The so-called currency theory had its origin in England in the early part of the last century, at the time when a forced circulation was given to the notes of the Bank of England by the suspension of specie payments and by investing the notes with the legal-tender power. In 1810 a Parliamentary Committee, appointed to investigate the rise of prices and the desirability and feasibility of the resumption of specie payments, reported that the notes of the Bank were depreciated and that their restoration to par and proper regulation would require the resumption of specie payments at the earliest possible moment and its permanent maintenance. It was in the discussion of this report that the currency theory made its appearance. Its advocates claimed that, instead of a resumption of specie payments or in addition to it, what was needed was a strict and definite limitation of the quantity of banknotes, and they based their claim upon the following process of reasoning, which constitutes the substance of the theory: -

In order that the value of the standard may be rendered stable and prices maintained at a fixed level, the quantity of the money of a country must be so regulated that its increase and decrease will correspond exactly to changes in the quantity of commodities and in the rapidity of their circulation. Bank-notes constitute the most expansible part of the currency, their issue depending simply upon the purchase of securities, and there is no limit to the amount of them that may be put into circulation, because they create a demand for themselves by raising prices directly in proportion to their quantity. On this account the maintenance of their value at a par with coin by the resumption of specie payments would not prevent inflation and a rise in prices. Hence the only way to cure the evil of inflated prices and to prevent its recurrence in the future was claimed to be the strict limitation of the quantity of bank-notes.

Crises were also explained in the following manner by means of this theory: The rise of prices, caused by an inflation of the currency through the overissue of bank-notes, overstimulates industry, thus causing overproduction and the promotion of unsound enterprises. The volume of discounts is then increased by a crop of unsound mercantile securities, and more notes are issued on them as a basis. This process continues until the inflated bubble of credit bursts, when a crisis ensues and a general liquidation takes place, accompanied by bank failures and a consequent decrease in the amount of notes in circulation. The field is thus cleared for a repetition of the above cycle of events, which is certain to follow in due course. If the quantity of bank-notes is not properly regulated, therefore, we may expect a periodical recurrence of crises and of the disastrous effects which normally accompany them.

The bank act* of 1844 was the direct result of the currency theory, its most characteristic feature being the placing of a definite limit to the quantity of notes that might be issued against securities. Its results, however, were very disappointing to its promoters and supporters. It failed utterly to accomplish the chief end of its existence, namely, the prevention of commercial crises. These calamitous events followed with customary regularity and were no less severe than formerly. The friends of the theory have explained this failure on the ground that the framers of the act of 1844 overlooked deposits, which are quite as efficient a means of inflating the currency as bank-notes and the use of which as currency was greatly stimulated by the act itself. It should be noted, however, that the currency theory, whether applied to bank-notes or to deposits, is based upon the assumption of an unlimited field for the circulation of bank currency.

As was pointed out in the chapter on the quantity theory, the demand for currency is created by the needs of commerce, instead of commerce being created as a means of employing money which some one has manufactured or may wish to manufacture. This statement needs no modification in view of the fact that banks are sometimes able to lend support to hazardous enterprises and to the plans of those who are inclined to push legitimate business too far. The rise of prices and inflation of the currency which generally follow the overstimulation of industry are results of the commerce and of the speculative operations which these enterprise promoters and over-optimistic business men create. The circulation of the bank currency follows and does not precede the increased commercial activity. The fact that bankers may conceivably themselves become promoters and may encourage others in unwise schemes by promises of assistance does not justify us in assigning to bank currency the causal influence which really belongs to the employment of the productive energies of a country in useless or unwisely planned enterprises. As reasonably might one assign the rise of the liquid in the barometer-tube as the cause of the storm, instead of the atmospheric changes which really produced it. The only remedy for the evil practices of which we are speaking is the elimination of the enterprise promoter and of the unwise business man. So far as possible, bankers should be prevented from lending help and encouragement to these persons, but we should not deprive the community of the advantages of the legitimate uses of an elastic currency because such men are occasionally able to make illegitimate use of the machinery by which it is created.

* See Chapter X (The Chief Banking Systems Of The World) for the terms of this act.

The natural limits to the circulation of bank currency described in the preceding section mark with sufficient accuracy the danger-line, and indicate the points at which safeguards are needed. We may now describe the safeguards themselves.


The various forms of bank currency are described in Macleod, v. I, ch. iv, sec. 4; Dunbar, chs. iv and v; Gambaro's Lessons in Commerce, chs. x and xi; Scharling, ch. i, sec. 2; and Schraut's Organisation des Kredits, chs. ii-vi.

On the proper limits to the issue of bank currency and on the currency theory see Macleod, v. II, ch. xiv, secs. 36-65, and ch. xvi; Conant's Modern Banks of Issue, ch. i and ch. v, pp. 119-129; Wilson's Capital, Currency, and Banking, chs. v-viii; Walker's Money, chs. xix and xx; Wagner's Lehre, chs. iv and v; Courcelle-Seneuil, bk. III, ch. iv; and Scharling, ch. iii, sec. 1.