Lombard Street: A Description of the Money Market Part 7

Certainly it could not. It could not have retained its own deposits.

A large part of these are the deposits of bankers, and they would not consent to help the Bank of England in a policy of isolation.

They would not agree to suspend payments themselves, and permit the Bank of England to survive, and get all their business. They would withdraw their deposits from the Bank; they would not a.s.sist it to stand erect amid their ruin. But even if this were not so, even if the banks were willing to keep their deposits at the Bank while it was not lending, they would soon find that they could not do it.

They are only able to keep those deposits at the Bank by the aid of the Clearing-house system, and if a panic were to pa.s.s a certain height, that system, which rests on confidence, would be destroyed by terror.

The common course of business is this. A B having to receive 50,000 l. from C D takes C D's cheque on a banker crossed, as it is called, and, therefore, only payable to another banker. He pays that cheque to his own credit with his own banker, who presents it to the banker on whom it is drawn, and if good it is an item between them in the general clearing or settlement of the afternoon. But this is evidently a very refined machinery, which a panic will be apt to destroy. At the first stage A B may say to his debtor C D, 'I cannot take your cheque, I must have bank-notes.' If it is a debt on securities, he will be very apt to say this. The usual practice--credit being good--is for the creditor to take the debtor's cheque, and to give up the securities. But if the 'securities'

really secure him in a time of difficulty, he will not like to give them up, and take a bit of paper--a mere cheque, which may be paid or not paid. He will say to his debtor, 'I can only give you your securities if you will give me bank-notes.' And if he does say so, the debtor must go to his bank, and draw out the 50,000 L. if he has it. But if this were done on a large scale, the bank's 'cash in house' would soon be gone; as the Clearing-house was gradually superseded it would have to trench on its deposit at the Bank of England; and then the bankers would have to pay so much over the counter that they would be unable to keep much money at the Bank, even if they wished. They would soon be obliged to draw out every s.h.i.+lling.

The diminished use of the Clearing-house, in consequence of the panic, would intensify that panic. By far the greater part of the bargains of the country in moneyed securities is settled on the Stock Exchange twice a month, and the number of securities then given up for mere cheques, and the number of cheques then pa.s.sing at the Clearing-house are enormous. If that system collapse, the number of failures would be incalculable, and each failure would add to the discredit that caused the collapse.

The non-banking customers of the Bank of England would be discredited as well as other people; their cheques would not be taken any more than those of others; they would have to draw out bank-notes, and the Bank reserve would not be enough for a t.i.the of such payments.

The matter would come shortly to this: a great number of brokers and dealers are under obligations to pay immense sums, and in common times they obtain these sums by the transfer of certain securities.

If, as we said just now, No. 1 has borrowed 50,000 L. of No. 2 on Exchequer bills, he, for the most part, cannot pay No. 2 till he has sold or pledged those bills to some one else. But till he has the bills he cannot pledge or sell them; and if No. 2 will not give them up till he gets his money, No. 1 will be ruined, because he cannot pay it. And if No. 2 has No. 3 to pay, as is very likely, he may be ruined because of No. 1's default, and No. 4 only on account of No.

3's default; and so on without end. On settling day, without the Clearing-house, there would be a ma.s.s of failures, and a bundle of securities. The effect of these failures would be a general run on all bankers, and on the Bank of England particularly.

It may indeed be said that the money thus taken from the Banking Department of the Bank of England would return there immediately; that the public who borrowed it would not know where else to deposit it; that it would be taken out in the morning, and put back in the evening. But, in the first place, this argument a.s.sumes that the Banking Department would have enough money to pay the demands on it; and this is a mistake: the Banking Department would not have a hundredth part of the necessary funds. And in the second, a great panic which deranged the Clearing-house would soon be diffused all through the country. The money therefore taken from the Bank of England could not be soon returned to the Bank; it would not come back on the evening of the day on which it was taken out, or for many days; it would be distributed through the length and breadth of the country, wherever there were bankers, wherever there was trade, wherever there were liabilities, wherever there was terror.

And even in London, so immense a panic would soon impair the credit of the Banking Department of the Bank of England. That department has no great prestige. It was only created in 1844, and it has failed three times since. The world would imagine that what has happened before will happen again; and when they have got money, they will not deposit it at an establishment which may not be able to repay it. This did not happen in former panics, because the case we are considering never arose. The Bank was helping the public, and, more or less confidently, it was believed that the Government would help the Bank. But if the policy be relinquished which formerly a.s.suaged alarm, that alarm will be protracted and enhanced, till it touch the Banking Department of the Bank itself.

I do not imagine that it would touch the Issue Department. I think that the public would be quite satisfied if they obtained bank-notes.

Generally nothing is gained by holding the notes of a bank instead of depositing them at a bank. But in the Bank of England there is a great difference: their notes are legal tender. Whoever holds them can always pay his debts, and, except for foreign payments, he could want no more. The rush would be for bank-notes; those that could be obtained would be carried north, south, east, and west, and, as there would not be enough for all the country, the Banking Department would soon pay away all it had.

Nothing, therefore, can be more certain than that the Bank of England has in this respect no peculiar privilege; that it is simply in the position of a Bank keeping the Banking reserve of the country; that it must in time of panic do what all other similar banks must do; that in time of panic it must advance freely and vigorously to the public out of the reserve.

And with the Bank of England, as with other Banks in the same case, these advances, if they are to be made at all, should be made so as if possible to obtain the object for which they are made. The end is to stay the panic; and the advances should, if possible, stay the panic. And for this purpose there are two rules: First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.

Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them.

The reason is plain. The object is to stay alarm, and nothing therefore should be done to cause alarm. But the way to cause alarm is to refuse some one who has good security to offer. The news of this will spread in an instant through all the money market at a moment of terror; no one can say exactly who carries it, but in half an hour it will be carried on all sides, and will intensify the terror everywhere. No advances indeed need be made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimally small fraction of the whole business. That in a panic the bank, or banks, holding the ultimate reserve should refuse bad bills or bad securities will not make the panic really worse; the 'unsound' people are a feeble minority, and they are afraid even to look frightened for fear their unsoundness may be detected. The great majority, the majority to be protected, are the 'sound' people, the people who have good security to offer.

If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security--on what is then commonly pledged and easily convertible--the alarm of the solvent merchants and bankers will be stayed. But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.

It may be said that the reserve in the Banking Department will not be enough for all such loans. If that be so, the Banking Department must fail. But lending is, nevertheless, its best expedient. This is the method of making its money go the farthest, and of enabling it to get through the panic if anything will so enable it. Making no loans as we have seen will ruin it; making large loans and stopping, as we have also seen, will ruin it. The only safe plan for the Bank is the brave plan, to lend in a panic on every kind of current security, or every sort on which money is ordinarily and usually lent. This policy may not save the Bank; but if it do not, nothing will save it.

If we examine the manner in which the Bank of England has fulfilled these duties, we shall find, as we found before, that the true principle has never been grasped; that the policy has been inconsistent; that, though the policy has much improved, there still remain important particulars in which it might be better than it is.

The first panic of which it is necessary here to speak, is that of 1825: I hardly think we should derive much instruction from those of 1793 and 1797; the world has changed too much since; and during the long period of inconvertible currency from 1797 to 1819, the problems to be solved were altogether different from our present ones. In the panic of 1825, the Bank of England at first acted as unwisely as it was possible to act. By every means it tried to restrict its advances. The reserve being very small, it endeavoured to protect that reserve by lending as little as possible. The result was a period of frantic and almost inconceivable violence; scarcely any one knew whom to trust; credit was almost suspended; the country was, as Mr. Huskisson expressed it, within twenty-four hours of a state of barter. Applications for a.s.sistance were made to the Government, but though it was well known that the Government refused to act, there was not, as far as I know, until lately any authentic narrative of the real facts. In the 'Correspondence' of the Duke of Wellington, of all places in the world, there is a full account of them. The Duke was then on a mission at St. Petersburg, and Sir R.

Peel wrote to him a letter of which the following is a part: 'We have been placed in a very unpleasant predicament on the other question--the issue of Exchequer Bills by Government. The feeling of the City, of many of our friends, of some of the Opposition, was decidedly in favour of the issue of Exchequer Bills to relieve the merchants and manufacturers.

'It was said in favour of the issue, that the same measure had been tried and succeeded in 1793 and 1811. Our friends whispered about that we were acting quite in a different manner from that in which Mr. Pitt did act, and would have acted had he been alive.

'We felt satisfied that, however plausible were the reasons urged in favour of the issue of Exchequer Bills, yet that the measure was a dangerous one, and ought to be resisted by the Government.

'There are thirty millions of Exchequer Bills outstanding. The purchases lately made by the Bank can hardly maintain them at par. If there were a new issue to such an amount as that contemplated--viz., five millions--there would be a great danger that the whole ma.s.s of Exchequer Bills would be at a discount, and would be paid into the revenue. If the new Exchequer Bills were to be issued at a different rate of interest from the outstanding ones--say bearing an interest of five per cent--the old ones would be immediately at a great discount unless the interest were raised. If the interest were raised, the charge on the revenue would be of course proportionate to the increase of rate of interest. We found that the Bank had the power to lend money on deposit of goods. As our issue of Exchequer Bills would have been useless unless the Bank cashed them, as therefore the intervention of the Bank was in any event absolutely necessary, and as its intervention would be chiefly useful by the effect which it would have in increasing the circulating medium, we advised the Bank to take the whole affair into their own hands at once, to issue their notes on the security of goods, instead of issuing them on Exchequer Bills, such bills being themselves issued on that security.

'They reluctantly consented, and rescued us from a very embarra.s.sing predicament.'

The success of the Bank of England on this occasion was owing to its complete adoption of right principles. The Bank adopted these principles very late; but when it adopted them it adopted them completely. According to the official statement which I quoted before, 'we,' that is, the Bank directors, 'lent money by every possible means, and in modes which we had never adopted before; we took in stock on security, we purchased Exchequer Bills, we made advances on Exchequer Bills, we not only discounted outright, but we made advances on deposits of bills of Exchange to an immense amount--in short, by every possible means consistent with the safety of the Bank.' And for the complete and courageous adoption of this policy at the last moment the directors of the Bank of England at that time deserve great praise, for the subject was then less understood even than it is now; but the directors of the Bank deserve also severe censure, for previously choosing a contrary policy; for being reluctant to adopt the new one; and for at last adopting it only at the request of, and upon a joint responsibility with, the Executive Government.

After 1825, there was not again a real panic in the money market till 1847. Both of the crises of 1837 and 1839 were severe, but neither terminated in a panic: both were arrested before the alarm reached its final intensity; in neither, therefore, could the policy of the Bank at the last stage of fear be tested.

In the three panics since 1844--in 1847, 1857, and 1866--the policy of the Bank has been more or less affected by the Act of 1844, and I cannot therefore discuss it fully within the limits which I have pre scribed for myself. I can only state two things: First, that the directors of the Bank above all things maintain, that they have not been in the earlier stage of panic prevented by the Act of 1844 from making any advances which they would otherwise have then made.

Secondly, that in the last stage of panic, the Act of 1844 has been already suspended, rightly or wrongly, on these occasions; that no similar occasion has ever yet occurred in which it has not been suspended; and that, rightly or wrongly, the world confidently expects and relies that in all similar cases it will be suspended again. Whatever theory may prescribe, the logic of facts seems peremptory so far. And these principles taken together amount to saying that, by the doctrine of the directors, the Bank of England ought, as far as they can, to manage a panic with the Act of 1844, pretty much as they would manage one without it--in the early stage of the panic because then they are not fettered, and in the latter because then the fetter has been removed.

We can therefore estimate the policy of the Bank of England in the three panics which have happened since the Act of 1844, without inquiring into the effect of the Act itself. It is certain that in all of these panics the Bank has made very large advances indeed. It is certain, too, that in all of them the Bank has been quicker than it was in 1825; that in all of them it has less hesitated to use its banking reserve in making the advances which it is one princ.i.p.al object of maintaining that reserve to make, and to make at once. But there is still a considerable evil. No one knows on what kind of securities the Bank of England will at such periods make the advances which it is necessary to make.

As we have seen, principle requires that such advances, if made at all for the purpose of curing panic, should be made in the manner most likely to cure that panic. And for this purpose, they should be made on everything which in common times is good 'banking security.'

The evil is, that owing to terror, what is commonly good security has ceased to be so; and the true policy is so to use the Banking reserve, that if possible the temporary evil may be stayed, and the common course of business be restored. And this can only be effected by advancing on all good Banking securities.

Unfortunately, the Bank of England do not take this course. The Discount office is open for the discount of good bills, and makes immense advances accordingly. The Bank also advances on consols and India securities, though there was, in the crisis of 1866, believed to be for a moment a hesitation in so doing. But these are only a small part of the securities on which money in ordinary times can be readily obtained, and by which its repayment is fully secured.

Railway debenture stock is as good a security as a commercial bill, and many people, of whom I own I am one, think it safer than India stock; on the whole, a great railway is, we think, less liable to unforeseen accidents than the strange Empire of India. But I doubt if the Bank of England in a panic would advance on railway debenture stock, at any rate no one has any authorised reason for saying that it would. And there are many other such securities.

The amount of the advance is the main consideration for the Bank of England, and not the nature of the security on which the advance is made, always a.s.suming the security to be good. An idea prevails (as I believe) at the Bank of England that they ought not to advance during a panic on any kind of security on which they do not commonly advance. But if bankers for the most part do advance on such security in common times, and if that security is indisputably good, the ordinary practice of the Bank of England is immaterial. In ordinary times the Bank is only one of many lenders, whereas in a panic it is the sole lender, and we want, as far as we can, to bring back the unusual state of a time of panic to the common state of ordinary times.

In common opinion there is always great uncertainty as to the conduct of the Bank: the Bank has never laid down any clear and sound policy on the subject. As we have seen, some of its directors (like Mr. Hankey) advocate an erroneous policy. The public is never sure what policy will be adopted at the most important moment: it is not sure what amount of advance will be made, or on what security it will be made. The best palliative to a panic is a confidence in the adequate amount of the Bank reserve, and in the efficient use of that reserve. And until we have on this point a clear understanding with the Bank of England, both our liability to crises and our terror at crises will always be greater than they would otherwise be.

CHAPTER VIII.

The Government of the Bank of England.

The Bank of England is governed by a board of directors, a Governor, and a Deputy-Governor; and the mode in which these are chosen, and the time for which they hold office, affect the whole of its business. The board of directors is in fact self-electing. In theory a certain portion go out annually, remain out for a year, and are subject to re-election by the proprietors. But in fact they are nearly always, and always if the other directors wish it, re-elected after a year. Such has been the unbroken practice of many years, and it would be hardly possible now to break it. When a vacancy occurs by death or resignation, the whole board chooses the new member, and they do it, as I am told, with great care. For a peculiar reason, it is important that the directors should be young when they begin; and accordingly the board run over the names of the most attentive and promising young men in the old-established firms of London, and select the one who, they think, will be most suitable for a bank director. There is a considerable ambition to fill the office. The status which is given by it, both to the individual who fills it and to the firm of merchants to which he belongs, is considerable. There is surprisingly little favour shown in the selection; there is a great wish on the part of the Bank directors for the time being to provide, to the best of their ability, for the future good government of the Bank. Very few selections in the world are made with nearly equal purity. There is a sincere desire to do the best for the Bank, and to appoint a well-conducted young man who has begun to attend to business, and who seems likely to be fairly sensible and fairly efficient twenty years later.

The age is a primary matter. The offices of Governor and Deputy-Governor are given in rotation. The Deputy-Governor always succeeds the Governor, and usually the oldest director who has not been m office becomes Deputy-Governor. Sometimes, from personal reasons, such as ill-health or special temporary occupation, the time at which a director becomes Deputy-Governor may be a little deferred, and, in some few cases, merchants in the greatest business have been permitted to decline entirely. But for all general purposes, the rule may be taken as absolute. Save in rare cases, a director must serve his time as Governor and Deputy-Governor nearly when his turn comes, and he will not be asked to serve much before his turn. It is usually about twenty years from the time of a man's first election that he arrives, as it is called, at the chair. And as the offices of Governor and Deputy-Governor are very important, a man who fills them should be still in the vigour of life.

Accordingly, Bank directors, when first chosen by the board, are always young men.

At first this has rather a singular effect; a stranger hardly knows what to make of it. Many years since, I remember seeing a very fresh and nice-looking young gentleman, and being struck with astonishment at being told that he was a director of the Bank of England. I had always imagined such directors to be men of tried sagacity and long experience, and I was amazed that a cheerful young man should be one of them. I believe I thought it was a little dangerous. I thought such young men could not manage the Bank well. I feared they had the power to do mischief.

Further inquiry, however, soon convinced me that they had not the power. Naturally, young men have not much influence at a board where there are many older members. And in the Bank of England there is a special provision for depriving them of it if they get it. Some of the directors, as I have said, retire annually, but by courtesy it is always the young ones. Those who have pa.s.sed the chair--that is, who have served the office of Governor--always remain. The young part of the board is the fluctuating part, and the old part is the permanent part; and therefore it is not surprising that the young part has little influence. The Bank directors may be blamed for many things, but they cannot be blamed for the changeableness and excitability of a neocracy.

Indeed, still better to prevent it, the elder members of the board--that is, those who have pa.s.sed the chair--form a standing committee of indefinite powers, which is called the Committee of Treasury. I say 'indefinite powers,' for I am not aware that any precise description has ever been given of them, and I doubt if they can be precisely described.

They are sometimes said to exercise a particular control over the relations and negotiations between the Bank and the Government. But I confess that I believe that this varies very much with the character of the Governor for the time being. A strong Governor does much mainly upon his own responsibility, and a weak Governor does little. Still the influence of the Committee of Treasury is always considerable, though not always the same. They form a a cabinet of mature, declining, and old men, just close to the executive; and for good or evil such a cabinet must have much power.

By old usage, the directors of the Bank of England cannot be themselves by trade bankers. This is a relic of old times. Every bank was supposed to be necessarily, more or less, in opposition to every other bank--banks in the same place to be especially in opposition. In consequence, in London, no banker has a chance of being a Bank director, or would ever think of attempting to be one.

I am here speaking of bankers in the English sense, and in the sense that would surprise a foreigner. One of the Rothschilds is on the Bank direction, and a foreigner would be apt to think that they were bankers if any one was. But this only ill.u.s.trates the essential difference between our English notions of banking and the continental. Ours have attained a much fuller development than theirs. Messrs. Rothschild are immense capitalists, having, doubtless, much borrowed money in their hands. But they do not take 100 L. payable on demand, and pay it back in cheques of 5 L. each, and that is our English banking. The borrowed money which they have is in large sums, borrowed for terms more or less long. English bankers deal with an aggregate of small sums, all of which are repayable on short notice, or on demand. And the way the two employ their money is different also. A foreigner thinks 'an Exchange business'--that is, the buying and selling bills on foreign countries--a main part of banking. As I have explained, remittance is one of the subsidiary conveniences which early banks subserve before deposit banking begins. But the ma.s.s of English country bankers only give bills on places in England or on London, and in London the princ.i.p.al remittance business has escaped out of the hands of the bankers.

Most of them would not know how to carry through a great 'Exchange operation,' or to 'bring home the returns.' They would as soon think of turning silk merchants. The Exchange trade is carried on by a small and special body of foreign bill-brokers, of whom Messrs.

Rothschild are the greatest. One of that firm may, therefore, well be on the Bank direction, notwithstanding the rule forbidding bankers to be there, for he and his family are not English bankers, either by the terms on which they borrow money, or the mode in which they employ it. But as to bankers in the English sense of the word, the rule is rigid and absolute. Not only no private banker is a director of the Bank of England, but no director of any joint stock bank would be allowed to become such. The two situations would be taken to be incompatible.

The ma.s.s of the Bank directors are merchants of experience, employing a considerable capital in trades in which they have been brought up, and with which they are well acquainted. Many of them have information as to the present course of trade, and as to the character and wealth of merchants, which is most valuable, or rather is all but invaluable, to the Bank. Many of them, too, are quiet, serious men, who, by habit and nature, watch with some kind of care every kind of business in which they are engaged, and give an anxious opinion on it. Most of them have a good deal of leisure, for the life of a man of business who employs only his own capital, and employs it nearly always in the same way, is by no means fully employed. Hardly any capital is enough to employ the princ.i.p.al partner's time, and if such a man is very busy, it is a sign of something wrong. Either he is working at detail, which subordinates would do better, and which he had better leave alone, or he is engaged in too many speculations, is incurring more liabilities than his capital will bear, and so may be ruined. In consequence, every commercial city abounds in men who have great business ability and experience, who are not fully occupied, who wish to be occupied, and who are very glad to become directors of public companies in order to be occupied. The direction of the Bank of England has, for many generations, been composed of such men.

Such a government for a joint stock company is very good if its essential nature be attended to, and very bad if that nature be not attended to. That government is composed of men with a high average of general good sense, with an excellent knowledge of business in general, but without any special knowledge of the particular business in which they are engaged. Ordinarily, in joint stock banks and companies this deficiency is cured by the selection of a manager of the company, who has been specially trained to that particular trade, and who engages to devote all his experience and all his ability to the affairs of the company. The directors, and often a select committee of them more especially, consult with the manager, and after hearing what he has to say, decide on the affairs of the company. There is in all ordinary joint stock companies a fixed executive specially skilled, and a somewhat varying council not specially skilled. The fixed manager ensures continuity and experience in the management, and a good board of directors ensures general wisdom.

But in the Bank of England there is no fixed executive. The Governor and Deputy-Governor, who form that executive, change every two years. I believe, indeed, that such was not the original intention of the founders. In the old days of few and great privileged companies, the chairman, though periodically elected, was practically permanent so long as his policy was popular. He was the head of the ministry, and ordinarily did not change unless the opposition came in. But this idea has no present relation to the const.i.tution of the Bank of England. At present, the Governor and Deputy-Governor almost always change at the end of two years; the case of any longer occupation of the chair is so very rare, that it need not be taken account of. And the Governor and Deputy-Governor of the Bank cannot well be shadows. They are expected to be constantly present; to see all applicants for advances out of the ordinary routine; to carry on the almost continuous correspondence between the Bank and its largest customer--the Government; to bring all necessary matters before the board of directors or the Committee of Treasury, in a word, to do very much of what falls to the lot of the manager in most companies. Under this s.h.i.+fting chief executive, there are indeed very valuable heads of departments. The head of the Discount Department is especially required to be a man of ability and experience. But these officers are essentially subordinate; no one of them is like the general manager of an ordinary bank--the head of all action. The perpetually present executive--the Governor and Deputy-Governor--make it impossible that any subordinate should have that position. A really able and active-minded Governor, being required to sit all day in the bank, in fact does, and can hardly help doing, its princ.i.p.al business.

In theory, nothing can be worse than this government for a bank a s.h.i.+fting executive; a board of directors chosen too young for it to be known whether they are able; a committee of management, in which seniority is the necessary qualification, and old age the common result; and no trained bankers anywhere.

Even if the Bank of England were an ordinary bank, such a const.i.tution would be insufficient; but its inadequacy is greater, and the consequences of that inadequacy far worse, because of its greater functions. The Bank of England has to keep the sole banking reserve of the country; has to keep it through all changes of the money market, and all turns of the Exchanges; has to decide on the instant in a panic what sort of advances should be made, to what amounts, and for what dates; and yet it has a const.i.tution plainly defective. So far the government of the Bank of England being better than that of any other bank--as it ought to be, considering that its functions are much harder and graver--any one would be laughed at who proposed it as a model for the government of a new bank; and that government, if it were so proposed, would on all hands be called old-fas.h.i.+oned, and curious.