Money and the Mechanism of Exchange
The Bank of England and the Money Market
We commenced the study of money with the barter of ordinary commodities, and money appeared in the first place as some common commodity handed about as a medium of exchange. By degrees, however, the subject assumed a greater and greater degree of complexity. The metals took the place of other commodities as currency, and delicate considerations began to enter concerning token and standard coins. From metallic representative money, we passed to paper representative money, and finally discovered that, by the cheque and clearing system, metallic money was almost eliminated from the internal exchanges of the country. Pecuniary transactions now present themselves in the form of a room full of accountants, hastily adding up sums of money. But we must never forget that all the figures in the books of a bank represent gold, and every creditor can demand the payment of the metal. In the ordinary state of trade no one cares to embarrass himself with a quantity of precious metal, which is both safer and more available in the vaults of a bank. But in international trade, gold and silver are still the media by which balances of indebtedness must be paid, and serious consequences may arise from any disproportion between the amount of transactions carried on, and the basis of gold upon which they are settled.
Expansion of Trade.
No one doubts that in the last thirty years there has been an immense expansion in the trade of this and most other countries. If, as is very commonly done, we take the foreign trade as a test of the general advance of industry, we find that the total declared real value of British and Irish produce exported from the United Kingdom was, in 1846, about 58 millions sterling. In 1866 it amounted to 189 millions, or more than three times as much. In the mean time the bank-note circulation had remained almost unchanged, and such alteration as there was, consisted in a decrease. The total circulation of bank-notes, English, Scotch, and Irish, was, in 1846, 39 millions, and in 1866, 38½ millions. I believe, however, that the best test of the progress of trade, both internal and external, is furnished by the out-put of coal, the mainspring of our wealth. Now, in 1854 the total quantity of coal raised was about 65 millions of tons, and the note currency 38 millions; in 1866 the coal raised had increased to 101½ millions of tons, or by 56 per cent., while the note currency still remained almost as before, namely, 38½ millions. Between 1866 and 1874, indeed, there was a remarkable increase in the circulation, the amount of which rose to £43,912,000, or by 14 per cent., but the production of coal had in the mean time risen to 127 millions, an increase, compared with 1854, of 95 per cent.
Competition of Bankers.
It is quite apparent, therefore, that the tendency is to carry on a greater and greater trade upon an amount of metallic currency which does not grow in anything like the same proportion. The system of banking, too, grows more perfect in the sense of increasing the economy with which money is used. The competition of many great banks, leads them to transact the largest possible business with the smallest reserves which they can venture to retain. Some of these banks pay dividends of from 20 to 25 per cent, which can only be possible by using large deposits in a very fearless manner. Even the reserves consist not so much of actual coins or bank-notes in the vaults, as of money employed at call in the Stock Exchange, or deposited in the Bank of England, which again lends the deposits out to a certain extent.
Now the larger the trade which is carried on, the larger will be the occasional demand for gold to make foreign payments; and if the stock of gold kept in London be growing comparatively smaller and smaller, the greater will be the difficulty in meeting the demand from time to time. Such is, I believe, the whole secret of the growing instability and delicacy of the money market in this country. There is a larger and larger quantity of claims for gold, and comparatively less gold to meet them, so that every now and then there is a natural difficulty in paying claims, and the rate of interest has to be suddenly raised to induce those who have gold to lend it, or to induce those who were demanding it to forego their claims for a time. Most people, it is true, attribute all these troubles, either to the much-abused gentlemen who meet weekly in the parlour of the Bank of England, or to Sir Robert Peel, who established the note issue of the Bank upon the partial deposit system already described (p. 222).
The Bank Charter Act of 1844.
At all times, during the last two hundred years, there has been some currency topic upon the anvil. In early days it was the scarcity of silver coin, the South Sea Bubble, or the price of the guinea. Later on came the restriction of specie payments, the bullion report, the one-pound note question, and the joint stock banks. Since 1844, however, all currency theorists have concentrated their attentions upon the Bank Charter Act of that year, and, while endlessly differing about the nature of the remedy, have been unanimous in attributing all kinds of evils to a settlement of our currency, which I believe to be a monument of sound and skilful financial legislation.
The Acts of 1844 and 1845 placed a fixed limit upon the amount of notes which can in this country be issued without an equal deposit of gold. At present (April, 1875) the Bank of England can issue, without gold, fifteen millions; the private and joint stock banks of England are individually restricted to fixed amounts, which, added together, make about £6,460,000, while the Scotch banks can, in a similar manner, issue notes to the amount of £2,750,000, and the Irish banks to the amount of £6,350,000, making in all about 30½ millions. In addition to this the Bank of England, and the Scotch and Irish banks, can issue as many more notes as they have deposits of bullion or coin; and in the year 1874, the extra amount thus issued was about 14½ millions. Let it be never forgotten, that no restriction is thus placed upon the sum total of the currency of the country; for the original legal tender of the country is the coined sovereign of 123.274 grains of gold, and every one who has the gold can readily turn it into sovereigns. The objectors to the Bank Charter Act urge that we want more currency, but they cannot really mean more metallic currency. We must not look to changes in the law to increase the amount of specie in the country, and, as I have remarked, any one can get sovereigns if he has the needful gold. This metal, again, is only to be had, in the absence of gold mines, by that state of foreign trade which brings it, and does not drain it away again. The principal currency, in short, must be regarded as a commodity, the supply of which is to be left to the natural action of the laws of supply and demand. The unrestricted issue of paper representative notes produces an artificial interference with these natural conditions.
The Free-banking School.
What the currency theorists want, then, is not more gold, but more promises to pay gold. The Free-banking School especially argue that it is among the elementary rights of an individual to make promises, and that each banker should be allowed to issue as many notes as he can get his customers to take, keeping such a reserve of metallic money, as he thinks, in his own private discretion, sufficient to enable him to redeem his promises. But this free issue of paper representative money does not at all meet the difficulty of the money market, which is a want of gold, not of paper; an the contrary, an unlimited issue of paper would tend to reduce the already narrow margin of gold upon which we erect an enormous system of trade. Here we reach the critical point of the whole theory of currency. There is also a school of currency writers, formerly represented in England by Ricardo and Tooke, who hold that it is impossible to over-issue convertible paper money. Arguments to this effect have been recently urged with great ability by Mr. R. H. Inglis Palgrave, in his work entitled "Notes on Banking," and his wide acquaintance with the subject should lend much force to his opinions. But there is, to my mind, an evident flaw in their position.
Possibility of Over-issue.
When prices are at a certain level, and trade in a quiescent state, a single banker is, no doubt, unable to put into circulation more than a certain quantity of bank-notes. He cannot produce a greater effect upon the whole currency than a single purchaser can by his sales or purchases produce upon the market for corn or cotton. But a number of bankers, all trying to issue additional notes, resemble a number of merchants offering to sell corn for future delivery, and the value of gold will be affected as the price of corn certainly is. We are too much accustomed to look upon the value of gold as a fixed datum line in commerce; but, in reality, it is a very variable thing. The tables of prices analysed by me in the Statistical Journal for June, 1865, show that between 1822 and 1825 there was an average rise of prices to the amount of 17 per cent.; and between 1844 and 1847, and 1852 and 1857, the average rises were respectively 13 and 31 per cent. Such variations of prices mean that the value of gold is itself altered in the inverse ratio; and these variations are produced mainly by extensions of credit. Every one who promises to pay gold on a future day, thereby increases the anticipated supply of gold, and there is no limit to the amount of gold which can thus be thrown upon the market. Every one who draws a bill or issues a note, unconsciously acts as a "bear" upon the gold market. Everything goes well, and apparent prosperity falls upon the whole community, so long as these promises to pay gold can be redeemed or replaced by new promises. But the rise of prices thus produced turns the foreign exchanges against the country, and creates a balance of indebtedness which must be paid in gold. The basis of the whole fabric of credit slips away, and produces that sudden collapse known as a commercial crisis.
Now, what is true of credit generally, is still more true of the special form of credit involved in bank promissory notes. These purport to be payable in gold coin on demand, so that they are taken by every one as equivalent to the coin. Even bills of exchange can be paid in notes, and as regards internal trade, no difficulty would be felt in maintaining credit so long as promises to pay gold circulate instead of gold. But foreigners will not hold such promises on the same footing; and, if the exchanges are against us, the metallic, not the paper, part of the currency will go abroad. It is at this moment that bankers will find no difficulty in expanding their issues, because many persons have claims to meet in gold, and the notes are regarded as gold. The notes will thus conveniently fill up the void occasioned by the exportation of specie; prices will be kept up, prosperity will continue, the balance of foreign trade will be still against us, and the game of replacing gold by promises will go on to an unlimited extent, until it becomes actually impossible to find more gold to make necessary payments abroad.
Professor Cliffe Leslie, writing in Macmillan's Magazine for August, 1864, correctly pointed out, as I think, that speculative credit often raises prices for a time above their natural range. Representative credit, on the other hand, by which I suppose he means notes issued against the actual deposit of metal, obviously forms no augmentation of the currency, and can have no effect in raising prices above the level which would exist under a purely metallic system.
The actual exhaustion of the bullion of a country is no mere ideal event, for it is what occurred in this country in 1839, under the free system of note issue. The Bank of England had parted with almost the whole of its bullion and was only saved from bankruptcy by the ignominious expedient of a large loan from the Bank of France. The narrow limits of this book evidently restrict me from entering into historical and statistical illustrations, but it may be said, that the collapse which followed the crisis of 1839 induced severer distress and depression of trade than has ever since been known in this country. We now carry on industry and commerce many times greater than in 1839, and there is nothing to indicate that either the bank directors or the commercial classes are more cautious or farseeing than they then were. On the contrary, competition, speculation, and the bold erection of the widest affairs upon the narrowest basis of real capital is more common than ever. Knowing as we do the very narrow margin of real metal upon which our many great banks conduct their business, it is impossible to entertain for a moment the notion of allowing the paper currency of the country to rest upon the discretionary reserves of such competing bankers.
The Right of Coining Bank Notes.
According, to the view which I adopt, the issue of notes is more analogous to the royal function of coinage than to the ordinary commercial operation of drawing bills. We ought to talk of coining notes, as John Law did; for though the design is impressed on paper instead of metal, the function of the note is exactly the same as that of a representative token. As to the right to issue promises, it no more exists than the right to establish private mints. For our present purposes that alone is right which the legislature declares to be expedient to the community at large. As almost every one has long agreed to place the coinage of money in the hands of the executive government, so I believe that the issue of paper representative money should continue to be practically in the hands of the government, or its agents acting under the strictest legislative control. M. Wolowski, in his admirable works on banking, has maintained that the issue of notes is a function distinct from the ordinary operations of a banker; and Mr. Gladstone has allowed that the distinction is a wholesome and vital one. Bankers enjoy the utmost degree of freedom in this country at present, in every other point, so that it is wholly a confusion of ideas to speak of the unrestricted emission of paper representative money as a question of free banking.
Professor Sumner and others have objected to the Bank Charter Act, that it cannot be regarded as a scientific settlement of the currency question, inasmuch as no other nation had adopted the same principles. Quite lately, however, the German Imperial government has adopted the main principle of a partial deposit, adding to it the liberty of increasing the issues under a tax of 5 per cent., an arrangement which I have described under the name of the Elastic Limit System (p. 226). This provision appears to be designed to avoid the suspension of the law during times of crisis, and it is quite possible that we might with advantage introduce a similar modification into our own currency law. But the fine or tax upon the excessive issue ought surely to be much more than 5 per cent., and in this country should certainly not be less than 10 per cent.
Scotch and English Banking.
It is common, indeed, to point to the Scotch banks as a proof that a perfectly sound currency may be furnished by banks acting on their own unfettered discretion. Up to 1845, the twelve or thirteen Scotch banks certainly did possess the right of freely issuing notes down to one-pound notes, and only in one or two cases did bankruptcy occur. All this I grant, holding that Englishmen and Americans, and natives of all countries, may well admire the wonderful skill, sagacity, and caution with which Scotch bankers have developed and conducted their system. There is no doubt, too, that Scotch bankers are guiding the course of development of the banking system in England, India, the Australian colonies, and everywhere, with conspicuous success. If we were all Scotchmen, I believe the unlimited issue of one-pound notes would be an excellent measure. But when we compare the Scotch and English banking systems, we discover a profound difference. In Scotland there exist only eleven great banks, which take good care that there shall not be a twelfth great bank. The undoubted monopoly which they possess is, however, used with great moderation and wisdom, and by an immense ramification of branches (p. 258), every village has its banks, and every poor man may have his bank deposit, if he will save a few pounds. In England and Wales we have 267 private and 123 joint stock banks, or, in all, 388 banking firms, including in these numbers the London banks, but not including any of the numerous branch banks. There is, no doubt, a tendency to approximate to the Scotch system by the amalgamation of smaller banks. Still many new banks are from time to time started, and the competition between them is of the keenest character. The high dividends expected by the shareholders can only be earned by bold trading on small reserves, and every commercial man is aware that the money market is becoming more and more sensitive.
Cash Reserves of Bankers.
It is important, but very difficult to decide, what is the amount of real cash held by the bankers of the United Kingdom in readiness to meet their liabilities. Many banks publish balance-sheets professing to show the reserve of ready money. I have already remarked (pp. 248-256) upon the ambiguity which attaches to the words money and cash as commonly used; and, when we inquire into the nature of the banker's ready money, it is found to consist in a great degree of money invested in government securities, deposited with other bankers, especially the Bank of England, or held "at call," that is, lent to speculators who invest it in negotiable securities. From the published balance-sheets we thus get no indication of the real metallic reserve of the country, available for the payment of foreign debts.
Mr. R. H. Inglis Palgrave, in his important "Notes on Banking," published both in the Statistical Journal, for March, 1873 (Vol. xxxvi. p. 106), and as a separate book, has given the results of an inquiry into this subject, and states the amount of coin and Bank of England notes, held by the bankers of the United Kingdom, as not exceeding four or five per cent. of their liabilities, or from one twenty-fifth to one twentieth part. Mr. T. B. Moxon, of Stockport and Manchester, has subsequently made an elaborate inquiry into the same point, and finds that the cash reserve does not exceed about seven per cent. of the deposits and notes payable on demand. He remarks that even of this reserve a large proportion is absolutely indispensable for the daily transactions of the bankers' business, and could not be parted with. Thus the whole fabric of our vast commerce is found to depend upon the improbability that the merchants and other customers of the banks will ever want, simultaneously and suddenly, so much as one-twentieth part of the gold money which they have a right to receive on demand at any moment during banking hours.
Remedy for the Sensitiveness of the Money Market.
The present state of things in England is not to be cured by any legislation. No government can save those from trouble who will make unlimited transactions in gold, without a sure prospect of finding the gold when wanted. It is absurd to suppose that any single establishment like the Bank of England, itself becoming hardly more important than some of the great city banks, can prop up the whole fabric of English commerce.
The only measure which can restore stability to the London market, or prevent it from becoming more and more sensitive, is to secure by some means the existence of more satisfactory cash reserves, either in actual coin, or in Bank of England notes, representing deposits of coin in the Bank vaults. It would be of comparatively little use, however, for some banks to become more prudent and self-denying, while others are allowed to stretch their resources to the utmost possible point, and outbid the more prudent banks in the rates of dividend they can pay. Combined action, therefore, seems requisite, somewhat in the manner suggested by Mr. Bagehot, as regards the city bankers.
As the Bank of England pays no interest upon the eight millions which it on the average of the last four years holds as the deposits of the London bankers, there seems to be no sufficient reason why the Bank should be allowed to make a profit out of so large a sum. If held by a committee of the depositing banks it would be equally safe, almost equally available, and might, moreover, by the investment of a portion in government stock, yield a profit to the depositors. It may be asked, Why not leave each bank to hold its own reserve in its own vaults? But there would then be no security against some banks running their reserves dangerously low, and trusting to extrinsic aid in times of difficulty. One objection which I should make to the scheme as put forth is, that government stock should not be allowed to form any part of the ultimate reserve. When loanable capital is very scarce, such stock can only be converted into actual bullion by forced sales which depreciate the funds, shock public confidence, and drain away money from those who would in some other channel have employed it in the money market. Unless government stocks be sent abroad, their sale cannot possibly increase the stock of gold in the country. A cash reserve ought to be composed of cash, and although it may be very convenient to bankers to use this word in a loose and ambiguous manner, it ought not to mean, in speaking of the ultimate reserves of the country, anything but gold coin or bullion, or warrants, actually issued against coin or bullion, on the deposit system previously considered.
It has been pointed out, moreover, in an able article in the Bankers' Magazine for February, 1875, that the proposed scheme would be very insufficient if carried out merely by a narrow circle of city bankers. The association should include, in one way or another, all the more important banks in the three kingdoms. The vast trade of the country cannot be placed upon a sound basis until the force of public opinion among bankers imposes upon each member the necessity of holding a cash reserve bearing a fair proportion to the liabilities incurred. It matters little who holds the reserve, provided it actually does exist in the form of metal, and is not evaporated away by being placed at call, or deposited with other banks which make free use of it. In the absence of some common action among bankers, it is certain that the sensitiveness of the money market will increase, and it is probable that commercial crises will from time to time recur, even exceeding in their violence and disastrous consequences those whose history we know too well.
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