THE METAMORPHOSIS OF THE FUND
This is because of the character of legal tender currency, and a legal
tender currency, however desirable and however great its merits, must
necessarily have its shortcomings in a progressive state.
The loanable fund is restricted, or controlled, not by the growth of
the country’s wealth, but by the production of gold. To control it
by so artificial and arbitrary a circumstance as the output of gold
may seem absurd, and from a strictly logical and economic standpoint
it is absurd. The loanable fund ought to be governed entirely by the
production of wealth, and not by something entirely independent of
wealth and having no natural or economic connection with it.
I am now speaking of the loanable fund which collects in the joint
stock banks. Of the other loanable fund, which collects in the Bank of
England, I will speak later.
What the banks lend is liquid wealth, but the amount they can lend
at any given moment is governed less by the amount of wealth that is
brought to them than by the amount of gold they possess. This is the
gold which, we say, constitutes their reserves.
Let us assume that it is the custom of the banks to keep a gold, or,
rather, a legal tender reserve--it is chiefly composed of Bank of
England notes--equal to fifteen per cent. of their combined pure and
loan deposits. It follows that the growth of these deposits must be
controlled by this fifteen per cent. reserve. This is so in practice.
When the reserve begins to fall below this fifteen per cent., then the
banks cease liquefying wealth and increasing the loan fund. When the
reserve increases beyond the fifteen per cent., then the banks continue
to liquefy the wealth.
It is then said that money--some say credit--is abundant, and the banks
cannot find full employment for it. When the reserve falls it is said
that money--or credit--is becoming scarce. We find, therefore, that the
loan-fund actually contracts when trade is active, and expands when
trade is depressed. In the economic interests of the nation the fund
should grow simultaneously with and commensurately with the growth of
trade and commerce.
In times of activity more wealth is created. It is like an abundant
harvest resulting from a favourable season. In times of inactivity less
wealth is created, to be likened to bad seasons and poor harvests.
In times of activity there is necessarily and inevitably a greater
demand for capital, that is to say, for more liquefied wealth. Bills
of discount multiply, and they are taken to the banks as security for
loans, in other words, to be converted into liquid form. Another phrase
is, into floating capital. If they could not be so converted, the needs
of the community in such times could not be met, for the bills of
discount could not be used as currency, or capital, like cheques. They
are discounted at the banks in order that they may be transformed into
cheques, the representatives of floating or circulating capital. In
this form they are able to reproduce wealth more rapidly than if they
had to remain in their original form.
So it is with other forms of wealth, all are taken to the banks to be
converted into quickly reproductive shape.
But the banks have to keep an eye on that gold reserve, watch it
closely. Managers have to calculate when the limit of their conversion
powers will be reached, and when it is reached their wealth-liquefying
machinery has for the time being to cease working. It does not follow
that when the machinery of one bank has to stop, the machinery of all
the banks simultaneously stops. The limit may not yet have been reached
in other banks. Borrowers, as they are called, then rush to them, and
as the numbers grow and the pressure increases, so is the limit of the
other banks more speedily reached, until at last the entire machinery
comes to a stop. It often comes to a stop when in the interests of the
economic welfare of the nation it should be working most actively.
But the machinery is controlled by another independent agency, and
the economic interests of the nation must suffer the effects of this
obtrusive force.
If this independent force be at times harmful and not beneficial to
the economic welfare and progress of the nation, what is to be said
of the cry that this force, in the most urgent times, should be made
more interfering and harmful? What is to be said of the cry that at the
moment when the need is greatest then the succour should be restricted?
What should we say of the doctor who by ligatures prevented the free
flow of blood in the body of an active, energetic man, in order to
paralyse his energies and enforce rest? We should say that he was not
only an unscientific doctor, ignorant of the functions of the bodily
organism, but that he was actually killing his patient. These gold
reserves, therefore, act like ligatures, for they stop the free and
health-giving flow of economic blood at the very moment when the flow
should be stimulated.
In inactive times we see the metamorphosis of the fund take place. The
loan deposits decrease, because the liquefied wealth becomes frozen
again and the production of wealth decreases, while the pure deposits
grow. The fact that the loan deposits decrease simultaneously with
the contraction of wealth production is an additional proof that the
loanable fund is wealth in liquid form. As the wealth in fixed form is
withdrawn from the bank so the loan deposits drop.
Now the increased pure deposits may be regarded as a portion of the
harvests gathered from the fructifying use of the liquid capital in
times of activity. They are called the profits, or the savings of
capital. They accumulate in times of depression. For lack of other
employment they are placed on deposit with the banks. They are, in a
way, loaned to the banks, and the banks are supposed to lend this money
to the classes of borrowers already described. But the banks at these
times benefit, or are presumed to benefit, not because the aggregate of
the deposits grow enormously compared with other periods, but because
these pure deposits bring them more gold. The loan deposits take gold,
the pure deposits bring gold.
This is why, the aggregate being the same, or even less, the potential
loanable fund is greater in inactive than in active times of trade.
The gold reserves increase and the proportion of the reserves to the
aggregate deposits rises. When this proportion rises, the banks say
they can afford to let it fall, and therefore they can liquefy more
wealth if there were more wealth to liquefy. But there is less wealth
to liquefy, and therefore money is now said to be abundant and cheap.
The banks are willing to take less interest, that is to say, a smaller
share of the profits earned by liquefied capital.
But depositors also have to take a smaller share of these profits.
The banks divide their smaller share of the profits with the pure
depositors, and, therefore, can give only a smaller rate of interest
on the deposits. Dissatisfied with this small rate of interest,
depositors seek for other channels of use, other forms of investment,
and when they find these other channels, they withdraw their deposits
and reconvert them into fixed or frozen capital. They may speculate
with them in mining or rubber shares, or invest them in Consols or War
Loans. When this is done, gold is automatically withdrawn from the
banks and the proportion may drop. Should the proportion drop, banks
can lend less, and the potential resources for liquefying capital
becoming less, they can begin to charge more for these services.
When the pure deposits increase the reserve of gold automatically
increases. Therefore, though the risks of the banks increase, because
the liabilities on demand increase, so the power to meet those risks
automatically increases. This being so, the necessity for increasing
gold reserves is less apparent; for they increase automatically.
When the pure deposits decrease and the loan deposits increase the
proportion falls, but it falls at a time when the risks are lessened if
set against the pure deposits as distinct from the loans owing to the
bank.
It will be seen, therefore, owing to the constantly fluctuating
character of a bank’s liabilities, or risks, it is impossible to
maintain a fixed, undeviating reserve, whether it be a high reserve
or a low reserve. And we know that this impossibility is demonstrated
every day in Lombard Street.
It is demonstrated at the end of each month, when the banks cease
lending, and when they compel their loan depositors to pay in their
loans. This is proof that a proportion of the deposits are loans to the
bank. As these loan deposits thereby contract, banks cannot compel the
pure depositors to withdraw their deposits, therefore the proportion
of the gold reserve to the _whole_ rises, and the wish of those who
clamour for high reserves is fulfilled.
This policy is resorted to because an idea exists amongst bankers that,
instead of going to theatres and other places of amusement, the public,
as a body, spends its leisure time during the closing days of each
month working out the proportion of the reserves to the total deposits.
This is a fantastic dream. The public does nothing of the kind. It is
fallacious to imagine the public working out the proportions minutely
and then deciding in strictly mathematical fashion whether a bank is
safe or not, and whether there is likely to be an immediate run upon
it or not. If bankers and theoretical financiers were only gifted with
the power to understand human psychology there would be less contention
amongst them on questions of pure theory. They would not magnify the
unimportant at the expense of the important functions of banking, and
magnify the superficial at the expense of the deep traits of British
character.
We see the same policy adopted at the end of each half-year, or year,
when the banks make up their half-yearly or yearly balance sheets.
Such a great deal has been made of this high reserve need--as though
it were possible for any mortal being to draw up an absolute line
of safety--that at these periods trade is penalized because bankers
imagine that the millions of this nation are auditing their accounts.
They see them poring over these accounts in the great castles of the
realm, and in the cottages of the poor. It is a pure delusion, and
if the millions engaged themselves voluntarily in these uncongenial
tasks, the result would only be national confusion, and not national
agreement. There can be national agreement on one thing connected with
the banking system, and one thing only, alike in the mansion and in the
cottage, and that is agreement upon the honesty and soundness of that
system. And honesty and soundness are not to be tested solely by the
bulk of the legal tender reserves.
The only members of the community who, perhaps, might be more concerned
than others about these reserves are the very members who share the
responsibility equally with the banks. They are those who borrow from
the banks, who get their liquid capital there. All they have to do is
to cease borrowing, cease converting their wealth into currency, and
the thing is done. The remedy is in their hands.
Do they do this? No. Do they show this feverish concern? No. What do
they do? These men, who have more at stake than the other millions,
actually growl when the banks refuse to liquefy their wealth. They
make it a grievance, and a sore grievance. To imagine, therefore, that
these growlers are watching minutely the movements in the reserve is a
delusion verging near to absurdity.
When some bank managers tell borrowers they must repay their loans,
then they rush round to other bank managers, caring not a fig about
reserves so long as they can get the accommodation they want, for their
needs are above all other considerations. And when they find that no
bank manager will serve them, and when all bank managers tell them they
are sold out, then they have to go to the Bank of England. They do not
like to go to the Bank of England, because they have to pay more for
the services that Bank renders. That is to say, they have to share with
the Bank of England a larger portion of the profits they make than the
portion they would divide with the joint stock banks.
By this analysis we see that the deposits of a bank, the so-called
loanable fund, consists of pure deposits, which we may call cash
deposits, and loan-deposits, which those who believe in credit creation
call credit deposits. These latter deposits represent the wealth
placed with the bank, and so long as this wealth is in liquid form in
these deposits it cannot be employed in its fixed form. These deposits
are loans owing by the bank and owing to the bank. Others call them
credit deposits created by the banks themselves.
These loans are made in relation to the proportion each bank is in
the habit of maintaining between its cash, or legal tender reserves,
and the deposits as a whole. The loan deposits increase or decrease
according as this proportion rises or falls.
It is left to the discretion of each bank to decide what the proportion
shall be. There is no legal compulsion. Therefore it is their practice
to retain the minimum ratio which they consider sufficient for their
safety. When this safety limit is passed, then they stop lending
and proceed to call in their loans. The totality of the deposits
automatically diminishes, and though not a sovereign has been added to
the reserve, the proportion rises.
This, then, is the important point. Not so much the amount of the
reserve, as the proportion. One bank may have fifty millions in its
reserve, and another bank only fifteen. But the smaller bank may have
a higher proportion to its liabilities and the larger bank a smaller
proportion. The test, therefore, if there must be a test, is the
proportion of the reserve to the total liabilities, and with this I
shall deal more fully later on.