The “Bullionist Controversy” Began in 1797 with a Massive Run on the Banks Followed by a Suspension of Specie Payment

The Bank of England had been the bulwark of the English (and, by serving as bankers’ bank, of the Scottish) banking system since its founding in 1694. The bank was the recipient of an enormous amount of monopoly privilege from the British government. Not only was it the receiver of all public funds, but no other corporate banks were allowed to exist, and no partnerships of more than six partners were allowed to issue bank notes. As a result, by the late eighteenth century, the Bank of England was serving as an inflationary engine of bank deposits and especially of paper money, on top of which a flood of small partnership banks (‘country banks’) were able to pyramid their own notes, using Bank of England notes as their reserve. As if this were not enough privilege, when the bank got into trouble by overinflating, it was permitted to suspend specie payment, that is, refuse to meet its obligation to redeem its notes and deposits in specie. This privilege was granted to the bank several times during the century after it opened its doors. However, each time the suspension, or ‘restriction’ of specie payment lasted only a few years.

In the 1790s, however, a startlingly new epoch began in the history of the British monetary system. In February 1793, a generation of fierce warfare broke out between revolutionary France and the crowned heads of Europe, led by Great Britain. While not exactly continuous, the war lasted, with slight interruptions, until Napoleon was finally defeated in 1815 and the monarchies of Europe reimposed the Bourbon dynasty upon the French nation. This massive war effort meant a rapid escalation of monetary inflation, government spending, and public debt by the British government.

During the 1780s, the inflationary process of bank credit expansion had managed to double the number of country banks in England, totalling nearly 400 by the outbreak of war. The shock of the war led to a massive financial crisis, including runs on the country banks, as well as numerous bankruptcies among banks and financial houses. One-third of the country banks suspended specie payment during 1793.

For a few years, the bank saved itself by pursuing a cautious and conservative policy. But soon, inflationary war finance, the drain of gold abroad in response to higher purchasing power elsewhere, the alarms of war, and the increased demand for gold upon the banks, all combined to precipitate a massive run on banks, including the Bank of England, in February 1797. The country banks suspended specie payments, and the government brought matters to a head by ‘forcing’ the bank to suspend specie payments, a ‘Restriction’ which the Bank of England of course was all too delighted to accept. For the bank could now continue operations, could expand credit, inflate its supply of notes and deposits, and insist that its debtors must repay their loans, while it could avoid the bother of redeeming its own obligations in specie. In effect, bank notes were unofficially legal tender, indeed virtually the only legal tender, and they were made official legal tender in 1812 until the resumption of specie payments in 1821.

—Murray N. Rothbard, Classical Economics, vol. 2 of An Austrian Perspective on the History of Economic Thought (Auburn, AL: Ludwig von Mises Institute, 2006), 159-160.