Karl Marx to Friedrich Engels
in Manchester
London, 3 February 1851

13 February. 1851.
Dear Engels,

Are you studying physiology with Mary or elsewhere? In the first case, I understand that this is not Hebrew, not even Russian.

For the time being, my new theory of rent has brought me only the honest consciousness after which every worthy burgher necessarily strives. However, I am in any case satisfied that you are satisfied with it. The inverse relation of the fertility of the soil to human fertility could not but deeply affect a stout-loined family father like me, the more so as *mon mariage est plus productif que mon industrie*.

Now I am laying before you only an illustration of the currency theory, the study of which in my case might be characterised by Hegelians as the study of “other-being”, of the “alien”, in short of the “sacred”.

The theory of Mr Loyd and *tutti frutti* from Ricardo onwards consists in the following:

Suppose we had a purely metallic currency. If it were too full here, prices would rise, hence the export of commodities would decrease. Their import from abroad to here would increase. Imports would thus exceed exports. Hence unfavourable balance of trade. Unfavourable exchange rate. Specie would be exported, the currency would contract, commodity prices would fall, imports would decrease, exports increase, money would flow back again, in short the situation would return to the old equilibrium.

In the reverse case likewise, *mutatis mutandis*.

Moral of this: Since paper money must imitate the movements of the metallic currency, since here an artificial regulation must take the place of what in the other case is a natural law, the Bank of England must increase its note issues when bullion flows in (e.g. by purchasing government securities, Exchequer bills, etc.) and reduce them when bullion decreases, by reducing its discounts or selling government paper. I now maintain that the Bank must act in the opposite way, increase its discounts when bullion decreases, and let them take their ordinary course when it increases. On pain of unnecessarily intensifying the commercial crisis that is on the way. But more on this *une autre fois*.

What I want to set forth here concerns the elementary foundations of the matter. I maintain, namely: Even under a purely metallic currency, its quantity, its expansion and contraction, have nothing to do with the outflow and inflow of precious metals, with the favourable or unfavourable balance of trade, with the favourable or unfavourable exchange rate, except in extreme || cases, which practically never occur but are theoretically determinable. Tooke puts forward the same assertion; but I have found no proof in his *History of Prices* for 1843–47.

You see the matter is important. Firstly, the whole theory of circulation is denied in its foundation. Secondly, it is shown how the course of crises, however much the credit system is a condition of them, has to do with the currency only insofar as mad encroachments of the state power into its regulation can aggravate the existing crisis, as in 1847.

In the following illustration, note that it is assumed here: The influx of bullion is connected with brisk business, not yet high but rising prices, abundance of capital, excess of exports over imports. The outflow of gold *vice versa, mutatis mutandis*. Now this is the presupposition of the people against whom the polemic is directed. They can say nothing against it. In reality, 1001 cases can occur where gold flows out, although in the country that exports it the prices of the other commodities stand far lower than in those to which it sends gold, e.g. this was the case for England 1809–11 and 12. Etc. etc. However, the general presupposition is, firstly, correct *in abstracto*, and secondly, adopted by the currency fellows. Therefore not to be debated here for the time being.

Suppose, then, that a purely metallic currency prevails in England. But this does not presuppose that the credit system has ceased to exist. The Bank of England would rather transform itself into a deposit and loan bank at the same time. Only its loans would consist solely of ready money. If one were not prepared to make this presupposition, what appears here as deposits of the Bank of England would appear as hoards of private individuals, and what appears as loans of the same, as loans of private individuals. Thus what is said here about the deposits of the Bank of England is only an abbreviation so as not to present the process piecemeal, but concentrated in one focus.

Case I. Influx of bullion. Here the matter is very simple. Much unemployed capital, hence increase of deposits. In order to employ them, the Bank would lower its rate of interest. Hence expansion of business in the country. The circulation would only increase if business expanded enough to make an increased || amount of currency necessary for its operation. Otherwise, the currency issued in excess would flow back into the Bank again through the maturity of bills of exchange, etc. as deposits etc. The currency here, therefore, does not operate as a cause. Its increase is ultimately the consequence of the greater capital set in motion, not the reverse. In the case indicated, therefore, the immediate consequence would be growth of deposits, i.e. of unemployed capital, not of circulation.

Case II. Here the matter really begins. Export of bullion || is presupposed. Beginning of a period of pressure. Exchange rate unfavourable. In addition, bad harvest etc. (or also a rise in the price of the raw materials of industry) makes a constantly larger import of commodities necessary.

Suppose the balance sheet of the Bank of England at the beginning of such a period stood as follows:

a) Capital . . . . . . . . £14,500,000.  Government securities . . £10,000,000
   Reserve . . . . . . . .  £3,500,000.     Bills of Exchange  . . . . £12,000,000
   Deposits . . . . . . . £12,000,000.     Bullion or coin . . . . . . .  £8,000,000
                         £30,000,000                             £30,000,000

Since under the presupposition no notes exist, the Bank owes only the £12 million deposits. According to its principle (which deposit and circulation banks have in common, that they need to hold only a third of their liabilities in cash), its bullion of £8 million is too large by half. To make more profit, it lowers the rate of interest and increases its discounts by, for example, £4 million, which are exported for corn etc. The Bank’s balance sheet then stands as follows:

b) Capital . . . . . . . . £14,500,000.  Government securities . . £10,000,000
   Reserve . . . . . . . .  £3,500,000.     Bills of Exchange  . . . . £16,000,000
   Deposits . . . . . . . £12,000,000.     Bullion or coin . . . . . . .  £4,000,000
                         £30,000,000                             £30,000,000

From this figure it follows:

The merchants act first upon the bullion reserve of the Bank as soon as they have to export gold. This exported gold diminishes its reserve (that of the Bank) without affecting the currency in the slightest. Whether the £4 million lie in its vaults or in a ship bound for Hamburg is all the same for the currency. Finally, it turns out that a considerable drain of bullion, here of £4 million sterling, can take place which in no way affects either the currency or the business of the country in general. Namely, during the whole period when the bullion reserve, which was too large in relation to the liabilities, is only being reduced to its due proportion to them.

c) But suppose that the circumstances which necessitated the drain of the £4 million continue, corn shortage, rise in the price of raw cotton, etc. The Bank grows anxious about its security. It raises the rate of interest and limits its discounts. Hence pressure in the commercial world. How does this pressure work? Drawings are made on the Bank’s deposits, its bullion sinks proportionately. If the deposits sink to £9 million, i.e. diminish by £3 million, then £3 million must go off from the Bank’s bullion reserve. The latter would thus fall (4M. – 3M.) to £1 million, against deposits of £9 million. A ratio || that would become dangerous for the Bank. If it therefore wants to keep its bullion reserve at one third of the deposits, it will reduce its discounts by £2 million. The balance sheet will then stand as follows:

   Capital . . . . . . . . £14,500,000.  Government securities  . £10,000,000
   Reserve . . . . . . . .  £3,500,000.     Bills under discount . . £14,000,000
   Deposits . . . . . . .  £9,000,000.     Bullion or coin . . . . . .  £3,000,000
                         £27,000,000                             £27,000,000

It follows from this: As soon as the drain becomes so great that the bullion reserve has reached its due proportion to the deposits, the Bank raises the rate of interest and reduces the discount. But then the effect on the deposits begins, and in consequence of their diminution the reserve of bullion diminishes, but the discount of bills diminishes in a greater proportion. The currency is not in the slightest affected. One part of the withdrawn bullion and deposits fills the vacuum which the contraction of bank accommodation creates in the domestic circulation, another part goes abroad.

d) Suppose the import of corn etc. continues, deposits sink to £4,500,000, then the Bank, in order to keep the necessary reserve against its liabilities, would further reduce its discounts by £3 million and the balance sheet would stand as follows:

   Capital . . . . . . . . £14,500,000.  Government securities  . £10,000,000
   Reserve . . . . . . . .  £3,500,000.     Bills under discount . . £11,000,000
   Deposits . . . . . . .  £4,500,000.     Bullion or coin . . . . . .  £1,500,000
                         £22,500,000                             £22,500,000

Under the presupposition, the Bank had reduced its discounts from £16 to £11 million, i.e. by £5 million. The necessary amount of circulation is replaced by the withdrawn deposits. But at the same time, shortage of capital, high price of raw materials, decrease of demand and therefore of business, hence finally of the circulation, of the necessary currency. The surplus part of it would be sent abroad as bullion for payment of the import. The currency is affected only at the end, and it would only be reduced beyond its necessary quantity when the bullion reserve is reduced beyond the most necessary proportion to the deposits.

To the above, the following remarks:

1) Instead of reducing its discounts, the Bank could sell its public securities, which under the presupposition would be unprofitable. However, the result is the same. Instead of its own reserve and discounts, it would reduce those of private individuals who put their money into the public securities.

2) I have here presupposed a drain on the Bank of £6,500,000. In 1839, one of £9–10 million took place.

3) The presupposed process with a purely metallic currency can, as with paper, proceed to the closing of the till, as happened twice in Hamburg in the 18th century.

Write soon.

Yours,
K. M.