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visibility: hidden;} + + /* ]]> */ </style> +</head> + +<body> +<div style='text-align:center'>*** START OF THE PROJECT GUTENBERG EBOOK 75730 ***</div> + +<div class="section"> +<h1>THE WAR AND OUR FINANCIAL FABRIC</h1> +<hr class="chap x-ebookmaker-drop"> +<div> </div> +</div> + +<div class="section center vspace wspace"> +<p class="xxlarge"> +THE WAR AND OUR<br> +<span class="gesperrt1">FINANCIAL FABRIC</span></p> + +<p class="p2"><span class="small">BY</span><br> +<span class="larger">WALTER WILLIAM WALL, F.J.I.</span></p> + +<p class="xsmall novspace">FELLOW OF THE ROYAL STATISTICAL SOCIETY<br> +AUTHOR OF “BRITISH RAILWAY FINANCE,” ETC.</p> + +<p class="p4 larger"><span class="smaller">LONDON</span><br> +CHAPMAN & HALL, <span class="smcap">Ltd.</span><br> +<span class="smaller">1915</span> +</p> +<hr class="chap x-ebookmaker-drop"> +<div> </div> +</div> + +<div class="chapter"> +<p><span class="pagenum" id="Page_v">v</span></p> + +<h2 class="nobreak" id="PREFACE">PREFACE</h2> +</div> + +<p class="in0"><span class="firstword">In</span> this work I attempt to gather up some of the +lessons to be learnt from the experiences of the +greatest of financial crises. Many predictions have +been unrealized and many theories destroyed, and we +are able, I think, to see with greater clearness and +to grasp with more boldness the problems that perplexed +us in the past. Banking, credit and currency +problems have ever been subjects of contentious +controversy, experts and academic critics alike being +unable to agree upon their reading of phenomena +and upon right interpretations. The problems are +indisputably complex, the most complex, probably, in +the vast domain of economics, and vision and logic +have not guided us with sureness amidst their intricacies. +Hence we have groped and gone our +different ways, finding ourselves at no common goal. +Royal Commissions have been asked for in order to +tackle and, if possible, to find solutions that will be +universally acceptable. For some time before last +year’s crisis a small committee of bankers had been<span class="pagenum" id="Page_vi">vi</span> +sitting in order primarily to deal with the reserve +problem and the provision of emergency currency. +It is believed they were on the point of presenting +a scheme to deal with future crises when the sudden +outbreak of the war put an end to their labours. +Whether or not their scheme will ever be made known +to the public may depend upon future developments. +Perhaps the public may never be enlightened, for +it may now be thought that inspiration and genius +discovered the most practical solutions at the right +moments. Something had to be done swiftly. And +that which was decided upon swiftly revealed deeper +insight, maybe, than slower deliberation.</p> + +<p>This is not uncommon, however, in the career of +genius. Civilization has profited more, perhaps, from +flashes of inspiration than from uninspired controversy.</p> + +<p>In order to build up my arguments I start from +the foundation, and in the earlier chapters deal +with the monetary problem and the general working +of the banking system. These lead us into the region +of dialectics and controversy and to a survey of the +happenings during the crisis.</p> + +<p>I urge amongst other contentions that banks do +not in the true connotation of the word create credit. +If it be possible to convince ourselves that they do +not create credit, that credit is a something existing +prior to and independently of banking, it will, I +think, make the gold reserve problem easier to solve.<span class="pagenum" id="Page_vii">vii</span> +What we gaze upon is not an unsubstantial structure +called in Lombard Street “the superstructure of +credit,” but is something more solid. It is a superstructure +of wealth. All that banks do is to transform +this wealth into liquid capital, resolve it into +its constituent, or original, elements. This enables +wealth to perform its fructifying functions, to reproduce +itself, just as the mature fruit reproduces itself +when re-sown. Were the wealth to remain in its +fixed, or, as the market would say, its frozen form, +what sort of wealth-harvest could we hope to gather +from it? Unless it be made liquid it cannot flow. +And if it did not flow, but remained frozen, +sterility would result. If this transforming machinery +were not provided by banks, the Government, +on the nation’s behalf, would have to provide +it, or the nation would become inert. As there is +not, and never can be, enough legal tender coinage +for this work, other legal tender currency should be +provided.</p> + +<p>In answer to those who have ever clamoured +for high gold reserves I have endeavoured to show +the impossibility, in the present system, of this +realization. What critics have at the back of their +consciousness is, not quantity <i lang="la">per se</i>, but proportion. +They do not mean a mere counting of sovereigns, +but the ratio of an individual bank’s reserve to +its liabilities. A small bank cannot have as much +gold as a large bank, but it can have as high a<span class="pagenum" id="Page_viii">viii</span> +proportion. Now, a high proportion can be attained +only by keeping down the loan-deposits. It cannot be +attained by getting a larger quantity of gold if the +loan-deposits grow correspondingly. When banks see +these deposits rising and the proportion falling, they +cease lending, call in their loans, and allow the proportion +to rise. We then see what we fallaciously +call the loan-fund of Lombard Street diminish, +showing that the loan-fund is not in the deposits, +but in the gold reserves and in the totality of the +wealth in the keeping of the banks at any given +moment.</p> + +<p>When banks cease to lend they drive borrowers +to the Bank of England. Borrowing there causes a +drop in the Bank’s proportion. Therefore, we cannot +have simultaneously high proportions of joint stock +bank reserves and a high proportion of a Bank of +England reserve unless both stop lending simultaneously. +As the Bank’s reserve is the reserve of +the joint stock banks collectively and the national +reserve, then, if its proportion falls, the reserve-proportion +of the entire system falls. The only way +to keep it high is for all to stop lending and for +the whole money market to lapse into a state of +stagnation. So far as my knowledge extends, this +has not been pointed out.</p> + +<p>We know that efforts are made, by raising the +Bank rate, to replenish the reserve automatically from +outside sources. But whether the gold flows in or<span class="pagenum" id="Page_ix">ix</span> +not, it does not disprove the fact that a high proportion +in the independent joint stock banks and +in the independent Bank of England cannot be +maintained at simultaneous moments except by a +simultaneous refusal to lend. It needs no exceptional +power of imagination to picture what would result +from this action. It would have the same consequences +as a great destruction of capital by war or any other +calamity. If we had an elastic legal tender system, +to provide for what I call a supplementary inflow of +legal tender, we could avoid many inconveniences +from which the money market and the nation +suffers.</p> + +<p>The supply of liquid capital in a perfect economic +system should keep pace with the output of wealth. +But our system is not perfect. Progress must +necessarily be impeded by artificial and arbitrary +restrictions.</p> + +<p>I think, too, we could simplify the problem by +segregating the composite deposits of a bank. These +deposits are an aggregation of what I call, for lack +of something more precise, pure deposits and loan-deposits. +The loan-deposits are debts to the bank, +which the bank has power to call in. If these loan-depositors +have legal power to withdraw money on +demand, the banks have power to withdraw from +many of them on demand. On the approach of a +crisis, or stringency, they do this, though in certain +contingencies such withdrawals might precipitate a<span class="pagenum" id="Page_x">x</span> +crisis. Nevertheless, the important fact remains that +they have power to call them in.</p> + +<p>If we set the gold reserves against the pure +deposits we shall find that the reserve is invariably +high.</p> + +<p>But why do we want a high proportion? Why +do we wish to hoard gold, when we know that the +hoarding of gold is more harmful than beneficial? +To avoid a panic, the critics and seers say. But a +panic is not a mathematical problem; it is a psychological +problem. If mathematics could save us from +fear and madness we could then automatically ensure +general sanity and common sense. What mathematical +proportion will save us from a panic? Who is to +lay down the proportion? Where are we to draw +the magical line of safety? Is it to be an exact +proportion or an approximate proportion? Is it to +be an universally exact or universally approximate +proportion? Or is it to be an individually exact or +approximate proportion? There can be no exactitude, +particularly if we include the Bank of England. In +mathematics, however, we must have exactitude, for +half per cent below the formula might be fatal. +And if in order to keep up the proportion simultaneously +in Lombard Street and Threadneedle Street +lending ceases, then the crisis comes, despite the +proportion.</p> + +<p>A psychological disease is not to be diagnosed by +the mathematician. We must find a psychological<span class="pagenum" id="Page_xi">xi</span> +remedy for it, and that remedy is knowledge and +common sense. The nation that met the crisis in +August last so calmly and has faced since, resolutely +and philosophically, the most terrible ordeal of its +existence, is not likely to be seized with ungovernable +madness because we cannot get an exact mathematical +formula in dealing with bank reserves. The knowledge, +and the only knowledge that will keep them +sane and calm, is that banking is conducted soundly. +The confidence of the community is based, and justly +based, upon sound banking methods. So long as +banks transform into currency the best wealth, then +they are soundly managed, irrespective of mathematical +gold reserves. The best wealth is to be tested +by time—that is, by its durability. The highest wealth +is durable; the lowest wealth transient.</p> + +<p>If we are to have no solid, lasting confidence in +sound banking, only in mathematical ratios, and if +the highest wealth the banks possess are to stand +them in no stead in a panic, then banks can reasonably +refuse to liquefy the best wealth. We could not +in that case blame them if they speculated. If they +maintain the mathematical inexact ratio laid down by +critics they will be mathematically safe, for sound +wealth in a panic will, the theorists say, be as worthless +as unsound wealth.</p> + +<p>If banks are conducted soundly, if they perform +vital services to the nation, if the nation would stagnate +without those services, if the nation restricts<span class="pagenum" id="Page_xii">xii</span> +their freedom of action by the provision of an inadequate +supply of legal tender and by the law of legal +tender, then it is the duty of the nation to help them +in that trouble for which they are not responsible. It +is also expedient for the nation to do this. It would +be conforming to the law of self-preservation. To do +otherwise would be national suicide.</p> + +<p>Banks cannot do two contrary things at the self-same +moment. They cannot keep a high proportion +and in the same moment lend freely. If they lend +freely the proportion speedily falls, and might speedily +fall far below the mathematical formula of safety. If +they do not lend freely the mathematicians say they +will aggravate the crisis. The only sensible course +for the nation to take is to be its own physician. The +Government on its behalf can do again what it did +last year—provide a supplementary fund of legal +tender currency. This was effective more than half a +century ago, and it has been effective again. And +experience is of greater value than theory.</p> + +<p>These, then, are some of the questions I discuss in +the following pages. I do not expect, of course, to +find common agreement. This would be presumption. +Nothing is more difficult than to destroy theories. +Experience is often impotent. Prophets are not +always silenced when their predictions are unrealized. +They continue to prophecy. They predicted confidently +that when the world-war came the financial +crisis would be far worse than the military crisis, and<span class="pagenum" id="Page_xiii">xiii</span> +that this country would be in the throes of a panic +the dimensions of which no human imagination could +conceive. Foreign countries with vast credits here +would take away every sovereign and every bar of +gold they could lay their hands on. Only those sovereigns +would remain that we had been far-sighted +enough to store in our back gardens, or, if we had no +back gardens, in our discarded stockings. Nothing of +this happened. There was no financial panic, no raid +upon our gold reserves. If there was any apprehension +it was mild and momentary, thanks to the +soundness of our banking system, the strength of our +financial structure, and the wisdom of our Government, +to say nothing of the soul of the nation. It was discovered +that, instead of other countries having it in +their power to take gold from us, they were so greatly +in our debt that they could not liquidate those debts, +and the exchanges went violently against them. Since +then gold has flowed into the country in unprecedented +amount, and there is still no sign of interruption +to the flow. This country is now overwhelmed +with gold. The reserves of the Bank of England and +of the joint stock banks continued to grow so rapidly +that loans, or “credits” as they are called, glutted +the market. Banks lent with difficulty even on +nominal terms. So far from predictions being fulfilled, +that has come to pass never dreamt of in the +wildest of dreams—a land towards which, in the midst +of war, the golden river was flowing, fed by tributary<span class="pagenum" id="Page_xiv">xiv</span> +streams, and undiminished in volume by huge purchases +of warlike stores and material from neutral +countries.</p> + +<p>The country was saved by wisdom—by the wisdom +of the people and by the wisdom of the Government +which promptly acted on the wisest advice. This +begot confidence and strengthened faith. It was calm +confidence and serene faith in intellectual ability that +enabled the country to go through the crisis with +success and that evoked the profound gratitude +of all.</p> + +<p>Confidence, the energizing, vitalizing spirit of +economic progress is distinct from what is called +Lombard Street credit. Yet both connote a confiding +in or a believing in something. In what? Confidence +is fundamentally a confiding in the greatness of the +nation. There can be no confidence in the littleness +of a nation.</p> + +<p>The financial writer would probably be discharged +who wrote in his money article: “Confidence in +Lombard Street yesterday was in superabundant +supply, and sellers could find no borrowers of it even +on nominal terms. In fact, before the close of business +balances of confidence were unplaceable. Overnight +confidence fetched no more than 1 per cent. +and weekly confidences 1½ per cent. In consequence, +therefore, of this great mass and weight of confidence +the discount market was very weak and rates fell +further. It is thought probable that the Bank of<span class="pagenum" id="Page_xv">xv</span> +England may have to make confidence scarcer and +dearer by taking it off the market, that is to say, by +borrowing confidence.”</p> + +<p>Is, therefore, that superstructure of “credit” that +superstructure of confidence beneath which the +country economically prospers? Is there not often +in Lombard Street an abundance of “credit” coincident +with a scarcity of confidence? And is not all +this “credit” impotent without confidence? Is prostrate +confidence to obtain its re-creative power only +from mountainous gold reserves? Or will it be regenerated +by a new faith in the essential greatness +and wealth of the country?</p> + +<p>I have great hopes of the future. I give abundant +reasons for this faith within me. Experience has +taught me the incalculable harm pessimism does. +Pessimism is like an infectious disease. It spreads +quickly. It is difficult to fight against it. There are +numerous sad-visaged prophets amongst us to-day—men +without hope, men without a smile. They +cannot cheer us. They see coming, with the inevitability +and irresistibility of doom, the day of sorrow, +the day when we shall reap the abundant aftermath +of woe. But dark as the night may be, I see a new +day of joy dawning, a day when the sowers will go +forth with renewed hope and energy, with the confidence +that they will gather in at the due season a +harvest more abundant than they have reaped before. +Let us not wring our hands and moan in dark corners.<span class="pagenum" id="Page_xvi">xvi</span> +Let us look forward with brave hearts and strong +minds to the day of victory and peace. That day will +bring us a new faith, a new confidence, perhaps a new +happiness in which we shall forget the old griefs and +despairs.</p> + +<p class="right"> +W. W. W. +</p> + +<p class="in0"> +<span class="smcap">Catford, S.E.</span><br> +<i class="in2">February, 1915.</i> +</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_xvii">xvii</span></p> + +<h2 class="nobreak" id="CONTENTS">CONTENTS</h2> +</div> + +<table id="toc"> +<tr class="xsmall"> + <td class="tdr">CHAP.</td> + <td class="tdl"></td> + <td class="tdr">PAGE</td> +</tr> +<tr> + <td class="tdr top">I.</td> + <td class="tdl"><span class="smcap">Introductory</span></td> + <td class="tdr"><a href="#toclink_1">1</a></td> +</tr> +<tr> + <td class="tdr top">II.</td> + <td class="tdl"><span class="smcap">What is Market Money?</span></td> + <td class="tdr"><a href="#toclink_13">13</a></td> +</tr> +<tr> + <td class="tdr top">III.</td> + <td class="tdl"><span class="smcap">The Currency of Custom</span></td> + <td class="tdr"><a href="#toclink_23">23</a></td> +</tr> +<tr> + <td class="tdr top">IV.</td> + <td class="tdl"><span class="smcap">Credit and Confidence</span></td> + <td class="tdr"><a href="#toclink_32">32</a></td> +</tr> +<tr> + <td class="tdr top">V.</td> + <td class="tdl"><span class="smcap">Sound Banking</span></td> + <td class="tdr"><a href="#toclink_43">43</a></td> +</tr> +<tr> + <td class="tdr top">VI.</td> + <td class="tdl"><span class="smcap">The Superstructure of Wealth</span></td> + <td class="tdr"><a href="#toclink_51">51</a></td> +</tr> +<tr> + <td class="tdr top">VII.</td> + <td class="tdl"><span class="smcap">What is the Loanable Fund?</span></td> + <td class="tdr"><a href="#toclink_61">61</a></td> +</tr> +<tr> + <td class="tdr top">VIII.</td> + <td class="tdl"><span class="smcap">The Metamorphosis of the Fund</span></td> + <td class="tdr"><a href="#toclink_70">70</a></td> +</tr> +<tr> + <td class="tdr top">IX.</td> + <td class="tdl"><span class="smcap">The Central Fund</span></td> + <td class="tdr"><a href="#toclink_80">80</a></td> +</tr> +<tr> + <td class="tdr top">X.</td> + <td class="tdl"><span class="smcap">The Central Reserve</span></td> + <td class="tdr"><a href="#toclink_88">88</a></td> +</tr> +<tr> + <td class="tdr top">XI.</td> + <td class="tdl"><span class="smcap">The Fiduciary Currency</span></td> + <td class="tdr"><a href="#toclink_97">97</a></td> +</tr> +<tr> + <td class="tdr top">XII.</td> + <td class="tdl"><span class="smcap">Banking Wealth</span></td> + <td class="tdr"><a href="#toclink_107">107</a></td> +</tr> +<tr> + <td class="tdr top">XIII.</td> + <td class="tdl"><span class="smcap">Elasticity or Inelasticity?</span></td> + <td class="tdr"><a href="#toclink_117">117</a></td> +</tr> +<tr> + <td class="tdr top">XIV.</td> + <td class="tdl"><span class="smcap">Exhaustibility</span></td> + <td class="tdr"><a href="#toclink_128">128</a></td> +</tr> +<tr> + <td class="tdr top">XV.</td> + <td class="tdl"><span class="smcap">The Theoretic Line of Safety</span></td> + <td class="tdr"><a href="#toclink_139">139</a></td> +</tr> +<tr> + <td class="tdr top">XVI.</td> + <td class="tdl"><span class="smcap">Some Psychological Phenomena</span></td> + <td class="tdr"><a href="#toclink_149">149</a></td> +</tr> +<tr> + <td class="tdr top">XVII.</td> + <td class="tdl"><span class="smcap">Equitable Responsibility</span></td> + <td class="tdr"><a href="#toclink_156">156</a></td> +</tr> +<tr> + <td class="tdr top">XVIII.</td> + <td class="tdl"><span class="smcap">Correlation</span></td> + <td class="tdr"><a href="#toclink_166">166</a><span class="pagenum" id="Page_xviii">xviii</span></td> +</tr> +<tr> + <td class="tdr top">XIX.</td> + <td class="tdl"><span class="smcap">The Supplementary Inflow</span></td> + <td class="tdr"><a href="#toclink_172">172</a></td> +</tr> +<tr> + <td class="tdr top">XX.</td> + <td class="tdl"><span class="smcap">Credit and Civilization</span></td> + <td class="tdr"><a href="#toclink_184">184</a></td> +</tr> +<tr> + <td class="tdr top">XXI.</td> + <td class="tdl"><span class="smcap">Confidence and Greatness</span></td> + <td class="tdr"><a href="#toclink_193">193</a></td> +</tr> +<tr> + <td class="tdr top">XXII.</td> + <td class="tdl"><span class="smcap">Frozen Wealth</span></td> + <td class="tdr"><a href="#toclink_202">202</a></td> +</tr> +<tr> + <td class="tdr top">XXIII.</td> + <td class="tdl"><span class="smcap">Some Conclusions</span></td> + <td class="tdr"><a href="#toclink_211">211</a></td> +</tr> +<tr> + <td class="tdr top"></td> + <td class="tdl"><span class="smcap">Appendices</span></td> + <td class="tdr"><a href="#toclink_221">221</a></td> +</tr> +</table> + +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_1">1</span></p> + +<h2 class="nobreak" id="THE_WAR_AND"><span id="toclink_1"></span><span class="larger">THE WAR AND<br> +OUR FINANCIAL FABRIC</span></h2> + +<h2 class="nobreak" id="CHAPTER_I">CHAPTER I<br> + +<span class="subhead">INTRODUCTORY</span></h2> +</div> + +<p class="in0"><span class="firstword">Treatises</span> innumerable have been written about +money. Famous and non-famous political economists +have attempted a definition of money. These definitions +have been divergent, and often irreconcilable. +Political economists have found it no easier to arrive +at a simple, understandable, explicit formula than +literary critics have found it to define poetry. All +of us have a vague idea of what money is, but it is +so vague that it is well-nigh impossible to present it +in a concise and precise phrase.</p> + +<p>This amazes the man in the street, who believes +that nothing is so simple, nothing so easily conceivable +as money. To him, of course, money +consists of so many pounds, shillings, and pence, +and when that is said, all is said. What more is +there to explain and define? He is wealthy or +poor, comfortable or miserable, according to the +quantity of pounds, shillings, and pence he possesses.<span class="pagenum" id="Page_2">2</span> +He knows that he can satisfy his needs, his desires, +his cravings if he has enough money with which to +buy what he wants, but if he has insufficient his +needs and longings will not be gratified.</p> + +<p>He knows that when he goes into a shop he +exchanges money for commodities. When he purchases +a pair of boots he does not tender for them +a watch, or loaves, or a couple of tender chickens +that he has bred on his poultry farm. He hands +over a few shillings, receives the boots neatly packed, +thanks the shopman, says “Good-day,” and is quite +unconscious that he really has exchanged for the +boots commodities that he or some other members +of the community have produced.</p> + +<p>It would be waste of time and labour, in a +treatise of this character, to devote several chapters +to the evolution of money, or, rather, to the evolution +of those articles that have served the usages +of exchange. Those who desire to acquaint themselves +with these historical facts must consult the +many works devoted thereto. The world’s monetary +systems, at the stage now reached by them—it does +not follow that it is a final stage—are the outcome +of experiments and improvements in national and +international exchange. In primitive days direct +barter was resorted to. Goods were exchanged +directly for goods, commodities for commodities. +The baker took his bread to the tailor when he was +in need of a garment, and the maker of footwear<span class="pagenum" id="Page_3">3</span> +took his handiwork to the baker or the butcher when +he wanted food.</p> + +<p>This worked well enough in small communities +living in circumscribed areas, having no intercourse +with communities living at inaccessible distances. +But as the communities grew, as their boundaries +expanded, as they came into closer touch with other +communities, as distance became shortened by the +discoveries of means of transport, as individual and +collective mentality strengthened, these primitive +communities had to face the increasing inconveniences +of direct barter. Necessity stimulated +ingenuity and invention until in the course of ages +the inconveniences were lessened by the use of +selected articles for exchange. These were selected +partly because of their scarcity and partly because +of their durability, for it was discovered that scarce +things were prized more highly than things that +were abundant.</p> + +<p>That which was scarce, therefore, by being more +highly prized became what we call more valuable. +That is to say, more store was set by its possession. +The possession of it excited admiration and envy +and greed; admiration and envy are the bases of +economic value to this day. They are not the bases +of ethical value, but economic law and moral law are +opposed in many directions.</p> + +<p>Scarce things, therefore, were just as much +prized by primitive people as they are prized by<span class="pagenum" id="Page_4">4</span> +civilized people to-day. It was these scarce things, +therefore, that could be exchanged for an abundance +of things, because no one valued what could easily +be got and what all could have. There was a time +when iron was scarce. As iron, too, was most useful +for a great variety of purposes and as its utility was +constantly showing itself, its scarcity, added to its +usefulness, made it increasingly prized and valued. +A ring of iron for a crown was of greater worth once +than are the diamond-studded crowns of present day +monarchs, and iron was at one time scarcer than +diamonds and rubies are now, and a man in +possession of a little iron could exchange that +possession for a great quantity of cattle with the +man who had more cattle than he knew what to +do with. Cattle, therefore, were what we call cheap +and iron was dear, the primitive idea being, as it still +is, that cheapness consists in much and dearness in +little, irrespective of their values in preserving life.</p> + +<p>Iron was dear because it was scarce, cattle were +cheap because they were plentiful. But man cannot +live by iron, though he can live on cattle. Judged, +therefore, from the standpoint of life-preservation, +cattle should be more precious than iron; but judged +from the standpoint of envy and vanity, iron was, +as gold now is, of greater value than cattle. The +one preserves life, the other pride, and here we +see some components of the foundation on which +the economic fabric has been reared.</p> + +<p><span class="pagenum" id="Page_5">5</span></p> + +<p>A savage with a little iron and no live stock was +considered wealthier and more enviable than the +man with no iron and a vast quantity of live stock. +The man in possession of the iron knew that he +could get as much live stock as he wanted by parting +with all or only a portion of his iron, and when he +exchanged a portion of his iron for cattle he actually +parted with money. The iron and the cattle were +money—the iron was the sovereign and the cattle +the pence in those days.</p> + +<p>Now, the iron being scarce and being highly +valued by the community on whose land it was +found, a greater value was conferred upon it in time +by law. The king and his counsellors of those days +enacted that a certain quantity of iron should discharge +so much taxes or redeem so much debt, that +the Government would accept it in payment of +taxes and in liquidation of debt, thereby absolving +the payer from all legal responsibilities and penalties. +From being merely an instrument of custom iron +was raised to the higher function of being a legal +instrument. It was given a certain arbitrary value, +the value being expressed in the amount of taxes +it should represent and in the amount of debt it +should legally discharge.</p> + +<p>Great importance lies in the conception that +the legal, apart from the custom value, was purely +arbitrary.</p> + +<p>Cattle would be accepted in payment of taxes and<span class="pagenum" id="Page_6">6</span> +in discharge of debt also; but, being more plentiful, +and therefore of less value, the Government decreed +that so many cattle would be equivalent to so many +pounds of iron. Those who had no iron, therefore, +had to pay in cattle, just as in these times those who +have no gold must pay in silver or bronze.</p> + +<p>Although a diamond may be worth many +sovereigns, it will not be accepted by the tax +collector, nor by our creditors, because it has +no legal value. That is to say, it is not a legal +instrument.</p> + +<p>We are beginning to have some glimmering now +of what money is. Money performs two important +functions. It is a medium of exchange and it is a +standard of value.</p> + +<p>Money was the instrument man invented, after +mental travail, to lessen or remove the inconveniences +of direct barter.</p> + +<p>Money represents the possession of a claim on +the products of the community. It is a present and +a future claim upon a portion of the wealth of the +general community. When the claim is exercised it +performs its function of a medium of exchange.</p> + +<p>The idea is this. We are all potential consumers +and producers. We have read of the early Christian +community, when all the members of that community +brought their goods and possessions to the common +store and divided equally. This is precisely how +society lives to-day. We all bring our goods and<span class="pagenum" id="Page_7">7</span> +possessions to the common store, or market, as it is +called, and there they are divided. But they are +not divided equally. This is the chief difference. +They are divided unequally in accord with our +notions of equitable distribution.</p> + +<p>Our claims on the common wealth are supposed +to be based justly upon our individual produce. The +more we produce the more we claim, the less we +produce the less we claim. This is the fundamental +idea, or hypothesis; but, like many ideas or hypotheses, +the practical working of it is far from just +and perfect. But the fundamental idea will make +clear the function money performs.</p> + +<p>We are familiar with those schemes of relief in +times of distress when tickets are given to the poor, +representing a certain quantity of food. On presentation +to the butcher the ticket is exchanged for a +pound of meat, and on presentation to the baker it +is exchanged for a quartern loaf. These tickets are +money. They are a media of exchange and possess +exchange value. They are claims on the butcher or +baker. If the possessor chooses, he can exchange +the ticket with another for a pint of ale, and the +other can claim the meat or the bread. They can +pass from hand to hand, become currency, as money +is called, and the exchange can be effected immediately +or deferred.</p> + +<p>The meat and the bread are subsequently paid +for out of another fund, and the butcher and baker<span class="pagenum" id="Page_8">8</span> +hand over the tickets and are paid their respective +portions out of this common fund.</p> + +<p>Now, the Government of the land can proclaim, +if it pleases, that these tickets can represent permanent +claims on the community. Instead of being +destroyed, they can be used over and over again for +an indefinite period—be made what is called legal +currency.</p> + +<p>What the laws have done is to decree that gold, +silver, copper, and paper shall represent our claims +on a certain proportion of the nation’s wealth. When +we take our products to market we exchange them +for these claims. These claims we afterwards present +to the butcher, baker, and tailor, and when we have +got rid of them we have exhausted our claims on +them. If we can get no further claims we become +poor or destitute. The only means of getting fresh +claims is to bring more wealth to market and +exchange it for more claims, and according to the +quantity and quality of that wealth, so are the claims +we get greater or smaller. The greater our claims +the richer we are, the smaller our claims the poorer +we are. If we bring to market products that no one +wants and people will not exchange part of their +claims for our merchandise, then we know our labour +has been in vain.</p> + +<p>In order to live, we must obtain these legal claims +on the general wealth, and if we cannot obtain them +we starve or become parasites.</p> + +<p><span class="pagenum" id="Page_9">9</span></p> + +<p>A distinction exists, and a most important distinction, +between money and legal tender currency. +Anything may be money. If I have no legal tender +currency and only a gold watch and I am in great +need of a dress suit and I offer the watch for the +suit and the watch is taken, that watch is money. +It is no one else’s concern if the tailor accepts the +watch in exchange for his labour, his skill, and his +cloth. He has liberty to exchange the dress suit, if +he pleases, for some ancient ornament he desires to +possess, instead of for legal coin or currency. But +he knows that the ornament will satisfy only his +desire, and will be no claim on any portion of the +community’s wealth. The butcher will not accept +it for meat. But it has performed the function of +money nevertheless.</p> + +<p>The law has decreed, however, that there shall +be a species of money, or currency, that shall have +permanent value as a medium of exchange. It has +decreed that all must accept this in exchange for +wealth and in discharge of all legal obligations. +With this object in view it has chosen gold to be +the legal claim, and has set up gold to be what is +called a standard of value. Treatises have been +written on standards and on values. Both are +highly controversial subjects, but these controversies +must be ignored here.</p> + +<p>This standard, or unit of value, is called in Great +Britain a sovereign. It was decreed that this coin<span class="pagenum" id="Page_10">10</span> +should consist of an arbitrary quantity of gold, mixed +with alloy, and that it should be stamped with +certain designs. These designs alone make it legal +money, or legal tender. If I had a coin, containing +exactly as much gold as a sovereign, and worth +exactly as much, but plain, with no design, it would +not be a legal coin. It would not be accepted in +discharge of debt, in payment of taxes, in exchange +for wealth. I could, perhaps, sell it to the jeweller +for something below its real value, because he could +make use of the metal to advantage; but it would be +useless to buy meat and bread with.</p> + +<p>The law, therefore, has decreed that a coin +composed of gold, of a certain weight, and with +certain designs upon it shall be a legal unit of value, +and that so much silver and so much bronze shall +be equal in value to this unit. It has decreed that +sovereigns shall be legal tender for liabilities to an +illimitable amount, that silver shall be legal tender +to the maximum equality of £2, and bronze to the +maximum equality of one shilling. That is to say, +a creditor, if he chooses, can demand gold in redemption +of his debt beyond £2, but whether he +will put the demand into execution or not depends +upon his will or circumstances.</p> + +<p>It is necessary, therefore, to lay emphasis upon +this distinction between money and legal tender +currency. Money is relative wealth, because it +represents relative, temporary claims; but legal<span class="pagenum" id="Page_11">11</span> +tender currency is absolute wealth because it represents +absolute, permanent claims.</p> + +<p>If Germany conquered this country and enacted +that the sovereign should no longer be legal currency, +and that the mark should be substituted for it, the +sovereign would then become a commodity, worth only +its value in gold. Sovereigns are commodities abroad, +just as continental gold units are commodities here. +Sovereigns have no legal value on the Continent. +Francs, marks, and dollars have no legal value in this +country. What, in each country, confers upon the +commodity gold its legal function as money is legislative +enactment. Legislative enactment can also make +a comparatively worthless product like paper of much +greater value than gold. The paper value of a +note for £100 is trifling. But because the Government +has decreed it shall be worth one hundred +sovereigns, then the individual members of the +community take it at its face value. What is its +value in Germany, especially when we are at war +with Germany?</p> + +<p>This shows the great and arbitrary power the +Government of a nation possesses.</p> + +<p>It can make stones legal tender if it chooses. Or +it can make diamonds legal tender. Many nations +have made silver and not gold legal tender.</p> + +<p>When individuals of a nation exchange commodities +they exchange it as in national legal tender. +There is, however, no international legal tender.<span class="pagenum" id="Page_12">12</span> +When nations exchange commodities the payment is +made in different instruments, such as bills of +exchange. Whenever gold is exchanged it is exchanged +solely as a monetary commodity, and not in +its national legal character as money. The gold in +the sovereign is valued according to its quantity, and +not by its value as a legal instrument, token or +claim. But it is rarely that gold passes from one +country to another in payment for goods received. +This payment is managed in a much easier and less +expensive fashion.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_13">13</span></p> + +<h2 class="nobreak" id="CHAPTER_II"><span id="toclink_13"></span>CHAPTER II<br> + +<span class="subhead">WHAT IS MARKET MONEY?</span></h2> +</div> + +<p class="in0"><span class="firstword">What</span> is the money that is bought and sold in the +money market? Who are the merchants there? +Who are the middlemen? Who are the sellers and +buyers? What sort of a place is this money market? +We can visualize a cattle market, where farmers +bring their cattle to sell, and we can visualize Covent +Garden, where fruit, vegetables, and flowers are sold: +but can we visualize a money market? Is it in some +vast building in the City? Is Lombard Street a +mighty emporium where many merchants congregate +at their stalls and offer, in the same fashion as +vendors of apples and sweets do, pounds, shillings, +and pence for sale?</p> + +<p>It is not located in any spacious building, like the +London Stock Exchange. Buyers do not go there +and offer golden sovereigns for golden sovereigns and +silver shillings for silver shillings. To the ordinary +man, who is perplexed by the mysteries of the money +market, it sounds strange, indeed, that money can be +bought with money. This is because he associates +money with pounds, shillings, and pence, and cannot<span class="pagenum" id="Page_14">14</span> +understand a sovereign being bought with a sovereign. +Yet he understands the business of a money-lender +and he understands borrowing. He knows that when +he borrows from a money-lender he borrows money +and pays something for the loan, something that +he calls interest. Well, the vendors of money in +Lombard Street are purely and simply money-lenders +on a great scale.</p> + +<p>Banks are wholesale business houses where money +is made, and where money is sold. The selling is +not, however, on all fours with apple selling. When +we sell apples we part with the apples for good. We +do not lend them for a definite period to the buyer, +and the buyer does not return them at the end of +that period. In buying and selling apples an absolute +exchange is made, money and fruit being +definitely parted with.</p> + +<p>In the money market the merchandise of the +merchants is not exchanged in this absolute fashion, +so that, in the literal connotation of the word, +Lombard Street is not a market.</p> + +<p>Lombard Street is an organism, essential to the +vitality, health, and welfare of the body politic, as the +heart and the lungs are necessary to the complete +life-preservation of the human body. The nation +could, of course, live without Lombard Street. But +without it, it would be a corpse-like, moribund life in +comparison with the vitality and energy imparted to +it by this economic organism.</p> + +<p><span class="pagenum" id="Page_15">15</span></p> + +<p>In Lombard Street money is made. What kind +of money? Some strongly insist that no money is +made, but only what is called credit. This, too, is +a highly controversial subject, on which divergent +views are held and are likely to be held.</p> + +<p>Instead of hoarding our money, placing our +golden sovereigns in bags and old tea-pots, and +burying them in our cellars, we have reached that +stage in our economic development when we place +them in the keeping of banks. We have several +purposes in view in doing this. We place money in +the keeping of the banks for absolute safety; we +place it there for convenience; and we place it there +to earn what we call interest on it. Hoarding, we +are intelligent enough to know, would be unsafe, +inconvenient, and unprofitable.</p> + +<p>Yet we really obey the instinct of hoarding when +we place our savings and surplus money in the +keeping of banks. But we have a secondary motive +in this action which we will call greed or avarice. +We desire our hoards to be fruitful. It is like placing +seed in the ground from which to gather future +harvests.</p> + +<p>But the banks do not hoard our money. If we +think they do we labour under a delusion. They +employ it in various ways. They lend it to a variety +of borrowers at interest, they invest it in all kinds of +securities and property, and earn interest on it by +this varied employment. Out of this interest they<span class="pagenum" id="Page_16">16</span> +maintain their vast and expensive establishments, +pay the salaries to their servants, and pay the +interest on the money we, as individuals, place in +their keeping.</p> + +<p>The position might be illustrated in a simple way. +I have saved up two hundred pounds. These two +hundred sovereigns I place on deposit at the bank, +and am allowed, say, 2½ per cent. interest. I prefer +the small interest because I believe the principal +will be safe always, safer than if invested in any +security or property. Moreover, I know that I can +draw this money out whenever I please, but were it +locked up in some security or mortgage, I should not +feel sure of getting possession of it again in a +moment of need. But the bank, lawfully, must +return me intact the two hundred sovereigns when I +ask for it.</p> + +<p>Now the bank re-lends this £200 at, say, 4 per +cent. interest, making a profit of 1½ per cent. interest. +Out of this interest it must pay salaries, +rent, and all working expenses. How can it do it?</p> + +<p>It doesn’t do it, and it couldn’t do it. No such +miracle could be done. This £200 is multiplied +greatly. The bank can make that £200 into £1000 +or £2000, and actually lend £2000. If I went one +day to ask for the £200, the bank might tell me +it could let me have only £10 or £20, and if I +insisted on having the £200, it might have to close +its doors and go into the bankruptcy court.</p> + +<p><span class="pagenum" id="Page_17">17</span></p> + +<p>How is this £200 made into a fund of £2000? +Do the sovereigns actually multiply in the bank’s +coffers? Is there a bank fairy that can make +sovereigns out of nothing? No. There is no bank +fairy, and no sovereigns are multiplied. Yet the +bank says it has £2000 to lend, and lends £2000.</p> + +<p>That which it lends over and above the original +sum of £200 is said to be the bank’s credit. The +bank is said, in the terminology of the money +market, to create credit to this extent. It keeps, +say, ten or twenty sovereigns in its till to provide +for the emergencies of a sudden demand, and +lends the rest of the gold and something beyond it. +This something else is called credit. Some people +say it is to all intents and purposes actually money; +others declare it is not. And in discussions on this +subject a lot of anger has been wasted and more +vanity wounded.</p> + +<p>Anyway, whether we call it money or whether we +call it credit, the fact is indisputable that this is the +tangible or intangible something with which banks +benefit the trade and commerce of the nation, and +help us all to become wealthier. This is the so-called +money of Lombard Street.</p> + +<p>They risk, however, grave dangers, and the community +risks grave dangers in setting up this +machinery to facilitate and smooth national and +international commercial dealings. These dangers +will be unfolded gradually in subsequent chapters.</p> + +<p><span class="pagenum" id="Page_18">18</span></p> + +<p>Already it has been hinted where one danger +lies.</p> + +<p>If of that £200 I place £100 on deposit and £100 +on current account at the bank, the bank has still +a total of 200 sovereigns, and can multiply this sum +into £1000 or £2000. But it pays interest then only +on half the sum—the sum on deposit. On the other +half it pays no interest, but it can lend the whole. +If I desire to withdraw the £200, I can by law draw +half on demand. The bank, however, can insist on +some days’ notice before allowing me to withdraw +the amount on deposit. But if I insisted on having +£100 and the bank had only £20 and could not get +the other £80 quickly, it might have to close its doors. +This would be a run on the bank that might bring it +to ruin.</p> + +<p>The bank hopes, of course, that I shall not +demand my money in a lump sum at a moment’s +notice; that there will be no run. It also hopes +that if I do demand it, it will at once demand the +return of its loan, or part of its loan, from those who +have borrowed from it, and thereby get the two +hundred sovereigns it owes to me. It will then be in +a position of having still on loan money, or credit, +based apparently on no gold.</p> + +<p>If it is not based on gold, it is based, however, on +some kind of wealth. Those who have borrowed +from the bank leave securities, Consols, say, as collateral +for the loan. If they do not repay the loan,<span class="pagenum" id="Page_19">19</span> +the bank has the securities, which it can sell in the +market for cash.</p> + +<p>If it has no gold, it has something it can exchange +for gold.</p> + +<p>It now becomes a little clearer that what the +bank has actually done is not to create £1800 out of +nothing, but to liquefy £1800 of the nation’s wealth. +Is this process of liquefaction granting credit or +creating currency? It looks more like a creation of +currency than a creation of credit. If the bank lent +without security, then it could with greater logic and +reason be called a creation of credit. But it does not +so lend.</p> + +<p>If gold is wealth and Consols are wealth, then it +lends wealth, whether it lends gold or Consols. +Therefore, what the banks apparently do is to lend +one man’s wealth to another man, taking a commission +from the borrower for the services rendered. +If Consols were made legal tender, like sovereigns, +we should not say that lending Consols was creating +credit.</p> + +<p>Selling Consols in the market is not creating +credit. The selling of Consols to a banker for a consideration +is not different essentially from selling +them in the market. The borrower virtually sells +them to the banker, and so long as the banker holds +them he is not creating credit.</p> + +<p>If a man hands over to me his mansion for a +loan, that mansion is mine till he repays the loan.<span class="pagenum" id="Page_20">20</span> +He has sold it to me temporarily. By lending him +the money I possess I do not lend him credit. I may +part with all my money, but I have the mansion, +which I can sell for money. If I cannot sell it, I may +lose much. But that will depend upon my wisdom +and foresight. I, at least, have something of some +value in the shape of the mansion.</p> + +<p>It is so with banks. Their security depends upon +the nature of the wealth they liquefy. If it be the +best wealth their security is sounder than if it be +the worst wealth. It is not necessary, and it should +certainly never be necessary, in the real interests +of the community, to liquefy only one kind of +wealth.</p> + +<p>Banking security should rest, therefore, chiefly +upon the highest wealth of the nation and not solely, +as some contend, upon that limited species called +legal tender. This aspect of the problem will be +elaborated in later chapters.</p> + +<p>Let us take another look at our modest current +account. We draw cheques against this current +account. We pay our income tax, our rent, our +tradesmen, with these cheques. The cheques are +accepted readily and unquestionably by all. Why? +Because the cheques, the paper, have intrinsic value? +No. But because they have trust in our <em>best</em> banks +and trust in our possession of the money in these +banks. A cheque on the <em>worst</em> banks would not be +so readily accepted.</p> + +<p><span class="pagenum" id="Page_21">21</span></p> + +<p>But we all know that the sovereigns are not +actually there. Does the drawing of a cheque create +credit? Or is the drawing of a cheque merely the +evidence that we actually have what we profess to +have? In drawing a cheque we do what the banks +do when they grant a loan. When we pay for a suit +with a cheque we receive the suit in exchange. When +a banker draws a cheque and receives Consols or +bills of discount, he really buys the Consols and +buys the bills. But some contend that he buys the +Consols with nothing. So it can be contended that +we bought our suit with nothing in the event of the +bank smashing.</p> + +<p>The cheques we draw become currency, become, +in the essential meaning of the word, money. They +are not legal tender; but legal tender is only a +small portion of the nation’s currency, that portion +arbitrarily selected by the legislature for a specific, +but important purpose.</p> + +<p>That that selection is wise is a view not unanimously +held by economic thinkers.</p> + +<p>But it is a selection that must control the policy +of bank management to a paramount extent. This +does not exclude, however, the scope and expediency +of legislative reform.</p> + +<p>We cannot draw cheques against our deposit +accounts. But though we can withdraw these deposits +the bank can insist, as I have said, on certain +notice. This notice, however, is never insisted upon.<span class="pagenum" id="Page_22">22</span> +It would be injudicious to insist upon it. It would +be injudicious because it would give rise to the +suspicion that the bank was unsoundly managed and +in a bad way. And suspicion is the surest way +towards the destruction of a bank.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_23">23</span></p> + +<h2 class="nobreak" id="CHAPTER_III"><span id="toclink_23"></span>CHAPTER III<br> + +<span class="subhead">THE CURRENCY OF CUSTOM</span></h2> +</div> + +<p class="in0"><span class="firstword">A</span> simple illustration has been given of how we +entrust our money with a bank and how a bank +employs it. Let us in our next step analyse a +typical balance sheet of a big bank, for it will help +us to get a clearer notion of the functions of a bank +and of the character and complexity of the money +market.</p> + +<table id="t23" class="balance"> +<tr> + <td class="tdl"><span class="in2"><i>Dr.</i></span></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> +</tr> +<tr> + <td class="tdl"><span class="smcap">To Capital Authorised</span></td> + <td class="tdc">30,000,000</td> + <td class="tdc"> 0</td> + <td class="tdc"> 0</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"><span class="smcap">To Capital Issued</span></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">3,000,000</td> + <td class="tdc"> 0</td> + <td class="tdc"> 0</td> +</tr> +<tr> + <td class="tdl">To Reserve Fund</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">1,125,000</td> + <td class="tdc"> 0</td> + <td class="tdc"> 0</td> +</tr> +<tr> + <td class="tdl">To Amount due by the bank on Current, Deposit, and other Accounts</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">37,583,237</td> + <td class="tdc"> 8</td> + <td class="tdc">11</td> +</tr> +<tr> + <td class="tdl">To Acceptances on account of customers</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">3,153,328</td> + <td class="tdc"> 7</td> + <td class="tdc">11</td> +</tr> +<tr> + <td class="tdl">To Rebate of Interest on Bills discounted, not yet due, carried to new account</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">53,807</td> + <td class="tdc"> 1</td> + <td class="tdc"> 3</td> +</tr> +<tr> + <td class="tdl">To Amount of Nett Profit</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bb">225,676</td> + <td class="tdc bb">10</td> + <td class="tdc bb"> 1</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bbd">£45,141,049</td> + <td class="tdc bbd"> 8</td> + <td class="tdc bbd"> 2</td> +</tr> +</table> + +<span class="pagenum" id="Page_24">24</span> + +<table id="t24" class="balance"> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr"></td> + <td class="tdc"><i>Cr.</i></td> + <td class="tdc"></td> +</tr> +<tr> + <td></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> +</tr> +<tr> + <td class="tdl">By Cash in Hand and at the Bank of England</td> + <td class="tdc">5,996,667</td> + <td class="tdc">14</td> + <td class="tdc"> 8</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl">By Money at Call and Short Notice</td> + <td class="tdc">5,674,476</td> + <td class="tdc"> 5</td> + <td class="tdc"> 1</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">11,671,143</td> + <td class="tdc">19</td> + <td class="tdc"> 9</td> +</tr> +<tr> + <td class="tdl">By <span class="smcap">Investments</span>—</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl sub">Consols and other Securities of, or guaranteed by, the British Government, of which £35,000 (Stock) is lodged with public bodies</td> + <td class="tdc">2,488,966</td> + <td class="tdc">12</td> + <td class="tdc"> 6</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl sub">By Indian, Colonial Government and other Securities</td> + <td class="tdc">3,771,738</td> + <td class="tdc">10</td> + <td class="tdc">11</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">6,260,705</td> + <td class="tdc"> 3</td> + <td class="tdc"> 5</td> +</tr> +<tr> + <td class="tdl">By Bills Discounted</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">6,811,870</td> + <td class="tdc">13</td> + <td class="tdc"> 8</td> +</tr> +<tr> + <td class="tdl">By Loans, Advances, other Accounts and Securities</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">16,218,748</td> + <td class="tdc">12</td> + <td class="tdc"> 6</td> +</tr> +<tr> + <td class="tdl">By Liabilities of Customers for Acceptances as per contra</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">3,153,328</td> + <td class="tdc"> 7</td> + <td class="tdc">11</td> +</tr> +<tr> + <td class="tdl">By Freehold and Leasehold Premises</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bb">1,025,252</td> + <td class="tdc bb">10</td> + <td class="tdc bb">11</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bbd">£45,141,049</td> + <td class="tdc bbd"> 8</td> + <td class="tdc bbd"> 2</td> +</tr> +</table> + +<p>On the liability side the capital issued is the +amount paid up by shareholders, capital which the +bank has employed in the ordinary course of its +business. It represents a contingent liability to +these shareholders, who have invested their capital +for the sake of the return in the shape of dividends. +The large sum of thirty-seven and a half millions is +the most important item. This is the real working +capital of the bank. It is apparently the aggregate +amount deposited by the public with the bank.</p> + +<p><span class="pagenum" id="Page_25">25</span></p> + +<p>This is what the bank owes to its clientele.</p> + +<p>But the deposits are not solely money actually +placed with the bank. This huge sum includes the +loans the bank has made to other customers, to its +borrowers. Every loan makes an additional deposit. +The man who borrows a sum of money from the +bank is credited with that sum and the credit appears +in the current accounts. The bank has security for +this loan, and, as already pointed out, this security +is liquefied into bank currency. Cheques can at +once be drawn against it so long as the loan runs +and cheques are the country’s currency. Securities, +therefore, have been converted into national currency +and indirectly into legal tender.</p> + +<p>The more, therefore, a bank lends the more do +its deposit and current accounts grow.</p> + +<p>The reserve fund speaks for itself. It is generally +a fund accumulated annually out of profits and +invested in the best securities. The larger the +reserve in proportion to the capital and business +the stronger is the bank’s position. It is a provision +against future contingencies and is not touched +except for these contingencies. One purpose is to +meet depreciation in investments or other losses. +The money being invested in the highest securities +these can be sold for cash whenever the need for +it arises.</p> + +<p>The acceptances on behalf of customers are +also practically covered by securities deposited by<span class="pagenum" id="Page_26">26</span> +customers, until they lodge the funds to meet the +bank’s liabilities in this direction. The net profit +is the fund due to the shareholders of the bank, who +receive their dividends therefrom.</p> + +<p>On the asset side, the cash in hand and at the +Bank of England consists of coin and notes. A +portion of this is in the tills and safes of the bank +in order to meet the ordinary daily needs, the incomings +and outgoings, while the rest is money +deposited with the Bank of England in precisely the +same way as an individual deposits money with a +joint stock bank. It serves two purposes. It +composes an additional reserve there in legal tender, +and facilitates the clearings between the various +banks, debits and credits being daily adjusted in the +books of the Bank of England.</p> + +<p>It is contended by many that the banks do not +keep reserves large enough in proportion to their +liabilities—reserves, that is to say, in actual legal +tender. It is contended that they trade on too slight +a margin of gold, or legal tender; but this question +must be threshed out when the way has been +cleared for it.</p> + +<p>The next item is the money at call and short +notice. This is practically the money lent by the +banks to money brokers, stock brokers, and discount +houses. Money at call practically means that the +bulk of it is lent from day to day and that banks +can demand its repayment at a moment’s notice.<span class="pagenum" id="Page_27">27</span> +The money is also borrowed on security, so that +while the banks owe the money to the borrowers +and the borrowers owe the money to the banks, the +banks have the securities. These securities thereby +become currency. They can also become currency +if the public will accept them as currency, but the +public prefers cheques to securities. The greater +convenience of cheques need not, of course, be +emphasized.</p> + +<p>It will be seen that a bank’s “investments” are +a large sum. They include the reserve fund, and the +bank’s annual income is, of course, swollen by the +interest it receives on these investments, in the same +way as an individual’s income is increased. These +investments are of the very highest class and +strengthen the assets the bank possesses against +its liabilities on deposits. It is presumed, of course, +that they can be readily sold for cash should the +need for the conversion arise.</p> + +<p>Bills discounted reveal the character of another +source of income. They represent investments in +another high-class security. A few bills may be +discounted directly on behalf of customers, but the +bulk are bills re-discounted from the discount houses. +Bill brokers discount bills at a certain price and the +banks re-discount them at a lower price, and both, +therefore, make a good aggregate profit out of the +business. Bill brokers are practically the middlemen +between merchants and the banks.</p> + +<p><span class="pagenum" id="Page_28">28</span></p> + +<p>These bills of discount being an investment and +a sound security are thereby liquefied into ordinary +currency and ordinary capital, capital which the +merchant is able to use in the ordinary course of his +business, while the nation at large benefits from the +increased capital employed and the greater production +and consumption that are the immediate +fruits of it.</p> + +<p>The largest item on the asset side is the composite +one of “loans, advances, other accounts and +securities.” These include customers’ overdrafts and +advances to customers on all kinds of security and +estate, and may, perhaps, be regarded as the least +liquid or the least readily realizable assets a bank +has. In this item are its chief risks, and, perhaps, +the soundness of banking is best judged by the size +of this account. The larger the size the greater, +presumably, are the risks; the smaller the size the +less are the risks.</p> + +<p>But the aggregate forms a portion of the wealth +of the community. A customer gives some kind of +security when he overdraws his account. But all +this composite wealth, of whatever class its component +elements may be, is, by the machinery of the +bank, converted into currency. These loans amount +to nearly half the liabilities on deposit and current +accounts, therefore additional currency to this amount +can be placed in circulation. If no banks lent on +such wealth there would be less potential capital in<span class="pagenum" id="Page_29">29</span> +circulation; the capital would be as stationary and +as unfruitful as hoarded coin. While, therefore, the +bank owes this sum to the borrowers, giving them +power to draw cheques against it or to take out the +whole sum in cash, the borrowers owe the money to +the bank; for the loans interest has, of course, to be +paid according to the class of security lodged. This +interest is one of the chief sources of a bank’s +income.</p> + +<p>The liabilities of customers for acceptances has +been explained. They offset the item on the liability +side. They may be regarded as a moderate source +of a bank’s income, and this class of business has to +be done with great care. As for the bank’s premises, +this is its own property in which it must do its +business, and it is self-explanatory.</p> + +<p>Having analysed a typical bank balance sheet, +we are able to see the kind of business a bank conducts +and the valuable functions it performs on +behalf of the community. A bank is in reality a +manufacturer of currency—not of legal tender currency, +but the currency of custom. The Government +does not provide this necessary machinery, so the +banks provide it, and we can imagine what would +happen to the country if the machinery broke down, +or if it were compulsorily stopped.</p> + +<p>This custom currency has become so much an +integral part of the economic and financial structure +of the country, that even our tax-gatherers will accept<span class="pagenum" id="Page_30">30</span> +a cheque as readily as sovereigns. Our currency is +to all intents and purposes a paper currency, the +soundness of which is rarely questioned. It is not +legal tender currency, but it is as vital to the well-being +of the nation as legal tender currency.</p> + +<p>The other paper currency is Bank of England +notes and, since the war, Treasury £1 and 10<i>s.</i> notes. +Even though the whole of these notes may not be +convertible into cash, they are legal tender simply and +solely because the legislature has enacted that they +shall be legal tender. This is, of course, something +outside custom. If the legislature were pleased to +do so, it could enact that cheques on certain specified +banks should be legal tender, just as it arbitrarily +enacted that the new Treasury notes, issued without +any gold backing at first, should be legal tender, +equal to the amount of their face value in gold.</p> + +<p>I wish to emphasize the distinction, therefore, +between the currency of custom—something that has +grown up out of the needs of the community, something +essential to its welfare and progress, the product +of an advanced stage of economics and of civilization—and +the currency called legal tender. Though debts +are paid and are payable in custom currency, the +power of this currency to redeem debt could be +destroyed in certain circumstances, the circumstances +of a panic. They may be remote circumstances, but, +remote as they are, they raise deep problems which +to this day are discussed with energy and heat.</p> + +<p><span class="pagenum" id="Page_31">31</span></p> + +<p>Ought the Government to provide machinery +more adequate than that it does provide to meet the +currency needs of the nation? This is one aspect of +the problem. Some say it ought to provide it, some +say this does not come within its province. It is left +to the banks to provide that currency as best they +may and quite apart from their methods of providing +it, it is indisputable that they administer to a vital +economic need. If, therefore, they administer to +that need, should the Government come to their +assistance in those circumstances which cause a +collapse of their machinery?</p> + +<p>This question has been answered in part by the +Government since the outbreak of the war. It helped +the machinery to work, and provided against a possible +collapse by issuing “emergency” currency +notes. The Government having acknowledged an +emergency and established a precedent, the problem +is now much simplified.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_32">32</span></p> + +<h2 class="nobreak" id="CHAPTER_IV"><span id="toclink_32"></span>CHAPTER IV<br> + +<span class="subhead">CREDIT AND CONFIDENCE</span></h2> +</div> + +<p class="in0"><span class="firstword">Credit,</span> which banks are said to create, has several +connotations. It has a social, an ethical, and a +financial connotation, and it is necessary to examine +awhile these connotations. From the derivation, or +original conception of the word, or idea, it is an +expression of belief or trust, as distinct from disbelief +and distrust.</p> + +<p>In the social world, when we say a person stands +in high credit, what is it we imply? That he is a +rich man, a man of great wealth? By no means. +He may be a poor man, that is to say poor relatively +to the position he occupies. In the social sphere he +can carry considerable weight even though he may +be dishonest, dishonourable and immoral. We ignore +his vices, yet hold him in high esteem. His credit +is based less on his character than on our snobbery. +We bow before title and caste, irrespective of the +merits of the individual. A lord of bad character +will be more sought after, receive more flattery and +deference, than a no-titled man of noble character. +If we were not snobbish we should despise him as he +deserves.</p> + +<p><span class="pagenum" id="Page_33">33</span></p> + +<p>From this springs the desire of men to gain title, +no matter what means and methods they employ to +this end. They know that a title in some potent +way aggrandizes them, and they can enter an +assembly with greater assurance and confidence and +pomposity than they could if their names were still +as plain as in their humble days.</p> + +<p>The conferring of a title is not necessarily a +recognition of high moral worth. But a title can +be a national recognition of intellectual merits, or +ability. The credit of those who receive this distinction +is strengthened. We have greater confidence +than before in their intellectual ability and power. +We have deeper trust in their wisdom and sagacity +and in their counsel. We have the less hesitation in +following their guidance in those paths with which +they are presumed to be intimately familiar. In this +greater, but still restricted, knowledge of theirs we +repose our trust.</p> + +<p>We know that moral credit is distinct from this. +It is based upon character solely, irrespective of +social position or means. A poor man may be a +man of high nobility. We may despise his poverty, +but we honour his spirit. We are conscious that he +is far beyond us, that we cannot reach the moral +plane upon which he stands. He is a man in whose +honesty, integrity, and conscientiousness we would +place unquestioning trust. We know that in no +circumstances would he disabuse that trust. We<span class="pagenum" id="Page_34">34</span> +know that he would have the moral power to resist +all temptation.</p> + +<p>Such a man may have great strength of character, +high moral worth, but he may be weak intellectually. +He may be no scholar, no man of erudition, no man +of imagination, and possess no exceptional ability. +His intellectual limitations may be the cause of his +poverty. But in whatever position he may be placed, +according to his limited qualifications, we know that +he will discharge his duties faithfully, conscientiously, +to the best of his ability, and will not swerve a +moment from the path of honesty and uprightness. +Such a man could be no thief and could tell no lie.</p> + +<p>He lessens our anxieties. We say we can trust +him as readily and as confidently as we can trust +ourselves. It is a matter for thankfulness that we +have such a servant in whom we can place our +trust.</p> + +<p>Here, therefore, are illustrations of intellectual +and moral credit which men are said to possess.</p> + +<p>Financial credit is another kind of credit. With +this, perhaps, mankind is more familiar. The +economic standing and welfare, as distinct from the +purely moral standing, of a nation is dependent upon +what we call financial credit. If I lend money to a +friend it is immaterial to me what his abilities or his +morals may be, so long as I know he will be in a +position to repay that loan. If his moral credit be +bad, he will, perhaps, not repay it if he has the<span class="pagenum" id="Page_35">35</span> +means; but even if his moral credit be bad he may +pay it from motives of expediency. He may want a +further loan later, and it would not be to his material +interests for me to propagate the fact that he will not +repay his debts. His credit is worth too much to +him to be placed in jeopardy of this kind. He must +redeem the debt if only from the business motive of +expediency.</p> + +<p>Tradesmen are said to live on credit. They +declare that if they refused to grant credit to their +customers they would speedily be in the bankruptcy +court. By granting such credit they run grave +risks. They have to trust to the honesty of their +customers and to their future means. Therefore +they have to face the risks of incurring losses by bad +debts, phenomena inseparable from such business. +On the other hand, they believe that by granting +such credit and running such risks they extend their +custom and compete with hopes of greater success +against their rivals. What they may lose in the way +of bad debts they may more than recoup in the +larger profits they make on the growth of their +business.</p> + +<p>It may be, from an ethical standpoint, a degrading +and deplorable way of living on each other +in a highly civilized community, but the fact serves +the purpose of illustrating our ideas of financial credit.</p> + +<p>We have to live by trusting in each other, +trusting in each other’s financial means and financial<span class="pagenum" id="Page_36">36</span> +honesty. A man may be highly moral and respectable +in his life, a worthy husband, father and citizen, +an able and faithful servant, thoroughly trustworthy, +yet may be mean and financially dishonest. Or he +may be the victim of misfortune and cannot redeem +his debts to the tradesman and others even if he +would.</p> + +<p>Looking more closely into the credit on which a +tradesman relies we find it altogether different from the +credit which, it is declared, banks create and prosper +on. We can, perhaps, contend that a tradesman +lends cheese, butter, and eggs, in the hope that he +will be paid for them eventually.</p> + +<p>I am the customer. I ask him to let me have +cheese, butter, and eggs for a month, and I will pay +for them at the end of the month. Were I a +stranger to him he might demur. But if he has +known me for years and knows that I am a man of +my word, a man to be trusted, he will gladly let me +have the goods on the credit of the reputation I +hold with him.</p> + +<p>What is the tradesman’s security? Simply my +word and my reputation. Simply his trust in me. I +do not leave with him my watch, my securities, or my +works on political economy. If, however, I failed to +pay for the goods I received of him and had left +some of my valuable possessions with him, he could +sell these possessions in the market, and indirectly +be paid for his goods.</p> + +<p><span class="pagenum" id="Page_37">37</span></p> + +<p>If he were indirectly paid for them, would he be +granting me credit? He would certainly not be +granting that kind of credit which the man in the +street understands as credit. Political economists +and financiers may be distinct from men in the +street, but the simple-minded, the man unversed +in the theories of political economy, would see +no difference between this and barter. In fact, it +looks exactly like the barter so beautifully and +so fascinatingly described in primers on political +economy. However, we do not pledge our watches +with the grocer for eggs and bacon. We pledge our +words and our character only, and at the end of the +month we hand him over a cheque, the national +currency, and once more demonstrate to him the +value of <em>our</em> credit, not <em>his</em>.</p> + +<p>Perhaps it is now less difficult for the simple-minded +to comprehend why political economists, +financiers, bank managers, and those highly gifted +men, financial journalists, cannot come to a common +agreement as to what it is banks create. There is +more agreement amongst them that banks do really +lend than there is as to the actual thing banks do +lend, credit or money.</p> + +<p>Perhaps they do not lend at all, neither credit +nor money? Perhaps they no more lend than my +employer lends when he pays me my weekly cheque +for services rendered. We call them lenders, because +it would seem absurd to call them converters. Yet<span class="pagenum" id="Page_38">38</span> +it seems obvious that they do quite a large business +in conversion, akin to what the Bank of +England does when it converts gold into notes. +The latter converts one species of wealth into one +species of currency; the joint stock banks convert +another species of wealth into another species of +currency.</p> + +<p>My employer pays me a cheque for services +rendered. I am presumed to have produced some +kind of wealth, which is converted into liquid and +current capital when I receive the cheque and put +it in circulation. When he gives me the cheque he +does not give me credit. He pays me for the wealth +I have produced and which the community has +consumed, and that wealth goes to the common +store.</p> + +<p>If a banker lends me, as it is said, £200 on +Consols—to put it in round, simple figures—does he +sell me his credit, or do I sell him mine? Or is +it, after all, barter? If it be bartering wealth, then +it cannot be credit. If he lends me £200 and takes +my Consols, he takes my wealth from me. It is no +longer in my possession. He has it, and if I leave +that £200 on deposit and do not withdraw a single +sovereign, he is wealthier to the extent of £200 than +he was before.</p> + +<p>If he be so much wealthier, what has he exchanged +with me? What has he sold to me? If he lends me +£200 on my credit, plus the Consols, and I borrow<span class="pagenum" id="Page_39">39</span> +£200 from him on his credit, less the Consols, then +we seem to exchange credit for credit. If credit be a +species of wealth and credit be exchanged for credit, +then wealth is exchanged for wealth.</p> + +<p>But, I repeat, this is not the sort of credit the +tradesman understands and lives on, nor is it the +man in the street’s conception of credit.</p> + +<p>Yet it is declared by those who pretend to a deep +knowledge of human psychology and temperament, +that the stability of banks depends upon the credit +they enjoy amongst the members of the community, +and that that credit, in its turn, is dependent entirely +on the proportion of gold the banks hold to their +deposit and current accounts. It is quite possible +that this is a delusion. Financiers may have misread +the public and may not be completely acquainted +with their arithmetical preoccupations. I do not +believe that one man in 100,000 deliberately and +seriously sits down each evening and works out the +proportion of gold held by his particular bank in its +last balance sheet.</p> + +<p>The ordinary individual believes that he can +use his leisure moments more profitably and more +pleasantly than in this occupation. I do not believe +that one man in 500,000 could say off-hand approximately +what is the proportion of his own bank or +the average proportion of all banks. He doesn’t +trouble to know, and he doesn’t bother himself about +it. He will tell you that he is burdened with quite<span class="pagenum" id="Page_40">40</span> +enough anxieties to trouble himself with this unnecessary +anxiety.</p> + +<p>This is my experience of my fellow-men, and I +shall not put greater faith in financiers than in my +own experience until they have cross-examined every +individual depositor in the country and given me each +one’s answer.</p> + +<p>If, therefore, it be a delusion that confidence +resides in individual knowledge of the exact proportion +of gold banks hold to their liabilities on deposit +and current account, then what is the basis of the +national confidence? It is not an individual confidence, +but a general confidence.</p> + +<p>I believe that this confidence is based, and justly +based, on the belief that our banks are soundly +managed. This belief is a tradition, a habit, a +custom. We inherit it as a nation, and the inheritance +is handed on from generation to generation. We +can, indeed, say that it is in our blood, in our system.</p> + +<p>Years have rolled on and this confidence has not +been abused. There have been times, of course, when +the country has found itself face to face with a +financial crisis, but it has been saved from disaster +by the wisdom of men in high financial stations and +by the common-sense of the nation. And this confidence +has been further strengthened by the manner +in which we have faced the greatest war in which the +nation has been involved.</p> + +<p>I shall analyse the phenomenon further in later<span class="pagenum" id="Page_41">41</span> +chapters, but I will say here that the manner in which +the general public received, as a mere matter of +course, the creation of the emergency currency notes +revealed a psychological trait, or characteristic, of +tremendous importance.</p> + +<p>It is my belief, then—in fact, it is my conviction—that, +so far as the general public is concerned, its +confidence in banks rests more in the belief of their +honest and sound management than in the knowledge +of the exact amount of gold they have in their reserves, +or where they actually hold their reserves. +And I believe, too, that if all were interrogated, forty-four +millions and more out of forty-five millions, including +some of our shrewd bank managers, would +say they believed that that confidence would be +strengthened if the public were assured that all the +reserves were held at the Bank of England than in +the safes of the joint stock banks.</p> + +<p>When the man in the street says that a something +is “as safe as the Bank of England,” it is no empty +phrase. The safety of the Bank of England is +ultimate, absolute safety. He associates the safety +of the Bank of England with the safety of the nation +itself. The Bank of England could fall only when +the Empire itself fell. And that fall, in his conception, +seems as remote as the fall of the skies.</p> + +<p>He would tell you, and tell you with all solemnity +and earnestness, that he would rather have his money +at the Bank of England than elsewhere. And if he<span class="pagenum" id="Page_42">42</span> +were told that that is the very place where the joint +stock banks keep their gold reserves, he would say, +with equal seriousness: “That’s right.” His mind +would then be at rest that all was absolutely right in +the best of all banking worlds.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_43">43</span></p> + +<h2 class="nobreak" id="CHAPTER_V"><span id="toclink_43"></span>CHAPTER V<br> + +<span class="subhead">SOUND BANKING</span></h2> +</div> + +<p class="in0"><span class="firstword">If</span> it is indisputable, therefore, that the confidence of +the individual, and therefore the confidence of the +nation, is based in the soundness of banking, we +must see if that confidence be justified or not. I +have, indeed, already said that it is justified. I must +give reasons why I think so.</p> + +<p>What is banking? What is soundness of banking? +These terms must be defined.</p> + +<p>I do not know if a definition of banking has been +given that is universally acceptable. I know what +the vague conception of banking is, but if a precise, +explicit definition has ever been given, agreed upon +unanimously by economic theorists, and accepted as +the right and only formula, I am ignorant of that fact.</p> + +<p>I consult Nuttall, and he describes a bank as an +establishment which trades in money, by receiving, +lending, exchanging, etc. He does not say it is an +establishment which trades in credit, by receiving, +lending, and exchanging credit, etc. This definition +may be false and misleading, and Mr. Nuttall may +have been deplorably ignorant of the functions of<span class="pagenum" id="Page_44">44</span> +a bank, but as, in my opinion, it is as good a definition +as I have met with in economic and financial +works, I will accept it. At any rate, I consider it in +no wise false or misleading.</p> + +<p>A bank trades in money. This is indisputable. +A bank receives money. This is indisputable. A +bank lends money. This is indisputable. A bank +exchanges money. This also is indisputable.</p> + +<p>What money does it trade in? We know there +are various kinds of money. Legal tender currency +is but one kind of money. Cheques, bills of exchange, +securities, and even commodities are other +kinds of money. Even if the legislature declared +that only legal tender shall be money, the legislature +could not by this declaration alter the laws of nature +and of economics. It can make one kind of money +legal tender, but it cannot destroy the law that anything +used for exchange purposes is money. If a +beggar steals a watch and afterwards exchanges the +watch for a decent shirt, the watch and the shirt +become money. They perform the functions of +money and the functions prove that they are money.</p> + +<p>A bank trades in money subscribed by its own +shareholders and money deposited with it by the +public. A bank in the course of time finds itself in +the possession of what it describes as its deposit and +current accounts. These accounts, it is popularly +supposed—included in the populace are political +economists and City financiers—are the aggregate of<span class="pagenum" id="Page_45">45</span> +the money placed with a bank by the public and the +money with which it mainly trades.</p> + +<p>These are called a bank’s liabilities, its immediate +liabilities the redemption of which can legally be +demanded at a moment’s notice. It is because they +can be so demanded that banks are ever faced with +a grave potential peril.</p> + +<p>It is necessary to clear the way by destroying a +delusion. This money on deposit is not entirely +money placed in the keeping of a bank in the same +fashion as one would keep money in a safe. This +fact, in my view, is of great importance. Only a +portion of these deposits is what we may call in an +indefinite way pure deposits. By pure deposits I +mean money placed with a bank that is not a direct +loan. If I place £100 of my savings in a bank, +instead of investing it, I call that a pure deposit, and +this money I can withdraw without the subtraction +of a farthing at a moment’s notice.</p> + +<p>But we have already seen, from our analysis of a +bank’s <a href="#t23">balance sheet in Chapter III</a>, that these +deposits are not all pure deposits. A considerable +portion of them consists of loans to all kinds of +people, loans made on the security of various kinds +of wealth. That is to say, the bank owes money to +these so-called depositors and the depositors owe that +money to the bank. The depositors have the power, +of course, to withdraw the entire sum of money lent +to them temporarily by the bank; but the bank, in<span class="pagenum" id="Page_46">46</span> +due course, has the power to claim the redemption of +the loans. Not only has it this power to call in these +loans, but it actually possesses the equivalent of the +loans in a portion of the country’s wealth.</p> + +<p>It is possible—but the wisdom or unwisdom of it +need not be discussed here—for the legislature to +enact that only pure deposits should be withdrawable +at a moment’s notice, and that borrowers should be +compelled in times of panic or vital urgency to give +long notice. I merely say that this is within the +power of the legislature to enact, but I do not say +here that it is practicable, necessary, or wise.</p> + +<p>I merely throw out the hint here in order to +emphasize the importance of the distinction between +pure deposits and loan deposits. The latter, I have +already urged, may be regarded as the product of the +machinery for converting wealth into currency, or +liquid capital. From a sound banking standpoint +the vital question to be considered and answered is +as to the kind of wealth that is so converted.</p> + +<p>Sound banking is to be tested by the nature of +the wealth so converted, or, in the language of the +financial community, the wealth on which loans are +made.</p> + +<p>Others argue that this is a matter of quite +secondary and even third-rate importance. They +contend that the matter of supreme and vital +importance is the amount of gold a bank holds in +proportion to its liabilities in deposits. Should there<span class="pagenum" id="Page_47">47</span> +be some differentiation here? Should it be the +amount of gold held in proportion to its pure +deposits, and not in proportion to its aggregation of +pure deposits and loan deposits? For the loans, as +we have seen, are automatically redeemable.</p> + +<p>If, say, a bank habitually holds gold to the proportion +of 15 per cent. of its aggregate deposits, +and if half these deposits are loans, then the gold +Will be equal to 30 per cent. of its pure deposits, a +proportion much higher than the figure advocated by +those who agitate seriously and zealously for higher +gold reserves.</p> + +<p>We have seen many small banks go under in +recent years. This was in some cases because they +lent their money on what I will call bad wealth. In +other words, because they gambled and speculated +with the money of their depositors. Here we have +some evidence that the general public are unable to +discriminate between sound and unsound banking. +This may be deplorable ignorance, but it is not +culpable ignorance. It is to a great degree inevitable +ignorance.</p> + +<p>The matter is dismissed by the quidnuncs saying +that fools deserve their misfortune, they should have +placed their money in sound banks. We should not +so readily denounce them as fools. The Government +is not without its most serious responsibility in the +matter. It should not allow such money-lending +establishments to describe themselves as banks. The<span class="pagenum" id="Page_48">48</span> +Government has a moral duty to protect the public, +and it would not be at all difficult to take steps to +this end. It should allow only those establishments +to call themselves banks that are conducted upon +sound banking principles.</p> + +<p>Joint stock banks have a legal safeguard. +Though they are under compulsion to repay deposits, +they are under no legal compulsion to repay them in +gold. They must repay them in legal tender, and +they can fulfil their legal obligations by paying out +in legal tender notes. These, of course, are Bank of +England notes and now the new Treasury emergency +notes.</p> + +<p>This being so it is immaterial, or it should be +immaterial, whether the reserve of a bank consists of +gold or legal tender notes. If it can redeem its +liabilities in notes and has sufficient notes for its +purpose, it can consider itself safe and can securely +stand in a crisis. The notes can, of course, be taken +to the Bank of England and be exchanged there for +gold; but this is immaterial to a bank which has +successfully met the peril of a run.</p> + +<p>Soundness of banking consists in the soundness +of the wealth that constitutes a bank’s assets. We +know there are infinite degrees and categories of +wealth. But it is easily possible to discriminate and +know exactly which is the highest class of wealth in +the country.</p> + +<p>Banks do and must speculate to some extent. It<span class="pagenum" id="Page_49">49</span> +is unavoidable. If they did not speculate they +would not incur bad and doubtful debts. But they +must keep their speculations within the most prudent +limits. This most of them undoubtedly do. Traders +complain that they are, indeed, too cautious in this +respect, that they do not lend freely enough. There +have been, indeed, most bitter complaints on this +head since the outbreak of the war.</p> + +<p>But we cannot reasonably insist upon banks being +ultra-cautious, and in the same breath complain of +their cautiousness. We cannot reasonably insist +upon them keeping large gold reserves, thereby +diminishing their loan capacity, and with equal +reason insist that they shall lend with increased +liberality.</p> + +<p>This is as impossible as trying to reach two goals +simultaneously, when each lies in a direction opposite +to the other. The man in the street would say you +cannot eat your cake and have it.</p> + +<p>When a bank lends to a man or firm on good +security, it cannot be sure, of course, that that man +or firm will be able to pay off the loan when it falls +due.</p> + +<p>We may, if we wish, call this a speculative chance, +but the bank is considerably safeguarded by the +security it possesses.</p> + +<p>Public confidence is based, therefore, upon the +soundness of banking methods. It is an article of +belief with us that banks become gravely imperilled<span class="pagenum" id="Page_50">50</span> +when confidence breaks down. It is when confidence +is destroyed that runs on banks commence. Fear +seizes the public, it develops into panic, depositors +clamour for their deposit money, and banks either +successfully meet these runs, or close their doors. +But so long as confidence is strong and unimpaired, +sound banks keep safe.</p> + +<p>The safety of banks depends, therefore, upon this +feeling of confidence in them, and this feeling of confidence, +in its turn, is based upon the intelligence and +common sense of the public. Up to now this intelligence +and common sense have been triumphant. They +have triumphed in a crisis unparalleled in the history +of the British Empire, in that very crisis, in fact, which +the prophets always feared would show their superficiality +and vulnerability.</p> + +<p>The predictions of the prophets have not been +realized. This is because human genius and +human wisdom have been mightier than human fear +and apprehension, because the nation had supreme +faith in the Government, in the economic strength of +the Empire, and in the might of its navy and army.</p> + +<p>And if the prophets have prophesied falsely in this +supreme situation, they are just as likely to prophesy +falsely in other potential emergencies.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_51">51</span></p> + +<h2 class="nobreak" id="CHAPTER_VI"><span id="toclink_51"></span>CHAPTER VI<br> + +<span class="subhead">THE SUPERSTRUCTURE OF WEALTH</span></h2> +</div> + +<p class="in0"><span class="firstword">In</span> our loose and indefinite way—as a result, maybe, +of our defective vision—we talk of a vast superstructure +of credit erected on a tiny gold basis. We +gaze upon this mighty fabric and shake our heads +ominously. As we gaze we see the structure grow, +extending upwards and outwards, enlarging itself by +some invisible and mysterious agency, and when we +cast our gaze to the foundations we see that it looks +like a towering edifice perched insecurely on a small, +uneven piece of rock. No wonder we have feared +that when storms break the whole crazy thing will +come crashing down, scattering ruin and devastation +in a vast area around it. It seems to us like a +structure built by a madman, in defiance of the laws +of architecture, and that there can be but one end, +sooner or later, to so fantastic a fabric.</p> + +<p>So have we been told time and again that our +superstructure of credit has been built only for fair +weather and not for foul.</p> + +<p>Well, it has withstood much foul weather since +the building of it commenced generations ago.<span class="pagenum" id="Page_52">52</span> +Storms have beaten against it, and to the naked eye +it has hardly swerved. The storms have made no +rents in its walls, and it still stands, growing visibly, +pointing its rising apex to the skies, and millions of +people to this day—stolid, unimaginative Britishers, +maybe—enter within its portals fearlessly and without +suspicion of their peril. They heed not those +who warn them that the whole thing may fall about +their heads at any moment, that it needs but an +earthquake, and all will be over in the twinkling of +an eye.</p> + +<p>“Foolish people!” these architectural guardians +of safety cry. “We have warned you, and you have +heeded us not. Let your fate be upon your own +heads. Let him who is guided by the feeble, confusing +light of his own folly, suffer the doom of his +folly. We, at least, have done our duty, bravely, like +voices crying unto the lost multitude, drunk with its +ignorance and conceit.”</p> + +<p>Well! well! Perhaps, after all, this superstructure +may have no counterpart in reality. It +may be but a fantastic dream, or nightmare, after +all, yet seemingly so vivid to our fearsomeness that +we find it almost impossible to believe that it can be +but a creation of the imagination.</p> + +<p>Would it not be more accurate to say that we +have erected in our midst a vast superstructure of +wealth? And cannot we say that this superstructure +is based, not upon a slight foundation of gold, but<span class="pagenum" id="Page_53">53</span> +upon the solid wealth of the nation, the empire, the +world? If it can be proved to our nervous eyes that +this is the real superstructure, after all, and not the +one we have seen in disturbing visions, perhaps we +shall feel more secure against and less apprehensive +of the force of storms.</p> + +<p>Let us look more closely at that balance sheet, +for then we shall come into actual physical contact +with the composition of this awe-striking structure. +We will analyse the various ingredients which we +shall describe as the assets of a bank.</p> + +<p>First of all, we see that the cash in hand and at +the Bank of England is nearly £6,000,000. This is +legal tender, that which the law of the land has +enacted shall be absolute, permanent wealth, not +subject to the vagaries of fashion or sentiment.</p> + +<p>Money at call and short notice is nearly as much—over +five and a half millions. This forms a +portion of the loan deposits, and being callable by +the banks practically on demand, they show that a +portion of the deposits payable on demand can also +be recalled on demand. The equivalent of these +loans, or deposits, the bank possesses in the shape +of wealth not in the absolute category of legal +tender. They are securities of the highest class, +securities representing the credit or wealth of the +nation. While these securities are lying in the safes +of the banks they have been converted into temporary +currency, and have been fulfilling all the purposes of<span class="pagenum" id="Page_54">54</span> +money in circulation. They have been resurrected +from dead into live capital. A similar process could +be gone through by selling the securities in the +market. The owner could convert them for his +purposes into liquid capital. But he sells them +temporarily to the bank instead of permanently in +the market, and when he has employed his liquid +capital temporarily, he repays it to the bank. He +rechanges it, as it were, into dead or illiquid capital, +until the moment comes when he desires to reconvert +it into live capital, or currency. The bank possesses +the wealth in bonds; he possesses the wealth in +currency, and the bank’s gain consists of the interest +on the accommodation, and his gain in the profit +accruing from the active employment of his capital.</p> + +<p>There is no more trust than a butcher has when +he sells a leg of mutton for 4<i>s.</i> 6<i>d.</i> on the nail. His +dead leg of mutton he converts into live legal tender +currency. If he never sold his mutton he would +starve. If the housewife’s husband earned no more +salary wherewith to exchange it for future legs of +mutton they would starve.</p> + +<p>If the banker lent the borrower money without +security, it would be more truly credit, for he would +have no wealth that was the equivalent of the +loan.</p> + +<p>If he, at certain seasons, is compelled to call in +these loans to bill-brokers and others and cannot +renew them—quite a frequent, familiar operation—those<span class="pagenum" id="Page_55">55</span> +who want to convert their dead wealth into +currency go to the Bank of England. Machinery +similar to that employed in the joint stock banks +is put into operation there. The Bank takes in the +securities, debits itself with the amount it empowers +the borrower to withdraw in currency, and credits +itself, not with words, but with valuable bonds. It +insists that these bonds shall be of the highest value, +and this insistence is inconsistent with the idea of +what the ordinary man regards as giving credit. +Otherwise, there would be greater trust in promises +than in securities.</p> + +<p>The objection borrowers have in going to the +Bank of England is, they have to pay more for the +services rendered. In the phraseology of Lombard +Street, they have to pay higher interest for their +loans, and being ordinary mortals, not too full of the +milk of self-sacrifice, they prefer to go where they +can deal more cheaply. This is precisely the motive +that sends the housewife to the cheap butcher. She +might get her leg of mutton a farthing a pound +cheaper than if she went to the dear, extortionate +butcher.</p> + +<p>And there are some people in the City who have +whispered that the Bank of England is extortionate. +And those who have listened to them have made +grimaces not altogether unlike expressions of sympathy +and agreement.</p> + +<p>Still keeping our attention on the balance sheet,<span class="pagenum" id="Page_56">56</span> +and turning it for a moment from the stern, unbending +business men at the Bank of England, we find +that the legal tender and the call loans total over +eleven millions and a half, and the deposits are thirty-seven +millions and a half.</p> + +<p>Next, investments exceed £6,000,000. The +balance sheet says these investments consist of +Consols and other securities of, or guaranteed by, +the British Government, Indian, Colonial, and other +securities.</p> + +<p>I do not think any critics, not even financial +journalists—for do not the public ask their advice +what to invest in?—will deny that here we have the +cream of investments. We could not, not the brainiest +critic of us all, imagine anything creamier. Why, +these are the creamiest things that make a hungry +City editor’s mouth water. I dare say the most +humble of them would confess that if a kind-hearted +employer would only give him a few thousand pounds’ +worth, he would not waste his intellectual resources +in writing another line of financial criticism. He +would be so content with this wealth that he could +till his death-moment repose in absolute idleness and +enjoy contemplation of the continued labours of less +fortunate City journalists.</p> + +<p>Here, then, is an aggregation of approximately +£18,000,000 of first-class wealth, or nearly 50 per +cent. of the total pure and loan deposits.</p> + +<p>Bills discounted approach £7,000,000. I need<span class="pagenum" id="Page_57">57</span> +not spend much labour in analysing and describing +what bills of discount are. Those who wish a detailed +description must consult other works dealing more +fully with elementals. It is sufficient to say here +that these bills represent also the best class of wealth, +distinct, of course, from gilt-edged securities, but +wealth, nevertheless, of the highest character. They +represent produce, raw materials, manufactures of a +vast and varied character, and when the bank has in +its possession these bills which it has discounted, it +practically has the varied wealth they represent.</p> + +<p>Cheques are to be regarded as our national +currency, bills of exchange are to be regarded as +international currency. Cheques are wealth converted +into national currency. When a bank discounts +bills it enables them to perform also all the +functions of our national currency. Until they are +so discounted their functions are limited to their +international purposes.</p> + +<p>This is one of the purposes served in re-discounting +them with the joint stock banks.</p> + +<p>The great bill-broking firms and discount houses +discount them on behalf of customers and re-discount +them with banks. It is in the re-discounting that +they make their profits and continue their existence. +They cannot tie up their capital in these investments. +They must re-discount them in order to liquefy +them and restore their capital. And all the vast +wealth behind the bills thereby becomes liquid<span class="pagenum" id="Page_58">58</span> +capital that can continue fructifying instead of becoming +stagnant.</p> + +<p>Now this wealth, I say, the banks indirectly +possess. It is theirs. They buy it. And if they +buy it and it comes into their possession and they +exchange money for it, as merchants and tradesmen +do, how do they grant credit? When the wealth is +eventually sold the proceeds go into the coffers of +the banks, and the banks hand over the promises to +pay. But the promises to pay are more tangible +than the promises of the schemer who flits from +suburb to suburb and town to town living on what +is called credit.</p> + +<p>Then there is the other composite wealth amounting +to over £16,000,000. These are advances to +tradesmen, merchants, and other persons well known +to bank managers, who deposit some kind of wealth +as security.</p> + +<p>They are loans to all sorts of people who have +pledged all sorts of wealth with banks. This wealth, +in other words, they have liquefied and the banks +have been paid consideration for liquefying it. People +have parted with the wealth, sold it, if you like, and +it has been passed over into the possession of the +banks.</p> + +<p>Adding these to the other loans we make a total +of nearly £22,000,000, which compose that portion +of the deposits which we call loan deposits. If we +add the bills discounted as another form of loan the<span class="pagenum" id="Page_59">59</span> +total is raised to £28,700,000 out of a total of +£37,600,000 of deposits. This leaves a residue of +£9,000,000 of pure deposits against which the bank +holds £6,000,000 of legal tender, or over 60 per cent. +If we add the £6,000,000 of investments, the total +considerably exceeds the aggregate of the pure +deposits.</p> + +<p>Ought the position to be made clearer to the +public, to the unsophisticated man in the street, by +segregating the deposits and showing their component +elements? What is the objection? Will some great +bank start reform in this direction if it be earnestly +and sincerely desired to show the public exactly what +the position of affairs is; if it be sincerely desired to +surround the groping man in the street with a bright +light? Why not extend reform here after commencing +with the segregation of a bank’s legal tender +reserve?</p> + +<p>I can imagine, however, that the refusal would +be strenuous.</p> + +<p>Are the pure deposits credit? If they are not +credit, entirely distinct from the loan deposits, but +consist of money in some form or other lodged with +the banks, they cannot form a part of what is +described as the credit superstructure of the banks. +The so-called credit superstructure must be composed, +then, of the loan deposits which are at one and the +same time loans by the bank, and loans to the bank. +If they are other people’s liabilities and at the same<span class="pagenum" id="Page_60">60</span> +time the bank’s liabilities, whose credit are they? +The borrower trusts the bank and the bank trusts +the borrower; whose credit comes first? Who is +the first creator of the credit? It is as difficult to +answer as the question which came into the world +first, the egg or the chicken?</p> + +<p>No matter how we answer the conundrum, it +seems to me indisputable that what we gaze upon +is a superstructure of wealth. And it is indisputable +that the banks furnish machinery vital to the +progress of humanity. And it seems to me vital to +the interests of national well-being that every +resource should be ready to prevent the collapse of +any sound banking establishment.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_61">61</span></p> + +<h2 class="nobreak" id="CHAPTER_VII"><span id="toclink_61"></span>CHAPTER VII<br> + +<span class="subhead">WHAT IS THE LOANABLE FUND?</span></h2> +</div> + +<p class="in0"><span class="firstword">The</span> loanable fund in Lombard Street is said to be +the totality of the deposits in the possession of the +joint stock and other banks, plus the deposits in the +Bank of England. We will, however, for the moment +leave out the Bank of England as being immaterial +in the present stage of our argument. Let us confine +ourselves to the deposits in the joint stock banks, +and let us assume that these total £800,000,000. +What is called the loanable fund, therefore, is a +mass of money aggregating £800,000,000. If a +merchant or any other person desires to get a loan +he gets a portion of this huge sum, and the commerce +and industries of the country are financed +thereout.</p> + +<p>It has been likened by the imaginative to a +vast reservoir of money, into which money is constantly +flowing from many channels, and out of +which it flows into a great number of channels. In +fact, these channels form a mighty network, like the +veins of the human body, and as the steady flow of +blood to all parts of the body is essential to health<span class="pagenum" id="Page_62">62</span> +and life, so the steady flow of money throughout +the economic organism is essential to its health and +life.</p> + +<p>It is indisputable that money or capital, however +we designate the element, is vital to the well-being of +the economic organism of the State. Without this +provision the organism would in time decay and +perish. Therefore some perennial source of this +life-giving and life-preserving element should be +provided by the Government or some other organization +if the nation is to thrive and progress. As the +Government has not hitherto provided that source, +and as the banks alone provide it, let us examine the +peculiar character and essence of that element.</p> + +<p>We have seen that this so-called loanable fund, +or reservoir of capital, consists of money hoarded +with the banks by the public and loans by the banks +to other members of the public. These deposits are, +in fact, representative for the most part of fixed +capital. It is the habit to call them mere book +entries, intangible and invisible, and that the only +sign of their existence are the figures written in the +books of a bank.</p> + +<p>I have endeavoured to show, however, that so far +from being intangible, they are tangible, because +they are the composite wealth of the community in +possession, not of the community, but of the banks. +It follows, therefore, that the loanable fund of the +country does not consist of an intangible something<span class="pagenum" id="Page_63">63</span> +called credit, book liabilities, but of a certain portion +of the wealth of the country.</p> + +<p>Now this must necessarily be so. Wealth is the +source of wealth and the fruit of wealth. If you use +wealth you produce wealth. We call the product +wealth, or capital, the terms being interchangeable. +Capital is wealth, therefore wealth must be capital, +and if the banks possess wealth they possess capital. +Wealth or capital is valued in the terms of money. +We know of no other terms than money for valuation +purposes. If we say a pound of cheese is worth a +pound of tobacco, we mean nothing unless we make +simultaneously a calculation by the common standard +of value.</p> + +<p>The cheese is worth sixpence, we say, or one-fortieth +of a sovereign, and the tobacco is worth +sixpence. If I borrow sixpence from the cheese-monger +and give him my tobacco I create a loanable +fund, for I can lend the sixpence to some one else for +half a pound of tea as security, and the third person +can lend it to some one else, and so on <i lang="la">ad infinitum</i> +till the sixpence drops down a deep well and is lost. +Though the sixpence be destroyed the wealth it has +created in the course of its existence is not destroyed, +for we assume that it has been used profitably and +fructifyingly in the hands of successive borrowers.</p> + +<p>If the wealth of the country constitutes the +loanable fund, it is possible to make this wealth +fruitful only by converting it into currency and<span class="pagenum" id="Page_64">64</span> +making it flowable, or liquid. We know that a +stagnant pool will not irrigate land. We know that +it must be made to flow along innumerable channels. +The pool of water is as unfructifying as fixed or +stagnant capital. In order to make fixed capital +flow and enrich the area through which it passes it +must be re-converted into its original substance, +currency. Fixed capital is rigid currency, as ice is +rigid water. It is frozen. Well, the banks merely +unfreeze it, or thaw it. It is a misuse of language +and terms to describe this thawing process as a +creation of credit.</p> + +<p>Now the Government does the same thing when +it issues its war loan. It unfreezes fixed capital; it +starts into fruitful circulation hoarded capital. A +similar effect follows other loans and other promotions. +The Bank of England does precisely the +same thing when it unfreezes gold direct from the +mines by giving notes for it. The gold is fixed, or +rigid, frozen capital. It is useless for fructifying +purposes of a certain character, and in order to make +it fructiferous, or fruitful, it has to be submitted to +the reconversion process. When it has gone through +this process it is able to perform exactly the same +functions, or the same services, as the conversion of +other wealth into currency by the banks.</p> + +<p>How is it that in one case the Bank of England +is said not to create credit, and in the other case the +banks create credit, when the two processes are<span class="pagenum" id="Page_65">65</span> +identical? Because, we say, the Bank of England +gives legal tender currency for the gold, and the banks +give only custom currency for the wealth. The one +is not exactly a loan, it is argued, but the other is.</p> + +<p>If gold were a commodity, just ordinary wealth, +would it be a loan then? The answer is that gold +is not a commodity. But we know that gold is a +commodity until it has been minted into sovereigns. +As an ordinary export and import it is a commodity.</p> + +<p>But, the answer comes, the notes are legal tender +and legal tender is not credit. Here comes in the +schism, the casuistry. Fundamentally, the argument +is this. The conversion of wealth into ordinary +money or currency is credit, the conversion of +wealth into legal tender is not credit.</p> + +<p>As the banks lend, therefore, something over and +beyond the exact amount of legal tender they +possess, they create credit. If they lend only the +sum equal to their legal tender they do not create +credit. Therefore, credit is a something not inherent +in legal tender.</p> + +<p>Now pure deposits are loaned to banks. Therefore +the pure deposits, if they are credit, are the +credit of the depositors. If I exchange gold for notes +at the Bank of England and deposit those notes with +a bank, the bank has not created these notes and, +therefore, has not created credit. And the legal +tender notes are, as I have already said, no part of +the structure of credit. The legal tender notes are<span class="pagenum" id="Page_66">66</span> +loaned to borrowers, or exchanged for other people’s +wealth, and in ordinary business transactions there +is no credit when there is equal exchange. Credit +comes in when there is no direct exchange, or when +there is unequal exchange.</p> + +<p>No wonder the views on this complicated problem +are irreconcilable. I may recall what Mr. A. C. Cole, +a director of the Bank of England, said years ago, +in an argument between him and Mr. Tritton, the +President of the Institute of Bankers.</p> + +<p>“Now, I was very much surprised, on reading +Mr. Tritton’s paper, to find him stating that the +commonly accepted opinion that a bank can create +credit is a pure fallacy. In my opinion, if a bank +does not create credit, it cannot make a profit; in +fact, it is by the creation of credit that banks earn +their dividends. While I was surprised at the above-mentioned +statement, I was equally surprised to find +that a number of the bankers who took part in the +discussion which followed his paper seemed to accept +the statement as correct.”</p> + +<p>Banks seem to me to make their profits by taking +a share of the profits earned by the merchants and +tradesmen of this country. The profits of the country +are divided, as we all know, amongst the capitalists, +the retailers, and the working people. If there were +no such division of profits industry would come to +a standstill, and the community would starve. The +producers share their profits with the consumers, and<span class="pagenum" id="Page_67">67</span> +the consumers with the producers. It is impossible +for one branch of the community to amass all the +profits and the other branches to have none.</p> + +<p>The banks form one branch of the community +that takes a due share of the aggregate profits of the +community.</p> + +<p>The banker says <i lang="la">de facto</i> to the merchant who +borrows from him: “I will help you to make your +capital liquid so that you can continually earn profits +by the use of it, if you will remunerate me by giving +me a portion of your profits.” The merchant readily +agrees to the bargain, knowing that it would be a bad +bargain for him if he did not earn with his mobile +capital larger profits than he would hand over to the +bank. If he makes ten per cent., say, he gives the +bank two or three per cent. If the bank made no +charge for its services, the merchant would then have +the greater part of the ten per cent. The merchant +is the middleman between the capitalist—that is, the +banker—and the consumer, and the middleman gets +the profits of the middleman. Unless the bank provided +him with the capital he would be helpless.</p> + +<p>It will be seen, therefore, that a bank’s profits are +not something over and above, out of the sphere of +the total profits of the community, but are a share of +them, just as my employer shares with me the profits +he makes. If he paid me no salary, his personal +profits would be larger. But they are diminished to +the extent of the salary he gives me.</p> + +<p><span class="pagenum" id="Page_68">68</span></p> + +<p>When banks raise their interest for loans it is +tantamount to raising the price of their services. +That is to say, they demand a larger share in the +profits of the community. Merchants then try, in +their turn, to obtain a larger portion of the profits of +the community.</p> + +<p>Less wealth is then liquefied, the wheels of trade +begin to revolve more slowly, and depression sometimes +begins. Profits diminish, less capital and +wealth are produced, and the effect is subsequently +seen in the so-called loanable fund.</p> + +<p>The character of the loanable fund alters, however, +in times of depression. The pure deposits then +increase and the loan deposits diminish. As it +becomes less profitable to liquefy fixed capital, then +less wealth is taken to the banks to be liquefied, and +therefore the banks have to take their lessened share +of the aggregate profits of the community. But a +considerable portion of capital already in liquid form +in the shape of profits, instead of being reconverted +into fixed capital, remains liquid, and in its liquid +form is hoarded with the banks. But this hoarded, +liquid capital is not credit now, although in its origin +it was called credit. Even those who hold that banks +originally created the credit will hardly deny that +these deposits are now money, even though the money +may be the product of former bank loans, or former +liquefaction of wealth. If in their original liquefaction +they were credit, why are they not credit<span class="pagenum" id="Page_69">69</span> +now? At what precise moment did they become no-credit? +If they originated as credit why are they +not permanent credit?</p> + +<p>However, we see the character of the loanable +fund change. The pure deposits grow, the loan-deposits +diminish, and banks are said to have more +money or capital than they can employ. This is so, +even if the aggregate of the deposits is precisely the +same before the depression as after it, the increase in +the pure deposits being, say, merely equal to the +decrease in the loan deposits.</p> + +<p>Why, if the deposits are equal in amount, is the +loanable fund much greater in times of depression +than in times of activity, and why do rates for loans +fall?</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_70">70</span></p> + +<h2 class="nobreak" id="CHAPTER_VIII"><span id="toclink_70"></span>CHAPTER VIII<br> + +<span class="subhead">THE METAMORPHOSIS OF THE FUND</span></h2> +</div> + +<p class="in0"><span class="firstword">This</span> is because of the character of legal tender +currency, and a legal tender currency, however +desirable and however great its merits, must necessarily +have its shortcomings in a progressive state.</p> + +<p>The loanable fund is restricted, or controlled, not +by the growth of the country’s wealth, but by the +production of gold. To control it by so artificial and +arbitrary a circumstance as the output of gold may +seem absurd, and from a strictly logical and economic +standpoint it is absurd. The loanable fund ought to +be governed entirely by the production of wealth, and +not by something entirely independent of wealth and +having no natural or economic connection with it.</p> + +<p>I am now speaking of the loanable fund which +collects in the joint stock banks. Of the other loanable +fund, which collects in the Bank of England, I +will speak later.</p> + +<p>What the banks lend is liquid wealth, but the +amount they can lend at any given moment is +governed less by the amount of wealth that is brought +to them than by the amount of gold they possess.<span class="pagenum" id="Page_71">71</span> +This is the gold which, we say, constitutes their +reserves.</p> + +<p>Let us assume that it is the custom of the banks +to keep a gold, or, rather, a legal tender reserve—it is +chiefly composed of Bank of England notes—equal to +fifteen per cent. of their combined pure and loan +deposits. It follows that the growth of these deposits +must be controlled by this fifteen per cent. reserve. +This is so in practice. When the reserve begins to +fall below this fifteen per cent., then the banks cease +liquefying wealth and increasing the loan fund. +When the reserve increases beyond the fifteen per +cent., then the banks continue to liquefy the wealth.</p> + +<p>It is then said that money—some say credit—is +abundant, and the banks cannot find full employment +for it. When the reserve falls it is said that money—or +credit—is becoming scarce. We find, therefore, +that the loan-fund actually contracts when trade is +active, and expands when trade is depressed. In the +economic interests of the nation the fund should grow +simultaneously with and commensurately with the +growth of trade and commerce.</p> + +<p>In times of activity more wealth is created. It is +like an abundant harvest resulting from a favourable +season. In times of inactivity less wealth is created, +to be likened to bad seasons and poor harvests. In +times of activity there is necessarily and inevitably a +greater demand for capital, that is to say, for more +liquefied wealth. Bills of discount multiply, and they<span class="pagenum" id="Page_72">72</span> +are taken to the banks as security for loans, in other +words, to be converted into liquid form. Another +phrase is, into floating capital. If they could not be +so converted, the needs of the community in such +times could not be met, for the bills of discount could +not be used as currency, or capital, like cheques. +They are discounted at the banks in order that they +may be transformed into cheques, the representatives +of floating or circulating capital. In this form they +are able to reproduce wealth more rapidly than if +they had to remain in their original form.</p> + +<p>So it is with other forms of wealth, all are taken +to the banks to be converted into quickly reproductive +shape.</p> + +<p>But the banks have to keep an eye on that gold +reserve, watch it closely. Managers have to calculate +when the limit of their conversion powers will be +reached, and when it is reached their wealth-liquefying +machinery has for the time being to cease working. +It does not follow that when the machinery of +one bank has to stop, the machinery of all the banks +simultaneously stops. The limit may not yet have +been reached in other banks. Borrowers, as they are +called, then rush to them, and as the numbers grow +and the pressure increases, so is the limit of the other +banks more speedily reached, until at last the entire +machinery comes to a stop. It often comes to a stop +when in the interests of the economic welfare of the +nation it should be working most actively.</p> + +<p><span class="pagenum" id="Page_73">73</span></p> + +<p>But the machinery is controlled by another +independent agency, and the economic interests of +the nation must suffer the effects of this obtrusive +force.</p> + +<p>If this independent force be at times harmful and +not beneficial to the economic welfare and progress of +the nation, what is to be said of the cry that this +force, in the most urgent times, should be made more +interfering and harmful? What is to be said of the +cry that at the moment when the need is greatest +then the succour should be restricted?</p> + +<p>What should we say of the doctor who by ligatures +prevented the free flow of blood in the body of an +active, energetic man, in order to paralyse his +energies and enforce rest? We should say that he +was not only an unscientific doctor, ignorant of the +functions of the bodily organism, but that he was +actually killing his patient. These gold reserves, +therefore, act like ligatures, for they stop the free +and health-giving flow of economic blood at the very +moment when the flow should be stimulated.</p> + +<p>In inactive times we see the metamorphosis of the +fund take place. The loan deposits decrease, because +the liquefied wealth becomes frozen again and the +production of wealth decreases, while the pure +deposits grow. The fact that the loan deposits +decrease simultaneously with the contraction of +wealth production is an additional proof that the +loanable fund is wealth in liquid form. As the wealth<span class="pagenum" id="Page_74">74</span> +in fixed form is withdrawn from the bank so the loan +deposits drop.</p> + +<p>Now the increased pure deposits may be regarded +as a portion of the harvests gathered from the fructifying +use of the liquid capital in times of activity. +They are called the profits, or the savings of capital. +They accumulate in times of depression. For lack +of other employment they are placed on deposit with +the banks. They are, in a way, loaned to the banks, +and the banks are supposed to lend this money to +the classes of borrowers already described. But the +banks at these times benefit, or are presumed to +benefit, not because the aggregate of the deposits +grow enormously compared with other periods, but +because these pure deposits bring them more gold. +The loan deposits take gold, the pure deposits bring +gold.</p> + +<p>This is why, the aggregate being the same, or +even less, the potential loanable fund is greater in +inactive than in active times of trade. The gold +reserves increase and the proportion of the reserves +to the aggregate deposits rises. When this proportion +rises, the banks say they can afford to let it fall, +and therefore they can liquefy more wealth if there +were more wealth to liquefy. But there is less wealth +to liquefy, and therefore money is now said to be +abundant and cheap. The banks are willing to take +less interest, that is to say, a smaller share of the +profits earned by liquefied capital.</p> + +<p><span class="pagenum" id="Page_75">75</span></p> + +<p>But depositors also have to take a smaller share +of these profits. The banks divide their smaller +share of the profits with the pure depositors, and, +therefore, can give only a smaller rate of interest on +the deposits. Dissatisfied with this small rate of +interest, depositors seek for other channels of use, +other forms of investment, and when they find these +other channels, they withdraw their deposits and +reconvert them into fixed or frozen capital. They +may speculate with them in mining or rubber shares, +or invest them in Consols or War Loans. When +this is done, gold is automatically withdrawn from +the banks and the proportion may drop. Should the +proportion drop, banks can lend less, and the potential +resources for liquefying capital becoming less, they +can begin to charge more for these services.</p> + +<p>When the pure deposits increase the reserve of +gold automatically increases. Therefore, though the +risks of the banks increase, because the liabilities on +demand increase, so the power to meet those risks +automatically increases. This being so, the necessity +for increasing gold reserves is less apparent; for they +increase automatically. When the pure deposits +decrease and the loan deposits increase the proportion +falls, but it falls at a time when the risks are lessened +if set against the pure deposits as distinct from the +loans owing to the bank.</p> + +<p>It will be seen, therefore, owing to the constantly +fluctuating character of a bank’s liabilities, or risks,<span class="pagenum" id="Page_76">76</span> +it is impossible to maintain a fixed, undeviating +reserve, whether it be a high reserve or a low reserve. +And we know that this impossibility is demonstrated +every day in Lombard Street.</p> + +<p>It is demonstrated at the end of each month, +when the banks cease lending, and when they compel +their loan depositors to pay in their loans. This is +proof that a proportion of the deposits are loans to +the bank. As these loan deposits thereby contract, +banks cannot compel the pure depositors to withdraw +their deposits, therefore the proportion of the gold +reserve to the <em>whole</em> rises, and the wish of those who +clamour for high reserves is fulfilled.</p> + +<p>This policy is resorted to because an idea exists +amongst bankers that, instead of going to theatres +and other places of amusement, the public, as a +body, spends its leisure time during the closing days +of each month working out the proportion of the +reserves to the total deposits. This is a fantastic +dream. The public does nothing of the kind. It is +fallacious to imagine the public working out the +proportions minutely and then deciding in strictly +mathematical fashion whether a bank is safe or not, +and whether there is likely to be an immediate run +upon it or not. If bankers and theoretical financiers +were only gifted with the power to understand human +psychology there would be less contention amongst +them on questions of pure theory. They would not +magnify the unimportant at the expense of the<span class="pagenum" id="Page_77">77</span> +important functions of banking, and magnify the +superficial at the expense of the deep traits of British +character.</p> + +<p>We see the same policy adopted at the end of +each half-year, or year, when the banks make up +their half-yearly or yearly balance sheets. Such a +great deal has been made of this high reserve need—as +though it were possible for any mortal being to +draw up an absolute line of safety—that at these +periods trade is penalized because bankers imagine +that the millions of this nation are auditing their +accounts. They see them poring over these accounts +in the great castles of the realm, and in the cottages +of the poor. It is a pure delusion, and if the millions +engaged themselves voluntarily in these uncongenial +tasks, the result would only be national confusion, +and not national agreement. There can be national +agreement on one thing connected with the banking +system, and one thing only, alike in the mansion and +in the cottage, and that is agreement upon the +honesty and soundness of that system. And honesty +and soundness are not to be tested solely by the bulk +of the legal tender reserves.</p> + +<p>The only members of the community who, perhaps, +might be more concerned than others about +these reserves are the very members who share the +responsibility equally with the banks. They are those +who borrow from the banks, who get their liquid capital +there. All they have to do is to cease borrowing,<span class="pagenum" id="Page_78">78</span> +cease converting their wealth into currency, and the +thing is done. The remedy is in their hands.</p> + +<p>Do they do this? No. Do they show this feverish +concern? No. What do they do? These men, who +have more at stake than the other millions, actually +growl when the banks refuse to liquefy their wealth. +They make it a grievance, and a sore grievance. To +imagine, therefore, that these growlers are watching +minutely the movements in the reserve is a delusion +verging near to absurdity.</p> + +<p>When some bank managers tell borrowers they +must repay their loans, then they rush round to +other bank managers, caring not a fig about reserves +so long as they can get the accommodation they want, +for their needs are above all other considerations. +And when they find that no bank manager will serve +them, and when all bank managers tell them they +are sold out, then they have to go to the Bank of +England. They do not like to go to the Bank of +England, because they have to pay more for the +services that Bank renders. That is to say, they +have to share with the Bank of England a larger +portion of the profits they make than the portion +they would divide with the joint stock banks.</p> + +<p>By this analysis we see that the deposits of a +bank, the so-called loanable fund, consists of pure +deposits, which we may call cash deposits, and loan-deposits, +which those who believe in credit creation +call credit deposits. These latter deposits represent<span class="pagenum" id="Page_79">79</span> +the wealth placed with the bank, and so long as this +wealth is in liquid form in these deposits it cannot +be employed in its fixed form. These deposits are +loans owing by the bank and owing to the bank. +Others call them credit deposits created by the banks +themselves.</p> + +<p>These loans are made in relation to the proportion +each bank is in the habit of maintaining between its +cash, or legal tender reserves, and the deposits as a +whole. The loan deposits increase or decrease according +as this proportion rises or falls.</p> + +<p>It is left to the discretion of each bank to decide +what the proportion shall be. There is no legal +compulsion. Therefore it is their practice to retain +the minimum ratio which they consider sufficient for +their safety. When this safety limit is passed, then +they stop lending and proceed to call in their loans. +The totality of the deposits automatically diminishes, +and though not a sovereign has been added to the +reserve, the proportion rises.</p> + +<p>This, then, is the important point. Not so much +the amount of the reserve, as the proportion. One +bank may have fifty millions in its reserve, and +another bank only fifteen. But the smaller bank +may have a higher proportion to its liabilities and +the larger bank a smaller proportion. The test, +therefore, if there must be a test, is the proportion +of the reserve to the total liabilities, and with this I +shall deal more fully later on.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_80">80</span></p> + +<h2 class="nobreak" id="CHAPTER_IX"><span id="toclink_80"></span>CHAPTER IX<br> + +<span class="subhead">THE CENTRAL FUND</span></h2> +</div> + +<p class="in0"><span class="firstword">What</span> I call the Central loanable fund is the fund in +what financial journalists call the Central Institution. +This is not to be regarded as an institution standing +in the centre of a great circle of banks, with directing +chords, as it were, radiating from this governing +centre. Why it is called the Central Institution I do +not know, except it be a birth of the mother of +invention, or a need arising out of the limitations +of the English language.</p> + +<p>But the origins are unimportant. The Bank of +England, let us say, stands in an unique position, +and it is a banking institution that possesses great, +but not absolute, autocratic powers. The public +attribute to it greater powers, and surround it with a +greater glory and majesty than it probably possesses. +This is a psychological fact of significance. It is the +Bank <em>of England</em>. That is <em>the</em> Bank; the Bank that +props up the nation, and which the nation in its +turn props up. It is a mutual propping up. The +one cannot fall headlong and leave the other standing +erect. Both must stand or fall together. As,<span class="pagenum" id="Page_81">81</span> +however, in the consciousness of the community the +nation is unshakable—then it follows that the Bank +of England is in the nation’s view unshakable.</p> + +<p>Let me say, before I proceed further, that there +is no delusion in this. It is a fact of tremendous +import.</p> + +<p>Where a delusion does exist is in the belief or +consciousness that the Bank of England is a State +bank and not a private bank like other banks. It +is, however, a private bank, like other banks, performs +similar functions, earns its profits in the same way +and distributes its dividends to its shareholders in +the same fashion. It is a proprietary establishment, +run by the directors for the benefit primarily of its +shareholders.</p> + +<p>It is only a State Bank in that the Government +deposits its funds with it alone, borrows from it now +and then, and employs the Bank as its medium for +issuing loans, paying interest on the funds and performing +many other functions on its behalf. These +functions, it need scarcely be said, are not performed +gratuitously. They provide a source of income for +the Bank.</p> + +<p>The Bank of England is also a banker for the +private individual in the same way as an ordinary +joint stock bank is.</p> + +<p>It is also the banker’s bank. It may seem strange +to some people to learn that the banks themselves +have a common bank. This common bank is the<span class="pagenum" id="Page_82">82</span> +Bank of England. But they bank with it in a strictly +limited way. They do not borrow from it, nor discount +or, rather, re-discount bills of exchange there. +The Bank of England is to the joint stock banks a +limited convenience.</p> + +<p>They deposit what is called their reserve funds +there. In the balance sheet we have examined we +see that that particular joint stock bank possessed in +coin in hand and at the Bank of England a sum +aggregating £5,996,668. How much it had in its +own safes and how much at the Bank of England, +no outsider can divine. At any rate, we learn that a +portion of it was in the keeping of the Bank of +England.</p> + +<p>This reserve performs two functions. It acts as +a part reserve against deposits, or liabilities, and it +helps in adjusting the balances between the various +banks, the adjustment being made in the books of +the Bank of England.</p> + +<p>I need not describe here the methods of the +bankers’ clearing house, how each day the cheques +are cleared, and how each bank at the close of each +day finds out how it stands in relation to the other +banks. Debits are settled, not by a direct transfer of +cash, but by drawing a cheque upon the Bank of +England, just as an ordinary individual redeems his +liability by handing to his creditor a draft on his +bank. If they both bank at the same bank the +necessary adjustments are made in the books of that<span class="pagenum" id="Page_83">83</span> +bank. The aggregate deposits of the bank are +unaffected, and the reserve is unaffected.</p> + +<p>All the joint stock banks, then, have accounts +with the Bank of England, and the deposits of the +Bank of England include reserves of the joint stock +banks. The Bank of England pays no interest on +its deposits.</p> + +<p>Let us now analyse a Bank of England return, +which we may call a Bank of England balance sheet. +The following return is a post-war return, issued some +months after the outbreak of the <span class="locked">war:—</span></p> + +<h3>BANK OF ENGLAND.</h3> + +<h4><span class="smcap">Issue Department.</span></h4> + +<table id="t83a" class="balance cols"> +<col> +<col> +<col class="bl"> +<col> +<tr> + <td> </td> + <td class="tdc">£</td> + <td> </td> + <td class="tdc">£</td> +</tr> +<tr> + <td class="tdl">Notes issued</td> + <td class="tdr">86,802,605</td> + <td class="tdl">Government debt</td> + <td class="tdr">11,015,100</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr"></td> + <td class="tdl">Other securities</td> + <td class="tdr">7,434,900</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr"></td> + <td class="tdl">Gold coin and bullion</td> + <td class="tdr">68,352,605</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bb"> </td> + <td class="tdl">Silver bullion</td> + <td class="bb"> </td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bbd">86,802,605</td> + <td> </td> + <td class="tdr bbd">86,802,605</td> +</tr> +</table> + +<h4><span class="smcap">Banking Department.</span></h4> + +<table id="t83b" class="balance cols"> +<col> +<col> +<col class="bl"> +<col> +<tr> + <td> </td> + <td class="tdc">£</td> + <td> </td> + <td class="tdc">£</td> +</tr> +<tr> + <td class="tdl">Proprietors’ capital</td> + <td class="tdr">14,553,000</td> + <td class="tdl">Government securities</td> + <td class="tdr">21,824,358</td> +</tr> +<tr> + <td class="tdl">Rest</td> + <td class="tdr">3,499,722</td> + <td class="tdl">Other securities</td> + <td class="tdr">108,836,570</td> +</tr> +<tr> + <td class="tdl">Public deposits</td> + <td class="tdr">47,393,479</td> + <td class="tdl">Notes</td> + <td class="tdr">52,098,065</td> +</tr> +<tr> + <td class="tdl">Other deposits</td> + <td class="tdr">117,593,833</td> + <td class="tdl">Gold and silver coin</td> + <td class="tdr">813,512</td> +</tr> +<tr> + <td class="tdl">Seven day and other bills</td> + <td class="tdr bb">32,471</td> + <td class="tdl"></td> + <td class="tdr bb"> </td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bbd">183,072,505</td> + <td> </td> + <td class="tdr bbd">183,072,505</td> +</tr> +</table> + +<p>We must leave out of consideration for the present<span class="pagenum" id="Page_84">84</span> +the Issue Department. This is quite distinct from +the Banking Department, and so far as the Banking +Department is concerned, its working is as independent +as though it were merely a Treasury Office +in Whitehall.</p> + +<p>The Proprietors’ Capital explains itself. It represents +the amount of capital subscribed by the +shareholders. The Rest may be regarded as the +Bank’s accumulated profits, and ordinary reserve +fund. It is the fund into which the profits flow and +the funds out of which the dividends are paid. It is +not allowed, however, to run below £3,000,000.</p> + +<p>The Public Deposits are the Treasury deposits, +and it will be observed that these are kept distinct +from the Other Deposits. As every return explains, +these deposits include Exchequer, Saving Banks, +Commissioners of National Debt, and Dividend +accounts. When we pay our income tax to the +Government it is paid into the Bank of England and +swells the Public Deposits, and the Government uses +them in the same way as the private individual uses +his deposits in his own bank.</p> + +<p>The Other Deposits are the aggregate deposits of +all the Bank of England’s depositors except the +Government. They include the Reserves of the banks +of the Kingdom and the loans the Bank has made to +its various customers. As they include loans they +are a composite account. The Seven Day and Other +Bills is an item of no importance.</p> + +<p><span class="pagenum" id="Page_85">85</span></p> + +<p>On the other side are the assets the Bank holds +against these varied liabilities. Government +Securities are securities lodged by the Government as +a security for loans, and they also include the Bank’s +own investments. The Other Securities include bills +of discount, and securities of the highest class lodged +with the Bank as security for the loan-deposits.</p> + +<p>The notes are the ordinary Bank of England legal +tender notes, and constitute, with the small amount +of gold and silver coin, the Reserve of the Bank +against its liabilities. In this particular week the +ratio of the Reserve to the liabilities was 32⅛ per +cent.</p> + +<p>It will be noted that the Reserve does not consist +of coin, but almost entirely of notes. But the notes +can be exchanged at the Issue Department for gold, so +that they are equivalent to a holding of gold.</p> + +<p>On the asset side of the return, then, we see the +character of the wealth the Bank possesses. This +wealth represents the loanable fund of the Bank and +totals a huge sum. The deposits are, of course, +merely book entries, or book liabilities, or credits, as +most call them, and what I call the liquefied form of +the wealth held against them.</p> + +<p>Those who borrow the most extensively from the +Bank are bill brokers, and they only borrow in those +seasons when the joint stock banks have reached the +limit imposed by their reserves and cease lending. +Having need of liquid capital and not being in a<span class="pagenum" id="Page_86">86</span> +position to wait until the joint stock banks can lend +again, it is with great reluctance the bill brokers +borrow from the Bank of England. The reluctance +is most natural, because the Bank of England +charges higher rates for discounting bills and for +lending money on security than the joint stock banks +charge. And it also discounts and lends for much +shorter periods. This explains the Bank rate, which +is of such great importance in the economic life of +the nation. It is the minimum rate at which it will +discount bills for customers and the brokers, while it +will lend only at half per cent. above its minimum +rate for discounting.</p> + +<p>The rates charged by the joint stock banks are +always well below Bank rates, except on the rarest of +occasions, and therefore bill brokers and borrowers +of money generally naturally go to the cheapest +market, and when they are forced to go into the +dearest market in Threadneedle Street they go there +from necessity and not from choice.</p> + +<p>We are able now to grasp in some measure what +the Central Fund is. The Bank of England, when +other sources are dried up, is always able and willing +to lend <em>at a price</em>. This price is regulated by the +calls upon it, by the state of its reserve, by the condition +of the foreign exchanges, and by a general +survey of financial conditions.</p> + +<p>The rate is an instrument for limiting borrowing, +for correcting the foreign exchange, for drawing gold<span class="pagenum" id="Page_87">87</span> +to England, and for replenishing its reserve, if the +proportion has fallen to what is considered below the +average ratio of prudence, or safety.</p> + +<p>The loanable fund of the Bank of England, therefore, +is identical with the loanable fund of what is +called the outside market. It is the highest class of +wealth liquefied, but to the Bank is given the sole +power of attracting gold from abroad as a basis to +this fund when that gold is needed.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_88">88</span></p> + +<h2 class="nobreak" id="CHAPTER_X"><span id="toclink_88"></span>CHAPTER X<br> + +<span class="subhead">THE CENTRAL RESERVE</span></h2> +</div> + +<p class="in0"><span class="firstword">The</span> Central Reserve is the reserve held by the Bank +of England. Not only is it the Central Reserve, but +it must be regarded as the National Reserve, the sole +reserve. This is regarded by many as the chief +weakness of the banking system.</p> + +<p>Let us first of all distinguish between reserve and +reserve. This Central Reserve is the national legal +tender reserve. The joint stock banks have other +reserves, as we have seen, composed of the highest +wealth in the kingdom, and though there may be +some reason, there does not appear to me to be the +soundest, deepest reason why the foundation of the +system should be considered unsound because of our +moderate legal tender reserve, dependent as it is +upon independent forces, and because we place minor +importance upon the country’s store of wealth.</p> + +<p>To me it would seem the soundest reason to plant +our banking system chiefly upon the solid basis of +wealth, and not let that system be in the capricious +control of a force that has no direct connection with +the country’s real wealth, especially when we have<span class="pagenum" id="Page_89">89</span> +now found it to be easily possible to meet that most +remote contingency, a national panic. The nation +lives like a parent whose obsession is that in some +far-off day his son may meet with a serious accident +that will affect his brain and make him an imbecile. +What will he do, then, when his son becomes mad? +He broods over the possibility; it darkens his life; +it keeps away joy and happiness; his health suffers; +his energies, mental and physical, become paralysed, +and death gathers him while his son is still in the +prime of healthy manhood.</p> + +<p>After all, what panics have we had in this country? +Not one but what has been quickly assuaged since +the banking system developed into its present stage +of soundness.</p> + +<p>As it is insisted in many quarters that the system +is far away from being sound enough simply because +we have not large enough gold reserves, we must +examine the national reserve from this point of view.</p> + +<p>This reserve is not only the Bank of England’s +reserve against its own liabilities, but is the reserve +against the aggregate liabilities of all the banks of +the kingdom. The joint stock banks, as has been +explained, keep their reserves at the Bank of England, +the gold they keep in their tills and in their strong +rooms being too small to take into serious consideration.</p> + +<p>If we take the average fluctuation of the Bank +of England’s reserve to its own liabilities as from<span class="pagenum" id="Page_90">90</span> +40 to 50 per cent. throughout the year—this is quite +a fair average variation of the proportion,—we should +probably find that the proportion of this reserve to +the total liabilities of all the banks would be as low +as from 1 to 3 or 4 per cent. This is, of course, a +very low proportion, but low as it is, it has served +us well enough in the past, and as we cannot ignore +experience, it should continue to serve us well in the +future.</p> + +<p>When the proportion, say, falls below 40 per +cent., and is approaching 30 per cent., the Bank of +England takes steps to restore it to what is considered +the normal or prudent level.</p> + +<p>The proportion, as is inevitable, begins to fall +as borrowers are driven to the Bank of England +when the joint stock banks have ceased giving +accommodation. Though not a single note may +be withdrawn from the reserve the proportion must +necessarily fall as the liabilities rise. But it by no +means always follows that when the proportion +falls from this cause alone the Bank will raise its +rate. This will depend upon general circumstances. +There will be no need for the step if general circumstances +are favourable, for the loan-deposits will in +time be paid off and the normal conditions of the +market will be restored.</p> + +<p>As a fact, nothing is more familiar and certain in +Lombard Street than these recurring phenomena. +At the end of quarters, especially the March quarter,<span class="pagenum" id="Page_91">91</span> +when the taxes are flowing into the Exchequer, +there is a considerable amount of borrowing from the +Bank of England. When the money flows back into +the market through Treasury disbursements, the +borrowers are able to repay their loans to the Bank.</p> + +<p>In these times we see the Bank’s liabilities grow +in twofold fashion. The Public Deposits grow owing +to the tax-ingathering, and the Other Deposits grow +because of the borrowing on the part of what is called +the outside market. At the same time, a counter-active +influence is at work. As the taxes are paid in +to the Government they come indirectly out of the +Other Deposits, because they come out of the deposits +of the joint stock banks and out of their reserves, so +this puts a check upon the growth of the Other +Deposits.</p> + +<p>The Bank of England generally raises its rate +when a large export of gold abroad takes place. +There are two main channels through which gold +flows from the reserve of the Bank of England. The +one channel is that which takes gold into national +circulation, to the provincial banks and to Scotland +and Ireland at certain seasons of the year; and the +other is the channel by which gold is taken to foreign +countries.</p> + +<p>The internal drain, as it is called, rarely has any +influence upon the movements of the Bank rate. This +is because gold is known to be in the country, and if +it is not in the Bank’s own reserve, it is practically in<span class="pagenum" id="Page_92">92</span> +the total reserves of the other banks, and it will all +return to the central reserve in due course.</p> + +<p>A foreign drain of gold arises from quite other +causes. It will arise from a complication of causes. +Gold may be taken from the Bank in order to liquidate +the country’s balance of debt to other countries. +It is a common phenomenon, for instance, to see at +certain seasons of the year large exports of gold to +New York, Egypt, and South America. These exports +are expected, and occasion no surprise. But sometimes +they are supplemented by large unexpected +withdrawals, there and elsewhere.</p> + +<p>As an offset to these withdrawals, the Bank can +replenish the reserve by purchases of gold in the +open market. Each week gold comes to London from +South Africa and often from India, and if the Bank +can buy this gold it may obviate the necessity of +raising the Bank rate. Sometimes, however, there +is keen competition for these arrivals of gold, keen +competition from the Continent or New York, and the +Bank may be unable to outbid its competitors.</p> + +<p>The Bank is bound to take all gold offered to it +at the statutory price of 77<i>s.</i> 9<i>d.</i> per ounce. But +competition will sometimes drive the price well +beyond this figure, and continental countries sometimes +buy the gold at a loss, as Germany did in 1914, +if they are determined to have it at any price.</p> + +<p>For many months before the outbreak of the war, +the competition was exceedingly keen, so keen that<span class="pagenum" id="Page_93">93</span> +for a long period the Bank of England was unable to +purchase an ounce of gold. This competition was +chiefly on the part of Germany and Russia, especially +Germany, thereby affording presumptive evidence of +her deliberate plans for war. But this competition +and buying must be regarded as abnormal.</p> + +<p>The normal buying and the normal competition +arise when gold is wanted in the normal course of +trading between different countries. If, for instance, +the New York exchange is driven down to such a +point that it is cheaper to send gold than to buy +drafts, or exchange, then gold is bought and shipped. +This applies equally when other exchanges are against +this country.</p> + +<p>Sometimes we can spare the gold so well, that it +is better to let it go than to keep it; which proves +the futility of having a greater mass of gold in the +country than the country needs. At other times we +may have too little, and cannot spare more, and it is +at such times that another kind of competition starts: +the competition of bank rates in the various European +centres.</p> + +<p>The object of raising the Bank rate is to raise +interest here. When the rate is advanced, the joint +stock banks immediately raise the interest they give +on their deposits, and the rate of discount simultaneously +rises. The latter, however, is not always +instantaneously responsive, for the rise in the Bank +rate may have been foreseen for some time, and rates<span class="pagenum" id="Page_94">94</span> +may have risen already in anticipation. It is often +possible to judge, in the light of experience, when the +Bank rate will be raised.</p> + +<p>The competition takes the form, therefore, of +raising rates of interest; in other words, of making +money more remunerative here than elsewhere. The +Continent will probably send gold here, or keep gold +here in order to earn the higher interest, especially in +discounting bills, and therefore the export of gold may +be stopped, and gold, at the same time, attracted here.</p> + +<p>It does not follow that this is the inevitable consequence. +This will depend, not entirely upon conditions +here, but may be ruled by conditions elsewhere. There +is no hard and fast rule, no sure working of the law +of cause and effect. If other countries are determined +to have the gold, they will take it, no matter how +high the rate may be raised here, and in latter years +the rate has not been so effective, probably, as in +former years.</p> + +<p>Whether it be effective or ineffective at given +moments, it is one means we possess—some call +it a weapon—of trying to replenish our national +reserve from other centres, and of increasing the +power of the Bank to buy gold in the open market.</p> + +<p>We do not like the reserve to run down too low, +because we fancy that a low reserve would create too +much nervousness in the financial community. We +do not imagine it would create a panic, but it may +prevent undue nervousness should the Bank take<span class="pagenum" id="Page_95">95</span> +measures to stop the drain. If gold flows here, it +will in course of time make bank, or market money, +more plentiful and cheap.</p> + +<p>At the same time, of course, the trade of the +country is necessarily penalized. It is not good for +trade that there should be frequent fluctuations in the +price of loans. It affects profits, the growth of capital, +and prices, and it also affects the employment of +labour. If too much has to be paid for bank loans, +then it becomes too dear a process to convert fixed +wealth into liquid capital, for users of capital may +not then be able to employ it remuneratively. And +this may be a precursor to trade depression and +stagnation.</p> + +<p>If at such times we could replenish the reserves +from the provision of other legal tender, it might +obviate it.</p> + +<p>If money be sent here for investment at the +higher rates of interest, it will increase the Bank’s +reserve and at the same time increase the supply of +money. As the supply of money from the joint stock +banks is dependent upon these gold reserves, their +gold reserves will be increased. For some of this +fresh gold will find its way to the banks. They can +then convert more wealth into currency, and thereby +stimulate trade.</p> + +<p>When foreigners invest their money here, they +earn their profits in the same way as our banks do. +Their profits are a portion of the general wealth of<span class="pagenum" id="Page_96">96</span> +the community. As profits can come only from the +production and consumption of wealth, and not from +the void, then they are a portion of that wealth. And +if profits are a constituent of wealth, even if we call +them a residue of wealth, then bank profits must come +from the same source, and not from space.</p> + +<p>Foreign banks, therefore, become possessed of a +part of this country’s wealth, for profits are purchasing +power, and purchasing power cannot be intangible; it +cannot be credit. In the same way, when we invest +money in a foreign country—say, Argentina—we receive +the interest in the shape of commodities, that is, +in the shape of the country’s wealth. They are this +country’s profits on that loan: something tangible, +something Argentina and her wealth-producers part +with, and something they would retain if they did +not send it here.</p> + +<p>Therefore the interest we pay on foreign loans +here must also be paid in wealth. And if foreign +bankers get their profit in the shape of wealth, so +must our bankers get their profits in the same +substance.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_97">97</span></p> + +<h2 class="nobreak" id="CHAPTER_XI"><span id="toclink_97"></span>CHAPTER XI<br> + +<span class="subhead">THE FIDUCIARY CURRENCY</span></h2> +</div> + +<p class="in0"><span class="firstword">In</span> speaking of the fiduciary currency of the country +I will confine myself for the moment to that portion +of it represented by Bank of England notes. The +war-emergency Treasury note currency I will deal +with later on.</p> + +<p>All countries have a fiduciary paper currency. +Some have a convertible currency, others an inconvertible, +and others a partially convertible; but the +dimensions of this treatise cannot be expanded by a +comparison of the systems of different countries. +Those who desire to be assisted by comparisons must +consult other works.</p> + +<p>Moreover, I wish to confine myself to our own +fiduciary currency since the Bank Charter Act of +1844. Prior to then the banks of this country were +permitted to issue their own notes, and to issue them +in unlimited quantities, with the provision that they +were payable in gold on demand.</p> + +<p>There were people who attributed the various +crises that occurred in different periods prior to 1844 +to the over-issue of these notes. It was contended<span class="pagenum" id="Page_98">98</span> +that this alleged over-issue brought about an inflation +of the currency and encouraged gambling and speculation. +Diverse views were held then, and diverse +views are likely always to be held, as to the true +origins and causes of financial crises. But whatever +the views or causes may be there can be little doubt, +human nature being what it is, that many joint stock +banks abused the powers with which they were +endowed. This privilege of issuing notes to an +unlimited amount is a dangerous privilege to give to +irresponsible institutions, and if the power be given +it must be given to responsible institutions or one +responsible institution.</p> + +<p>This view probably was chiefly responsible for the +Bank Charter Act of 1844. This Act provided that +the Issue Department of the Bank of England should +be separated forthwith from the Banking Department. +Securities to the value of £14,000,000, which +included the Government’s debt to the Bank, were to +be transferred to the Issue Department, together with +so much coin and bullion that the total so transferred +should equal the amount of notes then outstanding. +Notes could be demanded from the Issue Department +by any person in exchange for gold at the rate of +£3 17<i>s.</i> 9<i>d.</i> per standard ounce.</p> + +<p>It was further enacted that if any banker, having +the power of issue on May 6, 1844, should relinquish +such issue, the Issue Department should be authorized +to increase its issue of notes against securities<span class="pagenum" id="Page_99">99</span> +to the extent of two-thirds of the relinquished +issue.</p> + +<p>Bankers having the right to issue their own notes +on May 6, 1844, were allowed to continue the issue +under certain conditions, and to an agreed amount; +but no provision was made compelling them to keep +any reserve against their issues either in cash or +securities. Should any issue lapse from any cause, +it could not be restored, and no institutions were +allowed to acquire the right of issue in the future.</p> + +<p>It will be seen that the fixing of £14,000,000 as +the basis of the note issue against securities, and not +against gold, was a purely arbitrary sum. No matter +how it was arrived at, nothing will alter its arbitrariness, +and up to the present there has been no suspicion +of ill, uneconomic results from this arbitrary +figure. And being an arbitrary figure there seems +to be no overwhelmingly strong reason why it should +not be extended within judicious limits. We must +bear in mind that in 1844 national and international +commerce were not on the mighty scale they are now. +We must bear in mind that the population of this +country and its output of wealth were greatly less +than they are now, and greatly less than they will be +in the future, and if this arbitrary figure was +judicious and safe in the first half of the nineteenth +century, and in the second half too, a higher figure +should be equally as judicious and safe half a century +hence.</p> + +<p><span class="pagenum" id="Page_100">100</span></p> + +<p>When we deal with a currency system in an +arbitrary manner and control its workings in an +arbitrary way, it is opposed to a scientific way. A +scientific method may be an impossible method in a +delicate system like currency, and therefore, if we +must rely upon arbitrariness, this method can be +made elastic and adjustable in a cautious, judicious +way.</p> + +<p>In 1844 banking was in its infancy. It has grown +since then, but we cannot with assurance predict +what developments are ahead of it, and fifty years +hence the nation may look back upon the present +system in much the same way as we look back to +conditions half a century ago. We find that during +the past fifty or sixty years the currency system of +the country has gone through a tremendous metamorphosis. +The banknote system—excepting the +legal tender notes—has practically disappeared, and +another paper currency has taken its place.</p> + +<p>This is the cheque currency, the real currency of +the country, because it is representative of the wealth +of the country, as currency should be. It grows +with the country’s wealth and shrinks with the +country’s wealth, and this is precisely the automatic +function an ideal currency should perform. A +perfect currency should simultaneously expand and +contract with the output and exchange of wealth, +because a perfect currency should be that wealth in +liquid form.</p> + +<p><span class="pagenum" id="Page_101">101</span></p> + +<p>Let us for a moment examine what wealth is. +Wealth has been defined by many economists, and +the definitions and formulas have differed greatly. +But we can be more in agreement, perhaps, as to +how wealth actually comes into existence. Wealth +is the product of two forces, and it cannot come into +existence unless these forces interact. These forces +are production and consumption. Wealth is not the +product of production only, nor of consumption only. +We cannot consume what has not come into existence, +what has not been produced. We can produce +without consumption, but it is consumption that +converts it into wealth.</p> + +<p>Articles of merchandise and raw materials are +produced in order that they may be consumed. They +would not be produced if there were no prospect of +consumption. It is consumption that confers value +upon products. If products were not converted into +wealth they would perish; they would be valueless. +There must be a desire for them. If there were no +desire for them, labour and capital would not be +spent upon consuming them. A desire must exist +before production, or production must bring a desire +into being. And when that desire becomes active, as +distinct from passive, its activity becomes consumption. +We know that in states of trade depression the +markets are stocked with unconsumed and unconsumable +commodities, and these commodities cannot, +in the strict sense of the idea, be called wealth. They<span class="pagenum" id="Page_102">102</span> +are perishing, they are valueless, because no one +wants them, and vendors of these commodities face +loss and sometimes ruin. They try every art known +to them to stimulate desire for them in order to get +that desire manifested in purchasing them.</p> + +<p>To increase wealth we must necessarily increase +production and consumption; in other words, increase +supply and demand. This is the economic object of +all civilized nations. This wealth it is their object +to convert into money, for money is the reproductive +product of wealth. Wealth cannot become reproductive, +except in a most limited sense, unless it is +converted into reproductive form, and banks supply +not the entire, but the chief machinery for changing +it into this form. If, therefore, their chief function +is to change wealth into reproductive form, it is not +creating credit.</p> + +<p>Money is like the fruit ripened into seed. Fruits +of the earth must be ripened into seed before they +can reproduce their kind. If they perish before then, +they do not become reproductive. When this new +seed is sown in the earth, to be gathered into ripened +fruit at the next harvest, it performs the same function +that money performs when it circulates. It reproduces +and multiplies itself, and the harvest springing +up from it is new wealth.</p> + +<p>The more wealth, therefore, that is transformed +and reproduced and that multiplies, the richer, we +say, a country becomes. Therefore, it follows that<span class="pagenum" id="Page_103">103</span> +the transforming machinery should work with pace +equalling the creation of wealth if the country is to +reap the best harvests from its work. For every +pound’s worth of wealth coming into existence the +means should be provided for transforming it into +a pound’s worth of money.</p> + +<p>So far, the best means discovered is the cheque +system. No legal tender system, based upon gold, +could provide these essential means, because gold is +not provided sufficiently, and cannot be provided sufficiently. +The machinery we need can be made with +no precious metal. If we desire perfect machinery, +it is indisputable that no machinery could do the +work so efficiently as paper machinery.</p> + +<p>The paper currency system is, therefore, a great +advance upon the old banknote system. It is transformed +wealth, and as the cheques represent the +deposits, rising and falling in amount with them, +then the deposits must be transformed, reproducible +wealth. The note system, based on no wealth, was +credit.</p> + +<p>Returning to the Issue Department of the Bank +of England, we see that £11,015,100 of the total note +issue is based upon the sum of money owing by the +Government to the Bank, and that £7,434,000 is +based upon other securities of a gilt-edged order, +making a total of £18,450,000. The balance is based +pound for pound on gold.</p> + +<p>It will be seen, therefore, that if every note was<span class="pagenum" id="Page_104">104</span> +presented to the Bank to be converted into gold, over +£18,000,000 of these notes could not be converted. +Some have suggested that in that event, in order to +provide the gold, the securities could be sold for +gold, the Government debt could be converted into +bonds, and they also could be sold. But as this need +could arise only in a panic, when every one clamoured +for gold, and all who had securities were trying to +sell them for gold, the Bank of England would find +it impracticable to sell securities for gold. Such +securities, if they are to be sold at all, must be sold +at other times, and the gold must be acquired then +if the note issue is to be made absolutely convertible.</p> + +<p>Personally, I think the need is too remote, too +much in the realm of dreams, to be entertained +gravely. The gold could perform better services to +the community than to be hoarded in this fashion.</p> + +<p>Since the year of the Bank Charter Act we have +had three serious panics in the country. Now the +Act was passed to prevent panics. As it did not +prevent panics, the theories on which the legislation +was based proved untenable.</p> + +<p>Panics are not automatic. It was probably thought +by many that they were, and that they could be ended +in automatic fashion. It is impossible to foresee how +a panic will arise. According to every plausible +theory, a panic should surely have been the immediate +consequence of the European War. Not only<span class="pagenum" id="Page_105">105</span> +should a panic have arisen then, but it should have +been by far the worst panic this country has ever +faced. But no panic resulted, and all plausible +theories have been inoperative.</p> + +<p>Previous panics have been allayed by the actual +suspension, or by the potential suspension, of the +Bank Act. That is to say, by the knowledge that +the Bank of England would have power to issue note +currency to any amount, unbacked by the deposit of +gold. In other words, by the knowledge that sufficient +legal tender would be provided, <em>at a price</em>, for the +needs of all solvent people.</p> + +<p>The need, then, is currency—just as a person +prostrated by fever needs a tonic to restore him to +convalescence. When the need is rightly met, all +is well. To withhold the remedy would feed the +disease. Instead of being checked, the disease would +grow.</p> + +<p>Panic is a disease of the mind, and it most often +proceeds, like disease of the body, from excessive +indulgence in a disease-producing cause. It will +suddenly arise as an offspring of wild gambling and +frenzied speculation, and it will infect people in a +healthy condition who fear they will be victims of +the scourge. And it is not only the duty of the State, +but the highest wisdom of the State, to come to the +help of the healthy.</p> + +<p>We have seen how the State has performed this +duty in the past, in the days when banking was<span class="pagenum" id="Page_106">106</span> +immature, and we have seen how it has performed +its duty, with perfect and instantaneous success, when +the country became involved in the greatest crisis it +has ever faced. And this is an experience from which, +it seems to me, valuable lessons may be learnt.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_107">107</span></p> + +<h2 class="nobreak" id="CHAPTER_XII"><span id="toclink_107"></span>CHAPTER XII<br> + +<span class="subhead">BANKING WEALTH</span></h2> +</div> + +<p class="in0"><span class="firstword">Having</span> proceeded so far we may now be able to test, +perhaps, with more sureness the kind of wealth a +bank does transform, and the kind of wealth it should +transform. On the character of the wealth sound +banking should depend.</p> + +<p>Wealth has degrees. There is the highest wealth +and the lowest wealth, with infinite degrees between. +How are we to distinguish the highest from the lowest +wealth, to know the quality of that product which +comes into being from the satisfaction of desire? I +think it is <em>time</em> that will enable us to judge. That is +to say, wealth is to be judged by its enduring qualities. +The highest wealth is permanent, or lasting +wealth; the lowest is fleeting, or transient wealth.</p> + +<p>The most permanent wealth is food and air, +because without this wealth humanity would perish, +and banking systems with it. But air cannot be +transformed, from reasons well known; but food can, +and food satisfies the most lasting of human desires. +Only universal death can destroy that desire.</p> + +<p>Let us examine with closer scrutiny the typical<span class="pagenum" id="Page_108">108</span> +bank balance sheet given in a former chapter. First +of all comes gold. Now we regard gold as the most +permanent form of economic wealth. What alone +gives it this permanency is the law. It is not inherently +permanent; inherently, it is no more permanent +than are diamonds or corals. We know that +the quantity of gold in the earth is limited, and that +gold is perishable, and that it cannot be got below +certain depths, because men cannot live beyond those +depths. The time will come when gold will be exhausted, +and it will then be necessary to find another +substance to perform the functions allotted to it. As +law has made it permanent wealth, so law could +to-morrow, by its arbitrary decree, make it impermanent +wealth. If gold were allowed to be, like +diamonds, a mere commodity, then it would come in +a low degree of wealth.</p> + +<p>It is important, therefore, to be conscious of the +arbitrary power that makes this low degree of wealth +permanent wealth. Because law has decreed that it +shall be in the highest class of wealth, then it comes +first amongst a bank’s assets, because this is the +class of wealth that in certain circumstances would +have to satisfy the strongest of human desires. Is +it the wealth that a bank transforms? It is transformed, +because though it lies in a bank’s vaults, it +is transformed into the same substance as other +wealth and thereby becomes fruitful. In this manner +it is able to multiply itself, not into gold, but into<span class="pagenum" id="Page_109">109</span> +other forms of wealth. It multiplies itself into gold +indirectly by stimulating and helping the production +of it. When gold is brought to the Bank of England +and converted into notes, it performs the same services +as when it is taken to banks and is converted +into that other form of paper currency, cheques. +The gold gets into circulation, and is just as fruitful +though it be circulated in the form of coin, instead +of notes. It makes no difference whether this gold +is retained in the vaults of the joint stock banks, or +is placed in the keeping of the Bank of England. In +fact, if it is placed in the keeping of the Bank of +England, it can be made more fruitful, for the Bank +of England re-utilizes it, and increases the potential +amount of currency based upon it.</p> + +<p>The next asset is the money at call and short +notice. The money at call is, as already explained, +practically the money lent to bill brokers, and forms +a part of what is called a bank’s liquid reserve. If +in a time of grave urgency the bank “calls” this +money from the bill brokers, it simultaneously “calls” +in its loan deposits. It is understood that in those +moments the brokers would be unable to repay their +loans if they could not get the money from the banks. +If, therefore, they cannot get the money from the +banks, how can this portion of the deposits be withdrawable +from the banks? If they were withdrawn, +they would have to be paid in again the moment +they were withdrawn.</p> + +<p><span class="pagenum" id="Page_110">110</span></p> + +<p>We know that in those times, however, the loans +would be called and the bill-brokers would have to +borrow the money from the Bank of England. And +this money being paid over to the creditor bank, the +deposits would automatically fall, and the proportion +of the gold reserve to the other deposits would automatically +rise.</p> + +<p>It is a conviction in Lombard Street that in those +times the bill-brokers could get no money from the +joint stock banks. That being so, what is called the +credit superstructure does not appear to be so unwieldy +as it looks.</p> + +<p>The money at short notice presumably represents +the money lent to the Stock Exchange at settlement +times. Those to whom the money is lent owe the +money to the bank, and when the bank asks for +repayment the money must be got elsewhere, and it +can only be got from the Bank of England on a +certain class of security. Against these two classes +of loans, security is lodged with the lending bank.</p> + +<p>What class of wealth is this? The security for +the money at call is of a higher class than the security +for the money at short notice. The latter security +consists of all kinds of Stock Exchange securities. +The most fleeting kind of wealth we may call the +wealth brought into existence by speculation. It is +nevertheless wealth, for it satisfies a desire and is +exchanged. But as this desire is quickly destroyed, +then the wealth is either totally destroyed or partially<span class="pagenum" id="Page_111">111</span> +destroyed with it. Even war produces wealth, but +as this wealth satisfies only a fleeting desire its reproductive +power is transient. It is like scattering +seed on the rocky ground, little of which is able to +take deep root. The harvest is scanty, and like all +scanty harvests, it brings want and ruin in its train. +It lessens the reproductive and, therefore, the consumptive +power of labour, and thus directly affects +harvests elsewhere.</p> + +<p>Banks, therefore, in selecting the wealth constituted +in Stock Exchange securities must carefully +discriminate between the lasting wealth and the +fleeting wealth; in other words, between high-class +investment securities and speculative stocks and +shares. This, of course, calls for intimate knowledge +and sound judgment. These are qualifications all +bank managers must possess. If they possess the +qualifications and exercise the soundest judgment in +selecting the highest type of wealth, then they put +into practice all the principles of sound banking.</p> + +<p>Now, there is no suspicion that these qualifications +are not possessed and that this sound, selective +judgment is not shown by the managers of our great +banking institutions. This, therefore, is the basis of +the community’s confidence in them. That confidence +is justified.</p> + +<p>We need not minutely examine the bank’s “investments.” +Not only do these constitute wealth of +the highest class, but it is wealth not represented by<span class="pagenum" id="Page_112">112</span> +loans and immediate liabilities. They may justifiably +and safely be placed secondary only to the bank’s +gold, forming a portion of its liquid reserve. In the +hour of danger or peril to the community, it should +be the duty of the Government, should the need arise, +immediately to transform this wealth into legal +tender money.</p> + +<p>Bills discounted represent another form of the +highest wealth of the community, and the banks still +adhere to the soundest principles in discounting +them. These bills represent that class of wealth +that has to satisfy the most enduring desires of the +human race. Here, then, we see the best judgment +at work. There are, of course, many varieties of +bills of exchange. They may be placed in different +classes, or categories, according to their endorsements. +What is called in the market the “finest” +bills are those endorsed by the leading banks, and +they are called clearing bank acceptances. Banks +accept these bills for small commissions, and they +are more readily discounted then in the market, +simply because they have behind them the highest +class of wealth. Then there are bills accepted by +merchants and other houses or firms which are not +of the standing of the clearing banks. They are of +an inferior category. The value of the acceptances +and endorsements, and therefore the value of the +bills, depends greatly upon the standing or reputation +of the acceptors.</p> + +<p><span class="pagenum" id="Page_113">113</span></p> + +<p>Now the banks discount, as a rule, only the +“finest” bills, that is, the bills with the most +reliable acceptances, bills accepted, say, by other +banks. In exercising this discrimination they +exercise the soundest judgment, and nothing higher +can be expected of them.</p> + +<p>Such bills as these are readily discountable at +the Bank of England, and there is no sound reason +why, in certain given circumstances, they should +not be discounted even by the Government through +the agency of the Bank of England. It might be in +the interests of the country to do this, especially +as the machinery could immediately be set in motion. +And if the machinery could be set in motion immediately, +then the bills should be as good a reserve +as legal tender.</p> + +<p>It is to be believed, too, that the soundest judgment +is shown in the selection of the composite +wealth aggregated under loans and advances. These +represent the largest aggregate asset, but, at the +same time, they represent the greatest proportion +of the loan-deposits, deposits repayable to the bank. +Such loans as these should be made of very short +duration, renewable, of course, but renewable for +short periods. Is it possible to make some kind of +legal provision whereby in the event of a remote +disaster such as a panic these deposits, representing +liabilities to a bank, should be discriminated against +and not be withdrawable on demand? Could not<span class="pagenum" id="Page_114">114</span> +the position be made clearer, as I have hinted +already, by segregating the deposit and current +accounts? Were this hint adopted the amended +balance sheet would appear somewhat as <span class="locked">follows:—</span></p> + +<table id="t114a" class="balance"> +<tr> + <td class="tdl"><span class="in2"><i>Dr.</i></span></td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> +</tr> +<tr> + <td class="tdl">Capital Authorized, £30,000,000</td> + <td></td> + <td></td> + <td></td> +</tr> +<tr> + <td class="tdl">Capital Issued</td> + <td class="tdr">3,000,000</td> + <td class="tdc"> 0</td> + <td class="tdc"> 0</td> +</tr> +<tr> + <td class="tdl">Reserve Fund</td> + <td class="tdr">1,125,000</td> + <td class="tdc"> 0</td> + <td class="tdc"> 0</td> +</tr> +<tr> + <td class="tdl">Current, Deposit and Other Accounts</td> + <td class="tdr">8,908,141</td> + <td class="tdc">17</td> + <td class="tdc"> 8</td> +</tr> +<tr> + <td class="tdl">Loans on demand and on short notice due by customers, as per contra</td> + <td class="tdr">5,644,476</td> + <td class="tdc"> 5</td> + <td class="tdc"> 1</td> +</tr> +<tr> + <td class="tdl">Bills discounted, as per contra</td> + <td class="tdr">6,811,870</td> + <td class="tdc">13</td> + <td class="tdc"> 8</td> +</tr> +<tr> + <td class="tdl">Loans and advances due by customers as per contra</td> + <td class="tdr">16,218,748</td> + <td class="tdc">12</td> + <td class="tdc"> 6</td> +</tr> +<tr> + <td class="tdl">Acceptances on behalf of customers</td> + <td class="tdr">3,153,328</td> + <td class="tdc"> 7</td> + <td class="tdc">11</td> +</tr> +<tr> + <td class="tdl">Rebate of interest, etc.</td> + <td class="tdr">53,807</td> + <td class="tdc"> 1</td> + <td class="tdc"> 3</td> +</tr> +<tr> + <td class="tdl">Profit</td> + <td class="tdr bb">225,676</td> + <td class="tdc bb">10</td> + <td class="tdc bb"> 1</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bbd">£45,141,049</td> + <td class="tdc bbd"> 8</td> + <td class="tdc bbd"> 2</td> +</tr> +</table> + +<table id="t114b" class="balance"> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr"></td> + <td class="tdc"><i>Cr.</i></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdc"></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> + <td class="tdc">£</td> + <td class="tdc"><i>s.</i></td> + <td class="tdc"><i>d.</i></td> +</tr> +<tr> + <td class="tdl">Cash in hand and at Bank of England</td> + <td class="tdc">5,996,667</td> + <td class="tdc">14</td> + <td class="tdc">8</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl">Money at call and short notice as per contra</td> + <td class="tdc bb">5,674,476</td> + <td class="tdc bb"> 5</td> + <td class="tdc bb">1</td> + <td class="tdr"></td> + <td class="tdc"></td> + <td class="tdc"></td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">11,671,143</td> + <td class="tdc">19</td> + <td class="tdc"> 9</td> +</tr> +<tr> + <td class="tdl">Investments</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">6,260,705</td> + <td class="tdc"> 3</td> + <td class="tdc"> 5</td> +</tr> +<tr> + <td class="tdl">Bills discounted as per contra</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">6,811,870</td> + <td class="tdc">13</td> + <td class="tdc"> 8</td> +</tr> +<tr> + <td class="tdl">Loans, advances, etc., as per contra</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">16,218,748</td> + <td class="tdc">12</td> + <td class="tdc"> 6</td> +</tr> +<tr> + <td class="tdl">Liabilities for Acceptances as per contra</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr">3,153,328</td> + <td class="tdc"> 7</td> + <td class="tdc"> 8</td> +</tr> +<tr> + <td class="tdl">Freehold and leasehold premises</td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bb">1,025,252</td> + <td class="tdc bb">10</td> + <td class="tdc bb">11</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdc"></td> + <td class="tdr bbd">£45,141,049</td> + <td class="tdc bbd"> 8</td> + <td class="tdc bbd"> 2</td> +</tr> +</table> + +<p>The answer might be that this would look too +modest a balance sheet, and would give less scope<span class="pagenum" id="Page_115">115</span> +for boasting of the growth of deposits. The deposits +now look attenuated at less than £9,000,000, but +look at the cash reserve against them! Close on +£6,000,000! True, this cash melts at the Bank of +England, but it gives the balance sheet a truer and +stronger appearance. If it be sincerely desired to +give greater enlightenment to the public, as many +contend, then further enlightenment can be given in +this way, which is by no means the last word in +improving a balance sheet.</p> + +<p>But there is too much competition between banks; +too deep a jealousy and too keen a rivalry. This +keen and jealous competition may be well amongst +merchants and tradesmen, but it seems neither +healthy nor dignified amongst banks. The work +they do for the nation is too vital for this kind of +competition to be encouraged. Perhaps it would be +in the best interests of the nation if banks were +nationalized, and made branches of a National Bank.</p> + +<p>The main object of banks should not be that of +the ordinary tradesman, who boasts loudly and +sometimes vulgarly of the trade he is doing. There +should be no incitement to this in banking, no incitement +to dilate composite deposits, to swell profits +and to strain dividends. With all this rivalry and +incitement, this desire to gratify shareholders, it is +wonderful how cautiously and soundly managed +banks are. There should be no hesitation to perform +their functions within the limits of prudence,<span class="pagenum" id="Page_116">116</span> +but, at the same time, there should be no undignified +display and boastfulness. This does not make the +deep impression some imagine. On the contrary, it +tends to generate the suspicion in many prudent minds +that caution and safety are being unduly strained.</p> + +<p>The public have not failed to notice that contrary +policies have been adopted by the great banks in +dealing with their profits for the year of crisis, 1914. +Some reduced their dividends and others maintained +them. Some allowed liberally for depreciation, and +others allowed for no depreciation at all. Some +provided for the future, others were content to let +the future take care of itself. And what conclusions +can the public draw from such divided counsels and +irreconcilable policies? Able to agree as they often +are on common policy, they were unable to agree on +so important a policy as this. As one bank manager +said to the writer, when discussing this matter: +“Even if the dividends were earned, it was a matter +of sound expediency in times such as these to reduce +them. It would have strengthened their positions +and at the same time have made a better impression +on the public.” And there was much wisdom in +this view.</p> + +<p>Applying, as we have done, severe tests to bank +management, it emerges from them with great credit. +Sound as the management is no bank manager and +no bank directors would be vain enough to claim +that ideal soundness has been attained.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_117">117</span></p> + +<h2 class="nobreak" id="CHAPTER_XIII"><span id="toclink_117"></span>CHAPTER XIII<br> + +<span class="subhead">ELASTICITY OR INELASTICITY?</span></h2> +</div> + +<p class="in0"><span class="firstword">One</span> of the great subjects of controversy, on which it +seems impossible to arrive at a common agreement, +is whether the so-called loanable fund is elastic or +inelastic. It is admitted, I think, in a general sense +that in order best to help the trade of the country, it +should be elastic, that is, should be able to meet all +the needs upon it. This certainly should be the province +of banking, and, what is more, it should be the +province of Governments to provide sufficient money +to meet the expansion of trade. It would be a foolish +policy to shackle and bind trade, to arrest its growth, +by restricting facilities for its growth. It would be +like a foolish parent binding the limbs of his child +to stay their natural growth and to keep him a dwarf +and a freak, unable to do the work of a mature +man.</p> + +<p>As the banking system practically performs the +duties which in its non-existence would have to be +performed by a Government, then it devolves upon +this system to feed and succour commerce and to give +it every facility and every means for expansion. When<span class="pagenum" id="Page_118">118</span> +I said in <a href="#CHAPTER_XI">Chapter XI</a> that the transforming machinery +should work with a pace equalling the creation of +wealth, it was tantamount to the view expressed by +others that the loanable fund of Lombard Street +should be elastic.</p> + +<p>Instead of calling it a loanable fund, a vast pool of +money into which borrowers dip, a pool always filled +by a perennial spring, I prefer to call it machinery +for transforming fixed wealth into mobile capital, or +currency. When I take my wealth to a bank I take +it there because I cannot use it fruitfully as capital in +its fixed form. As I wish to use it fruitfully the bank +temporarily changes it into money for me, and in this +new shape I can make full use of it.</p> + +<p>Now, all who have practical experience of the +banking system know there are times when the banks +refuse to perform this office for wealth possessors. +The machinery comes to a temporary stop. When +we inquire why it has stopped, we learn that it is +because the proportion of the reserve to the liabilities +has fallen to too low a point. Others would say, it is +because the pool had been drained too far, was being +dried up, and that time must be given for money to +flow in again. If we liken it to a pool we find that +instead of it having been drained, it is really over-filled, +and that what the banks desire to do is to stop +the overflow and to let the water sink. The banks +say they have lent too much, and must now lend no +more for awhile; so they not only stop lending, but<span class="pagenum" id="Page_119">119</span> +call in loans, which again shows that the fund is +overflowing; it must be allowed to subside.</p> + +<p>We also see at times, when the fund is overflowing, +that banks are so eager to lend, that money is said to +be a glut on the market and exceedingly cheap. It is +offered at nominal rates of interest. Why, then, are +there times when banks are eager to lend when the +fund is supposed to be overflowing, and times when, +with an overflowing fund, they refuse to lend? Why +is it that at times when the fund is low they are +willing to lend, and why at other times when the +fund is low they are unwilling to lend?</p> + +<p>These phenomena prove, I think, that it is not a +fund of money in the real sense of the word. We can +never tell merely by looking at the aggregate deposits +of the banks whether they are able to lend at any +given moment or not. We can easily delude ourselves +by looking at the bulk of that fund. What governs +what we may call the transforming capacity of banks +is the quantity of gold they individually possess and +general financial and international conditions. In +times of uncertainty and apprehension, no matter +from what circumstances or events these arise, banks +may refuse to lend, no matter what the condition of +the so-called loan fund may be. So far from lending +when their deposits appear to be very high, they are +anxious to diminish these deposits and gather in gold.</p> + +<p>It follows that the more gold they hoard the less +becomes the loanable fund. Therefore the more legal<span class="pagenum" id="Page_120">120</span> +tender they accumulate at these times, the less money +they lend. Which seems anomalous and paradoxical. +The more money banks have at certain times the less +they have. When the hour of nervousness passes +they begin to lend again. The money in the shape of +gold diminishes in proportionate quantity, therefore +the loanable fund of Lombard Street apparently +increases as gold apparently diminishes.</p> + +<p>This fund is, at times, like a spring in a desert. +The thirsty traveller sees it shimmering in the distance +and hurries towards it in profound gratitude, +thankful that his thirst is to be slaked and his sufferings +are to be relieved at last. But just as he is +about to put his lips to the tempting waters, a voice +of warning stops him. He is not to drink, for the +waters are too precious and must be preserved. Not +a drop can be spared. So he does not slake his thirst, +and perhaps afterwards succumbs to the torture he is +suffering.</p> + +<p>The spring is there, but he is forbidden to drink!</p> + +<p>In the banks the source of money is there, but the +gold must be preserved, and the community must +depart unsatisfied, no matter what the consequences +may be. The banks will not lend because they must +keep and increase, not their deposits, their so-called +loanable fund, but their gold.</p> + +<p>These deposits, then, are not strictly a loanable fund, +otherwise the more they grew the greater would be +the fund. In fact, the fund would be inexhaustible,<span class="pagenum" id="Page_121">121</span> +increased and not diminished by the demands made +upon it. We know they are increased by loans. +Therefore the best means of increasing the fund +would be by increasing the loans, and we could then +witness money actually piling up mountain-high in +our midst. This could put all fables of money-making +by magic into the shade.</p> + +<p>Instead, however, of increasing the fund by lending +as fast as physical resources will permit, the +banks adopt the contrary policy. They stop making +loans and simultaneously diminish the loans they +have already made.</p> + +<p>Whatever views the public may hold, bankers +labour under no delusions as to the real nature of +the loan-fund. They know well enough they do +not lend out of that fund at all, for if they lent +out of it they would inordinately increase it by +lending and so make more profit. It helps to shed +more light on the nature of the deposits. Why are +banks anxious to diminish the deposits in times of +anxiety and apprehension? That is to say, the loan +deposits, and not the pure deposits? Why are they +anxious to diminish the aggregate of the so-called +money fund?</p> + +<p>They wish to take away from their borrowers their +power to withdraw, even temporarily, gold. If they +take this power from them the banks know they will +be in a far stronger position, even should the deposits +diminish by fifty per cent. In their own language<span class="pagenum" id="Page_122">122</span> +bankers say: “We must strengthen our cash position.” +This means, then, that the cash fund and the +deposit fund are not one and the same thing. The +cash fund is strengthened by weakening the deposit +fund. Cash grows as the loanable fund falls.</p> + +<p>If the loan deposits are thereby greatly diminished +until the deposits are mainly what I have called pure +deposits, it shows how the banks safeguard themselves +when they think danger is coming. Their +assets change. Gold takes the place of other wealth, +and the banks are able the better to meet a run on +the part of their depositors. They have automatically +met the danger from the presence of the loan-deposits, +and now they have only to face the danger +from the pure deposits. They have fortified themselves +for this by differentiating between the characters +of their deposits, which in their aggregate +are misleadingly called the loan fund of Lombard +Street. The gold is the real lending fund.</p> + +<p>This is done, too, often at a time most unfortunate +for the general community. It is done at a +time when the community should receive more and +not less help from the banks. Banks ought to lend +more freely in times of crisis than at other times, +for it is that freer lending that will help the country +to meet and get through the crisis. To stay help, to +withdraw help already given, is to increase the difficulties +of the general community, to feed alarm and +apprehension, to aggravate the crisis. The banks<span class="pagenum" id="Page_123">123</span> +do, therefore, what seems wise, perhaps, for them, +but unwise for the community.</p> + +<p>They are not to be blamed so severely as some +imagine. They have to look to the law in the same +way as the individual has to look at it, and they +cannot be blamed for acting in accordance with law. +It is, perhaps, the law that is unwise and not the +banks. Communities must abide by the laws they +make, and by the limited freedom laws allow. Laws +are not the last word in human wisdom. Laws can +be modified and improved upon.</p> + +<p>Banks have to work within restrictions imposed +upon them by the law, and if these restrictions become +harsh in times of difficulty and crisis, then it +is the law that is at fault and not the banks.</p> + +<p>Banks must pay out legal tender to their depositors +on demand. The Government restricts the supply +of legal tender by enacting that gold alone shall be +legal tender. Therefore the Government is not +irresponsible for the manner in which the machinery +works in all sorts of conditions.</p> + +<p>If the supply of legal tender is restricted, no banking +system, or any system like it, would be possible +if the reserves in legal tender had to be equal, or +nearly equal, to the deposits. If the banking system +is to be worked in the highest interests of the community, +then the gold reserves must necessarily be +greatly less than the deposits. If the people of this +country took to hoarding gold, then the banking<span class="pagenum" id="Page_124">124</span> +system would eventually come to a stop, which shows +again what the nature of the loan fund is. There +can be no loan fund without gold, and in that case +there could be no currency such as the cheque system +of this country.</p> + +<p>Ought we, then, to reform and modify the law? +I can imagine the time coming when legal tender +will not be confined to gold. But this is far distant. +I think reform can come in the manner in which we +have experienced it since the war. The Government +could ensure free working in times of apprehension +and crisis in the manner in which it ensured it in +August, 1914, by the creation of emergency currency. +What can be done successfully and beneficially once +can be done again.</p> + +<p>If there are times and occasions when banks stop +lending and when they call in their loans, then it +follows, reverting to market parlance, that the loan-fund +is inelastic. If it cannot always and invariably +respond to needs, then it cannot conform itself to +varying conditions and circumstances. This fact, +therefore, supports the contentions of those who say +that the fund is inelastic. In my way I say the +machinery is far from perfect. It always works with +difficulty at the very time when it should work with +ease. It will come to a dead stop at the moment +when it should be working at high pressure.</p> + +<p>To make the position clearer I will recall what +Mr. A. C. Cole said in his controversy with Mr. Tritton.</p> + +<p><span class="pagenum" id="Page_125">125</span></p> + +<p>“I entirely disagree,” he said, “as to the inelasticity +of this fund. My view is that the inelasticity +is apparent, but not real. By this I mean that +it is inelastic at any given moment because, in these +days of competition, bankers lend all their available +surpluses; but to say that the short loan fund is +permanently elastic is quite beside the mark. What +does inelasticity of the market mean? It means the +want of power of the market to adjust itself to +pressure or tension. Now, take the discount market. +The supply of money always adjusts itself to the +demand. Except in times of panic, good bills are +always discountable in London. This Mr. Tritton +practically admits in his paper. As regards the +large amounts of Treasury bills, Exchequer bonds, +etc., of which there has been a marked increase in +recent years, owing to the [Boer] war, Mr. Tritton +says it is not very clear from what source the funds +so invested have arisen. This gives away his case, +for it is an admission that the money has been forthcoming. +In other words, the supply in the short-loan +market has been increased because the demands +upon it have been larger, and this will always prove +to be the case. The short-loan market is really +augmented quicker than any other fund. It is quite +immaterial whether the funds belong to owners in +this country or to capitalists abroad. The fact +remains that the money is available when wanted, +or, in other words, the short-loan fund is so elastic<span class="pagenum" id="Page_126">126</span> +that it promptly adjusts itself to the demands upon +it, though temporary recourse to the Bank of England +may be necessary, while the adjustments take +place. The apparent inelasticity of the fund is +evidence of what I may call the efficiency of the +short-loan market. By efficiency I mean that the +total available funds in the market are in constant +use. This is not a bad thing for the community, but +it implies that on the least strain or dislocation of +the machinery of the market, recourse has to be +made to what is then the only available source of +supply—the central institution. But as the Bank of +England is always willing to discount or lend upon +good bills, the supply of money in the market is +never exhausted. It is simply a question (except in +times of panic, which we are not here considering) +of the rate of interest whether the money is forthcoming.”</p> + +<p>I cannot agree with Mr. Cole. If he admits that +there is an exception, and the exception works in a +time of panic, at the very moment when it is vital +to the community that the exception should be +removed, then he gives away his case. He admits +that the supply is not inexhaustible, for it suddenly +dries up when the need is greatest. To say that it +is “inelastic at any given moment,” that it is not +permanently inelastic, and that there are times when +borrowers are driven to the Bank of England, is +inconsistent and illogical. If there are moments<span class="pagenum" id="Page_127">127</span> +when it is inelastic, then it cannot be permanently +elastic.</p> + +<p>When soon after the present war complaints were +made that banks were not lending freely, and when +a warning to them came from the Chancellor of the +Exchequer, it furnished further proof of inelasticity +in times of difficulty and pressure.</p> + +<p>Let us now examine further the machinery of the +Bank of England and the rate of interest.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_128">128</span></p> + +<h2 class="nobreak" id="CHAPTER_XIV"><span id="toclink_128"></span>CHAPTER XIV<br> + +<span class="subhead">EXHAUSTIBILITY</span></h2> +</div> + +<p class="in0"><span class="firstword">If</span> what is called the loanable fund were perfectly +elastic and “promptly adjusted itself to the demands +upon it,” how is it that the value of money, called +the rate of interest, is not more uniform? It certainly +should be more uniform if it were a fund that +automatically responded to the demands upon it, +increasing as the output of wealth increased, decreasing +when the output of wealth fell off. In a +perfect system this would certainly happen; but +sound as banking may be within its limitations, we +must admit that it is far from being a system of +perfection. The fact that the rate of interest is not +uniform, that it rises and falls in a capricious and +not uniform way, is further proof that the fund is +not, as it should be in a perfect or improved system, +elastic.</p> + +<p>Experience shows us clearly that as demand grows +the potential supply diminishes; therefore it cannot +be a perennial, inexhaustible fund. If bankers find +that the demand is growing, they advance their rates +of interest. In other words, they demand a larger<span class="pagenum" id="Page_129">129</span> +share of the profits of the community. They have +two objects to serve in this. They desire to increase +their own profits and they desire to check the demands +upon them. From their point of view, it is better +to lend a little at a high rate of interest than much +at a low rate. In their annual or semi-annual +speeches bank chairmen are pleased if they can show +their shareholders that during a certain period the +rate of interest has been high; for it is evidence to +them that circumstances have been in their favour; +that they have done good, profitable business. They +lament times when interest has ruled low. And +interest rules low when the fund is said to be overflowing, +when the banks cannot lend as much as they +would like. There are, however, as I have already +pointed out, exceptions to this. It is no invariable +rule, or law, or sequence, whatever we may please to +call it, that interest is low when the fund is overflowing +and high when the fund has fallen. Interest +is governed by many causes extraneous to the power +of banks to lend, and these causes often arise in an +unforeseen, capricious way.</p> + +<p>We may say, however, while recognizing the effects +of irregular, uncertain causes, that the value of what +is called bank money is affected by the well-known +law of supply and demand, the law that affects the +prices of commodities and of labour. In a general +sense, when the supply of money is greater than +the demand the rate of interest falls; when the<span class="pagenum" id="Page_130">130</span> +demand is in excess of the supply the rate of +interest rises.</p> + +<p>Demand increases when borrowers multiply. +Borrowers go in growing numbers to the banks. As +the loans thereby increase, so the deposits increase. +If, therefore, the deposits compose the loanable fund, +the loanable fund increases. At last, however, the +loanable grows so large that the banks say they can +lend no more. Lend no more, when the loanable +fund is greater than ever? But the banker shakes +his head. He knows that though the loanable fund +is greater than ever in appearance, it is smaller than +ever in fact. He knows that the greater the demands +made upon him the more his power of lending +decreases, until the moment arrives when he has +to say “Stop!” He sees that as the fund rises the +proportion of the gold reserve falls. So he stops +lending, lets his loans run off, whether secured on +bills of discount or securities, and waits until that +so-called loan-fund falls. And when it has fallen, +when the loan-fund is less, then he can lend again, +although to the uninitiated he has apparently less +to lend.</p> + +<p>How, then, does this fund promptly respond to +the demands upon it if the supply of gold flowing into +the banks does not keep pace with those demands? +If the supply of gold, not loan-deposits, kept pace +with the demands then, and then only, could the +fund “promptly adjust itself to the demands upon it.”</p> + +<p><span class="pagenum" id="Page_131">131</span></p> + +<p>It is elementary knowledge in Lombard Street +that when the Bank of England is able, week after +week and month after month, to buy up all the +South African and other gold coming into the bullion +market, that it will tend to increase “credit” and +depress loan-rates. We know that the gold will +increase the supply of market money more surely +than the growth in the country’s wealth. This is +because we know the gold will eventually find its +way to the banks, increase their gold reserves, and +enable them to lend more.</p> + +<p>It proves, then, that the working of the fund, +elastically or otherwise, is dependent upon the flow +of gold into the Bank of England. This is because +the law has decreed that gold shall be legal tender. +Therefore, the supply of money for the help of +commerce, for the fettered working of the banking +system, is dependent in the ultimate resort upon the +law of the land. It is not dependent in the ultimate +resort upon the law of supply and demand, because +a more powerful law controls the economic law. If +the law, then, controls the supply of money, then the +law must control the supply of wealth, and the law +must control ultimately the prices of labour and of +commodities.</p> + +<p>When liquid capital is provided by the banks a +charge is made for it. This rate of interest not only +affects the amount of capital that shall be furnished, +but it must affect the prices of the product that comes<span class="pagenum" id="Page_132">132</span> +into existence from the use of that capital. If the +merchant has to pay a high price for that capital, +he must ask a higher price for his product, for he +will not use that capital unremuneratively. The +greater the abundance of capital employed in the +country the greater is the quantity of wealth produced, +and the cheaper the capital the lower are the prices +of its products. That is to say, the greater are the +chances of the community partaking of a larger share +of that wealth. If they partake of this larger share +it simultaneously increases the collective, or aggregate, +powers of consumption.</p> + +<p>It is indisputable that in times of trade activity +the demands for capital grow. Times of depression +are coincident with a decline in the demand.</p> + +<p>In this chapter I am but repeating much of what +I have urged in former chapters, but I am naturally +anxious to make my argument as strong as possible +by the help of wider and, I trust, clearer illustrations +as I proceed. When we travel over a wide tract of +country our vision is too weak to take in all its +topographical features. We can see general features, +but not the minute features which the botanist and +the geologist would examine. The poet would see +what the geologist would not see, and the botanist +would see what would escape the naturalist.</p> + +<p>So when we take a survey of the economic and +financial world we see a mechanism which is not the +same when examined minutely as when looked at<span class="pagenum" id="Page_133">133</span> +from a distance. When we look at it from afar we +cannot see those defects which on close examination +we are able to find.</p> + +<p>If rates of interest arbitrarily rise and fall, and +the supply of capital is controlled in an arbitrary +way, the general well-being of the community must +be affected. We suffer when the monopolist takes +advantage of the helplessness of the community to +raise prices. We suffer when shipowners take +advantage of accidental circumstances to raise +freights and the price of food. We suffer when the +colliery proprietors in the depth of winter raise the +price of coal. We suffer also when the banks raise +the rate of interest, thereby raising prices and +affecting employment.</p> + +<p>When prices rise, as they have almost uniformly +risen in recent years, many theories are advanced as +to the causes of this. Some attribute it to the +increased output of gold. They mean by this that +the output of gold has increased so greatly that more +money, or more purchasing power, is placed in the +hands of the community. Producers, observing this, +raise the prices of their commodities. If this were +so, the advance in prices would be general, and we +should be no worse or better off than when prices are +low. Wages would inevitably advance if prices were +affected by this universal, not local cause. But it is +asserted that wages have not advanced uniformly, +while tradesmen on their part declare that their<span class="pagenum" id="Page_134">134</span> +profits have fallen. Workmen and tradesmen alike +say that they are poorer than they were ten and +twenty years ago, and the housewife declares that a +sovereign now will only go as far as fifteen or ten +shillings went years back.</p> + +<p>It is impossible to prove that such a rise is a +consequence of an accelerated production of gold. It +is an hypothesis, and an hypothesis it will remain, for +it ignores a multitude of causes more important in +their aggregate effect than gold.</p> + +<p>It does not follow, then, that because at given +moments capital may be dearer than at other +moments, a general rise or a general fall in prices +will immediately follow. Neither can we lay it down +as an indisputable axiom that a 5 per cent. interest, +say, is detrimental to trade, and a 2 per cent. interest +is beneficial to trade. But we can say, I think, that +a very high rate of interest is harmful to trade, +particularly if it be prolonged, and that a constantly +fluctuating rate of interest is more unfavourable for +trade than a uniform rate, or a rate that varies but +slightly.</p> + +<p>A high rate of interest means dearth of capital, +and dearth of capital must affect production and +consumption and the output of wealth, just as a +dearth of seed must affect the coming harvest. The +community, therefore, must necessarily suffer from a +dearth of capital, and as the community is largely +dependent upon the banks for the supply of capital,<span class="pagenum" id="Page_135">135</span> +then it follows that it is best for the community that +the supply should be constant, that it should adjust +itself to the demands upon it. If it could do this, +then the rate of interest would tend to greater +uniformity. At any rate, it would not rise and fall +so capriciously as it does do. If it varied it would +vary within narrower compass.</p> + +<p>If this could be accomplished, if the supply of +capital were less dependent than it has been and still +is, upon extraneous circumstances, we may see +steadier prices, and perhaps one happy effect would +be less labour difficulties and less strikes. Strikes +are, in many instances, the effect of constantly +fluctuating prices. But the supply and price of +capital would not alone put an end to fluctuating +prices. I merely hint that it might help to correct +those frequent and extreme fluctuations that cause so +much discontentment, and so much envy, and so +much misery.</p> + +<p>It would be interesting to speculate what would +happen if the Germans conquered us and took +away our colonies and our goldfields. If Germany +restricted or cut off the supply of gold to this +country, what would happen to our loanable fund? +How would it affect what we call the creation of +credit? How would it affect the supply of capital? +If the law remained as it is, and the banks could get +no more gold reserves, then there would be no loanable +fund and no supply of capital. But the law<span class="pagenum" id="Page_136">136</span> +being what it is, the supply of capital is dependent +upon the supply of gold.</p> + +<p>Mr. Cole admits that on the <em>least</em> strain, or dislocation +of the machinery of the market, recourse has +to be made to what is then the only available source +of supply, the central institution, where it is simply a +question of the rate of interest whether the money +is forthcoming. After admitting, then, that the +machinery can break down and that then there +can be but one source of supply, that supply can only +be obtained at a higher price. If it is to be obtained +at a higher price, then it is to be obtained at the +general expense of the community. If capitalists will +not pay that higher price, then this is tantamount to +a lessened supply of money. As the Bank of England, +too, will not lend on the same class of wealth that +the other banks will lend on, a vast mass of wealth +is excluded. Therefore a vast mass of wealth cannot +be transformed into liquid capital. If no one will +liquefy this wealth, then the production of liquid +capital must be limited, and that capital must remain +in its fixed form till the other banks restart their +transforming machinery. If this be so, then the +supply even from the Bank of England is not, as +Mr. Cole would have us believe, unrestricted and +illimitable. It is, after all, a restricted supply, +regardless of the entire claims or needs of the community, +for narrower discrimination is practised. The +Bank of England may always be willing to discount<span class="pagenum" id="Page_137">137</span> +or lend upon good bills. But there are other bills +of a lower grade than this class of bill, and there +is a vast quantity of wealth that is rejected by the +Bank. If the lending is limited to good bills, and if +the quantity of good bills is limited, then the supply +of money from the Bank must be limited. To say +that the supply is inexhaustible is, therefore, misleading.</p> + +<p>We know, too, from experience that when the +Bank has been lending for a time on good bills it +has had at times to check these loans. And in order +to check them it has raised the Bank rate. Why has +it raised the rate? To replenish the supply that is +said to be inexhaustible. Mr. Cole says it could get +that supply from abroad, and therefore the fund +would be replenished inexhaustibly. If, however, +the supply from abroad were checked, as we can +imagine it could be, would the fund be inexhaustible +then? It would be interesting to know if, should the +Bank Act be suspended in certain circumstances, +this would fall in with Mr. Cole’s idea, or conception, +of inexhaustibility. Also if the creation of the +Treasury notes falls in with that idea.</p> + +<p>We know, of course, that since the war the Bank +has lent enormous sums of money by discounting +pre-moratorium bills of exchange. This may seem +to furnish proof of the inexhaustibility of the fund. +But while it has been lending it has been simultaneously +receiving gold. There has been no competition<span class="pagenum" id="Page_138">138</span> +for the gold from South Africa and elsewhere, and +therefore the Bank has been able to procure it in +the usual way. Then New York has been obliged to +liquidate its indebtedness to us in large amounts of +gold. But with all this, the proportion of the reserve +has kept well below the normal. What would have +happened had the rebellion spread in South Africa, +and had the mines there been closed down indefinitely?</p> + +<p>Even as it was, the Bank rate had to be maintained +at an artificially high level compared with +loan and discount rates in the outside market.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_139">139</span></p> + +<h2 class="nobreak" id="CHAPTER_XV"><span id="toclink_139"></span>CHAPTER XV<br> + +<span class="subhead">THE THEORETIC LINE OF SAFETY</span></h2> +</div> + +<p class="in0"><span class="firstword">It</span> will be clear, I think, from the analyses in the +foregoing chapters that banks have not only a +delicate, but a most difficult task to perform. So +difficult is the task that it is impossible to give +satisfaction to all classes of the community. They +have to give satisfaction to borrowers, to their +depositors, to their shareholders and, at the same +time, to the critics who say they are ever alert and +watchful that they are trading within safe limits.</p> + +<p>What critics mean when they talk of safe limits +they would not find it easy themselves to define with +exactness. They know what they mean by sound +principles of banking so far as lending on sound +security goes. They know what they mean when +they say that a bank must not engage in speculation, +and that it must carefully scrutinize every class of +wealth on which it lends. This seems to me a tacit +acknowledgment that banks do not create credit in +the sense that many suppose. It would come nearer +the conception of credit creation if banks were<span class="pagenum" id="Page_140">140</span> +allowed to speculate and attempt to create wealth out +of nothing.</p> + +<p>These critics lay it down as a first principle that +a bank must have adequate gold reserves. If they +do not have adequate gold reserves they put too great +a strain upon the credit structure. But they cannot +agree, they cannot even dogmatize, as to what an +adequate reserve is. Yet the banks are adjured to +give all the help they can to the trade and commerce +of the country. If they refuse that help they come +in for severe condemnation. They are condemned +by the academic critics and they are criticized by the +traders and criticized by their shareholders, and had +not nature fortunately given bank managers very +thick skins—which thicken daily in the environment +in which they live—they would be deserving objects +of commiseration. As it is, no one pities them, and +in time they become accustomed to an atmosphere +unwarmed by mercy. I have, indeed, met people +who regard bank managers as little removed from +callous brutes, men utterly indifferent to the appeals +of those seeking to make their bit in a highly civilized +community.</p> + +<p>After all, the lot of a banker, like a policeman’s, +is a hard one, and he is very roughly handled at +times by friend and foe alike: the friend beseeching +him to look to his reserves, the foe caring for nothing +so long as he can get his loan.</p> + +<p>Why does the friend beseech him always to have<span class="pagenum" id="Page_141">141</span> +an adequate gold reserve? Because the hour may +come, suddenly, swiftly, without warning, when the +phlegmatic Britisher will be in the grip of madness. +The man who has calmly and resolutely faced the +greatest crisis in his life; the man who has laughed +at Zeppelins and air craft, whose courage has risen +with his danger, is in a moment, in the twinkling of +an eye, to lose his reason and go amok amongst the +banks of the country, smashing everything in ungovernable +fury. There will be no restraining him +in that mad hour. No force will be powerful enough +to bind him. He will wreck, and the populace will +gaze on helplessly, until all are buried beneath the +ruins of a once beautiful and mighty fabric.</p> + +<p>It is because we fear this mad Samson will pull +down the pillars, that we would make those pillars +too strong even for his mighty strength. He would +strain himself against them in vain. They would +defy even the supernatural strength of madness.</p> + +<p>It is feared that the reserves will not be large +enough to meet an outbreak of panic. As the +banks are bound by law to repay deposits in gold, or +legal tender, if they have insufficient gold or legal +tender, they will come to smash. And if one great +bank falls, all will fall. The mighty structure will +then be a heap of ruins.</p> + +<p>Let us, then, assume that some day, we know not +when, it may be to-morrow or it may be generations +after we are dead and forgotten, a panic <em>may</em><span class="pagenum" id="Page_142">142</span> +come. It is said that the panic will surely be +hastened if the highly-strung, emotional, fear-stricken +Briton <em>thinks</em> the gold reserve is falling too low. He +may never know for certain whether or not it is too +low. But in some unfortunate moment, when, +perhaps, he is a little out of sorts, he may <em>think</em> it +is too low, and then it will be too late. Without +staying to reason, without staying even to consider +whether his disorder is physical or mental, or whether +a sluggish liver has blurred his vision, he is at the +bank doors before the maid has had time to bring +in his breakfast. And when his mighty fists smash +at those doors the doom of the nation has come.</p> + +<p>What it is necessary to do, therefore, is to calm +this nervous gentleman; to talk confidently and +assuringly to him, to talk about politics, philosophy, +poetry, the arts, anything but banking and bank +reserves, and then when he is smiling to take him +out and give him a good lunch.</p> + +<p>This is John Bull as some people picture him. +It may be a caricature, and John may resent it as a +libel upon his traits and temperament, but we must +accept it as a serious fact that some people have no +faith in John Bull’s common sense.</p> + +<p>Regarding John, therefore, as a highly nervous +old gentleman, who can never rest because of that +bank balance of his, wondering day and night +whether it is safe or not, and spoiling the peace of +the household by his restlessness, what we must try<span class="pagenum" id="Page_143">143</span> +to do is to convince the old man that his bank +balance is perfectly safe. It may seem difficult to +do this when we tell him that the bank has only £15 +left of his £100; but it might be equally as difficult +to set his mind at rest if we tell him that the bank +has only £40 of the £100, for he will want to know +where the other £60 is. Even £60 is more than +John can afford to lose.</p> + +<p>Well, all that we wiseacres must do now is to +have a little confab together and agree upon the +amount we shall tell him the bank actually has +intact of his £100. Perhaps we shall agree that +£15 is much too little. Perhaps to some £20 may +appear to be insufficient. After talking it over and +diagnosing in the most up-to-date scientific fashion +John’s nervous temperament, we agree that his +nervous system can be made quite normal, as normal +as our own, if we say the bank has £30 of his £100, +or nearly one-third.</p> + +<p>Thanks, then, to scientific calculation we have +settled this problem. John will be immune now +from nervous disorders, he will be able to sleep +calmly o’ nights, and will settle down into a nice, +comfortable, affable old party, a perfect husband, +and an indulgent parent, feeling that nothing now +is wanting in the best of all possible banking worlds. +Great mathematicians have assured him that the +banks will never fail now they have £30 of his £100 +in solid gold.</p> + +<p><span class="pagenum" id="Page_144">144</span></p> + +<p>How agreeable it would be if we could settle +this matter in a scientific way, calculating with +mathematical precision how much strain the banking +system will stand, and to a nicety what proportion +of the reserve to the liabilities will for ever +avert a panic. Unfortunately, mathematics will not +help us in this. If we could only lay down a +theoretic line of safety, knowing precisely how far +to go and where to stop, how happy and contented +we could be. The Philosopher’s Stone could perform +no greater miracle. The banks would then know +exactly how much to lend, exactly how much +deposits to receive, irrespective of gold production +and wealth production, and the trade and commerce +of this country could be governed perfectly in true +keeping with our needs and the progress of civilization +by that ideal law, rule-o’-thumb. It would be +impossible to imagine then to what heights of greatness +England would rise, or the reposeful content in +which she would live. As, however, scientific precision +is impossible, we must rule out this haphazard law.</p> + +<p>We must still trust as well as we can to experience. +So far experience has not failed us. This +much can be said in its favour.</p> + +<p>It is impossible to say what proportion of reserve +will save banks in a possible panic. Perhaps eighty +or ninety per cent, would not save them. Perhaps +they might go under with a thirty per cent. proportion, +when a thirty-one per cent. would have<span class="pagenum" id="Page_145">145</span> +averted the disaster. Nor must we rule out of +consideration when contemplating the theoretic line +of safety the composite character of the deposits.</p> + +<p>Banks are counselled to adopt two extreme +policies. That is to say, to do the impossible. They +are asked to lend freely to assist trade, and at the +same time are asked not to lend or to lend sparely. +During the early weeks of the war, for instance, +they were urged to give liberal assistance to commercial +men and others, and at the same time to +increase their reserves and to be ultra-cautious.</p> + +<p>Some critics, and the most distinguished amongst +them is Mr. Walter Bagehot, urge them always to +keep high reserves against the day of panic, and yet +when the panic comes to lend freely. They cannot +lend freely and simultaneously maintain high +reserves. They cannot have high and low reserves +at one and the same time. They cannot lend +sparingly and cautiously in the same moment as +they lend liberally and incautiously. They must +either keep high reserves and assist commerce as +sparingly as possible, or they must keep modest +reserves and help commerce as liberally as possible. +They cannot adopt contrary policies.</p> + +<p>What should we say of the farmer who kept his +seed in the barn and feared to sow it to-day lest a +storm should arise to-morrow and destroy it? He +must take his chances of a storm. And the country +must take its chances of a panic.</p> + +<p><span class="pagenum" id="Page_146">146</span></p> + +<p>But the chances are not so fearful as some +imagine. Quite apart from psychological considerations, +there is the country itself, the Government, +behind the banking system. The country, the +Government, cannot afford to see that system come +to ruin. It is not as if the Government would be +helpless. The Government has the power, and it +should use the power to prevent the ruin. Moreover, +it is the duty of the Government to prevent it.</p> + +<p>It is the Government’s duty because the Government +does not allow free banking in this country. +This may seem a startling assertion. Let us +examine it.</p> + +<p>If the Government enacts that gold shall be legal +tender, and that banking deposits must be repaid on +demand in their entirety in legal tender, then banking +is fettered by law. It is not free banking in the +full sense of the term. If banking is fettered by the +capricious output of gold, it is not free banking; and +if the commerce of the country is fettered by the +capricious output of gold, then its freedom of expansion +is fettered. If the output of legal tender +currency cannot keep pace with the needs and +requirements of commerce, then the limitations +imposed are not in accord with true notions of +freedom. We must work and progress as best we +can within those limitations, whether they be wise or +unwise.</p> + +<p>Since the war the Government appears to me to<span class="pagenum" id="Page_147">147</span> +have recognized this by the issue of Treasury notes. +Had these notes not been issued, then it would have +been the duty of the Government to have suspended +the Bank Act. Having issued these notes, the +Government could conscientiously ask the banks to +assist in a time of crisis traders and others with the +utmost liberality. If they were not so assisted, +the bankers justly deserved admonition. But had +the Government not have issued the notes and therewith +have provided legal tender currency in ample +measure, then it could not, conscientiously and justly, +have bidden the banks to lend freely irrespective of +their gold reserves. If, however, these reserves were +to be replenished, then the banks were sufficiently +safeguarded. There was no excuse for ultra-caution +and timidity then.</p> + +<p>I repeat, therefore, that what the Government +has done once by way of duty and by way of wisdom +and foresight, it can do again, and should do. The +country must not come to ruin merely in deference +to the apprehensive theories of some people, whose +theories so far, though long and tenaciously held, +have been like the passing nightmares of affrighted +men.</p> + +<p>In the days when Mr. Bagehot wrote his immortal +work, banking was still in the experimental stage. +It was slowly developing and learning from experience. +As banking has developed, so has the psychology +of the British race changed. As the confines of<span class="pagenum" id="Page_148">148</span> +its knowledge have been enlarged, as each generation +has arrived in a new environment, and as each +generation has become more familiar with and +habituated to banking, so are the probabilities of +panic lessened. A panic, after all, has a psychological +origin, and if, as I contend, the psychology +of our race is on a higher plane, and is more dependable +than it was half a century ago, then Mr. +Bagehot’s criticisms become less forcible as psychological +growth proceeds. They must not be taken, +therefore, as our criterion to-day, because the test +applied to them now is a different test. As the years +go on the criticisms will become feebler, and with his +profound instinctive knowledge of human nature, I +think, were he alive to-day, Mr. Bagehot would +modify those criticisms that deserved more consideration +in his days than in ours. He would be the first +to acknowledge, not only that the banking system +has progressed greatly, but that the system is conducted +on safer lines than in the times when he lived.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_149">149</span></p> + +<h2 class="nobreak" id="CHAPTER_XVI"><span id="toclink_149"></span>CHAPTER XVI<br> + +<span class="subhead">SOME PSYCHOLOGICAL PHENOMENA</span></h2> +</div> + +<p class="in0"><span class="firstword">It</span> has been said, and said truly, that the law can +exercise much restraint upon the freedom of the +individual. It is powerless, however, to restrain +madness. Yet it is precisely by artificial methods +that we would attempt to restrain madness, to keep +individuals and nations in a state of sanity. This +cannot be done. If the problem we are dealing with +is psychological, we must find a psychological solution. +We cannot cure a spiritual disease by a +material remedy. If we can grasp the potency of +fear growing into that species of madness called +panic, we shall be able to grasp the tremendous task +of allaying that fear during its earliest symptoms. We +should also grasp the immensity of the task when we +conceive how the healers of the disease would themselves +be afflicted by the disease, and that their +fears would confuse their minds and paralyse their +actions.</p> + +<p>Long before the greatest war in history broke out, +we were assured by financial and economic prophets +that when it did break out this country would be in<span class="pagenum" id="Page_150">150</span> +the throes of the most serious panic it has ever +known, and thousands of our business men would go +down to ruin in it. These prophecies were based +upon the inadequacy of our gold reserves, and upon +the top-heaviness of our credit superstructure.</p> + +<p>These prophecies have not been fulfilled. We +have had no panic, not even when the Bank of England +reserve fell to the lowest point for many a year, +not even when the rate rose swiftly to ten per cent. +Thousands of our great business men have not been +ruined. These are facts, not theories. They are +realizations, not predictions. So far from there +having been a panic, it has been very difficult at +times, as all acute observers will testify, to realize +that this country was at last engaged in a life and +death struggle. It was prophesied, too, and with no +doubts or hesitation, that the numbers of men thrown +out of employment would be so great, that drastic +martial law would have to be resorted to. These predictions +also have not been justified. The percentage +of employment has steadily risen, and this nation +has pursued its affairs and avocations calmly under +normal police law.</p> + +<p>If we are to learn deep and lasting lessons from +experience, this experience is of vastly greater value +than theory. In Germany and in France also we see +vast accumulations of gold, in comparison with which +our own gold reserves are puny. Yet we not only +raised immense war loans at a high price, but have<span class="pagenum" id="Page_151">151</span> +helped other countries with loans, while our burdens +were increased with the heavier taxes imposed upon us.</p> + +<p>True it is that but for our navy, circumstances +might have been greatly different. But had our navy +been sunk, had Germany acquired undisputed mastery +of the sea, had she been able to starve us, then no +gold reserves, even though mountains high, would +have saved us. The country could not live on gold +alone. It would have perished, and its banking +system with it. We cannot wage a life and death +struggle with gold alone, nor with credit alone.</p> + +<p>But when the former prophecies were made, no +account was made of the navy. The panic was to +come independently of the navy’s power. The public, +the moment war was declared, would realize that the +gold reserves were inadequate, they would clamour for +gold, the banks would close, and in a day or two the +money market would be a deserted, silent place, +stricken and devastated like some of the cities of +Belgium.</p> + +<p>Why did not this come to pass? Why were the +prophets not trusty seers? It is said that the bankers +met in conference to consider and exchange opinions +upon the position. They knew well enough that they +were no magicians, nor even ordinary conjurors. +They knew they could not make gold out of nothing. +What, then, could they do? Whether or not their +consciences smote them I know not. Whether or not +they bitterly repented and lamented the poverty of<span class="pagenum" id="Page_152">152</span> +their gold reserves I know not. Whether or not they +said to each other, in a hopeless, perplexed way: “I +told you so,” I know not. All I do know is that a +saviour came, a <i lang="la">deux ex machina</i>, that he was received +with open arms, welcomed with fervid gratitude, perhaps +with tears, that he was venerated, and that some +to-day, in their profound gratitude, would make him +a duke.</p> + +<p>Well, this saviour came and calmed that assembly; +in a magical way, subdued all fear, removed all perplexities, +daring to do, so some say, what some bankers +themselves dared not even hint. Greatness of mind +saved them and the nation and not the greatness of +our gold reserves, and this greatness of mind has +been acknowledged by all, not with the reluctance +of envy, but in the spirit of sincere thankfulness. +Greatness of mind, then, saved the nation from the +consequences of that psychological evil, fear and +madness. It was the right mental solution to a +mental disease. The spirit saved the spirit.</p> + +<p>So it has been throughout the ages. Greatness +of mind has led nations on. Littleness of mind has +brought them down. And who will deny that it is +littleness of mind that has brought Germany down? +A nation derives its greatness from the greatness of +its greatest souls.</p> + +<p>The nation was saved, then, in the hour of destiny +by obedience to wisdom. We cannot imagine in the +future a vaster crisis than the nation—yea, the world—faced<span class="pagenum" id="Page_153">153</span> +in that dark hour in August. It was not alone +the magnitude of it, it was the suddenness of it. We +were unprepared for it, and if wisdom could save us +in this hour, what can we hope from wisdom in the +hour of less peril?</p> + +<p>Had wisdom not prevailed, had we abandoned +ourselves to divided counsels and to folly, we might +not have saved ourselves from the consequences had +our gold reserves been much higher. They might +quickly have disappeared. Theoretic lines of safety +would not then have averted the wreck. They would +not, with magic power, have kept the public back.</p> + +<p>In that hour some would have cried hysterically: +“Lend, lend, lend!” Others, “Save, save, save!” +and only confusion and perplexity would come of it. +But the public were told, by the representative of the +Government, by the authoritative voice of the nation +itself: “Be calm! All your wants will be supplied! +The Government will supply them.”</p> + +<p>When a hungry multitude is clamouring for food, +mad with hunger, and when the barns are filled, they +are not appeased if told there is only sufficient food +for a few. Tell them there is enough food to go +round, even though it must be given sparingly, then +the clamour dies down and the multitude becomes +calm and patient.</p> + +<p>We saw no multitude clamouring for gold. The +clamour was merely anticipated. There may have +been no clamour, but it was wise to anticipate and<span class="pagenum" id="Page_154">154</span> +prepare for its possibility. At the right moment, +therefore, the public were assured that money, not +gold, would be forthcoming in any amount. It was +money, not gold, that allayed the first symptoms of +fear. With this money, no matter though it were +paper, the public were content. The notes were +instruments of law that placed them in an impregnable +position, and in an impregnable position they +knew they were safe.</p> + +<p>The faith the public put in gold is probably +greatly magnified. The public are not deeply versed +enough in monetary and currency problems to understand +the importance of gold as distinct from other +money, especially legal tender paper. The ordinary +man in possession of twenty £5 notes feels that he is +equally as safe and as strong as the man in possession +of one hundred sovereigns. We must not ignore +this fact, nor minimize it, when we argue about high +and low gold reserves. He knows that with notes he +can be just as solvent as the man with gold, though +he may think the notes a greater nuisance than gold. +And this belief and trust of his, this calmness, are all +essential elements of the psychological problem that +confronts the currency theorist and the banker. +They are not to be considered as mental phenomena +independent of that problem. They go to make up +its complexity.</p> + +<p>London being a free market for gold it was feared +in a crisis such as we have experienced, that the gold<span class="pagenum" id="Page_155">155</span> +would quickly be withdrawn from the Bank of England +and shipped abroad, and that in a short time we +should find ourselves with no gold reserves. This did +not happen. Granted that a great deal of gold was +withdrawn from the Bank, this was only temporary, +and since those days the Bank has secured gold at +a pace no prophet ever calculated. Two predictions +here have also been falsified. Neither the gold withdrawals, +nor the gold arrivals and accumulations +were on a scale forecasted by the theorist. Their +pre-calculations went ludicrously astray.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_156">156</span></p> + +<h2 class="nobreak" id="CHAPTER_XVII"><span id="toclink_156"></span>CHAPTER XVII<br> + +<span class="subhead">EQUITABLE RESPONSIBILITY</span></h2> +</div> + +<p class="in0"><span class="firstword">If</span> gold reserves alone are to be the test of sound +banking, and if gold reserves alone are to save banks +in the hour of crisis or panic, then the obligations of +banks towards the highest interests of the community +are weakened. If their wealth, their investments are +to be valueless in a time of crisis, to be so ignored, +that is, as to be worthless, to be taken no account of, +are not to keep them solvent and safe, then on what +grounds of reason and justice should the community +demand that banks should confine their trading to +the highest class of wealth? On what grounds can +the community demand that they should in all +seasons and in all times do that great work for trade +and commerce which neither the Government nor +any other institution does? Why should the banks +be asked to do all the sacrificing within the limitations +imposed by the community and the community +not come to their help, sacrifice nothing at +all, in the hour of the community’s troubles? For +the crisis, when it comes, is the nation’s and not +solely the banks’ crisis. If the crisis be none of the<span class="pagenum" id="Page_157">157</span> +nation’s seeking, it will certainly be none of the +banks’ seeking. If, however, the crisis be the effect +of over-speculation on the part of the community, it +would be mean action on the part of the community +to appeal to the banks to save it from the consequences +of its own folly.</p> + +<p>I urge that, in a time of national crisis, which has +taken the nation by surprise, which is no consequence +of its own folly, the responsibility should be shared +by the nation and the banks. It is possible that +it was this high sense of justice, this high sense of +equity, that inspired the measures that were taken +last August, and that brought the country safely +through the crisis. Had it not been for this higher +inspiration and deeper vision, and had we trusted +alone to narrow instinct and lack of insight, confusion +might have reigned, and the consequences might have +been as serious as those foretold by the prophets.</p> + +<p>If we are to lay it down as a rigid, unwritten law, +a law existing only in the conscience of an irresponsible +community, that banks must save themselves +only by their gold reserves, then by what +divine or earthly sense of justice shall we demand +that banks shall not speculate? Are the banks to +be the keepers of our consciences, as well as of our +purses? The banks must live. And if instead of +building up their deposits on sound wealth, they +build them up on unsound wealth, and keep that +proportion of reserves which critics demand they<span class="pagenum" id="Page_158">158</span> +shall keep, then they will have fulfilled their duty +from the standpoint of this narrow conception. +Suppose they speculated and kept even higher reserves +than those laid down by the mathematicians, +content with the higher profits made from speculation, +by whose standards of equity are they to be +judged?</p> + +<p>If high gold reserves alone can save them, or +should save them, and they possess these high +reserves, then they can be saved even if they speculated. +If the oracles say so, it must be so. If sound +wealth be useless to them, then unsound wealth +could not be more useless. If they could not get +legal tender for sound wealth, for gilt-edged securities, +they would be no worse off with brass-edged +securities.</p> + +<p>As I have already insisted, it is something +beyond lack of reason to ask banks in the same +moment to lend freely and to save their gold +reserves. It is as unreasonable as asking an ordinary +man to be generous and prodigal and at the same +time close-fisted and thrifty.</p> + +<p>Take that measure of the Government whereby +it arranged with the Bank of England to discount, +without recourse to the holder, all approved bills +accepted before the declaration of the moratorium, +guaranteeing the Bank against any loss it might +incur. This was, of course, placing a burden on the +shoulders of the community which was a perfectly<span class="pagenum" id="Page_159">159</span> +equitable burden. But quite apart from its equity, +it was, in its lowest aspect, an expedient burden. +That is to say, if the nation had refused to shoulder +this burden, it would have had a far greater burden +to bear in the dislocation of trade and its incalculable +losses.</p> + +<p>It would not have been just to place this burden +entirely on the shoulders of the banks. In such a +crisis the entire community had to face the perils as +a whole, and sink or swim as a whole.</p> + +<p>When in the end the gains and losses are weighed, +perhaps we shall find that the gains, moral and +material, greatly outweigh the losses.</p> + +<p>What was the duty of the banks, when this +measure was proclaimed, towards the nation and +towards themselves? Looking at it from the low +standpoint of self-preservation, what was their duty? +From a low and a high standpoint alike it was their +duty to help the Government, help the nation, +through the Bank of England. They could not give +that effective help by hoarding their gold, by getting +it from the Bank of England, by sending borrowers +to the Bank of England, by refusing help to legitimate +needs. Yet this is what some critics counselled +them to do—counselled them to increase and not ease +the difficulties of the Bank of England.</p> + +<p>If the country could depend calmly and securely +on the Bank of England, with the Government +behind it, then the banks also could depend upon it.<span class="pagenum" id="Page_160">160</span> +The Bank of England was the bulwark of England. +That bulwark could be weakened and not strengthened +by the hoarding of gold. If the Press and others +admonished, and wisely admonished, the citizens not +to hoard gold, then it was illogical to ask the banks +to hoard it, for they would be hoarding the citizens’ +gold. These contrary counsels were opposed to all +reason, and yet to this hour I see them advocated in +some quarters in the Press.</p> + +<p>The Bank of England needed all the gold it could +get as a basis for the discounting of this huge mass +of pre-moratorium paper. Gold subsequently poured +in from the gold mines and elsewhere, yet notwithstanding +this mighty inflow, the proportion of the +Bank’s reserve to the ever-growing deposits kept +comparatively low, far below the normal proportion. +It was in the interests of the country that the Bank +should get this gold from any quarters to enable it to +make a success of the remedial measure and to ease +the country’s financial burdens. How, then, could it +at the same time be in the interests of the nation for +the joint stock banks to take gold from the Bank, to +hoard it and not to send it there?</p> + +<p>Such action as this would have been inconsistent +with the fervent gratitude the bank chairmen and +the country have felt towards the Government and +its advisers.</p> + +<p>Furthermore, what made it additionally ill-advised +on the part of the banks to hoard gold and pile up<span class="pagenum" id="Page_161">161</span> +their reserves, was the subsequent proclamation by +the Government to the effect that the Bank of +England, on the authority of the Government, would +advance the necessary funds to meet acceptances for +which cover was not duly forthcoming from clients, +until one year after the close of the war. This +removed all necessity to hoard gold and to pile up +reserves, and it justified the rebuke of the Chancellor +of the Exchequer to those banks that refused necessary +accommodation to legitimate business. It was +also a rebuke to those critics who have seen no refuge +for the country in the dark hour of trouble except in +hoarding by the banks and parting by the public. +That is to say, they counsel the public not to demand +gold, and they counsel the banks to keep it. If, +therefore, the public are not to demand gold, and if +the banks are to accumulate it in their vaults, then +it means that in a crisis we can do without gold, and +that, after all, the credit which the banks are said to +create will alone save us. They are told that if they +will only go on creating this credit they will enable +us to pass safely through the crisis. It comes to this, +that the advice given places us in mental confusion. +Actual experience, therefore, seems to be trustier +than illogical advice.</p> + +<p>What has been the direct consequence of this discounting +of pre-moratorium bills and this great inflow +of gold, despite the issue of a War Loan to the +prodigious amount of £350,000,000? In the words<span class="pagenum" id="Page_162">162</span> +of the money article, day by day and week by week, +money has been a glut on the market, and has been +lent on nominal terms, while discount rates have +also fallen to nominal quotations. In other words, +the great joint stock banks, in spite of themselves, +have seen their gold reserves rising to an unprecedented +extent. Of what benefit to the country is +this great mass of idle gold? It is unproductive. +It serves no useful purpose if it cannot be employed. +It is like the grain in the barns perishing because it +cannot be consumed. Yet in spite of this state of +things, due to the supply of liquid capital exceeding +the output of wealth, there have been those who +have lamented the fall in discount rates lest this +should turn the exchanges against us, and gold +should be taken to New York or elsewhere. Would +it not be beneficial if some of the gold did go? If it +went in payment of wealth received, the gold would +then become productive. The right service of gold +is to help to produce wealth, and if it does this it +performs the services deputed to it by the community. +When gold passes from one nation to another in +exchange for wealth it never passes permanently. I +might just as reasonably urge that when I pay gold +to my tailor for my dress suit I part with the gold +for ever. I should part with it only in the event of +my immediate decease, or if I became a non-producer, +or in other ways were deprived of all claims +on the general wealth of the community. An idle<span class="pagenum" id="Page_163">163</span> +man, with pockets filled with gold, is a burden on +the community. He is no helper, no benefactor. +So a nation, idle, with mighty safes filled with gold, +will become stagnant if this gold is not scattered +broadcast in the shape of capital that energizes +the productive and consumptive capacity of man and +the land.</p> + +<p>The value of gold will ever inhere in its wise use, +not in its non-use.</p> + +<p>“It has been well said,” remarked Sir Felix +Schuster, in his recent annual address, “that it is +one of the paradoxes of finance, that at the moment +when the world’s capital is being squandered in war +the value of loanable capital in Lombard Street has +actually depreciated.” Sir Felix meant, of course, +that there was no great demand for capital, that it +was greatly in excess of needs, that loans consequently +were cheap, and that banks could hardly +lend profitably. I see no paradox in this. If the +creation of bank money is to be regulated by the +supply of gold only, it is an orthodox consequence. +Since the outbreak of the war the inflow of gold has +been greater than ever experienced. This has given +the banks power to lend more, to liquefy more +wealth, because their reserves have increased, and +the proportion of these to the liabilities has correspondingly +risen. But though a great deal of wealth +has come into existence, it must not be overlooked +that a great portion of it is not the kind of wealth<span class="pagenum" id="Page_164">164</span> +banks lend on. This was partly due to the closing +of the Stock Exchange, the subsequent restrictions +on business there, and the destruction of trade +between the belligerent and other countries. Securities +of a high class were scarce, and bills of exchange +became scarce, and while many industries, notably +the cotton industry, severely suffered, other industries, +especially war-provisioning industries, became +abnormally busy. There was deadlock for months in +some of the foreign exchanges, especially the New +York and Russian exchanges. While the kind of +wealth on which banks lend fell off, the mines continued +to produce gold, thus showing again how +independent this output is of real wealth production. +Had the gold mines also ceased working at the +beginning of the war, have suspended operations for +many months, we should not have seen, perhaps, +loanable capital in Lombard Street so excessive and +so depreciated as it was.</p> + +<p>Sir Felix saw a great danger in this great mass +of money and its cheapness: the danger of its turning +the exchanges against us. But this danger could +have done no more harm than the stoppage of the +gold mines had the rebellion spread in South Africa. +The danger can be easily exaggerated, especially at a +moment when we can see far ahead, and see the gold +still coming to us in an uninterrupted stream from +the mines.</p> + +<p>Even had the New York exchange turned against<span class="pagenum" id="Page_165">165</span> +us, it would turn round again in due course, as it +always has done and always will do so long as international +commerce proceeds.</p> + +<p>By no jugglery can we, in the existing system, +make cheap money dear, any more than we can +make cheap apples dear. It can be done by cornering; +but no cornering of money is possible. If banks +cannot lend at 1 per cent., they certainly cannot lend +at 2 per cent. Human nature must be re-created +first. If men will not part with bills of discount +at 1½ per cent., they will not part with them at 1¾ +per cent., and there is no law, written or unwritten, +that will compel them to do this. The law of supply +and demand operates as irresistibly in this case as +when we buy apples at an old lady’s stall.</p> + +<p>If there be great danger in a great abundance +and cheapness of money, then there must be a great +danger in an abundance of gold, which is the source +of the cheap money. Logic teaches us this. Reduce +the gold, hoard it or throw it in the ocean, then the +supply of Lombard Street money will decrease and +loanable rates will rise.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_166">166</span></p> + +<h2 class="nobreak" id="CHAPTER_XVIII"><span id="toclink_166"></span>CHAPTER XVIII<br> + +<span class="subhead">CORRELATION</span></h2> +</div> + +<p class="in0"><span class="firstword">It</span> may now pertinently be asked: Is it possible to +keep high gold reserves in the joint stock banks, +taking them as a unit, and simultaneously a high +reserve in the Bank of England? By high reserves +I mean, of course, a high proportion, for this is what +we all mean. What is the test of a high reserve? +There is no other test than the ratio of the gold +reserve to the liabilities. We cannot test it by a +quantity of gold <i lang="la">per se</i>. We cannot say that a hypothetical +quantity is sufficient and a hypothetical +quantity insufficient. A reserve must be related to +something. When we speak of gold reserves we +speak correlatively. They are not something standing +apart, in the air, as it were, an independent +quantity.</p> + +<p>If, then, when we speak of gold reserves, we are +conscious of their relation to something, what is this +something? Is it their relation to the nation’s commerce +as a whole, the nation’s needs as a whole, or +merely the restricted relationship to bank liabilities? +What critics mean is the relation between them and<span class="pagenum" id="Page_167">167</span> +the bank liabilities. But banks are units of a +system. They are not a whole in the same sense +as the Bank of England is. They are independent +entities. There are large banks and small banks +and medium-sized banks, and they have liabilities +corresponding to their size. Must the small bank +have in its safes exactly the same <em>quantity</em> of gold as +the large bank, irrespective of its liabilities? Or +must the small bank have, not the same quantity, +but the same <em>proportion</em>? Or are we to aggregate +all the liabilities of the banks of the kingdom and all +their gold reserves and say whether or not the total +quantity of gold is sufficient or insufficient? Even +then we must ask: Sufficient for what? Sufficient +to meet the total liabilities in a time of crisis? This +is what we mean. We mean a ratio, a hypothetical +ratio that is to save us from disaster.</p> + +<p>Now this ratio is constantly fluctuating. It is +fluctuating hour by hour, day by day, week by week, +month by month, and year by year. It is impossible +to keep it rigid. The critics know this, and they say +that only an approximate ratio is wanted. But as +we can never foretell, never pre-calculate what an +approximate crisis will be, an approximate panic, or +an approximate run, an approximate ratio may not +save us. If mathematics alone will save us, and not +common sense, then we must have mathematical precision, +seeing that we are dealing with figures, not +brains and temperaments.</p> + +<p><span class="pagenum" id="Page_168">168</span></p> + +<p>The only way to keep up an approximate ratio is, +not to buy gold, as many advocate, and hoard it, but +to stop lending, to call in loans, and so raise the +ratio figure. Then we can have a relative high gold +reserve. We are speaking, of course, in an ideal +sense, for there can be no simultaneous precision in +these movements amongst a number of independent +banks, whose business varies hour by hour.</p> + +<p>However, in order to maintain their high ratio +banks must cease to lend when this ratio threatens +to fall. It is useless buying several millions worth +of gold—if it could be bought—only to lend more +upon it, increase the liabilities and not alter the +habitual proportion.</p> + +<p>If, therefore, banks cease to lend in order to keep +up a high ratio of reserves to liabilities, what will be +the inevitable effect of this upon the reserve of the +Bank of England? They will drive borrowers, as has +been explained in former chapters, to the Bank. As +the Bank begins to lend, so will the ratio of its reserve +to its liabilities drop. Mr. Cole says the Bank of England +will always lend <em>at a price</em>. If, then, the Bank’s +ratio drops, then the ratio of the reserves of the +joint stock banks must fall, seeing that they hold +their reserves at the Bank of England. The ratio +will then drop in proportion to the aggregate bank +liabilities of the kingdom.</p> + +<p>The only remedy, then, is for the Bank of England +also to refuse to lend. But Mr. Bagehot and<span class="pagenum" id="Page_169">169</span> +other critics say this would bring on and aggravate +a crisis. So far from refusing to lend, banks, they +say, must lend liberally, with both hands. How, +then, are the Bank of England and the other banks +to lend liberally without increasing their liabilities +and reducing the proportion? The proportion could +be maintained only by an inflow of gold proportionate +to the rise in the liabilities. How are we to start +this inflow at the critical moment and maintain it?</p> + +<p>It cannot be done. There can, however, be an +automatic inflow, but only of legal tender notes, and +legal tender, from the standpoint of bank solvency, is +as potent as gold. We cannot produce gold at will, +but we can produce paper at will.</p> + +<p>Our gold reserves should be controlled, as I have +insisted already, not solely by the arbitrary output of +gold, but by the output of the nation’s wealth, and +by the nation’s needs, and no artificial obstacles +should arrest the growth of national wealth. We do +put obstacles in the way. Banks must keep an eye +on their approximate reserves. This is why they +refuse to lend at times, and send wealth-producers to +the Bank of England. We have to put up with this +in our present system. But to say that some hypothetical +ratio, which no one can agree upon, will save +us in certain grave, incalculable contingencies is as +untenable as many another economic hypothesis +which has no relation to the complexity of human +character and temperament.</p> + +<p><span class="pagenum" id="Page_170">170</span></p> + +<p>But the theorists have insisted in years past, it is +not the national needs we have to consider in a time +of crisis; it is the international claims upon us. +Look, they say, at the enormous foreign credits here, +placing unlimited power in the hands of foreigners +to take gold from us <em>in the time of war</em>. Well, the +war has come, the greatest of all wars, the war we +and the world most dreaded, and all these pre-existing +fears have not been realized. Foreign credits +are offset by foreign liabilities here. Instead of gold +being taken abroad in great quantity the exact +opposite has occurred, and why should it never +recur? Gold has come to London in quantities +never dreamed of and never experienced, proving +that the dimensions of this hypothetical danger were +greatly magnified.</p> + +<p>Since the war we have had too much gold and too +much capital, even at a time when unemployment +was low. I mean too much bank capital.</p> + +<p>It follows that, as conditions of banking are at +present, we cannot have high proportionate gold +reserves in the joint stock banks simultaneously +with a high proportionate reserve in the Bank of +England. This can only be done by stopping the +wheels of commerce, or slowing them down by +advances of the Bank of England rate to attract +gold from abroad. But the gold must flow in as +rapidly as the liabilities rise, unless the Bank of +England stops lending too. Trade must be penalized<span class="pagenum" id="Page_171">171</span> +whichever action be taken, and merchants and others +would rather have low ratios than be penalized. +They would suffer, and the country would share their +sufferings. To refuse to lend would have serious +consequences and would be the surest way to hasten +a panic.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_172">172</span></p> + +<h2 class="nobreak" id="CHAPTER_XIX"><span id="toclink_172"></span>CHAPTER XIX<br> + +<span class="subhead">THE SUPPLEMENTARY INFLOW</span></h2> +</div> + +<p class="in0"><span class="firstword">If</span> there must be in the country, for the benefit of +the country’s trade and commerce, for ensuring its +prosperity, a loanable fund, why should no provision +be made for what I call the supplementary inflow? +If no provision of this kind is made by a nation, how +can we reconcile this with national foresight? In +carrying on business on the soundest principles of +finance business concerns allow amply for contingencies +by building up reserve funds. If this be +sound in individual business, it should be sound in +national business. We cannot logically have contrary +business principles for the nation and the individual, +for in that direction confusion lies.</p> + +<p>The nation trades on its capital. It is a vast +undertaking, with a colossal capital. It incurs huge +liabilities, but against them it has huge assets. Why +should it not have amongst these assets large hidden +reserves?</p> + +<p>Some wealth depreciates, while other wealth +appreciates. Some wealth is destroyed, while new +wealth is created. Wealth is not destroyed by war<span class="pagenum" id="Page_173">173</span> +alone. It is destroyed by new desires, new inventions—which +destroy the wealth brought into existence +by former inventions and bring ruin on some industries +and men,—new fashions, and by lack of hope +and diminishing confidence. On the Stock Exchange +in recent years we have seen continual depreciation. +But other assets may at the same time have greatly +appreciated.</p> + +<p>We cannot get more gold than nature will produce, +and every ounce taken from her store lessens that +store. And the store will diminish as the future +needs of the world grow.</p> + +<p>The gathering of the gold and the garnering of it, +like the garnering of seed we fear to sow, must be +done at the expense of our wealth production. The +harvest of wealth must be less because of the +scantier seed sowing; in other words, because of +the diminished capital employed. Instead, therefore, +of the gold coming out of the nation’s profits, it +would come out of the nation’s capital, for unused +capital is not used capital.</p> + +<p>Gold is our capital in a fundamental sense. If +all the gold in the world were suddenly destroyed, +banks would cease to exist. Whence, then, could we +get the means of multiplying our capital? The +productive machinery of the country would become +inert. International trading would cease, because +international exchange would cease. Bills of exchange +would be as worthless as old newspapers,<span class="pagenum" id="Page_174">174</span> +for they would be unnegotiable. We should have +to get a substitute for gold.</p> + +<p>We try to attract gold to this country because it +is gold that keeps the capital-multiplying machinery +going, as oil keeps other machinery going. If we +always had a sufficiency of it there would be no +occasion for high Bank of England rates. If there +be just a sufficiency and no more, then we cannot +spare any for hoarding purposes.</p> + +<p>It would be wise of the nation to have at its +command a potential supplementary supply, not of +gold, but of legal tender, for legal tender can perform +all the offices of gold as national currency. Gold is +given its potency because it is made legal tender. +It has no other vital potency. Therefore paper, or +any other substance, can be given equal potency +by law.</p> + +<p>Now, the necessity of having this supplementary +supply has been tacitly acknowledged. The acknowledgment +is implied in the provisions of the Bank +Charter Act and the provision of legal tender notes +based on debt and securities. This provision, as I +have pointed out already, is arbitrary. It was fixed +at a time when no man had the visionary power to +foresee and forecast the great development of banking +in this country and the vast development of its +national and international trade. It was fixed at a +time when the country was groping towards a greatly +improved currency system, a system that has helped<span class="pagenum" id="Page_175">175</span> +in an incalculable degree the growth and development +of our commerce.</p> + +<p>But in the recent crisis it was not this potential +supply that the nation actually tapped. Before it +could be tapped it was necessary to suspend the Bank +Charter Act. Instead of this happening, a new and +unlooked-for supply was forthcoming in the shape of +the Treasury notes.</p> + +<p>This issue of Treasury notes brought a new +fiduciary currency into existence, and the issue was +on all fours with a free Government loan—a loan, +that is to say, on which no interest was paid. It +provided not only currency for the country, but +“silver war-bullets” for the Government. The issue +performed all the essential services which the supplementary +fund I advocate should and would perform.</p> + +<p>I am convinced that the alarm felt throughout the +country in those first critical days was magnified. +There was certainly some apprehension; but no good +purpose would be served by magnifying it. It is +indisputable, too, that even this moderate apprehension +disappeared the moment it was known that +a large amount of legal tender would be issued in the +shape of £1 and 10<i>s.</i> Treasury notes.</p> + +<p>The notes were based on what we call the credit, +or wealth, of the country. The public placed their +confidence in them because they felt they were placing +confidence in the wealth and power of the country, +in themselves as a nation. They could have no<span class="pagenum" id="Page_176">176</span> +sounder basis. The nation was indifferent to the +convertibility or inconvertibility of the notes. All +the country was conscious of was that the notes were +legal tender and as good as gold.</p> + +<p>Theorists attach too much importance to the effect +upon the public mind of an issue of inconvertible +notes. The great mass of people does not understand +convertibility or inconvertibility, certainly not in the +deep sense critics imagine it does. It understands, +however, confidence in the Government, and this +confidence is of greater worth than are vague ideas +of convertibility. The mass of the public is ignorant +of monetary and currency problems, but it is not +ignorant of the power of the Government and the +power of the law. When the mass of the public had +these notes—and even postal orders as legal tender—in +its possession, it knew it had purchasing power +equal to the denomination of the notes, and that +was all-sufficient. This explains the public’s satisfaction +and calmness. Moreover, it is a phenomenon +of deep psychological importance.</p> + +<p>There were sections of the public—merchants, +financiers, bankers, academicians, theorists, and pressmen—who +knew that the notes, though issued as convertible, +had behind them no gold backing. But even +many of these were not erudite students of currency. +Nevertheless, they could not help feeling and acknowledging +that the right and wise thing had been done. +And as for merchants, bill-brokers, bankers, and<span class="pagenum" id="Page_177">177</span> +other people who wanted legal tender currency, they +cared not so long as they could get it. This was their +chief concern. It was a matter of indifference to them +whether the notes were convertible or inconvertible.</p> + +<p>Perhaps the most fruitful point for controversy +at this juncture, now that we have experienced the +benefits of the policy, is whether it would have been +better to have suspended the Bank Act and have +issued Bank of England notes, or to have done what +actually was done. Much can be urged in support +of each policy. Bank of England notes would have +obviated any confusion arising from two distinct +species of fiduciary paper currency.</p> + +<p>The great virtue and convenience of the new +notes was their low denomination. It would have +created needless difficulties, perhaps, to have given +power to the Bank of England to issue such notes. +Confusion, therefore, was greatly lessened by making +the Treasury notes of low denomination and by +keeping the Bank of England notes at a high +denomination. As a fiduciary note, currency should +be as simple as possible and not complicated, the +distinction between the denominations should conform +to the idea of simplicity.</p> + +<p>I think it would be wise to teach the people that +the currency of the country is in reality based upon +the wealth of the country, and not upon an extraneous +thing like the capricious production of gold. This +would assist it to grasp more easily currency<span class="pagenum" id="Page_178">178</span> +problems. What would be the state of this country +with a mountain of gold and no wealth? Currency +being issued on a basis of wealth, it is issued on +something solid and durable.</p> + +<p>A certain London evening newspaper wrote in this +wise several months after the outbreak of the war: +“The puzzled public which draw its cheques and +accepts the cheques of others with a firm and +pathetic belief in the value of ‘a scrap of paper,’ was +a little scared at first when the value of securities +tumbled down and it had to accept notes in place of +its accustomed solid coin. People began to ask +whether the alleged wealth of the country was +supported by anything solid at all, or whether we +had not been living on a fiction. Fortunately, time +has proved that it is very substantial indeed.”</p> + +<p>Quite so. The wealth of this country is the most +substantial possession the country has. But, all the +same, there are many fallacies in the above passage. +The public were not puzzled, and there is no pathos +in its belief in the value of cheques. It was not +scared, even for a moment, when it had to accept +notes, no more scared than it has been when it has +received Bank of England notes. It took them with +inquisitiveness, but also readily and gladly. People +did not ask if the wealth of the country was +“alleged” and whether it was a fiction, and I think +it is foolish to put ideas into the heads of the public +which originally were never there.</p> + +<p><span class="pagenum" id="Page_179">179</span></p> + +<p>Is it absolutely necessary to issue a <em>limited</em> amount +of Treasury or other legal tender notes based on +gold? Or may the amount be unlimited? In a +war of world-wide magnitude, the Government and +the nation had to take account of the vital fact that, +not only might our commerce be destroyed by the +enemy’s navy, but that it might be impossible to +bring gold over to this country. This had to be foreseen +and provided for. The joint stock banks, however +high their gold reserves, could not alter this. +Therefore it was necessary, apart from these +reserves, to meet immediate emergencies by the issue +of legal tender notes. Though afterwards the Bank +of England was credited with enormous amounts of +gold, this gold did not come to London. It was +placed to the Bank’s account, or credit, in South +Africa, Australia, and Ottawa. This restricted probably +the supply of gold coin at a time when there +was an unprecedented demand for small currency for +our military requirements and in our vast military +camps. Though some industries may have slowed +down greatly, others worked at high pressure, +thereby probably more than offsetting the inactivity +of others. And allowance must be made for the +thousands called to the colours who might otherwise +have been parasites. By joining the army their +aggregate consumptive powers increased. All these +developments had to be pre-calculated, apart from +the positions of the joint stock banks and their<span class="pagenum" id="Page_180">180</span> +preparations for panic. It was not the time to hoard +gold, but to see that legal tender currency was +provided in ample measure.</p> + +<p>Ample measure is not superabundance, and if the +needs were just met nothing further was necessary. +Assuming, therefore, that they were just met and +no more, we may ask whether or not it would be wise +to withdraw the notes when the war is over and +normal conditions are restored. It is, perhaps, too +early to reply in dogmatic fashion.</p> + +<p>We must take into consideration that we may +never again see a world-war and never again face a +crisis such as we faced in August last. But I see no +powerful objection to the notes remaining. We may +regard them as the nucleus of the nation’s reserve +fund, the liquefying of its hidden credit, or wealth +reserve, as the veritable “I believe” in the immeasurable +potential wealth of the country. The War Loan +is another such reserve, a reserve representing the +present and future credit, or wealth, of the country. +The country’s potential wealth is the security behind +it. And the Treasury note issue may be regarded as +part of the loan, for the gold “ear-marked” against +it has probably come out of that loan. If the notes +were redeemed and the gold released again, the gold +would go into circulation and form part of the banks’ +reserves as before. By retaining the gold the +Government would have that store of gold which +critics have been asking for. So far as they are<span class="pagenum" id="Page_181">181</span> +concerned, therefore, their wishes would be fulfilled. +They could gaze with satisfaction on this store of +gold, for the delicate problem has been solved as to +who should buy it and store it and bear the expense +of it.</p> + +<p>Evidently it is the intention to have a gold +reserve equal to 100 per cent. of the notes in issue. +I see no urgency in this, no vital necessity. The +notes could be based partly on gold and partly on +Consols. I think a reserve equal to 50 or 60 per +cent. in gold would be ample.</p> + +<p>If posterity is to benefit more from the war than +the present generation, why should it not bear a +goodly part of the burden?</p> + +<p>It may be objected that Consols are a depreciating +security. They are an appreciating security also, +and years hence they may have a much higher value +than they have now. Gold also appreciates and +depreciates continually, measured by the prices of +securities and commodities. And the entire wealth +of the country is constantly appreciating and +depreciating.</p> + +<p>If the credit of the nation years after the war +becomes much higher than it is now, then to secure +the notes on the credit of the nation is to secure them +on something that will rise in value.</p> + +<p>This issue would not be like the varieties of paper +issues in Germany, whose credit has depreciated and +will continue to depreciate as her wealth diminishes<span class="pagenum" id="Page_182">182</span> +and becomes less negotiable. She cannot, as we can, +pay for goods entirely with goods, owing to the +destruction of her commerce. She must pay in gold; +in other words, she must live on her capital. And +she cannot live on her capital and speedily renew it. +There must be considerable destruction, because it +cannot quickly reproduce itself.</p> + +<p>I would, therefore, base part of the new issue on +a sound security like Consols, which is representative +of the country’s credit, or wealth. The notes themselves +are representative of its wealth, therefore +Consols would be an extra security. I would not +advocate the withdrawal of the notes, because the +machinery has now been provided for possible use at +a future crisis. The machinery could be set in +motion again without resorting to the cumbersome +process of suspending the Bank Charter Act. It +gives us a provision for unknown contingencies.</p> + +<p>To keep a limited amount of Treasury notes in +existence should be no more a potential danger to the +future of our financial fabric than the issue of a huge +war loan. On the contrary, they should help us the +better to bear the burden of a war loan if there be no +improvident, or over-issue of them. They should be +no greater menace than the sudden, prodigious output +of gold which we could not use. We would not +declaim against the imports of huge quantities of gold +each week and the corresponding increase of currency. +If so arbitrary an increase could do no harm and<span class="pagenum" id="Page_183">183</span> +would be considered beneficial, then a limited supply +of other currency, such as our Treasury notes, should +not be harmful. And if the discounting of millions of +unnegotiable pre-moratorium acceptances, creating +currency in such abundance as to make it exceedingly +cheap, is not harmful, then the issue of a limited +quantity of Treasury notes, against which the Government +is setting aside an equal quantity of gold, +should not be harmful. To predict that it will bring +economic evil in a distant future that cannot be foreseen, +is as valuable as many another theory that has +failed to stand the test of reality.</p> + +<p>It should be no more harmful to the future than +the issue of Bank of England notes has been, based +on a book debt and securities, during the last seventy +years.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_184">184</span></p> + +<h2 class="nobreak" id="CHAPTER_XX"><span id="toclink_184"></span>CHAPTER XX<br> + +<span class="subhead">CREDIT AND CIVILIZATION</span></h2> +</div> + +<p class="in0"><span class="firstword">I have</span> endeavoured to argue that our banking system +and a purely credit system are not identical. A perfect +credit system would be based entirely on faith, or +profound belief in individual and national integrity +and honour. Tradesmen know what kind of credit +this is. They know that men may have huge and +safe balances in banks, yet may be rogues. But a +bank’s faith is not of this implicit and profound +character. A bank demands material evidence of +faith, and it places greater value and trust in the +matter than in the spirit. Our banking system is +ahead of the banking systems of other countries, but +this is largely because our economic organism is +older, our national character stronger, our freedom +greater. Our so-called bank credit rests primarily on +national wealth and secondarily on character. A +bank will not lend on character alone. Character is +not the wealth it is ready to transform.</p> + +<p>It will not lend to the poor man, however noble +in character. But it will lend to the rogue who has +sound security and other solid wealth. If it can have<span class="pagenum" id="Page_185">185</span> +no faith in the rogue’s character, it has faith in his +wealth, and it takes care to have his wealth first. +Banks, therefore, are not judges of morals. A man’s +private morals are not their concern, only his wealth. +They desire to know nothing of a borrower’s private +virtues or vices, they are only concerned about his +financial or business standing.</p> + +<p>Therefore, if it be credit, it is a business, or wealth +credit, a non-moral, not a moral credit, and the superstructure +of credit on which the visionaries gaze is +not a moral superstructure.</p> + +<p>If the banks lent only on accommodation paper, +“kites” and such things, this would approach nearer +to our ideas of credit. For accommodation paper is +not representative of real wealth, though it may be +manufactured by a house of strong financial standing. +But banks, I believe, are most vigilant in distinguishing +between “kites” and genuine bills of exchange, +thereby demonstrating unmistakably their hesitation +in depending solely upon business character, and not +upon sound, genuine wealth.</p> + +<p>Credit is said to be evidence of civilization; the +higher the civilization the higher the credit, or belief. +Barter was the evidence of barbarism. As man +becomes more intelligent, as his knowledge expands, +as higher ideals lead him on, so he conceives loftier +codes of ethics. As he grows more humane so he +learns to have deeper trust in his neighbour. Knowledge +teaches him how his life depends on the services<span class="pagenum" id="Page_186">186</span> +rendered him by his neighbour, how he would struggle, +and perhaps die, without his neighbour’s help. +Knowledge growing into wisdom teaches him the still +higher truths of altruism and morality. The wise +nation, therefore, endeavouring to live by the higher +morality, is greater than the nation that has not yet +reached this mental and spiritual stage.</p> + +<p>The text of this chapter has been partly suggested +by a pregnant passage in Mr. Hartley Withers’ book, +“War and Lombard Street.” The value of the +passage lies in the fact that it echoes the views of +many. Let us examine it and endeavour to grasp +the ideas behind it.</p> + +<p>“After all,” says Mr. Withers, “you cannot have +credit without civilization, and at the beginning of +last August civilization went into the hands of a +Receiver, the God of Battles, who will in due course +bring forth his scheme of reconstruction. When the +five chief nations of Europe turn their attention from +production to destruction, it is idle to expect any +system of credit to go unscathed. Credit depends +on the assumption that goods produced will come to +market and be sold, and that securities that are based +on the earning power of production will fetch a price +on the exchanges of the world. War on the smallest +scale weakens this assumption with respect to certain +goods and certain securities; if its scale is big enough +it makes the assumption so precarious that credit is +shaken to its base.”</p> + +<p><span class="pagenum" id="Page_187">187</span></p> + +<p>When we contemplate and analyse civilization we +see two aspects, or conditions, of it. There is a +moral civilization and a non-moral civilization. +Many would contend that Germany presents a type +of non-moral civilization and that Great Britain and +other countries present types of moral civilization. +An advanced stage of economic civilization is not +essentially and implicitly an advanced moral or +ethical civilization. In moral civilization the +Esquimaux may be our superiors. In economic +civilization they are our inferiors. This is largely +due to environment. Rivalry in commerce is not +essentially moral rivalry. We can, indeed, call it +a mercenary, or sordid rivalry, in which virtue and +honesty play minor parts. We may flatter ourselves +that, as a nation, we would gladly be more virtuous +if other nations would let us. This is, at least, an +admission that other nations “do not play the moral +game.” Out of this rivalry wars have sprung, and +the present world-war is one of the fruits of the envy +begotten of our commercial supremacy.</p> + +<p>What is the kind of civilization, therefore, that +went into the hands of a Receiver? Germany is +fighting for low civilization, the allies for high +civilization. Indeed, it is said, and not without +truth, that it is not civilization warring with civilization, +but civilization warring against barbarism. +The motives of Germany are debased, the motives +of the allies lofty. If the allies, as all believe, have<span class="pagenum" id="Page_188">188</span> +been raised in this contest to a high plane of morality—I +might even say to a high plane of spirituality—then +moral civilization may gain, and a higher order +of credit, or belief, may come of it.</p> + +<p>From a narrow economic standpoint Germany’s +civilization has been high and may continue high. +But after the war, what will be the state of her moral +civilization? Lower than it has ever been, for +morally she will be degraded. No nations will be +able to put credit, or trust, in her. She will have +forfeited moral trust, forfeited all moral credit. But +will she have forfeited all economic credit? Should +she rehabilitate her economic credit, it will enable us +to see more clearly the distinction between moral and +economic credit.</p> + +<p>Her economic state will for a time surely be +weaker. Her finances will be in disorder; her +powers of production and consumption will be +weakened, and it will take her a long time to repair +the ravages to her economic system. This will apply +also in some degree to the allied Powers. They, too, +will have to repair damage to their respective +economic systems.</p> + +<p>But we may easily over-estimate the exertions +and the length of time needed to repair those ravages. +If the allies are victorious the moral gains will, at +any rate, be enormous, and these will be tremendous +assets to set against the liabilities. Should they be conquered +we may, indeed, woefully contemplate the future.</p> + +<p><span class="pagenum" id="Page_189">189</span></p> + +<p>Should, however, the allies be victorious, why +should credit be shaken to its base? Instead of +being shaken, the base of credit may become stronger +than before. If a higher civilization be the outcome, +then credit must become stronger, because its moral +foundation will be stronger than before.</p> + +<p>What is it we mean when we talk of the destruction +of wealth? What wealth is this war destroying? +The war is certainly producing wealth, even though +it may be the most fleeting wealth. The production +of some kind of wealth may temporarily cease, and +where the war has been waged there may have been +great destruction of wealth in devastated cities, towns +and villages. But other permanent wealth is being +produced. Military stores and materials are being +produced in prodigious quantities; but these cannot +be produced without increasing the consumptive +capacity of the nation in other directions, and consumption +is necessary to the production of wealth. +We also have to produce to pay for the materials we +get from abroad and to provide the materials bought +from us by other belligerent countries. There are +now less parasites in this country and more producers. +Even soldiers consume, though they may +produce nothing. But do we always rapidly increase +wealth when, in non-warring times, production far +outruns consumption? Nothing is more familiar +than the destruction of wealth by over-production. +The over-produce not only perishes, but the powers<span class="pagenum" id="Page_190">190</span> +of consumption are diminished when over-production +throws great numbers out of work.</p> + +<p>While, therefore, capital and wealth are being +destroyed—that is to say, a vast amount of capital +is spent that is not reproductive—while soldiers are +killing and not producing, they are consuming, and +those who take their places as new producers can +also consume more, and therefore can, even during +the war, continue to repair the destruction going on. +While destruction is proceeding, construction and +creation are also proceeding. It cannot be all +destruction and no construction. Who, then, can +say how much greater the destruction will be months +hence than the total construction, and how long it +will take to repair the residue destruction?</p> + +<p>We cannot confidently estimate. We know we +shall have greater burdens to bear in the shape of +extra taxation. But the conclusion of the war may +greatly lighten these burdens if the blessings of a +complete and lasting peace be as great as we hope +they will be.</p> + +<p>What we truly mean by economic credit is economic +confidence. If we eliminated the word “credit” from +our economic vocabulary and always used its synonym +confidence, we should have a clearer grasp of our +ideas. I think Mr. Withers will agree that he really +means confidence. If so, we may amend the passage +and say, “We cannot have confidence without civilization.... +Confidence depends on the assumption that<span class="pagenum" id="Page_191">191</span> +goods purchased will come to market and be sold—that +is, consumed—and that securities that are based +on the earning power of production, which power +comes from wealth, will fetch a price, high or low, +on the exchanges of the world.”</p> + +<p>We ascribe depression in trade to a lack of confidence. +We never say trade is depressed in consequence +of a lack of credit. When trade is depressed there +is often an abundance of what is called Lombard +Street credit. Therefore a scarcity of confidence is +frequently coincident with a superfluity of banking +“credit.” How, therefore, can they be one and the +same thing?</p> + +<p>It is confidence that increases wealth, because it +imparts the energy to produce and consume. Capital +without confidence is impotent, as impotent as a +weapon in the hands of a paralytic. Confidence can, +perhaps, re-create as quickly as war can destroy.</p> + +<p>If, therefore, victory in the present war comes to +the higher nations and to the greater number of +nations, these, together with the neutral nations, will +be revitalized by confidence. They will have a moral +and a spiritual re-birth. There can be no prolonged +exhaustion, no prolonged prostration in such re-birth. +On the contrary, it will bring economic regeneration +and re-creation.</p> + +<p>As the prospects of ultimate victory become more +assured the re-birth and re-creation will begin the +sooner. There are, indeed, no signs of moral or<span class="pagenum" id="Page_192">192</span> +economic prostration in this country, and I do not +believe such signs appear in France and Russia.</p> + +<p>More evil is done by pessimistic prediction than +we dream of. No man is gifted to see into the +economic future. We have seen already many dark +visions dispelled. There are many prophets amongst +us—some are on the directorates of banks—already +dressed in the mantle of woe, bidding us prepare for +the day of sorrow, when we shall gather the aftermath +of want and misery. The day of sorrow has indeed +come, but, with all respect to the penetrating vision +of these seers, the long day of joy may dawn for us +when this night is ended.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_193">193</span></p> + +<h2 class="nobreak" id="CHAPTER_XXI"><span id="toclink_193"></span>CHAPTER XXI<br> + +<span class="subhead">CONFIDENCE AND GREATNESS</span></h2> +</div> + +<p class="in0"><span class="firstword">Confidence,</span> I have said, is, in the production of +economic wealth, the vitalizing element. In economics +it plays the part that faith plays in religion. Confidence +and credit have like derivations, like connotations. +Confidence is a confiding in, credit a believing +in. But, we must ask, a confiding or believing in +what? Confidence, the spirit of economic prosperity, +is distinct from what is called Lombard Street credit. +Confidence is vastly more potent than Lombard Street +credit. If confidence be dead Lombard Street credit +cannot of itself revive it. But confidence can revive +Lombard Street credit. When the nation is prostrate +and languid confidence alone can revivify it. It is +the economic tonic.</p> + +<p>In the money article it would excite derision if +we wrote: “In Lombard Street to-day confidence +was again in superabundant supply, and lenders were +offering it on nominal terms. Confidence over the +night could be obtained in liberal quantity from +1½ per cent. downwards, and for a week at no more +than 1¾ per cent. In fact, balances of confidence<span class="pagenum" id="Page_194">194</span> +were unlendable. Owing to the cheapness of confidence +the discount market was again exceedingly +weak, and rates continued to fall.”</p> + +<p>Yet, it is said, we have built up in this country +a vast superstructure of confidence, or belief, based +on a slight foundation of gold.</p> + +<p>Now there may be in Lombard Street, and often +is, a vast amount of “credit,” but merchants and the +public have not the confidence to use it. Why? To +quote Mr. Withers: “Credit depends on the assumption +that goods produced will come to market and be +sold and that securities that are based on the earning +power of production will fetch a price on the exchanges +of the world.” In other words, if we have no confidence +in the future, we are afraid to spend our money. +So we eke it out, or hoard it, or practise thrift and +live in misery. And if we cease to buy we cease +to consume, production diminishes, goods perish in +markets, and men are thrown out of employment.</p> + +<p>When we say the credit of the British Government +stands high, we do not mean that the credit-money +of the Government has a high value, or price. We +mean that confidence in the British Government—that +is, in the British nation—is exceedingly strong. +When, therefore, foreigners buy British Consols they +buy them because they know they can have strong +confidence in British wealth and British character: +not because our joint stock banks have high gold +reserves, nor because London is the world’s banker<span class="pagenum" id="Page_195">195</span> +and a free market for gold. Foreigners know that +our gold reserves are insignificant compared with the +gold reserves of the leading continental countries, but +they know that Great Britain is the richest and the +<em>greatest</em> country in the world, and the British Empire +the richest and greatest empire the world has seen.</p> + +<p>Confidence, therefore, is based ultimately upon +<em>greatness</em>, and our greatness as a nation and an +empire was never more strikingly demonstrated and +vindicated than during the war crisis. Greatness +can exist, therefore, apart from gold reserves.</p> + +<p>Let us look back upon the years preceding the +crisis. Let us go back to the American crisis in +1907. This crisis was the result of a lack of confidence +in America’s economic and moral greatness. +It was the result of scandalous dishonesty, the kind +of dishonesty that we know to be impossible in this +country. Yet London could not but be shaken by +the panic there. London was, indeed, shaken by it +more than by the crisis last August. The United +States took gold from London in huge quantities at +a loss, and the Bank of England rate, in order to try +to stop these exports, had to be raised to a high +figure for an indefinite time. Some of our banks +were even accused of assisting the United States to +the hurt of our own banking position. But the storm +was faced and weathered. Years before then it had +faced and weathered another great storm in the +Baring crisis. These historical happenings show<span class="pagenum" id="Page_196">196</span> +how mightily strong is that superstructure we have +raised in our midst, whether it be a structure of +paper or of iron.</p> + +<p>Then came the Morocco crisis, which was the +beginning of the Stock Exchange depression, and +which has culminated in the European war. When +I speak of Stock Exchange depression I distinguish +it from trade depression, for depression on the Stock +Exchange often coincides with trade activity. The +Morocco crisis brought the fear of war upon the world. +If Germany was prepared one day to fight she began +to make financial preparations for it. There can be +little doubt that she prepared insidiously for this by +depressing in recent years values on the Stock Exchange, +selling securities to weaken us and strengthen +herself. This culminated in the colossal selling +weeks before the war, and in the heavy purchases of +gold in the London bullion market.</p> + +<p>There were, however, other unhappy events. +There were the revolution in Mexico, the financial +crises in Argentina and Brazil, the political and +financial crises in France, the Balkan wars, the +labour upheavals in South Africa, the epidemic of +strikes in this country, the failure of the Birkbeck +Bank, the Home Rule crisis, and the financial +troubles of our colonies and heavy borrowings on +their part. One trouble quickly followed another, +peril succeeded peril, and never, perhaps, has the +world struggled amidst such political and financial<span class="pagenum" id="Page_197">197</span> +trials. They were years of darkness, and the dawn +of a new and a brighter day seemed remote. The +nations were groping, knowing not what new peril +would confront them. Then the greatest peril of all +came in the world-wide catastrophe.</p> + +<p>These constantly occurring troubles could not but +gradually weaken confidence in the future. When +a man gropes his way in an impenetrable fog, in +a place strewn with snares and pitfalls, ignorant of +his whereabouts, knowing not whether he is progressing +or going round in a dangerous circle, he cannot +feel confident of avoiding a fatal end. He can trust +only in hope and in his destiny.</p> + +<p>This nation trusted in its destiny. Amidst these +multiplying trials and difficulties it trusted in the +strength of its own soul. Therefore, while prices +were falling on the Stock Exchange, trade was growing +and booming. More capital for trade was needed. +So wealth in the shape of securities was turned into +cash capital, which helped the downfall in stocks and +shares. There was no lack of confidence evidently in +our economic position and future. Our economic +prosperity is not dependent upon Stock Exchange +speculation. The Stock Exchange has often boomed +and flourished during economic depression. This is +because, when we have idle capital or surplus, we +gamble with it, or invest it, if we cannot employ it +profitably in business and commerce. We must +never, therefore, assume that when inactivity reigns<span class="pagenum" id="Page_198">198</span> +on the Stock Exchange and prices fall there, and +stocks and shares become depreciated, that the nation +is losing confidence, and that economic stagnation +has come. If prices fall on the Stock Exchange +through political and other causes, and because +merchants and others are turning securities into +cash, the aggregate value of the nation’s wealth may +be rising and accumulating far in excess of the +depreciation on the Stock Exchange. It is probable +that this has been so in recent years. Banks, for +instance, have had to write down their investments +year after year, yet they have earned large profits +and have easily maintained their dividends. They +could not have done this unless their losses in one +direction had been counterbalanced by their gains in +another. So it has been with other great financial +institutions. They have easily kept out of the bankruptcy +court.</p> + +<p>We have had a remarkable demonstration, then, +of the power of confidence even in recent years and +in last year’s crisis. The measures taken by the +Government did not weaken that confidence, but +strengthened it.</p> + +<p>Take the moratorium, the first real moratorium +this country has experienced. Had academic critics +been told in the beginning of July that war would +break out in the beginning of August, and that the +Government would declare a moratorium, I believe +they would unanimously have predicted disaster,<span class="pagenum" id="Page_199">199</span> +complete and irretrievable. If they foresaw disaster +as the certain end of a steady increase in armaments, +nothing short of the fall of the skies would follow +a moratorium. Nothing would more surely precipitate +a panic, for if anything would bring about a state +of bewildering confusion it would be a moratorium.</p> + +<p>Once again, then, the imaginative vigour of these +prophets was overrated. It was not equal to the +strain of foreseeing the probable effects of unexperienced +causes. The position was tackled, not by +pedants, but by practical minds; not by nervous +pedagogues, but by bold experts. And the shallow-minded +and timid amongst us were amazed. We +were veritably awe-stricken by the cool skill of our +financial mariners steering us in safety in the unchartered +waters of an unknown sea.</p> + +<p>The prolonged Bank holiday, the indefinite closing +of the Stock Exchange, were also decisions that in +prior contemplation would have filled with terror the +hearts of pundits, who unhesitatingly would have +pronounced the doom of the mighty British Empire. +The closing of the Stock Exchange would, in their +convictions, so have stricken down confidence that it +might never arise.</p> + +<p>Then there was the subsequent arrangement made +whereby those who had made loans to the Stock +Exchange could obtain from the Bank of England +advances up to 60 per cent. of the value of the +securities held by the lenders against loans outstanding<span class="pagenum" id="Page_200">200</span> +on July 29th. The Bank of England was +not to press for the repayment of these advances +until one year after the conclusion of peace, or after +the expiry of the Courts (Emergency Powers) Act, +1914, whichever should happen first; nor would it +demand in the meantime further margin.</p> + +<p>This arrangement has also been highly successful.</p> + +<p>The fixing of minimum prices for high-class +securities on the Stock Exchange was another +prudent step. It was artificial, but no one will pretend +that the position in this country and throughout +the world was a natural position. Measures of +precaution and of defence were as necessary to protect +the financial as the military citadel. Were they +not taken, the consequences that might have followed +might in all probability have been immeasurably +worse than the consequences of restricted liberty. +These minimum prices prevented attacks from the +enemy, and, therefore, destruction by the enemy. +The defensive position was greatly strengthened by +the further restrictions imposed by the Treasury +when the Stock Exchange reopened. These were +designed to prevent wholesale selling by enemy +countries and investors; and capitalists in this +country were thereby saved from the incalculable +losses such sales might have occasioned.</p> + +<p>All the measures taken by the Government in +this unprecedented crisis must be tested by their +success. Two or three years hence we shall be able<span class="pagenum" id="Page_201">201</span> +to survey them in clearer perspective and in truer +proportion. But we can say with assurance even +now that they have been successful. The real +measure of that success we may calculate with +greater certainty some day.</p> + +<p>The banking position and the banking system +have stood calm amidst it all. Even had the banks +or the nation possessed that hypothetical reserve +advocated by some, and had it at hand in some safe +corner of London, this would not of itself have made +the position more secure. Other remedial or precautionary +measures would still have had to be +taken. Had it not been the particular measures +that were actually conceived and taken, there would +have been others. But we happened to be fortunate +in the measures that were adopted, measures that +deepened and strengthened the nation’s confidence.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_202">202</span></p> + +<h2 class="nobreak" id="CHAPTER_XXII"><span id="toclink_202"></span>CHAPTER XXII<br> + +<span class="subhead">FROZEN WEALTH</span></h2> +</div> + +<p class="in0"><span class="firstword">We</span> are now in a position to look more closely into +the wealth of the banks and at their position in the +early days of the crisis, and to regard them from +what I call the standpoint of confidence. Many +happenings were foretold years ago by the prophets +as the outcome of a European war, but they never +foretold the closing of the Stock Exchange, nor foretold +a moratorium.</p> + +<p>I think it will be safe to say that in the closing +days of July no one in this country dreamed that the +Stock Exchange would be closed. I think it will be +safe to say that if this had been foreseen, many +would undoubtedly have predicted disaster as its +consequence. Though the Stock Exchange may be +regarded by moralists and puritans as the shrine of +Mammon, a place frequented only by gamblers and +parasites, it came home to them, as it came home to +the entire nation, that the institution plays a vital +part in our economic organism. If we destroyed it, +we should have to set up a similar institution in its<span class="pagenum" id="Page_203">203</span> +place. It is the market for the exchange of certain +essential species of the community’s wealth.</p> + +<p>The closing of the Stock Exchange not only froze +up a considerable portion of the wealth possessed +by banks, but a far mightier portion of wealth possessed +by the general community. The banks could +not liquefy their wealth, and the community could +not liquefy its wealth. Their wealth was useless +to both. There was no market for it, and when +markets no longer work, the machinery of exchange, +of production and distribution, works more slowly, +and in some directions comes to a standstill. This +was one market, but, as I have said, it was a vital +market. Its closing restricted the power of the +banks to liquefy capital, it restricted the facilities +of merchants, tradesmen, and others to exchange +investments for cash, or liquid capital. In other +words, it had the same effect as the destruction of a +vast amount of capital, and trade and employment +suffered accordingly.</p> + +<p>Banks, therefore, found themselves in possession +of unsaleable securities, those they held as collateral +for loans and those in which their reserve funds were +invested. The Stock Exchange owed to them approximately +£80,000,000. Unable, therefore, to realize +this wealth and to call in their loans, their position +was considerably weakened.</p> + +<p>Then there was that other mass of wealth held as +security against advances to customers, which in such<span class="pagenum" id="Page_204">204</span> +times was also unrealizable. The market for this +class of wealth was practically destroyed. The exchange +machinery came to a stop.</p> + +<p>It was inevitable, too, that on the outbreak of so +colossal a war, the foreign exchanges would break +down. International trading was thrown immediately +into a state of confusion. It was faced with all +the complicated risks of sea-warfare, contraband +declarations, neutral nation rights, insurance, freights, +and the thousand and one unforeseen difficulties +arising from warfare between great maritime nations. +Debtors to this country could not remit money or +goods to liquidate their debts, and debtors here could +not redeem their debts abroad.</p> + +<p>As pointed out in former chapters, prophets always +confidently foretold that one immediate result of such +a war would be a raid on our gold stores by foreign +countries. Our actual experiences showed how feeble +were these imaginings. They were too feeble to +foresee the impossibility of exporting great masses +of gold abroad. Our navy would stop their exportation +to enemy countries, whilst risks of capture, +freights and insurance would stop their export to +neutral countries. It was rumoured that the British +Government placed an embargo on exports of gold. +This is highly improbable, for the embargoes imposed +by the war were sufficiently preventative; certainly +so in the early months of the war.</p> + +<p>But apart from these tremendous difficulties and<span class="pagenum" id="Page_205">205</span> +obstacles, it was vastly more important to discover that +we had greater power to take gold from foreign countries +than foreigners had to take it from us, thereby again +destroying theories. It was revealed that this country +was, indeed, the world’s creditor; that nations were +indebted to us, not we to them. This was why, with +few exceptions, notably the French Exchange, the +exchanges went in our favour. This was violently +so with the New York Exchange, which consequently +broke down completely. America was greatly in this +country’s debt, and as it could not liquidate in the +ordinary way by buying exchange on London, New +York had eventually to send gold to Ottawa. This, +together with our subsequent huge military purchases +in the States, gradually improved the position, and +in a few months the exchange was working normally.</p> + +<p>Our banks called in credits from abroad, but our +debtors, with all the good will in the world, could not +remit the funds. Not only did this place the discount +and accepting houses in serious difficulties, but the +banks were involved in these difficulties. The wealth, +therefore, which in normal times the banks regard as +next to their cash reserves in matter of quality, was +practically of no avail. Bills of exchange became +as frozen as Stock Exchange securities, and naturally +enough the banks forthwith ceased to discount bills. +And as the bill brokers depend on the banks, they +could not discount. Moreover, it was useless at +first to call in loans from the bill brokers, for they<span class="pagenum" id="Page_206">206</span> +could not get the funds. So the deadlock was +complete.</p> + +<p>What, then, was the most expedient thing for the +Government to do in these unprecedented circumstances? +Let things take their course? Let the +problem solve itself? In that direction disaster lay. +Even though the banks might stand up, the nation’s +commercial and economic position could not stand +up. Dire confusion would have resulted; ruin would +have followed; there would have been unemployment +on a vast scale; and the nation would have been in +an infinitely weaker position than it was to face and +conduct the war. The problem was solved by the +moratorium; and the difficulties and complications +arising out of the moratorium were subsequently +removed by degrees by the other measures adopted.</p> + +<p>It was impossible for the highest human wisdom +to grasp in its entirety and instantly the vast problem +that had to be faced. No guidance was to be got +from tradition or precedent. It was like sudden ruin +overtaking an ordinary prosperous and comfortable +household. The disaster not having been foreseen, +and no provision having been made for it, the head +of the household is in a state of bewilderment. He +cannot at first see and think clearly. It is only by +force of will and self-control that he finds a way to +battle with his troubles and difficulties, and to minimize +and overcome them.</p> + +<p>So with the Government of the national household.<span class="pagenum" id="Page_207">207</span> +It had to exercise self-control, self-will, act +boldly and act firmly, adopting what appeared the +wisest course, not staying to ask what our forefathers +did or would have done. The nation’s ancestors +never had such trials and difficulties to face, such +problems to settle.</p> + +<p>The only action the wisdom of which I have +doubts, was the rapid advance in the Bank of England +rate to 10 per cent. It is possible that this would +have had graver consequences had the bulk of the +public understood the meaning of it. To those who +understood it looked like the symptoms of panic. +Fortunately, the bulk of the public did not understand +the significance of it. In its ignorance it regarded +it as something wisely and inevitably done, +a greater safeguard and, therefore, a measure designed +to strengthen and not weaken its confidence in the +banking and financial position.</p> + +<p>Those versed in its meaning were able to discount +its importance. Now, however, that recent experiences +have greatly enlightened the public, it would +be well to take this lesson to heart.</p> + +<p>The object of raising the rate was, presumably, +to protect the Bank’s reserve, and to draw gold from +abroad. No rate, however, will protect the reserve +in the day of world-wide panic, and no rate will bring +gold here in such a world-war. Scarcely was it raised +than it had to be brought down again. If it had to +be legally raised to 10 per cent. before emergency<span class="pagenum" id="Page_208">208</span> +currency could be issued, the sooner this piece of +red tape is destroyed the better.</p> + +<p>However, it is hardly likely that a crisis of the +dimensions we have experienced will recur. Should +it recur some generations hence, the Government in +those days will have experience and precedent to +guide them.</p> + +<p>Though the greater part of the wealth of the +banks was frozen in these early days, owing to the +circumstances I have mentioned, and they had only +their cash wealth to carry them through, there was +no panic. The stability of the banking structure was +not assailed by a tempest, and its position never +seemed in real peril. A zephyr might have blown +about it, but not a hurricane. Its foundations never +swerved visibly. Let us recall, too, that the crisis +occurred at an unfortunate time in the days when +there are heavy calls upon the banks for holiday +cash. If they paid depositors largely in notes, they +fulfilled their legal obligations, and their action in +this respect must be judged in the light of the legal +restrictions on which I have laid emphasis in former +chapters. If depositors had to go to the Bank of +England to exchange their notes for gold, this was no +proof of a panicky run on the Bank of England. +Moreover, there can be little doubt that in all their +elaborate scheming prior to the war, the Germans +prepared to start a panic by a fictitious run on the +Bank. But this plan failed as egregiously as their<span class="pagenum" id="Page_209">209</span> +plans to bring about revolution in India and the +colonies.</p> + +<p>So far as the depositors were concerned the +banks had little need to claim the protection of the +moratorium. The system soon began to work as +smoothly and as perfectly as in normal times.</p> + +<p>For all that, it is a pity that years ago the +Government did not take power on its own behalf, or +give provisional power to the Bank of England, to +issue legal tender notes of £1 and 10<i>s.</i> denomination. +Notes of high denomination are useless for ordinary +currency purposes. The recent crisis has demonstrated, +once and for all, their uselessness. Because +this provision had never been made, and because the +country had no machinery for providing small +currency in emergencies, new machinery had to be +improvised. This entailed delay, which, though it +had no grave consequences, resulted in needless loss. +It was responsible in chief measure for the prolonged +holiday, which was a joy to some people and a sorrow +to others. However, now that we have the machinery, +let us keep it to use, not to abuse. After all, very +little of the new paper currency has been needed.</p> + +<p>Having, then, in the crisis only their cash +reserves to rely upon, those reserves which some +critics have constantly insisted have ever been too +slender, the banks came through comfortably, +successfully, thoroughly justifying the confidence +reposed in them. This confidence has strengthened<span class="pagenum" id="Page_210">210</span> +as the days have gone by. It shows that confidence +is of greater value than “credit.” Such a statement +takes on the aspect of a paradox. Though wealth +was frozen, and though the creation of the highest +class of wealth was greatly slowed down, verging on +stoppage, still confidence remained. This appears to +me to be confidence not only in the soundness of our +banking system, but confidence in our entire economic +structure, in the wisdom of Government, in the +wealth of the nation, in the strength of our army and +navy, in the holiness of our crusade, and in the +strength of our national character. But would this +confidence remain were our banking system to fall? +As Mr. Lloyd George said in Parliament, the mere +knowledge of the currency facilities being available +gave confidence. That is, it strengthened confidence +in the nation’s financial fabric.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_211">211</span></p> + +<h2 class="nobreak" id="CHAPTER_XXIII"><span id="toclink_211"></span>CHAPTER XXIII<br> + +<span class="subhead">SOME CONCLUSIONS</span></h2> +</div> + +<p class="in0"><span class="firstword">In</span> writing this work I need hardly say—for it will be +apparent to all who have laboured through it—that I +have had two main purposes in view. I have written +it as a guide to the student of the money market, +and I have written it with the object of learning +some lessons which, I think, are to be learnt from the +unique experiences of the financial world since the +outbreak of the war. There is much contentious +matter within its pages, but this is inevitable in +dealing with a subject so profound and intricate, so +profound, indeed, as well nigh to baffle human vision +to see clearly, steadily, and wholly its vast complexities. +The financial fabric is something that has +grown up in our midst as a mysterious thing. It has +arisen not only out of our needs, but out of our +national character. It is no invention that has +suddenly revolutionized fashion in banking. It has +been an economic evolution, a product of environment, +and who will say that its evolution has +reached its final stage? The environment has been +gradually, inevitably, imperceptibly created and<span class="pagenum" id="Page_212">212</span> +modified by national character, that is to say, by +national psychology. This explains its distinction +from other systems. Other systems in the world +are likewise products of national character, products +of circumscribed environment. This is why they +differ, and why there is no scientific precision. +There may come a time when the world will have an +international banking system, but that day is far +distant. Meanwhile systems must remain national.</p> + +<p>It is important, therefore, for the student to +understand that it is a psychological product, a +something that has grown up out of the soul of the +nation. It is difficult to be clearly conscious of this, +to regard it as a something not purely scientific, +something not independent of human nature as are +mathematics. Banking is a part of our economic +system. Political economy has been called a dismal +science. This is a delusion. It is neither a science, +nor is it dismal. Students of political economy have +made it look dismal because they have regarded it as +a science, in the making of whose laws and in the +shaping of which human nature and constantly +changing character have no part. Political economy +is a branch of psychology. The subject is human +nature, in the same way as ethics or religion is +human nature. It deals with temperament and the +soul, and the temperament and the soul are not +strictly scientific subjects, like geology and astronomy. +We might just as reasonably describe religion as the +science of theological economy, and ethics as the<span class="pagenum" id="Page_213">213</span> +science of moral economy, as describe social intercourse +as political economy. If political economy +means the law of the State, then laws are made by +the citizens of a nation and are being constantly +modified. They are not laws beyond the control of +man.</p> + +<p>The banking system is in our control and we can +make laws to modify it as we please, and as our +wisdom dictates, or counsels. In gold there is +nothing marvellous. The world has given it certain +powers through its laws. One nation has largely +imitated another in this respect, until all the leading +nations have adopted it as the basis of their systems. +They have imitated each other in the same way in +evolving their naval and military systems. The day +may come when they will look upon gold as something +barbaric, in the same light as we regard the +iron currency of primitive nations. A thousand years +hence ours may be spoken of as a primitive age.</p> + +<p>In this work, then, I have endeavoured not only +to be analytical and critical, but to be constructive. +Many of the theories that are still held tenaciously I +cannot accept. I cannot accept the theory that banks +are creators of credit and build up an unsubstantial +and dangerous structure. When we talk of banking +credit and national credit we talk of two distinct conceptions. +Yet both kinds of credit are based fundamentally +on national wealth and national character. +It is said that banking credit is based on gold and +national credit on national wealth. Why is not<span class="pagenum" id="Page_214">214</span> +national credit also based on gold? We glory in a +towering national credit, because it is something to +be proud of, a monument to our greatness. Why, then, +should banking credit raise strong apprehensions?</p> + +<p>Before we talk glibly of banking credit it would +be more profitable, first of all, to get a clear conception +of what credit is, and having got that clear +conception to define it clearly. Joint stock companies +talk of other credits. They describe revenue +as credit, profits as credit, debts owing to them as +credit, their financial standing as credit. Ideas of +credit, therefore, are greatly complicated, and no +wonder they lead to confusion. We even talk of +Germany’s credit weakening, notwithstanding the +great mass of gold she possesses.</p> + +<p>It is when we talk of credit and confidence as one +and the same thing that the confusion becomes +greater. We talk of the superstructure of credit +raised by banks, and grow dizzy as we strain our +gaze towards its apex; yet we speak in the same +breath of the profound confidence we have in banks. +We cannot at the same moment have profound +confidence in them and yet gaze apprehensively +upon the system. The repose and the fear cannot +both be rational states of consciousness.</p> + +<p>Our confidence in banks reposes in our trust in +the wealth they possess and in the wealth they +transform into money. Without that confidence +they could not exist, despite their credit. But without +confidence the nation itself could not exist. It<span class="pagenum" id="Page_215">215</span> +is national confidence that supports the State. It is +national confidence that brings national prosperity. +Destroy confidence and you destroy wealth and +prosperity.</p> + +<p>As regards bank reserves, I think we can do in +the future what we have done in the past—trust them +to keep a fair average proportion. As things are, +we must not expect the system to work with perfect +elasticity. This cannot be done with inelastic gold +as a basis. We cannot have an absolutely safe +mathematical ratio. Whatever the ratio be, it alone +will not ensure us against disaster. Only the +Government—that is, the nation—can ensure us +against disaster. It is the duty of the nation to do +this, and it is also a prudent course to take. We +had an exemplification of this in the recent crisis. +Experience is a safer guide than theory.</p> + +<p>But the Government, in its turn, has the right +and the duty to insist upon sound banking. It +should allow no institutions to spring up calling +themselves banks which cannot be conducted soundly. +This is not safeguarding the community. Such +institutions should be differentiated, and should have +their proper designations. I think the fewer the +banks the better, therefore I favour amalgamations. +This is because I think they could be brought under +more complete control and could be more soundly +and safely administrated. In fact, I would go to the +logical extreme and make them branches of a State +Bank and not independent entities.</p> + +<p><span class="pagenum" id="Page_216">216</span></p> + +<p>It is because they and the Bank of England are +independent entities that we cannot simultaneously +have high reserves in the joint stock banks and high +reserves in the Bank of England unless both stop +lending simultaneously. A joint stock bank singly +can keep a high proportion because it can make all +its branches conform to the common policy. But as +the banks are not branches of the Bank of England +there can be no common policy. This has its grave +disadvantages at times. We may evolve in time to +closer union, to a more consistent and uniform +system. This certainly lies in the path of social +evolution.</p> + +<p>As to where the reserves should be kept, I do not +think, as the system is at present, that this is a +question of vital importance. The reserves appear +to me to be safer in the Bank of England, because +thereby they place greater obligations upon that +Bank, and this comes nearer to our notions of unity. +Behind the Bank of England is the Government, and +behind the Government is the State. One thing is +certain. Wherever the reserves be, they will not +suffice of themselves to save the banks in a state of +ungovernable panic without the help of the Government. +And all the banks must stand or fall together. +And if they stand or fall together their reserves must +be pooled in some fashion and somewhere.</p> + +<p>The Government can save them in these grave, +but, happily, remote circumstances, by setting the +machinery at work to produce legal tender currency.<span class="pagenum" id="Page_217">217</span> +The wisdom and efficacy of this have recently been +strikingly demonstrated.</p> + +<p>Many critics have foretold disaster from the +inadequacy of the gold reserves against the liabilities +in the Post Office Savings Bank. The Post Office +Savings Bank and the joint stock banks perform +distinct functions. The Savings Bank does not lend. +It does not transform wealth into liquid currency. +It is a huge State safe, where public savings are kept +in safety, and it performs the functions of the old +silver teapot in the household. Being a purely +State or National institution, it is a national liability. +It has behind it the entire wealth of the nation, and +it is absolutely safe unless the nation be swallowed +up in the seas. And if it were swallowed up the +depositors would not need their money.</p> + +<p>Gold, after all, performs but limited functions. It +is becoming less necessary in the internal economy of +the State owing to the growth of cheques. Gold is +merely a symbol, and we should not bow before it in +abject obeisance. It is even becoming of less importance +in its international functions, and I think the +European war will lessen its importance still further. +European nations have collected it more for war +purposes than for commercial. This has been the +case with Germany, which, in the consciousness +of its determination to fight for world dominion, +amassed the gold as a war chest. This gold is not in +circulation, but is lying idle in the Reichsbank, in +order that the Government may flood the country<span class="pagenum" id="Page_218">218</span> +with various sorts of paper currency. This paper +currency will in time be so inflated as to become +greatly depreciated. This is the danger run, the +danger of inflation and depreciation, yet we never +dream of the inflation of our cheque currency, because +it grows and contracts with our output of wealth.</p> + +<p>The depreciation of paper currency is evidence +often that a nation is living beyond its income. We +know the fate awaiting the individual when he “outruns +the constable.” In order to avoid insolvency he +must live more frugally, live well within his income, +and liquidate his debts. Then, in time, he will be +free and will not live in dread of his creditors.</p> + +<p>If a nation lived within itself, built a huge rampart +around itself, and had no commercial intercourse +with other nations, if it could live a happy, contented +community, on its own resources, then an inflated +currency would have no ill effects. It would not +necessarily bring bankruptcy and ruin. It would be +like a private individual living on his own resources +and on the fruits of his own labour, interchanging +nothing with his neighbours. Such a hermit would +be indebted to no man. He would depend on nature +alone, and if nature failed him, or sickness overtook +him, then he would die.</p> + +<p>But civilized nations are not hermit nations. +They live by mutual help, by mutual trading. They +deal with each other and they deal on the system of +barter, in the absence of an international currency. +Gold is a species of barter and passes from nation to<span class="pagenum" id="Page_219">219</span> +nation in all respects like an ordinary commodity. +Imports are paid for by exports, and exports pay for +imports. When, however, a country imports more +than it can pay for in exports, it must either cease to +import, or pay for the excess in gold, securities, or +some other form of payment. If it has to pay in gold +it may be living beyond its income and be paying for +its exports out of capital. If the gold be hoarded and +the paper currency be multiplied and inflated an +automatic rise in prices results. This is tantamount +to a depreciation of the paper currency, for this +currency can then purchase less. What is called the +credit of the nation falls. That is to say, belief in +its soundness weakens. This encourages imports +from foreign countries and discourages exports, and +the indebtedness to foreign countries increases. +Should this go on indefinitely, the country will get +deeper and deeper into debt and nearer to insolvency. +It will have to pay for its imports with its gold, or +stop importing. And if it stops importing, it might +stop importing vital products. Powers of production +and consumption will necessarily weaken, and that +country will get into the plight Germany has got into. +In time its credit and currency will become so debased +that foreigners will not risk exporting commodities, +lest they should lose more than they gain, for the +debtor country’s paper will become of less value.</p> + +<p>In the case of Russia, her currency also became +depreciated in terms of sterling value. This arose +from a different cause. Russia’s exports to England<span class="pagenum" id="Page_220">220</span> +and other countries were stopped by the closing of +the Baltic Sea and the Dardanelles. A little went +by the Archangel route, but, of course, it was wholly +inadequate. Russia, therefore, was unable to liquidate +her national indebtedness by her exports, and the +exchange went so greatly against her—that is to say, +the rouble became so greatly depreciated in terms of +our gold currency—that it was impossible for Russian +merchants to get remittances to send to this country +to liquidate their indebtedness here.</p> + +<p>The war crisis has been invaluable in teaching +us deep lessons. Had there been machinery for the +ready provision of legal tender currency the moment +the war was foreseen, a moratorium might have been +unnecessary, with all its complications and confusion. +A prolonged Bank holiday, with its inconveniences, +might likewise have been obviated. The crisis has +shown enlightened nations how terrible the risks and +consequences of war are. It has been invaluable in +revealing the spiritual, material, and financial strength +of Great Britain and the Empire, and in setting up +precedents for future guidance in the financial as well +as in the military and commercial spheres. And the +heavy financial burdens shouldered by the nation may +not in the long run be so heavy as some fear.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_221">221</span></p> + +<h2 class="nobreak" id="APPENDIX_A"><span id="toclink_221"></span>APPENDIX A</h2> +</div> + +<p class="in0"><span class="firstword">The</span> following pre-war Bank of England return, of June +24th, 1914, may be regarded as a normal return, and it +can be compared with the <a href="#t83a">abnormal return appearing in +Chapter IX</a>.</p> + +<h3><span class="smcap">Issue Department.</span></h3> + +<table id="t221a" class="balance cols"> +<col> +<col> +<col class="bl"> +<col> +<tr> + <td class="tdl"></td> + <td class="tdr">£</td> + <td class="tdl"></td> + <td class="tdr">£</td> +</tr> +<tr> + <td class="tdl">Notes issued</td> + <td class="tdr">56,753,275</td> + <td class="tdl">Government debt</td> + <td class="tdr">11,015,100</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr"></td> + <td class="tdl">Other securities</td> + <td class="tdr">7,434,900</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bb"> </td> + <td class="tdl">Gold coin and bullion</td> + <td class="tdr bb">38,303,275</td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bbd">56,753,275</td> + <td class="tdl"></td> + <td class="tdr bbd">56,753,275</td> +</tr> +</table> + +<h3><span class="smcap">Banking Department.</span></h3> + +<table id="t221b" class="balance cols"> +<col> +<col> +<col class="bl"> +<col> + +<tr> + <td class="tdl"></td> + <td class="tdc">£</td> + <td class="tdl"></td> + <td class="tdc">£</td> +</tr> +<tr> + <td class="tdl">Proprietors’ capital</td> + <td class="tdr">14,553,000</td> + <td class="tdl">Government securities</td> + <td class="tdr">11,046,570</td> +</tr> +<tr> + <td class="tdl">Rest</td> + <td class="tdr">3,160,254</td> + <td class="tdl">Other securities</td> + <td class="tdr">39,994,619</td> +</tr> +<tr> + <td class="tdl">Public deposits</td> + <td class="tdr">18,074,214</td> + <td class="tdl">Notes</td> + <td class="tdr">28,050,150</td> +</tr> +<tr> + <td class="tdl">Other deposits</td> + <td class="tdr">44,915,911</td> + <td class="tdl">Gold and silver coin</td> + <td class="tdr">1,624,988</td> +</tr> +<tr> + <td class="tdl">Seven-day and other bills</td> + <td class="tdr bb">12,948</td> + <td class="tdl"></td> + <td class="tdr bb"> </td> +</tr> +<tr> + <td class="tdl"></td> + <td class="tdr bbd">80,716,327</td> + <td class="tdl"></td> + <td class="tdr bbd">80,716,327</td> +</tr> +</table> + +<p>The proportion of the reserve this week was 47⅛ per cent.</p> +<hr class="chap x-ebookmaker-drop"> + +<div class="chapter"> +<p><span class="pagenum" id="Page_222">222</span></p> + +<h2 class="nobreak" id="APPENDIX_B"><span id="toclink_222"></span>APPENDIX B<br> + +<span class="subhead">MR. AUSTEN CHAMBERLAIN AND MR. LLOYD +GEORGE ON GOLD RESERVES</span></h2> +</div> + +<p class="in0"><span class="firstword">While</span> this book was in the press, interesting views upon +the note currency and the gold reserves were expressed in +the House of Commons by Mr. Austen Chamberlain and +Mr. Lloyd George. They coincide largely with my own +views. The opinions were expressed during the discussion +on February 23rd on the Chancellor of the Exchequer’s +statement on the financial arrangements made with France +and Russia.</p> + +<p>Mr. Austen Chamberlain said, to quote from the report +in the <cite>Morning Post</cite>:—</p> + +<p>“Mr. D. M. Mason the previous night urged the Government +to withdraw the Treasury notes now in circulation +here. He (Mr. Chamberlain) had held for a long time +that gold in the pockets of the people was not a very useful +reserve for any national purpose, that we carried about +the same amount of gold whether it was a time of crisis or +not, and that that gold was not readily made available for +the international currency when the need for it in that +capacity arose. Therefore, he held that the internal +circulation of gold was, on the whole, wasteful use of it, +that it was an out of date use of gold, and that the +greatest development of our financial system had been the<span class="pagenum" id="Page_223">223</span> +substitution of paper for gold. The largest substitution +had been in the form of the cheque. Provided that the +issue of notes was not an artificial inflation of the currency +but a response to a real need for currency, then the +more they could substitute notes for gold for internal use +the better, and the more economical, the more civilized, +and the more advanced the currency system became. +What he cared about was seeing a large reserve of gold +centralized for use in an emergency, and if they had +secured the reserve of gold and the emergency arose, then +the most foolish thing they could do was to fail to use the +gold. The gold was got together in order that in an +emergency, when the exchange went against them, the +adverse balance of the exchanges might be corrected by +the use of the gold, and unless the gold were used in that +way it seemed to be a pure waste of it to hold it in reserve. +That was not a doctrine that was popular in any +foreign country that he knew. But it was a sound +doctrine, and he hoped that the whole influence that we +could bring, through the Chancellor of the Exchequer, in +the councils of the Allies would be directed to making +them use their gold resources freely when those gold +resources were required. They had to study the psychology +of the people. If the Government used their gold freely +they very soon restored confidence in the public mind. +He hoped that our influence would be used to persuade +our Allies that in this matter the boldest course was the +safest course, and that States were as unwise to hoard gold +as individuals within States were.” (Hear, hear.)</p> + +<p>Mr. Lloyd George, in the course of his speech, said: +“As to the matter of currency, he was completely in +agreement with Mr. Chamberlain, who put the position so +effectively that he could not usefully add anything. He +thought it desirable that there should be considerable +reserves of gold in the Bank of England or in the<span class="pagenum" id="Page_224">224</span> +Treasury, and equally desirable that it should be freely +used whenever the emergency arose. We were on the +road to a much more efficient use of our gold reserve if +we used paper currency within safe limits. Our issues of +paper currency were well within safe limits. (Hear, hear.) +Not only so, but there was no country to be compared with +us in this respect. Foreign countries, he thought, had +always been nervous about using their gold. The fact +that we used it freely showed that was not our view. +There was too much disposition even to-day to worship the +golden calf. (Laughter.) This country had always gone +on the principle that the gold was there to use whenever +there was a demand for it, and that practice had never failed +us up to the present. It was true that we had never had +such a strain put upon it as during the past few months, and +it was probable that that strain would increase during the +next six or twelve months, when our purchases abroad would +be much heavier than ever before, and our sales to other +countries considerably less. He did not like to prophesy, +and he hated bragging, but he did not mind saying that +the resources of gold we had got would carry us through +any emergency that we could possibly foresee. (Cheers.) +That was his firm conviction, not merely from his observation, +but from careful inquiries in the City and elsewhere. +He agreed, however, that there was no special merit in +paying debts in gold where paper would do equally well, +and thought it wasteful, burdensome, and not particularly +useful.”</p> + +<p class="p2 center"> +<span class="small bt">PRINTED BY WILLIAM CLOWES AND SONS, LIMITED, LONDON AND BECCLES.</span> +</p> + +<div class="chapter transnote"> +<h2 class="nobreak" id="Transcribers_Notes">Transcriber’s Notes</h2> + +<p>Punctuation, hyphenation, and spelling were made +consistent when a predominant preference was found +in the original book; otherwise they were not changed.</p> + +<p>Simple typographical errors were corrected; unbalanced +quotation marks were remedied when the change was +obvious, and otherwise left unbalanced.</p> + +<p>Ditto marks have been replaced with the actual words.</p> +</div> +<div style='text-align:center'>*** END OF THE PROJECT GUTENBERG EBOOK 75730 ***</div> +</body> +</html> + diff --git a/75730-h/images/cover.jpg b/75730-h/images/cover.jpg Binary files differnew file mode 100644 index 0000000..e3aaad7 --- /dev/null +++ b/75730-h/images/cover.jpg |
