The easiest mode of explaining anything is, usually, to exemplify it by a single actual case. And in this subject, fortunately, there is a most conspicuous case near at hand. The German Government has lately taken large sums in bullion from this country, in part from the Bank of England, and in part not, according as it chose. It was in the main well advised, and considerate in its action; and did not take nearly as much from the Bank as it might, or as would have been dangerous. Still it took large sums from the Bank; and it might easily have taken more. How then did the German Government obtain this vast power over the Bank? The answer is, that it obtained it by means of the bankers' balances, and that it did so in two ways.

First, the German Government had a large balance of its own lying at a particular Joint Stock Bank. That bank lent this balance at its own discretion, to bill-brokers or others, and it formed a single item in the general funds of the London market. There was nothing special about it, except that it belonged to a foreign government, and that its owner was always likely to call it in, and sometimes did so. As long as it stayed unlent in the London Joint Stock Bank, it increased the balances of that bank at the Bank of England; but so soon as it was lent, say, to a bill-broker, it increased the bill-broker's balance; and as soon as it was employed by the bill-broker in the discount of bills, the owners of those bills paid it to their credit at their separate banks, and it augmented the balances of those bankers at the Bank of England. Of course if it were employed in the discount of bills belonging to foreigners, the money might be taken abroad, and by similar operations it might also be transferred to the English provinces or to Scotland. But, as a rule, such money when deposited in London, for a considerable time remains in London; and so long as it does so, it swells the aggregate balances of the body of bankers at the Bank of England. It is now in the balance of one bank, now of another, but it is always dispersed about those balances somewhere. The evident consequence is that this part of the bankers' balances is at the mercy of the German Government when it chooses to apply for it. Supposing, then, the sum to be three or four millions and I believe that on more than one occasion in the last year or two it has been quite as much, if not more--that sum might at once be withdrawn from the Bank of England. In this case the Bank of England is in the position of a banker who is liable for a large amount to a single customer, but with this addition, that it is liable for an unknown amount. The German Government, as is well known, keeps its account (and a very valuable one it must be) at the London Joint Stock Bank; but the Bank of England has no access to the account of the German Government at that bank; they cannot tell how much German money is lying to the credit there. Nor can the Bank of England infer much from the balance of the London Joint Stock Bank in their Bank, for the German money was probably paid in various sums to that bank, and lent out again in other various sums. It might to some extent augment that bank's balance at the Bank of England, or it might not, but it certainly would not be so much added to that balance; and inspection of that bank's balance would not enable the Bank of England to determine even in the vaguest manner what the entire sum was for which it might be asked at any moment. Nor would the inspection of the bankers' balances as a whole lead to any certain and sure conclusions. Something might be inferred from them, but not anything certain. Those balances are no doubt in a state of constant fluctuation; and very possibly during the time that the German money was coming in some other might be going out. Any sudden increase in the bankers' balances would be a probable indication of new foreign money, but new foreign money might come in without causing an increase, since some other and contemporaneous cause might effect a counteracting decrease.

This is the first, and the plainest way in which the German Government could take, and did take, money from this country; and in which it might have broken the Bank of England if it had liked. The German Government had money here and took it away, which is very easy to understand. But the Government also possessed a far greater power, of a somewhat more complex kind. It was the owner of many debts from England. A large part of the 'indemnity' was paid by France to Germany in bills on England, and the German Government, as those bills became due, acquired an unprecedented command over the market. As each bill arrived at maturity, the German Government could, if it chose, take the proceeds abroad; and it could do so in bullion, as for coinage purposes it wanted bullion. This would at first naturally cause a reduction in the bankers' balances; at least that would be its tendency. Supposing the German Government to hold bill A, a good bill, the banker at whose bank bill A was payable would have to pay it; and that would reduce his balance; and as the sum so paid would go to Germany, it would not appear to the credit of any other banker: the aggregate of the bankers' balances would thus be reduced. But this reduction would not be permanent. A banker who has to pay 100,000 L. cannot afford to reduce his balance at the Bank of England 100,000 L.; suppose that his liabilities are 2,000,000 L., and that as a rule he finds it necessary to keep at the Bank one-tenth of these liabilities, or 200,000 L., the payment of 100,000 L. would reduce his reserve to 100,000 L.; but his liabilities would be still 1,900,000 L. and therefore to keep up his tenth he would have 90,000 L. to find. His process for finding it is this: he calls in, say, a loan to the bill-brokers; and if no equal additional money is contemporaneously carried to these brokers (which in the case of a large withdrawal of foreign money is not probable), they must reduce their business and discount less. But the effect of this is to throw additional business on the Bank of England. They hold the ultimate reserve of the country, and they must discount out of it if no one else will: if they declined to do so there would be panic and collapse. As soon, therefore, as the withdrawal of the German money reduces the bankers' balances, there is a new demand on the Bank for fresh discounts to make up those balances. The drain on the Bank is twofold: first, the banking reserve is reduced by exportation of the German money, which reduces the means of the Bank of England; and then out of those reduced means the Bank of England has to make greater advances.

The same result may be arrived at more easily. Supposing any foreign Government or person to have any sort of securities which he can pledge in the market, that operation gives it, or him, a credit on some banker, and enables it, or him, to take money from the banking reserve at the Bank of England, and from the bankers' balances; and to replace the bankers' balances at their inevitable minimum, the Bank of England must lend. Every sudden demand on the country causes, in proportion to its magnitude, this peculiar effect. And this is the reason why the Bank of England ought, I think, to deal most cautiously and delicately with their banking deposits. They are the symbol of an indefinite liability: by means of them, as we see, an amount of money so great that it is impossible to a.s.sign a limit to it might be abstracted from the Bank of England. As the Bank of England lends money to keep up the bankers' balances, at their usual amount, and as by means of that usual amount whatever sum foreigners can get credit for may be taken from us, it is not possible to a.s.sign a superior limit (to use the scientific word) to the demands which by means of the bankers' balances may be made upon the Bank of England.

The result comes round to the simple point, on which this book is a commentary: the Bank of England, by the effect of a long history, holds the ultimate cash reserve of the country; whatever cash the country has to pay comes out of that reserve, and therefore the Bank of England has to pay it. And it is as the Bankers' Bank that the Bank of England has to pay it, for it is by being so that it becomes the keeper of the final cash reserve.

Some persons have been so much impressed with such considerations as these, that they have contended that the Bank of England ought never to lend the 'bankers' balances' at all, that they ought to keep them intact, and as an unused deposit. I am not sure, indeed, that I have seen that extreme form of the opinion in print, but I have often heard it in Lombard Street, from persons very influential and very qualified to judge; even in print I have seen close approximations to it. But I am satisfied that the laying down such a 'hard and fast' rule would be very dangerous; in very important and very changeable business rigid rules are apt to be often dangerous. In a panic, as has been said, the bankers' balances greatly augment. It is true the Bank of England has to lend the money by which they are filled. The banker calls in his money from the bill-broker, ceases to re-discount for that broker, or borrows on securities, or sells securities; and in one or other of these ways he causes a new demand for money which can only at such times be met from the Bank of England. Every one else is in want too. But without inquiring into the origin of the increase at panics, the amount of the bankers'

deposits in fact increases very rapidly; an immense amount of unused money is at such moments often poured by them into the Bank of England. And nothing can more surely aggravate the panic than to forbid the Bank of England to lend that money. Just when money is most scarce you happen to have an unusually large fund of this particular species of money, and you should lend it as fast as you can at such moments, for it is ready lending which cures panics, and non-lending or n.i.g.g.ardly lending which aggravates them.

At other times, particularly at the quarterly payment of the dividends, an absolute rule which laid down that the bankers'

balances were never to be lent, would be productive of great inconvenience. A large sum is just then paid from the Government balance to the bankers' balances, and if you permitted the Bank to lend it while it was still in the hands of the Government, but forbad them to lend it when it came into the hands of the bankers, a great tilt upwards in the value of money would be the consequence, for a most important amount of it would suddenly have become ineffective.

But the idea that the bankers' balances ought never to be lent is only a natural aggravation of the truth that these balances ought to be used with extreme caution; that as they entail a liability peculiarly great and singularly difficult to foresee, they ought never to be used like a common deposit.

It follows from what has been said that there are always possible and very heavy demands on the Bank of England which are not shown in the account of the Banking department at all: these demands may be greatest when the liabilities shown by that account are smallest, and lowest when those liabilities are largest. If, for example, the German Government brings bills or other good securities to this market, obtains money with them, and removes that money from the market in bullion, that money may, if the German Government choose, be taken wholly from the Bank of England. If the wants of the German Government be urgent, and if the amount of gold 'arrivals,' that is, the gold coming here from the mining countries, be but small, that gold will be taken from the Bank of England, for there is no other large store in the country. The German Government is only a conspicuous example of a foreign power which happens lately to have had an unusual command of good securities, and an unusually continuous wish to use them in England. Any foreign state hereafter which wants cash will be likely to come here for it; so long as the Bank of France should continue not to pay in specie, a foreign state which wants it must of necessity come to London for it.

And no indication of the likelihood or unlikelihood of that want can be found in the books of the Bank of England.

What is almost a revolution in the policy of the Bank of England necessarily follows: no certain or fixed proportion of its liabilities can in the present times be laid down as that which the Bank ought to keep in reserve. The old notion that one-third, or any other such fraction, is in all cases enough, must be abandoned. The probable demands upon the Bank are so various in amount, and so little disclosed by the figures of the account, that no simple and easy calculation is a sufficient guide. A definite proportion of the liabilities might often be too small for the reserve, and sometimes too great. The forces of the enemy being variable, those of the defence cannot always be the same.

I admit that this conclusion is very inconvenient. In past times it has been a great aid to the Bank and to the public to be able to decide on the proper policy of the Bank from a mere inspection of its account. In that way the Bank knew easily what to do and the public knew easily what to foresee. But, unhappily, the rule which is most simple is not always the rule which is most to be relied upon. The practical difficulties of life often cannot be met by very simple rules; those dangers being complex and many, the rules for encountering them cannot well be single or simple. A uniform remedy for many diseases often ends by killing the patient.

Another simple rule often laid down for the management of the Bank of England must now be abandoned also. It has been said that the Bank of England should look to the market rate, and make its own rate conform to that. This rule was, indeed, always erroneous. The first duty of the Bank of England was to protect the ultimate cash of the country, and to raise the rate of interest so as to protect it. But this rule was never so erroneous as now, because the number of sudden demands upon that reserve was never formerly so great. The market rate of Lombard Street is not influenced by those demands.

That rate is determined by the amount of deposits in the hands of bill-brokers and bankers, and the amount of good bills and acceptable securities offered at the moment. The probable efflux of bullion from the Bank scarcely affects it at all; even the real efflux affects it but little; if the open market did not believe that the Bank rate would be altered in consequence of such effluxes the market rate would not rise. If the Bank choose to let its bullion go unheeded, and is seen to be going so to choose, the value of money in Lombard Street will remain unaltered. The more numerous the demands on the Bank for bullion, and the more variable their magnitude, the more dangerous is the rule that the Bank rate of discount should conform to the market rate. In former quiet times the influence, or the partial influence, of that rule has often produced grave disasters. In the present difficult times an adherence to it is a recipe for making a large number of panics.

A more distinct view of abstract principle must be taken before we can fix on the amount of the reserve which the Bank of England ought to keep. Why should a bank keep any reserve? Because it may be called on to pay certain liabilities at once and in a moment. Why does any bank publish an account? In order to satisfy the public that it possesses cash--or available securities--enough to meet its liabilities. The object of publishing the account of the banking department of the Bank of England is to let the nation see how the national reserve of cash stands, to a.s.sure the public that there is enough and more than enough to meet not only all probable calls, but all calls of which there can be a chance of reasonable apprehension.

And there is no doubt that the publication of the Bank account gives more stability to the money market than any other kind of precaution would give. Some persons, indeed, feared that the opposite result would happen; they feared that the constant publication of the incessant changes in the reserve would terrify and hara.s.s the public mind. An old banker once told me: 'Sir, I was on Lord Althorp's committee which decided on the publication of the Bank account, and I voted against it. I thought it would frighten people. But I am bound to own that the committee was right and I was wrong, for that publication has given the money market a greater sense of security than anything else which has happened in my time.' The diffusion of confidence through Lombard Street and the world is the object of the publication of the Bank accounts and of the Bank reserve.

But that object is not attained if the amount of that reserve when so published is not enough to tranquillise people. A panic is sure to be caused if that reserve is, from whatever cause, exceedingly low. At every moment there is a certain minimum which I will call the apprehension minimum,' below which the reserve cannot fall without great risk of diffused fear; and by this I do not mean absolute panic, but only a vague fright and timorousness which spreads itself instantly, and as if by magic, over the public mind.

Such seasons of incipient alarm are exceedingly dangerous, because they beget the calamities they dread. What is most feared at such moments of susceptibility is the destruction of credit; and if any grave failure or bad event happens at such moments, the public fancy seizes on it, there is a general run, and credit is suspended. The Bank reserve then never ought to be diminished below the 'apprehension point.' And this is as much as to say, that it never ought very closely to approach that point; since, if it gets very near, some accident may easily bring it down to that point and cause the evil that is feared.

There is no 'royal road' to the amount of the 'apprehension minimum': no abstract argument, and no mathematical computation will teach it to us. And we cannot expect that they should. Credit is an opinion generated by circ.u.mstances and varying with those circ.u.mstances. The state of credit at any particular time is a matter of fact only to be ascertained like other matters of fact; it can only be known by trial and inquiry. And in the same way, nothing but experience can tell us what amount of 'reserve' will create a diffused confidence; on such a subject there is no way of arriving at a just conclusion except by incessantly watching the public mind, and seeing at each juncture how it is affected.

Of course in such a matter the cardinal rule to be observed is, that errors of excess are innocuous but errors of defect are destructive.

Too much reserve only means a small loss of profit, but too small a reserve may mean 'ruin.' Credit may be at once shaken, and if some terrifying accident happen to supervene, there may be a run on the Banking department that may be too much for it, as in 1857 and 1866, and may make it unable to pay its way without a.s.sistance--as it was m those years.

And the observance of this maxim is the more necessary because the 'apprehension minimum' is not always the same. On the contrary, in times when the public has recently seen the Bank of England exposed to remarkable demands, it is likely to expect that such demands may come again. Conspicuous and recent events educate it, so to speak; it expects that much will be demanded when much has of late often been demanded, and that little will be so, when in general but little has been so. A bank like the Bank of England must always, therefore, be on the watch for a rise, if I may so express it, in the apprehension minimum; it must provide an adequate fund not only to allay the misgivings of to-day, but also to allay what may be the still greater misgivings of to-morrow. And the only practical mode of obtaining this object is--to keep the actual reserve always in advance of the minimum 'apprehension' reserve.

And this involves something much more. As the actual reserve is never to be less, and is always, if possible, to exceed by a reasonable amount the 'minimum' apprehension reserve, it must when the Bank is quiet and taking no precautions very considerably exceed that minimum. All the precautions of the Bank take time to operate.

The princ.i.p.al precaution is a rise in the rate of discount, and such a rise certainly does attract money from the Continent and from all the world much faster than could have been antic.i.p.ated. But it does not act instantaneously; even the right rate, the ultimately attractive rate, requires an interval for its action, and before the money can come here. And the right rate is often not discovered for some time. It requires several 'moves,' as the phrase goes, several augmentations of the rate of discount by the Bank, before the really effectual rate is reached, and in the mean time bullion is ebbing away and the 'reserve' is diminishing. Unless, therefore, in times without precaution the actual reserve exceed the 'apprehension minimum' by at least the amount which may be taken away in the inevitable interval, and before the available precautions begin to operate, the rule prescribed will be infringed, and the actual reserve will be less than the 'apprehension' minimum. In time the precautions taken may attract gold and raise the reserve to the needful amount, but in the interim the evils may happen against which the rule was devised, diffused apprehension may arise, and then any unlucky accident may cause many calamities.

I may be asked, 'What does all this reasoning in practice come to?

At the present moment how much reserve do you say the Bank of England should keep? state your recommendation clearly (I know it will be said) if you wish to have it attended to.' And I will answer the question plainly, though in so doing there is a great risk that the principles I advocate may be in some degree injured through some mistake I may make in applying them.

I should say that at the present time the mind of the monetary world would become feverish and fearful if the reserve in the Banking department of the Bank of England went below 10,000,000 L. Estimated by the idea of old times, by the idea even of ten years ago, that sum, I know, sounds extremely large. My own nerves were educated to smaller figures, because I was trained in times when the demands on us were less, when neither was so much reserve wanted nor did the public expect so much. But I judge from such observations as I can make of the present state of men's minds, that in fact, and whether justifiably or not, the important and intelligent part of the public which watches the Bank reserve becomes anxious and dissatisfied if that reserve falls below 10,000,000 L. That sum, therefore, I call the 'apprehension minimum' for the present times. Circ.u.mstances may change and may make it less or more, but according to the most careful estimate I can make, that is what I should call it now.

It will be said that this estimate is arbitrary and these figures are conjectures. I reply that I only submit them for the judgment of others. The main question is one of fact--Does not the public mind begin to be anxious and timorous just where I have placed the apprehension point? and the deductions from that are comparatively simple questions of mixed fact and reasoning. The final appeal in such cases necessarily is to those who are conversant with and who closely watch the facts.

I shall perhaps be told also that a body like the Court of the Directors of the Bank of England cannot act on estimates like these: that such a body must have a plain rule and keep to it. I say in reply, that if the correct framing of such estimates is necessary for the good guidance of the Bank, we must make a governing body which can correctly frame such estimates. We must not suffer from a dangerous policy because we have inherited an imperfect form of administration. I have before explained in what manner the government of the Bank of England should, I consider, be strengthened, and that government so strengthened would, I believe, be altogether competent to a wise policy.

Then I should say, putting the foregoing reasoning into figures, that the Bank ought never to keep less than 11,000,000 L.. or 11,500,000 L. since experience shows that a million, or a million and a half, may be taken from us at any time. I should regard this as the practical minimum at which, roughly of course, the Bank should aim, and which it should try never to be below. And, in order not to be below 11,500,000 L., the Bank must begin to take precautions when the reserve is between 14,000,000 L. and 15,000,000 l.; for experience shows that between 2,000,000 L. and 3,000,000 L.

may, probably enough, be withdrawn from the Bank store before the right rate of interest is found which will attract money from abroad, and before that rate has had time to attract it. When the reserve is between 14,000,000 L. and 15,000,000 L., and when it begins to be diminished by foreign demand, the Bank of England should, I think, begin to act, and to raise the rate of interest.

CHAPTER XIII.

Conclusion.

I know it will be said that in this work I have pointed out a deep malady, and only suggested a superficial remedy. I have tediously insisted that the natural system of banking is that of many banks keeping their own cash reserve, with the penalty of failure before them if they neglect it. I have shown that our system is that of a single bank keeping the whole reserve under no effectual penalty of failure. And yet I propose to retain that system, and only attempt to mend and palliate it.

I can only reply that I propose to retain this system because I am quite sure that it is of no manner of use proposing to alter it. A system of credit which has slowly grown up as years went on, which has suited itself to the course of business, which has forced itself on the habits of men, will not be altered because theorists disapprove of it, or because books are written against it. You might as well, or better, try to alter the English monarchy and subst.i.tute a republic, as to alter the present const.i.tution of the English money market, founded on the Bank of England, and subst.i.tute for it a system in which each bank shall keep its own reserve. There is no force to be found adequate to so vast a reconstruction, and so vast a destructions and therefore it is useless proposing them.

No one who has not long considered the subject can have a notion how much this dependence on the Bank of England is fixed in our national habits. I have given so many ill.u.s.trations in this book that I fear I must have exhausted my reader's patience, but I will risk giving another. I suppose almost everyone thinks that our system of savings' banks is sound and good. Almost everyone would be surprised to hear that there is any possible objection to it. Yet see what it amounts to. By the last return the savings' banks--the old and the Post Office together--contain about 60,000,000 L. of deposits, and against this they hold in the funds securities of the best kind. But they hold no cash whatever. They have of course the petty cash about the various branches necessary for daily work. But of cash in ultimate reserve--cash in reserve against a panic--the savings' banks have not a sixpence. These banks depend on being able in a panic to realise their securities. But it has been shown over and over again, that in a panic such securities can only be realised by the help of the Bank of England--that it is only the Bank with the ultimate cash reserve which has at such moments any new money, or any power to lend and act. If in a general panic there were a run on the savings'

banks, those banks could not sell 100,000 L. of Consols without the help of the Bank of England; not holding themselves a cash reserve for times of panic, they are entirely dependent on the one Bank which does hold that reserve.

This is only a single additional instance beyond the innumerable ones given, which shows how deeply our system of banking is fixed in our ways of thinking. The Government keeps the money of the poor upon it, and the nation fully approves of their doing so. No one hears a syllable of objection. And every practical man--every man who knows the scene of action--will agree that our system of banking, based on a single reserve in the Bank of England, cannot be altered, or a system of many banks, each keeping its own reserve, be subst.i.tuted for it. Nothing but a revolution would effect it, and there is nothing to cause a revolution.

This being so, there is nothing for it but to make the best of our banking system, and to work it in the best way that it is capable of. We can only use palliatives, and the point is to get the best palliative we can. I have endeavoured to show why it seems to me that the palliatives which I have suggested are the best that are at our disposal.

I have explained why the French plan will not suit our English world. The direct appointment of the Governor and Deputy-Governor of the Bank of England by the executive Government would not lessen our evils or help our difficulties. I fear it would rather make both worse. But possibly it may be suggested that I ought to explain why the American system, or some modification, would not or might not be suitable to us. The American law says that each national bank shall have a fixed proportion of cash to its liabilities (there are two cla.s.ses of banks, and two different proportions; but that is not to the present purpose), and it ascertains by inspectors, who inspect at their own times, whether the required amount of cash is in the bank or not. It may be asked, could nothing like this be attempted in England? could not it, or some modification, help us out of our difficulties? As far as the American banking system is one of many reserves, I have said why I think it is of no use considering whether we should adopt it or not. We cannot adopt it if we would.

The one-reserve system is fixed upon us. The only practical imitation of the American system would be to enact that the Banking department of the Bank of England should always keep a fixed proportion--say one-third of its liabilities--in reserve. But, as we have seen before, a fixed proportion of the liabilities, even when that proportion is voluntarily chosen by the directors, and not imposed by law, is not the proper standard for a bank reserve.

Liabilities may be imminent or distant, and a fixed rule which imposes the same reserve for both will sometimes err by excess, and sometimes by defect. It will waste profits by over-provision against ordinary danger, and yet it may not always save the bank; for this provision is often likely enough to be insufficient against rare and unusual dangers. But bad as is this system when voluntarily chosen, it becomes far worse when legally and compulsorily imposed. In a sensitive state of the English money market the near approach to the legal limit of reserve would be a sure incentive to panic; if one-third were fixed by law, the moment the banks were close to one-third, alarm would begin, and would run like magic. And the fear would be worse because it would not be unfounded--at least, not wholly. If you say that the Bank shall always hold one-third of its liabilities as a reserve, you say in fact that this one-third shall always be useless, for out of it the Bank cannot make advances, cannot give extra help, cannot do what we have seen the holders of the ultimate reserve ought to do and must do. There is no help for us in the American system; its very essence and principle are faulty.

We must therefore, I think, have recourse to feeble and humble palliatives such as I have suggested. With good sense, good judgment, and good care, I have no doubt that they may be enough.

But I have written in vain if I require to say now that the problem is delicate, that the solution is varying and difficult, and that the result is inestimable to us all.

APPENDIX.

Note A.

Liabilities and Cash Reserve of the Chief Banking Systems.

The following is a comparison of the liabilities to the public, and of the cash reserve, of the banking systems of the United Kingdom, France, Germany, and the United States. For the United Kingdom the figures are the most defective, as they only include the deposits of the Bank of England, and of the London joint stock banks, and the banking reserve of the Bank of England, which is the only cash available against these liabilities is also the only cash reserve against the similar liabilities of the London private banks, the provincial English banks, and the Scotch and Irish banks. In the case of England, therefore, the method of comparison exhibits a larger proportion of cash to liabilities than what really exists.

(1) ENGLISH BANKING.

Liabilities.

Deposits of Bank of England, less estimated Joint Stock Bank balances, at December 31, 1872 L 29,000,000 Deposits of London Joint Stock Banks at December 31 1872 (see 'Economist,' February 8, 1873) L 91,000,000 ------------ Total liabilities L 120,000,000 ============= Reserve of Cash Banking Reserve in Bank of England. L 13,500,000 =============

Making proportion of cash reserve to liabilities to the public about 11'2 per cent.