Books: Lombard Street: A Description of the Money Market
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Walter Bagehot >> Lombard Street: A Description of the Money Market
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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 Departmentthat 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 gonot, 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
practicecredit being goodis 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 banknotes.' 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
banknotes, 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 caunot
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 banknotes.
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 securityon 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 onessay 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
amountin 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 pamc 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.
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