The gradual evolution of country shopkeepers into country bankers, which was the usual course of the foundation of such institutions in the days of which we are speaking, is well exemplified in the following case, which is related in Lawson’s _History of Banking_:—
“In a borough town of importance in one of the north midland counties dwelt a respectable draper, possessing a good connection with the farmers frequenting the market of the town. Although the name of Robin Hood had long lost its terrors, those of Turpin and Nevison filled all men’s minds with fear—and with good reason, for they and their fraternity exercised their calling with such energy and success that it was always a matter of doubt with travellers whether or not they should arrive in safety at the next inn or their destination, whatever that might be. With the farmers above alluded to there were more than ordinary grounds of alarm; the town almost adjoining the scene of the far-famed exploits of Robin Hood and his merry men, was admirably situated for a levy by their less romantic successors of extemporaneous taxes. To avoid as much as possible the losses thus arising, farmers, having full confidence in the honesty of the draper with whom they dealt, made him the depositary of their ready cash. Ready cash of his friends was to our draper as valuable as capital of his own, and buying for ready money was profitable. Still, money remained idle in his hands, and by degrees he began to grant accommodation to his neighbours. Our draper now became famous for his extraordinary command of money, and his correspondence extended as far as Preston, in Lancashire. The profits thus arising seemed boundless, and the next step was taken by our adventurous shopkeeper: he allowed a small interest to his friends the depositors. The new business flourished to such an extent that it swallowed up the old one, and our draper at length became a _banker proper_, and no more a shopkeeper.
“Such was the origin of the Smiths. First confined to the town of Nottingham, afterwards extended to Hull and Lincoln, the business of the firm required a London correspondent entirely in their interest, and such they found in the late Mr. Payne.”
And thus was founded the well-known firm of Smith, Payne, and Smith, whose business has recently been amalgamated with that of the Union Bank of London.
Many are the tales told of the wit and shrewdness of the early country bankers, and the following anecdote, related in Mr. Maberley Phillips’s interesting work on _Banks, Bankers, and Banking in Northumberland, Durham, and North Yorkshire_, is on a par with the well-known tale of the private Irish banker, who became so very unpopular, that to show the contempt in which he was held, the inhabitants of his district gathered together all his notes which they could lay hands on, and made a bonfire of them in front of his house; much to the banker’s amusement and gain.
Mr. Phillips’s story is of Jonathan Backhouse, a Quaker, who, though originally a linen and worsted manufacturer in Darlington, founded “Backhouse’s Bank” in 1774, in partnership with his father. This institution only went out of existence in 1896, when it was amalgamated with Messrs. Barclay and Company, Limited.
“Before the time of railways, near the beginning of the century, the commercial traveller of that day made his visits to the towns of the county of Durham either by mail coach or other conveyance, and sojourned for some days in each town, where he was an important person, especially at the head hotel or hostelry of the place. It so happened that one of these gentlemen, after having dined freely at the ‘King’s Head,’ Barnard Castle, was boasting to a company present in the commercial room of his own importance and wealth, and exhibiting in proof a sheaf of bank-notes taken on his journey.
“Jonathan Backhouse, attired in the usual dress of the Society of Friends, unknown to the rest of the company, was in the room quietly reading his newspaper, when he was attacked by the wealthy commercial, and by a series of sarcastic remarks held up to ridicule as a man out of harmony with the spirit of the time and place. Following up this raillery the commercial, displaying his handful of notes, offered to bet the Quaker £5, or any sum, that he could not produce as much money as he was exhibiting. Mr. Backhouse, after a great deal of banter, said _he did not bet_, but to show his indifference to money offered to put a £5 note in the fire if the commercial would do the same. Suiting the action to the word, Mr. Backhouse took out a £5 note and put it into the fire. The commercial, not wishing to be behind, did the same. Mr. Backhouse offered to repeat the process, but the commercial, considerably cowed, declined; when Mr. Backhouse quietly thanked him for having burned one of his (Mr. Backhouse’s) bank-notes for which he had received £5, while the note he (Mr. Backhouse) had burned was on his own bank, and only cost him the paper.”
CHAPTER IV
THE BANK CHARTER ACT OF 1844, AND ITS SUSPENSIONS
After the renewal of the Charter in 1833, the directors of the Bank of England laid down as a principle on which their future operations were to be guided, that one-third of their liabilities should be kept in cash and bullion, and the remaining two-thirds in securities. If this principle had been acted on, the Bank would have been saved from many of the troubles which shortly assailed it; but though the intentions of the directors were good, circumstances were too strong for them, and the actual proportions of cash and securities to liabilities respectively, often differed materially from the standard laid down. This was notably the case during the periods of financial pressure which were experienced in the years 1836 and 1837.
In the year 1839 matters assumed a very serious aspect. In the early part of this year the amount of cash held by the Bank was about one-third of the amount of securities, but during the year the amount invested in securities increased at the expense of the amount held in cash; and by September we find that securities stood at nearly £29,000,000, while the cash was reduced to a tenth of that figure, and stood at £2,936,000 only. In order to avert a calamity which appeared to be impending, the Bank arranged loans in Paris and Hamburg to the extent of between three and four millions.
This manifest exhibition of weakness on the part of the Bank led to the appointment of a committee of the House of Commons to inquire into the matter. The committee condemned the principles on which the Bank was working, but were powerless to effect any alteration, owing to the Charter of the Bank not expiring till 1844.
On the expiry of the Charter, however, Sir Robert Peel brought forward his famous Act for remodelling the Bank, and regulating the issues of the country banks throughout England and Wales.
The Act was passed on the 19th July, 1844, and continues without alteration to the present day. The main provisions enacted thereby, briefly stated, are as follows:—
I. The Issue Department and the ordinary Banking Department of the Bank of England were to be entirely separated as from the 31st August, 1844.
II. On such separation taking place, securities to the value of £14,000,000 (including the debt due to the Bank from the Government) were to be transferred to the Issue Department, together with so much gold coin and bullion that the total so transferred should equal the total amount of notes then outstanding. Thereafter (with the exception noted below) the Issue Department must not issue any notes in excess of a total of £14,000,000 except in exchange for gold coin or bullion.
III. The Issue Department might not at any time hold more silver than one-fourth part of the gold held. As a matter of fact, the Issue Department holds no silver.
IV. Notes might be demanded from the Issue Department by any person in exchange for gold at the rate of £3 17_s._ 9_d._ per standard ounce.
V. If any banker having the power of issue on the 6th May, 1844, should relinquish such issue, the Issue Department may be authorised to increase its issue of notes against securities to the extent of two-thirds of the issue so relinquished; but all the profits on such increased issue against securities were to belong to the Government.
VI. The Bank must issue a weekly statement of the position of both its Issue and Banking Departments, in a prescribed form.
VII. Bankers having the right to issue their own notes on the 6th May, 1844, might continue such issue under certain conditions, and to an agreed amount; but no provision was made compelling such bankers to keep any reserve either in cash or securities against their issues. If any issue lapsed, from any cause, it could not be resuscitated; and no institutions could acquire the right of issue in the future.
VIII. Banks consisting of more than six partners, though within the sixty-five-mile radius of London, might draw, accept, or endorse bills of exchange not being payable to bearer on demand.
The first return issued by the Bank in accordance with the regulations of the new Act was that of the 7th September, 1844, and was as follows:—
ACCOUNT OF THE LIABILITIES AND ASSETS OF THE BANK OF ENGLAND _For the Week ending 7th September, 1844_
_Dr._ ISSUE DEPARTMENT _Cr._ ---------------------------------+-------------------------------- £ | £ Notes issued 28,351,295 | Government debt 11,015,100 | Other securities 2,984,900 | Gold coin and | bullion 12,657,208 | Silver bullion 1,694,087 ----------- | ----------- £28,351,295 | £28,351,295 =========== | ===========
_Dr._ BANKING DEPARTMENT _Cr._ ---------------------------------+-------------------------------- £ | £ Proprietors’ capital 14,553,000 | Government Rest 3,564,729 | securities 14,554,834 Public deposits 3,630,809 | Other securities 7,835,616 Other deposits 8,644,348 | Notes 8,175,025 Seven-day and | Gold and silver coin 857,765 other bills 1,030,354 | ----------- | ----------- £31,423,240 | £31,423,240 =========== | ===========
For comparison we append the Return of the 2nd September, 1903.
_Dr._ ISSUE DEPARTMENT _Cr._ ---------------------------------+---------------------------- £ | £ Notes issued 51,831,835 | Government debt 11,015,100 | Other securities 7,434,900 | Gold coin and | bullion 33,381,835 | Silver bullion Nil ---------- | ---------- £51,831,835 | £51,831,835 ========== | ==========
_Dr._ BANKING DEPARTMENT _Cr._ --------------------------------+----------------------------- £ | £ Proprietors’ capital 14,553,000 | Government securities Rest 3,740,209 | 18,260,841 Public deposits 7,393,580 | Other securities 24,969,260 Other deposits 41,872,061 | Notes 22,322,875 Seven-day and | Gold and silver coin other bills 113,465 | 2,119,339 ---------- | ---------- £67,672,315 | £67,672,315 ========== | ==========
The provisions of the 1844 Act, above noted, are the principal ones which affected banking in general, and the Bank of England in particular—they were the food for much debate and discussion before they became law, and it may be added that several of the provisions then enacted have been the food for much debate and discussion ever since. Taken as a whole the Act has worked well, and has succeeded, in combination with greater knowledge and foresight, in maintaining our banking system in a sound condition.
The regulations as to the country bank-note issues were framed with the idea of ultimately eliminating entirely such issues; but though the amount of private notes in circulation has decreased, and also the number of bankers who have the power of issue—by lapses, bankruptcy, and amalgamations—the time when there are no country bank-notes has not arrived, notwithstanding that the framers of the Act confidently anticipated that such a result would be achieved long before now.
The main point of contention between the supporters and opponents of the Act lies in its want of elasticity in time of need. Under no circumstances can the Bank increase its issue of notes against securities beyond the prescribed limit, without a breach of the law; but on three occasions in the past the law has been broken, though with the consent of the Government, and subsequent confirmation of Parliament.
Under the laws regulating the Imperial Bank of Germany such procedure would not have been necessary. The German Bank Law has been framed largely on the same lines as our own, but it gives the Reichsbank power to increase the amount of notes issued against securities on a payment to the Government of a fine of 5 per cent. per annum on the excess issue. This fine is sufficient in ordinary times to act as a complete check on overissue, but in times of trouble it acts as an efficient safety-valve by relieving the minds of business people from the fear that “there will not be enough to go round.” If it is known that money can always be had at a price, the probability of a crisis developing into a panic is almost entirely obviated.
We will now briefly review the three occasions on which the Bank Act was suspended, and the effect of such suspensions.
The first of these occasions was during the panic in the year 1847—known as the “railway panic.” Shortly previous to this year a great accumulation of capital had led to a demand for new investments, which were duly provided for the public by those concerned with such matters. Added to this, interest rates had ruled low for some time, and this conduced to a period of speculative activity. Too much capital was put into fixed investments—chiefly railways—and in one session of Parliament sanction was asked for various railway schemes involving a total capital of £340,000,000. Wild gambling in railway stocks ensued, credit was inflated above all reason, and then the turn came. This was primarily due to a bad harvest and potato crop causing a heavy importation of corn, and consequent export of gold.
During the panic which ensued, the reserve of the Bank of England fell to £1,600,000, but when the panic was at its height, the Act, passed only three years before, was suspended. The Bank was authorised to increase its accommodation to the public by exceeding, to an indefinite extent, the limit fixed for the issue of notes not secured against gold. The effect of this suspension of the Act was immediate and complete. The fear that “there was not enough to go round” passed from men’s minds. As a matter of fact, the issue on this occasion did not exceed the normal limit, the mere knowledge that the Bank was empowered to exceed this limit proving sufficient to allay the panic.
The second suspension of the Bank Act was due to the crisis of 1857, a crisis that was brought about by reckless overtrading, and came upon the public very suddenly and with practically no warning. The reserve of the Bank of England had been allowed to fall dangerously low during the course of the year, and large financial operators had carried on vast transactions with hardly any capital—only credit—relying for assistance on the Bank. Bad news came to hand from America in September, detailing how there had been a serious financial collapse in that country; failures had occurred, shaking commercial credit to its core, and about one hundred and fifty banks had stopped payment.
A heavy drain of gold from here to America commenced, and by the middle of October credit was curtailed, and distrust was rife in England. Within a very short space of time many of our banks and financial houses were crippled and failed. In November heavy demands were made for gold for Scotland and Ireland, and on the 11th November the failure of Sanderson and Company—a great London discount house—was announced, with liabilities of upwards of five millions. Utter rottenness appeared to pervade the commercial world, and general bankruptcy seemed imminent, when for the second time the Bank Act was suspended. This took place on the 12th November, and at once had the effect of quieting the public mind. On this occasion the Bank had to make use to a large extent of its temporary authority to issue notes above the normal limit without holding gold against them. The severity of this crisis can be seen by the fact that in November the Bank reserve fell to under £600,000, while the bankers’ balances at the Bank of England alone stood at about five and a half millions, and the Bank Rate was as high as 10 per cent. This was also the rate charged by the Bank of France at the time, showing that the panic had spread, and was not solely confined to ourselves and America.
The third suspension of the Bank Act took place in 1866. Many elements of disturbance to the Money Market had been in force during two or three preceding years. The Civil War in America had resulted in gold being sent to this country; but the stoppage of the supply of cotton from America, owing to the war, disorganised one of our staple national industries, and supplies of cotton had to be obtained from elsewhere at high prices, and paid for in cash. Hence a drain of gold set in on a large scale. In addition, a large speculation had been built up on credit in the stocks and shares of the many new limited liability companies which were formed at that time.
General uneasiness began to prevail towards the end of 1865; in January, 1866, the Bank raised its discount rate to 8 per cent., and a crisis began to develop rapidly.
Speculators tried to sell their securities and found no market for them, several large railway contractors failed, and many of the newly formed limited liability companies succumbed and were wound up. The failure of the Joint Stock Discount Company, followed shortly by that of Barned’s Bank of Liverpool, brought matters to a head; the distrust became universal and culminated in panic. On the 9th May the Bank Rate was raised to 9 per cent. On the 10th May the failure of Overend, Gurney, and Company—for upwards of ten millions—was announced, and the Bank Rate went to 10 per cent. This failure was not made known till after business hours, so it was not till Friday, the 11th May, 1866—known as “Black Friday”—that the crisis reached its height.
The stoppage of this large house affected the whole world, and general failure seemed imminent, when, in the afternoon of the day on which the failure became known, it was announced that the Bank Act was again suspended, and calm began to take the place of mania. But though the panic was allayed, many failures shortly took place, which delayed the quick restoration of a sense of security. Among these failures may be mentioned the Bank of London, the Consolidated Bank, and Agra and Masterman’s Bank. All these three institutions were perfectly solvent as a matter of fact, but they found themselves in the dangerous position of having no _available_ assets. The two last-named banks subsequently resumed business.
From the above brief records of the financial tragedies of the past, we see that on each occasion reckless speculation and overtrading had been allowed to reach a dangerous height before any steps were taken to check them, and on each occasion the check came too late. But we also see the marvellously quick effect which the suspension of the Act had on the situation. Although a period of nearly half a century has elapsed since the time of the last suspension, the position remains the same, and it is only owing to greater knowledge and greater caution that such catastrophes have been averted.
In contemplating any future catastrophe of the kind which may come upon us, it is generally assumed that the Act would be again suspended; but delays are dangerous. By the time the situation had developed to such an extent that the Government might deem it expedient to give the Bank the necessary powers, a panic such as has never before been known might overtake us; whereas if the suspension of the Act were to a certain extent automatic, and responsible people knew for certain that money could always be had at a price, the probability of such a termination of any crisis would be very remote.
CHAPTER V
THE DEVELOPMENT OF LONDON AS THE FINANCIAL CENTRE OF THE WORLD
Before proceeding to examine the Money Market and banking system of more modern days, it will be well to glance at the causes which contributed to the predominance of London among international financial centres, and made it the clearing house of the world. At the present time this predominance is being assailed from several quarters—notably Paris, Berlin, and New York—but there is no doubt that London still holds a good lead, and with knowledge, activity, and perseverance there appears to be no reason why it should not continue to be in the forefront in the future.
In the _Wealth of Nations_ Adam Smith points out that the increase and riches of commercial and manufacturing towns contribute to the improvement and cultivation of the countries to which they belong, and that commerce and manufacture introduce order and good government, and with them the liberty and security of individuals.
In our own history we can trace the truth of these remarks. We have already drawn attention to the flourishing state of trade which developed during the reign of Elizabeth. New industries were started, villages grew into towns, and new markets for our wares were opened up in various parts of the then known world. In consequence of the wars on the Continent, many wealthy merchants came or were exiled to our shores, and settling here, helped to swell the growing business of London. We were fortunate in the fact that this “greater liberty and security of individuals,” enabling our forefathers to devote their attention and wealth to the further development and expansion of the commerce of the country, came about with us long before a similar state of affairs began to have effect with our continental neighbours, and this gave us a good start commercially. While our neighbours were still in the throes of continual disputes and unrest, we were laying the foundations of a world-wide system of trade. We were in a position to supply the Continent with their various needs as they arose, to our own immediate benefit and the further advancement of our commerce.
In connection with the more rapid development of commerce with us than with continental nations must be remembered the energy and activity of the race forming the population of our country—an energy and activity not only in starting and conducting new industries, but in spreading abroad to new lands and forming new colonies, thus enlarging the sphere of our operations and the number of our markets.
Our geographical position has assisted materially in our commercial development. The disturbances arising from the fear and risk of invasion have been less pronounced than with continental nations, and our extended coast-line, embracing many natural shelters, has engendered our vast shipping industry, without which we could never have attained to our present position. We have also had the advantage of another natural circumstance in the proximity of our coal and iron fields to each other. This gave us for a long period an unparalleled command of certain trades dependent on this fact. Thus we see that, owing to good government, national character, and natural conditions, our trade was built up on a firm foundation, and was spread abroad until its ramifications extended into every country of the world.
Turning now from the trade point of view to the monetary position, we find that as our trade grew, so did our means and capacity of dealing with that trade. Although in early days we were rather backward in our banking system, yet that system developed quicker with us than with other countries. The eighteenth century embraced many periods of financial distress, but the Government never defaulted in any of its engagements, and our leading merchants became renowned as men of honour and integrity. During the early part of the nineteenth century our position improved by leaps and bounds, our gold standard of currency was firmly established, our merchants’ names became known and honoured throughout the world, and direct financial operations between London and all foreign parts became matters of daily occurrence.
These monetary transactions were very essential in the financial growth of London, and were a large factor in our capital becoming the centre of finance. Owing to the vast extent of our trade, both as to its amount and diffusion, we were in a position to conduct financial transactions the world over. From this it followed that when commerce began to expand and grow among continental nations, it was found that the easiest way of settling the financial business arising therefrom was through the intermediary of London. England bought from and sold to all nations, but in the first half of the nineteenth century _reciprocal_ transactions between foreign centres of trade were few and far between. For instance, suppose a New York merchant shipped produce to Hamburg, he would draw on some appointed London house for payment; the merchant in Hamburg who had bought the goods would then have to find the means of providing this London house with the necessary funds to meet the draft from New York. This he would do by buying a draft in Hamburg from some merchant there who had shipped goods to London and was wanting payment. This draft he would remit to the London house on which the American exporter had drawn, and the London house would collect the money represented by the Hamburg draft, thus settling both transactions. This is only a rough example, but it is typical of what came to be a regular custom.
Various countries may trade together, but unless they have direct mutual financial transactions, they cannot settle their indebtedness without remitting precious metal of one kind or another, or employing the agency of another country which has direct financial dealings with both. In the time of which we are speaking London was the only centre which was in a position to carry out such transactions. In the latter half of the past century, and especially towards the close of the century, our position suffered through direct financial operations between various countries becoming established, thus eliminating the need of a middleman; but it may still be said of London that it has direct financial and trading connection with _every country of the world_, which at present cannot be said of either Paris, Berlin, or New York. The very fact of the establishment in London of branches of the leading banks and finance houses of France, Germany, and the United States, emphasises the position which London has attained and still holds in the financial world.
CHAPTER VI
FACTORS OF THE MONEY MARKET
Having now surveyed the history and development of our financial system up to a point when “system” can really be said to have started, and also having glanced at the causes which have placed London in the forefront of all financial centres, we will consider the formation, as a whole, of what is called the “Money Market”; and then more carefully examine certain of the more important factors which help to form that market.
There is no definite “market” for money in the sense of a “place of purchase and sale,” like a cattle market or a corn market; when we speak of the “Money Market” we refer to the body or aggregation of large dealers in money—bankers, bill-brokers, etc.—who either have money to lend or who require to borrow money, and by whom the rate to be charged for the use of money is largely settled, as a result of their mutual transactions.
This body of money-dealers is not clearly defined into two classes—lenders and borrowers—as an ordinary market is divided into two classes—buyers and sellers; but with money-dealers all are practically both buyers and sellers; that is, all are ready to sell the use of money at a certain price, and to buy the use of money at another price.
The Bank of England in bygone days was the predominant factor in the Money Market; but now, in ordinary times, it has somewhat fallen from its high estate in that respect. It is only at certain times that its funds find their way into the Money Market to any large extent. But the Bank still has the power, when occasion arises, to make its influence predominate, as it constitutes the final reserve, in case of need, of our banking system. The Bank likewise has the power to make its influence felt when the directors deem it advisable to obtain control of the Money Market, for the purpose of maintaining the monetary position on a basis of safety. As we shall see when dealing with the subject of the foreign exchanges, if, in order to check an outflow of gold, the directors of the Bank wish to raise the value of money in London—that is, to raise the rate at which money can be borrowed or lent—they raise the official rate of the Bank of England. If the outside market lags behind, or does not keep in line with the movement, they force it to do so by themselves borrowing large sums from the market, thus reducing the available supply of money in the hands of the market, and consequently enhancing the value of money.
The chief factor in the formation of the Money Market is the body of the joint-stock and private banks of London, and through them of the bankers of the kingdom. Practically all the working capital of the country and the floating money of private individuals, together with moneys awaiting permanent investment, are now in the hands of our bankers.
Of this vast accumulation of capital held by bankers—amounting in the United Kingdom to some £800,000,000—a certain part is retained in actual cash, besides a balance which is kept with the Bank of England or a London agent, some is invested in securities, and the balance is used in lending to those that require the use of further capital for their business or private needs. Of this balance so lent, a large percentage is advanced to individual customers by way of loan, overdraft, or in the discounting of bills; and the remainder is used in the Money Market proper, or what has been aptly called “The Short Loan Fund.” The rate of interest which private individuals have to pay for advances from time to time is largely based on the prevailing official rate of the Bank of England as regards loans, and on the “market rate” as regards the discounting of first-class bills.