Nineteenth century trade cycle theory 3

Gerry Jackson
12 September 2022 

Although these articles are not a direct criticism of Modern Monetary Theory they do show  that Australia’s free market economists are just as wrong about the trade cycle as are our MMT theorists which is why they failed to effectively refute MMT teachings.

In last post I finished with the observation Mill was puzzled by the fact that during a boom investments were made in projects that were not justified by the expected return despite the fact that Henry Thornton provided the clue to the solution1. (Ricardo was at one with Thornton on this issue2.) Thornton’s insights, combined with the embarrassing fact that the banking school was forced to admit that a boom required a monetary expansion, left Mill in a quandary. Our logician’s response was  to try and shore up his ‘theory’ with a lengthy quote from Tooke’s Considerations3, thereby committing the fallacy of appealing to authority.

Somehow Mill managed to overlook the fact that on page 52 of the same work Tooke also stated that rising prices are partly caused by expanding the currency while the expansion of the currency is partly caused by rising prices. On page 64 he accused the Bank of England, with respect to the 1825-1826 crisis4, of expanding the note issue when it should have been contracted. (Evidently Tooke was not a clear and consistent thinker, a failing that Colonel Robert Torrens mercilessly ridiculed5.)  Tooke made other statements that ran counter to Mill’s ‘theory’ and yet they still managed to elude Mill even though he was an ardent admirer of Tooke’s work.

A psychological theory of the trade cycle is by definition not only a non-monetary theory it is also a non-economic theory. Facts are stubborn creatures and the economic facts surrounding financial crises were impossible to ignore, forcing  Tooke and Mill to admit that a boom was impossible without credit expansion.  Determined, however, to cling to their fallacious reasoning they sought to resolve their dilemma by absurdly claiming that rising prices expanded the money supply.

They found themselves in this position because by firmly wedding themselves to John Fullarton’s bizarre reflux theory which argued that as convertible notes were really loans and not direct payments and that therefore an excess of notes becomes impossible because they would be returned to the banks once the loans came due thereby withdrawing them from circulation, leaving the money supply unchanged. Hence, the banking system, particularly the country banks, could not increase the note issue beyond the ‘needs of business’, despite monetary figures to the contrary.

But they failed to see that when these notes were returned to the banks they became demand deposits which could then be drawn  on at any time, an observation that the school’s proponent seized on. (It is of interest to note that James Mill ardently defended Smith’s needs of business theory even though he had to it had been refuted by Henry Thornton6. It seems clear J. S. Mill was, because of his father’s influence,  had become an adherent of the reflux theory before Fullarton formulated it.) Torrens’ response to Fullarton was devastating.

Mr. Fullarton reiterates this argument through several pages, innocently unconscious of the fact that, in order to give it any weight or validity, it is necessary that the loans should be repaid on the instant, they are granted. Allow any interval to elapse between the loan and the repayment, and no regularity of reflux can prevent redundancy from being increased to any conceivable extent7.

He immediately followed this with an example of how a bank discounting notes at £1,000 per day on 60-day loans would have expanded the note issue by £60,000 pounds before Fullarton’s so-called reflux process began to operate. Torrens’ slap-down of Tooke and Mill was brutal. He mercilessly mocked what he called Tooke’s idea of the “self-creation of money”. Describing Mill’s treatment of money as a “melancholy disappointment”, he points out where Mill had, on the one hand, stated that bank notes are credit instruments (MMT]) while in the same passage inadvertently admitting, contrary to banking school doctrine8, that they are indeed money9, leaving Torrens to wonder:

 How then can we comprehend the melancholy fact, that the author of Unsettled Questions in Political Economy should have descended to the rank of those who receive as an established truth a pretended discovery which cannot be explained or defended, except upon the absurd assumption that currency creates itself?10 (It’s no wonder Mill refused to debate Torrens.)

Although Mill refused to engage Torrens that didn’t stop him from attacking Henry Thornton’s monetary theory of the trade cycle that Ricardo, Pennington, Arbuthnot, Torrens and so many other had adopted. He falsely accused them of “ascribing all alternations of high and low prices to the issues of banks….”11 Torrens correctly dismissed Mill’s effort to discredit the monetary theory with the observation that Mill’s approach to the theory lacked the “a competent knowledge of the nature of the theory and of the grounds upon which it is founded being conveniently evaded12.”

Torrens was too generous. The monetary school theory had always aimed at explaining the cause of the trade cycle, never economic fluctuations in general, a fact that Mill must have known. Nevertheless, he based his theory on speculation driven by the belief “that the supply of one or more great articles of commerce is likely to fall short of the ordinary consumption13.” He provided no evidence to support his assertion.

It should be noted that neither school was able to provide an explanation for the disproportionalities or, as Mill himself put it, the “derangement of the national industry14” that made its appearance in the depression.  But if he, along with his contemporaries, had seen interest as the price of time, so to speak, then his conundrum would have solved itself.


1Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, J. Hatchard, Bookseller to the Queen, 1802. Thornton was the first to not only give sound and factual theory of the business cycle his was the most effective and certainly superior to the tripe that economic commentators publish every day. Unfortunately he failed to see the link between time and interest.

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

3Henry Thornton,  Paper Currency and Commercial distress, 1826. The Collected Works of John Stuart Mill, Vol. IV, Liberty Fund, 2006, p. 74. Oddly enough, Tooke’s Considerations closely mirrored what later came known as the currency school theory of the business cycle, the same theory the banking school bitterly attacked.

4Thomas Tooke, Considerations on the State of the Currency, John Murray, 1826, p. 43.

5Torrens, 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, pp. vii-ix.

6Henry Thornton,  Paper Currency and Commercial distress, 1826. The Collected Works of John Stuart Mill, Vol. IV, Liberty Fund, 2006 boom

7Torrens, 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, pp. 99, 106-107.

8Torrens, 1857, p. 56.

9Ibid. p. 120.

10Ibid. p. ix.

11Ibid. p. 93.

12Ibid. p. 94

13Ibid. p. 94

14Principles of Political Economy Vol. I, p. 78





2 thoughts on “Nineteenth century trade cycle theory 3”

  1. This is heavy stuff. I think this is a very important series. It made me realise how ignorant our economic commentators are. They’ve just been giving us rubbish.

  2. This is pretty dense stuff. I never got anything like this at uni. If what you are saying is correct then much if not all we get from think tanks financial pages is nonsense

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