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 demand in this case arose in the most effective of all ways. In
1867 and the first half of 1868 corn was dear, as the following
figures show:
GAZETTE AVERAGE PRICE OF WHEAT.
s. d.
December, 1866 60 3
January, 1867 61 4
February 60 10
March 59 9
April 61 6
May 64 8
June 65 8
July 65 0
August 67 8
September 62 8
October 1867 66 6
November 69 5
December 67 4
January, 1868 70 3
February 73 0
March 73 0
April 73 3
May 73 9
June 67 11
July 65 5
From that time it fell, and it was very cheap during the whole of
1869 and 1870. The effect of this cheapness is great in every
department of industry. The working classes, having cheaper food,
need to spend so much less on that food, and have more to spend on
other things. In consequence, there is a gentle augmentation of
demand through almost all departments of trade. And this almost
always causes a great augmentation in what may be called the
instrumental trades--that is, in the trades which deal in machines and
instruments used in many branches of commerce, and in the materials
for such. Take, for instance, the iron trade--
In the year 1869 we exported 2,568,000 tons
" 1870 " 2,716,000 tons
5,284,000 tons
" 1867 " 1,881,000 tons
" 1868 " 1,944,000 tons
3,826,000 tons
Increase 1,458,000 tons
that is to say, cheap corn operating throughout the world, created a
new demand for many kinds of articles; the production of a large
number of such articles being aided by iron in some one of its many
forms, iron to that extent was exported. And the effect is
cumulative. The manufacture of iron being stimulated, all persons
concerned in that great manufacture are well off, have more to
spend, and by spending it encourage other branches of manufacture,
which again propagate the demand; they receive and so encourage
industries in a third degree dependent and removed.
'It is quite true that corn has not been quite so cheap during the
present year. But even if it had been dearer than it is, it would
not all at once arrest the great trade which former cheapness had
created. The "ball," if we may so say, "was set rolling" in 1869 and
1870, and a great increase of demand was then created in certain
trades and propagated through all trades. A continuance of very high
prices would produce the reverse effect; it would slacken demand in
certain trades, and the effect would be gradually diffused through
all trades. But a slight rise such as that of this year has no
perceptible effect.
'When the stimulus of cheap corn is added to that of cheap money,
the full conditions of a great and diffused rise of prices are
satisfied. This new employment supplies a mode in which money can be
invested. Bills are drawn of greater number and greater magnitude,
and through the agencies of banks and discount houses, the savings
of the country are invested in such bills. There is thus a new want
and a new purchase-money to supply that want, and the consequence is
the diffused and remarkable rise of price which the figures show to
have occurred.
'The rise has also been aided by the revival of credit. This, as
need not be at length explained, is a great aid to buying, and
consequently a great aid to a rise of price. Since 1866, credit has
been gradually, though very slowly, recovering, and it is probably
as good as it is reasonable or proper that it should be. We are now
trusting as many people as we ought to trust, and as yet there is no
wild excess of misplaced confidence which would make us trust those
whom we ought not to trust.'
The process thus explained is the common process. The surplus of
loanable capital which lies in the hands of bankers is not employed
by them in any original way; it is almost always lent to a trade
already growing and already improving. The use of it develops that
trade yet farther, and this again augments and stimulates other
trades. Capital may long lie idle in a stagnant condition of
industry; the mercantile securities which experienced bankers know
to be good do not augment, and they will not invent other
securities, or take bad ones.
In most great periods of expanding industry, the three great causes
much loanable capital, good credit, and the increased profits
derived from better-used labour and better-used capitalhave acted
simultaneously; and though either may act by itself, there is a
permanent reason why mostly they will act together. They both tend
to grow together, if you begin from a period of depression. In such
periods credit is bad, and industry unemployed; very generally
provisions are high in price, and their dearness was one of the
causes which made the times bad. Whether there was or was not too
much loanable capital when that period begins, there soon comes to
be too much. Quiet people continue to save part of their incomes in
bad times as well as in good; indeed, of the two, people of
slightly-varying and fixed incomes have better means of saving in
bad times because prices are lower. Quiescent trade affords no new
securities in which the new saving can be invested, and therefore
there comes soon to be an excess of loanable capital. In a year or
two after a crisis credit usually improves, as the remembrance of
the disasters which at the crisis impaired credit is becoming
fainter and fainter. Provisions get back to their usual price, or
some great industry makes, from some temporary cause, a quick step
forward. At these moments, therefore, the three agencies which, as
has been explained, greatly develope trade, combine to develope it
simultaneously.
The certain result is a bound of national prosperity; the country
leaps forward as if by magic. But only part of that prosperity has a
solid reason. As far as prosperity is based on a greater quantity of
production, and that of the right articlesas far as it is based on
the increased rapidity with which commodities of every kind reach
those who want themits basis is good. Human industry is more
efficient, and therefore there is more to be divided among mankind.
But in so far as that prosperity is based on a general rise of
prices, it is only imaginary. A general rise of prices is a rise
only in name; whatever anyone gains on the article which he has to
sell he loses on the articles which he has to buy, and so he is just
where he was. The only real effects of a general rise of prices are
these: first, it straitens people of fixed incomes, who suffer as
purchasers, but who have no gain to correspond; and secondly, it
gives an extra profit to fixed capital created before the rise
happened. Here the sellers gain, but without any equivalent loss as
buyers. Thirdly, this gain on fixed capital is greatest in what may
be called the industrial 'implements,' such as coal and iron. These
are wanted in all industries, and in any general increase of prices,
they are sure to rise much more than other things. Everybody wants
them; the supply of them cannot be rapidly augmented, and therefore
their price rises very quickly. But to the country as a whole, the
general rise of prices is no benefit at all; it is simply a change
of nomenclature for an identical relative value in the same
commodities. Nevertheless, most people are happier for it; they
think they are getting richer, though they are not. And as the rise
does not happen on all articles at the same moment, but is
propagated gradually through society, those to whom it first comes
gain really; and as at first every one believes that he will gain
when his own article is rising, a buoyant cheerfulness overflows the
mercantile world.
This prosperity is precarious as far as it is real, and transitory
in so far as it is fictitious. The augmented production, which is
the reason of the real prosperity, depends on the full working of
the whole industrial organisationof all capitalists and labourers;
that prosperity was caused by that full working, and will cease with
it. But that full working is liable to be destroyed by the
occurrence of any great misfortune to any considerable industry.
This would cause misfortune to the industries dependent on that one,
and, as has been explained, all through society and back again. But
every such industry is liable to grave fluctuations, and the most
important--the provision industries--to the gravest and the suddenest.
They are dependent on the casualties of the seasons. A single bad
harvest diffused over the world, a succession of two or three bad
harvests, even in England only, will raise the price of corn
exceedingly, and will keep it high. And a great and protracted rise
in the price of corn will at once destroy all the real part of the
unusual prosperity of previous good times. It will change the full
working of the industrial machine into an imperfect working; it will
make the produce of that machine less than usual instead of more
than usual; instead of there being more than the average of general
dividend to be distributed between the producers, there will
immediately be less than the average.
And in so far as the apparent prosperity is caused by an unusual
plentifulness of loanable capital and a consequent rise in prices,
that prosperity is not only liable to reaction, but certain to be
exposed to reaction. The same causes which generate this prosperity
will, after they have been acting a little longer, generate an
equivalent adversity. The process is this: the plentifulness of
loanable capital causes a rise of prices; that rise of prices makes
it necessary to have more loanable capital to carry on the same
trade. 100,000 L. will not buy as much when prices are high as it
will when prices are low, it will not be so effectual for carrying
on business; more money is necessary in dear times than in cheap
times to produce the same changes in the same commodities. Even
supposing trade to have remained stationary, a greater capital would
be required to carry it on after such a rise of prices as has been
described than was necessary before that rise. But in this case the
trade will not have remained stationary; it will have
increasedcertainly to some extent, probably to a great extent. The
'loanable capital,' the lending of which caused the rise of prices,
was lent to enable it--to augment. The loanable capital lay idle in
the banks till some trade started into prosperity, and then was lent
in order to develope that trade; that trade caused other secondary
developments; those secondary developments enabled more loanable
capital to be lent; and that lending caused a tertiary development
of trade; and so on through society.
In consequence, a long-continued low rate of interest is almost
always followed by a rapid rise in that rate. Till the available
trade is found it lies idle, and can scarcely be lent at all; some
of it is not lent. But the moment the available trade is
discoveredthe moment that prices have risen--the demand for loanable
capital becomes keen. For the most part, men of business must carry
on their regular trade; if it cannot be carried on without borrowing
10 per cent more capital, 10 per cent more capital they must borrow.
Very often they have incurred obligations which must be met; and if
that is so the rate of interest which they pay is comparatively
indifferent. What is necessary to meet their acceptances they will
borrow, pay for it what they may; they had better pay any price than
permit those acceptances to be dishonoured. And in less extreme
eases men of business have a fixed capital, which cannot lie idle
except at a great loss; a set of labourers which must be, if
possible, kept together; a steady connection of customers, which
they would very unwillingly lose. To keep all these, they borrow;
and in a period of high prices many merchants are peculiarly anxious
to borrow, because the augmentation of the price of the article in
which they deal makes them really see, or imagine that they see,
peculiar opportunities of profit. An immense new borrowing soon
follows upon the new and great trade, and the rate of interest rises
at once, and generally rises rapidly.
This is the surer to happen that Lombard Street is, as has been
shown before, a very delicate market. A large amount of money is
held there by bankers and by bill-brokers at interest: this they
must employ, or they will be ruined. It is better for them to reduce
the rate they charge, and compensate themselves by reducing the rate
they pay, rather than to keep up the rate of charge, if by so doing
they cannot employ all their money. It is vital to them to employ
all the money on which they pay interest. A little excess therefore
forces down the rate of interest very much. But if that low rate of
interest should cause, or should aid in causing, a great growth of
trade, the rise is sure to be quick, and is apt to be violent. The
figures of trade are reckoned by hundreds of millions, where those
of loanable capital count only by millions. A great increase in the
borrowing demands of English commerce almost always changes an
excess of loanable capital above the demand to a greater deficiency
below the demand. That deficiency causes adversity, or apparent
adversity, in trade, just as, and in the same manner, that the
previous excess caused prosperity, or apparent prosperity. It causes
a fall of price that runs through society; that fall causes a
decline of activity and a diminution of profitsa painful contraction
instead of the previous pleasant expansion.
The change is generally quicker because some check to credit happens
at an early stage of it. The mercantile community will have been
unusually fortunate if during the period of rising prices it has not
made great mistakes. Such a period naturally excites the sanguine
and the ardent; they fancy that the prosperity they see will last
always, that it is only the beginning of a greater prosperity. They
altogether over-estimate the demand for the article they deal in, or
the work they do. They all in their degreeand the ablest and the
cleverest the mostwork much more than they should, and trade far
above their means. Every great crisis reveals the excessive
speculations of many houses which no one before suspected, and which
commonly indeed had not begun or had not carried very far those
speculations, till they were tempted by the daily rise of price and
the surrounding fever.
The case is worse, because at most periods of great commercial
excitement there is some mixture of the older and simpler kind of
investing mania. Though the money of saving persons is in the hands
of banks, and though, by offering interest, banks retain the command
of much of it, yet they do not retain the command of the whole, or
anything near the whole; all of it can be used, and much of it is
used, by its owners. They speculate with it in bubble companies and
in worthless shares, just as they did in the time of the South Sea
mania, when there were no banks, and as they would again in England
supposing that banks ceased to exist. The mania of 1825 and the
mania of 1866 were striking examples of this; in their case to a
great extent, as in most similar modern periods to a less extent,
the delirium of ancient gambling co-operated with the milder madness
of modern overtrading. At the very beginning of adversity, the
counters in the gambling mama, the shares in the companies created
to feed the mania, are discovered to be worthless; down they all go,
and with them much of credit.
The good times too of high price almost always engender much fraud.
All people are most credulous when they are most happy; and when
much money has just been made, when some people are really making
it, when most people think they are making it, there is a happy
opportunity for ingenious mendacity. Almost everything will be
believed for a little while, and long before discovery the worst and
most adroit deceivers are geographically or legally beyond the reach
of punishment. But the harm they have done diffuses harm, for it
weakens credit still farther.
When we understand that Lombard Street is subject to severe
alternations of opposite causes, we should cease to be surprised at
its seeming cycles. We should cease too to be surprised at the
sudden panics. During the period of reaction and adversity, just
even at the last instant of prosperity, the whole structure is
delicate. The peculiar essence of our banking system is an
unprecedented trust between man and man: and when that trust is much
weakened by hidden causes, a small accident may greatly hurt it, and
a great accident for a moment may almost destroy it.
Now too that we comprehend the inevitable vicissitudes of Lombard
Street, we can also thoroughly comprehend the cardinal importance of
always retaining a great banking reserve. Whether the times of
adversity are well met or ill met depends far more on this than on
any other single circumstance. If the reserve be large, its
magnitude sustains credit; and if it be small, its diminution
stimulates the gravest apprehensions. And the better we comprehend
the importance of the banking reserve, the higher we shall estimate
the responsibility of those who keep it.
CHAPTER VII.
A More Exact Account of the Mode in Which the Bank of England
Has Discharged Its Duty of Retaining a Good Bank Reserve,
and of Administering It Effectually.
The preceding chapters have in some degree enabled us to appreciate
the importance of the duties which the Bank of England is bound to
discharge as to its banking reserve.
If we ask how the Bank of England has discharged this great
responsibility, we shall be struck by three things: first, as has
been said before, the Bank has never by any corporate act or
authorised utterance acknowledged the duty, and some of its
directors deny it; second (what is even more remarkable), no
resolution of Parliament, no report of any Committee of Parliament
(as far as I know), no remembered speech of a responsible statesman,
has assigned or enforced that duty on the Bank; third (what is more
remarkable still), the distinct teaching of our highest authorities
has often been that no public duty of any kind is imposed on the
Banking Department of the Bank; that, for banking purposes, it is
only a joint stock bank like any other bank; that its managers
should look only to the interest of the proprietors and their
dividend; that they are to manage as the London and Westminster Bank
or the Union Bank manages.
At first, it seems exceedingly strange that so important a
responsibility should be unimposed, unacknowledged, and denied; but
the explanation is this. We are living amid the vestiges of old
controversies, and we speak their language, though we are dealing
with different thoughts and different facts. For more than fifty
yearsfrom 1793 down to 1844, there was a keen controversy as to the
public duties of the Bank. It was said to be the 'manager' of the
paper currency, and on that account many expected much good from it;
others said it did great harm; others again that it could do neither
good nor harm. But for the whole period there was an incessant and
fierce discussion. That discussion was terminated by the Act of
1844. By that Act the currency manages itself; the entire working is
automatic. The Bank of England plainly does not manage--cannot even be
said to manage--the currency any more. And naturally, but rashly, the
only reason upon which a public responsibility used to be assigned
to the Bank having now clearly come to an end, it was inferred by
many that the Bank had no responsibility. The complete uncertainty
as to the degree of responsibility acknowledged by the Bank of
England is best illustrated by what has been said by the Bank
directors themselves as to the panic of 1866. The panic of that year,
it will be remembered, happened, contrary to precedent, in the
spring, and at the next meeting of the Court of Bank proprietors--the
September meeting--there was a very remarkable discussion, which I
give at length below, and of which all that is most material was
thus described in the 'Economist':
'THE GREAT IMPORTANCE OF THE LATE MEETING
OF THE PROPRIETORS OF THE BANK OF ENGLAND.
'The late meeting of the proprietors of the Bank of England has a
very unusual importance. There can be no effectual inquiry now into
the history of the late crisis. A Parliamentary committee next year
would, unless something strange occur in the interval, be a great
waste of time. Men of business have keen sensations but short
memories, and they will care no more next February for the events of
last May than they now care for the events of October 1864. A pro
forma inquiry, on which no real mind is spent, and which everyone
knows will lead to nothing, is far worse than no inquiry at all.
Under these circumstances the official statements of the Governor of
the Bank are the only authentic expositions we shall have of the
policy of the Bank Directors, whether as respects the past or the
future. And when we examine the proceedings with care, we shall find
that they contain matter of the gravest import.
'This meeting may be considered to admit and recognise the fact that
the Bank of England keeps the sole banking reserve of the country.
We do not now mix up this matter with the country circulation, or
the question whether there should be many issuers of notes or only
one. We speak not of the currency reserve, but of the banking
reserve--the reserve held against deposits, and not the reserve held
against notes. We have often insisted in these columns that the Bank
of England does keep the sole real reserve--the sole considerable
unoccupied mass of cash in the country; but there has been no
universal agreement about it. Great authorities have been unwilling
to admit it. They have not, indeed, formally and explicitly
contended against it. If they had, they must have pointed out some
other great store of unused cash besides that at the Bank, and they
could not find such store. But they have attempted distinctions; have
said that the doctrine that the Bank of England keeps the sole
banking reserve of the country was "not a good way of putting it,"
was exaggerated, and was calculated to mislead.
'But the late meeting is a complete admission that such is the fact.
The Governor of the Bank said:
"'A great strain has within the last few months been put upon the
resources of this house, and of the whole banking community of
London; and I think I am entitled to say that not only this house,
but the entire banking body, acquitted themselves most honourably
and creditably throughout that very trying period. Banking is a very
peculiar business, and it depends so much upon credit that the least
blast of suspicion is sufficient to sweep away, as it were, the
harvest of a whole year. But the manner in which the banking
establishments generally in London met the demands made upon them
during the greater portion of the past half-year affords a most
satisfactory proof of the soundness of the principles on which their
business is conducted. This house exerted itself to the utmostand
exerted itself most successfully--to meet the crisis. We did not
flinch from our post. When the storm came upon us, on the morning on
which it became known that the house of Overend and Co. had failed,
we were in as sound and healthy a position as any banking
establishment could hold, and on that day and throughout the
succeeding week we made advances which would hardly be credited. I
do not believe that anyone would have thought of predicting, even at
the shortest period beforehand, the greatness of those advances. It
was not unnatural that in this state of things a certain degree of
alarm should have taken possession of the public mind, and that
those who required accommodation from the Bank should have gone to
the Chancellor of the Exchequer and requested the Government to
empower us to issue notes beyond the statutory amount, if we should
think that such a measure was desirable. But we had to act before we
could receive any such power, and before the Chancellor of the
Exchequer was perhaps out of his bed we had advanced one-half of our
reserves, which were certainly thus reduced to an amount which we
could not witness without regret. But we would not flinch from the
duty which we conceived was imposed upon us of supporting the
banking community, and I am not aware that any legitimate
application made for assistance to this house was refused. Every
gentleman who came here with adequate security was liberally dealt
with, and if accommodation could not be afforded to the full extent
which was demanded, no one who offered proper security failed to
obtain relief from this house."
'Now this is distinctly saying that the other banks of the country
need not keep any such banking reserveany such sum of actual cashof
real sovereigns and bank notes, as will help them through a sudden
panic. It acknowledges a "duty" on the part of the Bank of England
to "support the banking community," to make the reserve of the Bank
of England do for them as well as for itself.
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