The Principal Currency Drains.
The principal currency drains occur during the holiday season and at
harvest time, more especially during the latter period, when large
amounts of cash are sent into the country to satisfy the requirements
of labour. Early in November a demand for gold arises in Scotland,
owing to the fact that rents there fall due at Martinmas (11th
November); and as the Scotch banks, by the Act of 1845, are compelled
to hold gold against notes circulated in excess of their authorised
issues, a rather heavy call is made upon the Bank of England, whose
returns then show a noticeable decrease in the reserve and bullion.
During years of active trade, and, consequently, of brisk demand for
loanable capital, these autumnal drains of gold generally force up
the rate of interest, thereby making the last quarter of the year the
dearest for borrowers.
But we are discussing internal demands only, and as, so long as
gold does not leave the country, it is merely a question of certain
sums flowing from the London money market and drifting back to it
again, this ebb and flow, which is shown by the various ups and downs
occurring from time to time in the items of the Bank return, does not
create any apprehension. Indeed, these movements occur so regularly
at certain times of the year that large borrowers often anticipate
them in order that they may tide over such periods with the minimum
of inconvenience. It is, however, otherwise when gold is leaving the
country in large quantities in order to settle the balance of our
indebtedness to other nations, for that _may_ not come back. How it is
again enticed to these shores I will endeavour to explain.
We now come to a foreign drain of gold; and this depletion of the
currency, we know, flows from the store at the Bank of England into
the hands of the foreign creditors of the nation. We export to, and
import from, other nations on a gigantic scale, and as our imports
are invariably in excess of our exports, it follows that the balance
of indebtedness on this score is always very considerably against us;
but there are other debts due to this country which from time to time
turn the balance in favour of England, and the prices quoted for bills
on the various Exchanges are the indexes which tell us whether gold is
likely to be either received from, or sent to, the great commercial
centres of the world.
Other debts due to this country have been mentioned--debts which either
tend to reduce or turn in our favour the balance we owe to foreign
countries. England has immense sums invested in foreign securities, and
the interest received therefrom acts in this direction. So, too, does
the huge sum earned by her ships in the shape of freights. Then, again,
London, still earns a large amount in the shape of commissions, even if
her position as the Clearing House of the world is now less powerful
than formerly, owing to large accumulations of capital in other centres.
On the other hand a considerable amount of foreign capital is invested
in English securities, which, when sold on the Stock Exchange, give the
foreigner a claim on our stock of gold; and though we, by similar sales
of foreign securities, can prevent this temporary drain of specie, the
enormous dealings in stocks and shares on the various Exchanges are
most keenly watched by the directors of the Bank of England, lest huge
realisations of British securities by foreigners should drain the Bank
of its gold, with which international indebtedness can alone be settled.
This brings us to the markets for bills of exchange, the prices of
which, like those of every other security, are settled by supply
and demand. If, at a given date, this country owes a foreign nation
considerably more than it has to receive, then bills on England will be
plentiful in that country; and, further, they will be cheap, because,
as debtors to England have less to remit than the aggregate of bills
on England offered for sale, the supply will be in excess of the
demand, and English bills, consequently, can be bought at a discount.
Conversely, the supply of bills in London on the foreign country will
be smaller than the sum English debtors owe therein, and in order
to save the expense of exporting gold, such bills will be eagerly
sought after, and, as the supply is smaller than the demand, buyers
soon drive them to a premium, when the rate of exchange is said to be
"unfavourable" to England.
As the balance of our international indebtedness must be cancelled by
gold, it follows that the fewer the bills offering the higher will be
the prices paid for them; and when, just towards the end, it becomes
evident that the supply is limited the bidding is often spirited; but
the premium paid cannot exceed for any considerable length of time the
expense incurred by exporting and insuring the precious metals between
any two countries, as the debtor always has the choice of despatching
gold to his foreign creditor, and, naturally, he chooses the cheaper
expedient.
The extreme fluctuations are called "gold points," and they mark the
limit to premiums procurable on bills of exchange. The table given
below will show us those points at which gold will probably either
leave or reach this country:
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Exchange. | Mint Par. | Gold | Gold
| of Exchange. | Exports. | Imports.
-----------------+------------------+-----------+-----------
London on Paris | Francs 25·22½ | 25·12½ | 25·32½
Berlin | Marks 20·43 | 20·34 | 20·52
New York | Dollars 4·87 | 4·84 | 4·90
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When the rates are near those given in the second column, the Bank,
if its reserve be low, begins to consider the advisability of raising
its rate of discount, for it is evident that foreign bills are at a
stiff premium, and that a demand for gold may be made upon it at any
moment. Of course the difference between the "gold points" gives
scope for speculation, and some cambists gamble in bills for the rise
or the fall just as speculators do in securities. Then, again, the
arbitrageurs largely influence prices by buying and selling securities
which are dealt in on the Stock Exchanges of more than one country.
Wars, revolutions, panics, and social upheavals also cause abnormal
fluctuations in the rates.
Let us assume that a drain is threatened from Paris. The gold in an
English sovereign is, we can see, worth about 25·22½ francs, and if
only 25·12½ is being offered on 'Change, it follows that bullion
will soon be exported to France. This the Bank wants to prevent. The
cost of transmission of bullion between the two countries is about one
half per cent.; therefore, in order to induce French capitalists to
invest in English bills of three months' date, the rate of interest
in London must be more than two per cent. in excess of that in Paris
before it will pay them to ship bullion to this country, if it be the
intention of the purchasers to withdraw their capital when the bills
mature, as the gain of two per cent. per annum for three months only
just balances the loss of 10s. per cent. incurred on specie shipments,
while no margin is left to defray possible loss through unfavourable
exchanges at the time of withdrawal. Were a purchase of six months'
bills contemplated, the difference in the two rates would only have to
exceed one per cent. before bullion could be exported profitably.
When, therefore, the Bank of England wishes to influence the foreign
exchanges, it raises its rate by one, instead of by one half as is
usual when the drain is caused by the currency requirements of this
country, or by an increased demand for loanable capital when trade
is active and the foreign exchanges favourable. One constantly hears
the question: Why has the Bank of England raised the rate by one
instead of by one half as it did last time? A glance at the foreign
exchange tables will generally supply the answer. If the expenses
for transporting and insuring bullion between any two countries are
appreciable, then were the Bank rate raised by one half (remembering
that an addition of one half per cent. per annum gives a profit of
only 2s. 6d. per cent. on a transaction in three months' bills) it is
evident that the inducement is not sufficient to attract gold over here
for that consideration alone.
By raising its rate, and, if necessary, borrowing in the market in
order to bring the market rates in touch with its own, the Bank makes
an investment in English bills a profitable transaction; and the
greater its excess over foreign rates, the stronger is the inducement
to send money to England. Of course, were this country really living on
its capital, this influx of gold would only postpone the inevitable day
of settlement, for a bankrupt does not increase his wealth by borrowing
from one person in order to pay off another. But our receipts do not
always coincide with our payments; and when, for instance, gold is sent
to the United States in the autumn to help to pay for crops imported
here, the Bank of England, by raising its rate of discount, and making
that rate a representative one, attracts gold from the Continent, in
order to tide over the interval between debts payable by us immediately
and debts due to us at a future date.
English bills being a profitable investment, the price of paper on
England at once begins to rise, and when the so-called gold point is
reached the precious metals are shipped to these shores, because the
premium on bills on England is in excess of the cost of despatching
bullion. Every rise in the rate of discount here induces foreign
holders of long-dated paper on England to retain their purchases. If
they bought three months' bills on England when the Bank's discount
rate was three, interest at the rate of three per cent. per annum was
deducted from the face value of the bill to make it equivalent to a
bill due at sight. Should the minimum rate be raised to four per cent.,
and were the holders then to remit the bills to this country to be
discounted, they would have to submit to a deduction at the rate of
four per cent. per annum. In other words, they would lose one per cent.
per annum on the transaction. Long-dated bills would therefore be held
until near maturity in order to avoid this loss.
An accretion to the Bank rate, then, not only attracts gold or capital
here, but it also induces foreign holders of long-dated bills on
England to keep them in their cases. On the other hand, a fall in the
Bank's rate of discount from, say, three to two per cent. might not
only slacken the demand for English bills, but it would also cause a
considerable number of long-dated bills on England to be sent over here
to be discounted, as the foreign holders would naturally be anxious to
secure the profit between the three per cent. per annum paid to them,
and the two per cent. per annum at which they would then be taken from
them. The result might possibly be a temporary drain of gold from this
side.
But it is when a home and a foreign efflux of gold occur at the
same time that the situation becomes serious, and unless immediate
action is taken by the directors of the Bank of England to check the
outflow, there is always the danger--so small is our gold reserve when
contrasted with our exports and imports--that a balance against us at
an unlucky moment may create an awkward tension, which, unless speedily
relieved, may possibly produce a crisis.
We like to flatter ourselves that England is always safe; but so large
is the amount of bills offering from day to day in the London money
market that the very doubt of there not being sufficient capital in
the possession of the banks to discount them creates uneasiness; and
if it were thought that the Bank of England, which holds the few
millions of reserve upon which hundreds of millions of credit rest,
could not retain its gold, excitement would reach fever pitch in this
country, for everybody's income would be in danger, and the Government,
whose supineness allowed such a state of affairs to develop, would
be in danger too. But we know that, in the rate of discount, the
directors of the Bank possess an effective instrument to prevent such a
catastrophe, and have the experience to use it to advantage.
Money begins to leave the Bank for internal circulation during the
summer months in order to meet the demands created by the holidays and
the harvest, and then in October there is always the probability of a
large outflow of gold to the States to help pay for the crops imported
therefrom; while the movement of specie to Scotland in November,
occurring as it does just at a critical moment, is likely to cause some
apprehension, should the Bank's reserve have been depleted earlier,
unless the fact that it is merely a temporary transfer to enable the
Scotch banks to comply with the Act of 1845 be thoroughly grasped.
The October drain of gold from the Bank when the New York exchange is
unfavourable has in it an element of danger, especially if it happen at
a time when the reserve at the Bank of England is unusually low; and
if loanable capital be then abnormally scarce there is always the risk
that the end of the year requirements may produce a tension, which,
should credit be bad at the time, may develop into a panic.
If the Bank manage well, however, it fortunately often foresees that
the autumnal demands may possibly impose a severe temporary strain
upon its resources, and by raising its rate in anticipation of a short
period of exceptional demand, it attracts gold to itself in order to
be thoroughly prepared for possible large depletions of currency later
on, for it is easier to accumulate gold before the event than to check
an outflow when the movement is beginning to create uneasiness, and to
attract attention to the lack of preparedness on the part of the Bank
to meet large withdrawals of specie for export.
It is not my intention to write a treatise on the foreign exchanges,
and I am quite well aware that I have only touched on the fringe of a
great subject; but if these illustrations help, however slightly, to
elucidate certain of those undercurrents which determine prices, then
the sole aim of this chapter has been attained.