Alas, the accommodation Tom Humphrey seeks with me does not resolve the 
fundamental misrepresentation of classical monetary analysis entailed in 
his adoption of Keynes and Friedman's definition of money.

Thomas Humphrey wrote:
> Re: Henry Thornton — Perhaps we can accommodate James Ahiakpor by 
> distinguishing (like good classical monetary theorists) between (1) 
> “money" strictly speaking consisting of gold coin, and (2) the 
> "circulating medium" consisting of gold coin plus bank notes and 
> deposits and any other forms of transactions means of payment. 
> Substitute the term “circulating medium” for “money” in Thornton”s 
> analysis and nothing changes. His analysis remains the same. Thornton 
> was talking about the economy’s medium of exchange or means of 
> payment. Whether he called it “money” or “the circulating medium” or 
> something else is neither here nor there. As long as we realize that 
> Thornton was referring to the aggregate means of payment (what we 
> today might call “broad money”) his analysis stands.
>

This commingling of money proper with its substitutes as means of 
exchange confuses the separate roles of a central bank and commercial 
banks (depository institutions).  In Thornton's time, Bank of England 
notes were backed by bullion (100%).  But there were also country banks 
that issued their own notes outside of London. These were redeemable in 
Bank of England notes or in specie. Furthermore, commercial bank 
deposits originate from the public's savings.  Thus, the Bank of England 
had no control over their volume.  The equivalent of the 19th century 
experience during the Great Depression was the Fed being required to 
back its notes 40% by gold.  However, commercial banks were no longer 
printing their own notes, following the establishment of the Fed.  They 
took deposits from the public and engaged in lending these (savings) 
over and above their own "capital" (net worth).

In explaining the price level and its variations (from the Quantity 
Theory of Money), Thornton, just as Hume, Smith, and Ricardo, employed 
specie, along with Bank of England notes, as the relevant "circulating 
medium," rather than including all commercial bank deposits.  In that 
analysis, an increased use of credit in place of money in payments 
amounts to a reduced demand for money (to hold), and thus decreased the 
value of money -- prices rise.  Thus, I do not read Thornton as having 
employed "the aggregate means of payment (what we toady might call 
"broad money")" in his monetary analysis. I find Fisher's (1912; italics 
original) argument that "although a bank deposit transferable by check 
is included in circulating media, it is not money.  A bank /note/, on 
the other hand, is both circulating medium and money" to be helpful in 
appreciating the difference between money and its substitutes.
> Re: the 1930s failure of the Fed to act as a lender of last resort— I 
> agree with James that the Fed did indeed expand the high-powered 
> monetary base consisting of currency plus bank reserves. But the Fed 
> failed to expand the base sufficiently to prevent (1) a 33% 
> contraction of the stock of broad money (currency plus bank deposits), 
> and (2) the failure of 10,000 banks. If this doesn’t qualify as 
> lender-of-last-resort failure on a grand scale, I don’t know what does.
>

It is in the nature of fractional-reserve banking that a central bank 
will always fall short of meeting the public's demand to redeem their 
deposits in cash during a panic.  As David Ricardo (1: 358-59) observes, 
"Against such panics, Banks have no security, /on any system/; from 
their very nature they are subject to them, as at no time can there be 
in a Bank, or in a country, so much specie or bullion [modern fiat 
currency] as the monied individuals of such country have a right to 
demand.  Should every man withdraw his balance from his banker on the 
same day, many times the quantity of Bank notes now in circulation would 
be insufficient to answer such a demand.  A panic of this kind was the 
cause of the crisis in 1797; ... Neither the Bank nor Government were at 
that time to blame; it was the contagion of the unfounded fears of the 
timid part of the community, which occasioned the run on the Bank" 
(italics original).  Walter Bagehot (Lombard Street, 1873) harps on this 
problem constantly.  It is recognition of the nature of this problem 
with a fractional-reserve banking system that prompted some, including 
Irving Fisher, to call for a 100% reserve banking, following the 
experience of 1930-33.  But it is quite misleading to argue that the Fed 
caused a 33% contraction of broad money, a variable the Fed does not, 
and cannot, control.

> In terms of the expanded equation of exchange /Bm(c,r)V = PQ /where 
> /B/ is the high-powered monetary base, /m/ the money multiplier, an 
> inverse function of the public’s desired cash/deposit ratio /c/ and 
> bankers’ desired reserve/deposit ratio /r/, /V/ is money’s circulation 
> velocity, /P/ is the price level, and /Q/ is aggregate real output, 
> both Milton Friedman and Henry Thornton agreed that the duty of the 
> lender of last resort is to maintain the velocity-augmented money 
> stock /MV/ ( where /M = Bm)/ so as to keep nominal economic activity 
> /PQ/ unchanged in financial panics and crises. Such panics are marked 
> by rises in /c/ and /r/ causing falls in the multiplier /m/. They are 
> also marked by falls in /V/ reflecting increases in the public’s 
> demand for money to hold as the safest asset. The job of the lender of 
> last resort is to expand the monetary base sufficiently to offset the 
> panic-induced falls in the multiplier and velocity so as to keep 
> economic activity /PQ/ from falling. This the Fed failed to do at the 
> start of the Great Contraction.

I am aware that Milton Friedman has made this claim.  I don't know where 
Henry Thornton does.  I believe Thornton,following David Hume (1752 "Of 
Money"), would prescribe the duty of the monetary authorities as being, 
"if possible," to increase the quantity of money in a growing economy to 
sustain the price level from falling. I doubt that he would make the 
claim that a central bank could supply as much of its notes as demanded 
in a panic to prevent the price level from falling.  In fact, he argues 
in his hypothetical example (1802, 197 n) of a "great public alarm, ... 
, as that which might be occasioned by the landing in this country of 
any considerable body of enemies, it is likely that the price of Bank of 
England notes" would rise!  The 1935 Bank Act freed the Fed from the 40% 
backing of its notes by gold; the US also had left the Gold Standard in 
1933.  The establishment of the FDIC in 1934 cured the public's fears 
over the security of their deposits with banks and the runs ceased.  
Price deflation ended and the economy began its recovery.

We miss learning the right lessons from classical monetary analysis by 
adopting the Keynesian version.

James Ahiakpor

-- 
James C.W. Ahiakpor, Ph.D.
Professor
Department of Economics
California State University, East Bay
Hayward, CA 94542
510-885-3137
510-885-7175 (Fax; Not Private)