Banking School

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Between 1819 and 1844 England was the battleground of one of the most important monetary controversies in history: the debate between the banking school and the currency school. The resumption of specie payments following the Napoleonic Wars had not spared England the trauma of periodic financial crises. Financial crises in 1825, 1833, and 1839 became thought-provoking grist for the monetary debating mill.

The currency school found the answer to England’s financial turbulence in tighter linkages between domestic money supplies (defined as gold specie and paper money) and domestic gold supplies that varied with the import and export of gold.

The banking school saw domestic money supplies as a much more passive player in the drama of economic boom and crisis, and argued that the currency school’s definition of money supplies was narrow and unrealistic. To the banking school a more workable definition of domestic money supplies would, in addition to specie and paper money, include bank deposits and bills of exchange. Banks supplied these forms of money to meet the needs of trade. Part of the thinking of the banking school hinged upon the “law of reflux,” stating that every bank note or deposit issued on a loan was canceled when the loan was repaid. The “law of reflux” was akin to the “real bills doctrine” of a similar vintage.

The banking school felt it was unrealistic to attribute a close linkage between prices (inflation) and money supplies as narrowly conceived by the currency school, given the obvious importance of other types of money. The banking school further doubted if circulating domestic money supplies, even if totally metallic, would fluctuate in step with international gold flows as the currency school predicted. Rather than altering circulating money supplies, international gold flows might only lead to hoarding and dishoarding gold, especially within the banking community.

At the time of the debate between the banking school and the currency school, hundreds of banks issued their own bank notes. The banking school essentially defended the status quo, arguing that regulating the issuance of bank notes should be left to the wisdom of commercial bankers, subject to the requirement of convertibility. The bankers left to their own discretion would provide an elastic currency able to expand and contract to meet the needs of trade.

The Bank Charter Act of 1844 largely followed the recommendations of the currency school, especially in laying groundwork for monopolization of bank note issues by the Bank of England. Nevertheless, consistent with the thinking of the banking school, the act gave the Bank of England some discretion to expand and contract bank notes independently of gold flows.