Financial instability and bank liquidity in the classical theory of money

In opposition to the quantity theory, the classical monetary theory proposes one principle of regulation for each kind of issue—specie, convertible bank issue, and inconvertible paper. Furthermore, the contribution of Thomas Tooke, John Stuart Mill and John Fullarton shows that, if competition in banking creates the appearance of market discipline through the adverse clearing mechanism, the expectation of scarcity in some specific goods, securities or real estate markets, in which the prospects of gain are considerable, leads to a speculative process. Thence, the problem is not competitive banking activity per se, but the intertwining of the credit system and finance. By ruling out the long-standing and misleading association with the quantity theory or the real bills doctrine, we can appropriately reconsider the classical monetary theory on bank liquidity and finance.