Books: Lombard Street: A Description of the Money Market

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'In our judgment this language is most just, and the Governor of the
Bank could scarcely have done a greater public service than by using
language so businesslike and so distinct. Let us know precisely who
is to keep the banking reserve. If the joint stock banks and the
private banks and the country banks are to keep their share, let us
determine on that; Mr. Gladstone appeared not long since to say in
Parliament that it ought to be so. But at any rate there should be
no doubt whose duty it is. Upon grounds which we have often stated,
we believe that the anomaly of one bank keeping the sole banking
reserve is so fixed in our system that we cannot change it if we
would. The great evil to be feared was an indistinct conception of
the fact, and that is now avoided.

'The importance of these declarations by the Bank is greater,
because after the panic of 1857 the bank did not hold exactly the
same language. A person who loves concise expressions said lately
"that Overends broke the Bank in 1866 because it went, and in 1857
because it was not let go." We need not too precisely examine such
language; the element of truth in it is very plain--the great advances
made to Overends were a principal event in the panic of 1857; the
bill-brokers were then very much what the bankers were lately they
were the borrowers who wanted sudden and incalculable advances. But
the bill-brokers were told not to expect the like again. But
Alderman Salomons, on the part of the London bankers, said, "he
wished to take that opportunity of stating that he believed nothing
could be more satisfactory to the managers and shareholders of joint
stock banks than the testimony which the Governor of the Bank of
England had that day borne to the sound and honourable manner in
which their business was conducted. It was manifestly desirable that
the joint stock banks and the banking interest generally should work
in harmony with the Bank of England; and he sincerely thanked the
Governor of the Bank for the kindly manner in which he had alluded
to the mode in which the joint stock banks had met the late monetary
crisis." The Bank of England agrees to give other banks the
requisite assistance in case of need, and the other banks agree to
ask for it.

'Secondly. The Bank agrees, in fact, if not in name, to make limited
advances on proper security to anyone who applies for it. On the
present occasion 45,000,000 L. was so advanced in three months. And
the Bank do not say to the mercantile community, or to the bankers,
"Do not come to us again. We helped you once. But do not look upon
it as a precedent. We will not help you again." On the contrary, the
evident and intended implication is that under like circumstances
the Bank would act again as it has now acted.'

This article was much disliked by many of the Bank directors, and
especially by some whose opinion is of great authority. They thought
that the 'Economist' drew 'rash deductions' from a speech which was
in itself 'open to some objection'which was, like all such speeches,
defective in theoretical precision, and which was at best only the
expression of an opinion by the Governor of that day, which had not
been authorised by the Court of Directors, which could not bind the
Bank. However the article had at least this use, that it brought out
the facts. All the directors would have felt a difficulty in
commenting upon, or limiting, or in differing from, a speech of a
Governor from the chair. But there was no difficulty or delicacy in
attacking the 'Economist.' Accordingly Mr. Hankey, one of the most
experienced bank directors, not long after, took occasion to
observe: 'The "Economist" newspaper has put forth what in my opinion
is the most mischievous doctrine ever broached in the monetary or
banking world in this country; viz, that it is the proper function
of the Bank of England to keep money available at all times to
supply the demands of bankers who have rendered their own assets
unavailable. Until such a doctrine is repudiated by the banking
interest, the difficulty of pursuing any sound principle of banking
in London will be always very great. But I do not believe that such
a doctrine as that bankers are justified in relying on the Bank of
England to assist them in time of need is generally held by the
bankers in London.

'I consider it to be the undoubted duty of the Bank of England to
hold its banking deposits (reserving generally about one-third in
cash) in the most available securities; and in the event of a sudden
pressure in the money market, by whatever circumstance it may be
caused, to bear its full share of a drain on its resources. I am
ready to admit, however, that a general opinion has long prevailed
that the Bank of England ought to be prepared to do much more than
this, though I confess my surprise at finding an advocate for such
an opinion in the "Economist." If it were practicable for the
Bank to retain money unemployed to meet such an emergency, it would
be a very unwise thing to do so. But I contend that it is quite
impracticable, and if it were possible, it would be most
inexpedient; and I can only express my regret that the Bank, from a
desire to do everything in its power to afford general assistance in
times of banking or commercial distress, should ever have acted in a
way to encourage such an opinion. The more the conduct of the
affairs of the Bank is made to assimilate to the conduct of every
other well-managed bank in the United Kingdom, the better for the
Bank, and the better for the community at large.'

I am scarcely a judge, but I do not think Mr. Hankey replies to the
'Economist' very conclusively.

First. He should have observed that the question is not as to what
'ought to be,' but as to what is. The 'Economist' did not say that
the system of a single bank reserve was a good system, but that it
was the system which existed, and which must be worked, as you could
not change it.

Secondly. Mr. Hankey should have shown 'some other store of unused
cash' except the reserve in the Banking Department of the Bank of
England out of which advances in time of panic could be made. These
advances are necessary, and must be made by someone. The 'reserves'
of London bankers are not such store; they are used cash, not
unused; they are part of the Bank deposits, and lent as such.

Thirdly. Mr. Hankey should have observed that we know by the
published figures that the joint stock banks of London do not keep
one-third, or anything like one-third, of their liabilities in
'cash' even meaning by 'cash' a deposit at the Bank of England.
One-third of the deposits in joint stock banks, not to speak of the
private banks, would be 30,000,000 L.; and the private deposits of
the Bank of England are 18,000,000 L. According to his own
statement, there is a conspicuous contrast. The joint stock banks,
and the private banks, no doubt, too, keep one sort of reserve, and
the Bank of England a different kind of reserve altogether. Mr.
Hankey says that the two ought to be managed on the same principle;
but if so, he should have said whether he would assimilate the
practice of the Bank of England to that of the other banks, or that
of the other banks to the practice of the Bank of England.

Fourthly. Mr. Hankey should have observed that, as has been
explained, in most panics, the principal use of a 'banking reserve'
is not to advance to bankers; the largest amount is almost always
advanced to the mercantile public and to bill-brokers. But the point
is, that by our system all extra pressure is thrown upon the Bank of
England. In the worst part of the crisis of 1866, 50,000 L. 'fresh
money' could not be borrowed, even on the best securityeven on
Consols except at the Bank of England. There was no other lender to
new borrowers.

But my object now is not to revive a past controversy, but to show
in what an unsatisfactory and uncertain condition that controversy
has left a most important subject. Mr. Hankey's is the last
explanation we have had of the policy of the Bank. He is a very
experienced and attentive director, and I think expresses, more or
less, the opinions of other directors. And what do we find? Setting
aside and saying nothing about the remarkable speech of the Governor
in 1866, which at least (according to the interpretation of the
'Economist') was clear and excellent, Mr. Hankey leaves us in doubt
altogether as to what will be the policy of the Bank of England in
the next panic, and as to what amount of aid the public may then
expect from it. His words are too vague. No one can tell what a
'fair share' means; still less can we tell what other people at some
future time will say it means. Theory suggests, and experience
proves, that in a panic the holders of the ultimate Bank reserve
(whether one bank or many) should lend to all that bring good
securities quickly, freely, and readily. By that policy they allay a
panic; by every other policy they intensify it. The public have a
right to know whether the Bank of Englandthe holders of our ultimate
bank reserveacknowledge this duty, and are ready to perform it. But
this is now very uncertain.

If we refer to history, and examine what in fact has been the
conduct of the Bank directors, we find that they have acted exactly
as persons of their type, character, and position might have been
expected to act. They are a board of plain, sensible, prosperous
English merchants; and they have both done and left undone what such
a board might have been expected to do and not to do. Nobody could
expect great attainments in economical science from such a board;
laborious study is for the most part foreign to the habits of
English merchants. Nor could we expect original views on banking,
for banking is a special trade, and English merchants, as a body,
have had no experience in it. A 'board' can scarcely ever make
improvements, for the policy of a board is determined by the
opinions of the most numerous class of its membersits average
membersand these are never prepared for sudden improvements. A board
of upright and sensible merchants will always act according to what
it considers 'safe' principles--that is, according to the received
maxims of the mercantile world then and thereand in this manner the
directors of the Bank of England have acted nearly uniformly. Their
strength and their weakness were curiously exemplified at the time
when they had the most power. After the suspension of cash payments
in 1797, the directors of the Bank of England could issue what notes
they liked. There was no check; these notes could not come back upon
the Bank for payment; there was a great temptation to extravagant
issue, and no present penalty upon it. But the directors of the Bank
withstood the temptation; they did not issue their inconvertible
notes extravagantly. And the proof is, that for more than ten years
after the suspension of cash payments the Bank paper was
undepreciated, and circulated at no discount in comparison with
gold. Though the Bank directors of that day at last fell into
errors, yet on the whole they acted with singular judgment and
moderation. But when, in 1810, they came to be examined as to their
reasons, they gave answers that have become almost classical by
their nonsense. Mr. Pearse, the Governor of the Bank, said: 'In
considering this subject, with reference to the manner in which
bank-notes are issued, resulting from the applications made for
discounts to supply the necessary want of bank-notes, by which their
issue in amount is so controlled that it can never amount to an
excess, I cannot see how the amount of bank-notes issued can operate
upon the price of bullion, or the state of the exchanges; and
therefore I am individually of opinion that the price of bullion, or
the state of the exchanges, can never be a reason for lessening the
amount of banknotes to be issued, always understanding the control
which I have already described.

'Is the Governor of the Bank of the same opinion which has now been
expressed by the Deputy-Governor?

'Mr. Whitmore, I am so much of the same opinion, that I never think
it necessary to advert to the price of gold, or the state of the
exchange, on the days on which we make our advances.

'Do you advert to these two circumstances with a view to regulate
the general amount of your advances?--I do not advert to it with a
view to our general advances, conceiving it not to bear upon the
question.

And Mr. Harman, another Bank director, expressed his opinion in
these terms: 'I must very materially alter my opinions before I can
suppose that the exchanges will be influenced by any modifications
of our paper currency.'

Very few persons perhaps could have managed to commit so many
blunders in so few words.

But it is no disgrace at all to the Bank directors of that day to
have committed these blunders. They spoke according to the best
mercantile opinion of England. The City of London and the House of
Commons both approved of what they said; those who dissented were
said to be abstract thinkers and unpractical men. The Bank directors
adopted the ordinary opinions, and pursued the usual practice of
their time. It was this 'routine' that caused their moderation. They
believed that so long as they issued 'notes' only at 5 per cent, and
only on the discount of good bills, those notes could not be
depreciated. And as the number of 'good' billsbills which sound
merchants know to be gooddoes not rapidiy increase, and as the
market rate of interest was often less than 5 per cent, these checks
on over-issue were very effective. They failed in time, and the
theory upon which they were defended was nonsense; but for a time
their operation was powerful and excellent.

Unluckily, in the management of the matter before us--the management
of the Bank reserve--the directors of the Bank of England were neither
acquainted with right principles, nor were they protected by a
judicious routine. They could not be expected themselves to discover
such principles. The abstract thinking of the world is never to be
expected from persons in high places; the administration of
first-rate current transactions is a most engrossing business, and
those charged with them are usually but little inclined to think on
points of theory, even when such thinking most nearly concerns those
transactions. No doubt when men's own fortunes are at stake, the
instinct of the trader does somehow anticipate the conclusions of
the closet. But a board has no instincts when it is not getting an
income for its members, and when it is only discharging a duty of
office. During the suspension of cash paymentsa suspension which
lasted twenty-two yearsall traditions as to a cash reserve had died
away. After 1819 the Bank directors had to discharge the duty of
keeping a banking reserve, and (as the law then stood) a currency
reserve also, without the guidance either of keen interests, or good
principles, or wise traditions.

Under such circumstances, the Bank directors inevitably made
mistakes of the gravest magnitude. The first time of trial came in
1825. In that year the Bank directors allowed their stock of bullion
to fall in the most alarming manner:

On Dec. 24, 1824, the coin and bullion in the Bank was L10,721,000

On Dec. 25, 1825, it was reduced to L1,260,000

and the consequence was a panic so tremendous that its results are
well remembered after nearly fifty years. In the next period of
extreme trialin 1837, the Bank was compelled to draw for 2,000,000 L.
on the Bank of France; and even after that aid the directors
permitted their bullion, which was still the currency reserve as
well as the banking reserve, to be reduced to 2,404,000 L.: a great
alarm pervaded society, and generated an eager controversy, out of
which ultimately emerged the Act of 1844. The next trial came in
1847, and then the Bank permitted its banking reserve (which the law
had now distinctly separated) to fall to 1,176,000 L.; and so
intense was the alarm, that the executive Government issued a letter
of licence, permitting the Bank, if necessary, to break the new law,
and, if necessary, to borrow from the currency reserve, which was
full, in aid of the banking reserve, which was empty. Till 1857
there was an unusual calm in the money market, but in the autumn of
that year the Bank directors let the banking reserve, which even in
October was far too small, fall thus:

Oct. 10 4,024,000 L
" 17 3,217,000 L
" 24 3,485,000 L
" 31 2,258,000 L
Nov. 6 2,155,000 L
" 13 957,000 L

And then a letter of licence like that of 1847 was not only issued,
but used. The Ministry of the day authorised the Bank to borrow from
the currency reserve in aid of the banking reserve, and the Bank of
England did so borrow several hundred pounds till the end of the
month of November. A more miserable catalogue than that of the
failures of the Bank of England to keep a good banking reserve in
all the seasons of trouble between 1825 and 1857 is scarcely to be
found in history.

But since 1857 there has been a great improvement. By painful events
and incessant discussions, men of business have now been trained to
see that a large banking reserve is necessary, and to understand
that, in the curious constitution of the English banking world, the
Bank of England is the only body which could effectually keep it.
They have never acknowledged the duty; some of them, as we have
seen, deny the duty; still they have to a considerable extent begun
to perform the duty. The Bank directors, being experienced and able
men of business, comprehended this like other men of business. Since
1857 they have always kept, I do not say a sufficient banking
reserve, but a fair and creditable banking reserve, and one
altogether different from any which they kept before. At one period
the Bank directors even went farther: they made a distinct step in
advance of the public intelligence; they adopted a particular mode
of raising the rate of interest, which is far more efficient than
any other mode. Mr. Goschen observes, in his book on the Exchanges:
'Between the rates in London and Paris, the expense of sending gold
to and fro having been reduced to a minimum between the two cities,
the difference can never be very great; but it must not be forgotten
that, the interest being taken at a percentage calculated per annum,
and the probable profit having, when an operation in three-month
bills is contemplated, to be divided by four, whereas the percentage
of expense has to be wholly borne by the one transaction, a very
slight expense becomes a great impediment. If the cost is only 1/2 per
cent, there must be a profit of 2 per cent in the rate of interest,
or 1/2 per cent on three months, before any advantage commences; and
thus, supposing that Paris capitalists calculate that they may send
their gold over to England for 1/2 per cent expense, and chance their
being so favoured by the Exchanges as to be able to draw it back
without any cost at all, there must nevertheless be an excess of
more than 2 per cent in the London rate of interest over that in
Paris, before the operation of sending gold over from France, merely
for the sake of the higher interest, will pay.'

Accordingly, Mr. Goschen recommended that the Bank of England
should, as a rule, raise their rate by steps of 1 per cent at a time
when the object of the rise was to affect the 'foreign Exchanges.'
And the Bank of England, from 1860 onward, have acted upon that
principle. Before that time they used to raise their rate almost
always by steps of 1/2 per cent, and there was nothing in the general
state of mercantile opinion to compel them to change their policy.
The change was, on the contrary, most unpopular. On this occasion,
and, as far as I know, on this occasion alone, the Bank of England
made an excellent alteration of their policy, which was not exacted
by contemporary opinion, and which was in advance of it. The
beneficial results of the improved policy of the Bank were palpable
and speedy. We were enabled by it to sustain the great drain of
silver from Europe to India to pay for Indian cotton in the years
between 18621865. In the autumn of 1864 there was especial danger;
but, by a rapid and able use of their new policy, the Bank of
England maintained an adequate reserve, and preserved the country
from calamities which, if we had looked only to precedent, would
have seemed inevitable. All the causes which produced the panic of
1857 were in action in 1864the drain of silver in 1864 and the
preceding year was beyond comparison greater than in 1857 and the
years before itand yet in 1864 there was no panic. The Bank of
England was almost immediately rewarded for its adoption of right
principles by finding that those principles, at a severe crisis,
preserved public credit.

In 1866 undoubtedly a panic occurred, but I do not think that the
Bank of England can be blamed for it. They had in their till an
exceedingly good reserve according to the estimate of that timea
sufficient reserve, in all probability, to have coped with the
crises of 1847 and 1857. The suspension of Overend and Gurneythe
most trusted private firm in Englandcaused an alarm, in suddenness
and magnitude, without example. What was the effect of the Act of
1844 on the panic of 1866 is a question on which opinion will be
long divided; but I think it will be generally agreed that, acting
under the provisions of that law, the directors of the Bank of
England had in their banking department in that year a fairly large
reserve quite as large a reserve as anyone expected them to keepto
meet unexpected and painful contingencies.

From 1866 to 1870 there was almost an unbroken calm on the money
market. The Bank of England had no difficulties to cope with; there
was no opportunity for much discretion. The money market took care
of itself. But in 1870 the Bank of France suspended specie payments,
and from that time a new era begins. The demands on this market for
bullion have been greater, and have been more incessant, than they
ever were before, for this is now the only bullion market. This has
made it necessary for the Bank of England to hold a much larger
banking reserve than was ever before required, and to be much more
watchful than in former times lest that banking reserve should on a
sudden be dangerously diminished. The forces are greater and quicker
than they used to be, and a firmer protection and a surer solicitude
are necessary. But I do not think the Bank of England is
sufficiently aware of this. All the governing body of the Bank
certainly are not aware of it. The same eminent director to whom I
have before referred, Mr. Hankey, published in the 'Times' an
elaborate letter, saying again that one-third of the liabilities
were, even in these altered times, a sufficient reserve for the
Banking Department of the Bank of England, and that it was no part
of the business of the Bank to keep a supply of 'bullion for
exportation,' which was exactly the most mischievous doctrine that
could be maintained when the Banking Department of the Bank of
England had become the only great repository in Europe where gold
could at once be obtained, and when, therefore, a far greater store
of bullion ought to be kept than at any former period.

And besides this defect of the present time, there are some chronic
faults in the policy of the Bank of England, which arise, as will be
presently explained, from grave defects in its form of government.

There is almost always some hesitation when a Governor begins to
reign. He is the Prime Minister of the Bank Cabinet; and when so
important a functionary changes, naturally much else changes too. If
the Governor be weak, this kind of vacillation and hesitation
continues throughout his term of office. The usual defect then is,
that the Bank of England does not raise the rate of interest
sufficiently quickly. It does raise it; in the end it takes the
alarm, but it does not take the alarm sufficiently soon. A cautious
man, in a new office, does not like strong measures. Bank Governors
are generally cautious men; they are taken from a most cautious
class; in consequence they are very apt to temporise and delay. But
almost always the delay in creating a stringency only makes a
greater stringency inevitable. The effect of a timid policy has been
to let the gold out of the Bank, and that gold must be recovered. It
would really have been far easier to have maintained the reserve by
timely measures than to have replenished it by delayed measures; but
new Governors rarely see this.

Secondly. Those defects are apt, in part, or as a whole, to be
continued throughout the reign of a weak Governor. The objection to
a decided policy, and the indisposition to a timely action, which
are excusable in one whose influence is beginning, and whose reign
is new, is continued through the whole reign of one to whom those
defects are natural, and who exhibits those defects in all his
affairs.

Thirdly. This defect is enhanced, because, as has so often been
said, there is now no adequate rule recognised in the management of
the banking reserve. Mr. Weguelin, the last Bank Governor who has
been examined, said that it was sufficient for the Bank to keep from
one-fourth to one-third of its banking liabilities as a reserve. But
no one now would ever be content if the banking reserve were near to
one-fourth of its liabilities. Mr. Hankey, as I have shown,
considers 'about a third' as the proportion of reserve to liability
at which the Bank should aim; but he does not say whether he regards
a third as the minimum below which the reserve in the Banking
Department should never be, or as a fair average, about which the
reserve may fluctuate, sometimes being greater, or at others less.

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