Nineteenth century trade cycle theory: fact versus myth 1

Gerry Jackson

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 and as such serve to undermine MMT teachings.

Last week I singled out P. D. Jonson, Peter Smith and Steve Kates, who teaches at RMIT, as being hopelessly wrong in arguing that the boom-bust cycle is a natural feature of a capitalist economy.  I chose these three because they have written books in which they clearly state their views on the subject. To my knowledge there is not a single free market economist in Australia who would disagree with them. In this respect there is no fundamental difference between these economists and Bill Mitchell and his fellow MMT theorists. (It also puts them in the Marxist camp.) The striking thing about all of these economists is that not one of them ever provided the slightest indication of being aware of  the crucial role the gold standard played in classical thinking when it came to what they called “convulsions” or “revulsions”.

Steve Kates (Associate Professor of Economics, RMIT) stands out in particular because he preaches that the classical economists also adhered to the view that the boom and bust phenomenon is an unfortunate and unavoidable product of a free market economy and that they even developed a theory to explain it. I have to confess that it is beyond my understanding as to how any person with a passing knowledge of the economic literature of the time could draw this conclusion. I surmise from his writings that he largely relies on John Stuart Mill as the prime contemporary authority on the subject of economic crises. But Mill was every bit as wrongheaded on the phenomenon as was Thomas Tooke, founder of the banking school of which Mill became a leading member.

We need to go back to 1802 when Henry Thornton, a highly respected London banker, published his Inquiry into the Nature and Effects of the Paper Credit of Great Britain1. This monetary thesis was in part a response to Walter Boyd’s Letter to Pitt2 in which he accused the Bank of England of being responsible for inflation and the poor state of the exchanges. (Boyd was a strong bullionist while at that time Thornton was still an anti-bullionist).

Although Thornton’s  thesis was a disjointed and somewhat contradictory in places it still contained some remarkable insights. He described how inflation increased the demand for labour by reducing real wages relative to the price of the product3; the Cantillon effect where money enters the economy at certain points and how that affects the pattern of spending and incomes4; he went on to condemn forced saving as being unjust to the labourer. His great contribution was a theory of the business cycle in which he showed how artificially forcing down the rate of interest increased the demand for credit and so generated a boom. Yet these important facts are completely absent, along with the gold standard, from Steve Kates’ so-called classical approach to the trade cycle.

Ricardo adopted Thornton’s theory as did most of the currency school. The theory quickly came to dominate public thinking, a fact confirmed by George Warde Norman, a prominent director of the Bank of England and an opponent of the Thornton’s theory5, calling it an “unfounded assumption”6, believing as he did that there were non-monetary causes for these recurring financial crises, despite admitting that the crises of 1792, 1810, 1816, 1825 and 1836 had a monetary cause! Mr Norman was, to say the least, of two minds on the subject.

Thornton had been deeply affected by the 1793 monetary crisis that was so severe it caused a country-wide  collapse of numerous banks, even forcing his own bank to temporarily close its doors. It must have been this experience that turned his mind toward the problem of the financial crises that seemed to be striking the economy at random. A closer look at that event reveals that it was a monetary disorder that brought about the economic mayhem.

After the 1788-89 depression Britain underwent another credit-driven boom which peaked in 1792 and declined later that year culminating in the1793 banking crisis. (T. S. Ashton observed that 1790 “reflects the beginning of a spectacular building boom”7.) On 23 February 1790 the Bank’s note circulation was £10,217,360, by 25 February 1792 it had risen by £11,349,810, a 14.4 per cent increase. This increase was followed by “a great increase of the issues of the country banks.”8 (It has to be remembered that the Bank’s notes formed a reserve for the country banks.) The result of this monetary binge was rising prices and an initial fall in interest rates.

By early 1792 the exchanges were in trouble and the gold situation was worsening. In August 1791 the Bank’s stock of gold bullion stood at £8,056,000 but by February 1793 it had fallen to £4,011,000. The worsening situation was reflected in the price of consols which rapidly fell from 90 in November 1792 to 72 in March 1793. The Bank’s note issue had peaked at £11,889,000 in February 1793 after which it started to contract and  by August 1794 it had shrank by 14.5 per cent. The situation was catastrophic for the country banks. In March 1793 they suffered severe runs which “annihilated”9 100 of them and contracting their note issue by about 76 per cent9.  Money became so tight that overnight interest rates jumped to 16 per cent to 17 per cent10. However, it wasn’t long before the Bank went into reverse. In February 1797 the Bank’s note issue stood at £8,640,250. Come December 1800 it was £15,450,970, a 78.8 per cent increase.

To call the Bank’s monetary policy erratic would be an understatement. From 1812-1814 the country’s total note issue (including the country banks) rose by 18 per cent. The period 1814 to1816 saw it jump again by 18 per cent, then from 1816 to 1817 it dropped by 8 per cent only to see it rise by 6.7 per cent from 1817 to 1819. The move to the gold stand brought a massive and unanticipated drop in the total note issue from1819 to 1822 of 40 per cent causing prices to plummet by 45 per cent or more. No wonder Ricardo lamented

that from 1797 to 1819 we had no standard whatever by which to regulate the quantity or value of our money11.

No one could say with a straight face that the Bank’s directors were a quick study. They never made the link, as did Thornton, between changes in the note issue and changes in economic activity. (Unfortunately, Thornton was weak when it came to the link between the note issue and the volatility of the exchanges). It was this monetary disorder that created the bullion controversy, an important event in monetary history that is overlooked by today’s economists.

We find, for example, that the financial crises of 1763, 1772, 1783 and 1793 that preceded restriction followed the same pattern as the crises that emerged during the restriction. Marx described these  eighteenth-century crises as “credit and money crises, which automatically appear, along with the credit and banking system12. He clearly understood that the financial crises had their roots in the banking system. (This didn’t stop him from deriding the currency school for stressing the same point. Marx was not the most ethical of men.)

It is therefore not surprising to also find that the post-restriction crises of 1825, 1836, 1839, 1847, 1857, 1866, 1873, 1884, 1890, 1893 and 1907 also followed the same monetary pattern. Every single boom-bust event from 1717 to 1914 was caused by a deviation from the gold standard. (This article is not about economic fluctuations but a specific economic phenomenon.) Nevertheless, numerous economic historians were still reluctant to accept the evidence, always referring to other factors such as political events.

In referring to the period 1781 to 1791 Ashton noted that a rapid growth in the number country banks had led to a considerable increase in notes and bills of exchange which he called “the most volatile type of credit”13  and that “abuses of this most volatile type of credit were in evidence as they had been in 1763, 1773 and 1788.” In another passage he states:

Several of the inquests into the crises of the eighteenth century attribute the trouble to an excess of bills [meaning accommodation bills14] of this kind15.

Ashton appears unaware of the fact that a rapid increase in bills of any kind is always preceded by an increase in bank credit, which at that time consisted largely of notes. A contraction of notes was always followed by a fall in the number of bills. If he had read the classical economists he would have been made aware of this fact. He would also have been made aware of the classical debate surrounding the issue of whether bills were genuine money substitutes. They were not, as Colonel Torrens successfully explained in considerable detail16.

As an aside, It should be abundantly clear by now that Professor Mitchell’s views on the gold standard are nothing but a ragtag bundle of errors.


1Boyd, Walter, A Letter to the Right Honourable William Pitt on the Influence of the Stoppage of Issues in Specie at the Bank of England, on the Prices of Provisions, and other Commodities, T. Gillet, London, 2nd edition, 1801.

2Thornton, Henry, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, Messers F. & C. Rivington, 1802, pp. 187-8.

3Cantillon, Richard, Essay on the Nature of Trade in general, Translation Publishers, 2001.

Cantillon’s work was one of the founding stones of modern economics. One of his insights was to notes that new money enters the economy in steps and at different points thereby changing income streams and the pattern of production. Although his book was written about 1730 and distributed in manuscript form until it was published in 1755.

4Norman, George Ward, Letter To Charles Wood, Esq., M.P., On Money, And The Means Of Economizing The Use Of It, London: Pelham Richardson, 1841, p. 85.

5Norman, George Ward, Remarks upon Some Prevalent Errors, with Respect to Currency and Banking and Suggestions to the Legislature and the Public as to the Improvement of the Monetary System, Pelham Richardson, 1838, p. 30.

6Ashton, T. S., Economic Fluctuations in England 1700-1800, Clarendon Press, 1969, p. 101.

7Tooke, Thomas, Considerations on the State of the Currency, John Murray, Albemarles-Street, 1526, p. 81.

8Mushet, Robert, An Attempt to Explain from The Facts the Effects of the Issues of the Bank of England upon Its Own Interests, Public Credit and Country Banks, Baldwin, Craddock, and Joy, Paternoster Row, 1826, p. 177

9ibid, p. 157

10Thornton, 73.

11Ricardo, David, On Protection to Agriculture, John Murray, 1822, p. 22.

12Marx, Karl, Theories of Surplus Value, Lawrence & Wishart, 1987, p. 525.

13Ashton, 168.

14An accommodation bills were  drawn and accepted without any sale and purchase of goods and were usually drawn to satisfy a temporary need. For this reason they were sometimes derided as “fictitious bills” that promoted speculation.

15Ibid. 108

16Torens, Colonel Robert, The Principles And Practical Operation Of Sir Robert Peel’s Bill Of 1844: Explained And Defended, Longman, Brown, Greenman, Longmans, and Roberts, 1857, Ch. I.

3 thoughts on “Nineteenth century trade cycle theory: fact versus myth 1”

  1. This is turning into an economics and history course. Its stunning to me that right-wingers who are supposed to defend capitalism don’t know any of this stuff.

  2. After reading Gerry’s article Im left wondering if the economists he criticised really know anyting

  3. Another great series. I’m stunned that our right never thought of doing something like this.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.