Currency Policy during the War--Its Disastrous Mediaevalism--The
Report of the Cunliffe Committee--A Blast of Common Sense--The
Condemnation of our War Finance--Inflation and the Rise in Prices--The
Figures of the Present Position--The Break in the Old Relation between
Legal Tender and Gold--How to restore it--Stop Borrowing and reduce
the Floating Debt--Return to the Old System--The Committee's Sane
Conservatism--A Sound Currency vital to National Recovery.
Among the many features of the late war (how comfortable it is to talk
about the "late war"!) that seem likely to astonish the historian
of the future, perhaps the thing that will surprise him most is the
behaviour of the warring Governments in currency matters. It is
surely, a most extraordinary thing after all that has been thought,
said and written about monetary policy since money was invented that
as soon as a great economic effort was necessary on the part of the
leading civilised Powers, they should all have fallen back on the old
mediaeval dodge of depreciating the currency, varied to suit modern
needs, in order to pay part of their war bill, and should have
continued this policy throughout the course of the war, in spite of
the obvious results that it was producing in the shape of unrest,
suspicion and bitterness on the part of the working classes, who very
naturally thought that the consequent rise in prices was due to the
machinations of unscrupulous capitalists who were exploiting them. It
is even possible that the historian of a century hence may ascribe to
this cause the beginning of the end of our present economic system,
based on the private ownership of capital, for it is very evident that
we have not yet seen the end of the harvest that this bitterness and
discontent are producing.
A less important but still very objectionable consequence of the flood
of currency and credit that the Government has poured out to fill a
gap in its war finance is the encouragement that it has given to a
host of monetary quacks who believe that all the financial ills of
the world can be saved if only you give it enough money to handle,
oblivious of the effect on prices of mere multiplication of claims to
goods without a corresponding increase in the volume of goods. These
enthusiasts have seen that during war a Government can produce money
as fast as it likes, and since they think that producing money makes
every one happy they propose to adopt this simple method for paying
off war debt, restarting trade and generally creating a monetary
millennium. How far their nostrums are likely to be adopted, no
one can yet say, but some of the utterances of our rulers make one
shudder.
Into this atmosphere of quackery and delusion the report of the
Committee on Currency and Foreign Exchanges breathes a refreshing
blast of sound common sense. Everybody ought to read it. It costs but
twopence; it is only a dozen pages long, and it is described (if you
want to order it) as Cd. 9182. In view of the many attacks that have
been made on our banking system--especially the Bank Act of 1844--by
Chambers of Commerce and others before the war, it is rather
surprising that so little criticism should have been heard of this
Report, which practically advocates a return, as rapidly as possible,
to the practice and principles imposed by that Act. It may be that
peace, and all the preoccupations that have followed it, have absorbed
men's minds so entirely that questions of currency seem to be an
untimely irrelevance; or possibly the very heavy weight of the
Committee's authority may have silenced the opposition to its
recommendations. Presided over by Lord Cunliffe, the late Governor of
the Bank, and including Sir John Bradbury and Professor Pigou and an
imposing list of notable bankers, it was a body whose opinion
could only be challenged by critics gifted with the most serene
self-confidence.
One of the most interesting--especially to advocates of sound
finance--points in its Report is the implied condemnation that it
pronounces on the methods by which the war has been financed by our
rulers. It points out that "the need of the Government for funds
wherewith to finance the war in excess of the amounts raised by
taxation or by loans from the public has made necessary the creation
of credits in their favour with the Bank of England.... The balances
created by these operations passing by means of payments to
contractors and others to the Joint Stock banks have formed the
foundation of a great growth in their deposits, which have also
been swelled by the creation of credits in connection with the
subscriptions to the various War Loans.... The greatly increased
volume of bank deposits, representing a corresponding increase of
purchasing power and, therefore, tending in conjunction with other
causes to a great rise of prices, has brought about a corresponding
demand for legal tender currency which could not have been satisfied
under the stringent provisions of the Act of 1844." Here we have the
story of bad war finance put as clearly as it can be. Because the
Government was not able to raise all the money needed for the war on
sound lines--that is, by taxation and loans to it of money saved by
investors--it had recourse to credits raised for it by the Bank of
England and the other banks against Treasury Bills, Ways and Means
Advances, War Loans, War Bonds, and loans to customers who were taking
up War Loans, etc. Thereby as these credits created fresh deposits
there was a huge increase in the community's purchasing power; and
since the supply of goods to be purchased was stationary or reduced,
the only result was a great increase in prices which made the war,
perhaps, nearly twice as costly as it need have been and produced
all the suspicion and unrest that has already been referred to.
Considering that the Committee included an ex-Governor of the Bank
and the Permanent Secretary to the Treasury it could hardly have been
expected to use much plainer language concerning the failure of our
rulers to get money out of us in the right way for the war and
the vigour with which they made use of the demoralising weapon of
inflation.
It followed as a necessary consequence that the volume of legal tender
currency had to be greatly increased. As prices rose wages rose
with them, and so much more "cash" was needed in order to pay for a
turnover of goods which, fairly constant in volume, demanded more
currency because of their inflated prices. As the Committee says in
its Report (page 5): "Given the necessity for the creation of bank
credits in favour of the Government for the purpose of financing war
expenditure, these issues could not be avoided. If they had not been
made, the banks would have been unable to obtain legal tender with
which to meet cheques drawn for cash on their customers' accounts. The
unlimited issue of currency notes in exchange for credits at the Bank
of England is at once a consequence and an essential condition of the
methods which the Government have found necessary to adopt in order to
meet their war expenditure."
The effect of these causes upon the amount of legal tender currency
(other than subsidiary coin) in the banks and in circulation is
summarised by the Committee in the following table:--
"The amounts on June 30, 1914, may be estimated as follows:--
"Fiduciary Issue of the Bank of England £18,450,000
"Bank of England Notes issued against
gold coin or bullion 38,476,000
"Estimated amount of gold coin held
by Banks (excluding gold coin held
in the Issue Department of the
Bank of England) and in public
circulation 123,000,000
___________
"Grand total £179,926,000
___________
"The corresponding figures on July 10, 1918, as nearly as they can be
estimated, were:--
"Fiduciary Issue of the Bank of England 18,450,000
Currency Notes not covered by gold 230,412,000
___________
"Total Fiduciary Issues [1] £248,862,000
Bank of England Notes issued against
coin and bullion 65,368,000
Currency Notes covered by gold 28,500,000
Estimated amount of gold coin held
by Banks (excluding gold coin held
by Issue Department of Bank of
England), say 40,000,000
___________
"Grand total £382,730,000
"[Footnote 1: The notes issued by Scottish and Irish banks which have
been made legal tender during the war have not been included in the
foregoing figures. Strictly the amount (about £5,000,000) by which
these issues exceed the amount of gold and currency notes held by
those banks should be added to the figures of the present fiduciary
issues given above.]
"There is also a certain amount of gold coin still in the hands of the
public which ought to be added to the last-mentioned figure, but the
amount is unknown."
It will be noted that the gold held by the banks (other than the Bank
of England) and by the public has declined from £123 to £40 millions,
according to the Committee's estimate, while, on the other hand, the
circulation of bank notes has risen by £27 millions and the issue of
currency notes has taken place to the tune of £259 millions (at the
date of the Report; it is now nearly £300 millions), making a net
addition to legal tender currency of over £200 millions. When we
also remember that there has been a very heavy coinage of silver and
copper, that the Bank of England's deposits have risen by over £100
millions and the deposits of the other banks by nearly £700 millions,
and all this at a time when most of the industrial activity of the
country was going into the production of destructive weapons and the
support of those who were using them, the behaviour of commodities of
ordinary use in rising by nearly 100 per cent. seems to be an example
of remarkable moderation. With all this new buying power in the hands
of the community there is little wonder that some people should
think that we have enormously increased our wealth during this most
destructive and costly war, and should then feel hurt and disappointed
when they find that this new buying power is robbed of all its
beauty by the fact that its efficiency as buying power is seriously
diminished by its mere quantity.
Such being the state of affairs--a great mass of new credit and
currency based on securities--it is clear that our currency has been
deprived for the time being of that direct relation with its gold
basis that used in former time to regulate its volume according to
world prices and our international trade position. As the Committee
says, "It is not possible to judge to what extent legal tender
currency may in fact be depreciated in terms of bullion. But it is
practically certain that there has been some depreciation, and to this
extent therefore the gold standard has ceased to be effective." Very
well, then, what has to be done to get back to the old state of things
under which there was a more or less automatic check on the creation
of credit and the issue of currency? This check worked by a system
which was elastic and simple. It was not entirely automatic, because
its working had to be controlled by the Bank of England, which, by the
action of its discount rate, could, more or less, quicken or check the
working of the machine. Legal tender currency could only be increased
by imports of gold; and exports of gold reduced the available amount
of legal tender currency; and since a stock of legal tender currency
was essential to meet the demands upon them that bankers made
possible by creating credits, there was thus an Indirect and variable
connection between the country's gold stock and the extent to which
bankers would think it prudent to multiply credits. If credits were
multiplied too fast, our currency was depreciated in value as compared
with those of other countries and the exchanges went against us and
gold either was exported or began to look as if it might be exported.
If it was exported the legal tender basis of credit was reduced and
the creation of credit was checked. If the Directors of the Bank of
England thought it inadvisable that gold should be exported they
could, by raising the rate of discount and taking artificial measures
to control the supply of credit, produce, without the actual loss of
gold, the effects which that loss would have brought about.
The keystone of the system was the rigid link between legal tender
currency and gold. This was secured by the provisions of the Bank Act
of 1844, which laid down that above a certain line--which was before
the war roughly £18-1/2 millions--every Bank of England note issued
should have gold behind it, pound for pound. In other words, the Bank
of England note was, for practical purposes, a bullion certificate.
The legal limit on the fiduciary issue (that is, the issue of £18-1/2
millions against securities, not gold) could only be exceeded by a
breach of the law. The many critics of our banking system seized on
this hard-and-fast restriction and accused it of making our system
inelastic as compared with the German arrangement, under which the
legal limit could at any time be exceeded on payment of a tax or fine
on any excess perpetrated. These critics might have been right if
legal tender currency had been the only, or even the predominant,
means of payment in England. But, as every office boy knows, it was
not. Legal tender--gold and Bank of England notes--was hardly ever
seen in commercial and financial transactions on a serious scale. We
paid, sometimes, our retail purchases of goods and services in gold;
and Bank notes were a popular mode of payment on racecourses and in
other places where transactions took place between people who were not
very certain of one another's standing or good faith. But the great
bulk of payments was made in the cheque currency which our bankers had
developed outside of the law and could create as fast as prudence--and
an eye to the supply of legal tender which every holder of a cheque
had a right to demand--allowed them to do so. While cheques provided
the currency of commerce, another form of "money" was produced, again
without any restriction by the Act, by the pleasant convention which
caused a credit in the Bank of England's books to be regarded as
"cash" for balance-sheet purposes by the banks. These advantages
gave the English system a freedom and elasticity, in spite of the
strictness of the law that regulated the issue of paper currency, that
enabled it to work in a manner that, judged by the test of practical
results, had one great advantage over that of any of the rival
centres. It alone in days before the war fulfilled the functions of an
international banker by being ready at all times and without question
to pay out the gold that was, in the last resort, the final means of
settling international balances.
It is the object of Lord Cunliffe's Committee to restore as quickly
as possible the system which, has thus been tried by the test of
experience, "After the war," they say in their Report, "our gold
holdings will no longer be protected by the submarine danger, and it
will not be possible indefinitely to continue to support the exchanges
with foreign countries by borrowing abroad. Unless the machinery which
long experience has shown to be the only effective remedy for an
adverse balance of trade and an undue growth of credit is once
more brought into play there will be very grave danger of a credit
expansion in this country and a foreign drain of gold which might
jeopardise the convertibility of our note issues and the international
trade position of the country.... We are glad to find that there was
no difference of opinion among the witnesses who appeared before us as
to the vital importance of these matters." The first measure that they
put forward as essential to this end is the cessation at the earliest
possible moment of Government borrowings. "A large part of the credit
expansion arises, as we have shown, from the fact that the expenditure
of the Government during the war has exceeded the amounts which they
have been able to raise by taxation or by loans from the actual
savings of the people. They have been obliged therefore to obtain
money through the creation of credits by the Bank of England and the
Joint Stock banks, with the result that the growth of purchasing power
has exceeded that of purchasable goods and services." It is therefore
essential that as soon as possible the State should not only live
within its income but should begin to reduce indebtedness, especially
the floating debt, which, being largely held by the banks, has been
a cause of credit creation on a great scale. "The shortage of real
capital must be made good by genuine savings. It cannot be met by the
creation of fresh purchasing power in the form of bank advances to
the Government or to manufacturers under Government guarantee or
otherwise, and any resort to such expedients can only aggravate the
evil and retard, possibly for generations, the recovery of the country
from the losses sustained during the war." With these weighty words
the Committee brushes aside a host of schemes that have been urged for
putting everything right by devising new machinery for the manufacture
of new credit. That new credits will be needed for industry after war
is obvious, but what else are our banks for, if not to provide it?
They can only be set free to provide it on the scale required if, by
the necessary reduction of the floating debt, they are relieved of the
locking up of their funds in Government securities, which has been one
of the bad results of our bad war finance.
It goes without saying that the Committee does not recommend the
continuance in peace of the differential rates for home and foreign
money that were introduced as a war measure with a view to lowering
a rate at which the Government borrowed at home for war purposes. It
would evidently be too severe a strain on human nature to attempt to
work such a system, except in war-time, when the artificial conditions
by which the market was surrounded made it both feasible and desirable
to do so. With regard to the note issue, the Committee proposes a
return to the old system and a strictly drawn line for the amount of
the fiduciary note issue, the whole note issue (with the exception of
the few surviving private note issues) being put into the hands of the
Bank of England, all notes being payable in gold in London only
and being made legal tender throughout the United Kingdom. These
suggestions are subject to any special arrangements that may be made
with regard to Scotland and Ireland. An early resumption of the
circulation of gold for internal purposes is not contemplated. The
public has become used to paper money, which is in some ways more
convenient and cheaper; and the luxury of a gold circulation is one
that we can hardly afford at present. Gold will be kept by the Bank of
England in a central reserve, and all the other banks should, it is
suggested, transfer to it the whole of their present holdings of the
metal. In order to give the Bank of England a closer control of the
bullion market the Committee thinks it desirable that the export of
gold coin or bullion should, in future, be subject to the condition
that such coin or bullion had been obtained from the Bank for the
purpose. This measure would give the Bank of England a very close
control of the bullion market, so close that there is a danger that
if this control were too rigorously exercised, gold that now comes to
this country might be diverted, with a view to more advantageous sale,
to other centres. The amount of the fiduciary issue is a matter
that the Committee leaves open to be determined after experience of
post-war conditions. They "think that the stringent principles of
the Act (of 1844) have often had the effect of preventing dangerous
developments, and the fact that they have had to be temporarily
suspended on certain rare and exceptional occasions (and those limited
to the earlier years of the Act's operation, when experience of
working the system was still immature) does not," in their opinion,
invalidate this conclusion. So they propose that the separation of the
Issue or Banking Departments should be maintained, but that in future
if an emergency arose requiring an increase in the amount of fiduciary
currency, this should not involve a breach of the law, but should be
made legal (as it is now under the Currency and Bank Notes Act of
1914), subject to the consent of the Treasury.
It is not proposed at present to secure the circulation of paper
instead of gold by legislation. The Committee considers that "informal
action on the part of the banks may be expected to accomplish all
that is required." If necessary, however, it points out that
the circulation of gold could be prevented by making the notes
convertible, at the discretion of the Bank of England, into coin or
bar gold. The amount which, in the opinion of the Committee, should be
aimed at for the central gold reserve is £150 millions (a sum which is
already almost in sight on its figures quoted above); and "until
this amount has been reached and maintained concurrently with a
satisfactory foreign exchange position for a period of at least a
year," it thinks that the policy of reducing the uncovered note issue
"as and when opportunity offers" should be consistently followed. How
this opportunity is going to "offer" is not made clear; but presumably
a reflow of notes from circulation can only happen through a fall in
prices or a reduction in bank deposits by the liquidation of advances
made to the Government, directly or indirectly, by the banks.
Concerning the difficult problem of replacing the Bradbury notes by
Bank of England notes of £1 and 10s., an ingenious suggestion is made
by the Committee. It observes that there would be some awkwardness
in transferring the issue to the Bank of England before the future
dimensions of the fiduciary issue have been arrived at; and it
suggests that during the transitional period any expansion in Treasury
notes that may take place should be covered, not as now, by Government
securities, but by Bank of England notes taken from the Bank. By this
means any demands for new currency would operate in the normal way to
reduce the reserve of the Banking Department, "which would have to be
restored by raising money rates and encouraging gold imports," and so
a step would have been taken to getting back to a business basis in
the currency system and away from the profligate printing-press policy
of the war period.
Such are the suggestions made by this distinguished body for the
restoration of our currency. Little has been said against them in the
way of serious criticism, but their conservative tendency and the
fact that they practically recommend a return to the _status quo_ has
caused some impatience among the financial Hotspurs who proposed to
begin to build a new world by turning everything upside down. In
matters of finance this process is questionable, interesting as the
result would undoubtedly be. To get to work on tried lines and then,
when once industry and finance have recovered their old activity, to
amend the machine whenever it is creaking seems to be a more sensible
plan than to delay our start until we have fashioned a new heaven
and earth, and then very probably find that they do not work. If the
machine is to be set moving, it can only be done by close co-operation
between the Bank of England and the other banks which have grown by
amalgamation into institutions the size of which seem likely to
make the task of central control more difficult than ever. On this
important point the Committee is curiously silent. But it recommends
the adoption of a suggestion made by a Committee of Bankers, who
proposed that banks should in future be required "to publish a monthly
statement showing the average of their weekly balance-sheets during
the month." (Will this requisition apply to the Bank of England?) This
is a welcome suggestion as far as it goes, but unless something is
done by co-operative action to make the Bank rate more automatic in
its influence on the actions of the other banks, the difficulty of
making it effective seems likely to be considerable.
Getting the currency right is a most important matter for the future
of our financial position. Another is the question of our debt to
foreigners. Most of this debt we owe to America, and we only owe it
because we had to finance our Allies. We surely ought to be able to
arrange with America that anything that we have to do in giving our
Allies time before asking for repayment they also should do for
us--within limits, say, up to thirty years. In view of all that they
have made and we have lost by this war waged for the cause of all
mankind, this would seem to be reasonable concession on America's
part.