James Narron, David R. Skeie, and Donald P. Morgan
In the early 1800s, Napoleon’s plan to defeat Britain was to destroy its ability to trade. The plan, however, was initially foiled. After Britain helped the Portuguese government flee Napoleon in 1807, the Portuguese returned the favor by opening Brazil to British exports—a move that caused trade to boom. In addition, Britain was able to circumvent Napoleon’s continental blockade by means of a North Sea route through the Baltics, which provided continental Europe with a conduit for commodities from the Americas. But when Britain’s trade via the North Sea was interrupted in 1810, the boom ended in crisis. In this edition of Crisis Chronicles, we explore the British Export Bubble of 1810 and ask whether pegged or floating exchange rates are better for an economy.
The Credit of the Kingdom
As we noted in a previous post on the collapse of the French assignat, England had been at war with France since 1793. While public expenditures to finance the war mounted, revenue remained stagnant and, as the budget deficit widened, the pound began to depreciate. In 1797, the landing of a French frigate in a Welsh harbor caused a minor run on the Bank of England, and bullion reserves fell so low that by May of that year, the British government passed the Bank Restriction Act to exempt the Bank of England from having to convert banknotes into specie. The act was intended to “support the public and commercial credit of the kingdom” and was to be temporary—until June—but banknotes remained inconvertible for nearly twenty-five years.
Reflecting on the French experiment with the assignat, Lord Lansdowne, one of the most influential Whig politicians of his time, prophesied, “the fall will be slow perhaps, and gradual for a time, but it will be certain.” And as we saw with the assignat, gold disappeared from circulation and silver was scarce. The Bank of England even resorted to stamping the King’s head on Spanish dollars to maintain a circulating medium, and received permission to print lower-denomination £5 notes (the law forbade issuing lower-denomination notes).
Before the suspension of convertibility, the quantity of gold on hand constrained the Bank of England’s issuance of banknotes. But after the suspension, the Bank of England remained prudent in its issuance of banknotes and the public accepted the conversion from specie to paper without disturbance or confusion. The Bank of Ireland followed the Bank of England’s lead, as did other country banks that issued notes. And public expenditure remained relatively in check through about 1810.
British Trade with the Americas
As Spain’s influence in the Americas waned, Britain was able to do more business there, importing raw materials and exporting British manufactured goods. Then, in 1807, Napoleon demanded that Portugal join the trade boycott against the British and declare war on England. When Portugal hesitated, Napoleon’s ally, Spain, allowed French troops to pass through to Portugal, where the French captured Lisbon as Portugal’s royal family fled to Brazil. In exchange for Britain’s help in enabling the royal family to escape, the Portuguese granted Britain trade privileges with Brazil. Low-cost British goods found a new market that had previously been dominated by local artisans. Trade with the Americas not only rescued Britain from Napoleon’s continental boycott, but also helped the country achieve record exports from 1808 to 1810.
“Intercourse with the Continent”
Over time, however, the record exports led to speculation, and when trade between Holland and Britain was briefly interrupted as France’s attempts to blockade the North Sea ports intensified, access to the continental market was cut off and prices of colonial goods fell in England, even though they remained costly on the continent. The economic boom ended with a severe crisis in July and August 1810 as Britain experienced a number of commercial failures and merchant bankruptcies. The crisis spread to West Indian merchants, who then dragged down the bankers who had extended credit to them. As trade declined, West Indian docks remained stuffed with goods awaiting export. But by the summer of 1811, the crisis subsided.
As the nineteenth-century economist Thomas Tooke noted:
“The effects of a vast import of colonial and American produce, far above the scale of our consumption at the most prosperous periods of our commerce and attaining a magnitude hitherto unknown to us, have, in the present cramped state of our intercourse with the Continent, developed themselves in numerous bankruptcies, widely spreading in their influence, and unprecedented in extent of embarrassment . . . [and] further aided by the speculations which prevailed.”
But was the trade crisis exacerbated by an over-issuance of banknotes?
Irish Pound Report of 1804
In 1804, the Irish government commissioned an investigation into the depreciation of the Irish pound. Although less famous than England’s subsequent Bullion Report of 1810, a number of arguments were put forth on the cause of the depreciation of the Irish pound after the 1797 suspension of convertibility. For example, David Ricardo, an influential economist at the time (and to this day), argued that the depreciation of paper currency was due “almost entirely, if not solely, from an excess of paper.” Henry Thornton, another leading economist (and banker) of that era, agreed that in the long run, this was true, but stressed that short-run factors might produce the same result: “A good or bad harvest, in particular, will have a considerable influence in producing this temporary difference. . . . If the harvest fails, and imports are necessary . . . the means of payment are to be supplied more gradually. . . . Hence a temporary pressure arises at the time of any very unfavorable balance.” And while some blame might have been apportioned to the Bank of Ireland for over-issuing pounds after the suspension of convertibility into species, blame might also be shared with some Irish country banks, which also issued banknotes, a problem that we covered previously in our post on the Continental currency crisis.
Bullion Report of 1810
By 1809, British prices also started to rise and Bank of England notes began to further depreciate. So the government appointed a committee to determine if the 1797 suspension should end in two years, regardless of whether the war was finished.
The committee’s work, entitled the Bullion Report, has an important place in monetary history. Building on the Irish Pound Report of 1804, the Bullion Report posits that the credit policy of a central bank is the major influence on a country’s prices and exchange rates and that a central bank’s discretion in credit policy is limited by maintaining a fixed price of gold. So the debate between 1810 and 1811 was whether or not monetary policy could control exchange rates.
To Float or to Peg
Economists today agree (surprisingly!) that monetary policy can control exchange rates, although at the cost of monetary autonomy. In other words, the monetary authority can control the price of its currency (the exchange rate with other currencies), or the quantity, but not both, unless capital controls are imposed. If the monetary authority wants to peg the exchange rate between its currency and others, it has to allow the supply of its currency to adjust to meet demand at the pegged rate.
What economists don’t always agree on is whether pegged or floating exchange rates are better for an economy. For example, most countries pegged their currencies to the U.S. dollar, which was convertible to gold, during the Bretton Woods period. This regime ended in 1971 and, since then, most developed countries have had floating exchange rates. China, however, has pegged its exchange rate to be inexpensive relative to the U.S. dollar, leading to low export prices for goods from China. This has spurred Chinese output while holding down domestic consumption. As the international debate about fixed versus floating exchange rates continues, tell us what you think.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
James Narron is a senior vice president and cash product manager at the Federal Reserve Bank of San Francisco.
At the time this post was written, David R. Skeie was a senior financial economist in the Federal Reserve Bank of New York’s Research and Statistics Group. He is now an assistant professor of finance at Mays Business School, Texas A&M University.
Donald P. Morgan is an assistant vice president in the Bank’s Research and Statistics Group.