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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But, on the other hand, as we have seen, though the Bank, more or
less, does its duty, it does not distinctly acknowledge that it is
its duty. We are apt to be solemnly told that the Banking Department
of the Bank of England is only a bank like other banks--that it has
no peculiar duty in times of panic--that it then is to look to
itself alone, as other banks look. And there is this excuse for the
Bank. Hitherto questions of banking have been so little discussed in
comparison with questions of currency, that the duty of the Bank in
time of panic has been put on a wrong ground.
It is imagined that because bank notes are a legal tender, the Bank
has some peculiar duty to help other people. But bank notes are only
a legal tender at the Issue Department, not at the Banking
Department, and the accidental combination of the two departments in
the same building gives the Banking Department no aid in meeting a
panic. If the Issue Department were at Somerset House, and if it
issued Government notes there, the position of the Banking
Department under the present law would be exactly what it is now. No
doubt, formerly the Bank of England could issue what it pleased, but
that historical reminiscence makes it no stronger now that it can no
longer so issue. We must deal with what is, not with what was.
And a still worse argument is also used. It is said that because the
Bank of England keeps the 'State account' and is the Government
banker, it is a sort of 'public institution' and ought to help
everybody. But the custody of the taxes which have been collected
and which wait to be expended is a duty quite apart from panics. The
Government money may chance to be much or little when the panic
comes. There is no relation or connection between the two. And the
State, in getting the Bank to keep what money it may chance to have,
or in borrowing of it what money it may chance to want, does not
hire it to stop a panic or much help it if it tries.
The real reason has not been distinctly seen. As has been already
said--but on account of its importance and perhaps its novelty it is
worth saying againwhatever bank or banks keep the ultimate banking
reserve of the country must lend that reserve most freely in time of
apprehension, for that is one of the characteristic uses of the bank
reserve, and the mode in which it attains one of the main ends for
which it is kept. Whether rightly or wrongly, at present and in fact
the Bank of England keeps our ultimate bank reserve, and therefore
it must use it in this manner.
And though the Bank of England certainly do make great advances in
time of panic, yet as they do not do so on any distinct principle,
they naturally do it hesitatingly, reluctantly, and with misgiving.
In 1847, even in 1866--the latest panic, and the one in which on the
whole the Bank acted the best--there was nevertheless an instant when
it was believed the Bank would not advance on Consols, or at least
hesitated to advance on them. The moment this was reported in the
City and telegraphed to the country, it made the panic indefinitely
worse. In fact, to make large advances in this faltering way is to
incur the evil of making them without obtaining the advantage. What
is wanted and what is necessary to stop a panic is to diffuse the
impression, that though money may be dear, still money is to be had.
If people could be really convinced that they could have money if
they wait a day or two, and that utter ruin is not coming, most
likely they would cease to run in such a mad way for money. Either
shut the Bank at once, and say it will not lend more than it
commonly lends, or lend freely, boldly, and so that the public may
feel you mean to go on lending. To lend a great deal, and yet not
give the public confidence that you will lend sufficiently and
effectually, is the worst of all policies; but it is the policy now
pursued.
In truth, the Bank do not lend from the motives which should make a
bank lend. The holders of the Bank reserve ought to lend at once and
most freely in an incipient panic, because they fear destruction in
the panic. They ought not to do it to serve others; they ought to do
it to serve themselves. They ought to know that this bold policy is
the only safe one, and for that reason they ought to choose it. But
the Bank directors are not afraid. Even at the last moment they say
that 'whatever happens to the community, they can preserve
themselves.' Both in 1847 and 1857 (I believe also in 1866, though
there is no printed evidence of it) the Bank directors contended
that the Banking Department was quite safe though its reserve was
nearly all gone, and that it could strengthen itself by selling
securities and by refusing to discount. But this is a complete
dream. The Bank of England could not sell 'securities,' for in an
extreme panic there is no one else to buy securities. The Bank
cannot stay still and wait till its bills are paid, and so fill its
coffers, for unless it discounts equivalent bills, the bills which
it has already discounted will not be paid. 'When the reserve in the
ultimate bank or banks--those keeping the reserveruns low, it cannot
be augmented by the same means that other and dependent banks
commonly adopt to maintain their reserve, for the dependent banks
trust that at such moments the ultimate banks will be discounting
more than usual and lending more than usual. But ultimate banks have
no similar rear-guard to rely upon.
I shall have failed in my purpose if I have not proved that the
system of entrusting all our reserve to a single board, like that of
the Bank directors, is very anomalous; that it is very dangerous;
that its bad consequences, though much felt, have not been fully
seen; that they have been obscured by traditional arguments and
hidden in the dust of ancient controversies.
But it will be said--What would be better? What other system could
there be? We are so accustomed to a system of banking, dependent for
its cardinal function on a single bank, that we can hardly conceive
of any other. But the natural system--that which would have sprung up
if Government had let banking alone--is that of many banks of equal or
not altogether unequal size. In all other trades competition brings
the traders to a rough approximate equality. In cotton spinning, no
single firm far and permanently outstrips the others. There is no
tendency to a monarchy in the cotton world; nor, where banking has
been left free, is there any tendency to a monarchy in banking
either. In Manchester, in Liverpool, and all through England, we
have a great number of banks, each with a business more or less
good, but we have no single bank with any sort of predominance; nor
is there any such bank in Scotland. In the new world of Joint Stock
Banks outside the Bank of England, we see much the same phenomenon.
One or more get for a time a better business than the others, but no
single bank permanently obtains an unquestioned predominance. None
of them gets so much before the others that the others voluntarily
place their reserves in its keeping. A republic with many
competitors of a size or sizes suitable to the business, is the
constitution of every trade if left to itself, and of banking as
much as any other. A monarchy in any trade is a sign of some
anomalous advantage, and of some intervention from without.
I shall be at once asked--Do you propose a revolution? Do you propose
to abandon the one-reserve system, and create anew a many-reserve
system? My plain answer is that I do not propose it. I know it would
be childish. Credit in business is like loyalty in Government. You
must take what you can find of it, and work with it if possible. A
theorist may easily map out a scheme of Government in which Queen
Victoria could be dispensed with. He may make a theory that, since
we admit and we know that the House of Commons is the real
sovereign, any other sovereign is superfluous; but for practical
purposes, it is not even worth while to examine these arguments.
Queen Victoria is loyally obeyed--without doubt, and without
reasoning--by millions of human beings. If those millions began to
argue, it would not be easy to persuade them to obey Queen Victoria,
or anything else. Effectual arguments to convince the people who
need convincing are wanting. Just so, an immense system of credit,
founded on the Bank of England as its pivot and its basis, now
exists. The English people, and foreigners too, trust it implicitly.
Every banker knows that if he has to prove that he is worthy of
credit, however good may be his arguments, in fact his credit is
gone: but what we have requires no proof. The whole rests on an
instinctive confidence generated by use and years. Nothing would
persuade the English people to abolish the Bank of England; and if
some calamity swept it away, generations must elapse before at all
the same trust would be placed in any other equivalent. A
many-reserve system, if some miracle should put it down in Lombard
Street, would seem monstrous there. Nobody would understand it, or
confide in it. Credit is a power which may grow, but cannot be
constructed. Those who live under a great and firm system of credit
must consider that if they break up that one they will never see
another, for it will take years upon years to make a successor to it.
On this account, I do not suggest that we should return to a natural
or many-reserve system of banking. I should only incur useless
ridicule if I did suggest it. Nor can I propose that we should adopt
the simple and straightforward expedient by which the French have
extricated themselves from the same difficulty. In France all
banking rests on the Bank of France, even more than in England all
rests on the Bank of England. The Bank of France keeps the final
banking reserve, and it keeps the currency reserve too. But the
State does not trust such a function to a board of merchants, named
by shareholders. The nation itself--the Executive Government--names
the governor and deputy-governor of the Bank of France. These
officers have, indeed, beside them a council of 'regents,' or
directors, named by the shareholders. But they need not attend to
that council unless they think fit; they are appointed to watch over
the national interest, and, in so doing, they may disregard the
murmurs of the 'regents' if they like. And in theory, there is much
to be said for this plan. The keeping the single banking reserve
being a national function, it is at least plausible to argue that
Government should choose the functionaries. No doubt such a
political intervention is contrary to the sound economical doctrine
that 'banking is a trade, and only a trade.' But Government forgot
that doctrine when, by privileges and monopolies, it made a single
bank predominant over all others, and established the one-reserve
system. As that system exists, a logical Frenchman consistently
enough argues that the State should watch and manage it. But no such
plan would answer in England. We have not been trained to care for
logical sequence in our institutions, or rather we have been trained
not to care for it. And the practical result for which we do care
would in this case be bad. The governor of the Bank would be a high
Parliamentary official, perhaps in the Cabinet, and would change as
chance majorities and the strength of parties decide. A trade
peculiarly requiring consistency and special attainment would be
managed by a shifting and untrained ruler. In fact, the whole plan
would seem to an Englishman of business palpably absurd; he would
not consider it, he would not think it worth considering. That it
works fairly well in France, and that there are specious arguments
of theory for it, would not be sufficient to his mind.
All such changes being out of the question, I can propose only three
remedies.
First. There should be a clear understanding between the Bank and
the public that, since the Bank hold out ultimate banking reserve,
they will recognise and act on the obligations which this implies;
that they will replenish it in times of foreign demand as fully, and
Lend it in times of internal panic as freely and readily, as plain
principles of banking require.
This looks very different from the French plan, but it is not so
different in reality. In England we can often effect, by the
indirect compulsion of opinion, what other countries must effect by
the direct compulsion of Government. We can do so in this case. The
Bank directors now fear public opinion exceedingly; probably no kind
of persons are so sensitive to newspaper criticism. And this is very
natural. Our statesmen, it is true, are much more blamed, but they
have generally served a long apprenticeship to sharp criticism. If
they still care for it (and some do after years of experience much
more than the world thinks), they care less for it than at first,
and have come to regard it as an unavoidable and incessant irritant,
of which they shall never be rid. But a bank director undergoes no
similar training and hardening. His functions at the Bank fill a
very small part of his time; all the rest of his life (unless he be
in Parliament) is spent in retired and mercantile industry. He is
not subjected to keen and public criticism, and is not taught to
bear it. Especially when once in his life he becomes, by rotation,
governor, he is most anxious that the two years of office shall 'go
off well.' He is apt to be irritated even by objections to
principles on which he acts, and cannot bear with equanimity censure
which is pointed and personal. At present I am not sure if this
sensitiveness is beneficial. As the exact position of the Bank of
England in the Money Market is indistinctly seen, there is no
standard to which a Bank governor can appeal. He is always in fear
that 'something may be said;' but not quite knowing on what side
that 'something' may be, his fear is but an indifferent guide to
him. But if the cardinal doctrine were accepted, if it were
acknowledged that the Bank is charged with the custody of our sole
banking reserve, and is bound to deal with it according to admitted
principles, then a governor of the Bank could look to those
principles. He would know which way criticism was coming. If he was
guided by the code, he would have a plain defence. And then we may
be sure that old men of business would not deviate from the code. At
present the Board of Directors are a sort of semi-trustees for the
nation. I would have them real trustees, and with a good trust deed.
Secondly. The government of the Bank should be improved in a manner
to be explained. We should diminish the 'amateur' element; we should
augment the trained banking element; and we should ensure more
constancy in the administration.
Thirdly. As these two suggestions are designed to make the Bank as
strong as possible, we should look at the rest of our banking
system, and try to reduce the demands on the Bank as much as we can.
The central machinery being inevitably frail, we should carefully
and as much as possible diminish the strain upon it.
But to explain these proposals, and to gain a full understanding of
many arguments that have been used, we must look more in detail at
the component parts of Lombard street, and at the curious set of
causes which have made it assume its present singular structure.
CHAPTER III.
How Lombard Street Came to Exist, and Why It Assumed Its Present
Form.
In the last century, a favourite subject of literary ingenuity was
'conjectural history,' as it was then called. Upon grounds of
probability a fictitious sketch was made of the possible origin of
things existing. If this kind of speculation were now applied to
banking, the natural and first idea would be that large systems of
deposit banking grew up in the early world, just as they grow up now
in any large English colony. As soon as any such community becomes
rich enough to have much money, and compact enough to be able to
lodge its money in single banks, it at once begins so to do. English
colonists do not like the risk of keeping their money, and they wish
to make an interest on it. They carry from home the idea and the
habit of banking, and they take to it as soon as they can in their
new world. Conjectural history would be inclined to say that all
banking began thus: but such history is rarely of any value. The
basis of it is false. It assumes that what works most easily when
established is that which it would be the most easy to establish,
and that what seems simplest when familiar would be most easily
appreciated by the mind though unfamiliar. But exactly the contrary
is true. Many things which seem simple and which work well when
firmly established, are very hard to establish among new people, and
not very easy to explain to them. Deposit banking is of this sort.
Its essence is that a very large number of persons agree to trust a
very few persons, or some one person. Banking would not be a
profitable trade if bankers were not a small number, and depositors
in comparison an immense number. But to get a great number of
persons to do exactly the same thing is always very difficult, and
nothing but a very palpable necessity will make them on a sudden
begin to do it. And there is no such palpable necessity in banking.
If you take a country town in France, even now, you will not find
any such system of banking as ours. Cheque-books are unknown, and
money kept on running account by bankers is rare. People store their
money in a caisse at their houses. Steady savings, which are waiting
for investment, and which are sure not to be soon wanted, may be
lodged with bankers; but the common floating cash of the community
is kept by the community themselves at home. They prefer to keep it
so, and it would not answer a banker's purpose to make expensive
arrangements for keeping it otherwise. If a 'branch,' such as the
National Provincial Bank opens in an English country town, were
opened in a corresponding French one, it would not pay its expenses.
You could not get any sufficient number of Frenchmen to agree to put
their money there. And so it is in all countries not of British
descent, though in various degrees. Deposit banking is a very
difficult thing to begin, because people do not like to let their
money out of their sight, especially do not like to let it out of
sight without securitystill more, cannot all at once agree on any
single person to whom they are content to trust it unseen and
unsecured. Hypothetical history, which explains the past by. what is
simplest and commonest in the present, is in banking, as in most
things, quite untrue.
The real history is very different. New wants are mostly supplied by
adaptation, not by creation or foundation. Something having been
created to satisfy an extreme want, it is used to satisfy less
pressing wants, or to supply additional conveniences. On this
account, political Government--the oldest institution in the worldhas
been the hardest worked. At the beginning of history, we find it
doing everything which society wants done, and forbidding everything
which society does not wish done. In trade, at present, the first
commerce in a new place is a general shop, which, beginning with
articles of real necessity, comes shortly to supply the oddest
accumulation of petty comforts. And the history of banking has been
the same. The first banks were not founded for our system of deposit
banking, or for anything like it. They were founded for much more
pressing reasons, and having been founded, they, or copies from
them, were applied to our modern uses.
The earliest banks of Italy, where the name began, were finance
companies. The Bank of St. George, at Genoa, and other banks founded
in imitation of it, were at first only companies to make loans to,
and float loans for, the Governments of the cities in which they
were formed. The want of money is an urgent want of Governments at
most periods, and seldom more urgent than it was in the tumultuous
Italian Republics of the Middle Ages. After these banks had been
long established, they began to do what we call banking business;
but at first they never thought of it. The great banks of the North
of Europe had their origin in a want still more curious. The notion
of its being a prime business of a bank to give good coin has passed
out of men's memories; but wherever it is felt, there is no want of
business more keen and urgent. Adam Smith describes it so admirably
that it would be stupid not to quote his words:--'The currency of a
great state, such as France or England, generally consists almost
entirely of its own coin. Should this currency, therefore, be at any
time worn, clipt, or otherwise degraded below its standard value,
the state by a reformation of its coin can effectually re-establish
its currency. But the currency of a small state, such as Genoa or
Hamburgh, can seldom consist altogether in its own coin, but must be
made up, in a great measure, of the coins of all the neighbouring
states with which its inhabitants have a continual intercourse. Such
a state, therefore, by reforming its coin, will not always be able
to reform its currency. If foreign bills of exchange are paid in
this currency, the uncertain value of any sum, of what is in its own
nature so uncertain, must render the exchange always very much
against such a state, its currency being, in all foreign states,
necessarily valued even below what it is worth.
'In order to remedy the inconvenience to which this disadvantageous
exchange must have subjected their merchants, such small states,
when they began to attend to the interest of trade, have frequently
enacted, that foreign bills of exchange of a certain value should be
paid, not in common currency, but by an order upon, or by a transfer
in, the books of a certain bank, established upon the credit, and
under the protection of the state, this bank being always obliged to
pay, in good and true money, exactly according to the standard of
the state. The banks of Venice, Genoa, Amsterdam, Hamburgh and
Nuremburg, seem to have been all originally established with this
view, though some of them may have afterwards been made subservient
to other purposes. The money of such banks, being better than the
common currency of the country, necessarily bore an agio, which was
greater or smaller, according as the currency was supposed to be
more or less degraded below the standard of the state. The agio of
the bank of Hamburgh, for example, which is said to be commonly
about fourteen per cent, is the supposed difference between the good
standard money of the state, and the clipt, worn, and diminished
currency poured into it from all the neighbouring states.
'Before 1609 the great quantity of clipt and worn foreign coin,
which the extensive trade of Amsterdam brought from all parts of
Europe, reduced the value of its currency about 9 per cent below
that of good money fresh from the mint. Such money no sooner
appeared than it was melted down or carried away, as it always is in
such circumstances. The merchants, with plenty of currency, could
not always find a sufficient quantity of good money to pay their
bills of exchange; and the value of those bills, in spite of several
regulations which were made to prevent it, became in a great measure
uncertain.
'In order to remedy these inconveniences, a bank was established in
1609 under the guarantee of the City. This bank received both
foreign coin, and the light and worn coin of the country at its real
intrinsic value in the good standard money of the country, deducting
only so much as was necessary for defraying the expense of coinage,
and the other necessary expense of management. For the value which
remained, after this small deduction was made, it gave a credit in
its books. This credit was called bank money, which, as it
represented money exactly according to the standard of the mint, was
always of the same real value, and intrinsically worth more than
current money. It was at the same time enacted, that all bills drawn
upon or negotiated at Amsterdam of the value of six hundred guilders
and upwards should be paid in bank money, which at once took away
all uncertainty in the value of those bills. Every merchant, in
consequence of this regulation, was obliged to keep an account with
the bank in order to pay his foreign bills of exchange, which
necessarily occasioned a certain demand for bank money.'
Again, a most important function of early banks is one which the
present banks retain, though it is subsidiary to their main use;
viz. the function of remitting money. A man brings money to the bank
to meet a payment which he desires to make at a great distance, and
the bank, having a connection with other banks, sends it where it is
wanted. As soon as bills of exchange are given upon a large scale,
this remittance is a very pressing requirement. Such bills must be
made payable at a place convenient to the seller of the goods in
payment of which they are given, perhaps at the great town where his
warehouse is. But this may be very far from the retail shop of the
buyer who bought those goods to sell them again in the country. For
these, and a multitude of purposes, the instant and regular
remittance of money is an early necessity of growing trade; and that
remittance it was a first object of early banks to accomplish.
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