The Bank Act of 1844 made radical changes in the charter and established the Bank of England on its present basis.1 It divided the bank into two distinct departments, one to carry on banking operations (discount and deposit) solely; the other to issue notes, but not to transact any banking business. The average amount of the bank's notes outstanding in 1844 was £14,000,000. That sum in securities, including the Government's indebtedness to the bank, was to be transferred to the issue department, which in exchange should transfer £14,000,000 of notes to the banking department. This amount of notes could not be increased except in exchange for an equal sum of gold coin or bullion. Private and joint stock banks having the right to issue notes at that time were allowed to retain their existing circulation, but no additions could be made to it. It was expected that eventually the Bank of England would absorb the entire note-issuing function, so the act provided that whenever any bank should cease to issue notes, the Bank of England, upon authority of the Privy Council, might issue two-thirds of the amount thus lapsed or withdrawn by depositing an equivalent sum in securities with the issue department. Under the operation of this clause, the notes of joint-stock and private banks have declined from over £8,600,000 to £1,204,490, while those of the Bank of England have risen to about £18,450,000. 1
1 Withers and Palgrave: The English Banking System (Nat. Mon. Comm.), p. 149 et seq.
The act of 1844 changed completely the character of the bank note. Up to that time it had been a credit instrument based upon the general assets of the bank. The vol-ume of notes expanded and contracted-with- the demands of business for currency. By the bank act, however, the credit character of the note was entirely destroyed, and it became a mere receipt for gold. Bank notes can be issued only against the deposit of an equivalent amount of gold. The inelasticity of note issues thus established was not felt until the panic of 1847. In that year and again in 1857 the demand on the bank for notes was so urgent that the Government suspended the limitation on the note issues and allowed the bank to issue notes based on its general assets. It will thus be seen that the English note issue system is extremely inelastic, but check or deposit currency has so largely displaced the bank note in commercial payments as to make the latter a factor of inferior importance. Business is transacted largely by check, which, as we have seen, is much more elastic than bank notes. The smallest bank note issued by the Bank of England is £5, but in consequence of the financial disturbances of the European war in 1914, notes were issued by the Government in denominations of ten shillings and one pound in order to conserve the gold supply.
The discussion which led up to the passage of the act of 1844 developed two schools of opinion on the subject of bank currency which have persisted to the present time. One school supported the "currency principle," holding that the amount of note issues should be strictly limited, and assuming that "a certain amount of paper currency will be wanted by the community at all times and that the government may advantageously issue it, either directly or through an agency like the Bank of England." The English system is based on this principle. The other school favored an elastic currency based on the general assets and credit of the bank, and so responsive to the demands of trade. This isknown as the "banking principle," and is well exemplified in the- -French and Canadian banking systems.
1 Withers and Palgrave: The English Banking System, p. 12.