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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The same result may be arrived at more easily. Supposing any foreign
Government or person to have any sort of securities which he can
pledge in the market, that operation gives it, or him, a credit on
some banker, and enables it, or him, to take money from the banking
reserve at the Bank of England, and from the bankers' balances; and
to replace the bankers' balances at their inevitable minimum, the
Bank of England must lend. Every sudden demand on the country
causes, in proportion to its magnitude, this peculiar effect. And
this is the reason why the Bank of England ought, I think, to deal
most cautiously and delicately with their banking deposits. They are
the symbol of an indefinite liability: by means of them, as we see,
an amount of money so great that it is impossible to assign a limit
to it might be abstracted from the Bank of England. As the Bank of
England lends money to keep up the bankers' balances, at their usual
amount, and as by means of that usual amount whatever sum foreigners
can get credit for may be taken from us, it is not possible to
assign a superior limit (to use the scientific word) to the demands
which by means of the bankers' balances may be made upon the Bank of
England.
The result comes round to the simple point, on which this book is a
commentary: the Bank of England, by the effect of a long history,
holds the ultimate cash reserve of the country; whatever cash the
country has to pay comes out of that reserve, and therefore the Bank
of England has to pay it. And it is as the Bankers' Bank that the
Bank of England has to pay it, for it is by being so that it becomes
the keeper of the final cash reserve.
Some persons have been so much impressed with such considerations as
these, that they have contended that the Bank of England ought never
to lend the 'bankers' balances' at all, that they ought to keep them
intact, and as an unused deposit. I am not sure, indeed, that I have
seen that extreme form of the opinion in print, but I have often
heard it in Lombard Street, from persons very influential and very
qualified to judge; even in print I have seen close approximations
to it. But I am satisfied that the laying down such a 'hard and
fast' rule would be very dangerous; in very important and very
changeable business rigid rules are apt to be often dangerous. In a
panic, as has been said, the bankers' balances greatly augment. It
is true the Bank of England has to lend the money by which they are
filled. The banker calls in his money from the bill-broker, ceases
to re-discount for that broker, or borrows on securities, or sells
securities; and in one or other of these ways he causes a new demand
for money which can only at such times be met from the Bank of
England. Every one else is in want too. But without inquiring into
the origin of the increase at panics, the amount of the bankers'
deposits in fact increases very rapidly; an immense amount of unused
money is at such moments often poured by them into the Bank of
England. And nothing can more surely aggravate the panic than to
forbid the Bank of England to lend that money. Just when money is
most scarce you happen to have an unusually large fund of this
particular species of money, and you should lend it as fast as you
can at such moments, for it is ready lending which cures panics, and
non-lending or niggardly lending which aggravates them.
At other times, particularly at the quarterly payment of the
dividends, an absolute rule which laid down that the bankers'
balances were never to be lent, would be productive of great
inconvenience. A large sum is just then paid from the Government
balance to the bankers' balances, and if you permitted the Bank to
lend it while it was still in the hands of the Government, but
forbad them to lend it when it came into the hands of the bankers, a
great tilt upwards in the value of money would be the consequence,
for a most important amount of it would suddenly have become
ineffective.
But the idea that the bankers' balances ought never to be lent is
only a natural aggravation of the truth that these balances ought to
be used with extreme caution; that as they entail a liability
peculiarly great and singularly difficult to foresee, they ought
never to be used like a common deposit.
It follows from what has been said that there are always possible
and very heavy demands on the Bank of England which are not shown in
the account of the Banking department at all: these demands may be
greatest when the liabilities shown by that account are smallest,
and lowest when those liabilities are largest. If, for example, the
German Government brings bills or other good securities to this
market, obtains money with them, and removes that money from the
market in bullion, that money may, if the German Government choose,
be taken wholly from the Bank of England. If the wants of the German
Government be urgent, and if the amount of gold 'arrivals,' that is,
the gold coming here from the mining countries, be but small, that
gold will be taken from the Bank of England, for there is no other
large store in the country. The German Government is only a
conspicuous example of a foreign power which happens lately to have
had an unusual command of good securities, and an unusually
continuous wish to use them in England. Any foreign state hereafter
which wants cash will be likely to come here for it; so long as the
Bank of France should continue not to pay in specie, a foreign state
which wants it must of necessity come to London for it.
And no indication of the likelihood or unlikelihood of that want can
be found in the books of the Bank of England.
What is almost a revolution in the policy of the Bank of England
necessarily follows: no certain or fixed proportion of its
liabilities can in the present times be laid down as that which the
Bank ought to keep in reserve. The old notion that one-third, or any
other such fraction, is in all cases enough, must be abandoned. The
probable demands upon the Bank are so various in amount, and so
little disclosed by the figures of the account, that no simple and
easy calculation is a sufficient guide. A definite proportion of the
liabilities might often be too small for the reserve, and sometimes
too great. The forces of the enemy being variable, those of the
defence cannot always be the same.
I admit that this conclusion is very inconvenient. In past times it
has been a great aid to the Bank and to the public to be able to
decide on the proper policy of the Bank from a mere inspection of
its account. In that way the Bank knew easily what to do and the
public knew easily what to foresee. But, unhappily, the rule which
is most simple is not always the rule which is most to be relied
upon. The practical difficulties of life often cannot be met by very
simple rules; those dangers being complex and many, the rules for
encountering them cannot well be single or simple. A uniform remedy
for many diseases often ends by killing the patient.
Another simple rule often laid down for the management of the Bank
of England must now be abandoned also. It has been said that the
Bank of England should look to the market rate, and make its own
rate conform to that. This rule was, indeed, always erroneous. The
first duty of the Bank of England was to protect the ultimate cash
of the country, and to raise the rate of interest so as to protect
it. But this rule was never so erroneous as now, because the number
of sudden demands upon that reserve was never formerly so great. The
market rate of Lombard Street is not influenced by those demands.
That rate is determined by the amount of deposits in the hands of
bill-brokers and bankers, and the amount of good bills and
acceptable securities offered at the moment. The probable efflux of
bullion from the Bank scarcely affects it at all; even the real
efflux affects it but little; if the open market did not believe
that the Bank rate would be altered in consequence of such effluxes
the market rate would not rise. If the Bank choose to let its
bullion go unheeded, and is seen to be going so to choose, the value
of money in Lombard Street will remain unaltered. The more numerous
the demands on the Bank for bullion, and the more variable their
magnitude, the more dangerous is the rule that the Bank rate of
discount should conform to the market rate. In former quiet times
the influence, or the partial influence, of that rule has often
produced grave disasters. In the present difficult times an
adherence to it is a recipe for making a large number of panics.
A more distinct view of abstract principle must be taken before we
can fix on the amount of the reserve which the Bank of England ought
to keep. Why should a bank keep any reserve? Because it may be
called on to pay certain liabilities at once and in a moment. Why
does any bank publish an account? In order to satisfy the public
that it possesses cashor available securitiesenough to meet its
liabilities. The object of publishing the account of the banking
department of the Bank of England is to let the nation see how the
national reserve of cash stands, to assure the public that there is
enough and more than enough to meet not only all probable calls, but
all calls of which there can be a chance of reasonable apprehension.
And there is no doubt that the publication of the Bank account gives
more stability to the money market than any other kind of precaution
would give. Some persons, indeed, feared that the opposite result
would happen; they feared that the constant publication of the
incessant changes in the reserve would terrify and harass the public
mind. An old banker once told me: 'Sir, I was on Lord Althorp's
committee which decided on the publication of the Bank account, and
I voted against it. I thought it would frighten people. But I am
bound to own that the committee was right and I was wrong, for that
publication has given the money market a greater sense of security
than anything else which has happened in my time.' The diffusion of
confidence through Lombard Street and the world is the object of the
publication of the Bank accounts and of the Bank reserve.
But that object is not attained if the amount of that reserve when
so published is not enough to tranquillise people. A panic is sure
to be caused if that reserve is, from whatever cause, exceedingly
low. At every moment there is a certain minimum which I will call
the apprehension minimum,' below which the reserve cannot fall
without great risk of diffused fear; and by this I do not mean
absolute panic, but only a vague fright and timorousness which
spreads itself instantly, and as if by magic, over the public mind.
Such seasons of incipient alarm are exceedingly dangerous, because
they beget the calamities they dread. What is most feared at such
moments of susceptibility is the destruction of credit; and if any
grave failure or bad event happens at such moments, the public fancy
seizes on it, there is a general run, and credit is suspended. The
Bank reserve then never ought to be diminished below the
'apprehension point.' And this is as much as to say, that it never
ought very closely to approach that point; since, if it gets very
near, some accident may easily bring it down to that point and cause
the evil that is feared.
There is no 'royal road' to the amount of the 'apprehension
minimum': no abstract argument, and no mathematical computation will
teach it to us. And we cannot expect that they should. Credit is an
opinion generated by circumstances and varying with those
circumstances. The state of credit at any particular time is a
matter of fact only to be ascertained like other matters of fact; it
can only be known by trial and inquiry. And in the same way, nothing
but experience can tell us what amount of 'reserve' will create a
diffused confidence; on such a subject there is no way of arriving
at a just conclusion except by incessantly watching the public mind,
and seeing at each juncture how it is affected.
Of course in such a matter the cardinal rule to be observed is, that
errors of excess are innocuous but errors of defect are destructive.
Too much reserve only means a small loss of profit, but too small a
reserve may mean 'ruin.' Credit may be at once shaken, and if some
terrifying accident happen to supervene, there may be a run on the
Banking department that may be too much for it, as in 1857 and 1866,
and may make it unable to pay its way without assistanceas it was m
those years.
And the observance of this maxim is the more necessary because the
'apprehension minimum' is not always the same. On the contrary, in
times when the public has recently seen the Bank of England exposed
to remarkable demands, it is likely to expect that such demands may
come again. Conspicuous and recent events educate it, so to speak;
it expects that much will be demanded when much has of late often
been demanded, and that little will be so, when in general but
little has been so. A bank like the Bank of England must always,
therefore, be on the watch for a rise, if I may so express it, in
the apprehension minimum; it must provide an adequate fund not only
to allay the misgivings of to-day, but also to allay what may be the
still greater misgivings of to-morrow. And the only practical mode
of obtaining this object is--to keep the actual reserve always in
advance of the minimum 'apprehension' reserve.
And this involves something much more. As the actual reserve is
never to be less, and is always, if possible, to exceed by a
reasonable amount the 'minimum' apprehension reserve, it must when
the Bank is quiet and taking no precautions very considerably exceed
that minimum. All the precautions of the Bank take time to operate.
The principal precaution is a rise in the rate of discount, and such
a rise certainly does attract money from the Continent and from all
the world much faster than could have been anticipated. But it does
not act instantaneously; even the right rate, the ultimately
attractive rate, requires an interval for its action, and before the
money can come here. And the right rate is often not discovered for
some time. It requires several 'moves,' as the phrase goes, several
augmentations of the rate of discount by the Bank, before the really
effectual rate is reached, and in the mean time bullion is ebbing
away and the 'reserve' is diminishing. Unless, therefore, in times
without precaution the actual reserve exceed the 'apprehension
minimum' by at least the amount which may be taken away in the
inevitable interval, and before the available precautions begin to
operate, the rule prescribed will be infringed, and the actual
reserve will be less than the 'apprehension' minimum. In time the
precautions taken may attract gold and raise the reserve to the
needful amount, but in the interim the evils may happen against
which the rule was devised, diffused apprehension may arise, and
then any unlucky accident may cause many calamities.
I may be asked, 'What does all this reasoning in practice come to?
At the present moment how much reserve do you say the Bank of
England should keep? state your recommendation clearly (I know it
will be said) if you wish to have it attended to.' And I will answer
the question plainly, though in so doing there is a great risk that
the principles I advocate may be in some degree injured through some
mistake I may make in applying them.
I should say that at the present time the mind of the monetary world
would become feverish and fearful if the reserve in the Banking
department of the Bank of England went below 10,000,000 L. Estimated
by the idea of old times, by the idea even of ten years ago, that
sum, I know, sounds extremely large. My own nerves were educated to
smaller figures, because I was trained in times when the demands on
us were less, when neither was so much reserve wanted nor did the
public expect so much. But I judge from such observations as I can
make of the present state of men's minds, that in fact, and whether
justifiably or not, the important and intelligent part of the public
which watches the Bank reserve becomes anxious and dissatisfied if
that reserve falls below 10,000,000 L. That sum, therefore, I call
the 'apprehension minimum' for the present times. Circumstances may
change and may make it less or more, but according to the most
careful estimate I can make, that is what I should call it now.
It will be said that this estimate is arbitrary and these figures
are conjectures. I reply that I only submit them for the judgment of
others. The main question is one of fact--Does not the public mind
begin to be anxious and timorous just where I have placed the
apprehension point? and the deductions from that are comparatively
simple questions of mixed fact and reasoning. The final appeal in
such cases necessarily is to those who are conversant with and who
closely watch the facts.
I shall perhaps be told also that a body like the Court of the
Directors of the Bank of England cannot act on estimates like these:
that such a body must have a plain rule and keep to it. I say in
reply, that if the correct framing of such estimates is necessary
for the good guidance of the Bank, we must make a governing body
which can correctly frame such estimates. We must not suffer from a
dangerous policy because we have inherited an imperfect form of
administration. I have before explained in what manner the
government of the Bank of England should, I consider, be
strengthened, and that government so strengthened would, I believe,
be altogether competent to a wise policy.
Then I should say, putting the foregoing reasoning into figures,
that the Bank ought never to keep less than 11,000,000 L.. or
11,500,000 L. since experience shows that a million, or a million
and a half, may be taken from us at any time. I should regard this
as the practical minimum at which, roughly of course, the Bank
should aim, and which it should try never to be below. And, in order
not to be below 11,500,000 L., the Bank must begin to take
precautions when the reserve is between 14,000,000 L. and 15,000,000
l.; for experience shows that between 2,000,000 L. and 3,000,000 L.
may, probably enough, be withdrawn from the Bank store before the
right rate of interest is found which will attract money from
abroad, and before that rate has had time to attract it. When the
reserve is between 14,000,000 L. and 15,000,000 L., and when it
begins to be diminished by foreign demand, the Bank of England
should, I think, begin to act, and to raise the rate of interest.
CHAPTER XIII.
Conclusion.
I know it will be said that in this work I have pointed out a deep
malady, and only suggested a superficial remedy. I have tediously
insisted that the natural system of banking is that of many banks
keeping their own cash reserve, with the penalty of failure before
them if they neglect it. I have shown that our system is that of a
single bank keeping the whole reserve under no effectual penalty of
failure. And yet I propose to retain that system, and only attempt
to mend and palliate it.
I can only reply that I propose to retain this system because I am
quite sure that it is of no manner of use proposing to alter it. A
system of credit which has slowly grown up as years went on, which
has suited itself to the course of business, which has forced itself
on the habits of men, will not be altered because theorists
disapprove of it, or because books are written against it. You might
as well, or better, try to alter the English monarchy and substitute
a republic, as to alter the present constitution of the English
money market, founded on the Bank of England, and substitute for it
a system in which each bank shall keep its own reserve. There is no
force to be found adequate to so vast a reconstruction, and so vast
a destructions and therefore it is useless proposing them.
No one who has not long considered the subject can have a notion how
much this dependence on the Bank of England is fixed in our national
habits. I have given so many illustrations in this book that I fear
I must have exhausted my reader's patience, but I will risk giving
another. I suppose almost everyone thinks that our system of
savings' banks is sound and good. Almost everyone would be surprised
to hear that there is any possible objection to it. Yet see what it
amounts to. By the last return the savings' banks--the old and the
Post Office together--contain about 60,000,000 L. of deposits, and
against this they hold in the funds securities of the best kind. But
they hold no cash whatever. They have of course the petty cash about
the various branches necessary for daily work. But of cash in
ultimate reserve cash in reserve against a panicthe savings' banks
have not a sixpence. These banks depend on being able in a panic to
realise their securities. But it has been shown over and over again,
that in a panic such securities can only be realised by the help of
the Bank of Englandthat it is only the Bank with the ultimate cash
reserve which has at such moments any new money, or any power to
lend and act. If in a general panic there were a run on the savings'
banks, those banks could not sell 100,000 L. of Consols without the
help of the Bank of England; not holding themselves a cash reserve
for times of panic, they are entirely dependent on the one Bank
which does hold that reserve.
This is only a single additional instance beyond the innumerable
ones given, which shows how deeply our system of banking is fixed in
our ways of thinking. The Government keeps the money of the poor
upon it, and the nation fully approves of their doing so. No one
hears a syllable of objection. And every practical manevery man who
knows the scene of actionwill agree that our system of banking,
based on a single reserve in the Bank of England, cannot be altered,
or a system of many banks, each keeping its own reserve, be
substituted for it. Nothing but a revolution would effect it, and
there is nothing to cause a revolution.
This being so, there is nothing for it but to make the best of our
banking system, and to work it in the best way that it is capable
of. We can only use palliatives, and the point is to get the best
palliative we can. I have endeavoured to show why it seems to me
that the palliatives which I have suggested are the best that are at
our disposal.
I have explained why the French plan will not suit our English
world. The direct appointment of the Governor and Deputy-Governor of
the Bank of England by the executive Government would not lessen our
evils or help our difficulties. I fear it would rather make both
worse. But possibly it may be suggested that I ought to explain why
the American system, or some modification, would not or might not be
suitable to us. The American law says that each national bank shall
have a fixed proportion of cash to its liabilities (there are two
classes of banks, and two different proportions; but that is not to
the present purpose), and it ascertains by inspectors, who inspect
at their own times, whether the required amount of cash is in the
bank or not. It may be asked, could nothing like this be attempted
in England? could not it, or some modification, help us out of our
difficulties? As far as the American banking system is one of many
reserves, I have said why I think it is of no use considering
whether we should adopt it or not. We cannot adopt it if we would.
The one-reserve system is fixed upon us. The only practical
imitation of the American system would be to enact that the Banking
department of the Bank of England should always keep a fixed
proportionsay one-third of its liabilitiesin reserve. But, as we
have seen before, a fixed proportion of the liabilities, even when
that proportion is voluntarily chosen by the directors, and not
imposed by law, is not the proper standard for a bank reserve.
Liabilities may be imminent or distant, and a fixed rule which
imposes the same reserve for both will sometimes err by excess, and
sometimes by defect. It will waste profits by over-provision against
ordinary danger, and yet it may not always save the bank; for this
provision is often likely enough to be insufficient against rare and
unusual dangers. But bad as is this system when voluntarily chosen,
it becomes far worse when legally and compulsorily imposed. In a
sensitive state of the English money market the near approach to the
legal limit of reserve would be a sure incentive to panic; if
one-third were fixed by law, the moment the banks were close to
one-third, alarm would begin, and would run like magic. And the fear
would be worse because it would not be unfoundedat least, not
wholly. If you say that the Bank shall always hold one-third of its
liabilities as a reserve, you say in fact that this one-third shall
always be useless, for out of it the Bank cannot make advances,
cannot give extra help, cannot do what we have seen the holders of
the ultimate reserve ought to do and must do. There is no help for
us in the American system; its very essence and principle are
faulty.
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