The policy of the Bank has never been one of "grab," though the bill brokers often grumble; but its position, in relation to the market, is an extremely difficult one, so difficult at times as to be fraught with great anxiety; and remembering the power that devolves upon it by reason of its holding the bankers' balances, its policy seems one of enviable restraint and moderation. But that is only what everybody expects of the Bank of England.
CHAPTER X.
The Battle of the Banks.
But little has hitherto been said concerning the relations of the Bank of England with its rivals in the money market, and in order to trace the movement from its beginning we must return to 1826, in which year joint stock banks could be established in England at a greater distance than sixty-five miles from London. The Bank stoutly resisted this innovation, but the Government, in consequence of the constant failures of the country private bankers, passed the Act of 1826, and the thin edge of the wedge once inserted, the Bank's monopoly in London soon disappeared.
The London and Westminster, despite the determined opposition of the Bank of England, opened business in London during 1834, and the Bank's monopoly of banking was gone. All that then remained to it was the exclusive privilege of issuing notes in and within sixty-five miles of London, the only legal monopoly it still enjoys. Unable to keep the joint stock banks out of London the Bank actively opposed them, as also did the private bankers, who, while the Bank refused to open accounts for the new companies in its books, declined to admit them into the Clearing House, which was founded by the London bankers about 1775. The irony of Fate! They are now a feeble minority in a house of their own building. But history--both domestic and economic--can supply parallel instances.
Although the new system was destined to drive out the old, the joint stock banks made a bad start, and failures were at first so frequent that the public began to share the opinion of the Bank and to look upon them as anything but safe institutions. They were born in disaster, and their policy did not provide an antidote to the old evils; but, like the Bank of England itself, they were taught prudence by a series of panics and upheavals which threatened to wipe them out of existence. They were, in short, licked into shape, and that cautious prudent policy which now distinguishes our great banking companies is the fruit of a very bitter experience.
Towards the middle of the nineteenth century the manufactures of Great Britain began to increase by leaps and bounds, and population, which always augments rapidly when food is cheap and abundant, kept pace with the country's unprecedented commercial activity. In 1801 the population of London was less than one million. In 1837 it had increased to about two millions; and at the present time Greater London contains over six and a half millions.
It is quite evident that the Bank of England could not alone minister to the increasing wants of London, and both in the Metropolis and in the provinces its joint stock rivals rapidly accumulated credit. In June, 1854, the new banks were admitted into the Clearing House, and since that date they have carried all before them. They shared in the almost magical increase in the volume of British trade, but they neither created nor provided the incentive to that remarkable outburst of national prosperity which was the result of Free Trade, and which made this country the workshop of the world. Since then, however, the world has filled up.
The population of the United States in 1870 was 38,500,000; in 1900, 75,500,000. In 1871 the population of the German Empire was 41,000,000. In 1901 it had increased to 56,000,000. During the same period the population of the United Kingdom increased from 31,500,000 to 41,500,000. There are more people in the world to be fed, and as the earth fills up the struggle for existence must surely become fiercer. Noticing this, people naturally inquire whether, seeing the changed environment, Free Trade is suitable to the times. Some years ago, when trade was bad, the bimetallic controversy was raging, but since 1895 its advocates have been dumb, for the simple reason that people will not listen to theorists when times are good. They are then too intent upon making money. They think they may not get the chance again.
No doubt, when the depressed portion of the cycle came round bimetallists would have been heard again. But in the place of Bimetallism we now find Protection, and, in all truth, the question is serious enough; for, when the present wave of prosperity dies out in the States, there seems every probability that the huge American trusts will endeavour to swamp our markets with their goods. Free traders make quite a profession of faith of their commercial opinion. They declare that they are free traders with the same fervour they might infuse into the avowal that they were Protestants or Roman Catholics. But modern Christianity is eminently adaptable to every fresh situation. Is Free Trade?
The worse the times become, the louder, probably, will grow the controversy between the free traders and the protectionists; and when we remember that our workshops support our credit, and upon what an amazingly small reserve of the precious metals that credit is based, it is evident that the question ought to be approached with the greatest caution; for a decision that emptied our workshops would ruin the nation.
As the savings of the country increased, the joint stock banks accumulated credit with astonishing rapidity, and the Bank of England, slow to recognise the power of the new system, which was so admirably suited to the changed environment, was compelled to receive its hated rivals into the fold. The companies possessed no vaults for the storage of the precious metals on a large scale, and they were therefore glad to avail themselves of the facilities at the disposal of the Bank, whose premises were much better protected than their own. And then, again, as the Bank's notes were legal tender, the companies could send them from the head offices to the branches cheaply, while they were a convenient form in which to keep a certain proportion of their cash in hand.
The evolution of the Bank of England, we can see, has not proceeded smoothly; but it is remarkable that an institution, which owed its pre-eminence entirely to monopoly, did not gradually begin to sink into a second-rate banking company directly its exclusive privilege of joint stock banking was abrogated and free trade in banking established in England. So conservative was the Bank's policy that it seems little short of marvellous that its joint stock rivals should have quietly endured its studied insults. The new movement was then, however, not only in its infancy, but was under a cloud as well, and through the companies grouping themselves around the Bank they enabled that institution to retain its position in the centre of the money market. The power incident to that position has been fully explained in the previous chapter.
The London private bankers, whose lack of enterprise can only be attributed to the fact that they were imbued with those narrow City traditions which make London the home of Conservatism, also quite failed to grasp the situation, and allowed the new companies to expand in every direction, confident that so sudden a change must end in disaster, and, therefore, they were content to look on, to shake their heads sadly at the unprofessional conduct of those new banks, and to soothe their feelings by ever and anon declaring, with due solemnity, that joint stock banking would ruin the country.
Certainly, the new companies did not manage well at first, and a few of them were wiped out in consequence; but, in spite of mistakes, they progressed, because their system was adaptable to the requirements of a growing England. In these times it is the fashion to apotheosise man--to picture him as a kind of demi-god; therefore, it is asserted that man makes his mark on the times. But it is surely more rational and logical to assume that the times gradually mould the particular cast of brain that is adaptable to a constantly changing environment, and that the man who chances to possess that cast of brain goes with the tide--which takes him a long way. At any rate, such was the case with the joint stock banks, which owe their success entirely to the adaptability of their system to a changing market. Moreover, that market is still changing.
The old-fashioned London bankers found, to their great surprise, that they had not read the signs of the times aright; but the orthodox seldom play the _rôle_ of a prophet successfully, because they have lived too long in one groove, and so are apt to forget that England is not the world, which is steadily increasing in population. Instead of failing, the joint stock banks merely occupied the ground, and, by so doing, confined the business of the London private banker to the one street in which he was established and in which his father lived before him. They had no respect for age--those new companies!
The joint stock banks spread their tentacles north, south, east, and west of his sacred City, thereby effectually preventing his expansion, and "concentrating" his energies in the one street aforesaid, just as the nations of Europe have "concentrated" the kingdom of the unspeakable Turk. Great movements seldom originate within London, which is strikingly lacking in originality, and that new blood from the provinces which flows in an ever-increasing stream towards the great City, and alone arrests decay, also seems to bring with it the new ideas.
The London private bankers waited in vain for the expected disappearance of their rivals, who, despite severe panics and crises, continued to add rapidly to their resources, until, surrounded by rival branches, profitable expansion became difficult for the private banker, whose business is now so localised as to render effective competition with the companies impossible. He cannot make rapid progress because he does not possess the branches through which alone the necessary credit can flow to the central office, and therefore the extinction of private banking in its present form seems only a question of time, for the wealthy are certain to deal with those banks whose vast accumulations are at least the outward and visible sign of the confidence the public has in their stability.
But the joint stock banks did not confine their energies to London. The London and South Western Bank, which was established in 1862, began a vigorous crusade in the London suburbs, with the happiest results to its shareholders; and the London and Provincial Bank, which was formed two years later--in 1864--established small suburban branches in every direction, with equally satisfactory returns for its enterprise; while the London and County, larger and, perhaps, more cautious than either, also recognised the advantages of suburban expansion. A branch bank belonging to one of these three banks is now to be found in almost every London suburb.
The London and Westminster Bank (established in 1834) was the first in the field, but the atmosphere of the City is not favourable to progress, and the Westminster, though an exceptionally strong and well-managed bank, undoubtedly failed to move with the times. So, too, did the London Joint Stock Bank and the Union Bank of London, which has recently somewhat altered its name. It was not until the provincial joint stock banks invaded London that these companies began to realise the opportunity they had missed; Lloyd's and Parr's Banks however, evidently taking in the situation, adopted the new system, and by skilful amalgamations rapidly forced themselves to the front. The country banks, in short, practically took possession of Lombard Street.
Why the Bank of England did not share the same fate as the private bankers has already been demonstrated. It certainly was not one whit better informed than they; and it sympathised with them in their distrust of the intruders, whose speedy downfall it quite expected to witness. That the joint stock banks must come to grief was the opinion of the majority of City men in 1834, and the then directors of the Bank were City men imbued with those tenets which found credence within the sacred square mile.
The bank which keeps the Government account must always be a great power in the land. Had that account been removed in 1844, together with the last vestige of monopoly, the Bank--the directors of which shared to the full in that tenacity and narrow-mindedness characteristic of wealthy City merchants, whose businesses, and therefore whose ideas, flow in the narrowest of grooves--must have ceased to be a progressive institution. But no Government has ever hinted at deserting the Bank, whose record, though bristling with mistakes, is one of unbroken integrity; and the public has always looked upon its management as above suspicion. Especially was this the case during the first few decades of the new movement.
The Bank of England had public opinion behind it; and the joint stock banks, concerning whose stability opinion was divided, were not then strong enough to keep their own reserves and to defy the Bank; but when their system had stood the test of time, the Bank opened its doors to them, and the companies meekly bowed to the inevitable--for they were not the power in Lombard Street in those days that they are now.
In the first instance, we found the private bankers grouped around the Bank; and now we see our huge joint stock banking companies in a similar relation to her. They kept their reserves with her when their system was in its infancy, when the Bank of England, as a result of monopoly, was the greatest credit institution in the country. As the companies spread their tentacles throughout the land, accumulating credit at an extremely rapid pace, those reserves grew proportionately, until, to-day, we find the Bank of England in the centre of a system which owes over £910,000,000 in _cash_ to the public.
Our modern credit system has developed around the Bank, which, as the holder of the bankers' reserves, now occupies an almost national position. That position is, undoubtedly, the indirect result of a monopoly which, prior to 1826, enabled the Bank of England to build up a huge business unopposed by others of its kind. In other words, it had a start of 132 years. The greater, consequently, attracted the smaller. But united Lombard Street is now a much greater power than Threadneedle Street--therefore it is always wise to remember that the Bank of England can only retain its position in the centre of the money market so long as Lombard Street is agreed that it shall.
The banks are not legally obliged to keep their reserves with the Bank of England. Were they so inclined, they could withdraw them to-morrow and accumulate stores of the precious metals of their own. It follows, therefore, that the best of feeling should exist between the "Old Lady" and Lombard Street. Obviously she is not now in a position to dictate her own terms, as her greatest power is derived from the "bankers' balances" on the left-hand side of her balance sheet.
Perhaps it is now easier to understand that the Bank of England, when it from time to time states the lowest rate at which it will discount bills for outsiders, occupies the position of a most important lender, whose minimum rate, though not always the market rate, is seldom either greatly above or below those of its rivals.
CHAPTER XI.
The London Money Market.
It is usual, when describing the Money Market, to assert that it consists of the numerous banks in the City of London; but it seems to me that, in reality, the money market extends throughout the United Kingdom, for wherever there is a bank or a branch bank there is a market for money. Moreover, the demand arising for loanable capital in the provinces largely influences the rates of interest ruling from time to time in London, because, if demand is brisk in the country, the banks have less to lend in London, consequently the rate advances there.
When reference is made to the money market the London short loan fund is invariably meant, and we now have to consider how this fund is formed. The banks, which are liable to the public for huge sums of money at call and short notice, are obliged to keep a certain proportion of cash in their tills and strong rooms and with the Bank of England in order to be prepared for any sudden demand that may be made upon them.
Their cash in hand is, of course, required to meet the ordinary demands of a banking business, and that deposited with the Bank of England is held as a reserve fund against those risks of withdrawal from which a credit institution owing immense sums at call is never free. Roughly speaking, a well-managed bank would keep, say, six per cent. of its public liabilities in legal tender on the premises, and a further ten to twelve per cent. at its credit in the books of the Bank of England. The latter accumulation might be called the bank's _real_ reserve, for it is upon this that it would have to rely during a run.
Secondly, from eighteen to thirty per cent. of its liabilities to the public would be invested in first class securities. Those of and guaranteed by the British Government are in great request for this purpose, as the Bank of England would not hesitate to advance against such investments should a company find itself compelled to meet a sudden drain upon its resources. Every prudent banker therefore takes care that a large proportion of these securities is included in his list, which would also contain Metropolitan and other Corporation Stocks, English Railway Debentures, Colonial Government Securities, and so on. A banker's list, in short, should be a so-called "gilt-edged" one.
Thirdly, a banker lends a certain proportion of his deposits in the London money market. Some banks have eight per cent. there, some fourteen per cent., and others from fifteen to twenty per cent., though the larger and better managed companies generally employ from seven to fourteen per cent. therein. A certain amount of this "call money," however, represents money which has been lent to jobbers and brokers on the Stock Exchange for "carrying over" purposes at the various settlements, but by far the larger part of it is money which has been lent to the bill brokers and discount houses.
In no sense can this asset in the balance sheets of the banks be looked upon as a reserve. It is money invested in the London short loan market--money lent to the bill brokers, who, in times of bad credit, might not be able to repay it on demand. Just at the very moment when bankers are most in need, this asset is the least available; therefore, it is about the worst possible form in which the reserve of a credit institution, owing large sums at call, can be invested.
As a credit bank's debts are due at call and short notice, a true reserve can only consist of legal tender, and the till money, which is required in the ordinary course of business during normal times, certainly cannot be classed with that reserve. When considering what is a bank's real cash reserve, we ought to deduct from four to five per cent. from the ratio of cash in hand and with the Bank of England to liabilities, for a trader would not include the cash required from day to day in his business with any reserve he might accumulate against accidents.
Reverting to investments, we might take Consols as an illustration of their liquidity. During normal times Consols can be sold for cash at any moment, but it is otherwise in a time of panic, when practically everybody wants either to sell them or to borrow upon them. The market is then disorganised, and people require either gold or large credits at their bankers--not securities. Hence, even Consols are unsaleable when a panic develops into a crisis.
As the Bank of England holds the cash reserve of the nation, it alone can advance against securities in the midst of a crisis, and those banks which were caught short would then have to apply to the Bank for help. The Bank certainly would not lend upon any but gilt-edged securities during a time of stress, and if their customers then made a call upon them those companies which held second-rate investments would have to close their doors, as they could not obtain assistance from any other source. A strong list of securities is, therefore, essential to every bank that is anxious to protect its customers against disaster.
These three assets (cash in hand and at the Bank of England, money at call and notice, and investments) constitute a bank's so-called liquid assets. The ratio of total liquid assets to liabilities maintained by the best English banks ranges from 43 to 78 per cent. The last-named figures, which are quite exceptional in their strength, were published by Stuckey's Banking Company. The remainder of a bank's resources is employed in making advances and loans, and in discounting bills for its clients, whilst a small proportion is locked up in premises.
We can now form some idea as to what the short loan fund of the London money market really is. Immense sums are collected at the head offices of the banks in London through their metropolitan and provincial branches; and, as the demands of trade are always uncertain--now brisk, then slack--it is impossible for them to invest all their surplus capital in securities; consequently, a certain portion of it finds remunerative employment in this channel.
A huge stream of credit is constantly circulating through the three kingdoms, and London, so to speak, is the heart of the system. In years of active or good trade this stream increases in volume, and during years of depression it contracts; yet it is difficult to say whether or not the resources of the banks (the floating capital of the country) are appreciably lessened during a period of temporary depression, although the national turnover unquestionably is, as may be seen by the Clearing House returns. During years of rising prices and increasing trade activity profits are augmented, and, consequently, the resources of the banks are swollen; but when the profits are invested within the country, a similar amount of credit is returned to the banks by those who have sold their securities, and though less capital is created when trade is dull, it is questionable whether the resources of the banks then shrink very greatly, unless foreign securities are largely purchased.
We have seen that this stream of credit flows to London, and as demand throughout the country is not sufficiently strong to attract it all back again, a large fund of loanable capital accumulates in the hands of the London banks, and flows from them to the bill brokers, who employ it in discounting bills of exchange. But though by far the greater part of the London short loan fund is accumulated in this manner by the banks, other firms and companies also discharge their surplus capital into it. The pool, of course, is not a stagnant one, for capital is constantly flowing in and out.
The India Council, for instance, lends large sums in the London short loan market. The numerous foreign and colonial banks in London do the same, and so, too, do many of the large insurance companies and merchants, while during slack times money finds its way from the Stock Exchange to the bill broking houses. At first sight it seems strange that bankers should advance money to the bill brokers, and so provide their rivals with capital with which to compete against them, especially as the banks have discount departments of their own.
Let us, however, consider the position of the bill broker in relation to the Bank of England and the money market.
Towards the beginning of the nineteenth century the broker acted as agent for the country bankers, but this connection was naturally severed when the country firms opened accounts with the London bankers, and the broker, whose knowledge of bills was extensive, then transacted business for himself. Through holding out for high rates, the London private bankers drove a large amount of business into the hands of the bill brokers, who, by confining their attention solely to this class of credit document, came to be largely trusted by the joint stock companies, which could not obtain servants with the special training of their rivals.
In no other country has the bill broker such influence as in England. In Paris, for instance, the customer discounts with his banker, who re-discounts with the Bank of France; but in London, for reasons already stated, bills find their way to the bill brokers, who re-discount either with the banks or with the Bank of England. Moreover, all the best bills get into the hands of the bill brokers, who, at one time, only discounted the acceptances of the banks and the larger houses; but they now take small trade bills, and, should the banking business grow less profitable, it is questionable whether the banks might not endeavour to dispense with the middleman whom they now encourage.
We next have to consider the London money market as a whole. First we find a system which comprises Lombard Street and Threadneedle Street. In other words, the London banks, by keeping accounts with the Bank of England (Threadneedle Street), have placed that institution in the centre of the system, and we know the Bank derives great power from this situation; but its power is not innate--it is derived through and is dependent upon Lombard Street. This group we will call "the money market" or "the market."
Then we have the bill brokers, of whom we will speak as "the outside market." Every morning the bill broker goes from bank to bank inquiring at what rates he can borrow; and if Lombard Street (the London banks) cannot supply him with all the capital he requires, then he is compelled to apply to the Bank of England, which, however, he always endeavours to avoid, because the Bank invariably charges him a higher rate than do the other banks.
The Bank of England is a great bank of discount: consequently, the brokers are its rivals; so it is hardly reasonable to expect the Bank to charge the same rates to them as to its own clients, seeing that the brokers, by their competition, reduce the Bank's business. When trade is brisk loanable capital is in considerable demand, and the banks, therefore, have less money to lend to the bill brokers, who consequently are then driven to the Bank, which holds the bankers' balances.
But the Bank of England's position is an extremely delicate one; and when the resources of Lombard Street are temporarily exhausted and demand centres upon itself, it has to take care that its ratio of reserve of notes and cash in the Banking Department does not sink too low in proportion to its liabilities. Should the demand upon its resources prove considerable, it raises its rate until the pressure is reduced. As a large part of the trade of this country is conducted through the medium of bills of exchange, it is absolutely essential that there should always be a market for good bills. Otherwise, panic and failures would be the result; so, were the Bank to refuse to take bills from the brokers at a price, our credit system would collapse at once, unless the banks themselves, determined to crush the brokers, offered to deal direct with the holders. But the experiment would be a most risky one to make. Moreover, it could not be attempted at a critical moment.
When Lombard Street is not lending freely, or cannot lend further with comparative safety, the Bank, by raising its rate of discount from time to time, reduces the merchant's profit on each transaction, until at last money becomes so dear that he finds that he is making little or no profit on his goods. He therefore produces less, and, consequently, discounts less, when the pressure upon the Bank relaxes.
So long as money may be obtained, let the price paid for it be what it may, a sense of security pervades the community; but were it whispered during a period of temporary tightness that the Bank refused to discount good bills at any price, our credit system would be in imminent danger, for the trade of the country would be at a standstill. Further, did such a state of affairs continue for many days, the crash would come, and the Bank of England would then be swept away with the rest of the market. Our present system is so delicately poised that the Bank simply dare not refuse to take good trade bills from the brokers.
We next come to the other side of the picture. The broker, when he goes his rounds, sometimes finds that the surplus resources of the banks are abundant, and that they are ready to let him have even more than he requires. When he makes this discovery, he begins to higgle, to try to ascertain the lowest rate certain banks are prepared to accept; for the difference between the rate at which he discounts bills for his own customers and the rate at which he re-discounts or borrows, is his margin of profit, and he is naturally anxious to make it as wide as possible. (The poor man, be it remembered, does not visit Lombard Street simply because he finds the air pure and the society of bank officials congenial.) He therefore does his best to discover those banks which are in funds, and, having found them, to induce them to lend as cheaply as possible. This he can do when loanable capital is cheap and abundant, and the Bank of England probably doing but little business. Possibly, though the Bank rate is at two and a half, bills are being taken by the brokers at one and a half. Then the Bank, in order to get business, either lowers its rate of discount or else, by selling stock, endeavours to lessen the resources of Lombard Street.