ELASTICITY OR INELASTICITY?
One of the great subjects of controversy, on which it seems impossible
to arrive at a common agreement, is whether the so-called loanable
fund is elastic or inelastic. It is admitted, I think, in a general
sense that in order best to help the trade of the country, it should be
elastic, that is, should be able to meet all the needs upon it. This
certainly should be the province of banking, and, what is more, it
should be the province of Governments to provide sufficient money to
meet the expansion of trade. It would be a foolish policy to shackle
and bind trade, to arrest its growth, by restricting facilities for
its growth. It would be like a foolish parent binding the limbs of his
child to stay their natural growth and to keep him a dwarf and a freak,
unable to do the work of a mature man.
As the banking system practically performs the duties which in its
non-existence would have to be performed by a Government, then it
devolves upon this system to feed and succour commerce and to give it
every facility and every means for expansion. When I said in Chapter
XI that the transforming machinery should work with a pace equalling
the creation of wealth, it was tantamount to the view expressed by
others that the loanable fund of Lombard Street should be elastic.
Instead of calling it a loanable fund, a vast pool of money into which
borrowers dip, a pool always filled by a perennial spring, I prefer to
call it machinery for transforming fixed wealth into mobile capital,
or currency. When I take my wealth to a bank I take it there because I
cannot use it fruitfully as capital in its fixed form. As I wish to use
it fruitfully the bank temporarily changes it into money for me, and in
this new shape I can make full use of it.
Now, all who have practical experience of the banking system know there
are times when the banks refuse to perform this office for wealth
possessors. The machinery comes to a temporary stop. When we inquire
why it has stopped, we learn that it is because the proportion of
the reserve to the liabilities has fallen to too low a point. Others
would say, it is because the pool had been drained too far, was being
dried up, and that time must be given for money to flow in again. If
we liken it to a pool we find that instead of it having been drained,
it is really over-filled, and that what the banks desire to do is to
stop the overflow and to let the water sink. The banks say they have
lent too much, and must now lend no more for awhile; so they not only
stop lending, but call in loans, which again shows that the fund is
overflowing; it must be allowed to subside.
We also see at times, when the fund is overflowing, that banks are
so eager to lend, that money is said to be a glut on the market and
exceedingly cheap. It is offered at nominal rates of interest. Why,
then, are there times when banks are eager to lend when the fund is
supposed to be overflowing, and times when, with an overflowing fund,
they refuse to lend? Why is it that at times when the fund is low they
are willing to lend, and why at other times when the fund is low they
are unwilling to lend?
These phenomena prove, I think, that it is not a fund of money in the
real sense of the word. We can never tell merely by looking at the
aggregate deposits of the banks whether they are able to lend at any
given moment or not. We can easily delude ourselves by looking at the
bulk of that fund. What governs what we may call the transforming
capacity of banks is the quantity of gold they individually possess and
general financial and international conditions. In times of uncertainty
and apprehension, no matter from what circumstances or events these
arise, banks may refuse to lend, no matter what the condition of the
so-called loan fund may be. So far from lending when their deposits
appear to be very high, they are anxious to diminish these deposits and
gather in gold.
It follows that the more gold they hoard the less becomes the loanable
fund. Therefore the more legal tender they accumulate at these times,
the less money they lend. Which seems anomalous and paradoxical. The
more money banks have at certain times the less they have. When the
hour of nervousness passes they begin to lend again. The money in the
shape of gold diminishes in proportionate quantity, therefore the
loanable fund of Lombard Street apparently increases as gold apparently
diminishes.
This fund is, at times, like a spring in a desert. The thirsty
traveller sees it shimmering in the distance and hurries towards it in
profound gratitude, thankful that his thirst is to be slaked and his
sufferings are to be relieved at last. But just as he is about to put
his lips to the tempting waters, a voice of warning stops him. He is
not to drink, for the waters are too precious and must be preserved.
Not a drop can be spared. So he does not slake his thirst, and perhaps
afterwards succumbs to the torture he is suffering.
The spring is there, but he is forbidden to drink!
In the banks the source of money is there, but the gold must be
preserved, and the community must depart unsatisfied, no matter what
the consequences may be. The banks will not lend because they must keep
and increase, not their deposits, their so-called loanable fund, but
their gold.
These deposits, then, are not strictly a loanable fund, otherwise the
more they grew the greater would be the fund. In fact, the fund would
be inexhaustible, increased and not diminished by the demands made
upon it. We know they are increased by loans. Therefore the best means
of increasing the fund would be by increasing the loans, and we could
then witness money actually piling up mountain-high in our midst. This
could put all fables of money-making by magic into the shade.
Instead, however, of increasing the fund by lending as fast as physical
resources will permit, the banks adopt the contrary policy. They stop
making loans and simultaneously diminish the loans they have already
made.
Whatever views the public may hold, bankers labour under no delusions
as to the real nature of the loan-fund. They know well enough they do
not lend out of that fund at all, for if they lent out of it they would
inordinately increase it by lending and so make more profit. It helps
to shed more light on the nature of the deposits. Why are banks anxious
to diminish the deposits in times of anxiety and apprehension? That
is to say, the loan deposits, and not the pure deposits? Why are they
anxious to diminish the aggregate of the so-called money fund?
They wish to take away from their borrowers their power to withdraw,
even temporarily, gold. If they take this power from them the banks
know they will be in a far stronger position, even should the deposits
diminish by fifty per cent. In their own language bankers say: “We
must strengthen our cash position.” This means, then, that the cash
fund and the deposit fund are not one and the same thing. The cash
fund is strengthened by weakening the deposit fund. Cash grows as the
loanable fund falls.
If the loan deposits are thereby greatly diminished until the deposits
are mainly what I have called pure deposits, it shows how the banks
safeguard themselves when they think danger is coming. Their assets
change. Gold takes the place of other wealth, and the banks are able
the better to meet a run on the part of their depositors. They have
automatically met the danger from the presence of the loan-deposits,
and now they have only to face the danger from the pure deposits. They
have fortified themselves for this by differentiating between the
characters of their deposits, which in their aggregate are misleadingly
called the loan fund of Lombard Street. The gold is the real lending
fund.
This is done, too, often at a time most unfortunate for the general
community. It is done at a time when the community should receive more
and not less help from the banks. Banks ought to lend more freely in
times of crisis than at other times, for it is that freer lending that
will help the country to meet and get through the crisis. To stay help,
to withdraw help already given, is to increase the difficulties of the
general community, to feed alarm and apprehension, to aggravate the
crisis. The banks do, therefore, what seems wise, perhaps, for them,
but unwise for the community.
They are not to be blamed so severely as some imagine. They have to
look to the law in the same way as the individual has to look at it,
and they cannot be blamed for acting in accordance with law. It is,
perhaps, the law that is unwise and not the banks. Communities must
abide by the laws they make, and by the limited freedom laws allow.
Laws are not the last word in human wisdom. Laws can be modified and
improved upon.
Banks have to work within restrictions imposed upon them by the law,
and if these restrictions become harsh in times of difficulty and
crisis, then it is the law that is at fault and not the banks.
Banks must pay out legal tender to their depositors on demand. The
Government restricts the supply of legal tender by enacting that
gold alone shall be legal tender. Therefore the Government is not
irresponsible for the manner in which the machinery works in all sorts
of conditions.
If the supply of legal tender is restricted, no banking system, or any
system like it, would be possible if the reserves in legal tender had
to be equal, or nearly equal, to the deposits. If the banking system is
to be worked in the highest interests of the community, then the gold
reserves must necessarily be greatly less than the deposits. If the
people of this country took to hoarding gold, then the banking system
would eventually come to a stop, which shows again what the nature
of the loan fund is. There can be no loan fund without gold, and in
that case there could be no currency such as the cheque system of this
country.
Ought we, then, to reform and modify the law? I can imagine the time
coming when legal tender will not be confined to gold. But this is
far distant. I think reform can come in the manner in which we have
experienced it since the war. The Government could ensure free working
in times of apprehension and crisis in the manner in which it ensured
it in August, 1914, by the creation of emergency currency. What can be
done successfully and beneficially once can be done again.
If there are times and occasions when banks stop lending and when they
call in their loans, then it follows, reverting to market parlance,
that the loan-fund is inelastic. If it cannot always and invariably
respond to needs, then it cannot conform itself to varying conditions
and circumstances. This fact, therefore, supports the contentions of
those who say that the fund is inelastic. In my way I say the machinery
is far from perfect. It always works with difficulty at the very time
when it should work with ease. It will come to a dead stop at the
moment when it should be working at high pressure.
To make the position clearer I will recall what Mr. A. C. Cole said in
his controversy with Mr. Tritton.
“I entirely disagree,” he said, “as to the inelasticity of this fund.
My view is that the inelasticity is apparent, but not real. By this I
mean that it is inelastic at any given moment because, in these days
of competition, bankers lend all their available surpluses; but to say
that the short loan fund is permanently elastic is quite beside the
mark. What does inelasticity of the market mean? It means the want of
power of the market to adjust itself to pressure or tension. Now, take
the discount market. The supply of money always adjusts itself to the
demand. Except in times of panic, good bills are always discountable
in London. This Mr. Tritton practically admits in his paper. As
regards the large amounts of Treasury bills, Exchequer bonds, etc.,
of which there has been a marked increase in recent years, owing to
the [Boer] war, Mr. Tritton says it is not very clear from what source
the funds so invested have arisen. This gives away his case, for it is
an admission that the money has been forthcoming. In other words, the
supply in the short-loan market has been increased because the demands
upon it have been larger, and this will always prove to be the case.
The short-loan market is really augmented quicker than any other fund.
It is quite immaterial whether the funds belong to owners in this
country or to capitalists abroad. The fact remains that the money is
available when wanted, or, in other words, the short-loan fund is so
elastic that it promptly adjusts itself to the demands upon it, though
temporary recourse to the Bank of England may be necessary, while
the adjustments take place. The apparent inelasticity of the fund is
evidence of what I may call the efficiency of the short-loan market. By
efficiency I mean that the total available funds in the market are in
constant use. This is not a bad thing for the community, but it implies
that on the least strain or dislocation of the machinery of the market,
recourse has to be made to what is then the only available source of
supply--the central institution. But as the Bank of England is always
willing to discount or lend upon good bills, the supply of money in the
market is never exhausted. It is simply a question (except in times
of panic, which we are not here considering) of the rate of interest
whether the money is forthcoming.”
I cannot agree with Mr. Cole. If he admits that there is an exception,
and the exception works in a time of panic, at the very moment when it
is vital to the community that the exception should be removed, then he
gives away his case. He admits that the supply is not inexhaustible,
for it suddenly dries up when the need is greatest. To say that it is
“inelastic at any given moment,” that it is not permanently inelastic,
and that there are times when borrowers are driven to the Bank of
England, is inconsistent and illogical. If there are moments when it
is inelastic, then it cannot be permanently elastic.
When soon after the present war complaints were made that banks were
not lending freely, and when a warning to them came from the Chancellor
of the Exchequer, it furnished further proof of inelasticity in times
of difficulty and pressure.
Let us now examine further the machinery of the Bank of England and the
rate of interest.