cattle standard with a raw copper or bronze metallic standard. Various authors report the standard as copper or bronze, depending upon the translation of the Latin, which apparently used the same word to refer to both copper and bronze. This metal was used to make farm implements, rendering it valuable as money when the Romans changed from a pastoral to an agricultural society. The Romans remained on a bronze standard until the end of the Republic in 30 b.c.

The earliest bronze money, called aes rude, consisted of rude chunks of raw copper or bronze. These chunks began circulating as money while the Romans were on a cattle standard and were in use during the sixth century b.c. Specimens of this currency range in size from over 12 pounds to less than one ounce, and sometimes have an oblong or square shape. They must have been valued on the basis of weight.

During the fifth century b.c. a bit more refined form of bronze (or copper) money appeared, called aes signatum. This money took the form of regularly shaped bronze (or copper) bars with a specific weight. In the beginning one aes equaled a pound of bronze (or copper). These bars were stamped with an impressive variety of figures, including oxen and sheep, perhaps to create a psychological link between the new metallic money and livestock money. Swords, tripods, anchors, the Roman eagle, and fishbone-like markings are among the list of figures found on these bronze (copper) bars. During the fourth century b.c. the Romans began casting heavy round coins, known as aes grave. These coins, definitely circulating under the auspices of the government, came in sizes of various fractions or multiples of a pound of bronze (or copper), and often bore the image of a sheep, cow, or hog.

With the enactment of the Tarpeian law of 454 b.c., the government began the official transition to a metallic currency, providing that fines assessed in terms of cattle or sheep might be paid in the form of marked copper or bronze.

The weight of the aes steadily fell. According to Pliny, during the first Punic War in the third century b.c., “the Republic not having means to meet its needs, reduced the aes to two ounces of copper; by this contrivance a saving of five-sixths was effected, and the public debt liquidated” (Frank, 1959). During the second Punic War the weight of the aes was reduced to one ounce, and in 87 b.c. it was reduced to half an ounce to help pay for the Social War, a civil war that led to the end of the Republic.

The Roman language of money left an impressive legacy on our modern languages. The bronze coins were called pecunia, a reference to the images of livestock stamped on them. Pecos was the Latin word for cow, and in English money considerations are nowadays called pecuniary. The Latin word for pound, libra, was the predecessor of the English pound, the French livre, and the Italian lira. The word expenned meant “weighed out,” referring to the weighing of the asses in payment for goods. The English words “money” and “mint” evolved from the word moneta, the Latin term for the coins struck at the Senatorial Mint located in the Roman temple for the goddess Juno Moneta. Also, the English words “estimate” and “esteem” came from the Latin aestumare, meaning “to value in copper.”

During the third century b.c. the Romans began coinage of silver. These coins were struck, rather than cast, as the bronze coins had been. (Struck coins are stamped with hammers and cast coins are melted in molds.) By the middle of the second century b.c. bronze coins had lost much of their importance, and Augustus put the Romans on a bimetallic gold and silver standard in the last century b.c.

British Gold Sovereign

During the nineteenth century, the British gold sovereign coin was the pride of the British Empire, the last coin to achieve significant international stature before the era of paper money superseded metallic coinage. Sir Charles Oman, an author on English coinage, praises the sovereign as “the best piece ever produced from the English mint.” J. H. Clapman, author of a well-known economic history of England in the late nineteenth century, wrote that the sovereign had become “the chief coin of the world.”

Lord Liverpool’s Coinage Act of 1816 had established gold as the sole standard measure of value for English coinage, and had provided for the coinage of a 20 shilling gold piece containing 123.3 grains of gold. Under the Carolingian system, which survived in Britain until 1971, one pound sterling equaled 20 shillings, which equaled 240 pence. The new coin was called the sovereign. Over a span of approximately 100 years the sovereign lived up to Lord Liverpool’s dictum that gold coins should be made as perfect and kept as perfect as possible.

The sovereigns were popular in foreign countries and many left England permanently. Sometimes fluctuations in exchange rates made it profitable to melt down sovereigns, and resell the gold bullion to the English mint, where it was recoined. One Treasury official, referring to the burden of keeping the world supplied with coins, observed that “although it is certainly no part of our duty to provide coins for foreign Governments, the facilities afforded to our commerce by the diffusion of a sound circulating medium throughout the world may justify a voluntary burden for that purpose” (Challis, 1992). Sovereigns were also struck in Sydney, Australia, and Bombay, India.

Britain continued to mint sovereigns until 1914, when gold coinage ceased to circulate domestically.

During the interwar period Britain returned to a gold bullion standard, but gold coins were not minted. During the post–World War II era sovereigns were minted intermittently and sold as a hedge against inflation, but not as circulating currency.

The famous historian Arnold Toynbee, in Volume 7 of his Study of History, cited evidence that famous coins, such as the Athenian owls, continued to circulate in out-of-the-way parts of the world long after the disappearance of the government that issued them. According to Toynbee, “it may be anticipated that the English gold ‘sovereign,’ of which Englishmen saw the last in a.d. 1914, might still be circulating in Albania for generations, and in Arabia for centuries after that portentous date” (Toynbee, 1954).

The British pound sterling was the preeminent international currency during the nineteenth and early twentieth centuries, comparable to the United States dollar in the post–World War II era. The pound sterling, however, was the last international currency, the prestige of which was dependent on a precious metal coin of unquestioned weight and purity.

Bretton Woods System

From 1946 until 1971 the Bretton Woods System governed foreign exchange rate policies in the world economy. The foreign exchange rate is the rate at which one country’s currency can be converted into another country’s currency. The system took its name from Bretton Woods, New Hampshire, the 1944 site of the international conference of monetary officials who created it.

For an individual country foreign exchange rates determine the cost of imported products to domestic consumers and the price of domestic exports to foreign buyers. For example, the foreign exchange rate between British pounds and United States dollars determines the cost of a British pound if purchased by a United States dollar, and conversely, the cost of a United States dollar if purchased by a British pound. Therefore this exchange rate will determine the cost in dollars of British goods sold in the United States, and the cost in pounds of United States goods sold in Britain. Thus, foreign exchange rates determine the competitiveness of a country’s goods and services in the world market. Economies rise and fall with changes in foreign exchange rates.

Before World War I, the world economy was on a gold standard, which fixed the value of each country’s currency in terms of a fixed weight of gold, thereby setting exchange rates between currencies in the process. After World War I governments returned to the gold standard, but the result was unsatisfactory. The same governments abandoned the gold standard during the Great Depression, leaving foreign exchange rates free to float with varying degrees of government involvement.

The Bretton Woods System proposed to combine the stability of fixed exchange rates with the flexibility of floating exchange rates in a system of so-called adjustable peg exchange rates. Under an adjustable peg system, each country declared a par value of its currency in terms of gold and committed itself to buying and selling foreign currency and gold reserves to maintain this par value in foreign exchange markets. An individual country could not change the pegged value of its currency more than 10 percent without permission of the International Monetary Fund, a permanent international institution created by the Bretton Woods System.

In 1971 the Bretton Woods System came to an end because the United States needed to devalue its currency. The United States experienced a large outflow of dollars relative to inflow because of foreign expenditures from the Vietnam War and other obligations in foreign countries. By that time, however, most countries kept their currencies pegged to the value of the dollar rather than the value of gold, a practice that crept into the Bretton Woods System because gold monetary reserves were in short supply. In an effort to save the Bretton Woods System, the United States devalued its dollar relative to gold, but the outflow of dollars remained excessive. In 1973 the world economy went on a system of flexible exchange rates.

The Bretton Woods System kept alive a vestige of the gold standard when gold monetary reserves were inadequate to support the growth in world trade and money stock. It also provided stable exchange rates that reduced the risk and uncertainty associated with foreign trade, a factor that might have helped world trade recover from the disruption of world war. Perhaps its greatest accomplishment was the cooperation it fostered among trading partners in an important area of common interest.

Brazilian Hyperinflation

Between 1989 and 1994 Brazil saw inflation soar into hyperinflation dimensions, registering annual inflation rates from 1,600 to 2,500 percent.

Brazil can boast of a long history with inconvertible paper money. Notes of the Bank of Brazil appeared no later than 1808, and copper displaced gold and silver as the only metallic currency in circulation. In 1833 the government took over the issuance of paper notes, and in 1835 these notes were made legal tender. The currency system was reformed several times, but periods of monetary disorder became part of economic life in Brazil, although they never reached hyperinflation proportions until 1989.

Brazil shared an inflationary trend with the rest of the world during the post–World War II era, but with greater intensity. Between 1948 and 1965 the inflation rate in Brazil averaged 2 percent per month, lifting prices by a factor of 79 over the same time period. Annual inflation rates finished the decade of the 1960s in the 20 percent range. During the decade of the 1970s, when worldwide inflation gathered momentum, Brazil saw annual inflation rates reach 77 percent by 1979.

The dynamics of inflation seem to require that inflation persistently rise above the expected range. Brazilian inflation rose above 110 percent in 1980, and in 1988 entered four-digit territory. The year 1989 saw annual inflation exceed 1,700 percent. Inflation subsided to the three-digit range before soaring to 2,500 percent annually in 1993. The government began anti-inflation policies in earnest, cutting the inflation rate by half in one year. Annual inflation then dropped rapidly, reaching the 4 to 5 percent range in 1997.

Unlike other famous examples of hyperinflation, the blame for Brazilian hyperinflation cannot be pinned on wartime expenditures or war reparations. Brazil did bear a heavy debt burden, and much of the debt was owed to foreigners. Brazil’s central bank was a buyer of last resort of short-term government bonds, which was the immediate cause of the inflation.

Before inflation reached hyperinflation levels, Brazil had adopted a system of indexation, making inflation more bearable to average citizens. Under indexation, government bonds, wages, and other long-term contracts were automatically revised upward to adjust for inflation. The system of indexation contributed additional inertia to inflation, and initially may have slowed the rate of acceleration of inflation.

Taming inflation required deep and substantial economic reforms. Brazil underwent a capitalist revolution, emphasizing discipline in government spending, privatization, trade liberalization, and stringent monetary control. Brazil also phased in a new currency, and when the old currency was extinguished, prices stabilized. The new currency was tied to the United States dollar, and backed by foreign exchange reserves, including dollars.

Bolivian Hyperinflation

During the 1980s Bolivia experienced an episode of hyperinflation that reached annual rates of 24,000 percent during the peak years of 1984 and 1985. Cups of coffee sold for 12 million pesos. A 1 million peso note that was equivalent to $5,000 in 1982 was worth only 55 cents by 1985. During the period of raging hyperinflation, the Bolivian peso depreciated 40,000 percent, sometimes losing 1 to 2 percent per hour.

Paper pesos were counted in bundles of identical bills, and sometimes pesos were measured by the height of stacks of bills. In some cases, paper pesos were weighed. A university professor received pay in a stack of bills about 19 inches in length. A secretary received a stack of bills from 9 to 10 inches in length.

Despite the shortcuts in counting money, an airline desk clerk would spend 30 minutes counting the 85 million pesos charged for an airline ticket. Small-denomination bills became nearly worthless and were often seen blowing in the wind, piling up in muddy clumps alongside sewage ditches and in bushes on vacant lots.

The Bolivian government had to rely on foreign countries to print its paper pesos on the scale needed to satisfy the hunger of a hyperinflationary economy. Paper pesos measured in thousands of tons were flown in from Germany, Brazil, and Argentina, arriving at the La Paz airport on pallets.

Checking account and credit card transactions lost favor because the clearance process took up valuable time as the inflation clock ticked away. Banks had no money to finance mortgages for households and businesses, which paid for construction on a pay-as-you-build basis.

The United States dollar became the de facto, unofficial standard of value in Bolivia during the hyperinflation. Bolivia’s bustling cocaine trade with the United States supplied the Bolivian economy with dollars that fed a black market in currency. Currency traders walked the streets, offering to buy and sell dollars and pesos. Consumers came to town with dollars, traded the dollars for pesos before entering a store, then made their purchases with the pesos. The shopkeeper owner hardly received the pesos before going out on the street and converting the pesos back into dollars. Legally, transactions had to be conducted in pesos, but no one kept pesos longer than necessary. According to an article in the Wall Street Journal describing the Bolivian hyperinflation,

Civil servants won’t hand out a form without a bribe. Lawyers, accountants, hairdressers, even prostitutes have almost given up working to become money-changers in the streets. “We don’t produce anything. We are all currency speculators,” a heavy equipment dealer in La Paz says. “People don’t know what’s good and bad anymore. We have become an immoral society.”

(Wall Street Journal, 1985)

The blame for the Bolivian inflation has to be put at the feet of government finance. Tax revenues covered only 15 percent of the Bolivian government’s expenditures, and the government’s budget deficit equaled 25 percent of the country’s annual output. As late as 1990 the annual inflation rate was still 7,000 percent, well below the levels of the mid-1980s, but still high. In the 1990s the inflation rate began to subside substantially as the government reduced deficit spending.

Blood Money

In primitive societies, a murderer often could compensate his or her victim’s relatives with blood money, which the relatives were expected to accept in lieu of exacting violent revenge. Although the demand for some commodities tends to ebb and flow with fashion, commodities accepted as blood money tended to be goods that a tribe or people held in permanent high esteem, and these commodities often began to fill other roles of money, including as a medium of exchange.

In pre-World War II Samoa, a group of islands in the South Pacific, mats fulfilled the purpose of blood money. These prized mats could also compensate an injured husband, and bridegrooms received mats from the relatives of the bride. On the Fiji Islands, a single whale’s tooth, comparable in value to a big canoe, was the expected blood money for a murdered man. On the Santa Cruz Islands and Reef Islands, blood money came in the form of red feathers of the parrot Trichoglossus massena. In 1871 the murderer of a bishop paid a fine of four coils of feather money.

On the island of New Britain, northeast of New Guinea, sacred shells were strung, stored in coils, and used to fulfill many of the roles of money. The next of kin of a murdered individual received between 20 and 50 strings. Intertribal wars and feuds between individuals could be ended with the payment of these strings of sacred shells, called tambu or diwara. When an intertribal conflict came to an end, the number of people that each side lost was counted, and a balance of compensation paid to the side that lost the most members. In the Congo, cowrie shells were accepted as blood money.

In areas of Kenya, livestock met the need for blood money, and medieval Ireland also furnished instances of cows paid as blood money. In medieval Wales the murder of a king could be atoned with the payment of 1,000 cows. The murder of a Welsh tribesman (probably including women and children) cost the murderer 126 cows—120 for the murder, and 6 for the implied insult. The cows had be normal cows, bearing no more than five calves, and producing milk. It is probable that only a well-to-do man could afford this blood money. At that time a cow in Scotland was equal to 6 shillings or 72 pence, and pence was the largest denomination coin in circulation. The pence equivalent of 126 head of cattle would have been far more than an average Welsh tribesman could have marshaled, assuming that the value of cattle in Scotland and Wales was in a similar range. Otherwise coins of larger denominations would have been minted. Those who could not pay the blood money were subject to the eye-for-an-eye and tooth-for-a-tooth brand of justice. In medieval Sweden the fine for killing a slave was either three marks of woolen goods, or six marks of pfennige, or 4 good oxen. A slave could purchase his or her freedom for identical amounts.

Blood money was an important institution in primitive societies where no powerful state authority could avenge every wrong committed against tribal members. Acceptance of blood money was expected of tribe members as the only means of avoiding internecine warfare. Moreover, blood money was often the only thing that stood between a murderer and a sentence of execution. Blood money commodities tended to be hoarded because nobody knew when they would need them, and trying to purchase them after the commission of a murder was not always easy. Because it was payment for a human life, blood money tended to be paid in commodities most highly prized by a society. To settle blood disputes between tribes, common units of blood money evolved that facilitated other types of intertribal exchange. Blood money commodities, always in demand and evolving a store of value, represent the emergence of money at its most embryonic point.

Bland-Allison Silver Repurchase Act of 1878

The Bland-Allison Silver Repurchase Act of 1878 reaffirmed the status of the silver dollar as legal tender, and provided for the limited coinage of silver dollars. The Coinage Act of 1873 made no provision for the coinage of silver dollars, and dropped the silver standard from the definition of the dollar. It left preexisting silver dollars as legal tender—though none were in circulation at the time—but an amendment to coinage laws in 1874 made silver coins legal tender only for debts up to five dollars. The act failed to establish so-called free silver; that is, it did not commit the government to mint all the silver brought to the mint. Silver coinage was limited and gold coinage was unlimited. Congressman Richard P. Bland of Missouri introduced the bill in the House of Representatives, and Senator William B. Allison of Iowa guided the bill through the Senate. The act provided:

That there shall be coined, at the several mints of the United States, silver dollars of the weight of four hundred and twelve and a half grains troy of standard silver, as provided in the Act of January 18, 1837, on which shall be the devices and superscriptions provided by said act; which coins together with all silver dollars heretofore coined by the United States, of like weight and fineness, shall be legal tender at their nominal value, for all debts and dues public and private, except when otherwise provided by contract.

The bill that passed the House of Representatives provided for the free coinage of silver. It read that “any owner of silver bullion may deposit the same with any United States mint or assay office, to be coined into such dollars for his benefit upon the same terms and conditions as gold bullion is deposited for coinage under existing laws.” The Senate amended the bill, substituting the free silver provision with a limit on the coinage of silver to not less than $2 million or more than $4 million per month. An amendment making the silver dollars convertible into gold failed, as did an amendment that forbade the use of silver dollars in payment for interest on the public debt. Measures to increase the silver content of silver dollars also failed.

Also, the act directed the president of the United States to invite European nations to “join the United States in a conference to adopt a common ratio between gold and silver, for the purpose of establishing internationally the use of bimetallic money, and securing fixity of relative value between those metals.”

This provision led to the International Monetary Conference of 1878 in which the United States urged the adoption of a gold-silver bimetallic standard, but the European nations were not interested.

President Rutherford B. Hayes vetoed the Bland-Allison Act, citing the deterioration in the value of silver, and the injustice to creditors receiving payment in silver. The Senate voted 46 to 19 to override Hayes’s veto, and the House voted 196 to 73 to override the veto, making the Bland-Allison Act the law of the land.
President Hayes had vowed to veto a free silver bill, and he attached little significance in the Bland-Allison bill to the provision that limited the coinage of silver. The silver advocates were not happy, and the push for free silver took on the aura of a populist movement as the century progressed. The government apparently kept its silver purchases to the minimum allowed of $2 million per month. The coinage of silver continued until 1890, when the Sherman Silver Act required the government to almost double its silver purchases, but substituted the issuance of treasury notes for the coinage of silver. After the enactment of the Sherman Silver Act, concern over the future of America’s gold standard sparked a financial panic and Congress repealed it in 1893. The government discontinued the purchase of silver under the Bland-Allison and Sherman Acts.

Black Death

During an 18-month period starting in 1348 the bubonic plague, or Black Death, claimed the lives of at least one-third of the people living in Europe, perhaps the worst physical calamity in historic times. People avoided congregating at markets, fairs, or wherever goods were bought and sold. With no one to purchase them, goods at first piled up and prices fell, but after the plague had run its course, production fell off sharply. The labor force had fallen by one-third, while the amount of land, capital, and metallic coinage remained unchanged.

With the same amount of circulating money chasing fewer goods, prices rose. The shortage of labor tightened labor markets and wages appear to have doubled in a few years. Land lay uncultivated and rents fell as other prices climbed. As prices rose, albeit slower than wages, coinage began to leave in search of foreign markets where goods were cheaper, and governments debased coinage to make it less attractive in foreign markets and to stop the outflow of precious metals.

In 1351 Edward III, king of England, called Parliament together for the first time after the plague, “because the peace was not well kept, because servants and labourers would not work as they should, and because treasure was carried out of the kingdom and the realm impoverished nd made destitute of money” (Feavearyear, 1963). Edward debased the English currency, and Parliament enacted laws to hold down prices and particularly wages. Workers felt hard pressed and when the bankrupt government raised taxes in 1380, revolt broke out.

France, already desolate from war with England, also turned to coinage debasement. Even priests struck for pay raises. In 1358 France saw revolt break out in towns and rural areas.
The monetary dimensions of the Black Death show that not all monetary disturbances began as shocks to the money supply. Rather than the money supply increasing sharply, output fell precipitously after the Black Death. Either a sudden money supply increase or a sudden output drop reduces the ratio of output to money, usually causing prices to increase. The pattern of internal inflation followed by currency devaluation in foreign exchange markets has been a familiar pattern in the post–World War II era. Although the mechanics of the metallic coinage systems was a bit different, the results were the same, as monetary history immediately following the Black Death illustrates. Once prices start to rise, governments often react by putting a lid on prices, a strategy that nearly always fails. The redistribution of income puts different income classes on edge, often ending in social revolt, and, on occasion, political revolution.
The monetary disorder following the Black Death prompted a French theologian and one of the greatest thinkers of the age, Nicholas Oresme (c.1320– 1382) to write the first treatise on monetary economics, entitled A Treatise on the Origin, Nature, Law, and Alternations of Money. In this treatise Oresme explained Gresham’s law two centuries before Gresham lived.

Bisected Paper Money

Cutting notes into two or more pieces has seemed the answer to monetary and financial difficulties in more than one situation.

Immediately following World War II, the government of Finland, strapped for resources, bisected notes in denominations of 500, 1,000, and 5,000 markkaa. The left halves of the notes continued to circulate at half of the original face value, without any type of government overstamp, and the right halves became a forced loan to the government.

Greece implemented a similar expedient on two occasions. In 1915 the 100-drachma note was cut into a 75 drachmai and 25 drachmai note, mainly to meet a shortage of small change. In 1925 the Greek government bisected notes as a means of raising a forced loan. Similar to the Finnish episode, the Greek government bisected circulating notes, letting one half of each note circulate at half of its original face value and holding the other half as a loan certificate. These bisected notes also circulated without a government overstamp or overprint signifying their new value.

In 1944 Colombia faced a shortage of small change because people were hoarding coins to sell to tourists at inflated prices and to convert into buttons. The Banco de la Republica de Columbia withdrew one-peso notes dated 1942 and 1943, bisected the notes, overprinted each half note as now equal to a half peso, and recirculated the half pesos.

Toward the close of World War I officials of the Ottoman Empire cut one-livre bank notes into quarters, each equaling one-quarter of a livre. New denominations and signatures were overprinted on each note. The one-quarter-livre notes were apparently needed to meet the need for small change.

With the onset of World War I, Australia faced difficulty shipping currency to the 740 or so Fanning Islands. Virtually everyone on the islands was in the employ of Fanning Island Plantation Limited, a company engaged in exporting coconuts. The local manager of the plantation, with the aid of the United States military, arranged to have one-pound “plantation notes” printed in Hawaii and delivered to the islands. At the end of the war, Australian currency again circulated on the island, and most of the plantation notes were withdrawn, but some were bisected and used as movie tickets. The left half bore a one-shilling mark and the right half bore a two-shilling mark, reflecting the cost of attending movies on the islands.

The Bank of England has bisected notes as a security measure. After 1948 the new state of Israel sent bisected bank notes to the Bank of England for redemption. The notes were bisected and sent in two separate shipments, as protection against robbery.

The common theme in the history of bisected paper money is the exigencies of war. Bisected notes either replace disappearing small coinage or enable the government to arrange a forced loan on the government’s terms. The bisection of notes as protection against robbery does not affect money in circulation. It therefore is not a tool of monetary policy, but only a detail of handling banking operations.

Bimetallism

Under a bimetallic standard, a unit of money, such as a dollar, is defined in terms of two metals, usually gold and silver. The United States started out on a bimetallic standard that defined a dollar as equal to either 371.25 grains of silver or 24.75 grains of gold, fixing the relative value of silver to gold at 15 to 1. Bimetallic monetary standards date to the ancient world, and after the twelfth century they are well documented in European history. The use of two metals instead of one appeared as a reasonable means of supplementing money supplies.

A bimetallic monetary standard owes its complexity to the relationship between the price of metals fixed at a mint and the freely fluctuating market price of metals. A bimetallic system functions smoothly in the rare instance in which the market price and the mint price remain equal.

The true nature of a bimetallic standard is best examined when mint prices and market prices vary. If the mint ratio of silver to gold is 15 to 1 and the free market ratio is 16 to 1, citizens have an incentive to take silver to the mint for coinage, convert the silver coins into gold coins, and exchange the gold coins for a larger amount of silver on the free market. According to the theory of bimetallism, the actions of the mint in buying silver will lift the value of silver in the free market, reducing from 16 units to 15 units the amount of silver equal to a unit of gold in the free market. In thirteenth-century Genoa and Florence, a bimetallic system appeared to work according to the theory that market prices will gravitate toward mint prices.

Subsequent experience suggested that bimetallic systems do not work as the bimetallic theory suggested. Between 1792 and 1834 in the United States the mint ratio of silver to gold was 15 to 1 while the free market ratio was 15.5 to 1. This discrepancy between mint prices and market prices led to the disappearance of gold from circulation, because no one had an incentive to bring gold to the mint for coinage. Valued in silver, gold was worth more on the open market than at the mint. When Congress tried to remedy the situation by boosting the mint ratio to 16 to 1, above the free market ratio of 15.5 to 1, gold replaced silver as circulating money. Gold rather than silver was brought to the mint for coinage, and the United States began moving toward a gold standard. Under a bimetallic system, experience taught that the metal overvalued at the mint, compared to the free market, tended to drive the other metal out of circulation as predicted by Gresham’s law.

The last half of the nineteenth century saw a vigorous rivalry develop between bimetallism and the gold standard. The United States and France were the strongest supporters of bimetallism, and England championed the cause of the gold standard. The difficulties of keeping mint prices and market prices in line were a severe drawback to bimetallic standards, and the major trading partners of the world turned to the gold standard toward the end of the century.

Bills of Exchange

Bills of exchange developed during the Middle Ages as a means of transferring funds and making payments over long distances without physically moving bulky quantities of precious metals. In the hands of thirteenth-century Italian merchants, bankers, and foreign exchange dealers, the bill of exchange evolved into a powerful financial tool, accommodating short-term credit transactions as well as facilitating foreign exchange transactions.

The invention of the bill of exchange greatly facilitated foreign trade. The mechanics of this can be seen in the following example: Assume that a merchant in Flanders sold goods to a Venetian merchant and accepted in payment a bill of exchange drawn on the Venetian merchant promising to pay an agent of the Flemish merchant in Venice at a certain date in the future, and in a certain currency. The bill of exchange allowed the Venetian merchant to accept delivery on the goods from Flanders, sell them, and take the proceeds to redeem the bill of exchange in Venice, probably in Venetian currency.

Bills of exchange were also instruments for foreign exchange transactions. Merchants in Italy and major trading centers in Europe bought bills of exchange payable at future dates, in other places, and different currencies. In the example above, the Flemish merchant could sell the bill of exchange to an exchange dealer for currency of his own choosing. In turn, the exchange dealer could sell the bill of exchange to a Flemish merchant engaged in buying goods in Venice. When the bill came due for payment in Venice, the Flemish merchant would use it to buy goods in Venice where the bill of exchange was paid. While this process seems complicated, it substantially reduced the transportation of precious metals. In our example, a Venetian merchant bought goods from Flanders, and a Flemish merchant bought goods from Venice without any foreign currency leaving Venice or Flanders.

Bills of exchange gave cover to bankers evading usury laws by hiding interest charges in exchange rate adjustments that governed foreign exchange transactions. A Florentine bank could advance a sum to an Italian merchant and receive a bill of exchange payable at a future date to an agent of the Florentine bank in a foreign market. When the bill of exchange matured, the Florentine agent in the foreign market would draw another bill of exchange on the Italian merchant, payable at a date in the future at the Florentine bank that drew the first bill of exchange on the Italian merchant. The Italian merchant would be borrowing the use of money for the time it took for these transactions to be completed, and the interest would be embedded in the fees for handling the bills of exchange. Bills of exchange drawn only to grant credit were called dry bills of exchange.

Credit transactions involving bills of exchange are difficult to untangle, even challenging the talents of Adam Smith, who cited the difficulty of the subject of bills of exchange as credit instruments in the Wealth of Nations:

The practice of drawing and redrawing is so well known to all men of business that it may perhaps be thought unnecessary to give an account of it. But as this book may come into the hands of many people who are not men of business, and as the effects of this practice are not perhaps generally understood even by men of business themselves, I shall endeavor to explain it as distinctly as I can.

(Smith, 1952)

Smith goes on to describe a process by which bills of exchange are drawn and then redrawn with interest charges added, turning the bill of exchange into a form of long-term credit.
Bills of exchange circulated as money substitutes, partially playing the role of paper money, and economizing on the need to move specie between countries. When London became the financial center of world during the eighteenth century, bills of exchange became less important as credit instruments. Uninfluenced by church doctrines toward usury, the London financial markets developed financial instruments that clearly stated what interest rate was paid.

Belgian Monetary Reform: 1944–1945

The Belgian monetary reform, although not radical, was among the most thorough in post–World War II Europe. Numerous European countries, freshly liberated from Germany, found themselves awash in currency that had been spent lavishly to pay soldiers and finance military expenditures. Monetary reform aimed at soaking up a flood of currency was common in the liberated countries, including France and Italy, in an effort to avoid the hyperinflation debacles that followed World War I.

The Belgian government-in-exile returned to Brussels in September 1944 with plans in hand to reform the Belgium currency. In the course of the war the Belgian money supply had climbed 250 percent without commensurate increases in price levels, creating a situation ripe for a round of runaway inflation. Bank notes were up 350 percent and bank account money was up 125 percent. Either the money stock needed to decrease rapidly, or prices would soar.

Few European countries thought in terms of returning to prewar exchange rate parities, and Belgium was no exception. Before the war, the Belgian franc had traded at 145 francs to the pound sterling and 30 francs to the U.S. dollar. The postwar Belgian authorities aimed to maintain an exchange rate of 176.6 francs to the pound sterling, and 43.70 francs to the U.S. dollar.

The Belgian government had new currency printed in England. In October 1944 all Belgian notes over 100 francs were frozen. In five days a census of circulating cash was completed, and the process of distributing the new currency began. Each family could exchange 2,000 of the old francs for the new francs on a one-to-one basis. More exchange took place, up to certain limits, to replace old francs in notes, bank accounts, and post office accounts. Up to 60 percent of these funds were blocked, unavailable for conversion into new francs. These blocked funds could be used for certain purposes, such as special taxes, including war profiteering taxes, which ran as high as 100 percent for German collaborators. Noncollaborators paid war-profiteering taxes up to 80 percent.

The immediate result of these actions was the reduction of note circulation from 300 billion Belgian francs to 57.4 billion. By December 1944 the Belgian money stock had grown to 75 billion, and it grew rapidly in the following year as British and American troops used Belgium as a base.
Belgium’s gold holdings had been moved to France for safekeeping, which, however, did not prevent the Germans from capturing them. The Belgian government sued the French government in American courts, charging French negligence in securing Belgium’s gold. The American courts ruled in favor of Belgium, and awarded Belgium compensation out of French gold reserves held in the United States. Later all gold that the Germans confiscated from Allied governments was recovered, allowing France to recoup its payment to Belgium.
With heavy British and American expenditures in Belgium, coupled with the recovery of its gold reserves, Belgium emerged from the war with an abundance of monetary reserves, sufficient to support a stable currency

Beer Standard of Marxist Angola

During the late 1980s imported beer became a medium of exchange on the black market in Angola. By that time the economy of Marxist Angola was beginning to break under the strain of a 13-year war against rebels supported by the United States and South Africa. The inflationary wartime finance left the official currency of Angola, the kwanza, trading on the black market for 2,000 kwanzas per dollar, compared to the official rate of 30 kwanzas per dollar. As goods disappeared from the shelves of the state-operated stores, a black market rose up right in the middle of the garbage dump of Luanda, the capital of Angola. At the black market consumers purchased all kinds of goods with imported beer. The depreciating kwanzas were pegged to the price of beer.

Initially, the government tried to squelch the black market, which continued to grow as the state-owned industry ground to a halt. The state economists began to visit the black market to get ideas for Angola’s economy, which caught the same distemper as the other socialist economies of that era. The government learned to tolerate the black market as it sought to decentralize its own bureaucratic economy, which was suffering shortages of raw material and manpower arising from the war effort. Government officials turned to studying the black market as a crash course in capitalism. Soon the policeman at the black market were there only for crowd control. The black market had a name, the Roque Santeiro, the title of a popular Brazilian soap opera played in Angola, a former Portuguese colony.

Consumers acquired imported beer in one of two ways. If they had dollars, they went to one of the government-owned hard currency stores and bought a case of imported beer—Heineken, Beck’s, or Stella Artois—for $12. Only the middle classes, however, were likely to have dollars, which they acquired from foreign travel. Workers often got on the beer standard through their employers, who often paid them partially in coupons that they could spend in company-owned stores. These stores were owned by the multinational corporations that had employees in Angola. Workers could go to one of these stores, buy a case of imported beer, take it to the black market, sell it for 30,000 kwanzas, and then fill their grocery list shopping at the black market, or even buy a plane ticket to Lisbon. The plane ticket cost about two cases of imported beer. The black marketeer would break up the case of beer and sell it for about 2,000 kwanzas per can, turning a nice profit of 12,000 kwanzas.
The debasement of Angola’s currency amidst civil war sounded a very familiar note in history. Hyperinflation attended the War of Independence of the American colonies, one example of many that could be cited. The adoption of imported beer as a medium of exchange appeared, however, to have no precedent, and seemed a bit comical. It may have been a reaction to the tendency of socialist economies to emphasize austerity in the production of consumer goods, even in peacetime. The free market that rose up from the ash heap of Angola’s Marxist economy adopted as a monetary standard a symbol of Western variety and luxury in consumer goods—imported beer.

Barter

Barter is a rude form of exchange, based upon directly swapping goods for goods without the intermediary of money.

Exchange becomes more important as individuals specialize in the production of goods and services. Money considerably facilitates exchange because everyone accepts it in trade. In a money economy, individuals devoting all their energies and skills to the production of one commodity, such as cattle, can trade cows for money, and take money to town and buy groceries, televisions, automobiles, etc. In an economic system based upon barter, a cattle rancher must find someone who wants to trade cows for everything else he or she may want to acquire. Wanting to buy a television, the cattle rancher would have to find someone with more televisions than he or she needs for personal use, and who is in need of a cow. The cattle rancher, having more cows than needed for personal use, will trade a cow for a television. Economists call this conglomeration of circumstances a double coincidence of wants.

Barter exchange is necessarily time consuming and inefficient. It is hard to imagine someone working in a propeller shop making propellers for airplanes, and receiving pay in a bundle of propellers, and then trading propellers for everything they needed to maintain themselves. Money simplifies exchange and results in a constant ratio in the exchange rate between propellers, say, and televisions.

Historically, barter exchange precedes the use of money, but it has experienced resurgence at times. During the Middle Ages, metallic coinage became scarce in Europe, and barter exchange began to play a larger role. Serfs paid manor lords in certain hours of labor, and a noble would make payment in military service. In the American colonies, barter flourished because of a shortage of metallic currency. During the 1970s in the United States, barter again grew in popularity as a means of avoiding income taxes. Individuals with goods to sell, or services to be rendered, formed bartering organizations, with lists of goods that could be bartered.

In the 1990s an antiquated system of barter appeared in Russia just at the time that Western observers expected the emergence of a market economy. Some estimates suggest that as high as 70 percent of the transactions in Russia involve barter. City taxes may be paid in the form of clothes for policemen. Farmers bring food to factories in exchange for sheet metal, paint, and other useful items, and the factories pay workers in the food supplied by the farmers. Workers may be paid in kind: Workers at a timber factory received a bundle of plywood on payday. About 50 percent of industrial sales take the form of barter. A cannery trades its finished product, 12-ounce cans of meat, for livestock to slaughter, aluminum to make the cans, canning machinery, electricity, and cardboard boxes suitable for shipping canned meat.
In a country such as Russia barter emerges only after a complete breakdown of the currency. Companies must arrange deals involving several other companies in order to pay their own suppliers. They must find out what goods their suppliers will accept in payment, then set out to trade what they have to some other company that will accept these goods in order to get what their suppliers need. All kinds of imbalances develop. A police department might receive a large shipment of woolen socks but no new shoes.
Despite the obvious advantages of money exchange over barter exchange, metallic coinage, the most acceptable medium of exchange, was not freely embraced by ancient societies. Complaints against money were perhaps best expressed by the Chinese scholar Gong Yu (ca. 45 b.c.), who favored the abolition of coinage. He wrote:

Since the appearance of the uruzhu coins over seventy years ago, many people have been guilty of illicit coining. The rich hoard housefuls of coins, and yet are never satisfied. The people are restless. The merchants seek profit. Though you give land to the poor, they must still sell cheaply to the merchant. They become poorer and poorer, then become bandits. The reason? It is the deepening of the secondary occupations and the coveting of money. That is why evil cannot be banned. It arises entirely from money.

(Williams, 1997)

Ancient Chinese scholars were not alone in voicing skepticism about money. The New Testament has the often repeated refrain that the “love of money is the root of all evil.” The ancient Spartans legislated that only huge round metal discs could serve as money, hoping to discourage the accumulation and carrying of large sums of money. Metallic coinage was often blamed for the vices associated with the large seaport cities.
Despite reservations about money use, economies based upon money exchange rather than barter exchange support a much higher level of specialization among individuals, businesses, and regions, and this specialization fosters productivity. Greater specialization requires greater exchange, and money facilitates exchange. Economies using money are more efficient and productive, eclipsing economies based upon barter exchange.

Barbados Act of 1706

In 1706 the colonial assembly of Barbados, a British colony, enacted legislation that led to one of the more unusual monetary experiments in history, creating a fiat domestic currency that was virtually legal tender. The legislation sparked a strong protest from merchants, slave traders, and other English traders, the creditors in the economy of Barbados. The British Board of Trade acted to force the redemption of the paper money, but the episode reveals the secret war between debtors and creditors that often surfaces when monetary institutions are evolving.

Sir Bevill Granville, the lieutenant-governor at the time, favored a party of debt-ridden planters in the colonial assembly. With Granville’s patronage, the planter party, controlling leadership positions in the assembly, successfully sponsored the legislation, which passed in the lower house by a vote of 10 to 9. The planters clothed their proposal in arguments citing the shortage of coin as a contributing factor to the declining state of trade. To assure the successful execution of the plan, the assembly adopted the Triennial Act, which extended its own life for three years.

This proposal to create a locally issued paper money allowed each planter to receive “bills of credit” equaling in value to one quarter of the planter’s estate. The institution issuing these bills was a bank, and the bank manager was called the holder. Among other duties the holder had sole responsibility for appraising the estates of the planters, one of the many objections of the creditors. The legislation called for the acceptance of the bills at face value in all domestic transactions, and required creditors to forfeit half of a debt for refusing to accept the bills in payment. Planters had to redeem the bills in one year, or renew them. Renewed bills remained in circulation. When the planters who first drew the bills failed to redeem them or were unable to pay the interest and renew them, they faced something like a foreclosure sale on that part of their property pledged as security for the bills.
The major flaw of the bills in the eyes of the creditors was that they paid no interest to their holders. The planters paid 5 percent interest on the bills, which went to the bank to cover the administrative cost of issuing, redeeming, and renewing the bills. The merchants and traders who received the bills in payment earned no interest while they held them, a factor that assured the rapid depreciation of the bills in value.
The Royal African Company, a slave-trading company, was among the major critics of the law, and vigorously objected, with other merchants and traders, to the British Board of Trade. The British government recalled Granville, and sent as a replacement Mitford Crowe, an individual in good standing with the merchants. The British government ordered Barbados to redeem the bills held by creditors involuntarily. Meanwhile leadership in the assembly lost confidence in the new bills, and, failing to persuade the assembly to take action, dissolved it, calling for new elections. The new election became a battleground for a clash between creditors and debtors, and the creditors came out on top. The new assembly passed the Relief Act of 1707, which forced planters to redeem their paper bills in one year or face foreclosure auctions.
The experience of colonial Barbados illustrates the difficulty of developing a fiat money standard acceptable to creditors, who bear the burden when money loses its value. Perhaps there is a lesson in the fact that the same New World that flooded the Old World with an influx of precious metals, was also inventive in coming up with new variants of paper money.

Banking School

Between 1819 and 1844 England was the battleground of one of the most important monetary controversies in history: the debate between the banking school and the currency school. The resumption of specie payments following the Napoleonic Wars had not spared England the trauma of periodic financial crises. Financial crises in 1825, 1833, and 1839 became thought-provoking grist for the monetary debating mill.

The currency school found the answer to England’s financial turbulence in tighter linkages between domestic money supplies (defined as gold specie and paper money) and domestic gold supplies that varied with the import and export of gold.

The banking school saw domestic money supplies as a much more passive player in the drama of economic boom and crisis, and argued that the currency school’s definition of money supplies was narrow and unrealistic. To the banking school a more workable definition of domestic money supplies would, in addition to specie and paper money, include bank deposits and bills of exchange. Banks supplied these forms of money to meet the needs of trade. Part of the thinking of the banking school hinged upon the “law of reflux,” stating that every bank note or deposit issued on a loan was canceled when the loan was repaid. The “law of reflux” was akin to the “real bills doctrine” of a similar vintage.

The banking school felt it was unrealistic to attribute a close linkage between prices (inflation) and money supplies as narrowly conceived by the currency school, given the obvious importance of other types of money. The banking school further doubted if circulating domestic money supplies, even if totally metallic, would fluctuate in step with international gold flows as the currency school predicted. Rather than altering circulating money supplies, international gold flows might only lead to hoarding and dishoarding gold, especially within the banking community.

At the time of the debate between the banking school and the currency school, hundreds of banks issued their own bank notes. The banking school essentially defended the status quo, arguing that regulating the issuance of bank notes should be left to the wisdom of commercial bankers, subject to the requirement of convertibility. The bankers left to their own discretion would provide an elastic currency able to expand and contract to meet the needs of trade.

The Bank Charter Act of 1844 largely followed the recommendations of the currency school, especially in laying groundwork for monopolization of bank note issues by the Bank of England. Nevertheless, consistent with the thinking of the banking school, the act gave the Bank of England some discretion to expand and contract bank notes independently of gold flows.

Banking Acts of 1826 (England)

The Banking Acts of 1826 banned the issuance of bank notes of less than 5 pounds and ended the Bank of England’s 100-year monopoly on joint-stock banking.

The Act of 22 March 1826 put an end to notes of less than 5 pounds and required the redemption of the smaller notes by 5 April 1829. Apparently the number of people hanged for the capital offense of forging notes, even small ones, was one thing that moved Parliament to act. Scotland, where 1 pound notes were highly popular, was exempted from the act. Before the act passed Parliament, the eminent author Sir Walter Scott had written letters to the Edinburgh Weekly Journal that ridiculed the abolition of small notes in Scotland. Another prominent Scot, Adam Smith, in the Wealth of Nations, had argued against the issuance of small notes in 1776, observing:

Where the issuing of bank notes for such very small sums is allowed and commonly practiced, many mean people are both enabled and encouraged to become bankers. A person whose promissory note for five pounds, or even for twenty shillings, would be rejected by everybody, will get it to be received without scruple when it is issued for so small a sum as sixpence. But the frequent bankruptcies to which such beggarly bankers must be liable may occasion a very considerable inconveniency, and sometimes a very great calamity to many poor people who had received their notes in payment.

(Smith, 1952)

Arguments in favor of small notes cited the conservation of precious metal reserves when precious metal was no longer needed as a circulating medium. Scotland continued to circulate 1 pound notes throughout the nineteenth century, while Britain relied upon the gold sovereign coin to circulate as the 1 pound piece. Subsidiary silver coinage gradually replaced the role played by the small notes.

The Act of 26 May 1826 ended the Bank of England’s monopoly on joint-stock banking. In addition to giving the Bank of England a monopoly on joint-stock banking, an act of 1707 had prohibited banking partnerships with more than six members from engaging in the banking business. Small-scale partnerships dominated English banking in the countryside, while the Bank of England enjoyed a preeminent position within a radius of 65 miles around London. Joint-stock banks were organized as modern corporations, affording the owners (stockholders) the protection of limited liability. Unlike corporations, partnership banks, in the event of bankruptcy, exposed all the personal assets of partners to the demands of creditors. Scotland had pioneered the proliferation of joint-stock banking, but England had tended to reserve to the Bank of England the exclusive privilege of joint-stock banking.

The Act of 1826 preserved the Bank of England’s monopoly on joint-stock banking within a 65-mile radius of the center of London, but outside the London area it authorized the establishment of note-issuing banking corporations with an unlimited number of partners. To compensate for its loss of privilege, the Bank of England was authorized to set up branches anywhere in England or Wales. The Bank of England promptly opened branches in major cities, and for a while England flirted with the Scottish system of banking that emphasized competition between note-issuing incorporated banks. The Banking Act of 1833, however, made the Bank of England’s notes legal tender, and the Bank Charter Act of 1844 marked a sharp shift toward a policy of concentrating note-issuing authority with the Bank of England.

Bank Restriction Act of 1797 (England)

The Bank Restriction Act of 1797 began England’s first experience with inconvertible paper currency—that is, paper currency that was not convertible into precious metal at an official rate. From 1797 until 1821, roughly coinciding with the Napoleonic Wars, the Bank of England suspended payments, meaning that bank notes were no longer redeemable in specie or cash. During this era England managed a system of inconvertible paper currency that met the needs of trade without triggering a destructive episode of hyperinflation.

Prior to the suspension of payments, banks in England, Ireland, and Scotland issued bank notes that circulated as paper money, and these banks stood ready to redeem bank notes into gold and silver specie, assuring the acceptability of bank notes in trade. Beginning in 1793 banks had difficulty maintaining sufficient specie reserves to satisfy all requests for redemption of bank notes. Heavy government borrowing, coupled with subsidies to foreign allies and military expenditures, caused a major outflow of gold, draining the gold reserves of the Bank of England. The memory was still fresh of the financial debacle that followed John Law’s attempt to multiply without limit the paper money in France in 1720. Rumors of a French invasion of Ireland sparked a run on banks, further drawing down gold reserves at the Bank of England. The Privy Council at an emergency meeting on 26 February 1797 decided that the Bank of England should suspend payments, and on 3 May 1797 Parliament confirmed the action with enactment of the Bank Restriction Act. The suspension of payments, advanced as a temporary measure, was continually renewed, lasting six years after the end of the Napoleonic War in 1815. It dominated discussions of monetary issues in Parliament for 24 years.

Measures of inflation during the suspension of payments period were not available because the science of index numbers was still in its infancy. The values of gold and foreign currencies, priced in British pounds, were the main indicators that gauged the value of the paper pound. The Irish pound dropped significantly on foreign exchange markets in 1801, sparking serious discussion. In 1809 the other monetary shoe fell when the British pound dropped significantly on the Hamburg foreign exchange market. The House of Commons appointed a committee, the Select Committee on the High Price of Gold Bullion, to investigate the monetary situation and report to Parliament. The report of this committee, the Bullion Report, fastened the blame on excessive issue of bank notes and recommended the return to convertibility within two years. Thomas Malthus and David Ricardo, famous economists of the time, supported the Bullion Report, while most businessmen and bankers, particularly officials of the Bank of England, defended the suspension policy, arguing that banking policy had no effect on foreign exchange rates. In hindsight the Bullion Report represented sound monetary economics, surprisingly advanced for its time, but the exigencies of war forced England to remain on an inconvertible paper standard. Someone summed up the issues saying that the bankers turned out to be bad economists, and the economists bad politicians.

Two factors seemed to have spared England the ravages of a paper money system out of control. First, England had a developed capital market for long-term financing of government debt, Second, Parliament enacted an income tax that became effective in 1799. The government’s use of taxation and long-term borrowing lifted much of the pressure on the monetary system to pay for the war by printing bank notes.

When the war ended in 1815, contrary to expectations, the Bank of England still faced a drain on its gold reserves, and Parliament postponed the resumption of cash payments. In 1819 Parliament passed the Resumption of Cash Payments Act calling for the resumption of payments by 1823. The Bank of England’s reserve position improved faster than expected and full convertibility into gold was restored in May 1821. The Resumption of Cash Payments Act also put England squarely on the gold standard, which England had been moving toward during the eighteenth century.

Bank Rate

See Bank Charter Act of 1833,Gold Standard

Bank Restriction Act of 1797 (England)

The Bank Restriction Act of 1797 began England’s first experience with inconvertible paper currency—that is, paper currency that was not convertible into precious metal at an official rate. From 1797 until 1821, roughly coinciding with the Napoleonic Wars, the Bank of England suspended payments, meaning that bank notes were no longer redeemable in specie or cash. During this era England managed a system of inconvertible paper currency that met the needs of trade without triggering a destructive episode of hyperinflation.

Prior to the suspension of payments, banks in England, Ireland, and Scotland issued bank notes that circulated as paper money, and these banks stood ready to redeem bank notes into gold and silver specie, assuring the acceptability of bank notes in trade. Beginning in 1793 banks had difficulty maintaining sufficient specie reserves to satisfy all requests for redemption of bank notes. Heavy government borrowing, coupled with subsidies to foreign allies and military expenditures, caused a major outflow of gold, draining the gold reserves of the Bank of England. The memory was still fresh of the financial debacle that followed John Law’s attempt to multiply without limit the paper money in France in 1720. Rumors of a French invasion of Ireland sparked a run on banks, further drawing down gold reserves at the Bank of England. The Privy Council at an emergency meeting on 26 February 1797 decided that the Bank of England should suspend payments, and on 3 May 1797 Parliament confirmed the action with enactment of the Bank Restriction Act. The suspension of payments, advanced as a temporary measure, was continually renewed, lasting six years after the end of the Napoleonic War in 1815. It dominated discussions of monetary issues in Parliament for 24 years.

Measures of inflation during the suspension of payments period were not available because the science of index numbers was still in its infancy. The values of gold and foreign currencies, priced in British pounds, were the main indicators that gauged the value of the paper pound. The Irish pound dropped significantly on foreign exchange markets in 1801, sparking serious discussion. In 1809 the other monetary shoe fell when the British pound dropped significantly on the Hamburg foreign exchange market. The House of Commons appointed a committee, the Select Committee on the High Price of Gold Bullion, to investigate the monetary situation and report to Parliament. The report of this committee, the Bullion Report, fastened the blame on excessive issue of bank notes and recommended the return to convertibility within two years. Thomas Malthus and David Ricardo, famous economists of the time, supported the Bullion Report, while most businessmen and bankers, particularly officials of the Bank of England, defended the suspension policy, arguing that banking policy had no effect on foreign exchange rates. In hindsight the Bullion Report represented sound monetary economics, surprisingly advanced for its time, but the exigencies of war forced England to remain on an inconvertible paper standard. Someone summed up the issues saying that the bankers turned out to be bad economists, and the economists bad politicians.

Two factors seemed to have spared England the ravages of a paper money system out of control. First, England had a developed capital market for long-term financing of government debt, Second, Parliament enacted an income tax that became effective in 1799. The government’s use of taxation and long-term borrowing lifted much of the pressure on the monetary system to pay for the war by printing bank notes.

When the war ended in 1815, contrary to expectations, the Bank of England still faced a drain on its gold reserves, and Parliament postponed the resumption of cash payments. In 1819 Parliament passed the Resumption of Cash Payments Act calling for the resumption of payments by 1823. The Bank of England’s reserve position improved faster than expected and full convertibility into gold was restored in May 1821. The Resumption of Cash Payments Act also put England squarely on the gold standard, which England had been moving toward during the eighteenth century.