PREFACE
In this work I attempt to gather up some of the lessons to be learnt from the experiences of the greatest of financial crises. Many predictions have been unrealized and many theories destroyed, and we are able, I think, to see with greater clearness and to grasp with more boldness the problems that perplexed us in the past. Banking, credit and currency problems have ever been subjects of contentious controversy, experts and academic critics alike being unable to agree upon their reading of phenomena and upon right interpretations. The problems are indisputably complex, the most complex, probably, in the vast domain of economics, and vision and logic have not guided us with sureness amidst their intricacies. Hence we have groped and gone our different ways, finding ourselves at no common goal. Royal Commissions have been asked for in order to tackle and, if possible, to find solutions that will be universally acceptable. For some time before last year’s crisis a small committee of bankers had been sitting in order primarily to deal with the reserve problem and the provision of emergency currency. It is believed they were on the point of presenting a scheme to deal with future crises when the sudden outbreak of the war put an end to their labours. Whether or not their scheme will ever be made known to the public may depend upon future developments. Perhaps the public may never be enlightened, for it may now be thought that inspiration and genius discovered the most practical solutions at the right moments. Something had to be done swiftly. And that which was decided upon swiftly revealed deeper insight, maybe, than slower deliberation.
This is not uncommon, however, in the career of genius. Civilization has profited more, perhaps, from flashes of inspiration than from uninspired controversy.
In order to build up my arguments I start from the foundation, and in the earlier chapters deal with the monetary problem and the general working of the banking system. These lead us into the region of dialectics and controversy and to a survey of the happenings during the crisis.
I urge amongst other contentions that banks do not in the true connotation of the word create credit. If it be possible to convince ourselves that they do not create credit, that credit is a something existing prior to and independently of banking, it will, I think, make the gold reserve problem easier to solve. What we gaze upon is not an unsubstantial structure called in Lombard Street “the superstructure of credit,” but is something more solid. It is a superstructure of wealth. All that banks do is to transform this wealth into liquid capital, resolve it into its constituent, or original, elements. This enables wealth to perform its fructifying functions, to reproduce itself, just as the mature fruit reproduces itself when re-sown. Were the wealth to remain in its fixed, or, as the market would say, its frozen form, what sort of wealth-harvest could we hope to gather from it? Unless it be made liquid it cannot flow. And if it did not flow, but remained frozen, sterility would result. If this transforming machinery were not provided by banks, the Government, on the nation’s behalf, would have to provide it, or the nation would become inert. As there is not, and never can be, enough legal tender coinage for this work, other legal tender currency should be provided.
In answer to those who have ever clamoured for high gold reserves I have endeavoured to show the impossibility, in the present system, of this realization. What critics have at the back of their consciousness is, not quantity per se, but proportion. They do not mean a mere counting of sovereigns, but the ratio of an individual bank’s reserve to its liabilities. A small bank cannot have as much gold as a large bank, but it can have as high a proportion. Now, a high proportion can be attained only by keeping down the loan-deposits. It cannot be attained by getting a larger quantity of gold if the loan-deposits grow correspondingly. When banks see these deposits rising and the proportion falling, they cease lending, call in their loans, and allow the proportion to rise. We then see what we fallaciously call the loan-fund of Lombard Street diminish, showing that the loan-fund is not in the deposits, but in the gold reserves and in the totality of the wealth in the keeping of the banks at any given moment.
When banks cease to lend they drive borrowers to the Bank of England. Borrowing there causes a drop in the Bank’s proportion. Therefore, we cannot have simultaneously high proportions of joint stock bank reserves and a high proportion of a Bank of England reserve unless both stop lending simultaneously. As the Bank’s reserve is the reserve of the joint stock banks collectively and the national reserve, then, if its proportion falls, the reserve-proportion of the entire system falls. The only way to keep it high is for all to stop lending and for the whole money market to lapse into a state of stagnation. So far as my knowledge extends, this has not been pointed out.
We know that efforts are made, by raising the Bank rate, to replenish the reserve automatically from outside sources. But whether the gold flows in or not, it does not disprove the fact that a high proportion in the independent joint stock banks and in the independent Bank of England cannot be maintained at simultaneous moments except by a simultaneous refusal to lend. It needs no exceptional power of imagination to picture what would result from this action. It would have the same consequences as a great destruction of capital by war or any other calamity. If we had an elastic legal tender system, to provide for what I call a supplementary inflow of legal tender, we could avoid many inconveniences from which the money market and the nation suffers.
The supply of liquid capital in a perfect economic system should keep pace with the output of wealth. But our system is not perfect. Progress must necessarily be impeded by artificial and arbitrary restrictions.
I think, too, we could simplify the problem by segregating the composite deposits of a bank. These deposits are an aggregation of what I call, for lack of something more precise, pure deposits and loan-deposits. The loan-deposits are debts to the bank, which the bank has power to call in. If these loan-depositors have legal power to withdraw money on demand, the banks have power to withdraw from many of them on demand. On the approach of a crisis, or stringency, they do this, though in certain contingencies such withdrawals might precipitate a crisis. Nevertheless, the important fact remains that they have power to call them in.
If we set the gold reserves against the pure deposits we shall find that the reserve is invariably high.
But why do we want a high proportion? Why do we wish to hoard gold, when we know that the hoarding of gold is more harmful than beneficial? To avoid a panic, the critics and seers say. But a panic is not a mathematical problem; it is a psychological problem. If mathematics could save us from fear and madness we could then automatically ensure general sanity and common sense. What mathematical proportion will save us from a panic? Who is to lay down the proportion? Where are we to draw the magical line of safety? Is it to be an exact proportion or an approximate proportion? Is it to be an universally exact or universally approximate proportion? Or is it to be an individually exact or approximate proportion? There can be no exactitude, particularly if we include the Bank of England. In mathematics, however, we must have exactitude, for half per cent below the formula might be fatal. And if in order to keep up the proportion simultaneously in Lombard Street and Threadneedle Street lending ceases, then the crisis comes, despite the proportion.
A psychological disease is not to be diagnosed by the mathematician. We must find a psychological remedy for it, and that remedy is knowledge and common sense. The nation that met the crisis in August last so calmly and has faced since, resolutely and philosophically, the most terrible ordeal of its existence, is not likely to be seized with ungovernable madness because we cannot get an exact mathematical formula in dealing with bank reserves. The knowledge, and the only knowledge that will keep them sane and calm, is that banking is conducted soundly. The confidence of the community is based, and justly based, upon sound banking methods. So long as banks transform into currency the best wealth, then they are soundly managed, irrespective of mathematical gold reserves. The best wealth is to be tested by time—that is, by its durability. The highest wealth is durable; the lowest wealth transient.
If we are to have no solid, lasting confidence in sound banking, only in mathematical ratios, and if the highest wealth the banks possess are to stand them in no stead in a panic, then banks can reasonably refuse to liquefy the best wealth. We could not in that case blame them if they speculated. If they maintain the mathematical inexact ratio laid down by critics they will be mathematically safe, for sound wealth in a panic will, the theorists say, be as worthless as unsound wealth.
If banks are conducted soundly, if they perform vital services to the nation, if the nation would stagnate without those services, if the nation restricts their freedom of action by the provision of an inadequate supply of legal tender and by the law of legal tender, then it is the duty of the nation to help them in that trouble for which they are not responsible. It is also expedient for the nation to do this. It would be conforming to the law of self-preservation. To do otherwise would be national suicide.
Banks cannot do two contrary things at the self-same moment. They cannot keep a high proportion and in the same moment lend freely. If they lend freely the proportion speedily falls, and might speedily fall far below the mathematical formula of safety. If they do not lend freely the mathematicians say they will aggravate the crisis. The only sensible course for the nation to take is to be its own physician. The Government on its behalf can do again what it did last year—provide a supplementary fund of legal tender currency. This was effective more than half a century ago, and it has been effective again. And experience is of greater value than theory.
These, then, are some of the questions I discuss in the following pages. I do not expect, of course, to find common agreement. This would be presumption. Nothing is more difficult than to destroy theories. Experience is often impotent. Prophets are not always silenced when their predictions are unrealized. They continue to prophecy. They predicted confidently that when the world-war came the financial crisis would be far worse than the military crisis, and that this country would be in the throes of a panic the dimensions of which no human imagination could conceive. Foreign countries with vast credits here would take away every sovereign and every bar of gold they could lay their hands on. Only those sovereigns would remain that we had been far-sighted enough to store in our back gardens, or, if we had no back gardens, in our discarded stockings. Nothing of this happened. There was no financial panic, no raid upon our gold reserves. If there was any apprehension it was mild and momentary, thanks to the soundness of our banking system, the strength of our financial structure, and the wisdom of our Government, to say nothing of the soul of the nation. It was discovered that, instead of other countries having it in their power to take gold from us, they were so greatly in our debt that they could not liquidate those debts, and the exchanges went violently against them. Since then gold has flowed into the country in unprecedented amount, and there is still no sign of interruption to the flow. This country is now overwhelmed with gold. The reserves of the Bank of England and of the joint stock banks continued to grow so rapidly that loans, or “credits” as they are called, glutted the market. Banks lent with difficulty even on nominal terms. So far from predictions being fulfilled, that has come to pass never dreamt of in the wildest of dreams—a land towards which, in the midst of war, the golden river was flowing, fed by tributary streams, and undiminished in volume by huge purchases of warlike stores and material from neutral countries.
The country was saved by wisdom—by the wisdom of the people and by the wisdom of the Government which promptly acted on the wisest advice. This begot confidence and strengthened faith. It was calm confidence and serene faith in intellectual ability that enabled the country to go through the crisis with success and that evoked the profound gratitude of all.
Confidence, the energizing, vitalizing spirit of economic progress is distinct from what is called Lombard Street credit. Yet both connote a confiding in or a believing in something. In what? Confidence is fundamentally a confiding in the greatness of the nation. There can be no confidence in the littleness of a nation.
The financial writer would probably be discharged who wrote in his money article: “Confidence in Lombard Street yesterday was in superabundant supply, and sellers could find no borrowers of it even on nominal terms. In fact, before the close of business balances of confidence were unplaceable. Overnight confidence fetched no more than 1 per cent. and weekly confidences 1½ per cent. In consequence, therefore, of this great mass and weight of confidence the discount market was very weak and rates fell further. It is thought probable that the Bank of England may have to make confidence scarcer and dearer by taking it off the market, that is to say, by borrowing confidence.”
Is, therefore, that superstructure of “credit” that superstructure of confidence beneath which the country economically prospers? Is there not often in Lombard Street an abundance of “credit” coincident with a scarcity of confidence? And is not all this “credit” impotent without confidence? Is prostrate confidence to obtain its re-creative power only from mountainous gold reserves? Or will it be regenerated by a new faith in the essential greatness and wealth of the country?
I have great hopes of the future. I give abundant reasons for this faith within me. Experience has taught me the incalculable harm pessimism does. Pessimism is like an infectious disease. It spreads quickly. It is difficult to fight against it. There are numerous sad-visaged prophets amongst us to-day—men without hope, men without a smile. They cannot cheer us. They see coming, with the inevitability and irresistibility of doom, the day of sorrow, the day when we shall reap the abundant aftermath of woe. But dark as the night may be, I see a new day of joy dawning, a day when the sowers will go forth with renewed hope and energy, with the confidence that they will gather in at the due season a harvest more abundant than they have reaped before. Let us not wring our hands and moan in dark corners. Let us look forward with brave hearts and strong minds to the day of victory and peace. That day will bring us a new faith, a new confidence, perhaps a new happiness in which we shall forget the old griefs and despairs.
W. W. W.
Catford, S.E.
February, 1915.