EXHAUSTIBILITY
If what is called the loanable fund were perfectly elastic and
“promptly adjusted itself to the demands upon it,” how is it that the
value of money, called the rate of interest, is not more uniform? It
certainly should be more uniform if it were a fund that automatically
responded to the demands upon it, increasing as the output of wealth
increased, decreasing when the output of wealth fell off. In a perfect
system this would certainly happen; but sound as banking may be within
its limitations, we must admit that it is far from being a system of
perfection. The fact that the rate of interest is not uniform, that it
rises and falls in a capricious and not uniform way, is further proof
that the fund is not, as it should be in a perfect or improved system,
elastic.
Experience shows us clearly that as demand grows the potential supply
diminishes; therefore it cannot be a perennial, inexhaustible fund. If
bankers find that the demand is growing, they advance their rates of
interest. In other words, they demand a larger share of the profits
of the community. They have two objects to serve in this. They desire
to increase their own profits and they desire to check the demands
upon them. From their point of view, it is better to lend a little at
a high rate of interest than much at a low rate. In their annual or
semi-annual speeches bank chairmen are pleased if they can show their
shareholders that during a certain period the rate of interest has
been high; for it is evidence to them that circumstances have been
in their favour; that they have done good, profitable business. They
lament times when interest has ruled low. And interest rules low when
the fund is said to be overflowing, when the banks cannot lend as much
as they would like. There are, however, as I have already pointed out,
exceptions to this. It is no invariable rule, or law, or sequence,
whatever we may please to call it, that interest is low when the fund
is overflowing and high when the fund has fallen. Interest is governed
by many causes extraneous to the power of banks to lend, and these
causes often arise in an unforeseen, capricious way.
We may say, however, while recognizing the effects of irregular,
uncertain causes, that the value of what is called bank money is
affected by the well-known law of supply and demand, the law that
affects the prices of commodities and of labour. In a general sense,
when the supply of money is greater than the demand the rate of
interest falls; when the demand is in excess of the supply the rate of
interest rises.
Demand increases when borrowers multiply. Borrowers go in growing
numbers to the banks. As the loans thereby increase, so the deposits
increase. If, therefore, the deposits compose the loanable fund, the
loanable fund increases. At last, however, the loanable grows so large
that the banks say they can lend no more. Lend no more, when the
loanable fund is greater than ever? But the banker shakes his head. He
knows that though the loanable fund is greater than ever in appearance,
it is smaller than ever in fact. He knows that the greater the demands
made upon him the more his power of lending decreases, until the moment
arrives when he has to say “Stop!” He sees that as the fund rises the
proportion of the gold reserve falls. So he stops lending, lets his
loans run off, whether secured on bills of discount or securities, and
waits until that so-called loan-fund falls. And when it has fallen,
when the loan-fund is less, then he can lend again, although to the
uninitiated he has apparently less to lend.
How, then, does this fund promptly respond to the demands upon it if
the supply of gold flowing into the banks does not keep pace with those
demands? If the supply of gold, not loan-deposits, kept pace with the
demands then, and then only, could the fund “promptly adjust itself to
the demands upon it.”
It is elementary knowledge in Lombard Street that when the Bank of
England is able, week after week and month after month, to buy up all
the South African and other gold coming into the bullion market, that
it will tend to increase “credit” and depress loan-rates. We know that
the gold will increase the supply of market money more surely than the
growth in the country’s wealth. This is because we know the gold will
eventually find its way to the banks, increase their gold reserves, and
enable them to lend more.
It proves, then, that the working of the fund, elastically or
otherwise, is dependent upon the flow of gold into the Bank of England.
This is because the law has decreed that gold shall be legal tender.
Therefore, the supply of money for the help of commerce, for the
fettered working of the banking system, is dependent in the ultimate
resort upon the law of the land. It is not dependent in the ultimate
resort upon the law of supply and demand, because a more powerful law
controls the economic law. If the law, then, controls the supply of
money, then the law must control the supply of wealth, and the law must
control ultimately the prices of labour and of commodities.
When liquid capital is provided by the banks a charge is made for it.
This rate of interest not only affects the amount of capital that shall
be furnished, but it must affect the prices of the product that comes
into existence from the use of that capital. If the merchant has to
pay a high price for that capital, he must ask a higher price for his
product, for he will not use that capital unremuneratively. The greater
the abundance of capital employed in the country the greater is the
quantity of wealth produced, and the cheaper the capital the lower
are the prices of its products. That is to say, the greater are the
chances of the community partaking of a larger share of that wealth.
If they partake of this larger share it simultaneously increases the
collective, or aggregate, powers of consumption.
It is indisputable that in times of trade activity the demands for
capital grow. Times of depression are coincident with a decline in the
demand.
In this chapter I am but repeating much of what I have urged in former
chapters, but I am naturally anxious to make my argument as strong as
possible by the help of wider and, I trust, clearer illustrations as
I proceed. When we travel over a wide tract of country our vision is
too weak to take in all its topographical features. We can see general
features, but not the minute features which the botanist and the
geologist would examine. The poet would see what the geologist would
not see, and the botanist would see what would escape the naturalist.
So when we take a survey of the economic and financial world we see a
mechanism which is not the same when examined minutely as when looked
at from a distance. When we look at it from afar we cannot see those
defects which on close examination we are able to find.
If rates of interest arbitrarily rise and fall, and the supply of
capital is controlled in an arbitrary way, the general well-being of
the community must be affected. We suffer when the monopolist takes
advantage of the helplessness of the community to raise prices. We
suffer when shipowners take advantage of accidental circumstances to
raise freights and the price of food. We suffer when the colliery
proprietors in the depth of winter raise the price of coal. We suffer
also when the banks raise the rate of interest, thereby raising prices
and affecting employment.
When prices rise, as they have almost uniformly risen in recent years,
many theories are advanced as to the causes of this. Some attribute
it to the increased output of gold. They mean by this that the output
of gold has increased so greatly that more money, or more purchasing
power, is placed in the hands of the community. Producers, observing
this, raise the prices of their commodities. If this were so, the
advance in prices would be general, and we should be no worse or better
off than when prices are low. Wages would inevitably advance if prices
were affected by this universal, not local cause. But it is asserted
that wages have not advanced uniformly, while tradesmen on their part
declare that their profits have fallen. Workmen and tradesmen alike
say that they are poorer than they were ten and twenty years ago, and
the housewife declares that a sovereign now will only go as far as
fifteen or ten shillings went years back.
It is impossible to prove that such a rise is a consequence of an
accelerated production of gold. It is an hypothesis, and an hypothesis
it will remain, for it ignores a multitude of causes more important in
their aggregate effect than gold.
It does not follow, then, that because at given moments capital may
be dearer than at other moments, a general rise or a general fall
in prices will immediately follow. Neither can we lay it down as an
indisputable axiom that a 5 per cent. interest, say, is detrimental to
trade, and a 2 per cent. interest is beneficial to trade. But we can
say, I think, that a very high rate of interest is harmful to trade,
particularly if it be prolonged, and that a constantly fluctuating rate
of interest is more unfavourable for trade than a uniform rate, or a
rate that varies but slightly.
A high rate of interest means dearth of capital, and dearth of capital
must affect production and consumption and the output of wealth, just
as a dearth of seed must affect the coming harvest. The community,
therefore, must necessarily suffer from a dearth of capital, and as
the community is largely dependent upon the banks for the supply of
capital, then it follows that it is best for the community that the
supply should be constant, that it should adjust itself to the demands
upon it. If it could do this, then the rate of interest would tend
to greater uniformity. At any rate, it would not rise and fall so
capriciously as it does do. If it varied it would vary within narrower
compass.
If this could be accomplished, if the supply of capital were less
dependent than it has been and still is, upon extraneous circumstances,
we may see steadier prices, and perhaps one happy effect would be less
labour difficulties and less strikes. Strikes are, in many instances,
the effect of constantly fluctuating prices. But the supply and
price of capital would not alone put an end to fluctuating prices. I
merely hint that it might help to correct those frequent and extreme
fluctuations that cause so much discontentment, and so much envy, and
so much misery.
It would be interesting to speculate what would happen if the Germans
conquered us and took away our colonies and our goldfields. If Germany
restricted or cut off the supply of gold to this country, what would
happen to our loanable fund? How would it affect what we call the
creation of credit? How would it affect the supply of capital? If the
law remained as it is, and the banks could get no more gold reserves,
then there would be no loanable fund and no supply of capital. But the
law being what it is, the supply of capital is dependent upon the
supply of gold.
Mr. Cole admits 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, where
it is simply a question of the rate of interest whether the money
is forthcoming. After admitting, then, that the machinery can break
down and that then there can be but one source of supply, that supply
can only be obtained at a higher price. If it is to be obtained at a
higher price, then it is to be obtained at the general expense of the
community. If capitalists will not pay that higher price, then this
is tantamount to a lessened supply of money. As the Bank of England,
too, will not lend on the same class of wealth that the other banks
will lend on, a vast mass of wealth is excluded. Therefore a vast mass
of wealth cannot be transformed into liquid capital. If no one will
liquefy this wealth, then the production of liquid capital must be
limited, and that capital must remain in its fixed form till the other
banks restart their transforming machinery. If this be so, then the
supply even from the Bank of England is not, as Mr. Cole would have us
believe, unrestricted and illimitable. It is, after all, a restricted
supply, regardless of the entire claims or needs of the community, for
narrower discrimination is practised. The Bank of England may always be
willing to discount or lend upon good bills. But there are other bills
of a lower grade than this class of bill, and there is a vast quantity
of wealth that is rejected by the Bank. If the lending is limited to
good bills, and if the quantity of good bills is limited, then the
supply of money from the Bank must be limited. To say that the supply
is inexhaustible is, therefore, misleading.
We know, too, from experience that when the Bank has been lending for
a time on good bills it has had at times to check these loans. And in
order to check them it has raised the Bank rate. Why has it raised
the rate? To replenish the supply that is said to be inexhaustible.
Mr. Cole says it could get that supply from abroad, and therefore the
fund would be replenished inexhaustibly. If, however, the supply from
abroad were checked, as we can imagine it could be, would the fund be
inexhaustible then? It would be interesting to know if, should the Bank
Act be suspended in certain circumstances, this would fall in with Mr.
Cole’s idea, or conception, of inexhaustibility. Also if the creation
of the Treasury notes falls in with that idea.
We know, of course, that since the war the Bank has lent enormous sums
of money by discounting pre-moratorium bills of exchange. This may seem
to furnish proof of the inexhaustibility of the fund. But while it
has been lending it has been simultaneously receiving gold. There has
been no competition for the gold from South Africa and elsewhere, and
therefore the Bank has been able to procure it in the usual way. Then
New York has been obliged to liquidate its indebtedness to us in large
amounts of gold. But with all this, the proportion of the reserve has
kept well below the normal. What would have happened had the rebellion
spread in South Africa, and had the mines there been closed down
indefinitely?
Even as it was, the Bank rate had to be maintained at an artificially
high level compared with loan and discount rates in the outside market.