The Daily Reckoning Australia » david ricardo

David Ricardo’s Economic Theory is Sound Doctrine

William Rees-Mogg — Thu, 02 Apr 2009 00:01:29 +0000

David Ricardo's Principles of Political Economy and Taxation was first published by John Murray in 1817 and remained the classic statement of economic theory for at least a hundred years. It is always wise to look at Ricardo's doctrine when faced with a new economic situation. Two quotations from the Principles seem particularly relevant at the present time. The first concerns the difficulties caused by excess debt, if it reaches the point of reducing the future freedom of action of a government:

"If, on the breaking out of any future war, we shall not have very considerably reduced our debt, one of two things must happen, either the whole expense of that war must be defrayed by taxes raised from year to year, or we must, at the end of that war, if not before, submit to a national bankruptcy; not that we shall be unable to bear any large additions to the debt; it would be difficult to set limits to the powers of a great nation; but assuredly there are limits to the price, which in the form of perpetual taxation, individuals will submit to pay for the privilege merely of living in their nation country." (Ricardo, Principles, Ed. Straffa, p.249).

Gordon Brown has no intention of embarking on a new war, though he has defence commitments in Afghanistan, but he has failed to foresee that a large deficit makes it more difficult to support future deficits. They will be harder to meet by borrowing and they will result in levels of taxation which will discourage enterprise and possibly lead to migration.

On page 356 there is the statement on which the nineteenth century gold standard was based:
"Experience, however, shows that neither a State nor a Bank ever have had the unrestricted power of issuing paper money, without abusing that power; in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issues of paper money to the obligation of paying their notes, either in gold or bullion."

Under the gold standard, national governments had to regulate the issue of money by the discipline of convertibility into gold. William Stanley Jevons published his book on Money in 1873 - 58 years after Ricardo. He quotes Daniel Webster's observation about the U.S.: "We have suffered more from paper money than from every other cause or calamity. It has killed and caused more injustice than even the arms and artifices of our enemy." Jevons also observes, in his own right: The principle objections to "inconvertible paper currency are two in number,. 1. The great temptations which it offers to over issue and consequent depreciation. 2. The impossibility of varying its importance in accordance with the requirements of trade."

The essential qualification of an exchange system in classical Ricardian economic theory is therefore one of convertibility. The value of a currency is determined by its relative scarcity, and its relative scarcity is determined by its convertibility at a fixed rate into a fixed commodity; the Victorian economists regarded gold as the most convenient commodity, and the one which had the nearest to a stable rate of production.

There is a growing feeling that the present economic crisis requires a stabilisation of national currencies against some sort of world currency. The Chinese Government is interested in a world currency system such as Maynard Keynes advocated at Bretton Woods in 1944. The Russians have called for a partial restoration of a gold based system. In The Daily Telegraph of March 30th, Ambrose Evans-Pritchard reports that Arkady Dvorkevich, the Kremlin's Chief Economic Adviser, has stated that Russia "favours the inclusion of gold bullion in the basket-weighting of a new gold currency based on 'Special Drawing Rights' issued by the International Monetary Fund."

Historically, the world has moved in the course of a century from the pre-1914 gold standard, which was a system of classical discipline based on convertibility into gold, through a succession of floating rates, with the ultimate American convertibility into gold broken in 1971. As Jevons observed, an inconvertible floating paper money is in practice extremely liable to over-issue, leading to inflation. In the absence of convertibility at a fixed rate, a currency degenerates into mere paper. The Russians are the second largest gold producer, and are also major oil and gas producers. Naturally, they would like gold to play a part in any bundle of assets on which a new world currency might be based. We are in an early stage of a new exchange debate. What is interesting is that the debate has started with big power participation from China and Russia.

William Rees-Mogg
for The Daily Reckoning Australia

David Ricardo is the Dominant British Economist of the Nineteenth Century

William Rees-Mogg — Fri, 12 Dec 2008 00:30:44 +0000

David Ricardo is the dominant British economist of the nineteenth century, just as Adam Smith was the dominant economist of the eighteenth century, or Maynard Keynes of the twentieth century. Ricardo can be regarded as the father of monetary economics just as Adam Smith was the father of free market theory. From the early nineteenth century until the Great Depression of the 1930s, Ricardo was the authoritative figure; he represented the classic theory.

However, the classic theory broke down in the period between 1914 and 1933, in which period it failed to develop a satisfactory doctrine of war economics, failed to prevent the post war inflations in the defeated countries, particularly Germany, failed the foresee or prevent the Great Depression, and failed to maintain the Gold Standard. Before 1914, orthodoxy meant Ricardian theory and Ricardian finance. The Great Depression destroyed the Gold Standard and undermined the authority of the classic school.

That would not necessarily have surprised Ricardo himself. He had been a Government loan broker on a scale almost comparable to the Rothschild family, during the period of the Napoleonic War, and had raised millions of pounds for the British struggle against Napoleonic France. He had experienced the 1797 suspension of convertibility by the Bank of England. The 1797 panic was partly caused by the fear of a French invasion; it led to demand for gold from citizens who did not trust the banks and were afraid that the invasion might mean that bank notes could no longer be cashed in terms of gold.

Ricardo, in various writings, makes it quite clear that he thought that the banks could never have complete security against a panic of this kind. He argued, as it is again being argued today, that banks can never have enough cash in their balance sheets to provide for the cashing of all deposits. Banking depends upon lending more money than the banks will ever have in their vaults. To this point, Ricardian economics have remained current orthodoxy.

Nevertheless, the controversy in Britain seems again to be centred on the differences between Ricardo and Keynes. David Cameron, the leader of the Opposition, is not keen to be described as a Ricardian, presumably because Ricardo died nearly two hundred years ago, but his rejection of stimulus through Government debt would have seemed orthodox to 19th century Ricardians. An earlier Conservative leader, Ted Heath – the man who took Britain into Europe - dismissed Ricardo on the grounds that he died a hundred and fifty years ago. Politicians believe that even the logic of money becomes redundant with time.

The Labour Party have adopted Maynard Keynes as their champion in the battle of deceased economists, and use his powerful name as a cover for their policy of borrowing and spending in order to restart the British economy. Other interesting economists, either American like Irving Fisher or Austrian like Schumpeter, have become recruits to one side or the other, to inflation or stabilisation, to stimulus or sound finance. The international Central Banking community has also been split, with Germany, like the British Conservatives, supporting sound money, and France, like the British Labour Party, supporting stimulus. The United States, both Republicans and Democrats, are Keynesian, as are the Federal Reserve, Britain and France. The European Central Banks, Germany, the British Conservatives and China can be described as Ricardian.

It all depends on what one is trying to achieve. The left want – as who would not? – to reflate the world economy. The right – if one can call them the right – want to stabilise the world economy. Both sides nominally accept that their aim is to restore confidence. The left believe that large injections will restore confidence, by making money and credit plentiful. The right believe that confidence depends on a return to sound finance and sound national balance sheets. In the argument one can see the case for Keynes and the case for Ricardo. The Keynesian Budget produced by Gordon Brown and Alistair Darling cut VAT for 2009, but promised to restore it to its present level in 2010. That will provide a little extra cash for the market place in 2009, but lowers the expectation for 2010. That is not good Keynesianism. Maynard Keynes managed wartime finance in the Second World War by managing expectations. I fear that one cannot play around with Budget deficits in an arbitrary manner without rational expectations being damaged. One cannot have a surplus of debt by gratuitously cutting the Government’s revenue.

William Rees-Mogg
For The Daily Reckoning Australia