Chapter I: Introductory

I venture to call this Essay 'Lombard Street,' and not the 'Money Market,' or any such phrase, because I wish to deal, and to show that I mean to deal, with concrete realities. A notion prevails that the Money Market is something so impalpable that it can only be spoken of in very abstract words, and that therefore books on it must always be exceedingly difficult. But I maintain that the Money Market is as concrete and real as anything else; that it can be described in as plain words; that it is the writer's fault if what he says is not clear. In one respect, however, I admit that I am about to take perhaps an unfair advantage. Half, and more than half, of the supposed 'difficulty' of the Money Market has arisen out of the controversies as to 'Peel's Act,' and the abstract discussions on the theory on which that act is based, or supposed to be based. But in the ensuing pages I mean to speak as little as I can of the Act of 1844; and when I do speak of it, I shall deal nearly exclusively with its experienced effects, and scarcely at all, if at all, with its refined basis.

For this I have several reasons,—one, that if you say anything about the Act of 1844, it is little matter what else you say, for few will attend to it. Most critics will seize on the passage as to the Act, either to attack it or defend it, as if it were the main point. There has been so much fierce controversy as to this Act of Parliament—and there is still so much animosity—that a single sentence respecting it is far more interesting to very many than a whole book on any other part of the subject. Two hosts of eager disputants on this subject ask of every new writer the one question—Are you with us or against us? and they care for little else. Of course if the Act of 1844 really were, as is commonly thought, the primum mobile of the English Money Market, the source of all good according to some, and the source of all harm according to others,—the extreme irritation excited by an opinion on it would be no reason for not giving a free opinion. A writer on any subject must not neglect its cardinal fact, for fear that others may abuse him. But, in my judgment, the Act of 1844 is only a subordinate matter in the Money Market; what has to be said on it has been said at disproportionate length; the phenomena connected with it have been magnified into greater relative importance than they at all deserve. We must never forget that a quarter of a century has passed since 1844,—a period singularly remarkable for its material progress, and almost marvellous in its banking development. Even, therefore, if the facts so much referred to in 1844 had the importance then ascribed to them,—and I believe that in some respects they were even then overstated,—there would be nothing surprising in finding that in a new world new phenomena had arisen which now are larger and stronger. In my opinion this is the truth: since 1844, Lombard Street is so changed that we cannot judge of it without describing and discussing a most vigorous adult world which then was small and weak. On this account I wish to say as little as is fairly possible of the Act of 1844, and, as far as I can, to isolate and dwell exclusively on the 'Post-Peel' agencies, so that those who have had enough of that well-worn theme (and they are very many) may not be wearied, and that the new and neglected parts of the subject may be seen as they really are.

The briefest and truest way of describing Lombard Street is to say that it is by far the greatest combination of economical power and economical delicacy that the world has even seen. Of the greatness of the power there will be no doubt. Money is economical power. Everyone is aware that England is the greatest moneyed country in the world; everyone admits that it has much more immediately disposable and ready cash than any other country. But very few persons are aware how much greater the ready balance—the floating loan-fund which can be lent to anyone or for any purpose—is in England than it is anywhere else in the world. A very few figures will show how large the London loan-fund is, and how much greater it is than any other. The known deposits—the deposits of banks which publish their accounts—are, in

And the unknown deposits—the deposits in banks which do not publish their accounts—are in London much greater than those many other of these cities. The bankers' deposits of London are many times greater than those of any other city—those of Great Britain many times greater than those of any other country. 1

Of course the deposits of bankers are not a strictly accurate measure of the resources of a Money Market. On the contrary, much more cash exists out of banks in France and Germany, and in all non-banking countries, than could be found in England or Scotland, where banking is developed. But that cash is not, so to speak, 'money-market money:' it is not attainable. Nothing but their immense misfortunes, nothing but a vast loan in their own securities, could have extracted the hoards of France from the custody of the French people. The offer of no other securities would have tempted them, for they had confidence in no other securities. For all other purposes the money hoarded was useless and might as well not have been hoarded. But the English money is 'borrowable' money. Our people are bolder in dealing with their money than any continental nation, and even if they were not bolder, the mere fact that their money is deposited in a bank makes it far more obtainable. A million in the hands of a single banker is a great power; he can at once lend it where he will, and borrowers can come to him, because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all: no one knows where to find it or whom to ask for it. Concentration of money in banks, though not the sole cause, is the principal cause which has made the Money Market of England so exceedingly rich, so much beyond that of other countries.

The effect is seen constantly. We are asked to lend, and do lend, vast sums, which it would be impossible to obtain elsewhere. It is sometimes said that any foreign country can borrow in Lombard Street at a price: some countries can borrow much cheaper than others; but all, it is said, can have some money if they choose to pay enough for it. Perhaps this is an exaggeration; but confined, as of course it was meant to be, to civilised Governments, it is not much of an exaggeration. There are very few civilised Governments that could not borrow considerable sums of us if they choose, and most of them seem more and more likely to choose. If any nation wants even to make a railway—especially at all a poor nation—it is sure to come to this country—to the country of banks—for the money. It is true that English bankers are not themselves very great lenders to foreign states. But they are great lenders to those who lend. They advance on foreign stocks, as the phrase is, with 'a margin;' that is, they find eighty per cent. of the money, and the nominal lender finds the rest. And it is in this way that vast works are achieved with English aid which but for that aid would never have been planned.

In domestic enterprises it is the same. We have entirely lost the idea that any undertaking likely to pay, and seen to be likely, can perish for want of money; yet no idea was more familiar to our ancestors, or is more common now in most countries. A citizen of London in Queen Elizabeth's time could not have imagined our state of mind. He would have thought that it was of no use inventing railways (if he could have understood what a railway meant), for you would not have been able to collect the capital with which to make them. At this moment, in colonies and all rude countries, there is no large sum of transferable money; there is no fund from which you can borrow, and out of which you can make immense works. Taking the world as a whole—either now or in the past—it is certain that in poor states there is no spare money for new and great undertakings, and that in most rich states the money is too scattered, and clings too close to the hands of the owners, to be often obtainable in large quantities for new purposes. A place like Lombard Street, where in all but the rarest times money can be always obtained upon good security or upon decent prospects of probable gain, is a luxury which no country has ever enjoyed with even comparable equality before.

But though these occasional loans to new enterprises and foreign States are the most conspicuous instances of the power of Lombard Street, they are not by any means the most remarkable or the most important use of that power. English trade is carried on upon borrowed capital to an extent of which few foreigners have an idea, and none of our ancestors could have conceived. In every district small traders have arisen, who 'discount their bills' largely, and with the capital so borrowed, harass and press upon, if they do not eradicate, the old capitalist. 2 The new trader has obviously an immense advantage in the struggle of trade. If a merchant have 50,000 l. all his own,—to gain 10 per cent. on it he must make 5,000 l. a year, and must charge for his goods accordingly; but if another has only 10,000 l., and borrows 40,000 l. by discounts (no extreme instance in our modem trade), he has the same capital of 50,000 l. to use, and can sell much cheaper. If the rate at which he borrows be 5 per cent., he will have to pay 2,000 l. a year; and if, like the old trader, he make 5,000 l. a year, he will still, after paying his interest, obtain 3,000 l. a year, or 30 per cent., on his own 10,000 l. As most merchants are content with much less than 30 per cent., he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the old-fashioned trader—the man who trades on his own capital—out of the market. In modem English business, owing to the certainty of obtaining loans on discount of bills or otherwise at a moderate rate of interest, there is a steady bounty on trading with borrowed capital, and a constant discouragement to confine yourself solely or mainly to your own capital.

This increasingly democratic structure of English commerce is very unpopular in many quarters, and its effects are no doubt exceedingly mixed. On the one hand, it prevents the long duration of great families of merchant princes, such as those of Venice and Genoa, who inherited nice cultivation as well as great wealth, and who, to some extent, combined the tastes of an aristocracy with the insight and verve of men of business. These are pushed out, so to say, by the dirty crowd of little men. After a generation or two they retire into idle luxury. Upon their immense capital they can only obtain low profits, and these they do not think enough to compensate them for the rough companions and rude manners they must meet in business. This constant levelling of our commercial houses is, too, unfavourable to commercial morality. Great firms, with a reputation which they have received from the past, and which they wish to transmit to the future, cannot be guilty of small frauds. They live by a continuity of trade, which detected fraud would spoil. When we scrutinise the reason of the impaired reputation of English goods, we find it is the fault of new men with little money of their own, created by bank 'discounts.' These men want business at once, and they produce an inferior article to get it. They rely on cheapness, and rely successfully.

But these defects and others in the democratic structure of commerce are compensated by one great excellence. No country of great hereditary trade, no European country at least, was ever so little 'sleepy,' to use the only fit word, as England; no other was ever so prompt at once to seize new advantages. A country dependent mainly on great 'merchant princes' will never be so prompt; their commerce perpetually slips more and more into a commerce of routine. A man of large wealth, however intelligent, always thinks, more or less—'I have a great income, and I want to keep it. If things go on as they are I shall certainly keep it; but if they change I may not keep it.' Consequently he considers every change of circumstance a 'bore,' and thinks of such changes as little as he can. But a new man, who has his way to make in the world, knows that such changes are his opportunities; he is always on the look-out for them, and always heeds them when he finds them. The rough and vulgar structure of English commerce is the secret of its life; for it contains 'the propensity to variation,' which, in the social as in the animal kingdom, is the principle of progress.

In this constant and chronic borrowing, Lombard Street is the great go-between. It is a sort of standing broker between quiet saving districts of the country and the active employing districts. Why particular trades settled in particular places it is often difficult to say; but one thing is certain, that when a trade has settled in any one spot, it is very difficult for another to oust it—impossible unless the second place possesses some very great intrinsic advantage. Commerce is curiously conservative in its homes, unless it is imperiously obliged to migrate. Partly from this cause, and partly from others, there are whole districts in England which cannot and do not employ their own money. No purely agricultural county does so. The savings of a county with good land but no manufactures and no trade much exceed what can be safely lent in the county. These savings are first lodged in the local banks, are by them sent to London, and are deposited with London bankers, or with the bill brokers. In either case the result is the same. The money thus sent up from the accumulating districts is employed in discounting the bills of the industrial districts. Deposits are made with the bankers and bill brokers in Lombard Street by the bankers of such counties as Somersetshire and Hampshire, and those bill brokers and bankers employ them in the discount of bills from Yorkshire and Lancashire. Lombard Street is thus a perpetual agent between the two great divisions of England,—between the rapidly-growing districts, where almost any amount of money can be well and easily employed, and the stationary and the declining districts, where there is more money than can be used.

This organisation is so useful because it is so easily adjusted. Political economists say that capital sets towards the most profitable trades, and that it rapidly leaves the less profitable and non-paying trades. But in ordinary countries this is a slow process, and some persons who want to have ocular demonstration of abstract truths have been inclined to doubt it because they could not see it. In England, however, the process would be visible enough if you could only see the books of the bill brokers and the bankers. Their bill cases as a rule are full of the bills drawn in the most profitable trades, and cæteris paribus and in comparison empty of those drawn in the less profitable. If the iron trade ceases to be as profitable as usual, less iron is sold; the fewer the sales the fewer the bills; and in consequence the number of iron bills in Lombard street is diminished. On the other hand, if in consequence of a bad harvest the corn trade becomes on a sudden profitable, immediately 'corn bills' are created in great numbers, and if good are discounted in Lombard Street. Thus English capital runs as surely and instantly where it is most wanted, and where there is most to be made of it, as water runs to find its level.

This efficient and instantly-ready organisation gives us an enormous advantage in competition with less advanced countries—less advanced, that is, in this particular respect of credit. In a new trade English capital is instantly at the disposal of persons capable of understanding the new opportunities and of making good use of them. In countries where there is little money to lend, and where that little is lent tardily and reluctantly, enterprising traders are long kept back, because they cannot at once borrow the capital, without which skill and knowledge are useless. All sudden trades come to England, and in so doing often disappoint both rational probability and the predictions of philosophers. The Suez Canal is a curious case of this. All predicted that the canal would undo what the discovery of the passage to India round the Cape effected. Before that all Oriental trade went to ports in the South of Europe, and was thence diffused through Europe. That London and Liverpool should be centres of East Indian commerce is a geographical anomaly, which the Suez Canal, it was said, would rectify. 'The Greeks,' said M. de Tocqueville, 'the Styrians, the Italians, the Dalmatians, and the Sicilians, are the people who will use the Canal if any use it.' But, on the contrary, the main use of the Canal has been by the English. 3 None of the nations named by Tocqueville had the capital, or a tithe of it, ready to build the large screw steamers which alone can use the Canal profitably. Ultimately these plausible predictions may or may not be right, but as yet they have been quite wrong, not because England has rich people—there are wealthy people in all countries—but because she possesses an unequalled fund of floating money, which will help in a moment any merchant who sees a great prospect of new profit.

And not only does this unconscious 'organisation of capital,' to use a continental phrase, make the English specially quick in comparison with their neighbours on the continent at seizing on novel mercantile opportunities, but it makes them likely also to retain any trade on which they have once regularly fastened. Mr. Macculloch, following Ricardo, used to teach that all old nations had a special aptitude for trades in which much capital is required. The interest of capital having been reduced in such countries, he argued, by the necessity of continually resorting to inferior soils, they can undersell countries where profit is high in all trades needing great capital. And in this theory there is doubtless much truth, though it can only be applied in practice after a number of limitations and with a number of deductions of which the older school of political economists did not take enough notice. But the same principle plainly and practically applies to England, in consequence of her habitual use of borrowed capital. As has been explained, a new man, with a small capital of his own and a large borrowed capital, can undersell a rich man who depends on his own capital only. The rich man wants the full rate of mercantile profit on the whole of the capital employed in his trade, but the poor man wants only the interest of money (perhaps not a third of the rate of profit) on very much of what he uses, and therefore an income will be an ample recompense to the poor man which would starve the rich man out of the trade. All the common notions about the new competition of foreign countries with England and its dangers—notions in which there is in other aspects much truth—require to be reconsidered in relation to this aspect. England has a special machinery for getting into trade new men who will be content with low prices, and this machinery will probably secure her success, for no other country is soon likely to rival it effectually.

There are many other points which might be insisted on, but it would be tedious and useless to elaborate the picture. The main conclusion is very plain—that English trade is become essentially a trade on borrowed capital, and that it is only by this refinement of our banking system that we are able to do the sort of trade we do, or to get through the quantity of it.

But in exact proportion to the power of this system is its delicacy—I should hardly say too much if I said its danger. Only our familiarity blinds us to the marvellous nature of the system. There never was so much borrowed money collected in the world as is now collected in London. Of the many millions in Lombard street, infinitely the greater proportion is held by bankers or others on short notice or on demand; that is to say, the owners could ask for it all any day they please: in a panic some of them do ask for some of it. If any large fraction of that money really was demanded, our banking system and our industrial system too would be in great danger.

Some of those deposits too are of a peculiar and very distinct nature. Since the Franco-German war, we have become to a much larger extent than before the Bankers of Europe. A very large sum of foreign money is on various accounts and for various purposes held here. And in a time of panic it might be asked for. In 1866 we held only a much smaller sum of foreign money, but that smaller sum was demanded and we had to pay it at great cost and suffering, and it would be far worse if we had to pay the greater sums we now hold, without better resources than we had then.

It may be replied, that though our instant liabilities are great, our present means are large; that though we have much we may be asked to pay at any moment, we have very much always ready to pay it with. But, on the contrary, there is no country at present, and there never was any country before, in which the ratio of the cash reserve to the bank deposits was so small as it is now in England. 4 So far from our being able to rely on the proportional magnitude of our cash in hand, the amount of that cash is so exceedingly small that a bystander almost trembles when he compares its minuteness with the immensity of the credit which rests upon it.

Again, it may be said that we need not be alarmed at the magnitude of our credit system or at its refinement, for that we have learned by experience the way of controlling it, and always manage it with discretion. But we do not always manage it with discretion. There is the astounding instance of Overend, Gurney, and Co. to the contrary. Ten years ago that house stood next to the Bank of England in the City of London; it was better known abroad than any similar firm—known, perhaps, better than any purely English firm. The partners had great estates, which had mostly been made in the business. They still derived an immense income from it. Yet in six years they lost all their own wealth, sold the business to the company, and then lost a large part of the company's capital. And these losses were made in a manner so reckless and so foolish, that one would think a child who had lent money in the City of London would have lent it better. 5 After this example, we must not confide too surely in long-established credit, or in firmly-rooted traditions of business. We must examine the system on which these great masses of money are manipulated, and assure ourselves that it is safe and right.

But it is not easy to rouse men of business to the task. They let the tide of business float before them; they make money or strive to do so while it passes, and they are unwilling to think where it is going. Even the great collapse of Overends, though it caused a panic, is beginning to be forgotten. Most men of business think—'Anyhow this system will probably last my time. It has gone on a long time, and is likely to go on still.' But the exact point is, that it has not gone on a long time. The collection of these immense sums in one place and in few hands is perfectly new. In 1844 the liabilities of the four great London Joint Stock Banks were 10,637,000 l. ; they now are more than 60,000,000 l. 6 The private deposits of the Bank of England then were 9,000,000 l. ; they now are 18,000,000 l. There was in 1844 throughout the country but a fraction of the vast deposit business which now exists. We cannot appeal, therefore, to experience to prove the safety of our system as it now is, for the present magnitude of that system is entirely new. Obviously a system may be fit to regulate a few millions, and yet quite inadequate when it is set to cope with many millions. And thus it may be with 'Lombard Street,' so rapid has been its growth, and so unprecedented is its nature.

I am by no means an alarmist. I believe that our system, though curious and peculiar, may be worked safely; but if we wish so to work it, we must study it. We must not think we have an easy task when we have a difficult task, or that we are living in a natural state when we are really living in an artificial one. Money will not manage itself, and Lombard street has a great deal of money to manage.

Chapter II: A General View of Lombard Street

Chapter III: How Lombard Street Came to Exist, and Why It Assumed Its Present Form

I

In the last century, a favourite subject of literary ingenuity was 'conjectural history,' as it was then called. Upon grounds of probability a fictitious sketch was made of the possible origin of things existing. If this kind of speculation were now applied to banking, the natural and first idea would be that large systems of deposit banking grew up in the early world, just as they grow up now in any large English colony. As soon as any such community becomes rich enough to have much money, and compact enough to be able to lodge its money in single banks, it at once begins so to do. English colonists do not like the risk of keeping their money, and they wish to make an interest on it. They carry from home the idea and the habit of banking, and they take to it as soon as they can in their new world. Conjectural history would be inclined to say that all banking began thus: but such history is rarely of any value. The basis of it is false. It assumes that what works most easily when established is that which it would be the most easy to establish, and that what seems simplest when familiar would be most easily appreciated by the mind though unfamiliar. But exactly the contrary is true. Many things which seem simple and which work well when firmly established, are very hard to establish among new people, and not very easy to explain to them. Deposit banking is of this sort. Its essence is that a very large number of persons agree to trust a very few persons, or some one person. Banking would not be a profitable trade if bankers were not a small number, and depositors in comparison an immense number. But to get a great number of persons to do exactly the same thing is always very difficult, and nothing but a very palpable necessity will make them on a sudden begin to do it. And there is no such palpable necessity in banking. If you take a country town in France, even now, you will not find any such system of banking as ours. Cheque-books are unknown, and money kept on running account by bankers is rare. People store their money in a caisse at their houses. Steady savings, which are waiting for investment, and which are sure not to be soon wanted, may be lodged with bankers; but the common floating cash of the community is kept by the community themselves at home. They prefer to keep it so, and it would not answer a banker's purpose to make expensive arrangements for keeping it otherwise. If a 'branch,' such as the National Provincial Bank opens in an English country town, were opened in a corresponding French one, it would not pay its expenses. You could not get any sufficient number of Frenchmen to agree to put their money there. And so it is in all countries not of British descent, though in various degrees. Deposit banking is a very difficult thing to begin, because people do not like to let their money out of their sight,—especially do not like to let it out of sight without security—still more, cannot all at once agree on any single person to whom they are content to trust it unseen and unsecured. Hypothetical history, which explains the past by what is simplest and commonest in the present, is in banking, as in most things, quite untrue.

The real history is very different. New wants are mostly supplied by adaptation, not by creation or foundation. Something having been created to satisfy an extreme want, it is used to satisfy less pressing wants, or to supply additional conveniences. On this account, political Government—the oldest institution in the world—has been the hardest worked. At the beginning of history, we find it doing everything which society wants done, and forbidding everything which society does not wish done. In trade, at present, the first commerce in a new place is a general shop, which, beginning with articles of real necessity, comes shortly to supply the oddest accumulation of petty comforts. And the history of banking has been the same. The first banks were not founded for our system of deposit banking, or for anything like it. They were founded for much more pressing reasons, and having been founded, they, or copies from them, were applied to our modern uses.

The earliest banks of Italy, where the name began, were finance companies. The Bank of St. George, at Genoa, and other banks founded in imitation of it, were at first only companies to make loans to, and float loans for, the Governments of the cities in which they were formed. The want of money is an urgent want of Governments at most periods, and seldom more urgent than it was in the tumultuous Italian Republics of the Middle Ages. After these banks had been long established, they began to do what we call banking business; but at first they never thought of it. The great banks of the North of Europe had their origin in a want still more curious. The notion of its being a prime business of a bank to give good coin has passed out of men's memories; but wherever it is felt, there is no want of business more keen and urgent. Adam Smith describes it so admirably that it would be stupid not to quote his words:—

'The currency of a great state, such as France or England, generally consists almost entirely of its own coin. Should this currency, therefore, be at any time worn, clipt, or otherwise degraded below its standard value, the state by a reformation of its coin can effectually re-establish its currency. But the currency of a small state, such as Genoa or Hamburgh, can seldom consist altogether in its own coin, but must be made up, in a great measure, of the coins of all the neighbouring states with which its inhabitants have a continual intercourse. Such a state, therefore, by reforming its coin, will not always be able to reform its currency. If foreign bills of exchange are paid in this currency, the uncertain value of any sum, of what is in its own nature so uncertain, must render the exchange always very much against such a state, its currency being, in all foreign states, necessarily valued even below what it is worth.

'In order to remedy the inconvenience to which this disadvantageous exchange must have subjected their merchants, such small states, when they began to attend to the interest of trade, have frequently enacted, that foreign bills of exchange of a certain value should be paid, not in common currency, but by an order upon, or by a transfer in, the books of a certain bank, established upon the credit, and under the protection of the state, this bank being always obliged to pay, in good and true money, exactly according to the standard of the state. The banks of Venice, Genoa, Amsterdam, Hamburgh and Nuremburg, seem to have been all originally established with this view, though some of them may have afterwards been made subservient to other purposes. The money of such banks, being better than the common currency of the country, necessarily bore an agio, which was greater or smaller, according as the currency was supposed to be more or less degraded below the standard of the state. The agio of the bank of Hamburgh, for example, which is said to be commonly about fourteen per cent., is the supposed difference between the good standard money of the state, and the clipt, worn, and diminished currency poured into it from all the neighbouring states.

'Before 1609 the great quantity of clipt and worn foreign coin, which the extensive trade of Amsterdam brought from all parts of Europe, reduced the value of its currency about 9 per cent. below that of good money fresh from the mint. Such money no sooner appeared than it was melted down or carried away, as it always is in such circumstances. The merchants, with plenty of currency, could not always find a sufficient quantity of good money to pay their bills of exchange; and the value of those bills, in spite of several regulations which were made to prevent it, became in a great measure uncertain.

'In order to remedy these inconveniences, a bank was established in 1609 under the guarantee of the City. This bank received both foreign coin, and the light and worn coin of the country at its real intrinsic value in the good standard money of the country, deducting only so much as was necessary for defraying the expense of coinage, and the other necessary expense of management. For the value which remained, after this small deduction was made, it gave a credit in its books. This credit was called bank money, which, as it represented money exactly according to the standard of the mint, was always of the same real value, and intrinsically worth more than current money. It was at the same time enacted, that all bills drawn upon or negotiated at Amsterdam of the value of six hundred guilders and upwards should be paid in bank money, which at once took away all uncertainty in the value of those bills. Every merchant, in consequence of this regulation, was obliged to keep an account with the bank in order to pay his foreign bills of exchange, which necessarily occasioned a certain demand for bank money.' 19

Again, a most important function of early banks is one which the present banks retain, though it is subsidiary to their main use; viz. the function of remitting money. A man brings money to the bank to meet a payment which he desires to make at a great distance, and the bank, having a connection with other banks, sends it where it is wanted. As soon as bills of exchange are given upon a large scale, this remittance is a very pressing requirement. Such bills must be made payable at a place convenient to the seller of the goods in payment of which they are given, perhaps at the great town where his warehouse is. But this may be very far from the retail shop of the buyer who bought those goods to sell them again in the country. For these, and a multitude of purposes, the instant and regular remittance of money is an early necessity of growing trade; and that remittance it was a first object of early banks to accomplish.

These are all uses other than those of deposit banking which banks supplied that afterwards became in our English sense deposit banks. By supplying these uses, they gained the credit that afterwards enabled them to gain a living as deposit banks. Being trusted for one purpose, they came to be trusted for a purpose quite different, ultimately far more important, though at first less keenly pressing. But these wants only affect a few persons, and therefore bring the bank under the notice of a few only. The real introductory function which deposit banks at first perform is much more popular, and it is only when they can perform this more popular kind of business that deposit banking ever spreads quickly and extensively. This function is the supply of the paper circulation to the country, and it will be observed that I am not about to overstep my limits and discuss this as a question of currency. In what form the best paper currency can be supplied to a country is a question of economical theory with which I do not meddle here. I am only narrating unquestionable history, not dealing with an argument where every step is disputed. And part of this certain history is that the best way to diffuse banking in a community is to allow the banker to issue banknotes of small amount that can supersede the metal currency. This amounts to a subsidy to each banker to enable him to keep open a bank till depositors choose to come to it. The country where deposit banking is most diffused is Scotland, and there the original profits were entirely derived from the circulation. The note issue is now a most trifling part of the liabilities of the Scotch banks, but it was once their mainstay and source of profit. A curious book, lately published, has enabled us to follow the course of this in detail. The Bank of Dundee, now amalgamated with the Royal Bank of Scotland, was founded in 1763, and had become before its amalgamation, eight or nine years since, a bank of considerable deposits. But for twenty-five years from its foundation it had no deposits at all. It subsisted mostly on its note issue, and a little on its remittance business. Only in 1792, after nearly thirty years, it began to gain deposits, but from that time they augmented very rapidly. 20 The banking history of England has been the same, though we have no country bank accounts in detail which go back so far. But probably up to 1830 in England, or thereabouts, the main profit of banks was derived from the circulation, and for many years after that the deposits were treated as very minor matters, and the whole of so-called banking discussion turned on questions of circulation. We are still living in the débris of that controversy, for, as I have so often said, people can hardly think of the structure of Lombard Street, except with reference to the paper currency and to the Act of 1844, which regulates it now. The French are still in the same epoch of the subject. The great enquête of 1865 is almost wholly taken up with currency matters, and mere banking is treated as subordinate. And the accounts of the Bank of France show why. The last weekly statement before the German war showed that the circulation of the Bank of France was as much as 59,244,000 l., and that the private deposits were only 17,127,000 l. Now the private deposits are about the same, and the circulation is 112,000,000 l. 21 So difficult is it in even a great country like France for the deposit system of banking to take root, and establish itself with the strength and vigour that it has in England.

The experience of Germany is the same. The accounts preceding the war in North Germany showed the circulation of the issuing banks to be 39,875,000 l., and the deposits to be 6,472,000 l. while the corresponding figures at the present moment are—circulation, 60,000,000 l. and deposits 8,000,000 l. 22 It would be idle to multiply instances.

The reason why the use of bank paper commonly precedes the habit of making deposits in banks is very plain. It is a far easier habit to establish. In the issue of notes the banker, the person to be most benefited, can do something. He can pay away his own 'promises' in loans, in wages, or in payment of debts. But in the getting of deposits he is passive. His issues depend on himself; his deposits on the favour of others. And to the public the change is far easier too. To collect a great mass of deposits with the same banker, a great number of persons must agree to do something. But to establish a note circulation, a large number of persons need only do nothing. They receive the banker's notes in the common course of their business, and they have only not to take those notes to the banker for payment. If the public refrain from taking trouble, a paper circulation is immediately in existence. A paper circulation is begun by the banker, and requires no effort on the part of the public; on the contrary, it needs an effort of the public to be rid of notes once issued; but deposit banking cannot be begun by the banker, and requires a spontaneous and consistent effort in the community. And therefore paper issue is the natural prelude to deposit banking.

The way in which the issue of notes by a banker prepares the way for the deposit of money with him is very plain. When a private person begins to possess a great heap of bank-notes, it will soon strike him that he is trusting the banker very much, and that in return he is getting nothing. He runs the risk of loss and robbery just as if he were hoarding coin. He would run no more risk by the failure of the bank if he made a deposit there, and he would be free from the risk of keeping the cash. No doubt it takes time before even this simple reasoning is understood by uneducated minds. So strong is the wish of most people to see their money that they for some time continue to hoard bank-notes: for a long period a few do so. But in the end common sense conquers. The circulation of bank-notes decreases, and the deposit of money with the banker increases. The credit of the banker having been efficiently advertised by the note, and accepted by the public, he lives on the credit so gained years after the note issue itself has ceased to be very important to him.

The efficiency of this introduction is proportional to the diffusion of the right of note issue. A single monopolist issuer, like the Bank of France, works its way with difficulty through a country, and advertises banking very slowly. Even now the Bank of France, which, I believe, by law ought to have a branch in each Department, has only branches in sixty out of eighty-six. 23

On the other hand, the Swiss banks, where there is always one or more to every Canton, diffuse banking rapidly. We have seen that the liabilities of the Bank of France stand thus:—

But the aggregate Swiss banks, on the contrary, stand:—

[Note to the 14th Edition. The Swiss National Bank is now the only Swiss Bank authorised to issue notes. At the end of 1913 it had—

The reason is that a central bank which is governed in the capital and descends on a country district, has much fewer modes of lending money safely than a bank of which the partners belong to that district, and know the men and things in it. A note issue is mainly begun by loans; there are then no deposits to be paid. But the mass of loans in a rural district are of small amount; the bills to be discounted are trifling; the persons borrowing are of small means and only local repute; the value of any property they wish to pledge depends on local changes and local circumstances. A banker who lives in the district, who has always lived there, whose whole mind is a history of the district and its changes, is easily able to lend money safely there. But a manager deputed by a single central establishment does so with difficulty. The worst people will come to him and ask for loans. His ignorance is a mark for all the shrewd and crafty people thereabouts. He will have endless difficulties in establishing the circulation of the distant bank, because he has not the local knowledge which alone can teach him how to issue that circulation with safety.

A system of note issues is therefore the best introduction to a large system of deposit banking. As yet, historically, it is the only introduction: no nation as yet has arrived at a great system of deposit banking without going first through the preliminary stage of note issue, and of such note issues the quickest and most efficient in this way is one made by individuals resident in the district, and conversant with it.

And this explains why deposit banking is so rare. Such a note issue as has been described is possible only in a country exempt from invasion, and free from revolution. During an invasion note-issuing banks must stop payment; a run is nearly inevitable at such a time, and in a revolution too. In such great and close civil dangers a nation is always demoralised; everyone looks to himself, and everyone likes to possess himself of the precious metals. These are sure to be valuable, invasion or no invasion, revolution or no revolution. But the goodness of bank-notes depends on the solvency of the banker, and that solvency may be impaired if the invasion is not repelled or the revolution resisted.

Hardly any continental country has been till now exempt for long periods both from invasion and revolution. In Holland and Germany—two countries where note issue and deposit banking would seem as natural as in England and Scotland—there was never any security from foreign war. A profound apprehension of external invasion penetrated their whole habits, and men of business would have thought it insane not to contemplate a contingency so frequent in their history, and perhaps witnessed by themselves.

France indeed, before 1789, was an exception. For many years under the old régime she was exempt from serious invasion or attempted revolution. Her Government was fixed, as was then thought, and powerful; it could resist any external enemy, and the prestige on which it rested seemed too firm to fear any enemy from within. But then it was not an honest Government, and it had shown its dishonesty in this particular matter of note issue. The regent in Law's time had given a monopoly of note issue to a bad bank, and had paid off the debts of the nation in worthless paper. The Government had created a machinery of ruin, and had thriven on it. Among so apprehensive a race as the French the result was fatal. For many years no attempt at note issue or deposit banking was possible in France. So late as the foundation of the Caisse d'Escompte, in Turgot's time, the remembrance of Law's failure was distinctly felt, and impeded the commencement of better attempts.

This therefore is the reason why Lombard Street exists; that is, why England is a very great Money Market, and other European countries but small ones in comparison. In England and Scotland a diffused system of note issues started banks all over the country; in these banks the savings of the country have been lodged, and by these they have been sent to London. No similar system arose elsewhere, and in consequence London is full of money, and all continental cities are empty as compared with it.

Chapter IV: The Position of the Chancellor of the Exchequer in the Money Market

Nothing can be truer in theory than the economical principle that banking is a trade and only a trade, and nothing can be more surely established by a larger experience than that a Government which interferes with any trade injures that trade. The best thing undeniably that a Government can do with the Money Market is to let it take care of itself.

But a Government can only carry out this principle universally if it observe one condition: it must keep its own money. The Government is necessarily at times possessed of large sums in cash. It is by far the richest corporation in the country; its annual revenue payable in money far surpasses that of any other body or person. And if it begins to deposit this immense income as it accrues at any bank, at once it becomes interested in the welfare of that bank. It cannot pay the interest on its debt if that bank cannot produce the public deposits when that interest becomes due; it cannot pay its salaries, and defray its miscellaneous expenses, if that bank fail at any time. A modern Government is like a very rich man with very great debts which he cannot well pay; its credit is necessary to its prosperity, almost to its existence, and if its banker fail when one of its debts becomes due its difficulty is intense.

Another banker, it will be said, may take up the Government account. He may advance, as is so often done in other bank failures, what the Government needs for the moment in order to secure the Government account in future. But the imperfection of this remedy is that it fails in the very worst case. In a panic, and at a general collapse of credit, no such banker will probably be found. The old banker who possesses the Government deposit cannot repay it, and no banker not having that deposit will, at a bad crisis, be able to find the 5,000,000 l. or 6,000,000 l. which the quarter day of a Government such as ours requires. If a finance Minister, having entrusted his money to a bank, begins to act strictly, and say he will in all cases let the Money Market take care of itself, the reply is that in one case the Money Market will take care of him too, and he will be insolvent.

In the infancy of Banking it is probably much better that a Government should as a rule keep its own money. If there are not Banks in which it can place secure reliance, it should not seem to rely upon them. Still less should it give peculiar favour to any one, and by entrusting it with the Government account secure to it a mischievous supremacy above all other banks. The skill of a financier in such an age is to equalise the receipt of taxation, and the outgoing of expenditure; it should be a principal care with him to make sure that more should not be locked up at a particular moment in the Government coffers than is usually locked up there. If the amount of dead capital so buried in the Treasury does not at any time much exceed the common average, the evil so caused is inconsiderable: it is only the loss of interest on a certain sum of money, which would not be much of a burden on the whole nation; the additional taxation it would cause would be inconsiderable. Such an evil is nothing in comparison with that of losing the money necessary for inevitable expence by entrusting it to a bad Bank, or that of recovering this money by identifying the national credit with the bad Bank and so propping it up and perpetuating it. So long as the security of the Money Market is not entirely to be relied on, the Goverment of a country had much better leave it to itself and keep its own money. If the banks are bad, they will certainly continue bad and will probably become worse if the Government sustains and encourages them. The cardinal maxim is, that any aid to a present bad Bank is the surest mode of preventing the establishment of a future good Bank.

When the trade of Banking began to be better understood, when the Banking system was thoroughly secure, the Government might begin to lend gradually; especially to lend the unusually large sums which even under the most equable system of finance will at times accumulate in the public exchequer.

Under a natural system of banking it would have every facility. Where there were many banks keeping their own reserve, and each most anxious to keep a sufficient reserve, because its own life and credit depended on it, the risk of the Government in keeping a banker would be reduced to a minimum. It would have the choice of many bankers, and would not be restricted to any one.

Its course would be very simple, and be analogous to that of other public bodies in the country. The Metropolitan Board of Works, which collects a great revenue in London, has an account at the London and Westminster Bank, for which that bank makes a deposit of Consols as a security. 25 The Chancellor of the Exchequer would have no difficulty in getting such security either. If, as is likely, his account would be thought to be larger than any single bank ought to be entrusted with, the public deposits might be divided between several. Each would give security, and the whole public money would be safe. If at any time the floating money in the hands of Government were exceptionally large, he might require augmented security to be lodged, and he might obtain an interest. He would be a lender of such magnitude and so much influence, that he might command his own terms. He might get his account kept safe if anyone could.

If, on the other hand, the Chancellor of the Exchequer were a borrower, as at times he is, he would have every facility in obtaining what he wanted. The credit of the English Government is so good that he could borrow better than anyone else in the world. He would have greater facility, indeed, than now, for, except with the leave of Parliament, the Chancellor of the Exchequer cannot borrow by our present laws in the open market. He can only borrow from the Bank of England on what are called 'deficiency bills.' 26 In a natural system, he would borrow of any one out of many competing banks, selecting the one that would lend cheapest; but under our present artificial system, he is confined to a single bank, which can fix its own charge.

If contrary to expectation a collapse occurred, the Government might withdraw, as the American Government actually has withdrawn, its balance from the bankers. It might give its aid, lend Exchequer bills, or otherwise pledge its credit for the moment, but when the exigency was passed it might let the offending banks suffer. There would be a penalty for their misconduct. New and better banks, who might take warning from that misconduct, would arise. As in all natural trades, what is old and rotten would perish, what is new and good would replace it. And till the new banks had proved, by good conduct, their fitness for State confidence, the State need not give it. The Government could use its favour as a bounty on prudence, and the withdrawal of that favour as a punishment for culpable folly.

Under a good system of banking, a great collapse, except from rebellion or invasion, would probably not happen. A large number of banks, each feeling that their credit was at stake in keeping a good reserve, probably would keep one; if any one did not, it would be criticised constantly, and would soon lose its standing, and in the end disappear. And such banks would meet an incipient panic freely, and generously; they would advance out of their reserve boldly and largely, for each individual bank would fear suspicion, and know that at such periods it must 'show strength,' if at such times it wishes to be thought to have strength. Such a system reduces to a minimum the risk that is caused by the deposit. If the national money can safely be deposited in banks in any way, this is the way to make it safe.

But this system is nearly the opposite to that which the law and circumstances have created for us in England. The English Government, far from keeping cash from the money market till the position of that market was reasonably secure, at a very early moment, and while credit of all kinds was most insecure, for its own interests entered into the Money Market. In order to effect loans better, it gave the custody and profit of its own money (along with other privileges) to a single bank, and therefore practically and in fact it is identified with the Bank of this hour. It cannot let the money market take care of itself because it has deposited much money in that market, and it cannot pay its way if it loses that money.

Nor would any English statesman propose to 'wind up' the Bank of England. A theorist might put such a suggestion on paper, but no responsible government would think of it. At the worst crisis and in the worst misconduct of the Bank, no such plea has been thought of: in 1825 when its till was empty, in 1837 when it had to ask aid from the Bank of France, no such idea was suggested. By irresistible tradition the English Government was obliged to deposit its money in the money market and to deposit with this particular Bank.

And this system has plain and grave evils.

1st. Because being created by state aid, it is more likely than a natural system to require state help.

2ndly. Because, being a one- reserve system, it reduces the spare cash of the Money Market to a smaller amount than any other system, and so makes that market more delicate. There being a less hoard to meet liabilities, any error in the management of that reserve has a proportionately greater effect.

3rdly. Because, our one reserve is, by the necessity of its nature, given over to one board of directors, and we are therefore dependent on the wisdom of that one only, and cannot, as in most trades, strike an average of the wisdom and the folly, the discretion and the indiscretion, of many competitors.

Lastly. Because that board of directors is, like every other board, pressed on by its shareholders to make a high dividend, and therefore to keep a small reserve, whereas the public interest imperatively requires that they shall keep a large one.

These four evils were inseparable from the system, but there is besides an additional and accidental evil. The English Government not only created this singular system, but it proceeded to impair it, and demoralise all the public opinion respecting it. For more than a century after its creation (notwithstanding occasional errors) the Bank of England, in the main, acted with judgment and with caution. Its business was but small as we should now reckon, but for the most part it conducted that business with prudence and discretion. In 1696, it had been involved in the most serious difficulties, and had been obliged to refuse to pay some of its notes. For a long period it was in wholesome dread of public opinion, and the necessity of retaining public confidence made it cautious. But the English Government removed that necessity. In 1797, Mr. Pitt feared that he might not be able to obtain sufficient specie for foreign payments, in consequence of the low state of the Bank reserve, and he therefore required the Bank not to pay in cash. He removed the preservative apprehension which is the best security of all Banks.

For this reason the period under which the Bank of England did not pay gold for its notes—the period from 1797 to 1819—is always called the period of the Bank restriction. As the Bank during that period did not perform, and was not compelled by law to perform, its contract of paying its notes in cash, it might apparently have been well called the period of Bank license. But the word 'restriction' was quite right, and was the only proper word as a description of the policy of 1797. Mr. Pitt did not say that the Bank of England need not pay its notes in specie; he 'restricted' them from doing so; he said that they must not.

In consequence, from 1797 to 1844 (when a new era begins), there never was a proper caution on the part of the Bank directors. At heart they considered that the Bank of England had a kind of charmed life, and that it was above the ordinary banking anxiety to pay its way. And this feeling was very natural. A bank of issue, which need not pay its notes in cash, has a charmed life; it can lend what it wishes, and issue what it likes, with no fear of harm to itself, and with no substantial check but its own inclination. For nearly a quarter of a century, the Bank of England was such a bank, for all that time it could not be in any danger. And naturally the public mind was demoralised also. Since 1797, the public have always expected the Government to help the Bank if necessary. I cannot fully discuss the suspensions of the Act of 1844 in 1847, 1857, and 1866; but indisputably one of their effects is to make people think that Government will always help the Bank if the Bank is in extremity. And this is the sort of anticipation which tends to justify itself, and to cause what it expects.

On the whole, therefore, the position of the Chancellor of the Exchequer in our Money Market is that of one who deposits largely in it, who created it, and who demoralised it. He cannot, therefore, banish it from his thoughts, or decline responsibility for it. He must arrange his finances so as not to intensify panics, but to mitigate them. He must aid the Bank of England in the discharge of its duties; he must not impede or prevent it.

His aid may be most efficient. He is, on finance, the natural exponent of the public opinion of England. And it is by that opinion that we wish the Bank of England to be guided. Under a natural system of banking we should have relied on self-interest, but the State prevented that; we now rely on opinion instead; the public approval is a reward, its disapproval a severe penalty, on the Bank directors; and of these it is most important that the finance minister should be a sound and felicitous exponent.

Chapter V: The Mode in Which the Value of Money is Settled in Lombard Street

Many persons believe that the Bank of England has some peculiar power of fixing the value of money. They see that the Bank of England varies its minimum rate of discount from time to time, and that, more or less, all other banks follow its lead, and charge much as it charges; and they are puzzled why this should be. 'Money,' as economists teach, 'is a commodity, and only a commodity;' why then, it is asked, is its value fixed in so odd a way, and not the way in which the value of all other commodities is fixed?

There is at bottom, however, no difficulty in the matter. The value of money is settled, like that of all other commodities, by supply and demand, and only the form is essentially different. In other commodities all the large dealers fix their own price; they try to underbid one another, and that keeps down the price; they try to get as much as they can out of the buyer, and that keeps up the price. Between the two what Adam Smith calls the higgling of the market settles it. And this is the most simple and natural mode of doing business, but it is not the only mode. If circumstances make it convenient another may be adopted. A single large holder—especially if he be by far the greatest holder—may fix his price, and other dealers may say whether or not they will undersell him, or whether or not they will ask more than he does. A very considerable holder of an article may, for a time, vitally affect its value if he lay down the minimum price which he will take, and obstinately adhere to it. This is the way in which the value of money in Lombard Street is settled. The Bank of England used to be a predominant, and is still a most important, dealer in money. It lays down the least price at which alone it will dispose of its stock, 27 and this, for the most part, enables other dealers to obtain that price, or something near it.

The reason is obvious. At all ordinary moments there is not money enough in Lombard Street to discount all the bills in Lombard Street without taking some money from the Bank of England. As soon as the Bank rate is fixed, a great many persons who have bills to discount try how much cheaper than the Bank they can get these bills discounted. But they seldom can get them discounted very much cheaper, for if they did everyone would leave the Bank, and the outer market would have more bills than it could bear.

In practice, when the Bank finds this process beginning, and sees that its business is much diminishing, it lowers the rate, so as to secure a reasonable portion of the business to itself, and to keep a fair part of its deposits employed. At Dutch auctions an upset or maximum price used to be fixed by the seller, and he came down in his bidding till he found a buyer. The value of money is fixed in Lombard Street in much the same way, only that the upset price is not that of all sellers, but that of one very important seller, some part of whose supply is essential.

The notion that the Bank of England has a control over the Money Market, and can fix the rate of discount as it likes, has survived from the old days before 1844, when the Bank could issue as many notes as it liked. But even then the notion was a mistake. A bank with a monopoly of note issue has great sudden power in the Money Market, but no permanent power: it can affect the rate of discount at any particular moment, but it cannot affect the average rate. And the reason is, that any momentary fall in money, caused by the caprice of such a bank, of itself tends to create an immediate and equal rise, so that upon an average the value is not altered.

What happens is this. If a bank with a monopoly of note issue suddenly lends (suppose) 2,000,000 l. more than usual, it causes a proportionate increase of trade and increase of prices. The persons to whom that 2,000,000 l. was lent, did not borrow it to lock it up; they borrow it, in the language of the market, to 'operate with'—that is, they try to buy with it; and that new attempt to buy—that new demand—raises prices. And this rise of prices has three consequences. First. It makes everybody else want to borrow money. Money is not so efficient in buying as it was, and therefore operators require more money for the same dealings. If railway stock is 10 per cent. dearer this year than last, a speculator who borrows money to enable him to deal must borrow 10 per cent. more this year than last, and in consequence there is an augmented demand for loans. Secondly. This is an effectual demand, for the increased price of railway stock enables those who wish it to borrow more upon it. The common practice is to lend a certain portion of the market value of such securities, and if that value increases, the amount of the usual loan to be obtained on them increases too. In this way, therefore, any artificial reduction in the value of money causes a new augmentation of the demand for money, and thus restores that value to its natural level. In all business this is well known by experience: a stimulated market soon becomes a tight market, for so sanguine are enterprising men, that as soon as they get any unusual ease they always fancy that the relaxation is greater than it is, and speculate till they want more than they can obtain.

In these two ways sudden loans by an issuer of notes, though they may temporarily lower the value of money, do not lower it permanently, because they generate their own counteraction. And this they do whether the notes issued are convertible into coin or not. During the period of Bank restriction, from 1797 to 1819, the Bank of England could not absolutely control the Money Market, any more than it could after 1819, when it was compelled to pay its notes in coin. But in the case of convertible notes there is a third effect, which works in the same direction, and works more quickly. A rise of prices, confined to one country, tends to increase imports, because other countries can obtain more for their goods if they send them there, and it discourages exports, because a merchant who would have gained a profit before the rise by buying here to sell again will not gain so much, if any, profit after that rise. By this augmentation of imports the indebtedness of this country is augmented, and by this diminution of exports the proportion of that indebtedness which is paid in the usual way is decreased also. In consequence, there is a larger balance to be paid in bullion; the store in the bank or banks keeping the reserve is diminished, and the rate of interest must be raised by them to stay the efflux. And the tightness so produced is often greater than, and always equal to, the preceding unnatural laxity.

There is, therefore, no ground for believing, as is so common, that the value of money is settled by different causes than those which affect the value of other commodities, or that the Bank of England has any despotism in that matter. It has the power of a large holder of money, and no more. Even formerly, when its monetary powers were greater and its rivals weaker, it had no absolute control. It was simply a large corporate dealer, making bids and much influencing—though in no sense compelling—other dealers thereby.

But though the value of money is not settled in an exceptional way, there is nevertheless a peculiarity about it, as there is about many articles. It is a commodity subject to great fluctuations of value, and those fluctuations are easily produced by a slight excess or a slight deficiency of quantity. Up to a certain point money is a necessity. If a merchant has acceptances to meet to-morrow, money he must and will find today at some price or other. And it is this urgent need of the whole body of merchants which runs up the value of money so wildly and to such a height in a great panic. On the other hand, money easily becomes a 'drug,' as the phrase is, and there is soon too much of it. The number of accepted securities is limited, and cannot be rapidly increased; if the amount of money seeking these accepted securities is more than can be lent on them the value of money soon goes down. You may often hear in the market that bills are not to be had,—meaning good bills of course,—and when you hear this you may be sure that the value of money is very low.

If money were all held by the owners of it, or by banks which did not pay an interest for it, the value of money might not fall so fast. Money would, in the market phrase, be 'well held.' The possessors would be under no necessity to employ it all; they might employ part at a high rate rather than all at a low rate. But in Lombard Street money is very largely held by those who do pay an interest for it, and such persons must employ it all, or almost all, for they have much to pay out with one hand, and unless they receive much with the other they will be ruined. Such persons do not so much care what is the rate of interest at which they employ their money: they can reduce the interest they pay in proportion to that which they can make. The vital point to them is to employ it at some rate. If you hold (as in Lombard Street some persons do) millions of other people's money at interest, arithmetic teaches that you will soon be ruined if you make nothing of it even if the interest you pay is not high.

The fluctuations in the value of money are therefore greater than those on the value of most other commodities. At times there is an excessive pressure to borrow it, and at times an excessive pressure to lend it, and so the price is forced up and down.

These considerations enable us to estimate the responsibility which is thrown on the Bank of England by our system, and by every system on the bank or banks who by it keep the reserve of bullion or of legal tender exchangeable for bullion. These banks can in no degree control the permanent value of money, but they can completely control its momentary value. They cannot change the average value, but they can determine the deviations from the average. If the dominant banks manage ill, the rate of interest will at one time be excessively high, and at another time excessively low: there will be first a pernicious excitement, and next a fatal collapse. But if they manage well, the rate of interest will not deviate so much from the average rate; it will neither ascend so high nor descend so low. As far as anything can be steady the value of money will then be steady, and probably in consequence trade will be steady too—at least a principal cause of periodical disturbance will have been withdrawn from it.

Chapter VI: Why Lombard Street Is Often Very Dull, and Sometimes Extremely Excited

Any sudden event which creates a great demand for actual cash may cause, and will tend to cause, a panic in a country where cash is much economised, and where debts payable on demand are large. In such a country an immense credit rests on a small cash reserve, and an unexpected and large diminution of that reserve may easily break up and shatter very much, if not the whole, of that credit. Such accidental events are of the most various nature: a bad harvest, an apprehension of foreign invasion, the sudden failure of a great firm which everybody trusted, and many other similar events, have all caused a sudden demand for cash. And some writers have endeavoured to classify panics according to the nature of the particular accidents producing them. But little, however, is, I believe, to be gained by such classifications. There is little difference in the effect of one accident and another upon our credit system. We must be prepared for all of them, and we must prepare for all of them in the same way—by keeping a large cash reserve.

But it is of great importance to point out that our industrial organisation is liable not only to irregular external accidents, but likewise to regular internal changes; that these changes make our credit system much more delicate at some times than at others; and that it is the recurrence of these periodical seasons of delicacy which has given rise to the notion that panics come according to a fixed rule,—that every ten years or so we must have one of them.

Most persons who begin to think of the subject are puzzled on the threshold. They hear much of 'good times' and 'bad times,' meaning by 'good' times in which nearly everyone is very well off, and by 'bad' times in which nearly everyone is comparatively ill off. And at first it is natural to ask why should everybody, or almost everybody, be well off together? Why should there be any great tides of industry, with large diffused profit by way of flow, and large diffused want of profit, or loss, by way of ebb? The main answer is hardly given distinctly in our common books of political economy. These books do not tell you what is the fund out of which large general profits are paid in good times, nor do they explain why that fund is not available for the same purpose in bad times.

Our current political economy does not sufficiently take account of time as an element in trade operations; but as soon as the division of labour has once established itself in a community, two principles at once begin to be important, of which time is the very essence. These are—

First. That as goods are produced to be exchanged, it is good that they should be exchanged as quickly as possible.

Secondly. That as every producer is mainly occupied in producing what others want, and not what he wants himself, it is desirable that he should always be able to find, without effort, without delay, and without uncertainty, others who want what he can produce.

In themselves these principles are self-evident. Everyone will admit it to be expedient that all goods wanting to be sold should be sold as soon as they are ready; that every man who wants to work should find employment as soon as he is ready for it. Obviously also, as soon as the 'division of labour' is really established, there is a difficulty about both of these principles. A produces what he thinks B wants, but it may be a mistake, and B may not want it. A may be able and willing to produce what B wants, but he may not be able to find B—he may not know of his existence.

The general truth of these principles is obvious, but what is not obvious is the extreme greatness of their effects. Taken together, they make the whole difference between times of brisk trade and great prosperity, and times of stagnant trade and great adversity, so far as that prosperity and that adversity are real and not illusory. If they are satisfied, everyone knows whom to work for, and what to make, and he can get immediately in exchange what he wants himself. There is no idle labour and no sluggish capital in the whole community, and, in consequence, all which can be produced is produced, the effectiveness of human industry is augmented, and both kinds of producers—both capitalists and labourers—are much richer than usual, because the amount to be divided between them is also much greater than usual.

And there is a partnership in industries. No single large industry can be depressed without injury to other industries; still less can any great group of industries. Each industry when prosperous buys and consumes the produce probably of most (certainly of very many) other industries, and if industry A fail and is in difficulty, industries B, and C, and D, which used to sell to it, will not be able to sell that which they had produced in reliance on A's demand, and in future they will stand idle till industry A recovers, because in default of A there will be no one to buy the commodities which they create. Then as industry B buys of C, D, c., the adversity of B tells on C, D, c., and as these buy of E, F, c., the effect is propagated through the whole alphabet. And in a certain sense it rebounds. Z feels the want caused by the diminished custom of A, B, C, and so it does not earn so much; in consequence, it cannot lay out as much on the produce of A, B, C, and so these do not earn as much either. In all this money is but an instrument. The same thing would happen equally well in a trade of barter, if a state of barter on a very large scale were not practically impossible, on account of the time and trouble which it would necessarily require. As has been explained, the fundamental cause is that under a system in which everyone is dependent on the labour of everyone else, the loss of one spreads and multiplies through all, and spreads and multiplies the faster the higher the previous perfection of the system of divided labour, and the more nice and effectual the mode of interchange. And the entire effect of a depression in any single large trade requires a considerable time before it can be produced. It has to be propagated, and to be returned through a variety of industries, before it is complete. Short depressions, in consequence, have scarcely any discernible consequences; they are over before we think of their effects. It is only in the case of continuous and considerable depressions that the cause is in action long enough to produce discernible effects.

The most common, and by far the most important, case where the depression in one trade causes depression in all others, is that of depressed agriculture. When the agriculture of the world is ill off, food is dear. And as the amount of absolute necessaries which a people consumes cannot be much diminished, the additional amount which has to be spent on them is so much subtracted from what used to be spent on other things. All the industries, A, B, C, D, up to Z, are somewhat affected by an augmentation in the price of corn, and the most affected are the large ones, which produce the objects in ordinary times most consumed by the working classes. The clothing trades feel the difference at once, and in this country the liquor trade (a great source of English revenue) feels it almost equally soon. Especially when for two or three years harvests have been bad, and corn has long been dear, every industry is impoverished, and almost every one, by becoming poorer, makes every other poorer too. All trades are slack from diminished custom, and the consequence is a vast stagnant capital, much idle labour, and a greatly retarded production.

It takes two or three years to produce this full calamity, and the recovery from it takes two or three years also. If corn should long be cheap, the labouring classes have much to spend on what they like besides. The producers of those things become prosperous, and have a greater purchasing power. They exercise it, and that creates in the class they deal with another purchasing power, and so all through society. The whole machine of industry is stimulated to its maximum of energy, just as before much of it was slackened almost to its minimum.

A great calamity to any great industry will tend to produce the same effect, but the fortunes of the industries on which the wages of labour are expended are much more important than those of all others, because they act much more quickly upon a larger mass of purchasers. On principle, if there was a perfect division of labour, every industry would have to be perfectly prosperous in order that any one might be so. So far, therefore, from its being at all natural that trade should develop constantly, steadily, and equably, it is plain, without going farther, from theory as well as from experience, that there are inevitably periods of rapid dilatation, and as inevitably periods of contraction and of stagnation.

Nor is this the only changeable element in modern industrial societies. Credit—the disposition of one man to trust another—is singularly varying. In England, after a great calamity, everybody is suspicious of everybody; as soon as that calamity is forgotten, everybody again confides in everybody. On the Continent there has been a stiff controversy as to whether credit should or should not be called capital:' in England, even the little attention once paid to abstract economics is now diverted, and no one cares in the least for refined questions of this kind: the material practical point is that, in M. Chevalier's language, credit is 'additive,' or additional—that is, in times when credit is good productive power is more efficient, and in times when credit is bad productive power is less efficient. And the state of credit is thus influential, because of the two principles which have just been explained. In a good state of credit, goods lie on hand a much less time than when credit is bad; sales are quicker; intermediate dealers borrow easily to augment their trade, and so more and more goods are more quickly and more easily transmitted from the producer to the consumer.

These two variable causes are causes of real prosperity. They augment trade and production, and so are plainly beneficial, except where by mistake the wrong things are produced, or where also by mistake misplaced credit is given, and a man who cannot produce anything which is wanted gets the produce of other people's labour upon a false idea that he will produce it. But there is another variable cause which produces far more of apparent than of real prosperity and of which the effect is in actual life mostly confused with those of the others.

In our common speculations we do not enough remember that interest on money is a refined idea, and not a universal one. So far indeed is it from being universal, that the majority of saving persons in most countries would reject it. Most savings in most countries are held in hoarded specie. In Asia, in Africa, in South America, largely even in Europe, they are thus held, and it would frighten most of the owners to let them out of their keeping. An Englishman—a modern Englishman at least—assumes as a first principle that he ought to be able to 'put his money into something safe that will yield 5 per cent;' 28 but most saving persons in most countries are afraid to 'put their money' into anything. Nothing is safe to their minds; indeed, in most countries, owing to a bad Government and a backward industry, no investment, or hardly any, really is safe. In most countries most men are content to forego interest; but in more advanced countries, at some times there are more savings seeking investment than there are known investments for; at other times there is no such superabundance. Lord Macaulay has graphically described one of the periods of excess. He says—

'During the interval between the Restoration and the Revolution the riches of the nation had been rapidly increasing. Thousands of busy men found every Christmas that, after the expenses of the year's housekeeping had been defrayed out of the year's income, a surplus remained; and how that surplus was to be employed was a question of some difficulty. In our time, to invest such a surplus, at something more than three per cent., on the best security that has ever been known in the world, is the work of a few minutes. But in the seventeenth century, a lawyer, a physician, a retired merchant, who had saved some thousands, and who wished to place them safely and profitably, was often greatly embarrassed. Three generations earlier, a man who had accumulated wealth in a profession generally purchased real property, or lent his savings on mortgage. But the number of acres in the kingdom had remained the same; and the value of those acres, though it had greatly increased, had by no means increased so fast as the quantity of capital which was seeking for employment. Many too wished to put their money where they could find it at an hour's notice, and looked about for some species of property which could be more readily transferred than a house or a field. A capitalist might lend on bottomry or on personal security; but, if he did so, he ran a great risk of losing interest and principal. There were a few joint stock companies, among which the East India Company held the foremost place; but the demand for the stock of such companies was far greater than the supply. Indeed the cry for a new East India Company was chiefly raised by persons who had found difficulty in placing their savings at interest on good security. So great was that difficulty that the practice of hoarding was common. We are told that the father of Pope, the poet, who retired from business in the City about the time of the Revolution, carried to a retreat in the country a strong box containing near twenty thousand pounds, and took out from time to time what was required for household expenses; and it is highly probable that this was not a solitary case. At present the quantity of coin which is hoarded by private persons is so small, that it would, if brought forth, make no perceptible addition to the circulation. But, in the earlier part of the reign of William the Third, all the greatest writers on currency were of opinion that a very considerable mass of gold and silver was hidden in secret drawers and behind wainscots.