§ 4. The Rate of Interest not really Connected with the value of Money, but often confounded with it.

From the preceding considerations it would be seen, even if it were not otherwise evident, how great an error it is to imagine that the rate of interest bears any necessary relation to the quantity or value of the money in circulation. An increase of the currency has in itself no effect, and is incapable of having any effect, on the rate of interest. A paper currency issued by Government in the payment of its ordinary expenses, in however great excess it may be issued, affects the rate of interest in no manner whatever. It diminishes, indeed, the power of money to buy commodities, but not the power of money to buy money. If a hundred dollars will buy a perpetual annuity of four dollars a year, a [pg 448] depreciation which makes the hundred dollars worth only half as much as before has precisely the same effect on the four dollars, and therefore can not alter the relation between the two. Unless, indeed, it is known and reckoned upon that the depreciation will only be temporary; for people certainly might be willing to lend the depreciated currency on cheaper terms if they expected to be repaid in money of full value.

In considering the effect produced by the proceedings of banks in encouraging the excesses of speculation, an immense effect is usually attributed to their issues of notes, but until of late hardly any attention was paid to the management of their deposits, though nothing is more certain than that their imprudent extensions of credit take place more frequently by means of their deposits than of their issues. Says Mr. Tooke: “Supposing all the deposits received by a banker to be in coin, is he not, just as much as the issuing banker, exposed to the importunity of customers, whom it may be impolitic to refuse, for loans or discounts, or to be tempted by a high interest; and may he not be induced to encroach so much upon his deposits as to leave him, under not improbable circumstances, unable to meet the demands of his depositors?”

In truth, the most difficult questions of banking center around the functions of discount and deposit. The separation of the Issue from the Banking Department by the act of 1844, which renewed the charter of the Bank of England, makes this perfectly clear. After entirely removing from their effect on credit all influences due to issues, England has had the same difficulties to encounter as before, which shows that the real question is concerned with the two essential functions of banking—discount and deposit. Since 1844, there have been the commercial disturbances of 1847, 1857, 1866, and 1873. Although no expansion of notes, without a corresponding deposit of specie, is possible.