If the Bank adopt the latter expedient, it usually sells Consols for cash, and buys them back for the account, thereby temporarily reducing "bankers' balances," and attracting business to itself. The banks, having less to lend, raise their rates, which then approximate more closely to the Bank rate.
The brokers often complain bitterly of this interference by the Bank of England with the market's supply of loanable capital, asserting that this artificial enhancement of rates by the reduction of bankers' balances through the sale of stock affects their business injuriously, and benefits the Bank but little; and it certainly is difficult to see how the Bank of England can make a profit out of the transaction.
On the other hand, when the market rate is appreciably below the Bank rate, it is impossible to attract foreign gold to London; and the Bank, by borrowing on Consols, and making its rate representative, is acting in the public interest, should it be desirable either to attract gold to this country or to prevent its leaving these shores.
We can now see that the Bank of England, though it states its minimum rate, is often powerless to transact business thereat; and, recognising that its own rate is out of touch with the market rate, the Bank often discounts bills for its own customers at the rates ruling in the open market, as, were it to refuse to do so, its clients would naturally take their bills to the cheapest house. When, however, Lombard Street is empty, and the bill brokers are compelled to approach the Bank which holds the final reserve, the Bank of England is frequently in a position to charge its rivals one per cent. above its declared minimum, and the bill brokers quite naturally feel a little sore. For this reason they try every source of supply before making application to the Bank.
As security against loans made to them the brokers usually deposit either bills which they have discounted in the ordinary course of their business or gilt-edged securities, but sometimes the bill broker's credit is so good that the banks lend him money at call practically without security. When securities are deposited they are of course returned directly the loan is paid off.
There is also another little point to which attention may be drawn: to wit--that, although the market we are discussing is a special market, yet if a borrower's credit be good it is generally possible to obtain an advance either at or about Bank rate.
CHAPTER XII.
The Bank Rate and Stock Exchange Securities.
At the present time large advances are made by the banking companies to members of the Stock Exchange, and it is supposed that at the beginning of 1894, when the Bank rate fell to two per cent., and an investment of surplus funds in the London short loan market brought in very poor returns, the banks, tempted by higher rates, largely increased their loans to the Stock Exchange. In 1890 rumour had it that a few of the banks made rather heavy losses in connection with the South American gamble, which brought down the firm of Barings; and the unanimity they displayed, under the leadership of the late Mr. Lidderdale, in supporting the tottering structure, certainly lends force to the suggestion; for philanthropists are not to be found either in Lombard Street or in Gorgonzola Hall.
The same rumour was circulated after the Kaffir boom in 1895, and a little later it was whispered that some of the banks intended curtailing their loans to the Stock Exchange, and that in future mining shares would be received with the greatest circumspection. So close is the connection between the banks and the "House" that the utmost consternation prevailed when it was feared that the banks would not touch certain stocks and shares of a fluctuating character. The mere rumour created almost a panic among those dealers whose books were full of the tabooed securities.
But 1895 was a bad year for the banking companies, and, from a dividend point of view, 1896 was little better, for the Bank rate did not touch two-and-a-half per cent. until September of that year. The short loan market, therefore, was not a tempting place into which to pour surplus deposits, so the banks apparently thought better of their decision (if it were a decision), and continued their loans to the Stock Exchange on the same liberal scale, because such loans yielded a much better return than those to the bill brokers.
The very rumour that the banks intended increasing their margin on, say, American Rails, would cause those securities to fall, and were the threat actually executed, then, unless strong support came either from the public or from New York, the result would be failures of weak jobbers in that particular market, and a heavy fall in the prices of American Railway securities. There is the same link between the other markets of the Stock Exchange and the banks, and, such being the case, it naturally follows that the prices of securities are influenced by the abundance or scarcity of loanable capital, and that, therefore, continuation rates fluctuate with the Bank rate.
But a very considerable proportion of the transactions conducted on the Stock Exchange is of a speculative or gambling nature, in which those mysterious persons called "bulls" and "bears" figure largely, and whose object it is, not to invest savings in particular stocks and shares, but to receive a cheque from their broker representing differences due to them on the rise or fall of the securities in which they are temporarily interested.
The "bull" buys stock because he believes that it will rise, and that he will be able to sell it at a profit before the fortnightly settlement comes round, but he does not pay for it; and if his sanguine anticipation is not realised, so human and hopeful is he, that he endeavours to obtain a loan on his stock through his broker in order to carry it over to the next settlement, trusting that he will be able to sell at a profit before contango day again comes round. The broker sometimes obtains an advance on the stock through his banker, and so is enabled to accommodate his client, whom he charges both interest and commission. Again, the broker may carry over the stock through a jobber or with a money broker who is a member of the "House," as the Stock Exchange is colloquially called.
It has been suggested that some of these money brokers are in reality agents of the banks--that, in short, they are the middlemen between the banks and those who want to borrow on the Stock Exchange, just as the bill broker is the middleman between the banks and those persons who possess bills. The bill broker deposits the bills he has discounted for his customers as security against a loan from the banker, and the money broker deposits the stocks and shares against which he has advanced to members of the Stock Exchange as security for a loan from the banker to himself. His profit, therefore, like that of the bill broker, would be the difference between the rate at which he borrows from the banker and the rate at which he lends in the House. When large sums are advanced in this manner the prices of stocks and shares are forced up to fictitious figures in the hope that the public will come in and buy. Yet the Stock Exchange Committee preaches about the iniquities of the outside broker! Far be it from me to defend the possibly questionable methods of the latter; but, to an unbiased observer, it sounds somewhat like the pot calling the kettle black.
Huge sums of money are advanced every fortnight by the banks to the money brokers and jobbers, principally against sold stocks and shares, which are awaiting the arrival of _bonâ fide_ investors. The banks, of course, require a good margin in order to cover themselves against loss through any possible depreciation in the hypothecated securities, and when the settlement or day of reckoning arrives, fresh loans are made, or old advances are renewed, and the securities carried over to the end of the account. A high rate of interest naturally makes "carrying over" from account to account a very expensive operation, whilst an abnormally high rate renders the process prohibitive.
When, therefore, the Bank rate is high and money is dear, a check is immediately given to speculation on the Stock Exchange, because those persons who have bought securities for a rise prefer to sell at a loss before the settlement rather than pay excessive contango rates. It follows, then, that dear money greatly reduces the dimensions of the accounts open for the rise.
The banks, too, often become alarmed by the magnitude of the account, and having demands upon them for capital elsewhere, they grow nervous and lend less freely, at greatly enhanced rates, and then jobbers and money brokers have to refuse a large number of applicants. The result may be either a fall in the securities dealt in by a particular market or a general depression throughout the House. Then the "bears" come in and buy, take their profits, and are jubilant.
Conversely, a plethora of money and a low Bank rate encourage speculation, as was the case before the boom of 1895. Continuation rates are low, and capital comes out of trade into the better-class securities, which begin to rise in consequence. Then, for a little while, the "bulls" have it all their own way. But why does the Committee pose as the friend of the _bonâ fide_ investor? It is a little difficult to see where he comes in, unless it be in at the top and out at the bottom. As a matter of fact, there is so much gambling in securities taking place in the House that the genuine investor, if he do not understand the market, falls an easy prey to the "bulls" and "bears," who, by studying the habits of his kind, anticipate their requirements, and, after taking a large bite, pass on their hypothecated shares. On the other hand, the investor who studies the markets sometimes waits patiently for exhausted "bulls" or sells to frightened "bears." So, to those who know the game it is about as broad as it is long.
CHAPTER XIII.
The Banks as Stockbrokers.
Were business on the Stock Exchange solely of an investment nature, it has been suggested that that institution could dispense with over fifty per cent. of its members, for, during recent years, a large amount of the investment business of the country has drifted to the banks, which place their orders in the hands of a few brokers, with whom they divide the usual one-eighth per cent. commission. The large banking companies are outside brokers, and so eager are some of them to attract this class of business that they offer their clerks half the commission received from the broker upon all business introduced by them. Seeing that the average bank clerk is absolutely without experience of the markets, touts of this variety are a source of danger to the public.
The banker who divides his share of the commission with the clerk who introduces the business is satisfied with one-thirty-second per cent. commission; but the broker, who only gets one-sixteenth instead of one-eighth per cent., is, probably, less eager to make a close bargain for a customer of the bank than for one of his own. On the other hand, the volume of investment business which flows through the banks to the Stock Exchange is so large that those brokers who are favoured with the banks' custom must earn considerable sums by way of commission. Whether orders from customers of the banks receive that individual attention which the brokers give to those from their own clients is, however, another matter.
Most of the banks have Stock Departments, to which orders are sent by their country branches. These orders are steadily increasing, and the tendency seems to be for a large number of the provincial public to do their investment business through the banks. This class of business is, therefore, gradually drifting to the banks, and doubtless, as time goes on, the banking companies will become the recognised channel for the _bonâ fide_ country investor.
It follows that the non-speculative business is getting into a few hands, with the result that a large number of brokers on the Stock Exchange are, so to speak, "starved," and consequently obliged to turn their attention to the demand created by the more speculatively disposed members of the public. Yet, strange to say, in spite of the fact that orders are now diverted to the Stock Departments of the London banks and that, therefore, fewer brokers are required to transact the investment business of the country, the members of the Stock Exchange are increasing numerically. Seeing that the safe business is drifting through the banks into the hands of a few large brokers we may well ask how the smaller men obtain a living from their business?
The ground, year in year out, is being farmed assiduously by the banks, whose large capital and established credit inspire widespread confidence; and in the face of such competition the small broker's chance of success does not seem encouraging. How can he make a business? The banks, who place their orders with strong brokers, guarantee those customers who deal through them against the insolvency of both the broker and the jobber, and such a guarantee is unquestionably worth having. The small broker, as a rule, possesses very little capital; whereas the person who instructs his banker either to buy or to sell is conscious that he is dealing through an institution whose credit is practically unlimited, and whose resources amount to many millions. He has not, therefore, to ask himself whether his broker is safe, and this sense of security, inspired by a bank's millions, undoubtedly causes many people who would rather do business direct with a member of the Stock Exchange to deal with the banks. Moreover, a bank official is quite well aware of this advantage, and when a customer, who is undecided whether or not to employ a broker, asks what inducement the bank holds out to him, he quietly replies: "You have the bank's credit upon which to rely." Such an answer makes a customer reflect. Further, it seldom fails to effect its purpose, because, in the first place, it instils a doubt in the client's mind regarding the means of his broker; and, in the second place, because he cannot fail to recognise the greater security the bank affords him.
It is evident, then, that the small broker's path is bestrewn with almost insuperable difficulties, and that it is extremely hard for him to attract safe business. But the banking companies do not arrest the flow of speculative orders to his books.
The banks, which have a horror of speculation, confine their attention to the buying and selling of stocks and shares through their brokers. Were they to encourage gambling in securities they are fully aware that the result would be disastrous to the business of banking, for a certain number of their customers would be sure to neglect their business in the hope of snatching differences on the Stock Exchange, and such a policy would end in a crisis that would bring the country to the verge of ruin. For this reason alone the banks firmly and wisely refuse to foster speculation among their clients.
Capital, we all know, is the savings of labour; consequently the greater the profits made in trade during any one year, the larger is the fund awaiting investment. Now, if the banks were to incite the gambling fever among their customers, this fund would tend to diminish each year, and, seeing that the prosperity of the country is entirely dependent upon its trade, bankers, customers, and stockbrokers would speedily become involved in common ruin. Small wonder, then, that our large banking companies, which are responsible to the public for millions of money--a large proportion of which they must be prepared to return at any moment--decline to open speculative accounts for their clients. It would be madness on the part of such institutions to divert their customers' attention from trade to speculation in securities; and for this reason the bank clerk as amateur commission agent seems a step in the wrong direction.
Moreover, in this respect the policy of the banks appears contradictory. Recognising the temptations to which their clerks are exposed, it is their practice to instantly dismiss those men who indulge a passion for betting; yet some of them deliberately encourage their servants to tout for investment orders, apparently unconscious of the fact that once their attention is drawn to the markets, some of the clerks are almost certain to end by gambling for differences on their own account. Helping themselves to the money of the banks is probably the next step. Were not the question so serious, the fact that directors cannot make so palpable a deduction would be positively humorous, for it is evidently quite as undesirable, from their point of view, that a clerk should bet upon a stock as upon a horse.
The modern credit system, it will be seen, places a very large part of the safe or investment business in the hands of a minority of brokers, who, like the bankers, much prefer to do a good commission business, and to leave speculation to the smaller brokers, who have less to lose than they. These favoured brokers have grown accustomed to sleeping comfortably o' nights, undisturbed by the vision of settling day on the morrow; and, quite blind to the cause of their enviable freedom from care, they are disposed to be loud in their abuse of the risky manner in which some of the smaller brokers conduct their business. But, seeing that the non-speculative orders flow from the banks to themselves, it would be interesting if they would attempt to explain how the army of small brokers can live unless they cater for the wants of the speculator. As a rule their capital is small, consequently they cannot afford to wait years while they slowly build up a connection; so, as the safe business is cornered, they accept the risky. This they do, not from choice, but from necessity; and the Stock Exchange Committee, in order to prevent additions to the ranks of these undesirables, should take steps to reduce the number of members of the Stock Exchange very considerably. Already the investors of this country have to support a small army of over four thousand of them.
Of course, after every period of excitement, numerous weak members of the Stock Exchange are weeded out, and, in a sense, the _bonâ fide_ investor is the pigeon that is plucked by the speculator. The bulls buy in the fond hope that the investor will come in and relieve them of their stock; and the bears sell securities which they do not possess, trusting that investors will also sell, thereby enabling them to buy at a low figure and to pass on their securities at a profit to those to whom they have previously sold. The position is therefore often an artificial one, created by operators for the rise or fall, and the investor, unless he thoroughly understands the markets, is like a pigeon among hawks.
The larger the number of members of the House, the greater is the risk run by the investor who deals with a small broker; and as the investment business of the country flows largely in a particular channel, it is more than probable that, unless the Committee decides to admit new members sparingly, a large number of small brokers will one day be "hammered" after a period of intense excitement.
CHAPTER XIV.
The Short Loan Fund and the Price of Securities.
A certain proportion of the capital which flows into the London short loan fund is invested in securities by the bill brokers and the discount houses, and, as the said securities are deposited with the bankers from time to time against temporary advances, it follows that their choice is largely restricted to those of and guaranteed by the British Government, because the margin exacted on the so-called gilt-edged varieties is considerably less than that demanded upon the more fluctuating stocks and shares.
The bankers themselves invest largely in the same class, and they also employ vast sums in the short loan market; so that when the market rate for bills is higher than the interest received upon, say, Consols, the bankers are disposed to sell some of their Consols in order to obtain the higher rates ruling in the outside market. Obviously, then, any accretion or diminution in the short loan fund at once affects the prices of gilt-edged securities. If the Bank rate be high, and also representative, Consols ought to fall, and, conversely, if the Bank of England's rate be low, trade dull, and the market rate of discount smaller than the return on Consols, gilt-edged securities should rise.
If this be the case, a low Bank rate must give an immediate incentive to speculation in securities, and, therefore, the condition of the short loan fund is intimately connected with the prices of stocks and shares, but more particularly with those securities in which lenders in the money market largely invest. The banks--let the condition of the money market be what it may--must, of course, always invest a certain proportion of their resources in Consols, but the sum so invested is not constant.
Again, powerful business firms and companies hold Government stock as reserves against contingencies. The Government makes large purchases in the Consol market on account of the Post Office Savings Bank and the Sinking Fund, while numerous other "bull" points could be given. However, the fact remains that cheap money provides a strong inducement to large speculative purchases of Consols.
The large capitalists and those persons whose credit is good can borrow at, and sometimes even slightly below, Bank rate on Consols from the banks, which are satisfied with a small margin against possible depreciation on Government securities. If, therefore, we examine the period between February, 1894, and September, 1896, when the Bank rate was stationary at two per cent., it will be possible to illustrate this tendency. Day-to-day money was then sometimes quoted at one per cent. and under, and this state of affairs occasionally extended over protracted periods.
Now, suppose a person invested £20,000 in Consols at 112, and that his banker agreed to advance £18,000 against them at, say, seven days' notice at one per cent. per annum. Two-and-three-quarter Consols at 112 return £2 9s. per cent. (about). His annual income, therefore, on £20,000 would amount to about £490; but he owed his banker one per cent. on £18,000. Hence £180 must be deducted from £490. Upon a capital of £2000 he therefore earned £310; and a return of fifteen-and-a-half per cent. per annum on Consols is surely an excellent reward for his skill. Of course, we must not forget possible depreciation; but seeing that the banker's advance released £18,000, which he can use, he can afford to take some risk.
The following example, however, affords a more practical illustration of the possibilities of speculation in Consols during the depressed portion of a cycle, when the prices of commodities are low and loanable capital is cheap. First, we want to ascertain the movements in this security from, say, 1894 to 1896, and of these the table given hereunder supplies a good idea:--
========================================================================= | 1894. | 1895. | 1896. | Goschen's +----------+----------+----------+Bank rate from Two-and-three-quarters | Highest. | Highest. | Highest. |22nd Feb., 1894, per cent. | 103⅝ | 108⅛ | 114 | to 9th Sept., (Two-and-a-half | | | | 1896. per cent. | Lowest. | Lowest. | Lowest. | after | 98⅜ | 103½ | 105⅛ | Two per cent. 5th April, 1903) | | | | =========================================================================
Let us assume that a person invested £20,000 in Consols at parity in 1894, and arranged with his banker for a loan against them at Bank rate, and that the banker's margin was to be ten per cent. on the purchase price. He received, then, a loan of £18,000 from his banker, so the amount of his own capital remaining in the venture was £2000. Very probably, especially if his credit were beyond doubt, he would have made a closer bargain with his banker, and thus have reduced the margin slightly--but this is by the way.
Upon his £20,000 in Consols he obtained two-and-three-quarters per cent., so that his annual income therefrom was £550. But as he had to pay his banker two per cent. per annum on £18,000, £360 must be deducted from £550. His capital in the speculation being £2000, he made £190 thereupon. This gain works out at nine-and-a-half per cent. per annum, and nine-and-a-half per cent. on Consols may surely be classed among the minor forms of temptation. Moreover, as the Bank rate stood at two per cent. for slightly over two years and a half, he had a long run for his money.
But we see that he bought at parity, and that in 1896 Consols touched 114. Had he sold at 110 during that year, his £20,000 in Consols would have realised £22,000. He, however, owed his banker £18,000, so there remained £4000 to his credit. As his own capital in the speculation was £2000 he would have exactly doubled it, and nine-and-a-half per cent. per annum upon £2000 in Consols for close upon two years, with a bonus of £2000 at the finish, is painfully reminiscent of those financial dreams which so very seldom materialise; yet huge blocks of Consols were actually bought during this period of two per cent., and dealt with in the manner aforesaid.
Of course, the results were not always so satisfactory as those given in the above illustrations, and no doubt many such ventures ended in a loss, for prizes of this description are for the lucky few; though it is usual to dwell upon them to the mortification of the mutable many. The snatching of profits in this fashion requires skill and considerable patience, and those persons who receive specious pamphlets telling them how money is to be made in a marvellously short space of time by an infallible system may appreciate the plausibility of my illustrations, but yet should remember that they may find the results of similar speculations in Consols very disappointing.
The demand for Government securities created by these speculative operations is one of the causes which drive up the price of Consols during periods of cheap money, but it is not by any means the only cause. When the Bank rate advances, and capital can be employed more advantageously in the London short loan market, this period soon comes to an end, and consequent sales depress the Consol market.
Very many of the better class securities such as Colonial Government stocks, Foreign Government securities, and so on, yield from three to five per cent., and when the Bank of England rate is at from two to two and a half, though the margin demanded upon such stocks is wider than that required upon Consols, the difference between the interest received in the shape of dividends and that paid as the price of a loan often makes speculative dealings in them decidedly profitable. As the Bank rate increases, and the speculator's profit margin consequently narrows, the tendency is for stocks and shares so "carried" to fall in value. The holders or gamblers then begin to sell, and as the increased supply of such securities is certain not to be met by an enhanced demand on the part of investors, prices must fall. Seeing the better class securities declining in value, those investors who had previously held aloof are tempted to come in, and the greater the reaction, the stronger is the inducement to buy; consequently, the lower prices recede the larger becomes the number of purchasers, until demand overtakes supply and prices again begin to move upwards.
Broadly speaking, it is evident that, unless the markets are disorganised by panic or by some disquieting political occurrence, the prices of the so-called gilt-edged securities are influenced by the conditions prevailing in the London short loan money market.
CHAPTER XV.
Panic Years.
When in 1667 a Dutch fleet sailed up the Medway, demolished a fort at Sheerness, and, forcing a way into Chatham Docks, burnt all the ships assembled therein, to the consternation of the inhabitants of London, there was a run upon the banks; but a Stuart regarded both events with equanimity, for "Old Rowley" had a mind above trifles of this description, possibly because he had learnt many bitter truths in a world seldom understood by Kings. Cynics are not born--they are made; and Charles II. had drunk from that cup which sharpens the understanding.
France, during 1719 and 1720, was in the throes of the Mississippi scheme, which was engineered by that notorious Scotsman, John Law; and England, in 1720, witnessed the collapse of the South Sea Company, which Sir Robert Walpole, with rare insight and unerring financial instinct, had demonstrated was a mere gamble, that, at the best, could only enjoy a temporary success, which was absolutely dependent upon a rise in the company's stock; but the Government turned a deaf ear to his warning.
Scotland, we have seen, had its Darien venture in 1699; and in 1720 all England went mad over the South Sea Company, which offered to relieve the Government of part of the National Debt, and entered into an insane competition with the Bank of England for that purpose. Then occurred some spirited bidding between the two companies for this privilege; but the directors of the Bank proved themselves the less mad, and left their rival in possession of the incubus and the road to ruin.