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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These are all uses other than those of deposit banking which banks
supplied that afterwards became in our English sense deposit banks.
By supplying these uses, they gained the credit that afterwards
enabled them to gain a living as deposit banks. Being trusted for
one purpose, they came to be trusted for a purpose quite different,
ultimately far more important, though at first less keenly pressing.
But these wants only affect a few persons, and therefore bring the
bank under the notice of a few only. The real introductory function
which deposit banks at first perform is much more popular, and it is
only when they can perform this more popular kind of business that
deposit banking ever spreads quickly and extensively. This function
is the supply of the paper circulation to the country, and it will
be observed that I am not about to overstep my limits and discuss
this as a question of currency. In what form the best paper currency
can be supplied to a country is a question of economical theory with
which I do not meddle here. I am only narrating unquestionable
history, not dealing with an argument where every step is disputed.
And part of this certain history is that the best way to diffuse
banking in a community is to allow the banker to issue banknotes of
small amount that can supersede the metal currency. This amounts to
a subsidy to each banker to enable him to keep open a bank till
depositors choose to come to it. The country where deposit banking
is most diffused is Scotland, and there the original profits were
entirely derived from the circulation. The note issue is now a most
trifling part of the liabilities of the Scotch banks, but it was
once their mainstay and source of profit. A curious book, lately
published, has enabled us to follow the course of this in detail.
The Bank of Dundee, now amalgamated with the Royal Bank of Scotland,
was founded in 1763, and had become before its amalgamation, eight
or nine years since, a bank of considerable deposits. But for
twenty-five years from its foundation it had no deposits at all. It
subsisted mostly on its note issue, and a little on its remittance
business. Only in 1792, after nearly thirty years, it began to gain
deposits, but from that time they augmented very rapidly. The
banking history of England has been the same, though we have no
country bank accounts in detail which go back so far. But probably
up to 1830 in England, or thereabouts, the main profit of banks was
derived from the circulation, and for many years after that the
deposits were treated as very minor matters, and the whole of
so-called banking discussion turned on questions of circulation. We
are still living in the debris of that controversy, for, as I have
so often said, people can hardly think of the structure of Lombard
Street, except with reference to the paper currency and to the Act
of 1844, which regulates it now. The French are still in the same
epoch of the subject. The great enquete of 1865 is almost wholly
taken up with currency matters, and mere banking is treated as
subordinate. And the accounts of the Bank of France show why. The
last weekly statement before the German war showed that the
circulation of the Bank of France was as much as 59,244,000 L., and
that the private deposits were only 17,127,000 L. Now the private
deposits are about the same, and the circulation is 112,000,000 L.
So difficult is it in even a great country like France for the
deposit system of banking to take root, and establish itself with
the strength and vigour that it has in England.
The experience of Germany is the same. The accounts preceding the
war in North Germany showed the circulation of the issuing banks to
be 39,875,000 L., and the deposits to be 6,472,000 L. while the
corresponding figures at the present moment arecirculation,
60,000,000 L. and deposits 8,000,000 L. It would be idle to multiply
Instances.
The reason why the use of bank paper commonly precedes the habit of
making deposits in banks is very plain. It is a far easier habit to
establish. In the issue of notes the banker, the person to be most
benefited, can do something. He can pay away his own 'promises' in
loans, in wages, or in payment of debts. But in the getting of
deposits he is passive. His issues depend on himself; his deposits
on the favour of others. And to the public the change is far easier
too. To collect a great mass of deposits with the same banker, a
great number of persons must agree to do something. But to establish
a note circulation, a large number of persons need only do nothing.
They receive the banker's notes in the common course of their
business, and they have only not to take those notes to the banker
for payment. If the public refrain from taking trouble, a paper
circulation is immediately in existence. A paper circulation is
begun by the banker, and requires no effort on the part of the
public; on the contrary, it needs an effort of the public to be rid
of notes once issued; but deposit banking cannot be begun by the
banker, and requires a spontaneous and consistent effort in the
community. And therefore paper issue is the natural prelude to
deposit banking.
The way in which the issue of notes by a banker prepares the way for
the deposit of money with him is very plain. When a private person
begins to possess a great heap of bank-notes, it will soon strike
him that he is trusting the banker very much, and that in re turn he
is getting nothing. He runs the risk of loss and robbery just as if
he were hoarding coin. He would run no more risk by the failure of
the bank if he made a deposit there, and he would be free from the
risk of keeping the cash. No doubt it takes time before even this
simple reasoning is understood by uneducated minds. So strong is the
wish of most people to see their money that they for some time
continue to hoard bank-notes: for a long period a few do so. But in
the end common sense conquers. The circulation of bank-notes
decreases, and the deposit of money with the banker increases. The
credit of the banker having been efficiently advertised by the note,
and accepted by the public, he lives on the credit so gained years
after the note issue itself has ceased to be very important to him.
The efficiency of this introduction is proportional to the diffusion
of the right of note issue. A single monopolist issuer, like the
Bank of France, works its way with difficulty through a country, and
advertises banking very slowly. Even now the Bank of France, which,
I believe, by law ought to have a branch in each Department, has
only branches in sixty out of eighty-six. On the other hand, the
Swiss banks, where there is always one or more to every Canton,
diffuse banking rapidly. We have seen that the liabilities of the
Bank of France stand thus:
Notes L 112,000,000
Deposits L 15,000,000
But the aggregate Swiss banks, on the contrary, stand:
Notes L 761,000
Deposits L 4,709,000
The reason is that a central bank which is governed in the capital
and descends on a country district, has much fewer modes of lending
money safely than a bank of which the partners belong to that
district, and know the men and things in it. A note issue is mainly
begun by loans; there are then no deposits to be paid. But the mass
of loans in a rural district are of small amount; the bills to be
discounted are trifling; the persons borrowing are of small means
and only local repute; the value of any property they wish to pledge
depends on local changes and local circumstances. A banker who lives
in the district, who has always lived there, whose whole mind is a
history of the district and its changes, is easily able to lend
money safely there. But a manager deputed by a single central
establishment does so with difficulty. The worst people will come to
him and ask for loans. His ignorance is a mark for all the shrewd
and crafty people thereabouts. He will have endless difficulties in
establishing the circulation of the distant bank, because he has not
the local knowledge which alone can teach him how to issue that
circulation with safety.
A system of note issues is therefore the best introduction to a
large system of deposit banking. As yet, historically, it is the
only introduction: no nation as yet has arrived at a great system of
deposit banking without going first through the preliminary stage of
note issue, and of such note issues the quickest and most efficient
in this way is one made by individuals resident in the district, and
conversant with it.
And this explains why deposit banking is so rare. Such a note issue
as has been described is possible only in a country exempt from
invasion, and free from revolution. During an invasion note-issuing
banks must stop payment; a run is nearly inevitable at such a time,
and in a revolution too. In such great and close civil dangers a
nation is always demoralised; everyone looks to himself, and
everyone likes to possess himself of the precious metals. These are
sure to be valuable, invasion or no invasion, revolution or no
revolution. But the goodness of bank-notes depends on the solvency
of the banker, and that solvency may be impaired if the invasion is
not repelled or the revolution resisted.
Hardly any continental country has been till now exempt for long
periods both from invasion and revolution. In Holland and Germanytwo
countries where note issue and deposit banking would seem as natural
as in England and Scotlandthere was never any security from foreign
war. A profound apprehension of external invasion penetrated their
whole habits, and men of business would have thought it insane not
to contemplate a contingency so frequent in their history, and
perhaps witnessed by themselves.
France indeed, before 1789, was an exception. For many years under
the old regime she was exempt from serious invasion or attempted
revolution. Her Government was fixed, as was then thought, and
powerful; it could resist any external enemy, and the prestige on
which it rested seemed too firm to fear any enemy from within. But
then it was not an honest Government, and it had shown its
dishonesty in this particular matter of note issue. The regent in
Law's time had given a monopoly of note issue to a bad bank, and had
paid off the debts of the nation in worthiess paper. The Government
had created a machinery of ruin, and had thriven on it. Among so
apprehensive a race as the French the result was fatal. For many
years no attempt at note issue or deposit banking was possible in
France. So late as the foundation of the Caisse d'Escompte, in
Turgot's time, the remembrance of Law's failure was distinctly felt,
and impeded the commencement of better attempts.
This therefore is the reason why Lombard Street exists; that is, why
England is a very great Money Market, and other European countries
but small ones in comparison. In England and Scotland a diffused
system of note issues started banks all over the country; in these
banks the savings of the country have been lodged, and by these they
have been sent to London. No similar system arose elsewhere, and in
consequence London is full of money, and all continental cities are
empty as compared with it.
II.
The monarchical form of Lombard Street is due also to the note
issue. The origin of the Bank of England has been told by Macaulay,
and it is never wise for an ordinary writer to tell again what he
has told so much better. Nor is it necessary, for his writings are
in everyone s hands. Still I must remind my readers of the curious
story.
Of all institutions in the world the Bank of England is now probably
the most remote from party politics and from 'financing.' But in its
origin it was not only a finance company, but a Whig finance
company. It was founded by a Whig Government because it was in
desperate want of money, and supported by the 'City' because the
'City' was Whig. Very briefly, the story was this. The Government of
Charles II. (under the Cabal Ministry) had brought the credit of the
English State to the lowest possible point. It had perpetrated one
of those monstrous frauds, which are likewise gross blunders. The
goldsmiths, who then carried on upon a trifling scale what we should
now call banking, used to deposit their reserve of treasure in the
'Exchequer,' with the sanction and under the care of the Government.
In many European countries the credit of the State had been so much
better than any other credit, that it had been used to strengthen
the beginnings of banking. The credit of the state had been so used
in England: though there had lately been a civil war and several
revolutions, the honesty of the English Government was trusted
implicitly. But Charles II. showed that it was trusted undeservedly.
He shut up the 'Exchequer,' would pay no one, and so the
'goldsmiths' were ruined.
The credit of the Stuart Government never recovered from this
monstrous robbery, and the Government created by the Revolution of
1688 could hardly expect to be more trusted with money than its
predecessor. A Government created by a revolution hardly ever is.
There is a taint of violence which capitalists dread instinctively,
and there is always a rational apprehension that the Government
which one revolution thought fit to set up another revolution may
think fit to pull down. In 1694, the credit of William III.'s
Government was so low in London that it was impossible for it to
borrow any large sum; and the evil was the greater, because in
consequence of the French war the financial straits of the
Government were extreme. At last a scheme was hit upon which would
relieve their necessities. 'The plan,' says Macaulay, 'was that
twelve hundred thousand pounds should be raised at what was then
considered as the moderate rate of 8 per cent.' In order to induce
the subscribers to advance the money promptly on terms so
unfavourable to the public, the subscribers were to be incorporated
by the name of the Governor and Company of the Bank of England. They
were so incorporated, and the 1,200,000 L. was obtained.
On many succeeding occasions, their credit was of essential use to
the Government. Without their aid, our National Debt could not have
been borrowed; and if we had not been able to raise that money we
should have been conquered by France and compelled to take back
James II. And for many years afterwards the existence of that debt
was a main reason why the industrial classes never would think of
recalling the Pretender, or of upsetting the revolution settlement.
The 'fund-holder' is always considered in the books of that time as
opposed to his 'legitimate' sovereign, because it was to be feared
that this sovereign would repudiate the debt which was raised by
those who dethroned him, and which was spent in resisting him and
his allies. For a long time the Bank of England was the focus of
London Liberalism, and in that capacity rendered to the State
inestimable services. In return for these substantial benefits the
Bank of England received from the Government, either at first or
afterwards, three most important privileges.
First. The Bank of England had the exclusive possession of the
Government balances. In its first period, as I have shown, the Bank
gave credit to the Government, but afterwards it derived credit from
the Government. There is a natural tendency in men to follow the
example of the Government under which they live. The Government is
the largest, most important, and most conspicuous entity with which
the mass of any people are acquainted; its range of knowledge must
always be infinitely greater than the average of their knowledge,
and therefore, unless there is a conspicuous warning to the
contrary, most men are inclined to think their Government right,
and, when they can, to do what it does. Especially in money matters
a man might fairly reason'If the Government is right in trusting the
Bank of England with the great balance of the nation, I cannot be
wrong in trusting it with my little balance.'
Second. The Bank of England had, till lately, the monopoly of
limited liability in England. The common law of England knows
nothing of any such principle. It is only possible by Royal Charter
or Statute Law. And by neither of these was any real bank (I do not
count absurd schemes such as Chamberlayne's Land Bank) permitted
with limited liability in England till within these few years.
Indeed, a good many people thought it was right for the Bank of
England, but not right for any other bank. I remember hearing the
conversation of a distinguished merchant in the City of London, who
well represented the ideas then most current He was declaiming
against banks of limited liability, and some one asked'Why, what do
you say, then, to the Bank of England, where you keep your own
account?' 'Oh!' he replied, 'that is an exceptional case.' And no
doubt it was an exception of the greatest value to the Bank of
England, because it induced many quiet and careful merchants to be
directors of the Bank, who certainly would not have joined any bank
where all their fortunes were liable, and where the liability was
not limited.
Thirdly. The Bank of England had the privilege of being the sole
joint stock company permitted to issue bank notes in England.
Private London bankers did indeed issue notes down to the middle of
the last century, but no joint stock company could do so. The
explanatory clause of the Act of 1742 sounds most curiously to our
modern ears. 'And to prevent any doubt that may arise concerning the
privilege or power given to the said governor and company' that is,
the Bank of England' OF EXCLUSIVE BANKING; and also in regard to
creating any other bank or banks by Parliament, or restraining other
persons from banking during the continuance of the said privilege
granted to the governor and company of the Bank of England, as
before recited; it is hereby further enacted and declared by the
authority aforesaid, that it is the true intent and meaning of the
said Act that no other bank shall be created, established, or
allowed by Parliament, and that it shall not be lawful for any body
politic or corporate whatsoever created or to be created, or for any
other persons whatsoever united or to be united in covenants or
partnership exceeding the number of six persons in that part of
Great Britain called England, to borrow, owe, or take up any sum or
sums of money on their bills or notes payable on demand or at any
less time than six months from the borrowing thereof during the
continuance of such said privilege to the said governor and company,
who are hereby declared to be and remain a corporation with the
privilege of exclusive banking, as before recited.' To our modern
ears these words seem to mean more than they did. The term banking
was then applied only to the issue of notes and the taking up of
money on bills on demand. Our present system of deposit banking, in
which no bills or promissory notes are issued, was not then known on
a great scale, and was not called banking. But its effect was very
important. It in time gave the Bank of England the monopoly of the
note issue of the Metropolis. It had at that time no branches, and
so it did not compete for the country circulation. But in the
Metropolis, where it did compete, it was completely victorious. No
company but the Bank of England could issue notes, and
unincorporated individuals gradually gave way, and ceased to do so.
Up to 1844 London private bankers might have issued notes if they
pleased, but almost a hundred years ago they were forced out of the
field. The Bank of England has so long had a practical monopoly of
the circulation, that it is commonly believed always to have had a
legal monopoly.
And the practical effect of the clause went further: it was believed
to make the Bank of England the only joint stock company that could
receive deposits, as well as the only company that could issue
notes. The gift of 'exclusive banking' to the Bank of England was
read in its most natural modern sense: it was thought to prohibit
any other banking company from carrying on our present system of
banking. After joint stock banking was permitted in the country,
people began to inquire why it should not exist in the Metropolis
too? And then it was seen that the words I have quoted only forbid
the issue of negotiable instruments, and not the receiving of money
when no such instrument is given. Upon this construction, the London
and Westminster Bank and all our older joint stock banks were
founded. But till they began, the Bank of England had among
companies not only the exclusive privilege of note issue, but that
of deposit banking too. It was in every sense the only banking
company in London.
With so many advantages over all competitors, it is quite natural
that the Bank of England should have far outstripped them all.
Inevitably it became the bank in London; all the other bankers
grouped themselves round it, and lodged their reserve with it. Thus
our one reserve system of banking was not deliberately founded upon
definite reasons; it was the gradual consequence of many singular
events, and of an accumulation of legal privileges on a single bank
which has now been altered, and which no one would now defend.
CHAPTER IV.
The Position of the Chancellor of the Exchequer in the Money Market.
Nothing can be truer in theory than the economical principle that
banking is a trade and only a trade, and nothing can be more surely
established by a larger experience than that a Government which
interferes with any trade injuries that trade. The best thing
undeniably that a Government can do with the Money Market is to let
it take care of itself.
But a Government can only carry out this principle universally if it
observe one condition: it must keep its own money. The Government is
necessarily at times possessed of large sums in cash. It is by far
the richest corporation in the country; its annual revenue payable
in money far surpasses that of any other body or person. And if it
begins to deposit this immense income as it accrues at any bank, at
once it becomes interested in the welfare of that bank. It cannot
pay the interest on its debt if that bank cannot produce the public
deposits when that interest becomes due; it cannot pay its salaries,
and defray its miscellaneous expenses, if that bank fail at any
time. A modern Government is like a very rich man with very great
debts which he cannot well pay; its credit is necessary to its
prosperity, almost to its existence, and if its banker fail when one
of its debts becomes due its difficulty is intense.
Another banker, it will be said, may take up the Government account.
He may advance, as is so often done in other bank failures, what the
Government needs for the moment in order to secure the Government
account in future. But the imperfection of this remedy is that it
fails in the very worst case. In a panic, and at a general collapse
of credit, no such banker will probably be found. The old banker who
possesses the Government deposit cannot repay it, and no banker not
having that deposit will, at a bad crisis, be able to find the
5,000,000 L. or 6,000,000 L. which the quarter day of a Government
such as ours requires. If a finance Minister, having entrusted his
money to a bank, begins to act strictly, and say he will in all
cases let the Money Market take care of itself, the reply is that in
one case the Money Market will take care of him too, and he will be
insolvent.
In the infancy of Banking it is probably much better that a
Government should as a rule keep its own money. If there are not
Banks in which it can place secure reliance, it should not seem to
rely upon them. Still less should it give peculiar favour to any
one, and by entrusting it with the Government account secure to it a
mischievous supremacy above all other banks. The skill of a
financier in such an age is to equalise the receipt of taxation, and
the outgoing of expenditure; it should be a principal care with him
to make sure that more should not be locked up at a particular
moment in the Government coffers than is usually locked up there. If
the amount of dead capital so buried in the Treasury does not at any
time much exceed the common average, the evil so caused is
inconsiderable: it is only the loss of interest on a certain sum of
money, which would not be much of a burden on the whole nation; the
additional taxation it would cause would be inconsiderable. Such an
evil is nothing in comparison with that of losing the money
necessary for inevitable expence by entrusting it to a bad Bank, or
that of recovering this money by identifying the national credit
with the bad Bank and so propping it up and perpetuating it. So long
as the security of the Money Market is not entirely to be relied on,
the Goverment of a country had much better leave it to itself and
keep its own money. If the banks are bad, they will certainly
continue bad and will probably become worse if the Government
sustains and encourages them. The cardinal maxim is, that any aid to
a present bad Bank is the surest mode of preventing the
establishment of a future good Bank.
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