Gerard Jackson
22 August 2022

In my previous article  I stressed that Steve Kates (honorary adjunct associate professor in the College of Business at RMIT University in Melbourne)  has erred badly in claiming that there is a classical theory of the trade cycle and that it emerged from the general glut debates of the 1820s. I clearly showed that the first theory of what the much neglected James Pennington aptly called “alternate periods of commercial excitement and depressions”1 was formulated by Henry Thornton and published in 1802 and soon after was adopted by Ricardo2 and the currency school. Moreover, the theory had its roots in eighteenth century financial crises, which reveals that the origins of the trade cycle are not to be found in the Industrial Revolution but in the banking system3. It appears clear from his constant references to John Stuart Mill with respect to recessions that Steve Kates thinks of him as the classical school’s leading exponent of what he erroneously belies is the classical theory of the trade cycle.

It was the severe financial crisis of 1825-1826 that first drew Mill’s attention to the problem. In his essay Paper Currency and Commercial Distress4 he gave what was in essence a psychological explanation for these crises and one which coincided with Thomas Tooke’s own emerging theory the appearance of which I think can be discerned in his book Considerations on the State of the Currency5 and which later became a crucial part of the banking school that Tooke founded in about 1840.

Mill the ‘Ricardian’ fell under Tooke’s influence to the extent of rejecting the sound business cycle theory that Ricardo had supported and instead became a leading member of the banking school, giving it even greater credibility, a credibility it did not deserve. One could attribute Mill’s actions to his adherence to the reflux theory that his father ardently believed in and which was in accord with Tooke and John Fullarton’s fallacious argument  that “bank notes are only lent, and are returnable to the issuers”6 and therefore cannot add to the money supply. (This dangerous theory was based on Adam Smith’s reflux fallacy7.)

In additions to adopting Smith’s theory of the note issue Fullarton also developed the equally dangerous theory of gold hoards according to which gold drains could have no effect on prices because they would be met out of hoards and would therefore have no effect on the money supply8. To support his argument he asserted that the £20,000,000 France paid in reparations to the allies within a period of “27 months” must have come out of French hoards9. However, Colonel Torrens pointed out that the reparations were  paid from a loan London firm “and that the subscribers to the loan were for the most part British capitalists” with the French government paying them interest10. Unfortunately, Fullarton’s theories gained considerable support on the Continent, particularly in Germany.

Banking school advocates had no interest in taking prisoners. For them it was total war. Tooke launched a frontal assault at the currency school with his An inquiry into the Currency Principle11, Fullarton, who had a lasting and baleful influence on Tooke, called currency school supporters “deaf and incurable fanatics” and their theory a “rotten fabric”12, James Wilson, founder of The Economist, launched his own assault in his Capital, Currency and Banking13 in which he attacked prominent members of the school, J.S. Mill joined in the assault, falsely accusing currency school advocates  of playing “fantastic tricks with facts and dates”14.

The currency school’s response was devastating, reducing the banking school theory to a heap of intellectual rubble15.  And yet the banking school easily eclipsed its opponents. How the banking school emerged triumphant is a sad and sorry tale of how utterly fallacious reasoning can triumph over a sound theory grounded on solid empirical evidence.

Mill states in his 1826 essay that the “proximate cause of the [1825] commercial crisis was speculation” resulting in “mercantile miscalculations”16. From this he drew the conclusion that booms and busts are produced by waves of unjustified speculation caused by businessmen mistakenly anticipating a “deficiency in supply”17. In support of this odd assertion he simply cites as evidence the crises of 1784, 1793, 1810, 1811, 1814, 1815 and 1819 while curiously omitting 1797. He then appealed to Tooke’s High and Low Prices18 in the apparent belief that this work confirmed his ‘analysis, probably because it was he who declared author to be the “highest authority”19 on the subject of monetary theory. It apparently eluded Mill that he, England’s most prominent logician, tried to validate his analysis with an appeal to authority.

In a nutshell, the Banking School theory assumed that speculation creates a boom that drives up prices to a point where a large number of speculators think it is time to sell, at which stage prices begin falling and a depression sets in. (No attempt was made by banking school proponents to explain why businessmen should all of sudden become excessively optimistic about future profits to the point of making reckless investments or even why the banks would even fund them.) Mill argued, without any evidence, that this process accounted for “the commercial revulsions of 1810-11, and 1815-16” and that the “over-trading of the years 1824 and 1825” followed a similar pattern. Yet he was perplexed by the fact that the return on long term projects undertaken during the boom were so distant they would not have “ordinarily” justified the investment20, even though Henry Thornton had provided the key to this apparent mystery.


1Letter to William Huskisson 1827. Sayers, R. S., Economic Writings of James Pennington, London School of Economics and Political Science (University of London), 1963, p. 102.

2Ricardo, David, The High Price of Bullion, John Murray, 1810, pp. 46-48.

Ricardo made his point again when he stated that If the banks

charge less than the market rate of interest, there is no amount of money which they might not lend, — if they charge more than that rate, none but spendthrifts and prodigals would be found to borrow of them.

Principles of Political Economy and Taxation, Penguin Books, 1971, p. 358.

We  can clearly see that Steve Kates is gravely mistaken in arguing that John Stuart Mill’s explanation for the trade cycle can b “classical theory of the trade cycle”.

 3Abbot Payson Usher authored a highly detailed work medieval fractional reserve banking.

The Early History of Deposit Banking in Mediterranean Europe

4In The Collected Works of John Stuart Mill: Economics on Economics and Society 1824-1845, Liberty Fund 2006,  pp. 71-123.

5Tooke, Thomas, Considerations of the State of the Currency, John Murray, 1826. Tooke gave an excellent and detailed monetary explanation for the 1825 crisis in which he stressed that forcing down the rate of interest had expanded the note issue and fuelled speculation. And yet on page 63 he introduced psychological elements as a contributing factor to these crises. It appears that the idea that gave to the emergence of the banking school, of which John Stuart Mill became a prominent member, was already forming in Tooke’s mind.

6Fullarton, John, On the Regulation of Currencies: Being an Examination of the Principles, on which it is Proposed to Restrict, Within Certain Fixed Limits, the Future Issues on Credit of the Bank of England, and of the Other Banking Establishments Throughout the Country, John Murray, Second Edition, 1845, p. 66. Unfortunately, this work gained considerable success on the Continent, later influencing Marx and his disciples.

Marx, Karl, Capital, Vol. I, Penguin Book, 1982, pp. 214, 225.

Capital, Vol. III, Penguin Book, 1981, Chapters 25 and 28.

7According to Adam Smith the

whole paper money of every kind which can easily circulate in any country never can exceed the value of the gold and silver, of which it supplies the place, or which (the commerce being supposed the same) wouId circulate there, if there was no paper money…. . Should the circulating paper at any time exceed that sum, as the excess could neither be sent abroad nor be employed in the circulation of the country, it must immediately return upon the banks to be exchanged for gold and silver.

An Inquiry into the Nature and Causes of the Wealth of Nations, Liberty Classics, Vol I. 1981, pp. 300-301.

Both Henry Thornton and Robert Torrens refuted the reflux theory or, as it later became known, the needs of business doctrine.

Torrens, Robert, The Principles and Practical Operation of Sir Robert Peel’s Bill of 1844 Explained and Defended against the Objections of Tooke, Fullarton and Wilson, Longman, Brown, Brown, Green, and Longmans, 1848, p. 99, 107.

Thornton, Henry, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, J. Hatchard and Messrs F. and C. Rivington, 1802, pp. 44-46.

8Fullarton, pp.138-139

9Ibid. 141

10Torrens, pp. 133-134

11Tooke, Thomas, An Inquiry into the Currency Principle, Longman, Brown, Green, and Longmans, 1844.

12Fullarton, p. 47.

13Wilson, James, Capital, Currency, and Banking, Published at the Office of The Economist, 1847.

The book consisted of articles written by Wilson for The Economist from 1845 to 1847. It is remarkable that it was a leading member of the banking school, and not the currency school, who rightly focussed on vital role of fixed capital in trade cycle theory. This very Austrian approached led to the conclusion that if an inflation is  taken far enough a great deal of fixed capital would eventually have to be abandoned. (P, 148) Unfortunately, his work was badly marred by his rigid adherence to Fullarton’s fallacious reflux theory.

14Mill, John Stuart, Principles of Political Economy, Liberty Fund, 2005,  p. 661.

15Torrens, Robert, The Principles and Practical Operation of Sir Robert Peel’s Bill of 1844 Explained and Defended against the Objections of Tooke, Fullarton and Wilson, Longman, Brown, Brown, Green, and Longmans, 1857.

Apart from the final chapter the book is a devastating critique of the banking school. I cannot conceive how after reading this book any person could possibly take Mill’s so-called theory of the trade cycle seriously.

16Currency and Commercial Distress (1826), Essays on Economics and Society 1824-1845, Liberty Press, 206, p. 73.

Steve Kates refers to Mill as blaming businessmen for the “miscalculations” (investment mistakes) that caused the boom and then the depression. Kates, like Mill, overlooked the fact that prices govern production. Hence, the misdirection of production (“miscalculations”) only happens when the pricing process has been distorted to the extent that it creates clusters of entrepreneurial errors. It is important to recall that Irving Fisher pointed out that “[t]he rate of interest is the most  pervasive  price  in the whole  price  structure.” (The Theory of Interest, The Macmillan Company, 1930, p 33.)

What Kates erroneously calls the classical theory of the trade cycle is supposed to be a non-monetary one in which the rate of interest does not play a role. However, Mill makes a number of references to the rate of interest that unintentionally contradicts that belief. In one particular passage he states:

 An increase, therefore, of currency issued by banks, tends, while the process continues, to bring down or to keep down the rate of interest.

(Principles of Political Economy, Liberty Fund, Vol. II, 2005, p. 656.) P

In this, and other passages, Mill inadvertently admits that the so-called trade cycle is indeed a monetary phenomenon with its roots resting in the fractional reserve banking system and that the rate of interest is the key factor. He thereby validated Henry Thornton’s theory that Ricardo and the currency school adopted and which forms the basis of the Austrian theory of the trade cycle.

17Ibid. 73

18Ibid. 74

19Principles of Political Economy, Liberty Fund, 2005, p. 547

 20Currency and Commercial Distress, pp. 74-75. He noted that the flaw in his theory was the fact that

the profits of the enterprise will never yield anything like an adequate remuneration. It could, however, be no secret to the most sanguine projector, that the returns, even to the most successful of these schemes, must be distant.


  1. It’s taking a longer than I thought to get back to normal. I hope to be OK in a couple of weeks.

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