Banking School, Currency School,

Free Banking School

ANNA J. SCHWARTZ

Historians of economic thought conventionally represent British monetary

debates from the 1820s on as centred on the question of whether policy should
be governed by rules (espoused by adherents of the Currency School), or whether
authorities should be allowed discretion (espoused by adherents of the Banking
School). In fact many other questions were in dispute, including those raised by
neglected or misidentified participants in the debates - adherents of the Free
Banking School.
Among the questions in dispute were the following: (1) Should the banking
system follow the Currency School's principle that note issues should vary
one-to-one with the Bank of England's gold holdings? (2) Were the doctrines
of the Banking School - real bills, needs of trade and the law of reflux - valid?
(3) Was a monopoly of note issue desirable or, as the Free Banking School
contended, destabilizing? (4) Was overissue a problem and, if so, who was
responsible? (5) How should money be defined? (6) Why do trade cycles occur?
(7) Should there be a central bank? No, was the Free Banking School answer
to the final question; yes, was the answer of the other two schools, with disparate
views, as indicated, on the question of rules vs. authorities. What was not in
dispute was the viability of the gold standard system with gold convertibility of
Bank of England notes.
On what grounds did the schools oppose each other? Each of the first three
questions identifies the central doctrines that the adherents of one of the schools
shared; on the remaining questions, individual views within each school varied.
Before establishing the positions of each school in the monetary debates, we
introduce the institutional background and the principal participants.

INSTITUTIONAL BACKGROUND. The Bank of England, incorporated in 1694 as a

private institution with special privileges, stood at the head of the British banking

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© Palgrave Macmillan, a division of Macmillan Publishers Limited 1989
Banking School, Currency School, Free Banking School

system at the time of the debates. Until 1826 the Bank's charter was interpreted
to mean the prohibition of other joint stock banks in England. As a result banking
establishments were either one-man firms or partnerships with not more than
six members. Two types of banks predominated in England: the wealthy London
private banks which had voluntarily surrendered their note-issuing privilege, and
the country banks which depended almost exclusively on the business of note
issues. Numerous failures among the country banks demonstrated that the effect
of the Bank's charter was to foster the formation of banking units of uneconom-
ical size.
Banking in Ireland was patterned on English lines. The Bank of Ireland,
chartered in 1783 with the exclusive privilege of joint stock banking in Ireland,
surrendered its monopoly in 1821 in places farther than fifty miles from Dublin.
Joint-stock banking in the whole of Ireland was legalized in 1845.
The Bank of Scotland was founded in 1695 with privileges similar to those of
the Bank of England, except that it was formed to promote trade, not to support
the credit of the government. It lost its monopoly in 1716, and no further
monopolistic banking legislation was enacted in Scotland. With free entry
possible, many local private and joint stock banks, most of the latter well
capitalized, where established, anq a nationwide system of branch banking
developed. Unlike the English system, overissue was not a problem in the Scottish
system. The banks accepted each other's notes and evolved a system of note
exchange. Shareholders of Scottish joint stock banks (except for three chartered
banks) assumed unlimited liability. At the time of the debates banking in Scotland
was at a far more advanced stage than in England.

PRINCIPALS IN THE DEBATES. The leading spokesmen for the Currency School side
in the debates were McCulloch, Loyd (later Lord Overstone), Longfield, George
Warde Norman, and Torrens. Norman, a director of the Bank of England for
most of the years 1821-72, and of the Sun Insurance Company, 1830-64, was
active in the timber trade with Norway. The principal Banking School representa-
tives were Tooke, Fullarton, and John Stuart Mill, while James Wilson held
views that straddled Banking and Free Banking School doctrines. The most
prominent members of the Free Banking School were Parnell (later Baron
Congleton), James William Gilbart, and Poulett Scrope. Gilbart, a banker, was
general manager of the London and Westminster Bank, the first of the joint stock
banks authorized by the Bank Charter Act of 1833.

CURRENCY SCHOOL PRINCIPLE. The objective of the Currency School was to

achieve a price level that would be the same whether the money supply were
fully metallic or a mixed currency including both paper notes and metallic
currency. According to Loyd, gold inflows or outflows under a fully metallic
currency had the immediate effect of increasing or decreasing the currency in
circulation, whereas a mixed currency could operate properly only if inflows or
outflows of gold were exactly matched by an increase or decrease of the paper
component. He and others of the Currency School regarded a rise in the price

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