"Crisis Chronicles: The British Export Bubble of 1810 and Pegged versus Floating Exchange Rates"

From the Federal Reserve Bank of New York's Liberty Street Economics blog:

In the early 1800s, Napoleon’s plan to defeat Britain was to destroy its ability to trade. The plan, however, was initially foiled. After Britain helped the Portuguese government flee Napoleon in 1807, the Portuguese returned the favor by opening Brazil to British exports—a move that caused trade to boom. In addition, Britain was able to circumvent Napoleon’s continental blockade by means of a North Sea route through the Baltics, which provided continental Europe with a conduit for commodities from the Americas. But when Britain’s trade via the North Sea was interrupted in 1810, the boom ended in crisis. In this edition of Crisis Chronicles, we explore the British Export Bubble of 1810 and ask whether pegged or floating exchange rates are better for an economy.

The Credit of the Kingdom
As we noted in a previous post on the collapse of the French assignat, England had been at war with France since 1793. While public expenditures to finance the war mounted, revenue remained stagnant and, as the budget deficit widened, the pound began to depreciate. In 1797, the landing of a French frigate in a Welsh harbor caused a minor run on the Bank of England, and bullion reserves fell so low that by May of that year, the British government passed the Bank Restriction Act to exempt the Bank of England from having to convert banknotes into specie. The act was intended to “support the public and commercial credit of the kingdom” and was to be temporary—until June—but banknotes remained inconvertible for nearly twenty-five years.

     Reflecting on the French experiment with the assignat, Lord Lansdowne, one of the most influential Whig politicians of his time, prophesied, “the fall will be slow perhaps, and gradual for a time, but it will be certain.” And as we saw with the assignat, gold disappeared from circulation and silver was scarce. The Bank of England even resorted to stamping the King’s head on Spanish dollars to maintain a circulating medium, and received permission to print lower-denomination £5 notes (the law forbade issuing lower-denomination notes).
Before the suspension of convertibility, the quantity of gold on hand constrained the Bank of England’s issuance of banknotes. But after the suspension, the Bank of England remained prudent in its issuance of banknotes and the public accepted the conversion from specie to paper without disturbance or confusion. The Bank of Ireland followed the Bank of England’s lead, as did other country banks that issued notes. And public expenditure remained relatively in check through about 1810.

British Trade with the Americas
As Spain’s influence in the Americas waned, Britain was able to do more business there, importing raw materials and exporting British manufactured goods. Then, in 1807, Napoleon demanded that Portugal join the trade boycott against the British and declare war on England. When Portugal hesitated, Napoleon's ally, Spain, allowed French troops to pass through to Portugal, where the French captured Lisbon as Portugal's royal family fled to Brazil. In exchange for Britain’s help in enabling the royal family to escape, the Portuguese granted Britain trade privileges with Brazil. Low-cost British goods found a new market that had previously been dominated by local artisans. Trade with the Americas not only rescued Britain from Napoleon's continental boycott, but also helped the country achieve record exports from 1808 to 1810.

“Intercourse with the Continent”
Over time, however, the record exports led to speculation, and when trade between Holland and Britain was briefly interrupted as France’s attempts to blockade the North Sea ports intensified, access to the continental market was cut off and prices of colonial goods fell in England, even though they remained costly on the continent. The economic boom ended with a severe crisis in July and August 1810 as Britain experienced a number of commercial failures and merchant bankruptcies. The crisis spread to West Indian merchants, who then dragged down the bankers who had extended credit to them. As trade declined, West Indian docks remained stuffed with goods awaiting export. But by the summer of 1811, the crisis subsided. ...MORE