CORRELATION
It may now pertinently be asked: Is it possible to keep high gold
reserves in the joint stock banks, taking them as a unit, and
simultaneously a high reserve in the Bank of England? By high reserves
I mean, of course, a high proportion, for this is what we all mean.
What is the test of a high reserve? There is no other test than the
ratio of the gold reserve to the liabilities. We cannot test it by a
quantity of gold _per se_. We cannot say that a hypothetical quantity
is sufficient and a hypothetical quantity insufficient. A reserve
must be related to something. When we speak of gold reserves we speak
correlatively. They are not something standing apart, in the air, as it
were, an independent quantity.
If, then, when we speak of gold reserves, we are conscious of their
relation to something, what is this something? Is it their relation to
the nation’s commerce as a whole, the nation’s needs as a whole, or
merely the restricted relationship to bank liabilities? What critics
mean is the relation between them and the bank liabilities. But banks
are units of a system. They are not a whole in the same sense as the
Bank of England is. They are independent entities. There are large
banks and small banks and medium-sized banks, and they have liabilities
corresponding to their size. Must the small bank have in its safes
exactly the same _quantity_ of gold as the large bank, irrespective of
its liabilities? Or must the small bank have, not the same quantity,
but the same _proportion_? Or are we to aggregate all the liabilities
of the banks of the kingdom and all their gold reserves and say whether
or not the total quantity of gold is sufficient or insufficient? Even
then we must ask: Sufficient for what? Sufficient to meet the total
liabilities in a time of crisis? This is what we mean. We mean a ratio,
a hypothetical ratio that is to save us from disaster.
Now this ratio is constantly fluctuating. It is fluctuating hour by
hour, day by day, week by week, month by month, and year by year. It
is impossible to keep it rigid. The critics know this, and they say
that only an approximate ratio is wanted. But as we can never foretell,
never pre-calculate what an approximate crisis will be, an approximate
panic, or an approximate run, an approximate ratio may not save us. If
mathematics alone will save us, and not common sense, then we must have
mathematical precision, seeing that we are dealing with figures, not
brains and temperaments.
The only way to keep up an approximate ratio is, not to buy gold, as
many advocate, and hoard it, but to stop lending, to call in loans,
and so raise the ratio figure. Then we can have a relative high gold
reserve. We are speaking, of course, in an ideal sense, for there can
be no simultaneous precision in these movements amongst a number of
independent banks, whose business varies hour by hour.
However, in order to maintain their high ratio banks must cease to
lend when this ratio threatens to fall. It is useless buying several
millions worth of gold--if it could be bought--only to lend more upon
it, increase the liabilities and not alter the habitual proportion.
If, therefore, banks cease to lend in order to keep up a high ratio of
reserves to liabilities, what will be the inevitable effect of this
upon the reserve of the Bank of England? They will drive borrowers, as
has been explained in former chapters, to the Bank. As the Bank begins
to lend, so will the ratio of its reserve to its liabilities drop. Mr.
Cole says the Bank of England will always lend _at a price_. If, then,
the Bank’s ratio drops, then the ratio of the reserves of the joint
stock banks must fall, seeing that they hold their reserves at the Bank
of England. The ratio will then drop in proportion to the aggregate
bank liabilities of the kingdom.
The only remedy, then, is for the Bank of England also to refuse to
lend. But Mr. Bagehot and other critics say this would bring on and
aggravate a crisis. So far from refusing to lend, banks, they say, must
lend liberally, with both hands. How, then, are the Bank of England and
the other banks to lend liberally without increasing their liabilities
and reducing the proportion? The proportion could be maintained only by
an inflow of gold proportionate to the rise in the liabilities. How are
we to start this inflow at the critical moment and maintain it?
It cannot be done. There can, however, be an automatic inflow, but only
of legal tender notes, and legal tender, from the standpoint of bank
solvency, is as potent as gold. We cannot produce gold at will, but we
can produce paper at will.
Our gold reserves should be controlled, as I have insisted already,
not solely by the arbitrary output of gold, but by the output of the
nation’s wealth, and by the nation’s needs, and no artificial obstacles
should arrest the growth of national wealth. We do put obstacles in the
way. Banks must keep an eye on their approximate reserves. This is why
they refuse to lend at times, and send wealth-producers to the Bank of
England. We have to put up with this in our present system. But to say
that some hypothetical ratio, which no one can agree upon, will save us
in certain grave, incalculable contingencies is as untenable as many
another economic hypothesis which has no relation to the complexity of
human character and temperament.
But the theorists have insisted in years past, it is not the national
needs we have to consider in a time of crisis; it is the international
claims upon us. Look, they say, at the enormous foreign credits here,
placing unlimited power in the hands of foreigners to take gold from
us _in the time of war_. Well, the war has come, the greatest of all
wars, the war we and the world most dreaded, and all these pre-existing
fears have not been realized. Foreign credits are offset by foreign
liabilities here. Instead of gold being taken abroad in great quantity
the exact opposite has occurred, and why should it never recur?
Gold has come to London in quantities never dreamed of and never
experienced, proving that the dimensions of this hypothetical danger
were greatly magnified.
Since the war we have had too much gold and too much capital, even at a
time when unemployment was low. I mean too much bank capital.
It follows that, as conditions of banking are at present, we cannot
have high proportionate gold reserves in the joint stock banks
simultaneously with a high proportionate reserve in the Bank of
England. This can only be done by stopping the wheels of commerce,
or slowing them down by advances of the Bank of England rate to
attract gold from abroad. But the gold must flow in as rapidly as the
liabilities rise, unless the Bank of England stops lending too. Trade
must be penalized whichever action be taken, and merchants and others
would rather have low ratios than be penalized. They would suffer, and
the country would share their sufferings. To refuse to lend would have
serious consequences and would be the surest way to hasten a panic.