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 result is that we have placed the exclusive custody of our
entire banking reserve in the hands of a single board of directors
not particularly trained for the duty--who might be called 'amateurs,'
who have no particular interest above other people in keeping it
undiminished--who acknowledge no obligation to keep it undiminished
who have never been told by any great statesman or public authority
that they are so to keep it or that they have anything to do with it
who are named by and are agents for a proprietary which would have a
greater income if it was diminished, who do not fear, and who need
not fear, ruin, even if it were all gone and wasted.
That such an arrangement is strange must be plain; but its
strangeness can only be comprehended when we know what the custody
of a national banking reserve means, and how delicate and difficult
it is.
II.
Such a reserve as we have seen is kept to meet sudden and unexpected
demands. If the bankers of a country are asked for much more than is
commonly wanted, then this reserve must be resorted to. What then
are these extra demands? and how is this extra reserve to be used?
Speaking broadly, these extra demands are of two kind--sone from
abroad to meet foreign payments requisite to pay large and unusual
foreign debts, and the other from at home to meet sudden
apprehension or panic arising in any manner, rational or irrational.
No country has ever been so exposed as England to a foreign demand
on its banking reserve, not only because at present England is a
large borrower from foreign nations, but also (and much more)
because no nation has ever had a foreign trade of such magnitude, in
such varied objects, or so ramified through the world. The ordinary
foreign trade of a country requires no cash; the exports on one side
balance the imports on the other. But a sudden trade of import like
the import of foreign corn after a bad harvestor (what is much less
common, though there are cases of it) the cessation of any great
export, causes a balance to become due, which must be paid in cash.
Now, the only source from which large sums of cash can be withdrawn
in countries where banking is at all developed, is a 'bank reserve.'
In England especially, except a few sums of no very considerable
amount held by bullion dealers in the course of their business,
there are no sums worth mentioning in cash out of the banks; an
ordinary person could hardly pay a serious sum without going to some
bank, even if he spent a month in trying. All persons who wish to
pay a large sum in cash trench of necessity on the banking reserve.
But then what is 'cash?' Within a country the action of a Government
can settle the quantity, and therefore the value, of its currency;
but outside its own country, no Government can do so. Bullion is the
cash' of international trade; paper currencies are of no use there,
and coins pass only as they contain more or less bullion.
When then the legal tender of a country is purely metallic, all that
is necessary is that banks should keep a sufficient store of that
'legal tender.' But when the 'legal tender' is partly metal and
partly paper, it is necessary that the paper 'legal tender'--the bank
note--should be convertible into bullion. And here I should pass my
limits, and enter on the theory of Peel's Act if I began to discuss
the conditions of convertibility. I deal only with the primary
pre-requisite of effectual foreign payments--a sufficient supply of
the local legal tender; with the afterstep--the change of the local
legal tender into the universally acceptable commodity cannot deal.
What I have to deal with is, for the present, ample enough. The Bank
of England must keep a reserve of 'legal tender' to be used for
foreign payments if itself fit, and to be used in obtaining bullion
if itself unfit. And foreign payments are sometimes very large, and
often very sudden. The 'cotton drain,' as it is called--the drain to
the East to pay for Indian cotton during the American Civil War took
many millions from this country for a series of years. A bad harvest
must take millions in a single year. In order to find such great
sums, the Bank of England requires the steady use of an effectual
instrument.
That instrument is the elevation of the rate of interest. If the
interest of money be raised, it is proved by experience that money
does come to Lombard Street, and theory shows that it ought to come.
To fully explain the matter I must go deep into the theory of the
exchanges, but the general notion is plain enough. Loanable capital,
like every other commodity, comes where there is most to be made of
it. Continental bankers and others instantly send great sums here,
as soon as the rate of interest shows that it can be done
profitably. While English credit is good, a rise of the value of
money in Lombard Street immediately by a banking operation brings
money to Lombard Street. And there is also a slower mercantile
operation. The rise in the rate of discount acts immediately on the
trade of this country. Prices fall here; in consequence imports are
diminished, exports are increased, and, therefore, there is more
likelihood of a balance in bullion coming to this country after the
rise in the rate than there was before.
Whatever personsone bank or many banksin any country hold the
banking reserve of that country, ought at the very beginning of an
unfavourable foreign exchange at once to raise the rate of interest,
so as to prevent their reserve from being diminished farther, and so
as to replenish it by imports of bullion.
This duty, up to about the year 1860, the Bank of England did not
perform at all, as I shall show farther on. A more miserable history
can hardly be found than that of the attempts of the Bankif indeed
they can be called attempts--to keep a reserve and to manage a foreign
drain between the year 1819 (when cash payments were resumed by the
Bank, and when our modern Money Market may be said to begin) and the
year 1857. The panic of that year for the first time taught the Bank
directors wisdom, and converted them to sound principles. The
present policy of the Bank is an infinite improvement on the policy
before 1857: the two must not be for an instant confounded; but
nevertheless, as I shall hereafter show, the present policy is now
still most defective, and much discussion and much effort. will be
wanted before that policy becomes what it ought to be.
A domestic drain is very different. Such a drain arises from a
disturbance of credit within the country, and the difficulty of
dealing with it is the greater, because it is often caused, or at
least often enhanced, by a foreign drain. Times without number the
public have been alarmed mainly because they saw that the Banking
reserve was already low, and that it was daily getting lower. The
two maladiesan external drain and an internal-often attack the money
market at once. What then ought to be done?
In opposition to what might be at first sight supposed, the best way
for the bank or banks who have the custody of the bank reserve to
deal with a drain arising from internal discredit, is to lend
freely. The first instinct of everyone is the contrary. There being
a large demand on a fund which you want to preserve, the most
obvious way to preserve it is to hoard it--to get in as much as you
can, and to let nothing go out which you can help. But every banker
knows that this is not the way to diminish discredit. This discredit
means, 'an opinion that you have not got any money,' and to
dissipate that opinion, you must, if possible, show that you have
money: you must employ it for the public benefit in order that the
public may know that you have it. The time for economy and for
accumulation is before. A good banker will have accumulated in
ordinary times the reserve he is to make use of in extraordinary
times.
Ordinarily discredit does not at first settle on any particular
bank, still less does it at first concentrate itself on the bank or
banks holding the principal cash reserve. These banks are almost
sure to be those in best credit, or they would not be in that
position, and, having the reserve, they are likely to look stronger
and seem stronger than any others. At first, incipient panic amounts
to a kind of vague conversation: Is A. B. as good as he used to be?
Has not C. D. lost money? and a thousand such questions. A hundred
people are talked about, and a thousand think,--'Am I talked about,
or am I not?' 'Is my credit as good as it used to be, or is it
less?' And every day, as a panic grows, this floating suspicion
becomes both more intense and more diffused; it attacks more
persons; and attacks them all more virulently than at first. All men
of experience, therefore, try to strengthen themselves,' as it is
called, in the early stage of a panic; they borrow money while they
can; they come to their banker and offer bills for discount, which
commonly they would not have offered for days or weeks to come. And
if the merchant be a regular customer, a banker does not like to
refuse, because if he does he will be said, or may be said, to be in
want of money, and so may attract the panic to himself. Not only
merchants but all persons under pecuniary liabilities--present or
imminent--feel this wish to 'strengthen themselves,' and in
proportion to those liabilities. Especially is this the case with
what may be called the auxiliary dealers in credit. Under any system
of banking there will always group themselves about the main bank or
banks (in which is kept the reserve) a crowd of smaller money
dealers, who watch the minutae of bills, look into special
securities which busy bankers have not time for, and so gain a
livelihood. As business grows, the number of such subsidiary persons
augments. The various modes in which money may be lent have each
their peculiarities, and persons who devote themselves to one only
lend in that way more safely, and therefore more cheaply. In time of
panic, these subordinate dealers in money will always come to the
principal dealers. In ordinary times, the intercourse between the
two is probably close enough. The little dealer is probably in the
habit of pledging his 'securities' to the larger dealer at a rate
less than he has himself charged, and of running into the market to
lend again. His time and brains are his principal capital, and he
wants to be always using them. But in times of incipient panic, the
minor money dealer always becomes alarmed. His credit is never very
established or very wide; he always fears that he may be the person
on whom current suspicion will fasten, and often he is so.
Accordingly he asks the larged dealer for advances. A number of such
persons ask all the large dealers--those who have the money--the
holders of the reserve. And then the plain problem before the great
dealers comes to be 'How shall we best protect ourselves? No doubt
the immediate advance to these second-class dealers is annoying, but
may not the refusal of it even be dangerous? A panic grows by what
it feeds on; if it devours these second-class men, shall we, the
first class, be safe?'
A panic, in a word, is a species of neuralgia, and according to the
rules of science you must not starve it. The holders of the cash
reserve must be ready not only to keep it for their own liabilities,
but to advance it most freely for the liabilities of others. They
must lend to merchants, to minor bankers, to 'this man and that
man,' whenever the security is good. In wild periods of alarm, one
failure makes many, and the best way to prevent the derivative
failures is to arrest the primary failure which causes them. The way
in which the panic of 1825 was stopped by advancing money has been
described in so broad and graphic a way that the passage has become
classical. 'We lent it,' said Mr. Harman, on behalf of the Bank of
England, 'by every possible means and in modes 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 the deposit of bills of exchange
to an immense amount, in short, by every possible means consistent
with the safety of the Bank, and we were not on some occasions
over-nice. Seeing the dreadful state in which the public were, we
rendered every assistance in our power.' After a day or two of this
treatment, the entire panic subsided, and the 'City' was quite calm.
The problem of managing a panic must not be thought of as mainly a
'banking' problem. It is primarily a mercantile one. All merchants
are under liabilities; they have bills to meet soon, and they can
only pay those bills by discounting bills on other merchants. In
other words, all merchants are dependent on borrowing money, and
large merchants are dependent on borrowing much money. At the
slightest symptom of panic many merchants want to borrow more than
usual; they think they will supply themselves with the means of
meeting their bills while those means are still forthcoming. If the
bankers gratify the merchants, they must lend largely just when they
like it least; if they do not gratify them, there is a panic.
On the surface there seems a great inconsistency in all this. First,
you establish in some bank or banks a certain reserve; you make of
it or them a kind of ultimate treasury, where the last shilling of
the country is deposited and kept. And then you go on to say that
this final treasury is also to be the last lending-house; that out
of it unbounded, or at any rate immense, advances are to be made
when no once else lends. This seems like saying--first, that the
reserve should be kept, and then that it should not be kept. But
there is no puzzle in the matter. The ultimate banking reserve of a
country (by whomsoever kept) is not kept out of show, but for
certain essential purposes, and one of those purposes is the meeting
a demand for cash caused by an alarm within the country. It is not
unreasonable that our ultimate treasure in particular cases should
be lent; on the contrary, we keep that treasure for the very reason
that in particular cases it should be lent.
When reduced to abstract principle, the subject comes to this. An
'alarm' is an opinion that the money of certain persons will not pay
their creditors when those creditors want to be paid. If possible,
that alarm is best met by enabling those persons to pay their
creditors to the very moment. For this purpose only a little money
is wanted. If that alarm is not so met, it aggravates into a panic,
which is an opinion that most people, or very many people, will not
pay their creditors; and this too can only be met by enabling all
those persons to pay what they owe, which takes a great deal of
money. No one has enough money, or anything like enough, but the
holders of the bank reserve.
Not that the help so given by the banks holding that reserve
necessarily diminishes it. Very commonly the panic extends as far,
or almost as far, as the bank or banks which hold the reserve, but
does not touch it or them at all. In this case it is enough if the
dominant bank or banks, so to speak, pledge their credit for those
who want it. Under our present system it is often quite enough that
a merchant or a banker gets the advance made to him put to his
credit in the books of the Bank of England; he may never draw a
cheque on it, or, if he does, that cheque may come in again to the
credit of some other customer, who lets it remain on his account. An
increase of loans at such times is often an increase of the
liabilities of the bank, not a diminution of its reserve. Just so
before 1844, an issue of notes, as in to quell a panic entirely
internal did not diminish the bullion reserve. The notes went out,
but they did not return. They were issued as loans to the public,
but the public wanted no more; they never presented them for
payment; they never asked that sovereigns should be given for them.
But the acceptance of a great liability during an augmenting alarm,
though not as bad as an equal advance of cash, is the thing next
worst. At any moment the cash may be demanded. Supposing the panic
to grow, it will be demanded, and the reserve will be lessened
accordingly.
No doubt all precautions may, in the end, be unavailing. 'On
extraordinary occasions,' says Ricardo, 'a general panic may seize
the country, when every one becomes desirous of possessing himself
of the precious metals as the most convenient mode of realising or
concealing his property, against such panic banks have no security
_on any system_.' The bank or banks which hold the reserve may last
a little longer than the others; but if apprehension pass a certain
bound, they must perish too. The use of credit is, that it enables
debtors to use a certain part of the money their creditors have lent
them. If all those creditors demand all that money at once, they
cannot have it, for that which their debtors have used, is for the
time employed, and not to be obtained. With the advantages of credit
we must take the disadvantages too; but to lessen them as much as we
can, we must keep a great store of ready money always available, and
advance out of it very freely in periods of panic, and in times of
incipient alarm.
The management of the Money Market is the more difficult, because,
as has been said, periods of internal panic and external demand for
bullion commonly occur together. The foreign drain empties the Bank
till, and that emptiness, and the resulting rise in the rate of
discount, tend to frighten the market. The holders of the reserve
have, therefore, to treat two opposite maladies at once--one requiring
stringent remedies, and especially a rapid rise in the rate of
interest; and the other, an alleviative treatment with large and
ready loans.
Before we had much specific experience, it was not easy to prescribe
for this compound disease; but now we know how to deal with it. We
must look first to the foreign drain, and raise the rate of interest
as high as may be necessary. Unless you can stop the foreign export,
you cannot allay the domestic alarm. The Bank will get poorer and
poorer, and its poverty will protract or renew the apprehension. And
at the rate of interest so raised, the holdersone or more-of the
final Bank reserve must lend freely. Very large loans at very high
rates are the best remedy for the worst malady of the money market
when a foreign drain is added to a domestic drain. Any notion that
money is not to be had, or that it may not be had at any price, only
raises alarm to panic and enhances panic to madness. But though the
rule is clear, the greatest delicacy, the finest and best skilled
judgment, are needed to deal at once with such great and contrary
evils.
And great as is the delicacy of such a problem in all countries, it
is far greater in England now than it was or is elsewhere. The
strain thrown by a panic on the final bank reserve is proportional
to the magnitude of a country's commerce, and to the number and size
of the dependent banks--banks, that is, holding no cash reservethat
are grouped around the central bank or banks. And in both respects
our system causes a stupendous strain. The magnitude of our
commerce, and the number and magnitude of the banks which depend on
the Bank of England, are undeniable. There are very many more
persons under great liabilities than there are, or ever were,
anywhere else. At the commencement of every panic, all persons under
such liabilities try to supply themselves with the means of meeting
those liabilities while they can. This causes a great demand for new
loans. And so far from being able to meet it, the bankers who do not
keep an extra reserve at that time borrow largely, or do not renew
large loansvery likely do both.
London bankers, other than the Bank of England, effect this in
several ways. First, they have probably discounted bills to a large
amount for the bill brokers, and if these bills are paid, they
decline discounting any others to replace them. The directors of the
London and Westminster Bank had, in the panic of 1857, discounted
millions of such bills, and they justly said that if those bills
were paid they would have an amount of cash far more than sufficient
for any demand. But how were those bills to be paid? Some one
else must lend the money to pay them. The mercantile community could
not on a sudden bear to lose so large a sum of borrowed money; they
have been used to rely on it, and they could not carry on their
business without it. Least of all could they bear it at the
beginning of a panic, when everybody wants more money than usual.
Speaking broadly, those bills can only be paid by the discount of
other bills. When the bills (suppose) of a Manchester warehouseman
which he gave to the manufacturer become due, he cannot, as a rule,
pay for them at once in cash; he has bought on credit, and he has
sold on credit. He is but a middleman. To pay his own bill to the
maker of the goods, he must discount the bills he has received from
the shopkeepers to whom he has sold the goods; but if there is a
sudden cessation in the means of discount, he will not be able to
discount them. All our mercantile community must obtain new loans to
pay old debts. If some one else did not pour into the market the
money which the banks like the London and Westminster Bank take out
of it, the bills held by the London and Westminster Bank could not
be paid.
Who then is to pour in the new money? Certainly not the bill
brokers. They have been used to re-discount with such banks as the
London and Westminster millions of bills, and if they see that they
are not likely to be able to re-discount those bills, they instantly
protect themselves and do not discount them. Their business does not
allow them to keep much cash unemployed. They give interest for all
the money deposited with the--man interest often nearly approaching
the interest they can charge; as they can only keep a small reserve
a panic tells on them more quickly than on anyone else. They stop
their discounts, or much diminish their discounts, immediately.
There is no new money to be had from them, and the only place at
which they can have it is the Bank of England.
There is even a simpler case: the banker who is uncertain of his
credit, and wants to increase his cash, may have money on deposit at
the bill brokers. If he wants to replenish his reserve, he may ask
for it, suppose, just when the alarm is beginning. But if a great
number of persons do this very suddenly, the bill brokers will not
at once be able to pay without borrowing. They have excellent bills
in their case, but these will not be due for some days; and the
demand from the more or less alarmed bankers is for payment at once
and to-day. Accordingly the bill broker takes refuge at the Bank of
England the only place where at such a moment new money is to be
had.
The case is just the same if the banker wants to sell Consols, or to
call in money lent on Consols. These he reckons as part of his
reserve. And in ordinary times nothing can be better. According to
the saying, you 'can sell Consols on a Sunday.' In a time of no
alarm, or in any alarm affecting that particular banker only, he can
rely on such reserve without misgiving. But not so in a general
panic. Then, if he wants to sell 500,000 L. worth of Consols, he
will not find 500,000 L. of fresh money ready to come into the
market. All ordinary bankers are wanting to sell, or thinking they
may have to sell. The only resource is the Bank of England. In a
great panic, Consols cannot be sold unless the Bank of England will
advance to the buyer, and no buyer can obtain advances on Consols at
such a time unless the Bank of England will lend to him.
The case is worse if the alarm is not confined to the great towns,
but is diffused through the country. As a rule, country bankers only
keep so much barren cash as is necessary for their common business.
All the rest they leave at the bill brokers, or at the
interest-giving banks, or invest in Consols and such securities. But
in a panic they come to London and want this money. And it is only
from the Bank of England that they can get it, for all the rest of
London want their money for themselves.
If we remember that the liabilities of Lombard Street payable on
demand are far larger than those of any like market, and that the
liabilities of the country are greater still, we can conceive the
magnitude of the pressure on the Bank of England when both Lombard
Street and the country suddenly and at once come upon it for aid. No
other bank was ever exposed to a demand so formidable, for none ever
before kept the banking reserve for such a nation as the English.
The mode in which the Bank of England meets this great
responsibility is very curious. It unquestionably does make enormous
advances in every panic
In 1847 the loans on 'private securities'
increased from 18,963,000 L to 20,409,000 L
1857 ditto ditto 20,404,000 L to 31,350,000 L
1866 ditto ditto 18,507,000 L to 33,447,000 L
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