have already seen that one operation of the present currency system
is, either directly to produce a drain whenever money is redundant,
or else materially to aggravate it if produced by other agencies. We
have now to consider the effect of another part of the same system,
which comes into operation when the drain has taken place, and money
is deficient. It is a generally admitted principle, that in such a
case as this, in which the drain has been occasioned by a low rate of
interest and high prices, there is nothing but a rise in the rate of
interest, and a fall in prices, that can remedy the evil and recover
the exported treasure. But it by no means follows that prices must
necessarily fall as much below, as they had previously risen above
their average, or that the rate of interest must rise as much above,
as it had previously fallen below its average; as, in this case, the
evil produced would be fully equal to that which it was designed to
cure. For it must be remembered that the exported treasure will, in its
turn, produce an excess of currency in the countries which receive it;
and that that excess will necessarily lead to a rise in prices and a
fall in the rate of interest, precisely commensurate with the amount
received. It will not be necessary, therefore, that prices should fall
much below the average at home, in order to stimulate an increased
export of commodities to those countries in which prices have risen;
nor that the rate of interest should much exceed the average, in order
to encourage the purchase of our securities on account of the same
countries; both of which operations will have the effect of recovering
the treasure. But secondly, there is no necessity for our regaining
the gold as rapidly as we have previously parted with it; as the less
violent is the reaction, the less severe are the concomitant evils.
And thirdly, if indeed it should not have taken the first place, it
has been repeatedly proved to demonstration, that a rapid fall in
prices, instead of stimulating exportation, has the inevitable effect
of paralyzing industry, and thereby retarding the production of those
very commodities of which a more than ordinary quantity is required.
Now, in each of these respects, the effect of the present system is
to aggravate the severity of the reaction in every case in which the
reserve of unrepresented notes in the Bank of England, is not at the
very highest point when the drain begins to operate. For, supposing the
gold exported considerably to exceed the amount of this reserve, which
is invariably the case in every extensive drain which commences while
the reserve is either at or below its ordinary average, the amount of
circulating medium in the hands of the public must contract, at least
by the difference between the amount of the available reserve and
that of the exported treasure. Now this contraction in itself would
alone suffice to cause a serious fall in general prices, and could
hardly fail to put a sensible check upon the operations of productive
industry. But long before the contraction would have reached its
climax, and indeed before the available reserve of the Bank would
have been exhausted, the Bank would be compelled, in self defence, to
raise the rate of discount so high as completely to arrest the demand
for increased accommodation consequent on the drain. In addition,
therefore, to the contraction in the amount of circulating medium
operating directly upon prices, we have a rapid and excessive rise in
the rate of interest, proceeding step by step with that contraction,
till, ultimately, as the Bank reserve approaches to the verge of
exhaustion, a state of general discredit arises; the hoarding of
currency at once ensues, a still more ruinous decline in prices is the
consequence, and nothing but the suspension of the Act can avert the
spread of universal panic.
But, secondly, a drain may be produced by the failure of some staple
article of food or manufacture, and the consequent importation of an
adequate substitute. The most calamitous case of this kind which has
occurred in recent times, was the general failure of the potato crop
in 1846, which necessitated the transmission of more than £8,000,000
of treasure in payment for bread-stuffs, chiefly to America. In this
and similar cases the efflux of gold is not produced by any excess
of circulating medium, with its attendant rise in prices and fall in
the rate of interest; the recovery of the gold, therefore, should be
effected with the smallest possible diminution of currency, reduction
of prices, or enhancement of the rate of interest, and any unnecessary
aggravation of either of these is a perfectly gratuitous evil. Yet
here, as in the previous case, the provisions of the Act of 1844
require that the circulating medium should contract, at least by the
difference between the amount of the available reserve and that of
the exported gold. For example, should the drain commence when the
available reserve should amount to only £4,000,000, which is about the
average, and should it extend to six, eight, or even ten millions, the
amount of the circulating medium must inevitably contract, at the very
least by two, four, or six millions. And yet, there can be little doubt
that in such a case as this, a contraction of one or two millions would
be amply sufficient for the recovery of the treasure.
But the remaining case is still more glaring in its character. For,
should the war be protracted for several years in succession, it will
necessitate, not merely a single drain of gold to the extent of some
£8,000,000 or £10,000,000, but a continued series of annual drains,
every one of which may extend to that amount. In this case, therefore,
under the Act of 1844, the currency will be subjected either to one
continuous strain throughout the whole duration of the war, or else to
a succession of violent oscillations from deficiency to excess, and
from excess to deficiency, according as the bullion imported exceeds
that exported, as would probably be the case during the winter months;
and as the bullion exported may exceed that imported, as would probably
be the case during the summer months. Should the amount of bullion
received during the winter be equal to the amount exported during the
previous summer, we should then have an excess of currency with high
prices, and a low rate of interest in every spring, followed by a
deficiency of currency with low prices, and excessively high interest
in every autumn, except so far as this rule might be interfered
with in the case of those commodities, the supply of which would be
diminished through the rupture of our commercial relations with the
hostile country. But should the influx of gold during the winter, fall
short of the previous efflux, the effect would be, that the currency
would be subjected to a permanent deficiency; and we should only have
to look forward to low prices and enormous interest throughout the
whole continuance of the war, with the not improbable contingency of
the spread of general panic at every period of unusual pressure. And
to this it must be added, that should any serious deficiency in some
staple article of domestic consumption occur in the meantime, requiring
the importation of an adequate substitute from abroad, the additional
efflux of treasure which this would necessitate, might not only lead to
a suspension of cash payments by the Bank of England, but be the means
of throwing the whole commercial affairs of the nation into extreme,
if not irreparable, disorder.
It is now admitted by the best authorities, both practical and
theoretical, that what is really wanted in such cases as those just
described, is the adoption of some system that would recover the
exported treasure, with the smallest possible interference with the
amount of circulating medium, and the general prices of commodities. It
is likewise admitted that a rise in the rate of interest, accompanied
by a very moderate contraction of the currency, would be quite
sufficient to recover the exported treasure, without inflicting any
serious injury on the commercial public. For example, Mr. J. S. Mill,
who is perhaps the most eminent of living economists, in the chapter
on the Regulation of the Currency, thus expresses himself: “In the
first place, the gold might be brought back, not by a fall of prices,
but by the much more rapid and convenient medium of a rise of the
rate of interest, involving no fall of any prices except the prices
of securities. Either English securities would be bought on account
of foreigners, or foreign securities held in England, would be sent
abroad for sale, both which operations took place largely during the
mercantile difficulties of 1847, and not only checked the efflux
of gold, but turned the tide and brought the metal back.” And in
confirmation of this statement, we have the evidence of Mr. Morris,
late Governor of the Bank, before the Committee of the House of
Commons on Commercial Distress, to the fact, that a rise in the rate
of discount to 6 per cent. sufficed to recover the gold from Russia
and other continental countries--“Parties were importing gold during
the time that we were discounting at 6 and 7 per cent., but latterly,
when gold became scarce, they exerted themselves still more to bring
it.” But the testimony of Mr. J. Horsley Palmer, who has passed the
Bank Chair, is still more decisive. He was asked, “May not a favourable
exchange be maintained by the rate of interest being higher in this
country than on the Continent?” His answer is emphatic: “It is the only
mode, in my judgment, for correcting the foreign exchanges.”
Now this is the precise mode in which our proposed system would operate
in the case of every drain of bullion. The immediate effect of any
drain, from whatever cause produced, would be, not a contraction of
the circulating medium, but a gradual rise in the rate of interest. If
the drain were not very great, this rise in the rate of interest would
be sufficient to turn the exchanges in the manner described by Mr.
J. S. Mill. If the drain were more severe, the rate of interest would
rise still higher, till it would ultimately affect the public demand
for loans and discounts, at which point it would begin to produce a
very gradual contraction of the circulation. With this contraction
would proceed a slight reduction in prices sufficient to stimulate an
increased exportation, but not to paralyze domestic industry; and the
united operation of the rise in the rate of interest and the moderate
fall in prices, would recover the exported treasure, without involving
any serious convulsion in the commercial system.
As this is a matter of more than ordinary importance, it will be best
to enter somewhat more minutely into the mode of operation. We have
already observed that the present average amount of bullion held by the
Bank of England is about £14,000,000. Should the Bank, as we propose,
be allowed to issue some £10,000,000 of small notes, the average amount
of bullion would probably be thereby increased to about £24,000,000. We
have also shown that the present average issue of unrepresented notes
by the Bank is about £8,000,000, and that if it were allowed to replace
the country issues, the average would probably be thereby increased to
£15,000,000. We shall now suppose that a drain of bullion commences
when the amount both of the bullion and the unrepresented issues is at
this estimated average. In such a case the total issues of the Bank of
England would be thus composed:
Issued on bullion £24,000,000
” at 1 per cent. 11,000,000
” at 2 per cent. 4,000,000
-----------
£39,000,000
the Bank having still a reserve of £7,000,000 of unrepresented notes,
which it might issue at 2 per cent. before the issues at 4 per cent.
would be called into requisition. We shall also assume that the rate
of interest is at its ordinary average of about 4 per cent. In these
circumstances, then, we shall suppose that a drain originates from
any of the preceding causes to the extent of say £4,000,000;[D] the
effect will be as follows:--According as each million of bullion is
withdrawn from the Bank, for exportation, the amount of bullion notes,
and therefore of circulating medium in the possession of the public,
will suffer a corresponding diminution: an increased demand for banking
accommodation will therefore arise; but as this can only be accorded
by the Bank of England, through a further extension of the issues at 2
per cent., and as any considerable issue of such notes would require
a higher rate of interest than 4 per cent. to render it adequately
profitable, the effect of this increased demand for accommodation will
probably be a rise in the rate of interest from 4 to 4½ or, perhaps,
5 per cent. It is possible that this rise in the rate of discount
might not produce any effect upon the demand for accommodation, but
the probability is, that it would have some sensible influence, though
not very considerable. We shall estimate it, therefore, as likely to
diminish the amount of the currency by £1,000,000 of the £4,000,000
exported. The total issues would then have undergone the following
change:--
Issued on bullion £20,000,000
” at 1 per cent. 11,000,000
” at 2 per cent. 7,000,000
----------
£38,000,000
[D] In order to guard against misapprehension, it may be
necessary to observe, that when speaking of the amount of
any drain of bullion, we invariably mean the excess of
the treasure exported over that imported during the given
period. For example, should the efflux amount to £6,000,000
and the influx to only £2,000,000, the effect would be
the same as if there had been an efflux of £4,000,000
and no simultaneous influx: we should, therefore, assign
£4,000,000 and not £6,000.000, as the actual drain in such
a case.
and we should have a rise in the rate of interest to 4½ or perhaps 5
per cent., accompanied by a contraction in the total circulation to the
extent of £1,000,000, as a means of correcting the exchanges, which
there is little doubt it would suffice to do, if the drain were one of
only slight severity.
The drain of 1847, however, was much more severe than this--and in
order to show the operation in a somewhat analogous case, we shall
suppose the efflux of bullion to proceed to the extent of a second
£4,000,000. The effect would necessarily be very similar to that
just described, except that it would be more strongly marked in its
features. According as the demand for accommodation would increase,
and as the Bank would approach the exhaustion of the £11,000,000 of
unrepresented notes allowed to be issued at 2 per cent., it would be
obliged to raise the rate of discount still higher, so that, by the
time that the efflux of the second £4,000,000 would be complete, the
rate of discount would probably be not less than 5½ or 6 per cent., and
as this rise would undoubtedly have considerable effect in checking
the increased demand for accommodation, we may confidently assume the
consequent contraction of the circulation to be at least one million of
the four. The total issues therefore would have assumed this position:--
Issued on bullion £16,000,000
” at 1 per cent. 11,000,000
” at 2 per cent. 10,000,000
-----------
£37,000,000
exhibiting a rise in the rate of discount, from 4 to 5½ or 6 per cent.,
and a decrease of £2,000,000 in the amount of circulating medium, as
the total effect produced by a drain of £8,000,000 of bullion. And
should the drain proceed no further, we have ample data both in theory
and practise, for assuming that this rise in the rate of interest
would draw over foreign capital in the purchase of securities--that
this contraction in the currency would lower prices sufficiently to
stimulate the export of commodities, without paralyzing industry--and
that through the combined operation of the two agencies, the bullion
would be slowly but certainly recovered, with the smallest possible
detriment to commercial interests.
The case of a drain arising out of military expenditure presents no
peculiar feature of difficulty, as compared with the preceding. Should
the loss of gold continue to the extent of another £4,000,000, making
£12,000,000 altogether, the chief point of difference would be, that
the exhaustion of the £11,000,000 of unrepresented notes allowed to be
issued at 2 per cent., would necessitate a recourse to the issues at 4
per cent.; and that this would require a proportionate rise in the rate
of discount, in order to render such issue adequately profitable to the
Bank. But a rise in the rate of discount to 6 or 6½ per cent., would
allow the Bank a profit of 2 or 2½ per cent. out of such issue, over
and above the governmental charge; we may, therefore, assume that such
a rise would suffice as an inducement for the Bank to draw on those
issues. And supposing that a rise to 6 or 6½ per cent. would produce
a contraction in the demand for accommodation of a single million, as
before, the total operation on the issues would be as follows:--
Issued on bullion £12,000,000
” at 1 per cent. 11,000,000
” at 2 per cent. 11,000,000
” at 4 per cent. 2,000,000
----------
£36,000,000
the efflux of £12,000,000 of bullion having raised the rate of interest
from 4 to suppose 6 or 6½ per cent., and having reduced the total
issues of bullion notes and unrepresented notes from £39,000,000 to
£36,000,000; that is, by £3,000,000 out of £39,000,000. Now, in order
to convey an adequate conception of the advantages derived from such
a plan as this, we must contrast it more closely with the operation
of the present system in a similar case. We will suppose, therefore,
that a drain of £12,000,000 of bullion commences under the present
system, at a time when the bullion notes and unrepresented notes of
the Bank are both about their ordinary average, viz. £14,000,000 and
£8,000,000 respectively, making a total of £22,000,000. Now, bearing in
mind that the reserve of unrepresented notes can never practically be
reduced below £2,000,000, it will be at once apparent that a drain of
£12,000,000 in such a case would produce the following change:--
Issued on gold £2,000,000
” on securities 12,000,000
----------
£14,000,000
thereby effecting a reduction in the total circulation of the Bank
of £8,000,000 out of £22,000,000, while raising the rate of discount
in some fabulous proportion in order to keep down the demand for
accommodation, and at the same time placing in imminent jeopardy the
convertibility of the issues, if not the solvency of the Bank.
We should not be doing justice to our proposed system if we did not
subject it to a test still more severe than any of the preceding, and
one which could not arise under the present currency laws without
entailing upon the nation a very serious difficulty in meeting its
engagements. We refer to the very possible contingency already alluded
to, of our being obliged to discharge some heavy foreign liabilities
through the failure of some important article of domestic consumption,
or through any other cause, while already embarrassed by an excessive
military outlay. The events of the past twelve months, indeed, have
indubitably proved that it lies within the competency of a foreign
country at any time, when the bullion is at a minimum, to buy up all
the marketable English bills on the Continent at a trifling monetary
sacrifice, and by transmitting them for discount, entail so sudden a
demand for gold upon the Bank as may completely exhaust the treasure in
the coffers of that establishment. Now, it can be readily shown that
the provisions which we have proposed would altogether preclude the
possible occurrence of such a calamity as this. For, supposing such an
operation to be effected at a time when the bullion had been already
reduced, as just now supposed, to £12,000,000, and supposing £4,000,000
to be the highest probable limit of such a demand, the effect of this
sudden drain of an additional £4,000,000 might possibly be to raise the
rate of discount momentarily to perhaps 7 per cent., and might thereby
produce a contraction in the actual circulation of £1,000,000 or
£2,000,000, yet the result upon the issues could hardly be more violent
than to reduce them as follows:--
Issued on bullion £8,000,000
” at 1 per cent. 11,000,000
” at 2 per cent. 11,000,000
” at 4 per cent. 4,000,000
-----------
£34,000,000
and as the bullion withdrawn by such an operation should be rapidly
recovered, the additional pressure would be very soon relieved, and
would pass over without entailing any abatement of confidence in the
perfect security of the unrepresented issues[E].
[E] We have not alluded in the text to the effect of our
proposed system, in reducing the enormous fluctuations
in the rate of discount produced by the operation of the
Act of 1844; but this is a feature of the question too
important to be altogether passed over without reference.
In his examination before the Committee of the House of
Lords on Commercial Distress, Mr. J. H. Palmer, a very
competent authority, declared, that in his whole experience
he had never known such vicissitudes in the rates of
interest and discount as since the passing of the Act;
and the greater number of the witnesses were unanimous in
deploring the excessive injury inflicted on the community
by those vicissitudes. Now, one essential part of the
operation of the governmental charges of 1, 2, and 4 per
cent. would be the reduction of those violent oscillations
within more salutary limits; as we have just now seen that
3½ to 4 per cent. would be the probable minimum, and 6 to
7 per cent. the probable maximum, at which the Bank of
England would ever grant accommodation, and that moreover
it would only be in extraordinary cases that the range of
variation would exceed from 4 to 6 per cent.
We have now contrasted the operation of the present and the proposed
systems, in the cases in which there is an excess and in which there
is a deficiency of circulating medium. But the contrast would not be
complete if we did not consider a third case, somewhat intermediary
to the other two; viz. that in which an occasional or only temporary
expansion of the circulation is required by the domestic transactions
of the country. The principal case in which this occurs, is at the
payment of the dividends. At such times, whenever the reserve in the
banking department happens to be small, through a low stock of bullion
or through some degree of pressure, the effect of the restrictive
clauses of the Act of 1844 is to render the payment of the dividends a
matter of considerable difficulty, except at the expense of a serious
temporary contraction in the amount of accommodation afforded to the
public. In both the cases of April and October, 1847, already referred
to, this was one of the circumstances which contributed to aggravate
the pressure.[F] But other cases not unfrequently arise, in which
advances are requisite for some temporary purpose, and which the Act of
1844 has rendered almost impracticable. A striking illustration of this
occurred in the beginning of the year 1846, when Parliament required
that all Railway companies which intended applying for an Act, should
lodge 10 per cent. upon their capital, within fifteen days after the
meeting of Parliament. It may well be doubted whether, if Government
had been fully enlightened as regards the difficulty of performing such
a condition, this measure would have been insisted on; but however
that may be, it is indisputable that had the reserve in the banking
department been small at that period, or had not the Bank lent out the
notes as fast as they were received, the effect of the restrictive
clauses of the Act of 1844 was such, that the lodgments could not
possibly have been made at all; and even as it was, the difficulty of
effecting then occasioned great anxiety in the public mind.[G] And
similar cases may at any time arise, in which the operation of the Act
must necessarily produce considerable inconvenience to the public.