THE CENTRAL RESERVE
The Central Reserve is the reserve held by the Bank of England. Not
only is it the Central Reserve, but it must be regarded as the National
Reserve, the sole reserve. This is regarded by many as the chief
weakness of the banking system.
Let us first of all distinguish between reserve and reserve. This
Central Reserve is the national legal tender reserve. The joint stock
banks have other reserves, as we have seen, composed of the highest
wealth in the kingdom, and though there may be some reason, there does
not appear to me to be the soundest, deepest reason why the foundation
of the system should be considered unsound because of our moderate
legal tender reserve, dependent as it is upon independent forces, and
because we place minor importance upon the country’s store of wealth.
To me it would seem the soundest reason to plant our banking system
chiefly upon the solid basis of wealth, and not let that system be in
the capricious control of a force that has no direct connection with
the country’s real wealth, especially when we have now found it to
be easily possible to meet that most remote contingency, a national
panic. The nation lives like a parent whose obsession is that in some
far-off day his son may meet with a serious accident that will affect
his brain and make him an imbecile. What will he do, then, when his son
becomes mad? He broods over the possibility; it darkens his life; it
keeps away joy and happiness; his health suffers; his energies, mental
and physical, become paralysed, and death gathers him while his son is
still in the prime of healthy manhood.
After all, what panics have we had in this country? Not one but what
has been quickly assuaged since the banking system developed into its
present stage of soundness.
As it is insisted in many quarters that the system is far away from
being sound enough simply because we have not large enough gold
reserves, we must examine the national reserve from this point of view.
This reserve is not only the Bank of England’s reserve against its
own liabilities, but is the reserve against the aggregate liabilities
of all the banks of the kingdom. The joint stock banks, as has been
explained, keep their reserves at the Bank of England, the gold they
keep in their tills and in their strong rooms being too small to take
into serious consideration.
If we take the average fluctuation of the Bank of England’s reserve
to its own liabilities as from 40 to 50 per cent. throughout the
year--this is quite a fair average variation of the proportion,--we
should probably find that the proportion of this reserve to the total
liabilities of all the banks would be as low as from 1 to 3 or 4 per
cent. This is, of course, a very low proportion, but low as it is,
it has served us well enough in the past, and as we cannot ignore
experience, it should continue to serve us well in the future.
When the proportion, say, falls below 40 per cent., and is approaching
30 per cent., the Bank of England takes steps to restore it to what is
considered the normal or prudent level.
The proportion, as is inevitable, begins to fall as borrowers are
driven to the Bank of England when the joint stock banks have ceased
giving accommodation. Though not a single note may be withdrawn from
the reserve the proportion must necessarily fall as the liabilities
rise. But it by no means always follows that when the proportion
falls from this cause alone the Bank will raise its rate. This will
depend upon general circumstances. There will be no need for the step
if general circumstances are favourable, for the loan-deposits will
in time be paid off and the normal conditions of the market will be
restored.
As a fact, nothing is more familiar and certain in Lombard Street than
these recurring phenomena. At the end of quarters, especially the March
quarter, when the taxes are flowing into the Exchequer, there is a
considerable amount of borrowing from the Bank of England. When the
money flows back into the market through Treasury disbursements, the
borrowers are able to repay their loans to the Bank.
In these times we see the Bank’s liabilities grow in twofold fashion.
The Public Deposits grow owing to the tax-ingathering, and the Other
Deposits grow because of the borrowing on the part of what is called
the outside market. At the same time, a counter-active influence is at
work. As the taxes are paid in to the Government they come indirectly
out of the Other Deposits, because they come out of the deposits of the
joint stock banks and out of their reserves, so this puts a check upon
the growth of the Other Deposits.
The Bank of England generally raises its rate when a large export of
gold abroad takes place. There are two main channels through which gold
flows from the reserve of the Bank of England. The one channel is that
which takes gold into national circulation, to the provincial banks and
to Scotland and Ireland at certain seasons of the year; and the other
is the channel by which gold is taken to foreign countries.
The internal drain, as it is called, rarely has any influence upon the
movements of the Bank rate. This is because gold is known to be in the
country, and if it is not in the Bank’s own reserve, it is practically
in the total reserves of the other banks, and it will all return to
the central reserve in due course.
A foreign drain of gold arises from quite other causes. It will arise
from a complication of causes. Gold may be taken from the Bank in order
to liquidate the country’s balance of debt to other countries. It is
a common phenomenon, for instance, to see at certain seasons of the
year large exports of gold to New York, Egypt, and South America. These
exports are expected, and occasion no surprise. But sometimes they are
supplemented by large unexpected withdrawals, there and elsewhere.
As an offset to these withdrawals, the Bank can replenish the reserve
by purchases of gold in the open market. Each week gold comes to London
from South Africa and often from India, and if the Bank can buy this
gold it may obviate the necessity of raising the Bank rate. Sometimes,
however, there is keen competition for these arrivals of gold, keen
competition from the Continent or New York, and the Bank may be unable
to outbid its competitors.
The Bank is bound to take all gold offered to it at the statutory price
of 77_s._ 9_d._ per ounce. But competition will sometimes drive the
price well beyond this figure, and continental countries sometimes buy
the gold at a loss, as Germany did in 1914, if they are determined to
have it at any price.
For many months before the outbreak of the war, the competition was
exceedingly keen, so keen that for a long period the Bank of England
was unable to purchase an ounce of gold. This competition was chiefly
on the part of Germany and Russia, especially Germany, thereby
affording presumptive evidence of her deliberate plans for war. But
this competition and buying must be regarded as abnormal.
The normal buying and the normal competition arise when gold is wanted
in the normal course of trading between different countries. If, for
instance, the New York exchange is driven down to such a point that
it is cheaper to send gold than to buy drafts, or exchange, then gold
is bought and shipped. This applies equally when other exchanges are
against this country.
Sometimes we can spare the gold so well, that it is better to let it
go than to keep it; which proves the futility of having a greater mass
of gold in the country than the country needs. At other times we may
have too little, and cannot spare more, and it is at such times that
another kind of competition starts: the competition of bank rates in
the various European centres.
The object of raising the Bank rate is to raise interest here. When the
rate is advanced, the joint stock banks immediately raise the interest
they give on their deposits, and the rate of discount simultaneously
rises. The latter, however, is not always instantaneously responsive,
for the rise in the Bank rate may have been foreseen for some time, and
rates may have risen already in anticipation. It is often possible to
judge, in the light of experience, when the Bank rate will be raised.
The competition takes the form, therefore, of raising rates of
interest; in other words, of making money more remunerative here than
elsewhere. The Continent will probably send gold here, or keep gold
here in order to earn the higher interest, especially in discounting
bills, and therefore the export of gold may be stopped, and gold, at
the same time, attracted here.
It does not follow that this is the inevitable consequence. This
will depend, not entirely upon conditions here, but may be ruled by
conditions elsewhere. There is no hard and fast rule, no sure working
of the law of cause and effect. If other countries are determined to
have the gold, they will take it, no matter how high the rate may be
raised here, and in latter years the rate has not been so effective,
probably, as in former years.
Whether it be effective or ineffective at given moments, it is one
means we possess--some call it a weapon--of trying to replenish our
national reserve from other centres, and of increasing the power of the
Bank to buy gold in the open market.
We do not like the reserve to run down too low, because we fancy that
a low reserve would create too much nervousness in the financial
community. We do not imagine it would create a panic, but it may
prevent undue nervousness should the Bank take measures to stop the
drain. If gold flows here, it will in course of time make bank, or
market money, more plentiful and cheap.
At the same time, of course, the trade of the country is necessarily
penalized. It is not good for trade that there should be frequent
fluctuations in the price of loans. It affects profits, the growth of
capital, and prices, and it also affects the employment of labour.
If too much has to be paid for bank loans, then it becomes too dear
a process to convert fixed wealth into liquid capital, for users of
capital may not then be able to employ it remuneratively. And this may
be a precursor to trade depression and stagnation.
If at such times we could replenish the reserves from the provision of
other legal tender, it might obviate it.
If money be sent here for investment at the higher rates of interest,
it will increase the Bank’s reserve and at the same time increase the
supply of money. As the supply of money from the joint stock banks
is dependent upon these gold reserves, their gold reserves will be
increased. For some of this fresh gold will find its way to the banks.
They can then convert more wealth into currency, and thereby stimulate
trade.
When foreigners invest their money here, they earn their profits in the
same way as our banks do. Their profits are a portion of the general
wealth of the community. As profits can come only from the production
and consumption of wealth, and not from the void, then they are a
portion of that wealth. And if profits are a constituent of wealth,
even if we call them a residue of wealth, then bank profits must come
from the same source, and not from space.
Foreign banks, therefore, become possessed of a part of this country’s
wealth, for profits are purchasing power, and purchasing power cannot
be intangible; it cannot be credit. In the same way, when we invest
money in a foreign country--say, Argentina--we receive the interest
in the shape of commodities, that is, in the shape of the country’s
wealth. They are this country’s profits on that loan: something
tangible, something Argentina and her wealth-producers part with, and
something they would retain if they did not send it here.
Therefore the interest we pay on foreign loans here must also be paid
in wealth. And if foreign bankers get their profit in the shape of
wealth, so must our bankers get their profits in the same substance.