DOES RICARDOS THEORY OF MONEY BELONG TO THE CLASSICAL CANON ?

Ghislain Deleplace*

I would like first to warn the reader that I shall here understand the word canon as a synonym for orthodoxy . The concept of classical canon , as used by amuelson !"#$%& and 'ollander !"#%(&, refers to a )rowth model in which money plays no part. 'ence any confusion )enerated by this terminolo)ical substitution should be a*oided. +ow ,icardo is )enerally considered as the champion of classical monetary orthodoxy, based principally on his defence of the -uantity theory of money. .or example, chumpeter attributes to ,icardo this theory in /a0 strict sense !"#12 3 $(4&, and 5lau) insists that ,icardo was espousin) a hard6line *ersion of it !"##1 3 4"&. amuel 'ollander is more cautious 3 obser*in) that ,icardo made repeated applications of the 7-uantity theory8 of money durin) the course of the bullion debate !"#$# 3 2$2&, he shows that the precise characteristics of the ,icardian formulation of the theory !ibid& are more complex. In a paradoxical way, the most *irulent criti-ue of the ricardian macro6economic theory, 9eynes, praises some of ,icardo8s monetary positions in his Treatise on Money3 If ,icardo had had his way with his in)ot proposals, commodity money would ne*er ha*e been restored, and a pure mana)ed money would ha*e come into force in :n)land in "%"# ". It is worthwhile to notice that 9eynes mentions the in)ots proposals , i.e. ,icardo8s plan for establishin) an economical and secure currency in "%";. The purpose of the paper is less to discuss the orthodoxy in ,icardo8s theory of money than to look for a possible heterodox component in this plan, which is of particular importance because it was defended as early as "%"", -uoted in the second edition !"%"#& of On the Principles of Political Economy and Taxation, and submitted by its author to
*

:<:', =ni*ersity of <aris %, > rue de la ?ibert@, #41>;

aint6Denis cedex (>, .rance. :6mail 3

)hislain.deleplaceAuni*6paris%.fr. I thank for their comments Barie6Th@rCse 5oyer6Dambeu, +ancy Ehurchman, Timothy Da*is, Gilles Dostaler, ?ucien Gillard, :mmanuel Basset6Dene*re, Fean6+icolas ,ieucau, Bichel ,osier, Behrdad Gahabi.
"

9eynes !"#4(& 3 "2.

> <arliament the same year. The paper is or)aniHed in the followin) way. ection " considers the relation between the -uantity of money and its *alue, in the context of a mixed monetary re)ime with con*ertibility of notes into specie. ection > focuses on the chan)es introduced by the Ingot plan, where con*ertibility is in bullion. understandin) of it )i*en by 'ollander !"#$#&. 1. The relation et!een the "#antit$ an% the &al#e o' (one$ This relation is ob*iously central to ,icardo8s theory of money throu)hout his works, and constitutes what may be called the orthodox component of this theory. The role of the standard in the stabiliHation of the *alue of money is here deri*ed from this relation 3 The only use of a standard is to re)ulate the -uantity, and by the -uantity the *alue of the currency
/J0 without a standard it would be exposed to all the fluctuations to which the i)norance or the interests of the issuers mi)ht subIect it

ection 4 examines the role of the

international adIustment process followin) a premium on bullion, on the basis of the

>.

Then the -uestion arises of why the re)ulation of the -uantity of money is necessary to re)ulate its *alue. The answer is pro*ided in the first pa)es of chapter >$ of On the Principles of Political Economy and Taxation ! Kn Eurrency and 5anks &. If the monetary standard is )old, it has, like e*ery commodity produced in competiti*e conditions, a market price re)ulated by its natural price, itself determined by the difficulty of its production. This price !au)mented of the sei)nora)e if there exists one& determines the *alue of circulatin) coins accordin) to the -uantity of pure metal which they contain. In a mixed re)ime where both specie and bank notes circulate, the stability of the *alue of money re-uires that the current *alue of notes e-uals the *alue of the coins of same denomination. In other words, a L " note should not be depreciated in circulation as compared with the L " coin. If it is, this depreciation manifests itself by a rise in the market price of bullion !purchased with notes& abo*e the le)al *alue of the same wei)ht of )old in coins. 5ut there appears a difficulty. In contrast with the )old coin, the note has no intrinsic *alue , since its face *alue bears no relation with the difficulty of production of the paper. Its *alue only results from the confrontation between the -uantity of notes issued and the needs of the circulation for it 3 There is no point more important in issuin) paper money, than to be fully impressed with the effects
which follow from the principle of limitation of -uantity
> 4

4.

Proposals for an Economical and Secure Currency, in Wor s, IG 3 1#. Principles, in Wor s, I 3 414.

4 The needs of circulation bein) )i*en by the a))re)ate le*el of transactions implemented with notes, the only way to ensure monetary stability is to re)ulate the -uantity of notes issued so that their *alue remains e-ual to that of the coin. This analysis may be summariHed in the followin) way. ?et x G be the -uantity !measured in ounces& of fine )old contained in a newly issued L " coin M < E the le)al price !measured in L& of an ounce of coined )old M <G the market price !measured in L& of an ounce of )old bullion payed in notes, G E and GE the le)al and current *alue of the L " coin, G 5 the current *alue of the L " note !if depri*ed of le)al tender, the note has only a current *alue&. Gold bein) the monetary standard, these *alues are measured in )old wei)ht !ounces&. 5y definition 3 !"& !>&
G E N xG

< E N " O xG

These e-uations simply state that the L is le)ally defined by the wei)ht of fine )old contained in the L" coin. The current *alue of a coin is the )old wei)ht which it really contains. If all the circulatin) coins ha*e the le)al wei)ht, GE N G E N xG . The note bein) depri*ed of intrinsic *alue, its current *alue is indirectly measured by its purchasin) power in the market of the monetary standard, i.e. )old. Ps a conse-uence 3 !4& G5 N " O <G The e-uilibrium condition of a mixed monetary re)ime where coins and notes circulate side by side, i.e. the e-uality between the current *alues of notes and coins, reads 3 !2& !1& !;& G5 N G E N xG xG <G N " <G N < E This means !e-uation !1&& that the )old wei)ht contained in the coin is paid for in notes in the bullion market at a price of L ", or !e-uation !;&& that the market price of an ounce of )old in bullion paid for in notes is e-ual to the le)al price of an ounce of coined )old. :*ery rise in the market price of bullion o*er the mint price !then L 4."$."(."O>& is then a proof of the depreciation of the note in respect to the coin. The problem is now to determine G5. Kne may define the circulation period as the time durin) which e*ery note is used once to make a payment. If Q i is the -uantity of i !with i

.rom e-uations !4& and !2& it results that 3 This condition may also been written, followin) !>& 3

2 from " to n& exchan)ed for notes durin) this period, and <i its money price !measured in L&, the a))re)ate )old6*alue of the transactions durin) the period is e-ual to

Q < G
i i iN"

iNn

. This

*alue is necessarily e-ual to the )old6*alue Q5 G5 of the -uantity Q5 of notes in circulation, so that 3 !$& G5 N !" O Q5&
iNn iN"

Q < G
i i

The -uantities Qi and the )old6prices <i G E bein) )i*en, the current *alue of the note depends on its -uantity. Then the workin) of a mixed monetary re)ime re-uires the re)ulation of the issuin) of notes, which )uarantees the e-ualiHation of the current *alue of the paper to the le)al *alue of the coin of same denomination. It should be obser*ed that no e-uation re-uires the con*ertibility of notes into coins. This is stressed by ,icardo3 Kn these principles, it will be seen that it is not necessary that paper money should be payable in
specie to secure its *alue M it is only necessary that its -uantity should be re)ulated accordin) to the *alue of the metal which is declared to be the standard

2 .

Kne should now in-uire what ad*anta)es may be deri*ed from a re)ime with con*ertibility into bullion. This is the purpose of the Ingot plan. ). The Ingot plan The idea of the con*ertibility of notes a)ainst bullion was exposed for the first time by ,icardo in the !ppendix !"%""& to the fourth edition of his pamphlet The "igh Price of #ullion$ ! Proof of the %epreciation of #an &otes !first edition 3 "%"(&. The benefits to the public of this idea, ,icardo contended, was that the same security a)ainst the depreciation of the currency can be obtained by more )entle means than throu)h con*ertibility into specie !in Wor s, III 3 ">2&. This idea was recast and expanded in ,icardo8s Proposals for an Economical and Secure Currency !"%";&, and defended by him in "%"# durin) the depositions before the Eommittees of the 'ouses of Eommons and of ?ords on the ,esumption of Eash <ayments. The Ingot plan R as it is called in the literature 6 was considered by ,icardo as a permanent monetary re)ime, desi)ned to substitute for the post6"$#$ incon*ertibility and the pre6"$#$ con*ertibility ones, and not !as it would be e*entually adopted by <arliament in
2

Ibid 3 412.

1 "%"#& as a temporary arran)ement, desi)ned to facilitate the resumption of cash payments. Ps exposed in "%";, this plan exhibits two main principles 3 a& the -uantity of banknotes issued should be re)ulated accordin) to the obser*ed market price of bullion, instead of bein) let to the discretion of the 5ank, as before. This constitutes a Iudicious mana)ement of the -uantity of paper money !in Wor s, IG 3 1$&. 'ence I shall call this aspect of the plan the management principle. b& the banknotes should be con*ertible in bullion, instead of specie as before "$#$. This I shall call the ingot principle. The orthodox tradition has put a )reat emphasis on the first principle, which is consistent with the repeated warnin) by ,icardo a)ainst the e*ils of an excess of paper . 5ut there is no doubt that, for ,icardo, the uniformity in the *alue of money !i.e. its stability throu)h time at the official le*el& does not only come from this principle, but also from the second one. In other words, in the title of the pamphlet ! Proposals for an Economical and Secure Currency&, the security does not come only from the first principle, the economy bein) left to the second one !in the mithian tradition&. The con*ertibility in bullion is supposed to brin) more stability to the *alue of money, whate*er the principle adopted to re)ulate the issue of paper. This obser*ation is based on the )reat emphasis put by ,icardo on the relationship between his proposed system for the 5ank of :n)land and the banks of Pmsterdam and 'ambur), which he praises for their security 3 The plan here proposed appears to me to unite all the ad*anta)es of e*ery system of bankin) which
has been hitherto adopted in :urope. It is in some fearures similar to the banks of deposit of Pmsterdam and 'ambur)h. In those establishments bullion is always to be purchased from the 5ank at a fixed in*ariable price. The same thin) is proposed for the 5ank of :n)land /J0. The currency could neither be clipped nor deteriorated, and would possess a *alue as in*ariable as )old itself, the )reat obIect which the Dutch had in *iew, and which they most successfully accomplished by a system *ery like that which is here recommended

!!ppendix to The "igh Price of #ullion, "%"", in Wor s, III 3 ">;6$&1. This opinion is also to be found in the &otes on #entham's ( Sur les Prix ) !"%"(6"& 3 The 5ank of :n)land is certainly not *uite so secure as a bank of deposit such as Pmsterdam and
'ambur)h /J0. In 'olland and 'ambur)h the ad*anta)es of the 5anks is "S in the use of paper instead of

This relationship between ,icardo8s plan and the 5ank of 'ambur)h is also aknowled)ed by the banker

Plexander 5arin) in his deposition before the Eommittee of the 'ouse of Eommons on Barch "" and ">, "%"# 3 The plan in -uestion is, in fact, no other than that of the bank of 'ambur)h, only substitutin) a currency of paper in lieu of a transfer of book debt M and the bank of 'ambur)h has always been found, from lon) experience, the best institution for preser*in) the standard of *alue M the payments of the bank of 'ambur)h are solely in sil*er bullion !in Wor s, G 3 41%&.

;
metals which has been admirably described by the author /5entham0, and >S in ha*in) a uniform measure of *alue subIect to no debasement or deterioration

!in Wor s, III 3 >%%&.

The 5ank of :n)land has one ad*anta)e o*er the other two 3 she is infinitely more useful in makin) the whole capital of the country a*ailable !ibid&, because notes may be issued by discountin) commercial paper, while in Pmsterdam and 'ambur)h they can only be obtained a)ainst precious metals, so that /the banks0 ha*e actually in their coffers, as much bullion, as there are credits for bank money in their books M accordin)ly there is an inacti*e capital as )reat as the whole amount of the commercial circulation !!ppendix 3 ">;&. 5ut this ad*anta)e has a counterpart 3 notes may be issued in excess ;, hence the necessity to re)ulate their issue. +e*ertheless the Pmsterdam and 'ambur)h system embodies in itself a principle of security which, accordin) to ,icardo, may be borrowed throu)h the con*ertibility of notes in bullion. 'ow may the second principle contribute to the uniformity in the *alue of money more than con*ertibility into specie T This -uestion may be di*ided in two 3 a& how may it reduce the risks for the market price of bullion to depart from the official price of the metal chosen as standard T b& how may it impro*e the adIustment process allowin) the market price of bullion to return to its official price when it departs from it T The answer to -uestion a& lies in the understandin) of the fact that what is at stake in the adoption of the Ingot plan as a permanent re)ime is the demonetisation of gold in the domestic circulation. ,icardo is not ad*ocatin) a mixed re)ime of coins and paper con*ertible in bullion, but a pure re)ime of con*ertible paper . =nder such a re)ime, the issuin) of currency would no lon)er be shared by the Bint and the 5ank, but would be performed by the 5ank alone. There would still be a metallic standard, but it would no lon)er circulate domestically. Kf course, this did not mean immediately neither decryin) the coins remainin) in circulation, nor abolishin) the mintin) of specie. 5ut it was clear for ,icardo that, if the 5ank stopped contributin) to the circulation of specie, because she would stop pro*idin) it in exchan)e for notes, and if, on the contrary, she absorbed pro)ressi*ely the coins in circulation, by bein) compelled to purchase )old at a price hi)h enou)h to compensate for the loss of interest durin) the fabrication of the coins at the Bint, the circulation of specie would

,icardo obser*es that in one occasion the 5ank of 'ambur)h was obli)ed to suspend its payments in

conse-uence of ha*in) made too )reat ad*ances on )old bullion . This occured in "$;;6$. Ef. +eply to #osan*uet, in Wor s, III 3 "$16; n.

$ pro)ressi*ely *anish and a pure re)ime of con*ertible notes would smoothly be implemented$. The model abo*e must be modified in order to encompass such a re)ime. The definition of the unit of account, the L, is no lon)er stated by a wei)ht of )old coined in the one6pound coin, but in a wei)ht of uncoined )old !yG&. In other words, the official price !maintained at L 4."$."(."O>& does no lon)er refer to an ounce of )old coined in )uineas, but to an ounce of bullion, kept in the *aults of the 5ank of :n)land in the form of in)ots. If one calls G? the le)al *alue !measured in fraction of an ounce& of the L in bullion, and < ? the le)al price !measured in L& of an ounce of )old in bullion, by definition 3 !%& !#& !4& !"(& !""& or 3 !">& <G N < ? This means !e-uation !""&& that the wei)ht of )old le)ally definin) the L is paid in notes in the market at the price of L ", or !e-uation !">& that the le)al and market prices of an ounce of bullion are e-ual. In the -uantity relation !$&, the deri*ation of the )old6*alue of commodity i from its money price <i is no lon)er made with the *alue of the pound G E but
G? . This e-uation becomes 3
G? N yG

< ? N " O yG :-uation !4& )i*in) the current *alue of the note is unchan)ed 3 G5 N " O <G :-uation !2& which )i*es the e-uilibrium condition of the monetary re)ime becomes 3 G5 N G? N yG Thanks to e-uation !4&, this condition may be rewritten 3 yG <G N "

!"4&

G5 N !" O Q5&

Q < G
i= " i i

i =n

The management principle of Q5 is supposed to allow the stabiliHation of G 5 , hence the fulfilment of the e-uilibrium condition !">&. 5ut another way exists to stabiliHe directly <G 3 it is the arbitrage made by the buyers and sellers of bullion between the market and the 5ank. This stabiliHation of the market price for bullion re-uires that the 5ank could pro*ide
$

This explains the *ariations of his position between "%"", "%";, and "%"# on some technicalities of his plan,

such as the choice offered or not to the 5ank to pay in bullion or specie, and the responsibility )i*en to the Bint or the 5ank to stamp the in)ots. Ef. the introduction to the debates of "%"# in Wor s, G 3 41(6$(.

% all the bullion demanded for her notes at the le)al price < ? , an that she should be compelled to purchase all the bullion offered for her notes at a fixed price < ? 8, called #an buying price. < ? 8 will be fixed below < ? , and as close to < ? as may seem desirable 3 !"2& < ? 8 N < ? !" R b& with b ( If the two abo*e conditions are fulfilled, one )ets 3 !"1& < ? <G < ? !" R b&

which means that the mar)in of *ariation of < G R hence of G5 R is reduced to b. Then the purpose of the Ingot plan is 3 to pre*ent the *alue of money from *aryin) from the *alue of bullion more than the triflin) difference
between the prices at which the bank should buy and sell, and which would be an approximation to that uniformity in its *alue which is aknowled)ed to be so desirable

!in Wor s, IG 3 ;$&.

+ow two complementary answers may be offered to -uestion a&. .irstly, as obser*ed by ,icardo in the abo*e -uotation from the &otes on #entham, the elimination of the circulation of the standard would pro*ide the same ad*anta)e as in Pmsterdam or 'ambur), of ha*in) a uniform measure of *alue subIect to no debasement or deterioration . Ps is well known, this problem had been for lon) central to the debates on the defects of precious metals in performin) the function of standard of money %. The proposed plan allowed to suppress these defects without ha*in) to renounce the existence of a metallic standard. econdly, in a re)ime of con*ertibility into specie, two reasons may lead holders of notes to demand the con*ersion of their notes 3 the belief that they will be unable to retain the same purchasin) power as coins in domestic circulation, and the desire to obtain )old to hoard or export it. Ps, accordin) to ,icardo, no re)ime may protect a)ainst a panic resultin) in hoardin), one should concentrate on circulation and export only. In the first case, coined metal is looked for, because of its supposed better -uality as means of circulation M this leads to an internal drain of 5ank reser*es. In the second case, uncoined metal is looked for, and specie is only demanded to be melted and exported as bullion M this leads to an external drain of 5ank reser*es. +ow, with the Ingot plan, the internal drain disappears, since the abolition of specie eliminates any possible demand for con*ertibility aimed at replacin) the notes in domestic circulation. The domestic circulation !of notes& and the international circulation !of bullion& are separated, the only link bein) the con*ertibility of notes into bullion. Kf course, a drain of 5ank reser*es may still occure, but it may only be external. This ad*anta)e has been clearly
%

.or example, see teuart !"$;$&.

# seen by 9eynes, who attributes to ,icardo the paternity of the ,old Exchange Standard #. This aspect may be linked to the attribution by 9eynes to ,icardo of another paternity 3 that of mana)ed money !cf. the abo*e -uotation from ! Treatise on Money, "#4(&. In a monetary re)ime with a non6circulatin) standard, the mana)ement of the currency !first principle of the Ingot plan& allows to maintain the obIecti*e character of the standard, i.e. to make money conform to it. 'ence the link between the two disco*eries of ,icardo. 9eynes only pushes the ar)ument a little further 3 if, althou)h obIecti*e, the standard does not circulate, it may be anything. If it is )old, i.e. the internationally accepted means of payment, the mana)ement of money aims at the external stability of the *alue of money. If it is a basket of )oods si)nificant for domestic purposes, whate*er it is, it will aim at the internal stability of the *alue of money, which, in 9eynesUs *iew, is preferable"(. ?et us now turn to -uestion b& of the adIustment process. Vhat happens if the market price for bullion departs from its official price T If it is from below, an arbitra)e occurs when <G falls to the #an buying price < ? 8 3 holders of bullion will prefer to sell it to the 5ank than in the market. The 5ank simply replaces the Bint in the function of absorbin) the under*alued )old, until the market price of bullion returns to its official le*el. Durin) this process, the -uantity of notes increases, but it is not necessary to assume that this increase is the cause of a decline in their current *alue G 5, hence of the increase in the market price of bullion <G . The adIustment is simply the conse-uence of arbitra)e between the market for bullion and the 5ank. Kne should obser*e that the new obli)ation imposed to the 5ank to purchase bullion at a fixed price !a)ain in imitation of 'ambur)& is not an additional principleM it is contained in the ingot principle. In a pure metallic monetary re)ime, the standard is the only commodity which may be sold !at the Bint, with the cost of the sei)nora)e& and purchased !in circulation, with the cost of meltin) and possibly of fraud& at a fixed -administered. price. In a mixed re)ime with notes con*ertible into specie, it is also possible to purchase it at the same fixed price. In a pure re)ime of notes con*ertible in bullion, the standard mi)ht still be purchased at a fixed price, but not sold. Then no limit would exist to the decline in the market price of bullion. The obli)ation imposed to the 5ank
#

In Indian Currency and /inance !"#"4&, 9eynes mentions this paternity in a discussion of the Indian system of It follows that if the market price for )old in ,icardo is interpreted as a proxy for a )eneral price index, the link

currency. Ef. Collected Writings, I 3 >>, 1" M DG 3 $(.

"(

between ,icardo and 9eynes of the Treatise becomes still closer. The only difference remains as whether the stability of this index should be pursued for internal or external reasons. 5ut if, as did 9eynes in his Tract on Monetary +eform !"#>4&, ,icardo is also considered as the father of the <urchasin) <ower <arity theorem, both *iews are reconciled in a strictly orthodox fashion.

"( to purchase it at a fixed price is nothin) else than the way to ensure that the standard keeps the same specificity in re)ard to other commodities as in a re)ime with specie. The conse-uence of this obli)ation is for the 5ank a reduction of her profits in such circumstances, since she is forced to issue notes a)ainst bullion, which pro*ides no re*enue, instead of discountin) commercial paper, which pro*ides one. 5ut this loss is compensated by the cost she e*ades in the opposite case of a demand for con*ersion of notes, as compared with con*ertibility in specie, since she does not ha*e to bear the loss of interest durin) the time of fabrication of the coins at the Bint. Vhat now happens precisely in that case, i.e. when the market price < G increases abo*e its official price < ? T It seems that the only adIustment process will rely on the first principle of the Ingot plan, i.e. the re)ulation of the -uantity. 5ut, if it is so, there exists no ad*anta)e of the con*ertibility in bullion instead of specie 3 the mana)ement of the currency may be performed in the same way !i.e. accordin) to the market price of bullion, which induces here a limitation of the emission& in both re)imes. It cannot e*en be said that it would be performed at a lower cost for the 5ank or society. Kn the contrary, the le*el of the market price of bullion which starts the demand for con*ersion is now lower than in the old con*ertibility re)ime !because there is no lon)er any cost of meltin) and fraud&, and this mi)ht be *iewed as increasin) the *olatility of 5ank reser*es, hence as an ar)ument against the con*ertibility in bullion. This ar)ument may be compensated by another one 3 the demonetisation of )old in circulation structurally increases 5ank reser*es, because holders of coins sell them to the 5ank when the increased supply of metal dri*es down its market price to the 5ank buyin) price. Kf course, the -uantity of circulatin) notes increases in proportion, but we ha*e seen that it is not the case of the potential demand for con*ertibility 3 the holders of notes for domestic circulation are not a source of drain. 5ank reser*es then increase while the risk of con*ersion does not. Then the superiority of the con*ertibility in bullion, as far as the adIustment process in case of depreciation of the currency is concerned, is not clear6cut, and one should look for the possibility of another adIustment process than the re)ulation of the -uantity of notes . The international one seems to be a )ood candidate, since we ha*e seen that one characteristic of a pure re)ime of notes con*ertible in bullion is to limit the role of the standard as means of payment to external transactions only . *. The international a%+#,t(ent -ro.e,, in .a,e o' a -re(i#( on #llion

"" Ps is well known, a recurrent idea in ,icardo8s pamphlets durin) the 5ullion contro*ersy is that, when a redundancy of money pushes the market price of bullion abo*e its mint price R thus indicatin) a depreciation of the currency R the excess is exported and this restores the *alue of the currency, brin)in) back the price of bullion to its official le*el. Then, in case of a premium on bullion, for whate0er reason, its export should be considered as an adIustment process alternati*e to the limitation of the emission"". In his celebrated book The Economics of %a0id +icardo !"#$#&, amuel 'ollander has attracted the attention on the lo)ical conditions of such an international adIustment process and offered an illuminatin) interpretation of ,icardo8s position in the 5ullion debate ">. 'e first studies the important case, from the empirical perspecti*e, of a mixed circulation comprising incon0ertible paper as well as coin, the clearest account of which was first )i*en in the +eply to #osan*uet !'ollander, "#$# 3 24$ M '8s italics&. In short, the process )oes as follows. P money supply increase !for example throu)h an additional emission of notes& abo*e its e-uilibrium le*el leads to a depreciation of the currency, which manifests itself by increased money prices of commodities, includin) )old bullion. The premium on bullion o*er the mint price offers a possibility of profit for holders of coins ready to melt them !e*en fraudulously& and supply the metal in the market for bullion. This has two conse-uences 3 the reduction in the -uantity of currency increases the *alue of money and thus reduces the money prices of all commodities M but the increased supply of bullion dri*es down its money price more than them, so that the relati0e price of bullion in terms of commodities falls. If the initial situation was an e-uality between the purchasin) powers of bullion o*er commodities in the country and abroad, this fall leads to an export of bullion and a correspondin) import of )oods. The conclusion is rather impressi*e 3 The import of the discussion is that a correcti*e process is at work e0en in the incon0ertible case
pro*ided that coin constitutes part of the initial circulation

!ibid 3 24%6#&,

which was the situation of :n)land in "$##6"%(> but no lon)er in "%(#6"(. Pt the time of ,icardo8s in*ol*ement in the 5ullion contro*ersy, then, no correcti*e process of this kind still existed. I shall not discuss here this model for the case analyHed, but ask whether it applies to the two con*ertible re)imes under consideration, and, if so, which difference appears between
""

Kne should obser*e that I consider here the international adIustment process in response to a premium on

bullion, and not to a decline in the exchan)e rate, which is a different -uestion and does not really concern ,icardo.
">

ee 'ollander !"#$#& 3 24162>.

"> them. 'ollander mentions two cases of con*ertibility. The first one is a mixed currency of coin and notes, con*ertible into specie on demand, and freedom of metallic exportation !ibid 3 24# M '8s italics& R i.e. the pre6"$#$ re)ime, amended for freedom of meltin) and export R M a)ain the coins dri*en out of circulation are melted, the supply of metal is increased and export takes place when its relati*e price in terms of )oods has declined. The second one is the case where -con0ertible. notes alone circulate !ibid 3 22( M '8s italics&, with also con*ertibility in specie. This latter case, for which no reference to ,icardo is )i*en, is rather stran)e, because it is unclear why con*ertibility would be in specie if coins are depri*ed of le)al tender. Kne may understand it as a *ariation on the Ingot plan !to which 'ollander does not refer&, the important point bein) that bullion obtained directly from the 5ank or throu)h the meltin) of non6circulatin) coins is supplied in the market, which dri*es its relati*e price down, leadin) to its export. The conclusion of 'ollander is clear 3 Ps far as concerns the mechanism of bullion mo*ement, the two cases of con0ertibility are
analytically identical with the incon0ertible case where a mixed currency circulates , for in this case too an addition to the note issue will )enerate correcti*e outflows

!ibid 3 22(, '8s italics&.

This )eneraliHation does not seem to me to be acceptable. There is an ob*ious difference between the incon*ertibility case and the con*ertibility ones 3 if a)ents may obtain )old !in whate*er form& from the 5ank at a fixed price and without limit, they will not dri*e it out of circulation, either because coins are banished from it !re)ime with exclusi*e circulation of notes& or because there is a cost to )ather them !mixed re)ime&. 5ecause the 5ank is then the sole source of )old supply, con*ertibility of notes introduces a special effect, which pre0ents the money price of bullion from fallin) as a conse-uence of an increased supply, hence pre0ents the correcti*e process to be set into motion. This effect is mentioned by ,icardo in The "igh Price of #ullion in the case of con*ertibility of notes into specie 3 If to supply the deficiency of their /the 5ank0 stock of )old they were to purchase )old bullion at the
ad*anced price, and ha*e it coined into )uineas, this would not remedy the e*il, )uineas would still be demanded, but instead of bein) exported would be melted and sold to the 5ank as bullion at the ad*anced price

!in Wor s, III 3 1%&. ,icardo mentions on this point Pdam mith for an analo)ous case , which concerns

the Bint and not the 5ank, althou)h ,icardo replaces one by the other in his -uotation 3 7The operations of the 5ank,8 obser*ed Dr. mith, alludin) to an analo)ous case, 7were upon this
account somewhat like the web of <enelope, the work that was done in the day was undone in the ni)ht8

!ibid&. 'e also mentions Thornton !"%(>& and concludes 3

"4 The 5ank would be obli)ed therefore ultimately to adopt the only remedy in their power to put a stop
to the demand for )uineas. They would withdraw part of their notes from circulation, till they should ha*e increased the *alue of the remainder to that of )old bullion

!ibid 3 1#&.

This <enelope effect comes from the fact that, rather than exportin) bullion, their holders prefer to sell it back to the 5ank who has to demand it to replenish her reser*es M the profit is hi)her than in the export, because no transportation cost has to be incurred. In 'ollander8s terms, bullion is not exported, since its relati*e price in terms of commodities does not fall M and it is so because the depressi*e effect on the money price of bullion of an additional supply is always counteracted by an increased demand for bullion from the 5ank. Kn the contrary, in the mixed re)ime with coins and incon*ertible notes, one is sure that the increased supply of bullion dri*es down its market price , since there is no demand for it ori)inatin) anywhere else in the economy, until a demand for export appears, i.e. precisely until, accordin) to 'ollander, the market price for bullion has enou)h declined so as to depress its relati0e price in terms of )oods by a mar)in allowin) its export to become profitable. It seems to me, then, that the international adIustment process described by 'ollander cannot apply to a monetary re)ime with con*ertibility of notes. It is discarded by ,icardo himself in the case of con*ertibility in specie. 5ut the same line of ar)ument applies to the Ingot plan re)ime with con*ertibility in bullion 3 the <enelope effect is set into motion e*en -uicker and with a lar)er profit, since no meltin) cost is incurred. If this international adIustment process throu)h exports of bullion does not work in the Ingot plan !no less but no more than with con*ertibility in specie&, does it mean that the only possibility of adIustment must come from the internal mana)ement principle of notes T I do not think so, because of another conse-uence of the Ingot plan, which, as far as I know, has been o*erlooked by the literature. If the monetary re)ime is depri*ed of a mint and of a circulation of specie, i.e. of possibilities of arbitra)e with the market for the sale and the purchase of the metal, and if the 5ank purchases and sells bullion at fixed prices as close as would appear desirable, this means that the 5ank of :n)land becomes the re)ulator of the ?ondon market for )old, i.e., in the circumstances of the time, the central piece of the world market for )old."4.
"4

Kne of the two maIor bullion brokers in ?ondon at the time, +.B. ,othschild, seems to ha*e understood the

dan)er, since he stron)ly opposes ,icardo8s plan in his deposition before the Eommons8 Eommittee on % Barch "%"#. The reasons in*oked are the conse-uences for the 5ank of a panic in case of war, and the possibility to dis)uise sil*er bars as )old bars !cf. Wor s, G 3 41$&. Kne may think that these dan)ers, in ,othschild8s *iew, could be a*oided thanks to the expertise of a competent bullion brokerJ

"2 +ow let us )o back to the initial situation considered. P premium on bullion, whate*er its cause, means that, when this premium exceeds the cost of transportation of bullion, there is an inducement to import it, because, at the rulin) exchan)e rate, the price in L of bullion in ?ondon !after deduction of transportation cost& is hi)her than abroad. +ote that, if this premium on )old is 1ust enou)h to start imports of that commodity !allowin) for the profit re-uired in this business&, and e*en if the money price of the commodities increases in ?ondon by the same proportion !which means that this )eneral price increase has a monetary ori)in&, this will not start imports of them from abroad, because di*er)ence between domestic and forei)n prices must be higher for commodities than it is for )old, which is, accordin) to ,icardo !"%"( 3 ;4&, the cheapest exportable commodity . Then the transitory situation is characteriHed by an addition to the supply of )old in the ?ondon market, which may actually correct its market price downwards. This adIustment process is independent of any type of con*ertibility 3 it is simply the conse-uence of arbitra)e between the bill of exchan)e markets and the )old markets in ?ondon and abroad. 5ut, when the ?ondon market is centered on the 5ank !i.e. in the case of the Ingot plan&, this import of bullion by international arbitra)e allows the 5ank to resist the pressure put upon her by the demands for con*ersion of her notes, and constitutes an obstacle to the <enelope effect because the 5ank may postpone her purchase of )old in the market . Kf course, this international adIustment process only works if the premium o*er )old is )reat enou)h to induce )old imports, but small enou)h !when it is accompanied by a similar increase in commodity prices& not to induce imports of )oods. If it is lar)er, other imports will occur, some of them by 5ritish importers preferin) to buy cheaper abroad than at home. I said abo*e that the standard is the only commodity which may be purchased domestically at a fixed price. This means that any pri*ate a)ent, e*en if he does not want to enrich himself throu)h the <enelope effect but needs )old for industrial purpose, may escape at home !i.e. without ha*in) to import it& the conse-uence of an increased market price of it. .or all other commodities, this is not true 3 the only way is thou)h import. The conse-uence will be an increased demand of bills of exchan)e denominated in forei)n currencies, i.e. a decline in the exchange rate. Vhen this decline is )reat enou)h to make export of bullion profitable, a re*ersal of international bullion flows occurs, which puts an external drain on the 5ank "2.
"2

This explanation of the export of bullion, based on direct international comparisons of money prices !throu)h

the exchan)e rate&, may be prefered to the model offered by 'ollander, based on international comparisons of relati*e prices, e*en in ,icardo8s perspecti*e. Kne should obser*e that, accordin) to this explanation, imports of )oods occur before the export of bullion R and not as a conse-uence of it R and that this export is not the

"1 .rom now on, the orthodox ,icardo may come a)ain 3 there is no other way, in +icardo's perspecti0e, than a limitation of the note issue"1. The management principle of the Ingot plan comes a)ain into force, and the ingot principle has no lon)er any ad*anta)e abo*e the old6 fashioned con*ertibility in specie. +e*ertheless, e*en in ,icardo8s perspecti*e, the con*ertibility of notes in bullion is a better re)ime for a fine tuning of the *alue of money. In other words, the general property of a monetary standard is to stabiliHe the *alue of money, but the particular property of a non6 circulatin) monetary standard !in the Ingot plan, a )old exchan)e standard& is twofold 3 apart from una*oidable situations of panic, it reduces the risk of drain on the reser*es of the 5ank to the external one, and, in circumstances of small *ariations in the money price of the standard !for whate*er cause&, it allows an automatic stabiliHation of the *alue of money. Kne should obser*e that both ad*anta)es are independent of any relation between the -uantity of money and its *alue. In the abo*e model, ine-ualities !"1& are ensured independently of e-uation !"4& 6 i.e. of the mana)ement principle 6 throu)h arbitra)e between the bullion market and the 5ank 3 when < G falls to < ? 8, the supply of bullion in its market stops, which pre*ents <G from fallin) more, and when <G increases abo*e < ? , the supply of bullion in its market increases throu)h import, and <G is dri*en back to it. +ot only the ingot principle is independent of the management principle, but it )uarantees by itself the stability of the currency in normal conditions, makin) redundant the re)ulation of the -uantity of paper, except in situations of open crisis. In short, the Ingot plan does not assume any e*uilibrium *uantity of money, which would determine its e*uilibrium 0alue. There exists a legal *alue of money, the reciprocal of the le)al price of bullion, and a current *alue of money, the reciprocal of the market price of bullion. If, thanks to the con*ertibility in bullion, the market price of bullion is stabiliHed as desirably as it may seem at the le*el of its le)al price, the current *alue of money will be stabiliHed at the le*el of its le)al *alue as well. Then the stabiliHation of the *alue of money does not rely on the re)ulation of its -uantity. It is the *ariation of the -uantity of )old in its market which stabiliHes its price, hence the 0alue of money, and not the *ariation of the -uantity of money in circulation which stabiliHes its *alue, hence the mar et price of gold.
conse-uence of a fall in the relati*e price of )old in terms of commodities, but results from a decline in the exchan)e rate.
"1

In another perspecti*e, illustrated by the line of reasonin) Thornton6Tooke6Goschen, there exists another way

of escape 3 an increase in the discount rate, which attracts short6term capital and restores the exchan)e, in such a way that )old may flow in a)ain.

"; This interpretation pictures ,icardo on money in a rather unusual way, but makes sense of his opposition to the con*ertibility in specie and of his fierce defence of the ingot principle, which would be i)nored by monetary orthodoxy durin) more than a century after his death ";. There lies, it seems to me, the heterodox component in ,icardo8s theory of money .

REFERENCES

5lau), B. !"##1&, Vhy is the -uantity theory of money the oldest sur*i*in) theory in economics T , in B. 5lau) and alii, The 2uantity Theory of Money3 /rom 4oc e to 5eynes and /riedman, Pldershot 3 :dward :l)ar 3 >$62#. Deleplace, G. !"##;& Does Eirculation +eed a Bonetary tandard T , in G. Deleplace and :.F. +ell !eds.& Money in Motion3 The Post 5eynesian and Circulation !pproaches , ?ondon 3 Bacmillan 3 4(16>#. 'ollander, . !"#$#& The Economics of %a0id +icardo, ?ondon 3 'einemann. 6666666666666666 !"#%(& Kn <rofessor amuelson8s Eanonical Bodel of <olitical :conomy , 6ournal of Economic 4iterature, "%, Fune 3 11#6$2. 9eynes, F.B. !"#4(& ! Treatise on Money3 The Pure Theory of Money, in 9eynes !"#$"6%#&, *ol. G. 6666666666666666 !"#$"6%#& Collected Writings, ?ondon 3 Bacmillan, *olumes I to DDD. ?aidler, D. !"#%$&, 5ullionist Eontro*ersy , in F. :atwell, B. Bil)ate, and <. +ewman !eds.& The &ew Palgra0e3 ! %ictionary of Economics , ?ondon 3 Bacmillan, *ol. I 3 >%#6 #2. BarcuHHo, B.E., ,osselli, P. !"##"& +icardo and the ,old Standard3 The /oundations of the International Monetary Order, ?ondon 3 Bacmillan. ,icardo, D. !"#1"6$4& Wor s and Correspondence, ed. by <. raffa with the collaboration of B. Dobb, Eambrid)e 3 Eambrid)e =ni*ersity <ress, *olumes I to DI. amuelson, <.P. !"#$%& The Eanonical Elassical Bodel of <olitical :conomy , 6ournal of Economic 4iterature, ";, December 3 "2"1642.
";

=ntil the Gold tandard Pct of "#>1. uch an interpretation also leads to depri*e ,icardo of any paternity in

the 5ank Eharter Pct of "%22, which imposed a -uantity rationin) of note issue throu)h a "((W backin) of its increase by additional metallic reser*es of the 5ank, and -uestions the analytical continuity between ,icardo and the Currency School.

"$ chumpeter, F.P. !"#12& "istory of Economic !nalysis, +ew Xork 3 Kxford =ni*ersity <ress. teuart, F !"$;$& !n In*uiry into the Principles of Political Economy , +ew Xork 3 P.B. 9elley, "#;$. Thornton, '. !"%(>& !n En*uiry into the &ature and Effects of the Paper Credit of ,reat #ritain, +ew Xork 3 P.B. 9elley, "##".