Lombard Street: A Description of the Money Market

Chapter II

A General View of Lombard Street

I

The objects which you see in Lombard Street, and in that money world which is grouped about it, are the Bank of England, the Private Banks, the Joint Stock Banks, and the bill brokers. But before describing each of these separately we must look at what all have in common, and at the relation of each to the others.

The distinctive function of the banker,—says Ricardo, ‘begins as soon as he uses the money of
others;’ as long as he uses his own money he is only a capitalist. Accordingly all the banks in Lombard Street (and bill brokers are for this purpose only a kind of bankers) hold much money belonging to other people on running account and on deposit. In continental language, Lombard Street is an organization of credit, and we are to see if it is a good or bad organization in its kind, or if, as is most likely, it turn out to be mixed, what are its merits and what are its defects?

The main point on which one system of credit differs from another is ‘soundness.’ Credit means that a certain confidence is given, and a certain trust reposed. Is that trust justified? and is that confidence wise? These are the cardinal questions. To put it more simply—credit is a set of promises to pay; will those promises be kept? Especially in banking, where the ‘liabilities,’ or promises to pay, are so large, and the time at which to pay them, if exacted, is so short, an instant capacity to meet engagements is the cardinal excellence.

All which a banker wants to pay his creditors is a sufficient supply of the
legal tender of the country, no matter what that legal tender may be. Different countries differ in their laws of legal tender, but for the primary purposes of banking these systems are not material. A good system of currency will benefit the country, and a bad system will hurt it. Indirectly, bankers will be benefited or injured with the country in which they live; but practically, and for the purposes of their daily life, they have no need to think, and never do think, on theories of currency. They look at the matter simply. They say ‘I am under an obligation to pay such and such sums of legal currency; how much have I in my till, or have I at once under my command, of that currency?’ In America, for example, it is quite enough for a banker to hold ‘greenbacks,’ though the value of these changes as the Government chooses to enlarge or contract the issue.
*7 But a practical New York banker has no need to think of the goodness or badness of this system at all; he need only keep enough ‘greenbacks’ to pay all probable demands, and then he is fairly safe from the risk of failure.

By the law of England the legal tenders are gold and silver coin (the last for small amounts only), and Bank of England notes. But the number of our attainable bank notes is not, like American ‘greenbacks,’ dependent on the will of the State; it is limited by the provisions of the Act of 1844. That Act separates the Bank of England into two halves. The Issue Department only issues notes, and can only issue 15,000,000
l. on Government securities;
*8 for all the rest it must have bullion deposited. Take, for example an account, which may be considered an average specimen of those of the last few years—that for the last week of 1869:—

There are here 15,000,000
l. bank notes issued on securities, and 18,288,640
l. represented by bullion. The Bank of England has no power by law to increase the currency in any other manner.
*9 It holds the stipulated amount of securities, and for all the rest it must have bullion. This is the ‘cast iron’ system—the ‘hard and fast’ line which the opponents of the Act say ruins us, and which the partisans of the Act say saves us. But I have nothing to do with its expediency here. All which is to my purpose is that our paper ‘legal tender,’ our bank notes, can only be obtained in this manner. If, therefore, an English banker retains a sum of Bank of England notes or coin in due proportion to his liabilities, he has a sufficient amount of the legal tender of this country, and he need not think of anything more.

But here a distinction must be made. It is to be observed that properly speaking we should not include in the ‘reserve’ of a bank ‘legal tenders,’ or cash, which the Bank keeps to transact its daily business. That is as much a part of its daily stock-in-trade as its desks or offices; or at any rate, whatever words we may choose to use, we must carefully distinguish between this cash in the till which is wanted every day, and the
safety-fund, as we may call it, the special reserve held by the bank to meet extraordinary and unfrequent demands.

What then, subject to this preliminary explanation, is the amount of legal tender held by our bankers against their liabilities? The answer is remarkable, and is the key to our whole system. It may be broadly said that no bank in London or out of it holds any considerable sum in hard cash or legal tender (above what is wanted for its daily business) except the Banking Department of the Bank of England.
*10 That department had on the 29th day of December, 1869, liabilities as follows:

and a cash reserve of 11,297,000
l.*11 And this is all the cash reserve, we must carefully remember, which, under the law, the Banking Department of the Bank of England—as we cumbrously call it the Bank of England for banking purposes—possesses. That department can no more multiply or manufacture bank notes than any other bank can multiply them. At that particular day the Bank of England had only 11,297,000
l. in its till against liabilities of nearly three times the amount. It had ‘Consols’ and other securities which it could offer for sale no doubt, and which, if sold, would augment its supply of bank notes—and the relation of such securities to real cash will be discussed presently; but of real cash, the Bank of England for
this purpose—the banking bank—had then so much and no more.

And we may well think this a great deal, if we examine the position of other banks. No other bank holds any amount of substantial importance in its own till beyond what is wanted for daily purposes. All London banks keep their principal reserve on deposit at the Banking Department of the Bank of England. This is by far the easiest and safest place for them to use. The Bank of England thus has the responsibility of taking care of it. The same reasons which make it desirable for a private person to keep a banker make it also desirable for every banker, as respects his reserve, to bank with another banker if he safely can. The custody of very large sums in solid cash entails much care, and some cost; everyone wishes to shift these upon others if he can do so without suffering. Accordingly, the other bankers of London, having perfect confidence in the Bank of England, get that bank to keep their reserve for them.

The London bill brokers do much the same. Indeed, they are only a special sort of bankers who allow daily interest on deposits, and who for most of their money give security. But we have no concern now with these differences of detail. The bill brokers lend most of their money, and deposit the remnant either with the Bank of England or some London banker. That London banker lends what he chooses of it, the rest he leaves at the Bank of England. You always come back to the Bank of England at last.

But those who keep immense sums with a banker gain a convenience at the expense of a danger. They are liable to lose them if the bank fail. As all other bankers keep their banking reserve at the Bank of England, they are liable to fail if it fails. They are dependent on the management of the Bank of England in a day of difficulty and at a crisis for the spare money they keep to meet that difficulty and crisis. And in this there is certainly considerable risk. Three times ‘Peel’s Act’ has been suspended because the Banking Department was empty. Before the Act was broken—

In fact, in none of those years could the Banking Department of the Bank of England have survived if the law had not been broken.

Nor must it be fancied that this danger is unreal, artificial, and created by law. There is a risk of our thinking so, because we hear that the danger can be cured by breaking an Act; but substantially the same danger existed before the Act. In 1825, when only coin was a legal tender, and when there was only one department in the Bank, the Bank had reduced its reserve to 1,027,000
l., and was within an ace of stopping payment.

But the danger to the depositing banks is not the sole or the principal consequence of this mode of keeping the London reserve. The main effect is to cause the reserve to be much smaller in proportion to the liabilities than it would otherwise be. The reserve of the London bankers being on deposit in the Bank of England, the Bank always lends a principal part of it. Suppose, a favourable supposition, that the Banking Department holds more than two-fifths of its liabilities in cash—that it lends three-fifths of its deposits and retains in reserve only two-fifths. If then the aggregate of the bankers’ deposited reserve be 5,000,000
l., 3,000,000
l. of it will be lent by the Banking Department, and 2,000,000
l. will be kept in the till. In consequence, that 2,000,000
l. is all which is really held in actual cash as against the liabilities of the depositing banks. If Lombard Street were on a sudden thrown into liquidation, and made to pay as much as it could on the spot, that 2,000,000
l. would be all which the Bank of England could pay to the depositing banks, and consequently all, besides the small cash in the till, which those banks could on a sudden pay to the persons who have deposited with them.

We see then that the banking reserve of the Bank of England some 10,000,000
l.*12 on an average of years now, and formerly much less—is all which is held against the liabilities of Lombard Street; and if that were all, we might well be amazed at the immense development of our credit system—in plain English, at the immense amount of our debts payable on demand, and the smallness of the sum of actual money which we keep to pay them if demanded. But there is more to come. Lombard Street is not only a place requiring to keep a reserve, it is itself a place where reserves are kept. All country bankers keep their reserve in London. They only retain in each country town the minimum of cash necessary to the transaction of the current business of that country town. Long experience has told them to a nicety how much this is, and they do not waste capital and lose profit by keeping more idle. They send the money to London, invest a part of it in securities, and keep the rest with the London bankers and the bill brokers. The habit of Scotch and Irish bankers is much the same. All their spare money is in London, and is invested as all other London money now is; and, therefore, the reserve in the Banking Department of the Bank of England is the banking reserve not only of the Bank of England, but of all London—and not only of all London, but of all England, Ireland, and Scotland too.

Of late there has been a still further increase in our liabilities. Since the Franco-German war, we may be said to keep the European reserve also. Deposit Banking is indeed so small on the Continent, that no large reserve need be held on account of it. A reserve of the same sort which is needed in England and Scotland is not needed abroad. But all great communities have at times to pay large sums in cash, and of that cash a great store must be kept somewhere. Formerly there were two such stores in Europe, one was the Bank of France, and the other the Bank of England. But since the suspension of specie payments by the Bank of France, its use as a reservoir of specie is at an end. No one can draw a cheque on it and be sure of getting gold or silver for that cheque. Accordingly the whole liability for such international payments in cash is thrown on the Bank of England.
*13 No doubt foreigners cannot take from us
our own money; they must send here ‘value’ in some shape or other for all they take away. But they need not send ‘cash;’ they may send good bills and discount them in Lombard Street and take away any part of the produce, or all the produce, in bullion. It is only putting the same point in other words to say that all exchange operations are centering more and more in London. Formerly for many purposes Paris was a European settling-house, but now it has ceased to be so. The note of the Bank of France has not indeed been depreciated enough to disorder ordinary transactions. But any depreciation, however small—even the liability to depreciation without its reality—is enough to disorder exchange transactions. They are calculated to such an extremity of fineness that the change of a decimal may be fatal, and may turn a profit into a loss. Accordingly London has become the sole great settling-house of exchange transactions in Europe, instead of being formerly one of two.
*14 And this pre-eminence London will probably maintain, for it is a natural pre-eminence. The number of mercantile bills drawn upon London incalculably surpasses those drawn on any other European city; London is the place which receives more than any other place, and pays more than any other place, and therefore it is the natural ‘clearing house.’ The pre-eminence of Paris partly arose from a distribution of political power, which is already disturbed; but that of London depends on the regular course of commerce, which is singularly stable and hard to change.

Now that London is the clearing-house to foreign countries, London has a new liability to foreign countries. At whatever place many people have to make payments, at that place those people must keep money. A large deposit of foreign money in London is now necessary for the business of the world. During the immense payments from France to Germany, the sum
in transitu—the sum in London—has perhaps been unusually large. But it will ordinarily be very great. The present political circumstances no doubt will soon change. We shall soon hold in Lombard Street far less of the money of foreign governments; but we shall hold more and more of the money of private persons; for the deposit at a clearing-house necessary to settle the balance of commerce must tend to increase as that commerce itself increases.

And this foreign deposit is evidently of a delicate and peculiar nature. It depends on the good opinion of foreigners, and that opinion may diminish or may change into a bad opinion. After the panic of 1866, especially after the suspension of Peel’s Act (which many foreigners confound with a suspension of cash payments), a large amount of foreign money was withdrawn from London. And we may reasonably presume that in proportion as we augment the deposits of cash by foreigners in London, we augment both the chances and the disasters of a ‘run’ upon England.

And if that run should happen, the bullion to meet it must be taken from the Bank. There is no other large store in the country. The great exchange dealers may have a little for their own purposes, but they have no store worth mentioning in comparison with this. If a foreign creditor is so kind as to wait his time and buy the bullion as it comes into the country, he may be paid without troubling the Bank or distressing the money market. The German Government has recently been so kind; it was in no respect afraid. But a creditor who takes fright will not wait, and if he wants bullion in a hurry he must come to the Bank of England.

In consequence all our credit system depends on the Bank of England for its security. On the wisdom of the directors of that one Joint Stock Company, it depends whether
England shall be solvent or insolvent. This may seem too strong, but it is not. All banks depend on the Bank of England, and all merchants depend on some banker. If a merchant have 10,000
l. at his bankers, and wants to pay it to some one in Germany, he will not be able to pay it unless his banker can pay him, and the banker will not be able to pay if the Bank of England should be in difficulties and cannot produce his ‘reserve.’

The directors of the Bank are, therefore, in fact, if not in name, trustees for the public, to keep a banking reserve on their behalf; and it would naturally be expected either that they distinctly recognized this duty and engaged to perform it, or that their own self-interest was so strong in the matter that no engagement was needed. But so far from there being a distinct undertaking on the part of the Bank directors to perform this duty, many of them would scarcely acknowledge it, and some altogether deny it. Mr. Hankey, one of the most careful and most experienced of them, says in his book on the Bank of England, the best account of the practice and working of the Bank which anywhere exists—’I do not intend here to enter at any length on the subject of the general management of the Bank, meaning the Banking Department, as the principle upon which the business is conducted does not differ, as far as I am aware, from that of any well-conducted bank in London.’ But, as anyone can see by the published figures, the Banking Department of the Bank of England keeps as a great reserve in bank notes and coin between 30 and 50 per cent. of its liabilities, and the other banks only keep in bank notes and coin the bare minimum they need to open shop with. And such a constant difference indicates, I conceive, that the two are
not managed on the same principle.

The practice of the Bank has, as we all know, been much and greatly improved. They do not now manage like the other Banks in Lombard Street. They keep an altogether different kind and quantity of reserve; but though the practice is mended the theory is not. There has never been a distinct resolution passed by the Directors of the Bank of England, and communicated by them to the public, stating even in the most general manner, how much reserve they mean to keep or how much they do not mean, or by what principle in this important matter they will be guided.

The position of the Bank directors is indeed most singular. On the one side a great city opinion—a great national opinion, I may say, for the nation has learnt much from many panics—requires the directors to keep a large reserve. The newspapers, on behalf of the nation, are always warning the directors to keep it, and watching that they do keep it; but, on the other hand, another less visible but equally constant pressure pushes the directors in exactly the reverse way, and inclines them to diminish the reserve.

This is the natural desire of all directors to make a good dividend for their shareholders. The more money lying idle the less,
cæteris paribus, is the dividend; the less money lying idle the greater is the dividend. And at almost every meeting of the proprietors of the Bank of England, there is a conversation on this subject. Some proprietor says that he does not see why so much money is kept idle, and hints that the dividend ought to be more.

Indeed, it cannot be wondered at that the Bank proprietors do not quite like their position. Theirs is the oldest bank in the City, but their profits do not increase, while those of other banks most rapidly increase. In 1844, the dividend on the stock of the Bank of England was 7 per cent., and the price of the stock itself 212; the dividend now is 9 per cent., and the price of the stock 232. But in the same time the shares of the London and Westminster Bank, in spite of an addition of 100 per cent. to the capital, have risen from 27 to 66, and the dividend from 6 per cent. to 20 per cent.
*15 That the Bank proprietors should not like to see other companies getting richer than their company is only natural.

Some part of the lowness of the Bank dividend, and of the consequent small value of Bank stock, is undoubtedly caused by the magnitude of the Bank capital; but much of it is also due to the great amount of unproductive cash—of cash which yields no interest—that the Banking Department of the Bank of England keeps lying idle. If we compare the London and Westminster Bank—which is the first of the joint-stock banks in the public estimation and known to be very cautiously and carefully managed—with the Bank of England, we shall see the difference at once. The London and Westminster has only 13 per cent. of its liabilities lying idle. The Banking Department of the Bank of England has over 40 per cent.
*16 So great a difference in the management must cause, and does cause, a great difference in the profits. Inevitably the shareholders of the Bank of England will dislike this great difference; more or less, they will always urge their directors to diminish (as far as possible) the unproductive reserve, and to augment as fall as possible their own dividend.

In most banks there would be a wholesome dread restraining the desire of the shareholders to reduce the reserve; they would fear to impair the credit of the bank. But fortunately or unfortunately, no one has any fear about the Bank of England. The English world at least believes that it will not, almost that it
cannot, fail. Three times since 1844 the Banking Department has received assistance, and would have failed without it. In 1825, the entire concern almost suspended payment; in 1797, it actually did so. But still there is a faith in the Bank, contrary to experience, and despising evidence. No doubt in every one of these years the condition of the Bank, divided or undivided, was in a certain sense most sound; it could
ultimately have paid all its creditors all it owed, and returned to its shareholders all their own capital. But ultimate payment is not what the creditors of a bank want; they want present, not postponed, payment; they want to be repaid according to agreement; the contract was that they should be paid on demand, and if they are not paid on demand they may be ruined. And that instant payment, in the years I speak of, the Bank of England certainly could not have made. But no one in London ever dreams of questioning the credit of the Bank, and the Bank never dreams that its own credit is in danger. Somehow everybody feels the Bank is sure to come right. In 1797, when it had scarcely any money left, the Government said not only that it need not pay away what remained, but that it
must not. The ‘effect of letters of licence’ to break Peel’s Act has confirmed the popular conviction that the Government is close behind the Bank, and will help it when wanted. Neither the Bank nor the Banking Department have ever had an idea of being put ‘into liquidation;’ most men would think as soon of ‘winding up’ the English nation.

Since then the Bank of England, as a bank, is exempted from the perpetual apprehension that makes other bankers keep a large reserve—the apprehension of discredit—it would seem particularly necessary that its managers should be themselves specially interested in keeping that reserve, and specially competent to keep it. But I need not say that the Bank directors have not their personal fortune at stake in the management of the Bank. They are rich City merchants, and their stake in the Bank is trifling in comparison with the rest of their wealth. If the Bank
were wound up, most of them would hardly in their income feel the difference. And what is more, the Bank directors are not trained bankers; they were not bred to the trade, and do not in general give the main power of their minds to it. They are merchants, most of whose time and most of whose real mind are occupied in making money in their own business and for themselves.

It might be expected that as this great public duty was cast upon the Banking Department of the Bank, the principal statesmen (if not Parliament itself) would have enjoined on them to perform it. But no distinct resolution of Parliament has ever enjoined it; scarcely any stray word of any influential statesman. And, on the contrary, there is a whole
catena of authorities, beginning with Sir Robert Peel and ending with Mr. Lowe,
*17 which say that the Banking Department of the Bank of England is only a Bank like any other bank—a Company like other companies; that in this capacity it has no peculiar position, and no public duties at all. Nine-tenths of English statesmen, if they were asked as to the management of the Banking Department of the Bank of England, would reply that it was no business of theirs or of Parliament at all; that the Banking Department alone must look to it.

The result is that we have placed the exclusive custody of our entire banking reserve in the hands of a single board of directors not particularly trained for the duty—who might be called ‘amateurs,’—who have no particular interest above other people in keeping it undiminished—who acknowledge no obligation to keep it undiminished—who have never been told by any great statesman or public authority that they are so to keep it or that they have anything to do with it—who are named by and are agents for a proprietary which would have a greater income if it
was diminished,—who do not fear, and who need not fear, ruin, even if it were all gone and wasted.

That such an arrangement is strange must be plain; but its strangeness can only be comprehended when we know what the custody of a national banking reserve means, and how delicate and difficult it is.

II

Such a reserve as we have seen is kept to meet sudden and unexpected demands. If the bankers of a country are asked for much more than is commonly wanted, then this reserve must be resorted to. What then are these extra demands? and how is this extra reserve to be used? Speaking broadly, these extra demands are of two kinds—one from abroad to meet foreign payments requisite to pay large and unusual foreign debts, and the other from at home to meet sudden apprehension or panic arising in any manner, rational or irrational.

No country has ever been so exposed as England to a foreign demand on its banking reserve, not only because at present England is a large borrower from foreign nations, but also (and much more) because no nation has ever had a foreign trade of such magnitude, in such varied objects, or so ramified through the world. The ordinary foreign trade of a country requires no cash; the exports on one side balance the imports on the other. But a sudden trade of import like the import of foreign corn after a bad harvest—or (what is much less common, though there are cases of it) the cessation of any great export, causes a balance to become due, which must be paid in cash.

Now, the only source from which large sums of cash can be withdrawn in countries where banking is at all developed, is a ‘bank reserve.’ In England especially, except a few sums of no very considerable amount held by bullion dealers in the course of their business, there are no sums worth mentioning in cash out of the banks; an ordinary person could hardly pay a serious sum without going to some bank, even if he spent a month in trying. All persons who wish to pay a large sum in cash trench of necessity on the banking reserve. But then what is ‘cash?’ Within a country the action of a Government can settle the quantity, and therefore the value, of its currency; but outside its own country, no Government can do so. Bullion is the ‘cash’ of international trade; paper currencies are of no use there, and coins pass only as they contain more or less bullion.

When then the legal tender of a country is purely metallic, all that is necessary is that banks should keep a sufficient store of that ‘legal tender.’ But when the ‘legal tender’ is partly metal and partly paper, it is necessary that the paper ‘legal tender’—the bank note—should be convertible into bullion. And here I should pass my limits, and enter on the theory of Peel’s Act if I began to discuss the conditions of convertibility. I deal only with the primary pre-requisite of effectual foreign payments—a sufficient supply of the local legal tender; with the afterstep—the change of the local legal tender into the universally acceptable commodity—I cannot deal.

What I have to deal with is, for the present, ample enough. The Bank of England must keep a reserve of ‘legal tender’ to be used for foreign payments if itself fit, and to be used in obtaining bullion if itself unfit. And foreign payments are sometimes very large, and often very sudden. The ‘cotton drain,’ as it is called—the drain to the East to pay for Indian cotton during the American Civil War—took many millions from this country for a series of years. A bad harvest must take millions in a single year. In order to find such great sums, the Bank of England requires the steady use of an effectual instrument.

That instrument is the elevation of the rate of interest. If the interest of money be raised, it is proved by experience that money
does come to Lombard Street, and theory shows that it
ought to come. To fully explain the matter I must go deep into the theory of the exchanges, but the general notion is plain enough. Loanable capital, like every other commodity, comes where there is most to be made of it. Continental bankers and others instantly send great sums here, as soon as the rate of interest shows that it can be done profitably. While English credit is good, a rise of the value of money in Lombard Street immediately by a banking operation brings money to Lombard Street. And there is also a slower mercantile operation. The rise in the rate of discount acts immediately on the trade of this country. Prices fall here; in consequence imports are diminished, exports are increased, and, therefore, there is more likelihood of a balance in bullion coming to this country after the rise in the rate than there was before.

Whatever persons—one bank or many banks—in any country hold the banking reserve of that country, ought at the very beginning of an unfavourable foreign exchange at once to raise the rate of interest, so as to prevent their reserve from being diminished farther, and so as to replenish it by imports of bullion.

This duty, up to about the year 1860, the Bank of England did not perform at all, as I shall show farther on. A more miserable history can hardly be found than that of the attempts of the Bank—if indeed they can be called attempts—to keep a reserve and to manage a foreign drain between the year 1819 (when cash payments were resumed by the Bank, and when our modern Money Market may be said to begin) and the year 1857. The panic of that year for the first time taught the Bank directors wisdom, and converted them to sound principles. The present policy of the Bank is an infinite improvement on the policy before 1857: the two must not be for an instant confounded; but nevertheless, as I shall hereafter show, the present policy is now still most defective, and much discussion and much effort will be wanted before that policy becomes what it ought to be.

A domestic drain is very different. Such a drain arises from a disturbance of credit within the country, and the difficulty of dealing with it is the greater, because it is often caused, or at least often enhanced, by a foreign drain. Times without number the public have been alarmed mainly because they saw that the Banking reserve was already low, and that it was daily getting lower. The two maladies—an external drain and an internal—often attack the money market at once. What then ought to be done?

In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of everyone is the contrary. There being a large demand on a fund which you want to preserve, the most obvious way to preserve it is to hoard it—to get in as much as you can, and to let nothing go out which you can help. But every banker knows that this is not the way to diminish discredit. This discredit means, ‘an opinion that you have not got any money,’ and to dissipate that opinion, you must, if possible, show that you have money: you must employ it for the public benefit in order that the public may know that you have it. The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.

Ordinarily discredit does not at first settle on any particular bank, still less does it at first concentrate itself on the bank or banks holding the principal cash reserve. These banks are almost sure to be those in best credit, or they would not be in that position, and, having the reserve, they are likely to look stronger and seem stronger than any others. At first, incipient panic amounts to a kind of vague conversation: Is A. B. as good as he used to be? Has not C. D. lost money? and a thousand such questions. A hundred people are talked about, and a thousand think, ‘Am I talked about, or am I not?’ ‘Is my credit as good as it used to be, or is it less?’ And every day, as a panic grows, this floating suspicion becomes both more intense and more diffused; it attacks more persons; and attacks them all more virulently than at first. All men of experience, therefore, try to ‘strengthen themselves,’ as it is called, in the early stage of a panic; they borrow money while they can; they come to their banker and offer bills for discount, which commonly they would not have offered for days or weeks to come. And if the merchant be a regular customer, a banker does not like to refuse, because if he does he will be said, or may be said, to be in want of money, and so may attract the panic to himself. Not only merchants but all persons under pecuniary liabilities—present or imminent—feel this wish to ‘strengthen themselves,’ and in proportion to those liabilities. Especially is this the case with what may be called the auxiliary dealers in credit. Under any system of banking there will always group themselves about the main bank or banks (in which is kept the reserve) a crowd of smaller money dealers, who watch the minutæ of bills, look into special securities which busy bankers have not time for, and so gain a livelihood. As business grows, the number of such subsidiary persons augments. The various modes in which money may be lent have each their peculiarities, and persons who devote themselves to one only lend in that way more safely, and therefore more cheaply. In time of panic, these subordinate dealers in money will always come to the principal dealers. In ordinary times, the intercourse between the two is probably close enough. The little dealer is probably in the habit of pledging his ‘securities’ to the larger dealer at a rate less than he has himself charged, and of running into the market to lend again. His time and brains are his principal capital, and he wants to be always using them. But in times of incipient panic, the minor money dealer always becomes alarmed. His credit is never very established or very wide; he always fears that he may be the person on whom current suspicion will fasten, and often he is so. Accordingly he asks the larger dealer for advances. A number of such persons ask all the large dealers—those who have the money—the holders of the reserve. And then the plain problem before the great dealers comes to be ‘How shall we best protect ourselves? No doubt the immediate advance to these second-class dealers is annoying, but may not the refusal of it even be dangerous? A panic grows by what it feeds on; if it devours these second-class men, shall we, the first class, be safe?’

A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harman, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.’ After a day or two of this treatment, the entire panic subsided, and the ‘City’ was quite calm.

The problem of managing a panic must not be thought of as mainly a ‘banking’ problem. It is primarily a mercantile one. All merchants are under liabilities; they have bills to meet soon, and they can only pay those bills by discounting bills on other merchants. In other words, all merchants are dependent on borrowing money, and large merchants are dependent on borrowing much money. At the slightest symptom of panic many merchants want to borrow more than usual; they think they will supply themselves with the means of meeting their bills while those means are still forthcoming. If the bankers gratify the merchants, they must lend largely just when they like it least; if they do not gratify them, there is a panic.

On the surface there seems a great inconsistency in all this. First, you establish in some bank or banks a certain reserve; you make of it or them a kind of ultimate treasury, where the last shilling of the country is deposited and kept. And then you go on to say that this final treasury is also to be the last lending-house; that out of it unbounded, or at any rate immense, advances are to be made when no one else lends. This seems like saying—first, that the reserve should be kept, and then that it should not be kept. But there is no puzzle in the matter. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An ‘alarm’ is an opinion that the money of certain persons will not pay their creditors when those creditors want to be paid. If possible, that alarm is best met by enabling those persons to pay their creditors to the very moment. For this purpose only a little money is wanted. If that alarm is not so met, it aggravates into a panic, which is an opinion that most people, or very many people, will not pay their creditors; and this too can only be met by enabling all those persons to pay what they owe, which takes a great deal of money. No one has enough money, or anything like enough, but the holders of the bank reserve.

Not that the help so given by the banks holding that reserve necessarily diminishes it. Very commonly the panic extends as far, or almost as far, as the bank or banks which hold the reserve, but does not touch it or them at all. In this case it is enough if the dominant bank or banks, so to speak, pledge their credit for those who want it. Under our present system it is often quite enough that a merchant or a banker gets the advance made to him put to his credit in the books of the Bank of England; he may never draw a cheque on it, or, if he does, that cheque may come in again to the credit of some other customer, who lets it remain on his account. An increase of loans at such times is often an increase of the liabilities of the bank, not a diminution of its reserve. Just so before 1844, an issue of notes, as in 1825, to quell a panic entirely internal did not diminish the bullion reserve. The notes went out, but they did not return. They were issued as loans to the public, but the public wanted no more; they never presented them for payment; they never asked that sovereigns should be given for them. But the acceptance of a great liability during an augmenting alarm, though not as bad as an equal advance of cash, is the thing next worst. At any moment the cash
may be demanded. Supposing the panic to grow, it
will be demanded, and the reserve will be lessened accordingly.

No doubt all precautions may, in the end, be unavailing. ‘On extraordinary occasions,’ says Ricardo, ‘a general panic may seize the country, when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realising or concealing his property,—against such panic banks have no security
on any system.’ The bank or banks which hold the reserve may last a little longer than the others; but if apprehension pass a certain bound, they must perish too. The use of credit is, that it enables debtors to use a certain part of the money their creditors have lent them. If all those creditors demand all that money at once, they cannot have it, for that which their debtors have used, is for the time employed, and not to be obtained. With the advantages of credit we must take the disadvantages too; but to lessen them as much as we can, we must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm.

The management of the Money Market is the more difficult, because, as has been said, periods of internal panic and external demand for bullion commonly occur together. The foreign drain empties the Bank till, and that emptiness, and the resulting rise in the rate of discount, tend to frighten the market. The holders of the reserve have, therefore, to treat two opposite maladies at once—one requiring stringent remedies, and especially a rapid rise in the rate of interest; and the other, an alleviative treatment with large and ready loans.

Before we had much specific experience, it was not easy to prescribe for this compound disease; but now we know how to deal with it. We must look first to the foreign drain, and raise the rate of interest as high as may be necessary. Unless you can stop the foreign export, you cannot allay the domestic alarm. The Bank will get poorer and poorer, and its poverty will protract or renew the apprehension. And at the rate of interest so raised, the holders—one or more—of the final Bank reserve must lend freely. Very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain. Any notion that money is not to be had, or that it may not be had at any price, only raises alarm to panic and enhances panic to madness. But though the rule is clear, the greatest delicacy, the finest and best skilled judgment, are needed to deal at once with such great and contrary evils.

And great as is the delicacy of such a problem in all countries, it is far greater in England now than it was or is elsewhere. The strain thrown by a panic on the final bank reserve is proportional to the magnitude of a country’s commerce, and to the number and size of the dependent banks—banks, that is, holding no cash reserve—that are grouped around the central bank or banks. And in both respects our system causes a stupendous strain. The magnitude of our commerce, and the number and magnitude of the banks which depend on the Bank of England, are undeniable. There are very many more persons under great liabilities than there are, or ever were, anywhere else. At the commencement of every panic, all persons under such liabilities try to supply themselves with the means of meeting those liabilities while they can. This causes a great demand for new loans. And so far from being able to meet it, the bankers who do not keep an extra reserve at that time borrow largely, or do not renew large loans—very likely do both.

London bankers, other than the Bank of England, effect this in several ways. First, they have probably discounted bills to a large amount for the bill brokers, and if these bills are paid, they decline discounting any others to replace them. The directors of the London and Westminster Bank had, in the panic of 1857, discounted millions of such bills, and they justly said that if those bills were paid they would have an amount of cash far more than sufficient for any demand.
*18 But how were those bills to be paid? Some one else must lend the money to pay them. The mercantile community could not on a sudden bear to lose so large a sum of borrowed money; they have been used to rely on it, and they could not carry on their business without it. Least of all could they bear it at the beginning of a panic, when everybody wants more money than usual. Speaking broadly, those bills can only be paid by the discount of other bills. When the bills (suppose) of a Manchester warehouseman which he gave to the manufacturer become due, he cannot, as a rule, pay for them at once in cash; he has bought on credit, and he has sold on credit. He is but a middleman. To pay his own bill to the maker of the goods, he must discount the bills he has received from the shopkeepers to whom he has sold the goods; but if there is a sudden cessation in the means of discount, he will not be able to discount them. All our mercantile community must obtain new loans to pay old debts. If some one else did not pour into the market the money which the banks like the London and Westminster Bank take out of it, the bills held by the London and Westminster Bank could not be paid.

Who then is to pour in the new money? Certainly not the bill brokers. They have been used to re-discount with such banks as the London and Westminster millions of bills, and if they see that they are not likely to be able to re-discount those bills, they instantly protect themselves and do not discount them. Their business does not allow them to keep much cash unemployed. They give interest for all the money deposited with them—an interest often nearly approaching the interest they can charge; as they can only keep a small reserve a panic tells on them more quickly than on anyone else. They stop their discounts, or much diminish their discounts, immediately. There is no new money to be had from them, and the only place at which they can have it is the Bank of England.

There is even a simpler case: the banker who is uncertain of his credit, and wants to increase his cash, may have money on deposit at the bill brokers. If he wants to replenish his reserve, he may ask for it, suppose, just when the alarm is beginning. But if a great number of persons do this very suddenly, the bill brokers will not at once be able to pay without borrowing. They have excellent bills in their case, but these will not be due for some days; and the demand from the more or less alarmed bankers is for payment at once and to-day. Accordingly the bill broker takes refuge at the Bank of England—the only place where at such a moment new money is to be had.

The case is just the same if the banker wants to sell Consols, or to call in money lent on Consols. These he reckons as part of his reserve. And in ordinary times nothing can be better. According to the saying, you ‘can sell Consols on a Sunday.’ In a time of no alarm, or in any alarm affecting that particular banker only, he can rely on such reserve without misgiving. But not so in a general panic. Then, if he wants to sell 500,000
l. worth of Consols, he will not find 500,000
l. of fresh money ready to come into the market. All ordinary bankers are wanting to sell, or thinking they may have to sell. The only resource is the Bank of England. In a great panic, Consols cannot be sold unless the Bank of England will advance to the buyer, and no buyer can obtain advances on Consols at such a time unless the Bank of England will lend to him.

The case is worse if the alarm is not confined to the great towns, but is diffused through the country. As a rule, country bankers only keep so much barren cash as is necessary for their common business. All the rest they leave at the bill brokers, or at the interest-giving banks, or invest in Consols and such securities. But in a panic they come to London and want this money. And it is only from the Bank of England that they can get it, for all the rest of London want their money for themselves.

If we remember that the liabilities of Lombard Street payable on demand are far larger than those of any like market, and that the liabilities of the country are greater still, we can conceive the magnitude of the pressure on the Bank of England when both Lombard Street and the country suddenly and at once come upon it for aid. No other bank was ever exposed to a demand so formidable, for none ever before kept the banking reserve for such a nation as the English.

The mode in which the Bank of England meets this great responsibility is very curious. It unquestionably does make enormous advances in every panic—

But, on the other hand, as we have seen, though the Bank, more or less, does its duty, it does not distinctly acknowledge that it is its duty. We are apt to be solemnly told that the Banking Department of the Bank of England is only a bank like other banks—that it has no peculiar duty in times of panic—that it then is to look to itself alone, as other banks look. And there is this excuse for the Bank. Hitherto questions of banking have been so little discussed in comparison with questions of currency, that the duty of the Bank in time of panic has been put on a wrong ground.

It is imagined that because bank notes are a legal tender, the Bank has some peculiar duty to help other people. But bank notes are only a legal tender at the Issue Department, not at the Banking Department, and the accidental combination of the two departments in the same building gives the Banking Department no aid in meeting a panic. If the Issue Department were at Somerset House, and if it issued Government notes there, the position of the Banking Department under the present law would be exactly what it is now. No doubt, formerly the Bank of England could issue what it pleased, but that historical reminiscence makes it no stronger now that it can no longer so issue. We must deal with what is, not with what was.

And a still worse argument is also used. It is said that because the Bank of England keeps the ‘State account’ and is the Government banker, it is a sort of ‘public institution’ and ought to help everybody. But the custody of the taxes which have been collected and which wait to be expended is a duty quite apart from panics. The Government money may chance to be much or little when the panic comes. There is no relation or connection between the two. And the State, in getting the Bank to keep what money it may chance to have, or in borrowing of it what money it may chance to want, does not hire it to stop a panic or much help it if it tries.

The real reason has not been distinctly seen. As has been already said—but on account of its importance and perhaps its novelty it is worth saying again—whatever bank or banks keep the ultimate banking reserve of the country must lend that reserve most freely in time of apprehension, for that is one of the characteristic uses of the bank reserve, and the mode in which it attains one of the main ends for which it is kept. Whether rightly or wrongly, at present and in fact the Bank of England keeps our ultimate bank reserve, and therefore it must use it in this manner.

And though the Bank of England certainly do make great advances in time of panic, yet as they do not do so on any distinct principle, they naturally do it hesitatingly, reluctantly, and with misgiving. In 1847, even in 1866—the latest panic, and the one in which on the whole the Bank acted the best—there was nevertheless an instant when it was believed the Bank would not advance on Consols, or at least hesitated to advance on them. The moment this was reported in the City and telegraphed to the country, it made the panic indefinitely worse. In fact, to make large advances in this faltering way is to incur the evil of making them without obtaining the advantage. What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.

In truth, the Bank do not lend from the motives which should make a bank lend. The holders of the Bank reserve ought to lend at once and most freely in an incipient panic, because they fear destruction in the panic. They ought not to do it to serve others; they ought to do it to serve themselves. They ought to know that this bold policy is the only safe one, and for that reason they ought to choose it. But the Bank directors are not afraid. Even at the last moment they say that ‘whatever happens to the community, they can preserve themselves.’ Both in 1847 and 1857 (I believe also in 1866, though there is no printed evidence of it) the Bank directors contended that the Banking Department was quite safe though its reserve was nearly all gone, and that it could strengthen itself by selling securities and by refusing to discount. But this is a complete dream. The Bank of England could not sell ‘securities,’ for in an extreme panic there is no one else to buy securities. The Bank cannot stay still and wait till its bills are paid, and so fill its coffers, for unless it discounts equivalent bills, the bills which it has already discounted will not be paid. When the reserve in the ultimate bank or banks—those keeping the reserve—runs low, it cannot be augmented by the same means that other and dependent banks commonly adopt to maintain their reserve, for the dependent banks trust that at such moments the ultimate banks will be discounting more than usual and lending more than usual. But ultimate banks have no similar rear-guard to rely upon.

I shall have failed in my purpose if I have not proved that the system of entrusting all our reserve to a single board, like that of the Bank directors, is very anomalous; that it is very dangerous; that its bad consequences, though much felt, have not been fully seen; that they have been obscured by traditional arguments and hidden in the dust of ancient controversies.

But it will be said—What would be better? What other system could there be? We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size. In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without.

I shall be at once asked—Do you propose a revolution? Do you propose to abandon the one-reserve system, and create anew a many-reserve system? My plain answer is that I do not propose it. I know it would be childish. Credit in business is like loyalty in Government. You must take what you can find of it, and work with it if possible. A theorist may easily map out a scheme of Government in which Queen Victoria could be dispensed with. He may make a theory that, since we admit and we know that the House of Commons is the real sovereign, any other sovereign is superfluous; but for practical purposes, it is not even worth while to examine these arguments. Queen Victoria is loyally obeyed—without doubt, and without reasoning—by millions of human beings. If those millions began to argue, it would not be easy to persuade them to obey Queen Victoria, or anything else. Effectual arguments to convince the people who need convincing are wanting. Just so, an immense system of credit, founded on the Bank of England as its pivot and its basis, now exists. The English people, and foreigners too, trust it implicitly. Every banker knows that if he has to
prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone: but what we have requires no proof. The whole rests on an instinctive confidence generated by use and years. Nothing would persuade the English people to abolish the Bank of England; and if some calamity swept it away, generations must elapse before at all the same trust would be placed in any other equivalent. A many-reserve system, if some miracle should put it down in Lombard Street, would seem monstrous there. Nobody would understand it, or confide in it. Credit is a power which may grow, but cannot be constructed. Those who live under a great and firm system of credit must consider that if they break up that one they will never see another, for it wrn take years upon years to make a successor to it.

On this account, I do not suggest that we should return to a natural or many-reserve system of banking. I should only incur useless ridicule if I did suggest it. Nor can I propose that we should adopt the simple and straightforward expedient by which the French have extricated themselves from the same difficulty. In France all banking rests on the Bank of France, even more than in England all rests on the Bank of England. The Bank of France keeps the final banking reserve, and it keeps the currency reserve too. But the State does not trust such a function to a board of merchants, named by shareholders. The nation itself—the Executive Government—names the governor and deputy-governor of the Bank of France. These officers have, indeed, beside them a council of
‘régents,’ or directors, named by the shareholders. But they need not attend to that council unless they think fit; they are appointed to watch over the national interest, and, in so doing, they may disregard the murmurs of the
‘régents’ if they like. And in theory, there is much to be said for this plan. The keeping the single banking reserve being a national function, it is at least plausible to argue that Government should choose the functionaries. No doubt such a political intervention is contrary to the sound economical doctrine that ‘banking is a trade, and only a trade.’ But Government forgot that doctrine when, by privileges and monopolies, it made a single bank predominant over all others, and established the one-reserve system. As that system exists, a logical Frenchman consistently enough argues that the State should watch and manage it. But no such plan would answer in England. We have not been trained to care for logical sequence in our institutions, or rather we have been trained not to care for it. And the practical result for which we do care would in this case be bad. The governor of the Bank would be a high Parliamentary official, perhaps in the Cabinet, and would change as chance majorities and the strength of parties decide. A trade peculiarly requiring consistency and special attainment would be managed by a shifting and untrained ruler. In fact, the whole plan would seem to an Englishman of business palpably absurd; he would not consider it, he would not think it worth considering. That it works fairly well in France, and that there are specious arguments of theory for it, would not be sufficient to his mind.

All such changes being out of the question, I can propose only three remedies.

First. There should be a clear understanding between the Bank and the public that, since the Bank hold our ultimate banking reserve, they will recognise and act on the obligations which this implies;—that they will replenish it in times of foreign demand as fully, and lend it in times of internal panic as freely and readily, as plain principles of banking require.

This looks very different from the French plan, but it is not so different in reality. In England we can often effect, by the indirect compulsion of opinion, what other countries must effect by the direct compulsion of Government. We can do so in this case. The Bank directors now fear public opinion exceedingly; probably no kind of persons are so sensitive to newspaper criticism. And this is very natural. Our statesmen, it is true, are much more blamed, but they have generally served a long apprenticeship to sharp criticism. If they still care for it (and some do after years of experience much more than the world thinks), they care less for it than at first, and have come to regard it as an unavoidable and incessant irritant, of which they shall never be rid. But a bank director undergoes no similar training and hardening. His functions at the Bank fill a very small part of his time; all the rest of his life (unless he be in Parliament) is spent in retired and mercantile industry. He is not subjected to keen and public criticism, and is not taught to bear it. Especially when once in his life he becomes, by rotation, governor, he is most anxious that the two years of office shall ‘go off well.’ He is apt to be irritated even by objections to principles on which he acts, and cannot bear with equanimity censure which is pointed and personal. At present I am not sure if this sensitiveness is beneficial. As the exact position of the Bank of England in the Money Market is indistinctly seen, there is no standard to which a Bank governor can appeal. He is always in fear that ‘something may be said;’ but not quite knowing on what side that ‘something’ may be, his fear is but an indifferent guide to him. But if the cardinal doctrine were accepted, if it were acknowledged that the Bank is charged with the custody of our sole banking reserve, and is bound to deal with it according to admitted principles, then a governor of the Bank could look to those principles. He would know which way criticism was coming. If he was guided by the code, he would have a plain defence. And then we may be sure that old men of business would not deviate from the code. At present the Board of Directors are a sort of
semi-trustees for the nation. I would have them real trustees, and with a good trust deed.

Secondly. The government of the Bank should be improved in a manner to be explained. We should diminish the ‘amateur’ element; we should augment the trained banking element; and we should ensure more constancy in the administration.

Thirdly. As these two suggestions are designed to make the Bank as strong as possible, we should look at the rest of our banking system, and try to reduce the demands on the Bank as much as we can. The central machinery being inevitably frail, we should carefully and as much as possible diminish the strain upon it.

But to explain these proposals, and to gain a full understanding of many arguments that have been used, we must look more in detail at the component parts of Lombard street, and at the curious set of causes which have made it assume its present singular structure.