A More Exact Account of the Mode in Which the Bank of England
Has Discharged Its Duty of Retaining a Good Bank Reserve,
and of Administering It Effectually.
The preceding chapters have in some degree enabled us to appreciate
the importance of the duties which the Bank of England is bound to
discharge as to its banking reserve.
If we ask how the Bank of England has discharged this great
responsibility, we shall be struck by three things: first, as has
been said before, the Bank has never by any corporate act or
authorised utterance acknowledged the duty, and some of its
directors deny it; second (what is even more remarkable), no
resolution of Parliament, no report of any Committee of Parliament
(as far as I know), no remembered speech of a responsible statesman,
has assigned or enforced that duty on the Bank; third (what is more
remarkable still), the distinct teaching of our highest authorities
has often been that no public duty of any kind is imposed on the
Banking Department of the Bank; that, for banking purposes, it is
only a joint stock bank like any other bank; that its managers
should look only to the interest of the proprietors and their
dividend; that they are to manage as the London and Westminster Bank
or the Union Bank manages.
At first, it seems exceedingly strange that so important a
responsibility should be unimposed, unacknowledged, and denied; but
the explanation is this. We are living amid the vestiges of old
controversies, and we speak their language, though we are dealing
with different thoughts and different facts. For more than fifty
years--from 1793 down to 1844--there was a keen controversy as to the
public duties of the Bank. It was said to be the 'manager' of the
paper currency, and on that account many expected much good from it;
others said it did great harm; others again that it could do neither
good nor harm. But for the whole period there was an incessant and
fierce discussion. That discussion was terminated by the Act of
1844. By that Act the currency manages itself; the entire working is
automatic. The Bank of England plainly does not manage--cannot even be
said to manage--the currency any more. And naturally, but rashly, the
only reason upon which a public responsibility used to be assigned
to the Bank having now clearly come to an end, it was inferred by
many that the Bank had no responsibility. The complete uncertainty
as to the degree of responsibility acknowledged by the Bank of
England is best illustrated by what has been said by the Bank
directors themselves as to the panic of 1866. The panic of that year,
it will be remembered, happened, contrary to precedent, in the
spring, and at the next meeting of the Court of Bank proprietors--the
September meeting--there was a very remarkable discussion, which I
give at length below, and of which all that is most material was
thus described in the 'Economist':
'THE GREAT IMPORTANCE OF THE LATE MEETING
OF THE PROPRIETORS OF THE BANK OF ENGLAND.
'The late meeting of the proprietors of the Bank of England has a
very unusual importance. There can be no effectual inquiry now into
the history of the late crisis. A Parliamentary committee next year
would, unless something strange occur in the interval, be a great
waste of time. Men of business have keen sensations but short
memories, and they will care no more next February for the events of
last May than they now care for the events of October 1864. A _pro
forma_ inquiry, on which no real mind is spent, and which everyone
knows will lead to nothing, is far worse than no inquiry at all.
Under these circumstances the official statements of the Governor of
the Bank are the only authentic expositions we shall have of the
policy of the Bank Directors, whether as respects the past or the
future. And when we examine the proceedings with care, we shall find
that they contain matter of the gravest import.
'This meeting may be considered to admit and recognise the fact that
the Bank of England keeps the sole banking reserve of the country.
We do not now mix up this matter with the country circulation, or
the question whether there should be many issuers of notes or only
one. We speak not of the currency reserve, but of the banking
reserve--the reserve held against deposits, and not the reserve held
against notes. We have often insisted in these columns that the Bank
of England does keep the sole real reserve--the sole considerable
unoccupied mass of cash in the country; but there has been no
universal agreement about it. Great authorities have been unwilling
to admit it. They have not, indeed, formally and explicitly
contended against it. If they had, they must have pointed out some
other great store of unused cash besides that at the Bank, and they
could not find such store. But they have attempted distinctions; have
said that the doctrine that the Bank of England keeps the sole
banking reserve of the country was "not a good way of putting it,"
was exaggerated, and was calculated to mislead.
'But the late meeting is a complete admission that such is the fact.
The Governor of the Bank said:
"'A great strain has within the last few months been put upon the
resources of this house, and of the whole banking community of
London; and I think I am entitled to say that not only this house,
but the entire banking body, acquitted themselves most honourably
and creditably throughout that very trying period. Banking is a very
peculiar business, and it depends so much upon credit that the least
blast of suspicion is sufficient to sweep away, as it were, the
harvest of a whole year. But the manner in which the banking
establishments generally in London met the demands made upon them
during the greater portion of the past half-year affords a most
satisfactory proof of the soundness of the principles on which their
business is conducted. This house exerted itself to the utmost--and
exerted itself most successfully--to meet the crisis. We did not
flinch from our post. When the storm came upon us, on the morning on
which it became known that the house of Overend and Co. had failed,
we were in as sound and healthy a position as any banking
establishment could hold, and on that day and throughout the
succeeding week we made advances which would hardly be credited. I
do not believe that anyone would have thought of predicting, even at
the shortest period beforehand, the greatness of those advances. It
was not unnatural that in this state of things a certain degree of
alarm should have taken possession of the public mind, and that
those who required accommodation from the Bank should have gone to
the Chancellor of the Exchequer and requested the Government to
empower us to issue notes beyond the statutory amount, if we should
think that such a measure was desirable. But we had to act before we
could receive any such power, and before the Chancellor of the
Exchequer was perhaps out of his bed we had advanced one-half of our
reserves, which were certainly thus reduced to an amount which we
could not witness without regret. But we would not flinch from the
duty which we conceived was imposed upon us of supporting the
banking community, and I am not aware that any legitimate
application made for assistance to this house was refused. Every
gentleman who came here with adequate security was liberally dealt
with, and if accommodation could not be afforded to the full extent
which was demanded, no one who offered proper security failed to
obtain relief from this house."
'Now this is distinctly saying that the other banks of the country
need not keep any such banking reserve--any such sum of actual cash--of
real sovereigns and bank notes, as will help them through a sudden
panic. It acknowledges a "duty" on the part of the Bank of England
to "support the banking community," to make the reserve of the Bank
of England do for them as well as for itself.
'In our judgment this language is most just, and the Governor of the
Bank could scarcely have done a greater public service than by using
language so business-like and so distinct. Let us know precisely who
is to keep the banking reserve. If the joint stock banks and the
private banks and the country banks are to keep their share, let us
determine on that; Mr. Gladstone appeared not long since to say in
Parliament that it ought to be so. But at any rate there should be
no doubt whose duty it is. Upon grounds which we have often stated,
we believe that the anomaly of one bank keeping the sole banking
reserve is so fixed in our system that we cannot change it if we
would. The great evil to be feared was an indistinct conception of
the fact, and that is now avoided.
'The importance of these declarations by the Bank is greater,
because after the panic of 1857 the bank did not hold exactly the
same language. A person who loves concise expressions said lately
"that Overends broke the Bank in 1866 because it went, and in 1857
because it was not let go." We need not too precisely examine such
language; the element of truth in it is very plain--the great advances
made to Overends were a principal event in the panic of 1857; the
bill-brokers were then very much what the bankers were lately they
were the borrowers who wanted sudden and incalculable advances. But
the bill-brokers were told not to expect the like again. But
Alderman Salomons, on the part of the London bankers, said, "he
wished to take that opportunity of stating that he believed nothing
could be more satisfactory to the managers and shareholders of joint
stock banks than the testimony which the Governor of the Bank of
England had that day borne to the sound and honourable manner in
which their business was conducted. It was manifestly desirable that
the joint stock banks and the banking interest generally should work
in harmony with the Bank of England; and he sincerely thanked the
Governor of the Bank for the kindly manner in which he had alluded
to the mode in which the joint stock banks had met the late monetary
crisis." The Bank of England agrees to give other banks the
requisite assistance in case of need, and the other banks agree to
ask for it.
'Secondly. The Bank agrees, in fact, if not in name, to make limited
advances on proper security to anyone who applies for it. On the
present occasion 45,000,000 L. was so advanced in three months. And
the Bank do not say to the mercantile community, or to the bankers,
"Do not come to us again. We helped you once. But do not look upon
it as a precedent. We will not help you again." On the contrary, the
evident and intended implication is that under like circumstances
the Bank would act again as it has now acted.'
This article was much disliked by many of the Bank directors, and
especially by some whose opinion is of great authority. They thought
that the 'Economist' drew 'rash deductions' from a speech which was
in itself 'open to some objection--'which was, like all such speeches,
defective in theoretical precision, and which was at best only the
expression of an opinion by the Governor of that day, which had not
been authorised by the Court of Directors, which could not bind the
Bank. However the article had at least this use, that it brought out
the facts. All the directors would have felt a difficulty in
commenting upon, or limiting, or in differing from, a speech of a
Governor from the chair. But there was no difficulty or delicacy in
attacking the 'Economist.' Accordingly Mr. Hankey, one of the most
experienced bank directors, not long after, took occasion to
observe: 'The "Economist" newspaper has put forth what in my opinion
is the most mischievous doctrine ever broached in the monetary or
banking world in this country; viz, that it is the proper function
of the Bank of England to keep money available at all times to
supply the demands of bankers who have rendered their own assets
unavailable. Until such a doctrine is repudiated by the banking
interest, the difficulty of pursuing any sound principle of banking
in London will be always very great. But I do not believe that such
a doctrine as that bankers are justified in relying on the Bank of
England to assist them in time of need is generally held by the
bankers in London.
'I consider it to be the undoubted duty of the Bank of England to
hold its banking deposits (reserving generally about one-third in
cash) in the most available securities; and in the event of a sudden
pressure in the money market, by whatever circumstance it may be
caused, to bear its full share of a drain on its resources. I am
ready to admit, however, that a general opinion has long prevailed
that the Bank of England ought to be prepared to do much more than
this, though I confess my surprise at finding an advocate for such
an opinion in the "Economist." If it were practicable for the
Bank to retain money unemployed to meet such an emergency, it would
be a very unwise thing to do so. But I contend that it is quite
impracticable, and if it were possible, it would be most
inexpedient; and I can only express my regret that the Bank, from a
desire to do everything in its power to afford general assistance in
times of banking or commercial distress, should ever have acted in a
way to encourage such an opinion. The more the conduct of the
affairs of the Bank is made to assimilate to the conduct of every
other well-managed bank in the United Kingdom, the better for the
Bank, and the better for the community at large.'
I am scarcely a judge, but I do not think Mr. Hankey replies to the
'Economist' very conclusively.
First. He should have observed that the question is not as to what
'ought to be,' but as to what is. The 'Economist' did not say that
the system of a single bank reserve was a good system, but that it
was the system which existed, and which must be worked, as you could
not change it.
Secondly. Mr. Hankey should have shown 'some other store of unused
cash' except the reserve in the Banking Department of the Bank of
England out of which advances in time of panic could be made. These
advances are necessary, and must be made by someone. The 'reserves'
of London bankers are not such store; they are used cash, not
unused; they are part of the Bank deposits, and lent as such.
Thirdly. Mr. Hankey should have observed that we know by the
published figures that the joint stock banks of London do not keep
one-third, or anything like one-third, of their liabilities in
'cash' even meaning by 'cash' a deposit at the Bank of England.
One-third of the deposits in joint stock banks, not to speak of the
private banks, would be 30,000,000 L.; and the private deposits of
the Bank of England are 18,000,000 L. According to his own
statement, there is a conspicuous contrast. The joint stock banks,
and the private banks, no doubt, too, keep one sort of reserve, and
the Bank of England a different kind of reserve altogether. Mr.
Hankey says that the two ought to be managed on the same principle;
but if so, he should have said whether he would assimilate the
practice of the Bank of England to that of the other banks, or that
of the other banks to the practice of the Bank of England.
Fourthly. Mr. Hankey should have observed that, as has been
explained, in most panics, the principal use of a 'banking reserve'
is not to advance to bankers; the largest amount is almost always
advanced to the mercantile public and to bill-brokers. But the point
is, that by our system all extra pressure is thrown upon the Bank of
England. In the worst part of the crisis of 1866, 50,000 L. 'fresh
money' could not be borrowed, even on the best security--even on
Consols except at the Bank of England. There was no other lender to
new borrowers.
But my object now is not to revive a past controversy, but to show
in what an unsatisfactory and uncertain condition that controversy
has left a most important subject. Mr. Hankey's is the last
explanation we have had of the policy of the Bank. He is a very
experienced and attentive director, and I think expresses, more or
less, the opinions of other directors. And what do we find? Setting
aside and saying nothing about the remarkable speech of the Governor
in 1866, which at least (according to the interpretation of the
'Economist') was clear and excellent, Mr. Hankey leaves us in doubt
altogether as to what will be the policy of the Bank of England in
the next panic, and as to what amount of aid the public may then
expect from it. His words are too vague. No one can tell what a
'fair share' means; still less can we tell what other people at some
future time will say it means. Theory suggests, and experience
proves, that in a panic the holders of the ultimate Bank reserve
(whether one bank or many) should lend to all that bring good
securities quickly, freely, and readily. By that policy they allay a
panic; by every other policy they intensify it. The public have a
right to know whether the Bank of England--the holders of our ultimate
bank reserve--acknowledge this duty, and are ready to perform it. But
this is now very uncertain.
If we refer to history, and examine what in fact has been the
conduct of the Bank directors, we find that they have acted exactly
as persons of their type, character, and position might have been
expected to act. They are a board of plain, sensible, prosperous
English merchants; and they have both done and left undone what such
a board might have been expected to do and not to do. Nobody could
expect great attainments in economical science from such a board;
laborious study is for the most part foreign to the habits of
English merchants. Nor could we expect original views on banking,
for banking is a special trade, and English merchants, as a body,
have had no experience in it. A 'board' can scarcely ever make
improvements, for the policy of a board is determined by the
opinions of the most numerous class of its members--its average
members--and these are never prepared for sudden improvements. A board
of upright and sensible merchants will always act according to what
it considers 'safe' principles--that is, according to the received
maxims of the mercantile world then and there--and in this manner the
directors of the Bank of England have acted nearly uniformly. Their
strength and their weakness were curiously exemplified at the time
when they had the most power. After the suspension of cash payments
in 1797, the directors of the Bank of England could issue what notes
they liked. There was no check; these notes could not come back upon
the Bank for payment; there was a great temptation to extravagant
issue, and no present penalty upon it. But the directors of the Bank
withstood the temptation; they did not issue their inconvertible
notes extravagantly. And the proof is, that for more than ten years
after the suspension of cash payments the Bank paper was
undepreciated, and circulated at no discount in comparison with
gold. Though the Bank directors of that day at last fell into
errors, yet on the whole they acted with singular judgment and
moderation. But when, in 1810, they came to be examined as to their
reasons, they gave answers that have become almost classical by
their nonsense. Mr. Pearse, the Governor of the Bank, said: 'In
considering this subject, with reference to the manner in which
bank-notes are issued, resulting from the applications made for
discounts to supply the necessary want of bank-notes, by which their
issue in amount is so controlled that it can never amount to an
excess, I cannot see how the amount of bank-notes issued can operate
upon the price of bullion, or the state of the exchanges; and
therefore I am individually of opinion that the price of bullion, or
the state of the exchanges, can never be a reason for lessening the
amount of bank-notes to be issued, always understanding the control
which I have already described.
'Is the Governor of the Bank of the same opinion which has now been
expressed by the Deputy-Governor?
'Mr. Whitmore, I am so much of the same opinion, that I never think
it necessary to advert to the price of gold, or the state of the
exchange, on the days on which we make our advances.
'Do you advert to these two circumstances with a view to regulate
the general amount of your advances?--I do not advert to it with a
view to our general advances, conceiving it not to bear upon the
question.
And Mr. Harman, another Bank director, expressed his opinion in
these terms: 'I must very materially alter my opinions before I can
suppose that the exchanges will be influenced by any modifications
of our paper currency.'
Very few persons perhaps could have managed to commit so many
blunders in so few words.
But it is no disgrace at all to the Bank directors of that day to
have committed these blunders. They spoke according to the best
mercantile opinion of England. The City of London and the House of
Commons both approved of what they said; those who dissented were
said to be abstract thinkers and unpractical men. The Bank directors
adopted the ordinary opinions, and pursued the usual practice of
their time. It was this 'routine' that caused their moderation. They
believed that so long as they issued 'notes' only at 5 per cent, and
only on the discount of good bills, those notes could not be
depreciated. And as the number of 'good' bills--bills which sound
merchants know to be good--does not rapidly increase, and as the
market rate of interest was often less than 5 per cent, these checks
on over-issue were very effective. They failed in time, and the
theory upon which they were defended was nonsense; but for a time
their operation was powerful and excellent.
Unluckily, in the management of the matter before us--the management
of the Bank reserve--the directors of the Bank of England were neither
acquainted with right principles, nor were they protected by a
judicious routine. They could not be expected themselves to discover
such principles. The abstract thinking of the world is never to be
expected from persons in high places; the administration of
first-rate current transactions is a most engrossing business, and
those charged with them are usually but little inclined to think on
points of theory, even when such thinking most nearly concerns those
transactions. No doubt when men's own fortunes are at stake, the
instinct of the trader does somehow anticipate the conclusions of
the closet. But a board has no instincts when it is not getting an
income for its members, and when it is only discharging a duty of
office. During the suspension of cash payments--a suspension which
lasted twenty-two years--all traditions as to a cash reserve had died
away. After 1819 the Bank directors had to discharge the duty of
keeping a banking reserve, and (as the law then stood) a currency
reserve also, without the guidance either of keen interests, or good
principles, or wise traditions.
Under such circumstances, the Bank directors inevitably made
mistakes of the gravest magnitude. The first time of trial came in
1825. In that year the Bank directors allowed their stock of bullion
to fall in the most alarming manner:
On Dec. 24, 1824, the coin and bullion in the Bank was L 10,721,000
On Dec. 25, 1825, it was reduced to L 1,260,000
and the consequence was a panic so tremendous that its results are
well remembered after nearly fifty years. In the next period of
extreme trial--in 1837-9--the Bank was compelled to draw for 2,000,000 L.
on the Bank of France; and even after that aid the directors
permitted their bullion, which was still the currency reserve as
well as the banking reserve, to be reduced to 2,404,000 L.: a great
alarm pervaded society, and generated an eager controversy, out of
which ultimately emerged the Act of 1844. The next trial came in
1847, and then the Bank permitted its banking reserve (which the law
had now distinctly separated) to fall to 1,176,000 L.; and so
intense was the alarm, that the executive Government issued a letter
of licence, permitting the Bank, if necessary, to break the new law,
and, if necessary, to borrow from the currency reserve, which was
full, in aid of the banking reserve, which was empty. Till 1857
there was an unusual calm in the money market, but in the autumn of
that year the Bank directors let the banking reserve, which even in
October was far too small, fall thus:
Oct. 10 4,024,000 L
" 17 3,217,000 L
" 24 3,485,000 L
" 31 2,258,000 L
Nov. 6 2,155,000 L
" 13 957,000 L
And then a letter of licence like that of 1847 was not only issued,
but used. The Ministry of the day authorised the Bank to borrow from
the currency reserve in aid of the banking reserve, and the Bank of
England did so borrow several hundred pounds till the end of the
month of November. A more miserable catalogue than that of the
failures of the Bank of England to keep a good banking reserve in
all the seasons of trouble between 1825 and 1857 is scarcely to be
found in history.
But since 1857 there has been a great improvement. By painful events
and incessant discussions, men of business have now been trained to
see that a large banking reserve is necessary, and to understand
that, in the curious constitution of the English banking world, the
Bank of England is the only body which could effectually keep it.
They have never acknowledged the duty; some of them, as we have
seen, deny the duty; still they have to a considerable extent begun
to perform the duty. The Bank directors, being experienced and able
men of business, comprehended this like other men of business. Since
1857 they have always kept, I do not say a sufficient banking
reserve, but a fair and creditable banking reserve, and one
altogether different from any which they kept before. At one period
the Bank directors even went farther: they made a distinct step in
advance of the public intelligence; they adopted a particular mode
of raising the rate of interest, which is far more efficient than
any other mode. Mr. Goschen observes, in his book on the Exchanges:
'Between the rates in London and Paris, the expense of sending gold
to and fro having been reduced to a minimum between the two cities,
the difference can never be very great; but it must not be forgotten
that, the interest being taken at a percentage calculated per annum,
and the probable profit having, when an operation in three-month
bills is contemplated, to be divided by four, whereas the percentage
of expense has to be wholly borne by the one transaction, a very
slight expense becomes a great impediment. If the cost is only 1/2 per
cent, there must be a profit of 2 per cent in the rate of interest,
or 1/2 per cent on three months, before any advantage commences; and
thus, supposing that Paris capitalists calculate that they may send
their gold over to England for 1/2 per cent expense, and chance their
being so favoured by the Exchanges as to be able to draw it back
without any cost at all, there must nevertheless be an excess of
more than 2 per cent in the London rate of interest over that in
Paris, before the operation of sending gold over from France, merely
for the sake of the higher interest, will pay.'
Accordingly, Mr. Goschen recommended that the Bank of England
should, as a rule, raise their rate by steps of 1 per cent at a time
when the object of the rise was to affect the 'foreign Exchanges.'
And the Bank of England, from 1860 onward, have acted upon that
principle. Before that time they used to raise their rate almost
always by steps of 1/2 per cent, and there was nothing in the general
state of mercantile opinion to compel them to change their policy.
The change was, on the contrary, most unpopular. On this occasion,
and, as far as I know, on this occasion alone, the Bank of England
made an excellent alteration of their policy, which was not exacted
by contemporary opinion, and which was in advance of it. The
beneficial results of the improved policy of the Bank were palpable
and speedy. We were enabled by it to sustain the great drain of
silver from Europe to India to pay for Indian cotton in the years
between 18621865. In the autumn of 1864 there was especial danger;
but, by a rapid and able use of their new policy, the Bank of
England maintained an adequate reserve, and preserved the country
from calamities which, if we had looked only to precedent, would
have seemed inevitable. All the causes which produced the panic of
1857 were in action in 1864--the drain of silver in 1864 and the
preceding year was beyond comparison greater than in 1857 and the
years before it--and yet in 1864 there was no panic. The Bank of
England was almost immediately rewarded for its adoption of right
principles by finding that those principles, at a severe crisis,
preserved public credit.
In 1866 undoubtedly a panic occurred, but I do not think that the
Bank of England can be blamed for it. They had in their till an
exceedingly good reserve according to the estimate of that time--a
sufficient reserve, in all probability, to have coped with the
crises of 1847 and 1857. The suspension of Overend and Gurney--the
most trusted private firm in England caused an alarm, in suddenness
and magnitude, without example. What was the effect of the Act of
1844 on the panic of 1866 is a question on which opinion will be
long divided; but I think it will be generally agreed that, acting
under the provisions of that law, the directors of the Bank of
England had in their banking department in that year a fairly large
reserve quite as large a reserve as anyone expected them to keep--to
meet unexpected and painful contingencies.
From 1866 to 1870 there was almost an unbroken calm on the money
market. The Bank of England had no difficulties to cope with; there
was no opportunity for much discretion. The money market took care
of itself. But in 1870 the Bank of France suspended specie payments,
and from that time a new era begins. The demands on this market for
bullion have been greater, and have been more incessant, than they
ever were before, for this is now the only bullion market. This has
made it necessary for the Bank of England to hold a much larger
banking reserve than was ever before required, and to be much more
watchful than in former times lest that banking reserve should on a
sudden be dangerously diminished. The forces are greater and quicker
than they used to be, and a firmer protection and a surer solicitude
are necessary. But I do not think the Bank of England is
sufficiently aware of this. All the governing body of the Bank
certainly are not aware of it. The same eminent director to whom I
have before referred, Mr. Hankey, published in the 'Times' an
elaborate letter, saying again that one-third of the liabilities
were, even in these altered times, a sufficient reserve for the
Banking Department of the Bank of England, and that it was no part
of the business of the Bank to keep a supply of 'bullion for
exportation,' which was exactly the most mischievous doctrine that
could be maintained when the Banking Department of the Bank of
England had become the only great repository in Europe where gold
could at once be obtained, and when, therefore, a far greater store
of bullion ought to be kept than at any former period.
And besides this defect of the present time, there are some chronic
faults in the policy of the Bank of England, which arise, as will be
presently explained, from grave defects in its form of government.
There is almost always some hesitation when a Governor begins to
reign. He is the Prime Minister of the Bank Cabinet; and when so
important a functionary changes, naturally much else changes too. If
the Governor be weak, this kind of vacillation and hesitation
continues throughout his term of office. The usual defect then is,
that the Bank of England does not raise the rate of interest
sufficiently quickly. It does raise it; in the end it takes the
alarm, but it does not take the alarm sufficiently soon. A cautious
man, in a new office, does not like strong measures. Bank Governors
are generally cautious men; they are taken from a most cautious
class; in consequence they are very apt to temporise and delay. But
almost always the delay in creating a stringency only makes a
greater stringency inevitable. The effect of a timid policy has been
to let the gold out of the Bank, and that gold must be recovered. It
would really have been far easier to have maintained the reserve by
timely measures than to have replenished it by delayed measures; but
new Governors rarely see this.
Secondly. Those defects are apt, in part, or as a whole, to be
continued throughout the reign of a weak Governor. The objection to
a decided policy, and the indisposition to a timely action, which
are excusable in one whose influence is beginning, and whose reign
is new, is continued through the whole reign of one to whom those
defects are natural, and who exhibits those defects in all his
affairs.
Thirdly. This defect is enhanced, because, as has so often been
said, there is now no adequate rule recognised in the management of
the banking reserve. Mr. Weguelin, the last Bank Governor who has
been examined, said that it was sufficient for the Bank to keep from
one-fourth to one-third of its banking liabilities as a reserve. But
no one now would ever be content if the banking reserve were near to
one-fourth of its liabilities. Mr. Hankey, as I have shown,
considers 'about a third' as the proportion of reserve to liability
at which the Bank should aim; but he does not say whether he regards
a third as the minimum below which the reserve in the Banking
Department should never be, or as a fair average, about which the
reserve may fluctuate, sometimes being greater, or at others less.
In a future chapter I shall endeavour to show that one-third of its
banking liabilities is at present by no means an adequate reserve
for the Banking Department--that it is not even a proper minimum, far
less a fair average; and I shall allege what seem to me good reasons
for thinking that, unless the Bank aim by a different method at a
higher standard, its own position may hereafter be perilous, and the
public may be exposed to disaster.
II.
But, as has been explained, the Bank of England is bound, according
to our system, not only to keep a good reserve against a time of
panic, but to use that reserve effectually when that time of panic
comes. The keepers of the Banking reserve, whether one or many, are
obliged then to use that reserve for their own safety. If they
permit all other forms of credit to perish, their own will perish
immediately, and in consequence.
As to the Bank of England, however, this is denied. It is alleged
that the Bank of England can keep aloof in a panic; that it can, if
it will, let other banks and trades fail; that if it chooses, it can
stand alone, and survive intact while all else perishes around it.
On various occasions, most influential persons, both in the
government of the Bank and out of it, have said that such was their
opinion. And we must at once see whether this opinion is true or
false, for it is absurd to attempt to estimate the conduct of the
Bank of England during panics before we know what the precise
position of the Bank in a panic really is.
The holders of this opinion in its most extreme form say, that in a
panic the Bank of England can stay its hand at any time; that,
though it has advanced much, it may refuse to advance more; that
though the reserve may have been reduced by such advances, it may
refuse to lessen it still further; that it can refuse to make any
further dis counts; that the bills which it has discounted will
become due; that it can refill its reserve by the payment of those
bills; that it can sell stock or other securities, and so replenish
its reserve still further. But in this form the notion scarcely
merits serious refutation. If the Bank reserve has once become low,
there are, in a panic, no means of raising it again. Money parted
with at such a time is very hard to get back; those who have taken
it will not let it go--not, at least, unless they are sure of getting
other money in its place. And at such instant the recovery of money
is as hard for the Bank of England as for any one else, probably
even harder. The difficulty is this: if the Bank decline to
discount, the holders of the bills previously discounted cannot pay.
As has been shown, trade in England is largely carried on with
borrowed money. If you propose greatly to reduce that amount, you
will cause many failures unless you can pour in from elsewhere some
equivalent amount of new money. But in a panic there is no new money
to be had; everybody who has it clings to it, and will not part with
it. Especially what has been advanced to merchants cannot easily be
recovered; they are under immense liabilities, and they will not
give back a penny which they imagine that even possibly they may
need to discharge those liabilities. And bankers are in even greater
terror. In a panic they will not discount a host of new bills; they
are engrossed with their own liabilities and those of their own
customers, and do not care for those of others. The notion that the
Bank of England can stop discounting in a panic, and so obtain fresh
money, is a delusion. It can stop discounting, of course, at
pleasure. But if it does, it will get in no new money; its bill case
will daily be more and more packed with bills 'returned unpaid.'
The sale of stock, too, by the Bank of England in the middle of a
panic is impossible. The bank at such a time is the only lender on
stock, and it is only by loans from a bank that large purchases, at
such a moment, can be made. Unless the Bank of England lend, no
stock will be bought. There is not in the country any large sum of
unused ready money ready to buy it. The only unused sum is the
reserve in the Banking Department of the Bank of England: if,
therefore, in a panic that Department itself attempt to sell stock,
the failure would be ridiculous. It would hardly be able to sell any
at all. Probably it would not sell fifty pounds' worth. The idea
that the Bank can, during a panic, replenish its reserve in this or
in any other manner when that reserve has once been allowed to
become empty, or nearly empty, is too absurd to be steadily
maintained, though I fear that it is not yet wholly abandoned.
The second and more reasonable conception of the independence of the
Bank of England is, however, this: It may be said, and it is said,
that if the Bank of England stop at the beginning of a panic, if it
refuse to advance a shilling more than usual, if it begin the battle
with a good banking reserve, and do not diminish it by extra loans,
the Bank of England is sure to be safe. But this form of the
opinion, though more reasonable and moderate, is not, therefore,
more true. The panic of 1866 is the best instance to test it. As
everyone knows, that panic began quite suddenly, on the fall of
'Overends.' Just before, the Bank had 5,812,000 L. in its reserve;
in fact, it advanced 13,000,000 L. of new money in the next few
days, and its reserve went down to nothing, and the Government had
to help. But if the Bank had not made these advances, could it have
kept its reserve?
Certainly it could not. It could not have retained its own deposits.
A large part of these are the deposits of bankers, and they would
not consent to help the Bank of England in a policy of isolation.
They would not agree to suspend payments themselves, and permit the
Bank of England to survive, and get all their business. They would
withdraw their deposits from the Bank; they would not assist it to
stand erect amid their ruin. But even if this were not so, even if
the banks were willing to keep their deposits at the Bank while it
was not lending, they would soon find that they could not do it.
They are only able to keep those deposits at the Bank by the aid of
the Clearing-house system, and if a panic were to pass a certain
height, that system, which rests on confidence, would be destroyed
by terror.
The common course of business is this. A B having to receive 50,000
l. from C D takes C D's cheque on a banker crossed, as it is called,
and, therefore, only payable to another banker. He pays that cheque
to his own credit with his own banker, who presents it to the banker
on whom it is drawn, and if good it is an item between them in the
general clearing or settlement of the afternoon. But this is
evidently a very refined machinery, which a panic will be apt to
destroy. At the first stage A B may say to his debtor C D, 'I cannot
take your cheque, I must have bank-notes.' If it is a debt on
securities, he will be very apt to say this. The usual
practice--credit being good--is for the creditor to take the debtor's
cheque, and to give up the securities. But if the 'securities'
really secure him in a time of difficulty, he will not like to give
them up, and take a bit of paper--a mere cheque, which may be paid or
not paid. He will say to his debtor, 'I can only give you your
securities if you will give me bank-notes.' And if he does say so,
the debtor must go to his bank, and draw out the 50,000 L. if he has
it. But if this were done on a large scale, the bank's 'cash in
house' would soon be gone; as the Clearing-house was gradually
superseded it would have to trench on its deposit at the Bank of
England; and then the bankers would have to pay so much over the
counter that they would be unable to keep much money at the Bank,
even if they wished. They would soon be obliged to draw out every
shilling.
The diminished use of the Clearing-house, in consequence of the
panic, would intensify that panic. By far the greater part of the
bargains of the country in moneyed securities is settled on the
Stock Exchange twice a month, and the number of securities then
given up for mere cheques, and the number of cheques then passing at
the Clearing-house are enormous. If that system collapse, the number
of failures would be incalculable, and each failure would add to the
discredit that caused the collapse.
The non-banking customers of the Bank of England would be
discredited as well as other people; their cheques would not be
taken any more than those of others; they would have to draw out
bank-notes, and the Bank reserve would not be enough for a tithe of
such payments.
The matter would come shortly to this: a great number of brokers and
dealers are under obligations to pay immense sums, and in common
times they obtain these sums by the transfer of certain securities.
If, as we said just now, No. 1 has borrowed 50,000 L. of No. 2 on
Exchequer bills, he, for the most part, cannot pay No. 2 till he has
sold or pledged those bills to some one else. But till he has the
bills he cannot pledge or sell them; and if No. 2 will not give them
up till he gets his money, No. 1 will be ruined, because he cannot
pay it. And if No. 2 has No. 3 to pay, as is very likely, he may be
ruined because of No. 1's default, and No. 4 only on account of No.
3's default; and so on without end. On settling day, without the
Clearing-house, there would be a mass of failures, and a bundle of
securities. The effect of these failures would be a general run on
all bankers, and on the Bank of England particularly.
It may indeed be said that the money thus taken from the Banking
Department of the Bank of England would return there immediately;
that the public who borrowed it would not know where else to deposit
it; that it would be taken out in the morning, and put back in the
evening. But, in the first place, this argument assumes that the
Banking Department would have enough money to pay the demands on it;
and this is a mistake: the Banking Department would not have a
hundredth part of the necessary funds. And in the second, a great
panic which deranged the Clearing-house would soon be diffused all
through the country. The money therefore taken from the Bank of
England could not be soon returned to the Bank; it would not come
back on the evening of the day on which it was taken out, or for
many days; it would be distributed through the length and breadth of
the country, wherever there were bankers, wherever there was trade,
wherever there were liabilities, wherever there was terror.
And even in London, so immense a panic would soon impair the credit
of the Banking Department of the Bank of England. That department
has no great prestige. It was only created in 1844, and it has
failed three times since. The world would imagine that what has
happened before will happen again; and when they have got money,
they will not deposit it at an establishment which may not be able
to repay it. This did not happen in former panics, because the case
we are considering never arose. The Bank was helping the public,
and, more or less confidently, it was believed that the Government
would help the Bank. But if the policy be relinquished which
formerly assuaged alarm, that alarm will be protracted and enhanced,
till it touch the Banking Department of the Bank itself.
I do not imagine that it would touch the Issue Department. I think
that the public would be quite satisfied if they obtained bank-notes.
Generally nothing is gained by holding the notes of a bank instead
of depositing them at a bank. But in the Bank of England there is a
great difference: their notes are legal tender. Whoever holds them
can always pay his debts, and, except for foreign payments, he could
want no more. The rush would be for bank-notes; those that could be
obtained would be carried north, south, east, and west, and, as
there would not be enough for all the country, the Banking
Department would soon pay away all it had.
Nothing, therefore, can be more certain than that the Bank of
England has in this respect no peculiar privilege; that it is simply
in the position of a Bank keeping the Banking reserve of the
country; that it must in time of panic do what all other similar
banks must do; that in time of panic it must advance freely and
vigorously to the public out of the reserve.
And with the Bank of England, as with other Banks in the same case,
these advances, if they are to be made at all, should be made so as
if possible to obtain the object for which they are made. The end is
to stay the panic; and the advances should, if possible, stay the
panic. And for this purpose there are two rules: First. That these
loans should only be made at a very high rate of interest. This will
operate as a heavy fine on unreasonable timidity, and will prevent
the greatest number of applications by persons who do not require
it. The rate should be raised early in the panic, so that the fine
may be paid early; that no one may borrow out of idle precaution
without paying well for it; that the Banking reserve may be
protected as far as possible.
Secondly. That at this rate these advances should be made on all
good banking securities, and as largely as the public ask for them.
The reason is plain. The object is to stay alarm, and nothing
therefore should be done to cause alarm. But the way to cause alarm
is to refuse some one who has good security to offer. The news of
this will spread in an instant through all the money market at a
moment of terror; no one can say exactly who carries it, but in half
an hour it will be carried on all sides, and will intensify the
terror everywhere. No advances indeed need be made by which the Bank
will ultimately lose. The amount of bad business in commercial
countries is an infinitesimally small fraction of the whole
business. That in a panic the bank, or banks, holding the ultimate
reserve should refuse bad bills or bad securities will not make the
panic really worse; the 'unsound' people are a feeble minority, and
they are afraid even to look frightened for fear their unsoundness
may be detected. The great majority, the majority to be protected,
are the 'sound' people, the people who have good security to offer.
If it is known that the Bank of England is freely advancing on what
in ordinary times is reckoned a good security--on what is then
commonly pledged and easily convertible--the alarm of the solvent
merchants and bankers will be stayed. But if securities, really good
and usually convertible, are refused by the Bank, the alarm will not
abate, the other loans made will fail in obtaining their end, and
the panic will become worse and worse.
It may be said that the reserve in the Banking Department will not
be enough for all such loans. If that be so, the Banking Department
must fail. But lending is, nevertheless, its best expedient. This is
the method of making its money go the farthest, and of enabling it
to get through the panic if anything will so enable it. Making no
loans as we have seen will ruin it; making large loans and stopping,
as we have also seen, will ruin it. The only safe plan for the Bank
is the brave plan, to lend in a panic on every kind of current
security, or every sort on which money is ordinarily and usually
lent. This policy may not save the Bank; but if it do not, nothing
will save it.
If we examine the manner in which the Bank of England has fulfilled
these duties, we shall find, as we found before, that the true
principle has never been grasped; that the policy has been
inconsistent; that, though the policy has much improved, there still
remain important particulars in which it might be better than it is.
The first panic of which it is necessary here to speak, is that of
1825: I hardly think we should derive much instruction from those of
1793 and 1797; the world has changed too much since; and during the
long period of inconvertible currency from 1797 to 1819, the
problems to be solved were altogether different from our present
ones. In the panic of 1825, the Bank of England at first acted as
unwisely as it was possible to act. By every means it tried to
restrict its advances. The reserve being very small, it endeavoured
to protect that reserve by lending as little as possible. The result
was a period of frantic and almost inconceivable violence; scarcely
any one knew whom to trust; credit was almost suspended; the country
was, as Mr. Huskisson expressed it, within twenty-four hours of a
state of barter. Applications for assistance were made to the
Government, but though it was well known that the Government refused
to act, there was not, as far as I know, until lately any authentic
narrative of the real facts. In the 'Correspondence' of the Duke of
Wellington, of all places in the world, there is a full account of
them. The Duke was then on a mission at St. Petersburg, and Sir R.
Peel wrote to him a letter of which the following is a part: 'We
have been placed in a very unpleasant predicament on the other
question--the issue of Exchequer Bills by Government. The feeling of
the City, of many of our friends, of some of the Opposition, was
decidedly in favour of the issue of Exchequer Bills to relieve the
merchants and manufacturers.
'It was said in favour of the issue, that the same measure had been
tried and succeeded in 1793 and 1811. Our friends whispered about
that we were acting quite in a different manner from that in which
Mr. Pitt did act, and would have acted had he been alive.
'We felt satisfied that, however plausible were the reasons urged in
favour of the issue of Exchequer Bills, yet that the measure was a
dangerous one, and ought to be resisted by the Government.
'There are thirty millions of Exchequer Bills outstanding. The purchases
lately made by the Bank can hardly maintain them at par. If there were a
new issue to such an amount as that contemplated--viz., five
millions--there would be a great danger that the whole mass of Exchequer
Bills would be at a discount, and would be paid into the revenue. If the
new Exchequer Bills were to be issued at a different rate of interest
from the outstanding ones--say bearing an interest of five per cent--the
old ones would be immediately at a great discount unless the interest
were raised. If the interest were raised, the charge on the revenue
would be of course proportionate to the increase of rate of interest. We
found that the Bank had the power to lend money on deposit of goods. As
our issue of Exchequer Bills would have been useless unless the Bank
cashed them, as therefore the intervention of the Bank was in any event
absolutely necessary, and as its intervention would be chiefly useful by
the effect which it would have in increasing the circulating medium, we
advised the Bank to take the whole affair into their own hands at once,
to issue their notes on the security of goods, instead of issuing them
on Exchequer Bills, such bills being themselves issued on that security.
'They reluctantly consented, and rescued us from a very embarrassing
predicament.'
The success of the Bank of England on this occasion was owing to its
complete adoption of right principles. The Bank adopted these
principles very late; but when it adopted them it adopted them
completely. According to the official statement which I quoted
before, 'we,' that is, the Bank directors, 'lent money by every
possible means, and in modes which we had never adopted before; we
took in stock on security, we purchased Exchequer Bills, we made
advances on Exchequer Bills, we not only discounted outright, but we
made advances on deposits of bills of Exchange to an immense
amount--in short, by every possible means consistent with the safety
of the Bank.' And for the complete and courageous adoption of this
policy at the last moment the directors of the Bank of England at
that time deserve great praise, for the subject was then less
understood even than it is now; but the directors of the Bank
deserve also severe censure, for previously choosing a contrary
policy; for being reluctant to adopt the new one; and for at last
adopting it only at the request of, and upon a joint responsibility
with, the Executive Government.
After 1825, there was not again a real panic in the money market
till 1847. Both of the crises of 1837 and 1839 were severe, but
neither terminated in a panic: both were arrested before the alarm
reached its final intensity; in neither, therefore, could the policy
of the Bank at the last stage of fear be tested.
In the three panics since 1844--in 1847, 1857, and 1866--the policy of
the Bank has been more or less affected by the Act of 1844, and I
cannot therefore discuss it fully within the limits which I have pre
scribed for myself. I can only state two things: First, that the
directors of the Bank above all things maintain, that they have not
been in the earlier stage of panic prevented by the Act of 1844
from making any advances which they would otherwise have then made.
Secondly, that in the last stage of panic, the Act of 1844 has been
already suspended, rightly or wrongly, on these occasions; that no
similar occasion has ever yet occurred in which it has not been
suspended; and that, rightly or wrongly, the world confidently
expects and relies that in all similar cases it will be suspended
again. Whatever theory may prescribe, the logic of facts seems
peremptory so far. And these principles taken together amount to
saying that, by the doctrine of the directors, the Bank of England
ought, as far as they can, to manage a panic with the Act of 1844,
pretty much as they would manage one without it--in the early stage of
the panic because then they are not fettered, and in the latter
because then the fetter has been removed.
We can therefore estimate the policy of the Bank of England in the
three panics which have happened since the Act of 1844, without
inquiring into the effect of the Act itself. It is certain that in
all of these panics the Bank has made very large advances indeed. It
is certain, too, that in all of them the Bank has been quicker than
it was in 1825; that in all of them it has less hesitated to use its
banking reserve in making the advances which it is one principal
object of maintaining that reserve to make, and to make at once. But
there is still a considerable evil. No one knows on what kind of
securities the Bank of England will at such periods make the
advances which it is necessary to make.
As we have seen, principle requires that such advances, if made at
all for the purpose of curing panic, should be made in the manner
most likely to cure that panic. And for this purpose, they should be
made on everything which in common times is good 'banking security.'
The evil is, that owing to terror, what is commonly good security
has ceased to be so; and the true policy is so to use the Banking
reserve, that if possible the temporary evil may be stayed, and the
common course of business be restored. And this can only be effected
by advancing on all good Banking securities.
Unfortunately, the Bank of England do not take this course. The
Discount office is open for the discount of good bills, and makes
immense advances accordingly. The Bank also advances on consols and
India securities, though there was, in the crisis of 1866, believed
to be for a moment a hesitation in so doing. But these are only a
small part of the securities on which money in ordinary times can be
readily obtained, and by which its repayment is fully secured.
Railway debenture stock is as good a security as a commercial bill,
and many people, of whom I own I am one, think it safer than India
stock; on the whole, a great railway is, we think, less liable to
unforeseen accidents than the strange Empire of India. But I doubt
if the Bank of England in a panic would advance on railway debenture
stock, at any rate no one has any authorised reason for saying that
it would. And there are many other such securities.
The amount of the advance is the main consideration for the Bank of
England, and not the nature of the security on which the advance is
made, always assuming the security to be good. An idea prevails (as
I believe) at the Bank of England that they ought not to advance
during a panic on any kind of security on which they do not commonly
advance. But if bankers for the most part do advance on such
security in common times, and if that security is indisputably good,
the ordinary practice of the Bank of England is immaterial. In
ordinary times the Bank is only one of many lenders, whereas in a
panic it is the sole lender, and we want, as far as we can, to bring
back the unusual state of a time of panic to the common state of
ordinary times.
In common opinion there is always great uncertainty as to the
conduct of the Bank: the Bank has never laid down any clear and
sound policy on the subject. As we have seen, some of its directors
(like Mr. Hankey) advocate an erroneous policy. The public is never
sure what policy will be adopted at the most important moment: it is
not sure what amount of advance will be made, or on what security it
will be made. The best palliative to a panic is a confidence in the
adequate amount of the Bank reserve, and in the efficient use of
that reserve. And until we have on this point a clear understanding
with the Bank of England, both our liability to crises and our
terror at crises will always be greater than they would otherwise
be.