6. We must now consider the effect of Paper Money, or an Inconvertible Paper Currency, on the Foreign Exchanges and the Market Price of bullion. So long as Paper is convertible, that is, so long as the holder of it has power to demand payment of it at sight, it is very clear that it cannot circulate at a discount, because, if it fell to a discount, every person who held it would immediately go and demand gold for it. But if while it is in circulation, the power of convertibility is taken away, then it becomes, in all respects, equivalent to a new standard, just as much as gold and silver, and its value will be affected by the same principles, i.e. by the sole question of the quantity of it in circulation, compared to the operations it represents.

Under the old system of attempting to fix the price of gold and silver relatively to each other, there was no power of convertibility of one into the other similar to the convertibility of the note. If silver fell to a discount as compared with gold, no person could demand as a right to have their silver exchanged for gold: consequently the inevitable result of a considerable change in the quantity of either metal was a change in their market values. Thus in 1794, gold rose to 84s. if purchased with silver bullion: now if, speaking by analogy, the silver coin had been convertible into gold, the difference never could have arisen, any more than a bank note, convertible at the will of the holder of it, could circulate at a discount.

Now Paper, when issued as a substantive Coinage, follows exactly the same rules: if only the usual quantity of it is issued, i.e. no greater quantity than would have been issued if it were convertible into specie, it will continue to circulate at its par value; but if these issues be continued, and if it be deprived of the natural corrector of an over-issue, viz. payment on demand, and it is maintained in circulation, exactly the same result follows as attends an excessive issue of silver - it falls to a discount.

Now the silver coin may fall to a discount from two circumstances: either if silver be coined with too great profuseness, the excessive quantity of it will diminish its value, even though the coin be of full weight: or if the silver coin be suffered to fall into a degraded state by clipping and wearing, so that it does not contain the full legal weight of bullion, it then becomes depreciated. The apparent result in figures will be just the game in either case: guineas will rise to 24s. or 30s. But as silver has general value, and is, from its qualities, a recognised measure of value, it is not correct to apply the term depreciation to it as long as the coin contains its full legal weight of bullion. But the case is different with Paper: it is only received on account of bearing a promise to pay a certain quantity of bullion on the face of it: and if it is not able to fulfil that promise it is depreciated.

Now if, for the public convenience, it is deemed advisable to issue Paper Money, or an Inconvertible Paper Currency, the only way of maintaining its currency at par is by limiting its quantity. We do not mean by this by limiting its quantity to. an absolute fixed amount, but by devising some means whereby a greater quantity of it shall not be issued than if it were convertible into gold. If more than this be issued, it will be followed by the same result as attends an excessive issue of silver, it will fall to a discount, which in this case is depreciation: and the necessary consequences of a Depreciated Currency will follow, viz. the Market Price (or Paper Price) of bullion will rise above the Mint Price and the Foreign Exchanges will fall.

Now if such a state of things happens, the proper remedy is to diminish the quantity of the Paper in circulation until the Market Price of bullion is reduced to the level of the Mint Price. If the power of demanding five sovereigns be taken away from the holder of a £5 note, still if he can purchase bullion with it in the market to the amount of five sovereigns, it is of course a proof that the Note is current at par: and the limitation need not proceed beyond that. But if this be not done the next best thing is to allow all persons to receive the notes at whatever value they choose to put upon them: and to let them make a difference, if they choose, between the prices of articles when paid in gold or in paper. If this be allowed no very great inconvenience will take place in the internal trade of the country. It is entirely by adopting judicious measures to limit the quantity of notes in circulation that the Bank of France has preserved its notes at par although they are inconvertible.

But suppose that the law makes it a crime to make a difference between paper and gold and a punishable offence to give twenty pounds in gold for twenty-five pounds in paper - what will be the consequence? Exactly the same as we have seen happen when the silver and gold coins were improperly rated, the one which was underrated disappeared from circulation. This has happened both in the case of gold coin and silver coin. Now when Paper Money is issued in too great abundance, and has a tendency to overflow the channel of circulation, its natural effect is to raise prices when paid in it. If people were free in their transactions, they would gradually make a difference in price between payments in paper and payments in bullion: but if the owners of the coin are prevented by law from receiving more for it than the same nominal sum in paper, they will do exactly the same thing as is invariably done when in a metallic currency, part is depreciated and part is of full weight - they will either hoard or export it. At all events it will disappear from circulation. As the gold gradually disappears and Paper issues multiply, people begin to estimate all prices by the Paper price, and the Paper ends by finally displacing the entire gold Coinage.

The convertibility of the Coin into the legal amount of bullion is the test of the depreciation of the Metallic Currency: so the convertibility of the Note into Coin is the test of the depreciation of the Note. When Paper becomes the standard of Currency the Market Price of bullion means the Price of it paid in Paper Money, or the Paper Price of it, and it is clear that if the Paper Price of bullion rises above the Mint Price it is the proof and the measure of the Depreciation of the Paper Currency.

Whenever the Currency of a country becomes redundant, that is to say when prices are raised so much higher in one country than in its neighbours, that the value of money sensibly diminishes, the natural corrective for such a state of things is to take a certain portion of it out of circulation, so that by diminishing the quantity of it its value may be raised. When people find that the same quantity of gold will not purchase an equal amount of commodities in this country as they will in another, their own natural instincts will lead them to purchase commodities abroad where they are cheap, and bring them for sale here where they are dear. The natural instincts of trade will, therefore, produce an equilibrium in value in the currency of neighbouring countries.

When the Currency of a country consists partly of paper and partly of gold and silver, it is quite clear that only the metallic portion of it can be exported in payment of foreign commodities. The paper portion of it, which has no value abroad, must remain at home. If the issues of paper be continued so as to prevent the Currency from recovering its value, the process of the exportation of the metallic portion will go on until it is entirely exhausted. If this be the case, the only method of restoring the Currency to its par value is by diminishing the quantity of the paper, until the drain is stopped by the enhancement of the value of the whole Currency. Some persons used to maintain that as the gold goes out, paper should be issued to supply the vacuum until the gold comes back. But it requires little sagacity to see that if that be done the gold never will come back again, and the drain will not cease until it is totally exhausted, and the only way to bring it back again is to raise its value at home, which can be done only by removing the plethora of paper.

We have seen that with bullion, the Rate of Exchange can never continue very long above or below the cost of transmitting bullion : but the Nominal Exchange can vary to any amount according to the Depreciation of the Coinage. The very same effect follows an excessive issue of Paper Money; and it may fall to any amount of Depreciation. And just as the rise of the Paper Price of bullion above the Mint Price shews the Depreciation of the Paper, so the same thing will manifestly cause a fall of the Foreign Exchange below the limits of the Real Exchange.