THE MONEY MARKET.

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LOMBARD STREET:
A Description of the Money Market
BY WALTER BAGEHOT,
THIRD EDITION
London
HENRY S. KING CO. 65 CORNHILL 12 PATERNOSTER ROW,
1873

CONTENTS

Econlib Editor's Notes

When I was a graduate student in international monetary theory, my adviser and others occasionally suggested that I read Walter Bagehot some time. Because I was a graduate student, I doubted that any writer on "institutions" from the 1800s could be worth my time, so of course I didn't even look the book up. My mistake!

When Walter Bagehot wrote Lombard Street: A Description of the Money Market, in 1873, he did the unthinkable: In language as fresh and clear today as it was over 100 years ago, he respectfully dissected the Bank of England's foundations, economic incentives, goals, and functions. In the process, he illuminated in a mere few hundred brilliant pages what distinguishes a Central Bank from a commercial bank, both on a daily basis and during crises such as bank panics and recessions. The constitutions of most national Central Banks were reinvented and forever changed as a consequence. The U.S. Federal Reserve, founded in late 1913, and the Central Bank of Central Banks—the International Monetary Fund (IMF)—have ever since been influenced by the enduring independent thought and extraordinary clarity provided by Bagehot in this famous book.

Bagehot's book was so readable and so remarkable that it was re-issued three times within a year, and was republished in many editions both during his lifetime and afterwards.

Our choice at Econlib, after studying several editions, is to provide the main text the way it was at the end of 1873 (in Bagehot's third edition, printed within the first year of publication). In doing so, we hope we have caught any errors Bagehot himself may have noticed, while preserving the original language and authoritative care taken in the various quotations.

But: We are also adding some footnotes and a second Appendix provided later (that is, after Bagehot's death in 1877): specifically, material from the 12th Edition (1906) and from the 14th Edition (1915). We believe that these later additions reflect the historical influence and popularity of this book during a period of time when the incipient Federal Reserve and other international Central Banks were founded and were, during their emergence, greatly influenced by it. The later footnotes are marked according to their editions. We have also included various prefaces, introductions, and Bagehot's own "Advertisement," to editions through the 14th, which explain who wrote which of the additions: E. Johnstone, A. W. Wright, and Hartley Withers all contributed.

We have preserved intact all of Bagehot's original spellings, capitalization, and punctuation from the third edition, with the minor alteration that in a few cases we've indented long quotations from other sources for the sake of visual clarity. We've also preserved the punctuation and spelling of the additional material from later editions; thus, the observant reader will notice that punctuation differs in style in footnotes from later editions.

Lauren Landsburg

Editor, Library of Economics and Liberty

Advertisement

The composition of this little book has occupied a much longer time than, perhaps, my readers may think its length or its importance deserves. It was begun as long ago as the autumn of 1870; and though its progress has been often suspended by pressing occupations and imperfect health, I have never ceased to work at it when I could. But I fear that in consequence, in some casual illustrations at least, every part of the book may not seem, as the lawyers would say, "to speak from the same time." The figures and the examples which it is most natural to use at one time are not quite those which it is most natural to use at another; and a slowly written book on a living and changing subject is apt a little to want unity in this respect.

I fear that I must not expect a very favourable reception for this work. It speaks mainly of four sets of persons—the Bank of England, Joint Stock Banks other than that Bank, private bankers, and bill-brokers; and I am much afraid that neither will altogether like what is said of then. I can only say that the opinions now expressed have not been formed hastily or at a distance from the facts; that, on the contrary, they have been slowly matured in "Lombard Street" itself, and that, perhaps, as they will not be altogether pleasing to any one, I may at least ask for the credit of having been impartial in my criticism.

I should also say that I am indebted to a friend for the correction of the final proof sheets, which an attack of illness prevented me from fully revising. If it had not been for his kind assistance, the publication of the book must have been postponed till the autumn, which, as its production has already been so slow, would have been very annoying to me.

Walter Bagehot.
The Poplars, Wimbledon

Prefatory Note to the Eleventh Edition

In this Edition additional Notes have been inserted by Mr. E. Johnstone, in Appendix II., and the other Notes have been revised by him, so as to bring up the work to the present date.

Prefatory Note to the Twelfth Edition

As more than thirty years have elapsed since the first publication of this little book, it has been thought desirable to bring the figures, and some of the examples used, up to the present time.

My best thanks are due to the friend who has placed his services at my disposal for this purpose.

The new matter is confined to notes, and the text of the original work has not been touched.

Eliza Bagehot.

* * * Like the English Constitution, the English credit system is a living thing, that has grown out of its past and is growing into its future. Past, present, and future are thus one continuing process, and no one can hope to understand its present, still less to peer into its future, unless he knows something of the past that is part of them. Bagehot's "Lombard Street" lights up, with the fire of its author's genius, the road that we have travelled, and helps us to see where we are and to wonder whither we are going. Its usefulness, as a work of reference and a standard of comparison, has been enhanced in this new edition by a careful revision of the Notes, carried out by Mr. A. W. Wright, a member of the staff of the Economist newspaper, long edited by Bagehot.

Hartley Withers.

LOMBARD STREET TO-DAY
by Hartley Withers

Bagehot's "Lombard Street" was begun, as he tells us in his "Advertisement," in the autumn of 1870. It is a wonderful achievement, that a book dealing with the shifting quicksands of the money market should still, after more than forty years, be a classic of which no one who wishes to understand the subject can afford to be ignorant. Since it is so, it is evidently desirable to give, for those of its readers who are not acquainted with the money market of to-day, a brief account of the chief movements and tendencies which have altered the conditions since Bagehot wrote.

This task is all the easier, since the most notable results of these movements and tendencies have amply confirmed what he said. Lombard Street has accepted the bill that Bagehot drew on it. There are two chief outstanding facts of modern monetary development. One is the reliance of the London money market and the money markets of the world on the Bank of England as the custodian of the central gold reserve. This is the principal theme of Bagehot's argument, to which all its digressions and excursions ultimately return. The other is the development of joint stock banking in England by the gradual diminution of the old private banking firms and the coincident expansion of the banking companies by growth and amalgamation. All this Bagehot foresaw and predicted.

The Cheque Currency of To-day.

This development has modified the problem of the money market in several important respects. Since the ordinary joint stock banks with offices in London were forbidden, by the Bank of England's charter, to exercise the right of note issue, it has been their special function to spread the use of cheques in England and to make them the predominant form of paper currency, reducing the banknote to a secondary place as currency, and at the same time raising it to a more important one as part of the basis of credit. Since the joint stock banks have covered England with branch offices, ready and eager to give banking facilities to customers of quite moderate means, the cheque has become the chief circulating medium in commercial payments, and the banknote has almost ceased to circulate. The outstanding note issues of all the English banks, other than the Bank of England, which publish balance sheets have now sunk to slightly over £100,000, and it is significant to observe that they are habitually below the amount authorised by the Act of 1844, so that their diminution has been due, not so much to the reduction of the number of banks with the right of issue, as to a change in the habits of the people, which does not now want even as many banknotes as it might have, since it has been accustomed to the greater convenience and safety of the cheque.

At the same time what is usually described as the circulation of the Bank of England note has increased, but its actual circulation as currency in the hands of the people is probably less than when Bagehot wrote. The Bank return for the last week of 1869, which he quotes in Chapter II., shows notes issued by the Issue Department £33,288,640 and notes held by the Banking Department £10,389,690, making the amount in circulation just below 23 millions. In recent years the circulation has fluctuated from 28 to 30 millions, but it is probable that the whole of this apparent increase has been due, not to circulation in the strict sense of the word, but to the use of Bank of England notes as till money and cash reserve by the other banks. It is impossible to arrive at definite figures on this subject because the banks do not, in their published statements, give any clue to the details of which their cash holding is composed—how much of it is coin and how much consists of Bank of England notes. But the great increase that has taken place during the last forty years, both in the number of bank offices open and in the aggregate liabilities of the banks, makes the probability of the above assumption almost amount to certainty.

The Banknote and the Fiduciary Issue.

This change in the position of the Bank of England note is highly important. It is due, not to any action by the Bank of England, but to an external process arising out of the development of the other joint stock banks and the rapidity with which they have multiplied offices, sowing their banking crop all over the country. By means of it the Bank of England note has largely ceased to be an instrument of credit passed from hand to hand in the course of commercial transactions, and has become part of the cash on which the other banks base their credit operations, and multiply the ever-growing volume of the cheque currency which is now, to an overwhelming extent, the money of modern England. This development has greatly modified the views of the commercial community on the subject of the regulations imposed by Peel's Act of 1844 on the issue of the Bank of England note. By this Act the note issue could only be increased beyond a certain point by the holding of actual bullion against each new note issued. As long as the Bank of England note was currency required for business circulation, this restriction was open to criticism as the infliction of a cast-iron fetter where elasticity was most of all desirable; and the advantages of the German system, which provided for an expansion in the issue of notes against securities—fiduciary issue as it is generally called—when money is in great demand, was frequently held up as an example for England. But now that it is more clearly perceived that the money of England is the cheque, which can be multiplied to an extent which is only limited by the prudence of bankers and the security that their customers may be able to provide, and that the Bank of England note is chiefly used as part of the banking cash reserve, the opinion is commonly held in the City that the restrictions on its issue imposed by Peel's Act should be carried still further, and that that part of the issue which is fiduciary, or based on securities, should gradually be abolished, the securities behind it being replaced by gold. Since most of the profit on the fiduciary issue goes to the Government the difficulty of introducing any change tending towards its abolition is redoubled; but as a matter of theory it is safe to say that a majority of well-informed City opinion is now in favour of making the Bank of England note a pure and simple bullion certificate. And this change of opinion concerning the only law which seriously restricts the banker in the conduct of his business is striking evidence of the extent to which English banking has been modified by the development of the use of the cheque.

It has been revolutionised rather than modified, for the cheque has freed banking from the fetters of the Bank Act. The Bank Act said that there should be no increase in the note currency except by an increase in the Bank of England's bullion. If commerce had continued to use the note currency and had expanded as it has, there would by this time have been a vast pile of useless gold in the Bank's vaults. But the Act laid no restriction on the drawing of cheques, and all the new joint stock banks, which had sprung up when it was discovered that banking did not necessarily mean note-issuing, pushed on the use of the cheque currency wherever they carried their victories. They thus developed that side of banking which was free from legal restriction and at the same time gave the commercial community the most perfectly safe, elastic, and adaptable form of currency that the world has yet seen. And in another respect the growth of these great institutions which have carried out this important development has modified in a very important respect the problem of the money market as it showed itself to Bagehot. When he wrote, the Bank of England was at al ordinary times the most important factor in the market. "At all ordinary moments," he wrote, "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." This is no longer true.

The Power of the Outer Banks.

So far is the above quotation—from Chapter V. of "Lombard Street"—from being verified by modern conditions that it may be said that at all ordinary moments Lombard Street carries on its business without any necessity for taking money from the Bank of England, and that consequently the Bank rate—the rate at which the Bank will discount bills—is at all ordinary moments not a direct influence in the rate at which the outside market—consisting of the other banks and bill brokers—is working. It is only in times of special demands, such as quarter-day payments, the collection of the direct taxes in the January to March quarter, abnormally active trade, or a foreign drain of gold, that the Bank of England's assistance is required, and its rate only becomes an influence when there is apprehension or expectation in the market that it may be raised or lowered. Since Bagehot wrote, the process that he foretold of the growth and predominance of the joint stock banks has gone so far that they have not only almost obliterated the old private firms, but have taken out of the Bank of England's hands the business of providing currency and regulating the London money market, except on special occasions. They provide the cheque currency of to-day, and in ordinary times the rate at which they lend to the bill brokers makes the price of short loans, and the rate at which they discount bills makes the discount rate in London. Between these rates made by the outer banks and the official rate of the Bank of England, there is only a slender and shadowy connection which comes into being from the fact that the rate allowed to depositors by the outer banks is usually 1½ per cent. below Bank rate. But of the sum of money held by the banks on behalf of customers, it is probable that less than half is on deposit, the rest of it being held on current account, and so in most cases receiving no rate at all. It is impossible to be certain on this point, since very few of the banks show in their balance sheets separate statements of current and deposit accounts. But among those which do so, deposits are half the amount, or less, of the current accounts. And consequently it often happens that bankers lend money to bill brokers at the same rate at which they are paying to depositors. There is thus this loose connection between Bank rate and the market rate for loans, that the latter is not as a rule likely to be more than 1½ per cent. below the former, but the connection is so indefinite and untrustworthy, and the funds over which the outside market now has control are so vast, that when the Bank of England considers it necessary, owing to the threat of a foreign drain or for any other reason, to raise its rate, it often has to make this action effective by borrowing from the outside market in order to curtail artificially the supplies of the latter, and compel applications to itself, so as to make its rate an effective influence on those current in the market.

The Problem Modified.

Modified by this development, the problem of Lombard Street to-day is concerned rather with the conduct of the outer joint stock banks than of the Bank of England. The difficulties and responsibilities of the Bank of England have been increased, but at least they are recognised and provided for. If Bagehot could look back over the history of the money market through the forty years that have passed since he wrote "Lombard Street," he would see that his criticisms of the attitude of the Bank towards its position had borne good fruit. Its duty as custodian of the gold reserve has been definitely recognised by its consistent action, and by the equally constant pressure of public opinion. Between them the Bank's sense of duty and the public's insistence on its responsibility have produced a marked advance along the line indicated by Bagehot. He pointed to ten millions as the limit below which the Bank's reserve should not be allowed to fall; now it is rarely below twenty millions. He maintained that "one third of its banking liabilities is at present by no means an adequate reserve for the Banking Department." During 1913 the average proportion of the reserve to liabilities was 49.7 per cent. And all this has been achieved in spite of the growth of banking development outside, which, as has been shown, has made Lombard Street independent of assistance from the Bank, save at exceptional times, instead of being normally dependent on it and so constantly under its control. It is this outside development that has changed the face of the problem. It has already been shown to have altered England's currency, which now consists chiefly of cheques, and it is also the cause of continued heart-searchings among the banking community concerning the adequacy of its cash reserves, in spite of the improvement achieved by the Bank of England. The increase in the Bank's reserve has been great, both absolutely and relatively to its own direct liabilities, but it is criticised as insufficient when compared with the mass of banking liabilities of the country, which arc based on the outer banks' cash holding, included in which are their balances at the Bank of England. It is the proportion of cash to liabilities shown by the outer banks which is the problem that vexes the banking world today, and has vexed it for nearly twenty years. This problem has been aired and discussed at bank meetings and in addresses to the Bankers' Institute ever since the crisis of 1890. No definite step has been taken towards its solution, but the discussion is very far from having been fruitless. The proportion of cash held by the leading banks has improved steadily and rapidly. Bagehot quotes, in Chapter IX., Mr. Weguelin, Governor of the Bank, as stating in 1857 that the joint stock banks of London had deposits of 30 millions and 2 millions of cash reserve. Here the proportion is 6.6 per cent. The latest statement * of the London joint stock banks shows deposits 565 millions, cash 86 millions, proportion 15.2 per cent. The improvement is remarkable, and if we could be sure that the rest of the banks were equally prudent, and that the proportion shown by the London banks were normal and habitual, and not to some extent and in some cases specially arranged for purposes of publication, critics could find little more to say on this subject. Unfortunately, we cannot be sure of either of these things. The evidence is all on the other side. Banking reformers press continually for more frequent and clearer statements of their position by the country banks, and for the adoption of the average system in all bank statements, so that there may be no possibility of specially arranged displays. And they contend, with much good reason behind them, that, if this system were adopted, the question of an adequate cash reserve would very quickly be solved.

It should be noted that experience in this country and elsewhere has not endorsed Bagehot's view that our one-reserve system, based on a gold store held by one chief bank, is unnatural and wrong, and only to be tolerated because it is now so deeply ingrained in our banking habits that its alteration would be a dangerous experiment. It is now generally recognised that this system gives us a credit organisation of unrivalled elasticity, and banking reformers in America are now endeavouring to adopt it, with modifications necessitated by local conditions.

In his concluding chapter Bagehot states that the account of the Secretary for India in Council is contained in the public deposits in the Bank return. This was so when he wrote, but the public deposits are now only those of the various departments of the British Government. The India Council's balance is included in the other deposits, and has been so since 1892.

Such are the main points in which the problem of Lombard Street and the relations of the various components of the money market have been modified since Bagehot wrote. It should also be noted that the progress of banking development abroad has lessened the difference which he described between England and other countries in the matter of the use of credit.

Hartley Withers.

LOMBARD STREET.

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

£
London (31st December, 1872) 120,000,000
Paris (27th February, 1873) 13,000,000
New York (February, 1873) 40,000,000
German Empire (31st January, 1873) 8,000,000

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

I

The objects which you see in Lombard Street, and in that money world which is grouped about it, are the Bank of England, the Private Banks, the Joint Stock Banks, and the bill brokers. But before describing each of these separately we must look at what all have in common, and at the relation of each to the others.

The distinctive function of the banker,—says Ricardo, 'begins as soon as he uses the money of others;' as long as he uses his own money he is only a capitalist. Accordingly all the banks in Lombard Street (and bill brokers are for this purpose only a kind of bankers) hold much money belonging to other people on running account and on deposit. In continental language, Lombard Street is an organization of credit, and we are to see if it is a good or bad organization in its kind, or if, as is most likely, it turn out to be mixed, what are its merits and what are its defects?

The main point on which one system of credit differs from another is 'soundness.' Credit means that a certain confidence is given, and a certain trust reposed. Is that trust justified? and is that confidence wise? These are the cardinal questions. To put it more simply—credit is a set of promises to pay; will those promises be kept? Especially in banking, where the 'liabilities,' or promises to pay, are so large, and the time at which to pay them, if exacted, is so short, an instant capacity to meet engagements is the cardinal excellence.

All which a banker wants to pay his creditors is a sufficient supply of the legal tender of the country, no matter what that legal tender may be. Different countries differ in their laws of legal tender, but for the primary purposes of banking these systems are not material. A good system of currency will benefit the country, and a bad system will hurt it. Indirectly, bankers will be benefited or injured with the country in which they live; but practically, and for the purposes of their daily life, they have no need to think, and never do think, on theories of currency. They look at the matter simply. They say 'I am under an obligation to pay such and such sums of legal currency; how much have I in my till, or have I at once under my command, of that currency?' In America, for example, it is quite enough for a banker to hold 'greenbacks,' though the value of these changes as the Government chooses to enlarge or contract the issue. 7 But a practical New York banker has no need to think of the goodness or badness of this system at all; he need only keep enough 'greenbacks' to pay all probable demands, and then he is fairly safe from the risk of failure.

By the law of England the legal tenders are gold and silver coin (the last for small amounts only), and Bank of England notes. But the number of our attainable bank notes is not, like American 'greenbacks,' dependent on the will of the State; it is limited by the provisions of the Act of 1844. That Act separates the Bank of England into two halves. The Issue Department only issues notes, and can only issue 15,000,000 l. on Government securities; 8 for all the rest it must have bullion deposited. Take, for example an account, which may be considered an average specimen of those of the last few years—that for the last week of 1869:—

An account pursuant to the Act 7th and 8th Victoria, cap. 32, for the week ending on Wednesday, the 29th day of December, 1869.
ISSUE DEPARTMENT.
Notes issued £33,288,640 Government debt £11,015,100
Other securities 3,984,900
Gold coin and bullion 18,288,640
Silver bullion
£33,288,640 £33,288,640
BANKING DEPARTMENT.
Proprietor's capital £14,553,000 Government securities £13,811,953
Rest 3,103,301 Other securities 19,781,988
Public deposits, including Exchequer, Savings' Banks, Commissioners of National Debt, and dividend accounts 8,585,215 Notes 10,389,690
Other deposits 18,204,607 Gold and silver coin 907,982
Seven-day and other bills 445,490
£44,891,613 £44,891,613
GEO. FORBES, Chief Cashier
Dated 30th December, 1869.

There are here 15,000,000 l. bank notes issued on securities, and 18,288,640 l. represented by bullion. The Bank of England has no power by law to increase the currency in any other manner. 9 It holds the stipulated amount of securities, and for all the rest it must have bullion. This is the 'cast iron' system—the 'hard and fast' line which the opponents of the Act say ruins us, and which the partisans of the Act say saves us. But I have nothing to do with its expediency here. All which is to my purpose is that our paper 'legal tender,' our bank notes, can only be obtained in this manner. If, therefore, an English banker retains a sum of Bank of England notes or coin in due proportion to his liabilities, he has a sufficient amount of the legal tender of this country, and he need not think of anything more.

But here a distinction must be made. It is to be observed that properly speaking we should not include in the 'reserve' of a bank 'legal tenders,' or cash, which the Bank keeps to transact its daily business. That is as much a part of its daily stock-in-trade as its desks or offices; or at any rate, whatever words we may choose to use, we must carefully distinguish between this cash in the till which is wanted every day, and the safety- fund, as we may call it, the special reserve held by the bank to meet extraordinary and unfrequent demands.

What then, subject to this preliminary explanation, is the amount of legal tender held by our bankers against their liabilities? The answer is remarkable, and is the key to our whole system. It may be broadly said that no bank in London or out of it holds any considerable sum in hard cash or legal tender (above what is wanted for its daily business) except the Banking Department of the Bank of England. 10 That department had on the 29th day of December, 1869, liabilities as follows:

Public deposits £8,575,000
Private deposits 18,205,000
Seven-day and other bills 445,000
Total £27,235,000

and a cash reserve of 11,297,000 l. 11 And this is all the cash reserve, we must carefully remember, which, under the law, the Banking Department of the Bank of England—as we cumbrously call it the Bank of England for banking purposes—possesses. That department can no more multiply or manufacture bank notes than any other bank can multiply them. At that particular day the Bank of England had only 11,297,000 l. in its till against liabilities of nearly three times the amount. It had 'Consols' and other securities which it could offer for sale no doubt, and which, if sold, would augment its supply of bank notes—and the relation of such securities to real cash will be discussed presently; but of real cash, the Bank of England for this purpose—the banking bank—had then so much and no more.

And we may well think this a great deal, if we examine the position of other banks. No other bank holds any amount of substantial importance in its own till beyond what is wanted for daily purposes. All London banks keep their principal reserve on deposit at the Banking Department of the Bank of England. This is by far the easiest and safest place for them to use. The Bank of England thus has the responsibility of taking care of it. The same reasons which make it desirable for a private person to keep a banker make it also desirable for every banker, as respects his reserve, to bank with another banker if he safely can. The custody of very large sums in solid cash entails much care, and some cost; everyone wishes to shift these upon others if he can do so without suffering. Accordingly, the other bankers of London, having perfect confidence in the Bank of England, get that bank to keep their reserve for them.

The London bill brokers do much the same. Indeed, they are only a special sort of bankers who allow daily interest on deposits, and who for most of their money give security. But we have no concern now with these differences of detail. The bill brokers lend most of their money, and deposit the remnant either with the Bank of England or some London banker. That London banker lends what he chooses of it, the rest he leaves at the Bank of England. You always come back to the Bank of England at last.

But those who keep immense sums with a banker gain a convenience at the expense of a danger. They are liable to lose them if the bank fail. As all other bankers keep their banking reserve at the Bank of England, they are liable to fail if it fails. They are dependent on the management of the Bank of England in a day of difficulty and at a crisis for the spare money they keep to meet that difficulty and crisis. And in this there is certainly considerable risk. Three times 'Peel's Act' has been suspended because the Banking Department was empty. Before the Act was broken—

In 1847, the Banking Department was reduced to £1,994,000
1857 " 1,462,000
1866 " 3,000,000

In fact, in none of those years could the Banking Department of the Bank of England have survived if the law had not been broken.

Nor must it be fancied that this danger is unreal, artificial, and created by law. There is a risk of our thinking so, because we hear that the danger can be cured by breaking an Act; but substantially the same danger existed before the Act. In 1825, when only coin was a legal tender, and when there was only one department in the Bank, the Bank had reduced its reserve to 1,027,000 l., and was within an ace of stopping payment.

But the danger to the depositing banks is not the sole or the principal consequence of this mode of keeping the London reserve. The main effect is to cause the reserve to be much smaller in proportion to the liabilities than it would otherwise be. The reserve of the London bankers being on deposit in the Bank of England, the Bank always lends a principal part of it. Suppose, a favourable supposition, that the Banking Department holds more than two-fifths of its liabilities in cash—that it lends three-fifths of its deposits and retains in reserve only two-fifths. If then the aggregate of the bankers' deposited reserve be 5,000,000 l., 3,000,000 l. of it will be lent by the Banking Department, and 2,000,000 l. will be kept in the till. In consequence, that 2,000,000 l. is all which is really held in actual cash as against the liabilities of the depositing banks. If Lombard Street were on a sudden thrown into liquidation, and made to pay as much as it could on the spot, that 2,000,000 l. would be all which the Bank of England could pay to the depositing banks, and consequently all, besides the small cash in the till, which those banks could on a sudden pay to the persons who have deposited with them.

We see then that the banking reserve of the Bank of England some 10,000,000 l. 12 on an average of years now, and formerly much less—is all which is held against the liabilities of Lombard Street; and if that were all, we might well be amazed at the immense development of our credit system—in plain English, at the immense amount of our debts payable on demand, and the smallness of the sum of actual money which we keep to pay them if demanded. But there is more to come. Lombard Street is not only a place requiring to keep a reserve, it is itself a place where reserves are kept. All country bankers keep their reserve in London. They only retain in each country town the minimum of cash necessary to the transaction of the current business of that country town. Long experience has told them to a nicety how much this is, and they do not waste capital and lose profit by keeping more idle. They send the money to London, invest a part of it in securities, and keep the rest with the London bankers and the bill brokers. The habit of Scotch and Irish bankers is much the same. All their spare money is in London, and is invested as all other London money now is; and, therefore, the reserve in the Banking Department of the Bank of England is the banking reserve not only of the Bank of England, but of all London—and not only of all London, but of all England, Ireland, and Scotland too.

Of late there has been a still further increase in our liabilities. Since the Franco-German war, we may be said to keep the European reserve also. Deposit Banking is indeed so small on the Continent, that no large reserve need be held on account of it. A reserve of the same sort which is needed in England and Scotland is not needed abroad. But all great communities have at times to pay large sums in cash, and of that cash a great store must be kept somewhere. Formerly there were two such stores in Europe, one was the Bank of France, and the other the Bank of England. But since the suspension of specie payments by the Bank of France, its use as a reservoir of specie is at an end. No one can draw a cheque on it and be sure of getting gold or silver for that cheque. Accordingly the whole liability for such international payments in cash is thrown on the Bank of England. 13 No doubt foreigners cannot take from us our own money; they must send here 'value' in some shape or other for all they take away. But they need not send 'cash;' they may send good bills and discount them in Lombard Street and take away any part of the produce, or all the produce, in bullion. It is only putting the same point in other words to say that all exchange operations are centering more and more in London. Formerly for many purposes Paris was a European settling-house, but now it has ceased to be so. The note of the Bank of France has not indeed been depreciated enough to disorder ordinary transactions. But any depreciation, however small—even the liability to depreciation without its reality—is enough to disorder exchange transactions. They are calculated to such an extremity of fineness that the change of a decimal may be fatal, and may turn a profit into a loss. Accordingly London has become the sole great settling-house of exchange transactions in Europe, instead of being formerly one of two. 14 And this pre-eminence London will probably maintain, for it is a natural pre-eminence. The number of mercantile bills drawn upon London incalculably surpasses those drawn on any other European city; London is the place which receives more than any other place, and pays more than any other place, and therefore it is the natural 'clearing house.' The pre-eminence of Paris partly arose from a distribution of political power, which is already disturbed; but that of London depends on the regular course of commerce, which is singularly stable and hard to change.

Now that London is the clearing-house to foreign countries, London has a new liability to foreign countries. At whatever place many people have to make payments, at that place those people must keep money. A large deposit of foreign money in London is now necessary for the business of the world. During the immense payments from France to Germany, the sum in transitu— the sum in London—has perhaps been unusually large. But it will ordinarily be very great. The present political circumstances no doubt will soon change. We shall soon hold in Lombard Street far less of the money of foreign governments; but we shall hold more and more of the money of private persons; for the deposit at a clearing-house necessary to settle the balance of commerce must tend to increase as that commerce itself increases.

And this foreign deposit is evidently of a delicate and peculiar nature. It depends on the good opinion of foreigners, and that opinion may diminish or may change into a bad opinion. After the panic of 1866, especially after the suspension of Peel's Act (which many foreigners confound with a suspension of cash payments), a large amount of foreign money was withdrawn from London. And we may reasonably presume that in proportion as we augment the deposits of cash by foreigners in London, we augment both the chances and the disasters of a 'run' upon England.

And if that run should happen, the bullion to meet it must be taken from the Bank. There is no other large store in the country. The great exchange dealers may have a little for their own purposes, but they have no store worth mentioning in comparison with this. If a foreign creditor is so kind as to wait his time and buy the bullion as it comes into the country, he may be paid without troubling the Bank or distressing the money market. The German Government has recently been so kind; it was in no respect afraid. But a creditor who takes fright will not wait, and if he wants bullion in a hurry he must come to the Bank of England.

In consequence all our credit system depends on the Bank of England for its security. On the wisdom of the directors of that one Joint Stock Company, it depends whether England shall be solvent or insolvent. This may seem too strong, but it is not. All banks depend on the Bank of England, and all merchants depend on some banker. If a merchant have 10,000 l. at his bankers, and wants to pay it to some one in Germany, he will not be able to pay it unless his banker can pay him, and the banker will not be able to pay if the Bank of England should be in difficulties and cannot produce his 'reserve.'

The directors of the Bank are, therefore, in fact, if not in name, trustees for the public, to keep a banking reserve on their behalf; and it would naturally be expected either that they distinctly recognized this duty and engaged to perform it, or that their own self-interest was so strong in the matter that no engagement was needed. But so far from there being a distinct undertaking on the part of the Bank directors to perform this duty, many of them would scarcely acknowledge it, and some altogether deny it. Mr. Hankey, one of the most careful and most experienced of them, says in his book on the Bank of England, the best account of the practice and working of the Bank which anywhere exists—'I do not intend here to enter at any length on the subject of the general management of the Bank, meaning the Banking Department, as the principle upon which the business is conducted does not differ, as far as I am aware, from that of any well-conducted bank in London.' But, as anyone can see by the published figures, the Banking Department of the Bank of England keeps as a great reserve in bank notes and coin between 30 and 50 per cent. of its liabilities, and the other banks only keep in bank notes and coin the bare minimum they need to open shop with. And such a constant difference indicates, I conceive, that the two are not managed on the same principle.

The practice of the Bank has, as we all know, been much and greatly improved. They do not now manage like the other Banks in Lombard Street. They keep an altogether different kind and quantity of reserve; but though the practice is mended the theory is not. There has never been a distinct resolution passed by the Directors of the Bank of England, and communicated by them to the public, stating even in the most general manner, how much reserve they mean to keep or how much they do not mean, or by what principle in this important matter they will be guided.

The position of the Bank directors is indeed most singular. On the one side a great city opinion—a great national opinion, I may say, for the nation has learnt much from many panics—requires the directors to keep a large reserve. The newspapers, on behalf of the nation, are always warning the directors to keep it, and watching that they do keep it; but, on the other hand, another less visible but equally constant pressure pushes the directors in exactly the reverse way, and inclines them to diminish the reserve.

This is the natural desire of all directors to make a good dividend for their shareholders. The more money lying idle the less, cæteris paribus, is the dividend; the less money lying idle the greater is the dividend. And at almost every meeting of the proprietors of the Bank of England, there is a conversation on this subject. Some proprietor says that he does not see why so much money is kept idle, and hints that the dividend ought to be more.

Indeed, it cannot be wondered at that the Bank proprietors do not quite like their position. Theirs is the oldest bank in the City, but their profits do not increase, while those of other banks most rapidly increase. In 1844, the dividend on the stock of the Bank of England was 7 per cent., and the price of the stock itself 212; the dividend now is 9 per cent., and the price of the stock 232. But in the same time the shares of the London and Westminster Bank, in spite of an addition of 100 per cent. to the capital, have risen from 27 to 66, and the dividend from 6 per cent. to 20 per cent. 15 That the Bank proprietors should not like to see other companies getting richer than their company is only natural.

Some part of the lowness of the Bank dividend, and of the consequent small value of Bank stock, is undoubtedly caused by the magnitude of the Bank capital; but much of it is also due to the great amount of unproductive cash—of cash which yields no interest—that the Banking Department of the Bank of England keeps lying idle. If we compare the London and Westminster Bank—which is the first of the joint-stock banks in the public estimation and known to be very cautiously and carefully managed—with the Bank of England, we shall see the difference at once. The London and Westminster has only 13 per cent. of its liabilities lying idle. The Banking Department of the Bank of England has over 40 per cent. 16 So great a difference in the management must cause, and does cause, a great difference in the profits. Inevitably the shareholders of the Bank of England will dislike this great difference; more or less, they will always urge their directors to diminish (as far as possible) the unproductive reserve, and to augment as fall as possible their own dividend.

In most banks there would be a wholesome dread restraining the desire of the shareholders to reduce the reserve; they would fear to impair the credit of the bank. But fortunately or unfortunately, no one has any fear about the Bank of England. The English world at least believes that it will not, almost that it cannot, fail. Three times since 1844 the Banking Department has received assistance, and would have failed without it. In 1825, the entire concern almost suspended payment; in 1797, it actually did so. But still there is a faith in the Bank, contrary to experience, and despising evidence. No doubt in every one of these years the condition of the Bank, divided or undivided, was in a certain sense most sound; it could ultimately have paid all its creditors all it owed, and returned to its shareholders all their own capital. But ultimate payment is not what the creditors of a bank want; they want present, not postponed, payment; they want to be repaid according to agreement; the contract was that they should be paid on demand, and if they are not paid on demand they may be ruined. And that instant payment, in the years I speak of, the Bank of England certainly could not have made. But no one in London ever dreams of questioning the credit of the Bank, and the Bank never dreams that its own credit is in danger. Somehow everybody feels the Bank is sure to come right. In 1797, when it had scarcely any money left, the Government said not only that it need not pay away what remained, but that it must not. The 'effect of letters of licence' to break Peel's Act has confirmed the popular conviction that the Government is close behind the Bank, and will help it when wanted. Neither the Bank nor the Banking Department have ever had an idea of being put 'into liquidation;' most men would think as soon of 'winding up' the English nation.

Since then the Bank of England, as a bank, is exempted from the perpetual apprehension that makes other bankers keep a large reserve—the apprehension of discredit—it would seem particularly necessary that its managers should be themselves specially interested in keeping that reserve, and specially competent to keep it. But I need not say that the Bank directors have not their personal fortune at stake in the management of the Bank. They are rich City merchants, and their stake in the Bank is trifling in comparison with the rest of their wealth. If the Bank were wound up, most of them would hardly in their income feel the difference. And what is more, the Bank directors are not trained bankers; they were not bred to the trade, and do not in general give the main power of their minds to it. They are merchants, most of whose time and most of whose real mind are occupied in making money in their own business and for themselves.

It might be expected that as this great public duty was cast upon the Banking Department of the Bank, the principal statesmen (if not Parliament itself) would have enjoined on them to perform it. But no distinct resolution of Parliament has ever enjoined it; scarcely any stray word of any influential statesman. And, on the contrary, there is a whole catena of authorities, beginning with Sir Robert Peel and ending with Mr. Lowe, 17 which say that the Banking Department of the Bank of England is only a Bank like any other bank—a Company like other companies; that in this capacity it has no peculiar position, and no public duties at all. Nine-tenths of English statesmen, if they were asked as to the management of the Banking Department of the Bank of England, would reply that it was no business of theirs or of Parliament at all; that the Banking Department alone must look to it.

The result is that we have placed the exclusive custody of our entire banking reserve in the hands of a single board of directors not particularly trained for the duty—who might be called 'amateurs,'—who have no particular interest above other people in keeping it undiminished—who acknowledge no obligation to keep it undiminished—who have never been told by any great statesman or public authority that they are so to keep it or that they have anything to do with it—who are named by and are agents for a proprietary which would have a greater income if it was diminished,—who do not fear, and who need not fear, ruin, even if it were all gone and wasted.

That such an arrangement is strange must be plain; but its strangeness can only be comprehended when we know what the custody of a national banking reserve means, and how delicate and difficult it is.

II

Such a reserve as we have seen is kept to meet sudden and unexpected demands. If the bankers of a country are asked for much more than is commonly wanted, then this reserve must be resorted to. What then are these extra demands? and how is this extra reserve to be used? Speaking broadly, these extra demands are of two kinds—one from abroad to meet foreign payments requisite to pay large and unusual foreign debts, and the other from at home to meet sudden apprehension or panic arising in any manner, rational or irrational.

No country has ever been so exposed as England to a foreign demand on its banking reserve, not only because at present England is a large borrower from foreign nations, but also (and much more) because no nation has ever had a foreign trade of such magnitude, in such varied objects, or so ramified through the world. The ordinary foreign trade of a country requires no cash; the exports on one side balance the imports on the other. But a sudden trade of import like the import of foreign corn after a bad harvest—or (what is much less common, though there are cases of it) the cessation of any great export, causes a balance to become due, which must be paid in cash.

Now, the only source from which large sums of cash can be withdrawn in countries where banking is at all developed, is a 'bank reserve.' In England especially, except a few sums of no very considerable amount held by bullion dealers in the course of their business, there are no sums worth mentioning in cash out of the banks; an ordinary person could hardly pay a serious sum without going to some bank, even if he spent a month in trying. All persons who wish to pay a large sum in cash trench of necessity on the banking reserve. But then what is 'cash?' Within a country the action of a Government can settle the quantity, and therefore the value, of its currency; but outside its own country, no Government can do so. Bullion is the 'cash' of international trade; paper currencies are of no use there, and coins pass only as they contain more or less bullion.

When then the legal tender of a country is purely metallic, all that is necessary is that banks should keep a sufficient store of that 'legal tender.' But when the 'legal tender' is partly metal and partly paper, it is necessary that the paper 'legal tender'—the bank note—should be convertible into bullion. And here I should pass my limits, and enter on the theory of Peel's Act if I began to discuss the conditions of convertibility. I deal only with the primary pre-requisite of effectual foreign payments—a sufficient supply of the local legal tender; with the afterstep—the change of the local legal tender into the universally acceptable commodity—I cannot deal.

What I have to deal with is, for the present, ample enough. The Bank of England must keep a reserve of 'legal tender' to be used for foreign payments if itself fit, and to be used in obtaining bullion if itself unfit. And foreign payments are sometimes very large, and often very sudden. The 'cotton drain,' as it is called—the drain to the East to pay for Indian cotton during the American Civil War—took many millions from this country for a series of years. A bad harvest must take millions in a single year. In order to find such great sums, the Bank of England requires the steady use of an effectual instrument.

That instrument is the elevation of the rate of interest. If the interest of money be raised, it is proved by experience that money does come to Lombard Street, and theory shows that it ought to come. To fully explain the matter I must go deep into the theory of the exchanges, but the general notion is plain enough. Loanable capital, like every other commodity, comes where there is most to be made of it. Continental bankers and others instantly send great sums here, as soon as the rate of interest shows that it can be done profitably. While English credit is good, a rise of the value of money in Lombard Street immediately by a banking operation brings money to Lombard Street. And there is also a slower mercantile operation. The rise in the rate of discount acts immediately on the trade of this country. Prices fall here; in consequence imports are diminished, exports are increased, and, therefore, there is more likelihood of a balance in bullion coming to this country after the rise in the rate than there was before.

Whatever persons—one bank or many banks—in any country hold the banking reserve of that country, ought at the very beginning of an unfavourable foreign exchange at once to raise the rate of interest, so as to prevent their reserve from being diminished farther, and so as to replenish it by imports of bullion.

This duty, up to about the year 1860, the Bank of England did not perform at all, as I shall show farther on. A more miserable history can hardly be found than that of the attempts of the Bank—if indeed they can be called attempts—to keep a reserve and to manage a foreign drain between the year 1819 (when cash payments were resumed by the Bank, and when our modern Money Market may be said to begin) and the year 1857. The panic of that year for the first time taught the Bank directors wisdom, and converted them to sound principles. The present policy of the Bank is an infinite improvement on the policy before 1857: the two must not be for an instant confounded; but nevertheless, as I shall hereafter show, the present policy is now still most defective, and much discussion and much effort will be wanted before that policy becomes what it ought to be.

A domestic drain is very different. Such a drain arises from a disturbance of credit within the country, and the difficulty of dealing with it is the greater, because it is often caused, or at least often enhanced, by a foreign drain. Times without number the public have been alarmed mainly because they saw that the Banking reserve was already low, and that it was daily getting lower. The two maladies—an external drain and an internal—often attack the money market at once. What then ought to be done?

In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of everyone is the contrary. There being a large demand on a fund which you want to preserve, the most obvious way to preserve it is to hoard it—to get in as much as you can, and to let nothing go out which you can help. But every banker knows that this is not the way to diminish discredit. This discredit means, 'an opinion that you have not got any money,' and to dissipate that opinion, you must, if possible, show that you have money: you must employ it for the public benefit in order that the public may know that you have it. The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.

Ordinarily discredit does not at first settle on any particular bank, still less does it at first concentrate itself on the bank or banks holding the principal cash reserve. These banks are almost sure to be those in best credit, or they would not be in that position, and, having the reserve, they are likely to look stronger and seem stronger than any others. At first, incipient panic amounts to a kind of vague conversation: Is A. B. as good as he used to be? Has not C. D. lost money? and a thousand such questions. A hundred people are talked about, and a thousand think, 'Am I talked about, or am I not?' 'Is my credit as good as it used to be, or is it less?' And every day, as a panic grows, this floating suspicion becomes both more intense and more diffused; it attacks more persons; and attacks them all more virulently than at first. All men of experience, therefore, try to 'strengthen themselves,' as it is called, in the early stage of a panic; they borrow money while they can; they come to their banker and offer bills for discount, which commonly they would not have offered for days or weeks to come. And if the merchant be a regular customer, a banker does not like to refuse, because if he does he will be said, or may be said, to be in want of money, and so may attract the panic to himself. Not only merchants but all persons under pecuniary liabilities—present or imminent—feel this wish to 'strengthen themselves,' and in proportion to those liabilities. Especially is this the case with what may be called the auxiliary dealers in credit. Under any system of banking there will always group themselves about the main bank or banks (in which is kept the reserve) a crowd of smaller money dealers, who watch the minutæ of bills, look into special securities which busy bankers have not time for, and so gain a livelihood. As business grows, the number of such subsidiary persons augments. The various modes in which money may be lent have each their peculiarities, and persons who devote themselves to one only lend in that way more safely, and therefore more cheaply. In time of panic, these subordinate dealers in money will always come to the principal dealers. In ordinary times, the intercourse between the two is probably close enough. The little dealer is probably in the habit of pledging his 'securities' to the larger dealer at a rate less than he has himself charged, and of running into the market to lend again. His time and brains are his principal capital, and he wants to be always using them. But in times of incipient panic, the minor money dealer always becomes alarmed. His credit is never very established or very wide; he always fears that he may be the person on whom current suspicion will fasten, and often he is so. Accordingly he asks the larger dealer for advances. A number of such persons ask all the large dealers—those who have the money—the holders of the reserve. And then the plain problem before the great dealers comes to be 'How shall we best protect ourselves? No doubt the immediate advance to these second-class dealers is annoying, but may not the refusal of it even be dangerous? A panic grows by what it feeds on; if it devours these second-class men, shall we, the first class, be safe?'

A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to 'this man and that man,' whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. 'We lent it,' said Mr. Harman, on behalf of the Bank of England, 'by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.' After a day or two of this treatment, the entire panic subsided, and the 'City' was quite calm.

The problem of managing a panic must not be thought of as mainly a 'banking' problem. It is primarily a mercantile one. All merchants are under liabilities; they have bills to meet soon, and they can only pay those bills by discounting bills on other merchants. In other words, all merchants are dependent on borrowing money, and large merchants are dependent on borrowing much money. At the slightest symptom of panic many merchants want to borrow more than usual; they think they will supply themselves with the means of meeting their bills while those means are still forthcoming. If the bankers gratify the merchants, they must lend largely just when they like it least; if they do not gratify them, there is a panic.

On the surface there seems a great inconsistency in all this. First, you establish in some bank or banks a certain reserve; you make of it or them a kind of ultimate treasury, where the last shilling of the country is deposited and kept. And then you go on to say that this final treasury is also to be the last lending-house; that out of it unbounded, or at any rate immense, advances are to be made when no one else lends. This seems like saying—first, that the reserve should be kept, and then that it should not be kept. But there is no puzzle in the matter. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An 'alarm' is an opinion that the money of certain persons will not pay their creditors when those creditors want to be paid. If possible, that alarm is best met by enabling those persons to pay their creditors to the very moment. For this purpose only a little money is wanted. If that alarm is not so met, it aggravates into a panic, which is an opinion that most people, or very many people, will not pay their creditors; and this too can only be met by enabling all those persons to pay what they owe, which takes a great deal of money. No one has enough money, or anything like enough, but the holders of the bank reserve.

Not that the help so given by the banks holding that reserve necessarily diminishes it. Very commonly the panic extends as far, or almost as far, as the bank or banks which hold the reserve, but does not touch it or them at all. In this case it is enough if the dominant bank or banks, so to speak, pledge their credit for those who want it. Under our present system it is often quite enough that a merchant or a banker gets the advance made to him put to his credit in the books of the Bank of England; he may never draw a cheque on it, or, if he does, that cheque may come in again to the credit of some other customer, who lets it remain on his account. An increase of loans at such times is often an increase of the liabilities of the bank, not a diminution of its reserve. Just so before 1844, an issue of notes, as in 1825, to quell a panic entirely internal did not diminish the bullion reserve. The notes went out, but they did not return. They were issued as loans to the public, but the public wanted no more; they never presented them for payment; they never asked that sovereigns should be given for them. But the acceptance of a great liability during an augmenting alarm, though not as bad as an equal advance of cash, is the thing next worst. At any moment the cash may be demanded. Supposing the panic to grow, it will be demanded, and the reserve will be lessened accordingly.

No doubt all precautions may, in the end, be unavailing. 'On extraordinary occasions,' says Ricardo, 'a general panic may seize the country, when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realising or concealing his property,—against such panic banks have no security on any system.' The bank or banks which hold the reserve may last a little longer than the others; but if apprehension pass a certain bound, they must perish too. The use of credit is, that it enables debtors to use a certain part of the money their creditors have lent them. If all those creditors demand all that money at once, they cannot have it, for that which their debtors have used, is for the time employed, and not to be obtained. With the advantages of credit we must take the disadvantages too; but to lessen them as much as we can, we must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm.

The management of the Money Market is the more difficult, because, as has been said, periods of internal panic and external demand for bullion commonly occur together. The foreign drain empties the Bank till, and that emptiness, and the resulting rise in the rate of discount, tend to frighten the market. The holders of the reserve have, therefore, to treat two opposite maladies at once—one requiring stringent remedies, and especially a rapid rise in the rate of interest; and the other, an alleviative treatment with large and ready loans.

Before we had much specific experience, it was not easy to prescribe for this compound disease; but now we know how to deal with it. We must look first to the foreign drain, and raise the rate of interest as high as may be necessary. Unless you can stop the foreign export, you cannot allay the domestic alarm. The Bank will get poorer and poorer, and its poverty will protract or renew the apprehension. And at the rate of interest so raised, the holders—one or more—of the final Bank reserve must lend freely. Very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain. Any notion that money is not to be had, or that it may not be had at any price, only raises alarm to panic and enhances panic to madness. But though the rule is clear, the greatest delicacy, the finest and best skilled judgment, are needed to deal at once with such great and contrary evils.

And great as is the delicacy of such a problem in all countries, it is far greater in England now than it was or is elsewhere. The strain thrown by a panic on the final bank reserve is proportional to the magnitude of a country's commerce, and to the number and size of the dependent banks—banks, that is, holding no cash reserve—that are grouped around the central bank or banks. And in both respects our system causes a stupendous strain. The magnitude of our commerce, and the number and magnitude of the banks which depend on the Bank of England, are undeniable. There are very many more persons under great liabilities than there are, or ever were, anywhere else. At the commencement of every panic, all persons under such liabilities try to supply themselves with the means of meeting those liabilities while they can. This causes a great demand for new loans. And so far from being able to meet it, the bankers who do not keep an extra reserve at that time borrow largely, or do not renew large loans—very likely do both.

London bankers, other than the Bank of England, effect this in several ways. First, they have probably discounted bills to a large amount for the bill brokers, and if these bills are paid, they decline discounting any others to replace them. The directors of the London and Westminster Bank had, in the panic of 1857, discounted millions of such bills, and they justly said that if those bills were paid they would have an amount of cash far more than sufficient for any demand. 18 But how were those bills to be paid? Some one else must lend the money to pay them. The mercantile community could not on a sudden bear to lose so large a sum of borrowed money; they have been used to rely on it, and they could not carry on their business without it. Least of all could they bear it at the beginning of a panic, when everybody wants more money than usual. Speaking broadly, those bills can only be paid by the discount of other bills. When the bills (suppose) of a Manchester warehouseman which he gave to the manufacturer become due, he cannot, as a rule, pay for them at once in cash; he has bought on credit, and he has sold on credit. He is but a middleman. To pay his own bill to the maker of the goods, he must discount the bills he has received from the shopkeepers to whom he has sold the goods; but if there is a sudden cessation in the means of discount, he will not be able to discount them. All our mercantile community must obtain new loans to pay old debts. If some one else did not pour into the market the money which the banks like the London and Westminster Bank take out of it, the bills held by the London and Westminster Bank could not be paid.

Who then is to pour in the new money? Certainly not the bill brokers. They have been used to re-discount with such banks as the London and Westminster millions of bills, and if they see that they are not likely to be able to re-discount those bills, they instantly protect themselves and do not discount them. Their business does not allow them to keep much cash unemployed. They give interest for all the money deposited with them—an interest often nearly approaching the interest they can charge; as they can only keep a small reserve a panic tells on them more quickly than on anyone else. They stop their discounts, or much diminish their discounts, immediately. There is no new money to be had from them, and the only place at which they can have it is the Bank of England.

There is even a simpler case: the banker who is uncertain of his credit, and wants to increase his cash, may have money on deposit at the bill brokers. If he wants to replenish his reserve, he may ask for it, suppose, just when the alarm is beginning. But if a great number of persons do this very suddenly, the bill brokers will not at once be able to pay without borrowing. They have excellent bills in their case, but these will not be due for some days; and the demand from the more or less alarmed bankers is for payment at once and to-day. Accordingly the bill broker takes refuge at the Bank of England—the only place where at such a moment new money is to be had.

The case is just the same if the banker wants to sell Consols, or to call in money lent on Consols. These he reckons as part of his reserve. And in ordinary times nothing can be better. According to the saying, you 'can sell Consols on a Sunday.' In a time of no alarm, or in any alarm affecting that particular banker only, he can rely on such reserve without misgiving. But not so in a general panic. Then, if he wants to sell 500,000 l. worth of Consols, he will not find 500,000 l. of fresh money ready to come into the market. All ordinary bankers are wanting to sell, or thinking they may have to sell. The only resource is the Bank of England. In a great panic, Consols cannot be sold unless the Bank of England will advance to the buyer, and no buyer can obtain advances on Consols at such a time unless the Bank of England will lend to him.

The case is worse if the alarm is not confined to the great towns, but is diffused through the country. As a rule, country bankers only keep so much barren cash as is necessary for their common business. All the rest they leave at the bill brokers, or at the interest-giving banks, or invest in Consols and such securities. But in a panic they come to London and want this money. And it is only from the Bank of England that they can get it, for all the rest of London want their money for themselves.

If we remember that the liabilities of Lombard Street payable on demand are far larger than those of any like market, and that the liabilities of the country are greater still, we can conceive the magnitude of the pressure on the Bank of England when both Lombard Street and the country suddenly and at once come upon it for aid. No other bank was ever exposed to a demand so formidable, for none ever before kept the banking reserve for such a nation as the English.

The mode in which the Bank of England meets this great responsibility is very curious. It unquestionably does make enormous advances in every panic—

In 1847 the loans on 'private securities' £ £
increased from 18,963,000 to 20,409,000
1857 " 20,404,000 to 31,350,000
1866 " 18,507,000 to 33,447,000

But, on the other hand, as we have seen, though the Bank, more or less, does its duty, it does not distinctly acknowledge that it is its duty. We are apt to be solemnly told that the Banking Department of the Bank of England is only a bank like other banks—that it has no peculiar duty in times of panic—that it then is to look to itself alone, as other banks look. And there is this excuse for the Bank. Hitherto questions of banking have been so little discussed in comparison with questions of currency, that the duty of the Bank in time of panic has been put on a wrong ground.

It is imagined that because bank notes are a legal tender, the Bank has some peculiar duty to help other people. But bank notes are only a legal tender at the Issue Department, not at the Banking Department, and the accidental combination of the two departments in the same building gives the Banking Department no aid in meeting a panic. If the Issue Department were at Somerset House, and if it issued Government notes there, the position of the Banking Department under the present law would be exactly what it is now. No doubt, formerly the Bank of England could issue what it pleased, but that historical reminiscence makes it no stronger now that it can no longer so issue. We must deal with what is, not with what was.

And a still worse argument is also used. It is said that because the Bank of England keeps the 'State account' and is the Government banker, it is a sort of 'public institution' and ought to help everybody. But the custody of the taxes which have been collected and which wait to be expended is a duty quite apart from panics. The Government money may chance to be much or little when the panic comes. There is no relation or connection between the two. And the State, in getting the Bank to keep what money it may chance to have, or in borrowing of it what money it may chance to want, does not hire it to stop a panic or much help it if it tries.

The real reason has not been distinctly seen. As has been already said—but on account of its importance and perhaps its novelty it is worth saying again—whatever bank or banks keep the ultimate banking reserve of the country must lend that reserve most freely in time of apprehension, for that is one of the characteristic uses of the bank reserve, and the mode in which it attains one of the main ends for which it is kept. Whether rightly or wrongly, at present and in fact the Bank of England keeps our ultimate bank reserve, and therefore it must use it in this manner.

And though the Bank of England certainly do make great advances in time of panic, yet as they do not do so on any distinct principle, they naturally do it hesitatingly, reluctantly, and with misgiving. In 1847, even in 1866—the latest panic, and the one in which on the whole the Bank acted the best—there was nevertheless an instant when it was believed the Bank would not advance on Consols, or at least hesitated to advance on them. The moment this was reported in the City and telegraphed to the country, it made the panic indefinitely worse. In fact, to make large advances in this faltering way is to incur the evil of making them without obtaining the advantage. What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.

In truth, the Bank do not lend from the motives which should make a bank lend. The holders of the Bank reserve ought to lend at once and most freely in an incipient panic, because they fear destruction in the panic. They ought not to do it to serve others; they ought to do it to serve themselves. They ought to know that this bold policy is the only safe one, and for that reason they ought to choose it. But the Bank directors are not afraid. Even at the last moment they say that 'whatever happens to the community, they can preserve themselves.' Both in 1847 and 1857 (I believe also in 1866, though there is no printed evidence of it) the Bank directors contended that the Banking Department was quite safe though its reserve was nearly all gone, and that it could strengthen itself by selling securities and by refusing to discount. But this is a complete dream. The Bank of England could not sell 'securities,' for in an extreme panic there is no one else to buy securities. The Bank cannot stay still and wait till its bills are paid, and so fill its coffers, for unless it discounts equivalent bills, the bills which it has already discounted will not be paid. When the reserve in the ultimate bank or banks—those keeping the reserve—runs low, it cannot be augmented by the same means that other and dependent banks commonly adopt to maintain their reserve, for the dependent banks trust that at such moments the ultimate banks will be discounting more than usual and lending more than usual. But ultimate banks have no similar rear-guard to rely upon.

I shall have failed in my purpose if I have not proved that the system of entrusting all our reserve to a single board, like that of the Bank directors, is very anomalous; that it is very dangerous; that its bad consequences, though much felt, have not been fully seen; that they have been obscured by traditional arguments and hidden in the dust of ancient controversies.

But it will be said—What would be better? What other system could there be? We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size. In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without.

I shall be at once asked—Do you propose a revolution? Do you propose to abandon the one-reserve system, and create anew a many-reserve system? My plain answer is that I do not propose it. I know it would be childish. Credit in business is like loyalty in Government. You must take what you can find of it, and work with it if possible. A theorist may easily map out a scheme of Government in which Queen Victoria could be dispensed with. He may make a theory that, since we admit and we know that the House of Commons is the real sovereign, any other sovereign is superfluous; but for practical purposes, it is not even worth while to examine these arguments. Queen Victoria is loyally obeyed—without doubt, and without reasoning—by millions of human beings. If those millions began to argue, it would not be easy to persuade them to obey Queen Victoria, or anything else. Effectual arguments to convince the people who need convincing are wanting. Just so, an immense system of credit, founded on the Bank of England as its pivot and its basis, now exists. The English people, and foreigners too, trust it implicitly. Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone: but what we have requires no proof. The whole rests on an instinctive confidence generated by use and years. Nothing would persuade the English people to abolish the Bank of England; and if some calamity swept it away, generations must elapse before at all the same trust would be placed in any other equivalent. A many-reserve system, if some miracle should put it down in Lombard Street, would seem monstrous there. Nobody would understand it, or confide in it. Credit is a power which may grow, but cannot be constructed. Those who live under a great and firm system of credit must consider that if they break up that one they will never see another, for it wrn take years upon years to make a successor to it.

On this account, I do not suggest that we should return to a natural or many-reserve system of banking. I should only incur useless ridicule if I did suggest it. Nor can I propose that we should adopt the simple and straightforward expedient by which the French have extricated themselves from the same difficulty. In France all banking rests on the Bank of France, even more than in England all rests on the Bank of England. The Bank of France keeps the final banking reserve, and it keeps the currency reserve too. But the State does not trust such a function to a board of merchants, named by shareholders. The nation itself—the Executive Government—names the governor and deputy-governor of the Bank of France. These officers have, indeed, beside them a council of 'régents,' or directors, named by the shareholders. But they need not attend to that council unless they think fit; they are appointed to watch over the national interest, and, in so doing, they may disregard the murmurs of the 'régents' if they like. And in theory, there is much to be said for this plan. The keeping the single banking reserve being a national function, it is at least plausible to argue that Government should choose the functionaries. No doubt such a political intervention is contrary to the sound economical doctrine that 'banking is a trade, and only a trade.' But Government forgot that doctrine when, by privileges and monopolies, it made a single bank predominant over all others, and established the one-reserve system. As that system exists, a logical Frenchman consistently enough argues that the State should watch and manage it. But no such plan would answer in England. We have not been trained to care for logical sequence in our institutions, or rather we have been trained not to care for it. And the practical result for which we do care would in this case be bad. The governor of the Bank would be a high Parliamentary official, perhaps in the Cabinet, and would change as chance majorities and the strength of parties decide. A trade peculiarly requiring consistency and special attainment would be managed by a shifting and untrained ruler. In fact, the whole plan would seem to an Englishman of business palpably absurd; he would not consider it, he would not think it worth considering. That it works fairly well in France, and that there are specious arguments of theory for it, would not be sufficient to his mind.

All such changes being out of the question, I can propose only three remedies.

First. There should be a clear understanding between the Bank and the public that, since the Bank hold our ultimate banking reserve, they will recognise and act on the obligations which this implies;—that they will replenish it in times of foreign demand as fully, and lend it in times of internal panic as freely and readily, as plain principles of banking require.

This looks very different from the French plan, but it is not so different in reality. In England we can often effect, by the indirect compulsion of opinion, what other countries must effect by the direct compulsion of Government. We can do so in this case. The Bank directors now fear public opinion exceedingly; probably no kind of persons are so sensitive to newspaper criticism. And this is very natural. Our statesmen, it is true, are much more blamed, but they have generally served a long apprenticeship to sharp criticism. If they still care for it (and some do after years of experience much more than the world thinks), they care less for it than at first, and have come to regard it as an unavoidable and incessant irritant, of which they shall never be rid. But a bank director undergoes no similar training and hardening. His functions at the Bank fill a very small part of his time; all the rest of his life (unless he be in Parliament) is spent in retired and mercantile industry. He is not subjected to keen and public criticism, and is not taught to bear it. Especially when once in his life he becomes, by rotation, governor, he is most anxious that the two years of office shall 'go off well.' He is apt to be irritated even by objections to principles on which he acts, and cannot bear with equanimity censure which is pointed and personal. At present I am not sure if this sensitiveness is beneficial. As the exact position of the Bank of England in the Money Market is indistinctly seen, there is no standard to which a Bank governor can appeal. He is always in fear that 'something may be said;' but not quite knowing on what side that 'something' may be, his fear is but an indifferent guide to him. But if the cardinal doctrine were accepted, if it were acknowledged that the Bank is charged with the custody of our sole banking reserve, and is bound to deal with it according to admitted principles, then a governor of the Bank could look to those principles. He would know which way criticism was coming. If he was guided by the code, he would have a plain defence. And then we may be sure that old men of business would not deviate from the code. At present the Board of Directors are a sort of semi- trustees for the nation. I would have them real trustees, and with a good trust deed.

Secondly. The government of the Bank should be improved in a manner to be explained. We should diminish the 'amateur' element; we should augment the trained banking element; and we should ensure more constancy in the administration.

Thirdly. As these two suggestions are designed to make the Bank as strong as possible, we should look at the rest of our banking system, and try to reduce the demands on the Bank as much as we can. The central machinery being inevitably frail, we should carefully and as much as possible diminish the strain upon it.

But to explain these proposals, and to gain a full understanding of many arguments that have been used, we must look more in detail at the component parts of Lombard street, and at the curious set of causes which have made it assume its present singular structure.

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

Head Office 1
Branches 139
Auxiliary Offices 71
Agencies 360
Total 571

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:—

Notes £112,000,000
Deposits £15,000,000

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

These are the amounts at December 31st, 1865. See 'Grundzüge der National-Œkonomie,' von Max Wirth, Dritter Band, p. 491.
Notes £761,000,000
Deposits £4,709,000

[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—

Deposits £1,880,000
Circulation £10,999,000

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.

II.

The monarchical form of Lombard Street is due also to the note issue. The origin of the Bank of England has been told by Macaulay, and it is never wise for an ordinary writer to tell again what he has told so much better. Nor is it necessary, for his writings are in everyone's hands. Still I must remind my readers of the curious story.

Of all institutions in the world the Bank of England is now probably the most remote from party politics and from 'financing.' But in its origin it was not only a finance company, but a Whig finance company. It was founded by a Whig Government because it was in desperate want of money, and supported by the 'City' because the 'City' was Whig. Very briefly, the story was this. The Government of Charles II. (under the Cabal Ministry) had brought the credit of the English State to the lowest possible point. It had perpetrated one of those monstrous frauds, which are likewise gross blunders. The goldsmiths, who then carried on upon a trifling scale what we should now call banking, used to deposit their reserve of treasure in the 'Exchequer,' with the sanction and under the care of the Government. In many European countries the credit of the State had been so much better than any other credit, that it had been used to strengthen the beginnings of banking. The credit of the state had been so used in England: though there had lately been a civil war and several revolutions, the honesty of the English Government was trusted implicitly. But Charles II. showed that it was trusted undeservedly. He shut up the 'Exchequer,' would pay no one, and so the 'goldsmiths' were ruined.

The credit of the Stuart Government never recovered from this monstrous robbery, and the Government created by the Revolution of 1688 could hardly expect to be more trusted with money than its predecessor. A Government created by a revolution hardly ever is. There is a taint of violence which capitalists dread instinctively, and there is always a rational apprehension that the Government which one revolution thought fit to set up another revolution may think fit to pull down. In 1694, the credit of William III.'s Government was so low in London that it was impossible for it to borrow any large sum; and the evil was the greater, because in consequence of the French war the financial straits of the Government were extreme. At last a scheme was hit upon which would relieve their necessities. 'The plan,' says Macaulay, 'was that twelve hundred thousand pounds should be raised at what was then considered as the moderate rate of 8 per cent.' In order to induce the subscribers to advance the money promptly on terms so unfavourable to the public, the subscribers were to be incorporated by the name of the Governor and Company of the Bank of England. They were so incorporated, and the 1,200,000 l. was obtained.

On many succeeding occasions, their credit was of essential use to the Government. Without their aid, our National Debt could not have been borrowed; and if we had not been able to raise that money we should have been conquered by France and compelled to take back James II. And for many years afterwards the existence of that debt was a main reason why the industrial classes never would think of recalling the Pretender, or of upsetting the revolution settlement. The 'fund-holder' is always considered in the books of that time as opposed to his 'legitimate' sovereign, because it was to be feared that this sovereign would repudiate the debt which was raised by those who dethroned him, and which was spent in resisting him and his allies. For a long time the Bank of England was the focus of London Liberalism, and in that capacity rendered to the State inestimable services. In return for these substantial benefits the Bank of England received from the Government, either at first or afterwards, three most important privileges.

First. The Bank of England had the exclusive possession of the Government balances. In its first period, as I have shown, the Bank gave credit to the Government, but afterwards it derived credit from the Government. There is a natural tendency in men to follow the example of the Government under which they live. The Government is the largest, most important, and most conspicuous entity with which the mass of any people are acquainted; its range of knowledge must always be infinitely greater than the average of their knowledge, and therefore, unless there is a conspicuous warning to the contrary, most men are inclined to think their Government right, and, when they can, to do what it does. Especially in money matters a man might fairly reason—'If the Government is right in trusting the Bank of England with the great balance of the nation, I cannot be wrong in trusting it with my little balance.'

Second. The Bank of England had, till lately, the monopoly of limited liability in England. The common law of England knows nothing of any such principle. It is only possible by Royal Charter or Statute Law. And by neither of these was any real bank (I do not count absurd schemes such as Chamberlayne's Land Bank) permitted with limited liability in England till within these few years. Indeed, a good many people thought it was right for the Bank of England, but not right for any other bank. I remember hearing the conversation of a distinguished merchant in the City of London, who well represented the ideas then most current He was declaiming against banks of limited liability, and some one asked—'Why, what do you say, then, to the Bank of England, where you keep your own account?' 'Oh!' he replied, 'that is an exceptional case.' And no doubt it was an exception of the greatest value to the Bank of England, because it induced many quiet and careful merchants to be directors of the Bank, who certainly would not have joined any bank where all their fortunes were liable, and where the liability was not limited.

Thirdly. The Bank of England had the privilege of being the sole joint stock company permitted to issue bank notes in England. Private London bankers did indeed issue notes down to the middle of the last century, but no joint stock company could do so. The explanatory clause of the Act of 1742 sounds most curiously to our modern ears. 'And to prevent any doubt that may arise concerning the privilege or power given to the said governor and company'—that is, the Bank of England—'of EXCLUSIVE BANKING; and also in regard to creating any other bank or banks by Parliament, or restraining other persons from banking during the continuance of the said privilege granted to the governor and company of the Bank of England, as before recited;—it is hereby further enacted and declared by the authority aforesaid, that it is the true intent and meaning of the said Act that no other bank shall be created, established, or allowed by Parliament, and that it shall not be lawful for any body politic or corporate whatsoever created or to be created, or for any other persons whatsoever united or to be united in covenants or partnership exceeding the number of six persons in that part of Great Britain called England, to borrow, owe, or take up any sum or sums of money on their bills or notes payable on demand or at any less time than six months from the borrowing thereof during the continuance of such said privilege to the said governor and company, who are hereby declared to be and remain a corporation with the privilege of exclusive banking, as before recited.' To our modern ears these words seem to mean more than they did. The term banking was then applied only to the issue of notes and the taking up of money on bills on demand. Our present system of deposit banking, in which no bills or promissory notes are issued, was not then known on a great scale, and was not called banking. But its effect was very important. It in time gave the Bank of England the monopoly of the note issue of the Metropolis. It had at that time no branches, and so it did not compete for the country circulation. But in the Metropolis, where it did compete, it was completely victorious. No company but the Bank of England could issue notes, and unincorporated individuals gradually gave way, and ceased to do so. Up to 1844 London private bankers might have issued notes if they pleased, but almost a hundred years ago they were forced out of the field. The Bank of England has so long had a practical monopoly of the circulation, that it is commonly believed always to have had a legal monopoly.

And the practical effect of the clause went further: it was believed to make the Bank of England the only joint stock company that could receive deposits, as well as the only company that could issue notes. The gift of 'exclusive banking' to the Bank of England was read in its most natural modern sense: it was thought to prohibit any other banking company from carrying on our present system of banking. After joint stock banking was permitted in the country, people began to inquire why it should not exist in the Metropolis too? And then it was seen that the words I have quoted only forbid the issue of negotiable instruments, and not the receiving of money when no such instrument is given. Upon this construction, the London and Westminster Bank and all our older joint stock banks were founded. But till they began, the Bank of England had among companies not only the exclusive privilege of note issue, but that of deposit banking too. It was in every sense the only banking company in London.

With so many advantages over all competitors, it is quite natural that the Bank of England should have far outstripped them all. Inevitably it became the bank in London; all the other bankers grouped themselves round it, and lodged their reserve with it. Thus our one- reserve system of banking was not deliberately founded upon definite reasons; it was the gradual consequence of many singular events, and of an accumulation of legal privileges on a single bank which has now been altered, and which no one would now defend.

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.