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.