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Lombard Street: A Description of the Money Market by Walter Bagehot

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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.


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 injuries 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

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. 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.' 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 pmdence,
and the withdrawal of that favour as a punishment for culpable

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
species 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.


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, and this, for the most
part, enables other dealers to obtain that price, or something near

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 buythat 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 0 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 effiux. 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 compellingother 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 points 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 tooat least
a principal cause of periodical disturbance will have been withdrawn
from it.


Why Lombard Street Is Often Very Dull, and Sometimes Extremely

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 wayby keeping a large cash reserve.

But it is of great importance to point out that our industrial
organisation is liable not only to irregnlar external accidents, but
likewise to regnlar 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 ex plain 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

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 Bhe 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 labourersare 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

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

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
additionalthat 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 leastassumes as a first principle that he ought
to be able to 'put his money into something safe that will yield 5
per cent;' 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 highiy 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.

'The natural effect of this state of things was that a crowd of
projectors, ingenious and absurd, honest and knavish, employed
themselves in devising new schemes for the employment of redundant
capital. It was about the year 1688 that the word stockjobber was
first heard in London. In the short space of four years a crowd of
companies, every one of which confidently held out to subscribers
the hope of immense gains, sprang into existence--the Insurance
Company, the Paper Company, the Lutestring Company, the Pearl
Fishery Company, the Glass Bottle Company, the Alum Company, the
Blythe Coal Company, the Swordblade Company. There was a Tapestry
Company, which would soon furnish pretty hangings for all the
parlours of the middle class, and for all the bedchambers of the
higher. There was a Copper Company, which proposed to explore the
mines of England, and held out a hope that they would prove not less
valuable than those of Potosi. There was a Diving Company, which
undertook to bring up precious effects from shipwrecked vessels, and
which announced that it had laid in a stock of wonderful machines
resembling complete suits of armour. In front of the helmet was a
huge glass eye like that of a Cyclops; and out of the crest went a
pipe through which the air was to be admitted. The whole process was
exhibited on the Thames. Fine gentlemen and fine ladies were invited
to the show, were hospitably regaled, and were delighted by seeing
the divers in their panoply descend into the river and return laden
with old iron and ship's tackle. There was a Greenland Fishing
Company, which could not fail to drive the Dutch whalers and herring
busses out of the Northern Ocean. There was a Tanning Company, which
promised to furnish leather superior to the best that was brought
from Turkey or Russia. There was a society which undertook the
office of giving gentlemen a liberal education on low terms, and
which assumed the sounding name of the Royal Academies Company. In a
pompous advertisement it was announced that the directors of the
Royal Academies Company had engaged the best masters in every branch
of knowledge, and were about to issue twenty thousand tickets at
twenty shillings each. There was to be a lottery--two thousand prizes
were to be drawn; and the fortunate holders of the prizes were to be
taught, at the charge of the Company, Latin, Greek, Hebrew, French,
Spanish, conic sections, trigonometry, heraldry, japaning,
fortification, bookkeeping, and the art of playing the theorbo.'

The panic was forgotten till Lord Macaulay revived the memory of it.
But, in fact, in the South Sea Bubble, which has always been
remembered, the form was the same, only a little more extravagant;
the companies in that mania were for objects such as these:--' "Wrecks
to be fished for on the Irish Coast--Insurance of Horses and other
Cattle (two millions)--Insurance of Losses by Servants--To make Salt
Water Fresh--For building of Hospitals for Bastard Children--For
building of Ships against Pirates--For making of Oil from Sun-flower
Seeds--For improving of Malt Liquors--For recovery of Seamen's Wages--For
extracting of Silver from Lead--For the transmuting of Quicksilver
into a malleable and fine Metal--For making of Iron with Pit-coal--For
importing a Number of large Jack Asses from Spain--For trading in
Human Hair--For fatting of Hogs--For a Wheel of Perpetual Motion." But
the most strange of all, perhaps, was "For an Undertaking which
shall in due time be revealed." Each subscriber was to pay down two
gnineas, and hereafter to receive a share of one hundred, with a
disclosure of the object; and so tempting was the offer, that 1,000
of these subscriptions were paid the same morning, with which the
projector went off in the afternoon.' In 1825 there were
speculations in companies nearly as wild, and just before 1866 there
were some of a like nature, though not equally extravagant. The fact
is, that the owners of savings not finding, in adequate quantities,
their usual kind of investments, rush into anything that promises
speciously, and when they find that these specious investments can
be disposed of at a high profit, they rush into them more and more.
The first taste is for high interest, but that taste soon becomes
secondary. There is a second appetite for large gains to be made by
selling the principal which is to yield the interest. So long as
such sales can be effected the mania continues; when it ceases to be
possible to effect them, ruin begins.

So long as the savings remain in possession of their owners, these
hazardous gamblings in speculative undertakings are almost the whole
effect of an excess of accumulation over tested investment. Little
effect is produced on the general trade of the country. The owners
of the savings are too scattered and far from the market to change
the majority of mercantile transactions. But when these savings come
to be lodged in the hands of bankers, a much wider result is
produced. Bankers are close to mercantile life; they are always
ready to lend on good mercantile securities; they wish to lend on
such securities a large part of the money entrusted to them. When,
therefore, the money so entrusted is unusually large, and when it
long continues so, the general trade of the country is, in the
course of time, changed. Bankers are daily more and more ready to
lend money to mercantile men; more is lent to such men; more
bargains are made in consequence; commodities are more sought after;
and, in consequence, prices rise more and more.

The rise of prices is quickest in an improving state of credit.
Prices in general are mostly determined by wholesale transactions.
The retail dealer adds a percentage to the wholesale prices, not, of
course, always the same percentage, but still mostly the same. Given
the wholesale price of most articles, you can commonly tell their
retail price. Now wholesale transactions are commonly not cash
transactions, but bill transactions. The duration of the bill varies
with the custom of the trade; it may be two, three months, or six
weeks, but there is always a bill. Times of credit mean times in
which the bills of many people are taken readily; times of bad
credit, times when the bills of much fewer people are taken, and
even of those suspiciously. In times of good credit there are a
great number of strong purchasers, and in times of bad credit only a
smaller number of weak ones; and, therefore, years of improving
credit, if there be no disturbing cause, are years of rising price,
and years of decaying credit, years of falling price.

This is the meaning of the saying 'John Bull can stand many things,
but he cannot stand two per cent:' it means that the greatest effect
of the three great causes is nearly peculiar to England; here, and
here almost alone, the excess of savings over investments is
deposited in banks; here, and here only, is it made use of so as to
affect trade at large; here, and here only, are prices gravely
affected. In these circumstances, a low rate of interest, long
protracted, is equivalent to a total depreciation of the precious
metals. In his book on the effect of the great gold discoveries,
Professor Jevons showed, and so far as I know, was the first to
show, the necessity of eliminating these temporary changes of value
in gold before you could judge properly of the permanent
depreciation. He proved, that in the years preceding both 1847 and
1857 there was a general rise of prices; and in the years succeeding
these years, a great fall. The same might be shown of the years
before and after 866, _mutatis mutandis_.

And at the present moment we have a still more remarkable example,
which was thus analysed in the Economist of the 30th December, 1871,
in an article which I venture to quote as a whole:


'Most persons are aware that the trade of the country is in a state
of great activity. All the usual tests indicate that--the state of the
Revenue, the Bankers' Clearing-house figures, the returns of exports
and imports are all plain, and all speak the same language. But few
have, we think, considered one most remarkable feature of the
present time, or have sufficiently examined its consequences. That
feature is the great rise in the price of most of the leading
articles of trade during the past year. We give at the foot of this
paper a list of articles, comprising most first-rate articles of
commerce, and it will be seen that the rise of price, though not
universal and not uniform, is nevertheless very striking and very
general. The most remarkable cases are--

January December
L, s. d. L, s. d.
Wool--South Down hogs per pack 13 0 0 21 15 0
Cotton--Upland ordinary per lb. 0 0 7 1/4 0 0 8
No. 40 mule yarn, &c. per lb. 0 1 1 1/2 0 1 2 1/2
Iron--Bars, British per ton 7 2 6 8 17 6
Pig, No. 1 Clyde per ton 2 13 3 3 16 0
Lead per ton 18 7 6 8 17 6
Tin per ton 137 0 0 157 0 0
Copper--Sheeting per ton 75 10 0 95 0 0
Wheat (GAZETTE average) per qr. 2 12 0 2 15 8

--and in other cases there is a tendency upwards in price much more
often than there is a tendency downwards.

'This general rise of price must be due either to a diminution in
the supply of the quoted articles, or to an increased demand for
them. In some cases there has no doubt been a short supply. Thus in
wool, the diminution in the home breed of sheep has had a great
effect on the price--

In 1869 the home stock of sheep was 29,538,000
In 1871 27,133,000
Diminution 2,405,000
Equal to 8.1 per cent

and in the case of some other articles there may be a similar cause
operating. But taking the whole mass of the supply of commodities in
this country, as shown by the plain test of the quantities imported,
it has not diminished, but augmented. The returns of the Board of
Trade prove this in the most striking manner, and we give below a
table of some of the important articles. The rise in prices must,
therefore, be due to an increased demand, and the first question is,
to what is that demand due?

'We believe it to be due to the combined operation of three causes
cheap money, cheap corn, and improved credit. As to the first
indeed, it might be said at first sight that so general an increase
must be due to a depreciation of the precious metals. Certainly in
many controversies facts far less striking have been alleged as
proving it. And indeed there plainly is a diminution in the
purchasing power of money, though that diminution is not general and
permanent, but local and temporary. The peculiarity of the precious
metals is that their value depends for unusually long periods on the
quantity of them which is in the market. In the long run, their
value, like that of all others, is determined by the cost at which
they can be brought to market. But for all temporary purposes, it is
the supply in the market which governs the price, and that supply in
this country is exceedingly variable. After a commercial crisis, 1866
for example, two things happen: first, we call in the debts which are
owing to us in foreign countries; and we require these debts to be
paid to us, not in commodities, but in money. From this cause
principally, and omitting minor causes, the bullion in the Bank of
England, which was 13,156,000 L. in May 1866, rose to 19,413,000 L.
in January 1867, being an increase of over 6,000,000 L. And then
there comes also a second cause, tending in the same direction.
During a depressed period the savings of the country increase
considerably faster than the outlet for them. A person who has made
savings does not know what to do with them. And this new unemployed
saving means additional money. Till a saving is invested or employed
it exists only in the form of money: a farmer who has sold his wheat
and has 100 L. 'to the good,' holds that 100 L. in money, or some
equivalent for money, till he sees some advantageous use to be made
of it. Probably he places it in a bank, and this enables it to do
more work. If 3,000,000 L. of coin be deposited in a bank, and it
need only keep 1,000,000 L. as a reserve, that sets 2,000,000 L.
free, and is for the time equivalent to an increase of so much coin.
As a principle it may be laid down that all new unemployed savings
require _either an increased stock of the precious metals, or an
increase in the efficiency of the banking expedients by which these
metals are economised_. In other words, in a saving and uninvesting
period of the national industry, we accumulate gold, and augment the
efficiency of our gold. If therefore such a saving period follows
close upon an occasion when foreign credits have been diminished and
foreign debts called in, the augmentation in the effective quantity
of gold in the country is extremely great. The old money called in
from abroad and the new money representing the new saving co-operate
with one another. And their natural tendency is to cause a general
rise in price, and what is the same thing, a diffused diminution in
the purchasing power of money.

'Up to this point there is nothing special in the recent history of
the money market. Similar events happened both after the panic of
1847, and after that of 1857. But there is another cause of the same
kind, and acting in the same direction, which is peculiar to the
present time; this cause is the amount of the foreign money, and
especially of the money of foreign Governments, now in London. No
Government probably ever had nearly as much at its command as the
German Government now has. Speaking broadly, two things happened:
during the war England was the best place of shelter for foreign
money, and this made money more cheap here than it would otherwise
have been; after the war England became the most convenient paying
place, and the most convenient resting place for money, and this
again has made money cheaper. The commercial causes, for which there
are many precedents, have been aided by a political cause for the
efficacy of which there is no precedent.

'But though plentiful money is necessary to high prices, and though
it has a natural tendency to produce these prices, yet it is not of
itself sufficient to produce them. In the cases we are dealing with,
in order to lower prices there must not only be additional money,
but a satisfactory mode of employing that additional money. This is
obvious if we remember whence that augmented money is derived. It is
derived from the savings of the people, and will only be invested in
the manner which the holders for the time being consider suitable to
such savings. It will not be used in mere expenditure; it would be
contrary to the very nature of it so to use it. A new channel of
demand is required to take off the new money, or that new money will
not raise prices. It will lie idle in the banks, as we have often
seen it. We should still see the frequent, the common phenomenon of
dull trade and cheap money existing side by side.

'The demand in this case arose in the most effective of all ways. In
1867 and the first half of 1868 corn was dear, as the following
figures show:

s. d.
December, 1866 60 3
January, 1867 61 4
February 60 10
March 59 9
April 61 6
May 64 8
June 65 8
July 65 0
August 67 8
September 62 8
October 1867 66 6
November 69 5
December 67 4
January, 1868 70 3
February 73 0
March 73 0
April 73 3
May 73 9
June 67 11
July 65 5

From that time it fell, and it was very cheap during the whole of
1869 and 1870. The effect of this cheapness is great in every
department of industry. The working classes, having cheaper food,
need to spend so much less on that food, and have more to spend on
other things. In consequence, there is a gentle augmentation of
demand through almost all departments of trade. And this almost
always causes a great augmentation in what may be called the
instrumental trades--that is, in the trades which deal in machines and
instruments used in many branches of commerce, and in the materials
for such. Take, for instance, the iron trade--

In the year 1869 we exported 2,568,000 tons
" 1870 " 2,716,000 tons
5,284,000 tons
" 1867 " 1,881,000 tons
" 1868 " 1,944,000 tons
3,826,000 tons
Increase 1,458,000 tons

that is to say, cheap corn operating throughout the world, created a
new demand for many kinds of articles; the production of a large
number of such articles being aided by iron in some one of its many
forms, iron to that extent was exported. And the effect is
cumulative. The manufacture of iron being stimulated, all persons
concerned in that great manufacture are well off, have more to
spend, and by spending it encourage other branches of manufacture,
which again propagate the demand; they receive and so encourage
industries in a third degree dependent and removed.

'It is quite true that corn has not been quite so cheap during the
present year. But even if it had been dearer than it is, it would
not all at once arrest the great trade which former cheapness had
created. The "ball," if we may so say, "was set rolling" in 1869 and
1870, and a great increase of demand was then created in certain
trades and propagated through all trades. A continuance of very high
prices would produce the reverse effect; it would slacken demand in
certain trades, and the effect would be gradually diffused through
all trades. But a slight rise such as that of this year has no
perceptible effect.

'When the stimulus of cheap corn is added to that of cheap money,
the full conditions of a great and diffused rise of prices are
satisfied. This new employment supplies a mode in which money can be
invested. Bills are drawn of greater number and greater magnitude,
and through the agencies of banks and discount houses, the savings
of the country are invested in such bills. There is thus a new want
and a new purchase-money to supply that want, and the consequence is
the diffused and remarkable rise of price which the figures show to
have occurred.

'The rise has also been aided by the revival of credit. This, as
need not be at length explained, is a great aid to buying, and
consequently a great aid to a rise of price. Since 1866, credit has
been gradually, though very slowly, recovering, and it is probably
as good as it is reasonable or proper that it should be. We are now
trusting as many people as we ought to trust, and as yet there is no
wild excess of misplaced confidence which would make us trust those
whom we ought not to trust.'

The process thus explained is the common process. The surplus of
loanable capital which lies in the hands of bankers is not employed
by them in any original way; it is almost always lent to a trade
already growing and already improving. The use of it develops that
trade yet farther, and this again augments and stimulates other
trades. Capital may long lie idle in a stagnant condition of
industry; the mercantile securities which experienced bankers know
to be good do not augment, and they will not invent other
securities, or take bad ones.

In most great periods of expanding industry, the three great causes
much loanable capital, good credit, and the increased profits
derived from better-used labour and better-used capitalhave acted
simultaneously; and though either may act by itself, there is a
permanent reason why mostly they will act together. They both tend
to grow together, if you begin from a period of depression. In such
periods credit is bad, and industry unemployed; very generally
provisions are high in price, and their dearness was one of the
causes which made the times bad. Whether there was or was not too
much loanable capital when that period begins, there soon comes to
be too much. Quiet people continue to save part of their incomes in
bad times as well as in good; indeed, of the two, people of
slightly-varying and fixed incomes have better means of saving in
bad times because prices are lower. Quiescent trade affords no new
securities in which the new saving can be invested, and therefore
there comes soon to be an excess of loanable capital. In a year or
two after a crisis credit usually improves, as the remembrance of
the disasters which at the crisis impaired credit is becoming
fainter and fainter. Provisions get back to their usual price, or
some great industry makes, from some temporary cause, a quick step
forward. At these moments, therefore, the three agencies which, as
has been explained, greatly develope trade, combine to develope it

The certain result is a bound of national prosperity; the country
leaps forward as if by magic. But only part of that prosperity has a
solid reason. As far as prosperity is based on a greater quantity of
production, and that of the right articlesas far as it is based on
the increased rapidity with which commodities of every kind reach
those who want themits basis is good. Human industry is more
efficient, and therefore there is more to be divided among mankind.
But in so far as that prosperity is based on a general rise of
prices, it is only imaginary. A general rise of prices is a rise
only in name; whatever anyone gains on the article which he has to
sell he loses on the articles which he has to buy, and so he is just
where he was. The only real effects of a general rise of prices are
these: first, it straitens people of fixed incomes, who suffer as
purchasers, but who have no gain to correspond; and secondly, it
gives an extra profit to fixed capital created before the rise
happened. Here the sellers gain, but without any equivalent loss as
buyers. Thirdly, this gain on fixed capital is greatest in what may
be called the industrial 'implements,' such as coal and iron. These
are wanted in all industries, and in any general increase of prices,
they are sure to rise much more than other things. Everybody wants
them; the supply of them cannot be rapidly augmented, and therefore
their price rises very quickly. But to the country as a whole, the
general rise of prices is no benefit at all; it is simply a change
of nomenclature for an identical relative value in the same
commodities. Nevertheless, most people are happier for it; they
think they are getting richer, though they are not. And as the rise
does not happen on all articles at the same moment, but is
propagated gradually through society, those to whom it first comes
gain really; and as at first every one believes that he will gain
when his own article is rising, a buoyant cheerfulness overflows the
mercantile world.

This prosperity is precarious as far as it is real, and transitory
in so far as it is fictitious. The augmented production, which is
the reason of the real prosperity, depends on the full working of
the whole industrial organisationof all capitalists and labourers;
that prosperity was caused by that full working, and will cease with
it. But that full working is liable to be destroyed by the
occurrence of any great misfortune to any considerable industry.
This would cause misfortune to the industries dependent on that one,
and, as has been explained, all through society and back again. But
every such industry is liable to grave fluctuations, and the most
important--the provision industries--to the gravest and the suddenest.
They are dependent on the casualties of the seasons. A single bad
harvest diffused over the world, a succession of two or three bad
harvests, even in England only, will raise the price of corn
exceedingly, and will keep it high. And a great and protracted rise
in the price of corn will at once destroy all the real part of the
unusual prosperity of previous good times. It will change the full
working of the industrial machine into an imperfect working; it will
make the produce of that machine less than usual instead of more
than usual; instead of there being more than the average of general
dividend to be distributed between the producers, there will
immediately be less than the average.

And in so far as the apparent prosperity is caused by an unusual
plentifulness of loanable capital and a consequent rise in prices,
that prosperity is not only liable to reaction, but certain to be
exposed to reaction. The same causes which generate this prosperity
will, after they have been acting a little longer, generate an
equivalent adversity. The process is this: the plentifulness of
loanable capital causes a rise of prices; that rise of prices makes
it necessary to have more loanable capital to carry on the same
trade. 100,000 L. will not buy as much when prices are high as it
will when prices are low, it will not be so effectual for carrying
on business; more money is necessary in dear times than in cheap
times to produce the same changes in the same commodities. Even
supposing trade to have remained stationary, a greater capital would
be required to carry it on after such a rise of prices as has been
described than was necessary before that rise. But in this case the
trade will not have remained stationary; it will have
increasedcertainly to some extent, probably to a great extent. The
'loanable capital,' the lending of which caused the rise of prices,
was lent to enable it--to augment. The loanable capital lay idle in
the banks till some trade started into prosperity, and then was lent
in order to develope that trade; that trade caused other secondary
developments; those secondary developments enabled more loanable
capital to be lent; and that lending caused a tertiary development
of trade; and so on through society.

In consequence, a long-continued low rate of interest is almost
always followed by a rapid rise in that rate. Till the available
trade is found it lies idle, and can scarcely be lent at all; some
of it is not lent. But the moment the available trade is
discoveredthe moment that prices have risen--the demand for loanable
capital becomes keen. For the most part, men of business must carry
on their regular trade; if it cannot be carried on without borrowing
10 per cent more capital, 10 per cent more capital they must borrow.
Very often they have incurred obligations which must be met; and if
that is so the rate of interest which they pay is comparatively
indifferent. What is necessary to meet their acceptances they will
borrow, pay for it what they may; they had better pay any price than
permit those acceptances to be dishonoured. And in less extreme
eases men of business have a fixed capital, which cannot lie idle
except at a great loss; a set of labourers which must be, if
possible, kept together; a steady connection of customers, which
they would very unwillingly lose. To keep all these, they borrow;
and in a period of high prices many merchants are peculiarly anxious
to borrow, because the augmentation of the price of the article in
which they deal makes them really see, or imagine that they see,
peculiar opportunities of profit. An immense new borrowing soon
follows upon the new and great trade, and the rate of interest rises
at once, and generally rises rapidly.

This is the surer to happen that Lombard Street is, as has been
shown before, a very delicate market. A large amount of money is
held there by bankers and by bill-brokers at interest: this they
must employ, or they will be ruined. It is better for them to reduce
the rate they charge, and compensate themselves by reducing the rate
they pay, rather than to keep up the rate of charge, if by so doing
they cannot employ all their money. It is vital to them to employ
all the money on which they pay interest. A little excess therefore
forces down the rate of interest very much. But if that low rate of
interest should cause, or should aid in causing, a great growth of
trade, the rise is sure to be quick, and is apt to be violent. The
figures of trade are reckoned by hundreds of millions, where those
of loanable capital count only by millions. A great increase in the
borrowing demands of English commerce almost always changes an
excess of loanable capital above the demand to a greater deficiency
below the demand. That deficiency causes adversity, or apparent
adversity, in trade, just as, and in the same manner, that the
previous excess caused prosperity, or apparent prosperity. It causes
a fall of price that runs through society; that fall causes a
decline of activity and a diminution of profitsa painful contraction
instead of the previous pleasant expansion.

The change is generally quicker because some check to credit happens
at an early stage of it. The mercantile community will have been
unusually fortunate if during the period of rising prices it has not
made great mistakes. Such a period naturally excites the sanguine
and the ardent; they fancy that the prosperity they see will last
always, that it is only the beginning of a greater prosperity. They
altogether over-estimate the demand for the article they deal in, or
the work they do. They all in their degreeand the ablest and the
cleverest the mostwork much more than they should, and trade far
above their means. Every great crisis reveals the excessive
speculations of many houses which no one before suspected, and which
commonly indeed had not begun or had not carried very far those
speculations, till they were tempted by the daily rise of price and
the surrounding fever.

The case is worse, because at most periods of great commercial
excitement there is some mixture of the older and simpler kind of
investing mania. Though the money of saving persons is in the hands
of banks, and though, by offering interest, banks retain the command
of much of it, yet they do not retain the command of the whole, or
anything near the whole; all of it can be used, and much of it is
used, by its owners. They speculate with it in bubble companies and
in worthless shares, just as they did in the time of the South Sea
mania, when there were no banks, and as they would again in England
supposing that banks ceased to exist. The mania of 1825 and the
mania of 1866 were striking examples of this; in their case to a
great extent, as in most similar modern periods to a less extent,
the delirium of ancient gambling co-operated with the milder madness
of modern overtrading. At the very beginning of adversity, the
counters in the gambling mama, the shares in the companies created
to feed the mania, are discovered to be worthless; down they all go,
and with them much of credit.

The good times too of high price almost always engender much fraud.
All people are most credulous when they are most happy; and when
much money has just been made, when some people are really making
it, when most people think they are making it, there is a happy
opportunity for ingenious mendacity. Almost everything will be
believed for a little while, and long before discovery the worst and
most adroit deceivers are geographically or legally beyond the reach
of punishment. But the harm they have done diffuses harm, for it
weakens credit still farther.

When we understand that Lombard Street is subject to severe
alternations of opposite causes, we should cease to be surprised at
its seeming cycles. We should cease too to be surprised at the
sudden panics. During the period of reaction and adversity, just
even at the last instant of prosperity, the whole structure is
delicate. The peculiar essence of our banking system is an
unprecedented trust between man and man: and when that trust is much
weakened by hidden causes, a small accident may greatly hurt it, and
a great accident for a moment may almost destroy it.

Now too that we comprehend the inevitable vicissitudes of Lombard
Street, we can also thoroughly comprehend the cardinal importance of
always retaining a great banking reserve. Whether the times of
adversity are well met or ill met depends far more on this than on
any other single circumstance. If the reserve be large, its
magnitude sustains credit; and if it be small, its diminution
stimulates the gravest apprehensions. And the better we comprehend
the importance of the banking reserve, the higher we shall estimate
the responsibility of those who keep it.


A More Exact Account of the Mode in Which the Bank of England
Has Discharged Its Duty of Retaining a Good Bank Reserve,
and of Administering It Effectually.

The preceding chapters have in some degree enabled us to appreciate
the importance of the duties which the Bank of England is bound to
discharge as to its banking reserve.

If we ask how the Bank of England has discharged this great
responsibility, we shall be struck by three things: first, as has
been said before, the Bank has never by any corporate act or
authorised utterance acknowledged the duty, and some of its
directors deny it; second (what is even more remarkable), no
resolution of Parliament, no report of any Committee of Parliament
(as far as I know), no remembered speech of a responsible statesman,
has assigned or enforced that duty on the Bank; third (what is more
remarkable still), the distinct teaching of our highest authorities
has often been that no public duty of any kind is imposed on the
Banking Department of the Bank; that, for banking purposes, it is
only a joint stock bank like any other bank; that its managers
should look only to the interest of the proprietors and their
dividend; that they are to manage as the London and Westminster Bank
or the Union Bank manages.

At first, it seems exceedingly strange that so important a
responsibility should be unimposed, unacknowledged, and denied; but
the explanation is this. We are living amid the vestiges of old
controversies, and we speak their language, though we are dealing
with different thoughts and different facts. For more than fifty
yearsfrom 1793 down to 1844, there was a keen controversy as to the
public duties of the Bank. It was said to be the 'manager' of the
paper currency, and on that account many expected much good from it;
others said it did great harm; others again that it could do neither
good nor harm. But for the whole period there was an incessant and
fierce discussion. That discussion was terminated by the Act of
1844. By that Act the currency manages itself; the entire working is
automatic. The Bank of England plainly does not manage--cannot even be
said to manage--the currency any more. And naturally, but rashly, the
only reason upon which a public responsibility used to be assigned
to the Bank having now clearly come to an end, it was inferred by
many that the Bank had no responsibility. The complete uncertainty
as to the degree of responsibility acknowledged by the Bank of
England is best illustrated by what has been said by the Bank
directors themselves as to the panic of 1866. The panic of that year,
it will be remembered, happened, contrary to precedent, in the
spring, and at the next meeting of the Court of Bank proprietors--the
September meeting--there was a very remarkable discussion, which I
give at length below, and of which all that is most material was
thus described in the 'Economist':


'The late meeting of the proprietors of the Bank of England has a
very unusual importance. There can be no effectual inquiry now into
the history of the late crisis. A Parliamentary committee next year
would, unless something strange occur in the interval, be a great
waste of time. Men of business have keen sensations but short
memories, and they will care no more next February for the events of
last May than they now care for the events of October 1864. A pro
forma inquiry, on which no real mind is spent, and which everyone
knows will lead to nothing, is far worse than no inquiry at all.
Under these circumstances the official statements of the Governor of
the Bank are the only authentic expositions we shall have of the
policy of the Bank Directors, whether as respects the past or the
future. And when we examine the proceedings with care, we shall find
that they contain matter of the gravest import.

'This meeting may be considered to admit and recognise the fact that
the Bank of England keeps the sole banking reserve of the country.
We do not now mix up this matter with the country circulation, or
the question whether there should be many issuers of notes or only
one. We speak not of the currency reserve, but of the banking
reserve--the reserve held against deposits, and not the reserve held
against notes. We have often insisted in these columns that the Bank
of England does keep the sole real reserve--the sole considerable
unoccupied mass of cash in the country; but there has been no
universal agreement about it. Great authorities have been unwilling
to admit it. They have not, indeed, formally and explicitly
contended against it. If they had, they must have pointed out some
other great store of unused cash besides that at the Bank, and they
could not find such store. But they have attempted distinctions; have
said that the doctrine that the Bank of England keeps the sole
banking reserve of the country was "not a good way of putting it,"
was exaggerated, and was calculated to mislead.

'But the late meeting is a complete admission that such is the fact.
The Governor of the Bank said:

"'A great strain has within the last few months been put upon the
resources of this house, and of the whole banking community of
London; and I think I am entitled to say that not only this house,
but the entire banking body, acquitted themselves most honourably
and creditably throughout that very trying period. Banking is a very
peculiar business, and it depends so much upon credit that the least
blast of suspicion is sufficient to sweep away, as it were, the
harvest of a whole year. But the manner in which the banking
establishments generally in London met the demands made upon them
during the greater portion of the past half-year affords a most
satisfactory proof of the soundness of the principles on which their
business is conducted. This house exerted itself to the utmostand
exerted itself most successfully--to meet the crisis. We did not
flinch from our post. When the storm came upon us, on the morning on
which it became known that the house of Overend and Co. had failed,
we were in as sound and healthy a position as any banking
establishment could hold, and on that day and throughout the
succeeding week we made advances which would hardly be credited. I
do not believe that anyone would have thought of predicting, even at
the shortest period beforehand, the greatness of those advances. It
was not unnatural that in this state of things a certain degree of
alarm should have taken possession of the public mind, and that
those who required accommodation from the Bank should have gone to
the Chancellor of the Exchequer and requested the Government to
empower us to issue notes beyond the statutory amount, if we should
think that such a measure was desirable. But we had to act before we
could receive any such power, and before the Chancellor of the
Exchequer was perhaps out of his bed we had advanced one-half of our
reserves, which were certainly thus reduced to an amount which we
could not witness without regret. But we would not flinch from the
duty which we conceived was imposed upon us of supporting the
banking community, and I am not aware that any legitimate
application made for assistance to this house was refused. Every
gentleman who came here with adequate security was liberally dealt
with, and if accommodation could not be afforded to the full extent
which was demanded, no one who offered proper security failed to
obtain relief from this house."

'Now this is distinctly saying that the other banks of the country
need not keep any such banking reserveany such sum of actual cashof
real sovereigns and bank notes, as will help them through a sudden
panic. It acknowledges a "duty" on the part of the Bank of England
to "support the banking community," to make the reserve of the Bank
of England do for them as well as for itself.

'In our judgment this language is most just, and the Governor of the
Bank could scarcely have done a greater public service than by using
language so businesslike and so distinct. Let us know precisely who
is to keep the banking reserve. If the joint stock banks and the
private banks and the country banks are to keep their share, let us
determine on that; Mr. Gladstone appeared not long since to say in
Parliament that it ought to be so. But at any rate there should be
no doubt whose duty it is. Upon grounds which we have often stated,
we believe that the anomaly of one bank keeping the sole banking
reserve is so fixed in our system that we cannot change it if we
would. The great evil to be feared was an indistinct conception of
the fact, and that is now avoided.

'The importance of these declarations by the Bank is greater,
because after the panic of 1857 the bank did not hold exactly the
same language. A person who loves concise expressions said lately
"that Overends broke the Bank in 1866 because it went, and in 1857
because it was not let go." We need not too precisely examine such
language; the element of truth in it is very plain--the great advances
made to Overends were a principal event in the panic of 1857; the
bill-brokers were then very much what the bankers were lately they
were the borrowers who wanted sudden and incalculable advances. But
the bill-brokers were told not to expect the like again. But
Alderman Salomons, on the part of the London bankers, said, "he
wished to take that opportunity of stating that he believed nothing
could be more satisfactory to the managers and shareholders of joint
stock banks than the testimony which the Governor of the Bank of
England had that day borne to the sound and honourable manner in
which their business was conducted. It was manifestly desirable that
the joint stock banks and the banking interest generally should work
in harmony with the Bank of England; and he sincerely thanked the
Governor of the Bank for the kindly manner in which he had alluded
to the mode in which the joint stock banks had met the late monetary
crisis." The Bank of England agrees to give other banks the
requisite assistance in case of need, and the other banks agree to
ask for it.

'Secondly. The Bank agrees, in fact, if not in name, to make limited
advances on proper security to anyone who applies for it. On the
present occasion 45,000,000 L. was so advanced in three months. And
the Bank do not say to the mercantile community, or to the bankers,
"Do not come to us again. We helped you once. But do not look upon
it as a precedent. We will not help you again." On the contrary, the
evident and intended implication is that under like circumstances
the Bank would act again as it has now acted.'

This article was much disliked by many of the Bank directors, and
especially by some whose opinion is of great authority. They thought
that the 'Economist' drew 'rash deductions' from a speech which was
in itself 'open to some objection'which was, like all such speeches,
defective in theoretical precision, and which was at best only the
expression of an opinion by the Governor of that day, which had not
been authorised by the Court of Directors, which could not bind the
Bank. However the article had at least this use, that it brought out
the facts. All the directors would have felt a difficulty in
commenting upon, or limiting, or in differing from, a speech of a
Governor from the chair. But there was no difficulty or delicacy in
attacking the 'Economist.' Accordingly Mr. Hankey, one of the most
experienced bank directors, not long after, took occasion to
observe: 'The "Economist" newspaper has put forth what in my opinion
is the most mischievous doctrine ever broached in the monetary or
banking world in this country; viz, that it is the proper function
of the Bank of England to keep money available at all times to
supply the demands of bankers who have rendered their own assets
unavailable. Until such a doctrine is repudiated by the banking
interest, the difficulty of pursuing any sound principle of banking
in London will be always very great. But I do not believe that such
a doctrine as that bankers are justified in relying on the Bank of
England to assist them in time of need is generally held by the
bankers in London.

'I consider it to be the undoubted duty of the Bank of England to
hold its banking deposits (reserving generally about one-third in
cash) in the most available securities; and in the event of a sudden
pressure in the money market, by whatever circumstance it may be
caused, to bear its full share of a drain on its resources. I am
ready to admit, however, that a general opinion has long prevailed
that the Bank of England ought to be prepared to do much more than
this, though I confess my surprise at finding an advocate for such
an opinion in the "Economist." If it were practicable for the
Bank to retain money unemployed to meet such an emergency, it would
be a very unwise thing to do so. But I contend that it is quite
impracticable, and if it were possible, it would be most
inexpedient; and I can only express my regret that the Bank, from a
desire to do everything in its power to afford general assistance in
times of banking or commercial distress, should ever have acted in a
way to encourage such an opinion. The more the conduct of the
affairs of the Bank is made to assimilate to the conduct of every
other well-managed bank in the United Kingdom, the better for the
Bank, and the better for the community at large.'

I am scarcely a judge, but I do not think Mr. Hankey replies to the
'Economist' very conclusively.

First. He should have observed that the question is not as to what
'ought to be,' but as to what is. The 'Economist' did not say that
the system of a single bank reserve was a good system, but that it
was the system which existed, and which must be worked, as you could
not change it.

Secondly. Mr. Hankey should have shown 'some other store of unused
cash' except the reserve in the Banking Department of the Bank of
England out of which advances in time of panic could be made. These
advances are necessary, and must be made by someone. The 'reserves'
of London bankers are not such store; they are used cash, not
unused; they are part of the Bank deposits, and lent as such.

Thirdly. Mr. Hankey should have observed that we know by the
published figures that the joint stock banks of London do not keep
one-third, or anything like one-third, of their liabilities in
'cash' even meaning by 'cash' a deposit at the Bank of England.
One-third of the deposits in joint stock banks, not to speak of the
private banks, would be 30,000,000 L.; and the private deposits of
the Bank of England are 18,000,000 L. According to his own
statement, there is a conspicuous contrast. The joint stock banks,
and the private banks, no doubt, too, keep one sort of reserve, and
the Bank of England a different kind of reserve altogether. Mr.
Hankey says that the two ought to be managed on the same principle;
but if so, he should have said whether he would assimilate the
practice of the Bank of England to that of the other banks, or that
of the other banks to the practice of the Bank of England.

Fourthly. Mr. Hankey should have observed that, as has been
explained, in most panics, the principal use of a 'banking reserve'
is not to advance to bankers; the largest amount is almost always
advanced to the mercantile public and to bill-brokers. But the point
is, that by our system all extra pressure is thrown upon the Bank of
England. In the worst part of the crisis of 1866, 50,000 L. 'fresh
money' could not be borrowed, even on the best securityeven on
Consols except at the Bank of England. There was no other lender to
new borrowers.

But my object now is not to revive a past controversy, but to show
in what an unsatisfactory and uncertain condition that controversy
has left a most important subject. Mr. Hankey's is the last
explanation we have had of the policy of the Bank. He is a very
experienced and attentive director, and I think expresses, more or
less, the opinions of other directors. And what do we find? Setting
aside and saying nothing about the remarkable speech of the Governor
in 1866, which at least (according to the interpretation of the
'Economist') was clear and excellent, Mr. Hankey leaves us in doubt
altogether as to what will be the policy of the Bank of England in
the next panic, and as to what amount of aid the public may then
expect from it. His words are too vague. No one can tell what a
'fair share' means; still less can we tell what other people at some
future time will say it means. Theory suggests, and experience
proves, that in a panic the holders of the ultimate Bank reserve
(whether one bank or many) should lend to all that bring good
securities quickly, freely, and readily. By that policy they allay a
panic; by every other policy they intensify it. The public have a
right to know whether the Bank of Englandthe holders of our ultimate
bank reserveacknowledge this duty, and are ready to perform it. But
this is now very uncertain.

If we refer to history, and examine what in fact has been the
conduct of the Bank directors, we find that they have acted exactly
as persons of their type, character, and position might have been
expected to act. They are a board of plain, sensible, prosperous
English merchants; and they have both done and left undone what such
a board might have been expected to do and not to do. Nobody could
expect great attainments in economical science from such a board;
laborious study is for the most part foreign to the habits of
English merchants. Nor could we expect original views on banking,
for banking is a special trade, and English merchants, as a body,
have had no experience in it. A 'board' can scarcely ever make
improvements, for the policy of a board is determined by the
opinions of the most numerous class of its membersits average
membersand these are never prepared for sudden improvements. A board
of upright and sensible merchants will always act according to what
it considers 'safe' principles--that is, according to the received
maxims of the mercantile world then and thereand in this manner the
directors of the Bank of England have acted nearly uniformly. Their
strength and their weakness were curiously exemplified at the time
when they had the most power. After the suspension of cash payments
in 1797, the directors of the Bank of England could issue what notes
they liked. There was no check; these notes could not come back upon
the Bank for payment; there was a great temptation to extravagant
issue, and no present penalty upon it. But the directors of the Bank
withstood the temptation; they did not issue their inconvertible
notes extravagantly. And the proof is, that for more than ten years
after the suspension of cash payments the Bank paper was
undepreciated, and circulated at no discount in comparison with
gold. Though the Bank directors of that day at last fell into
errors, yet on the whole they acted with singular judgment and
moderation. But when, in 1810, they came to be examined as to their
reasons, they gave answers that have become almost classical by
their nonsense. Mr. Pearse, the Governor of the Bank, said: 'In
considering this subject, with reference to the manner in which
bank-notes are issued, resulting from the applications made for
discounts to supply the necessary want of bank-notes, by which their
issue in amount is so controlled that it can never amount to an
excess, I cannot see how the amount of bank-notes issued can operate
upon the price of bullion, or the state of the exchanges; and
therefore I am individually of opinion that the price of bullion, or
the state of the exchanges, can never be a reason for lessening the
amount of banknotes to be issued, always understanding the control
which I have already described.

'Is the Governor of the Bank of the same opinion which has now been
expressed by the Deputy-Governor?

'Mr. Whitmore, I am so much of the same opinion, that I never think
it necessary to advert to the price of gold, or the state of the
exchange, on the days on which we make our advances.

'Do you advert to these two circumstances with a view to regulate
the general amount of your advances?--I do not advert to it with a
view to our general advances, conceiving it not to bear upon the

And Mr. Harman, another Bank director, expressed his opinion in
these terms: 'I must very materially alter my opinions before I can
suppose that the exchanges will be influenced by any modifications
of our paper currency.'

Very few persons perhaps could have managed to commit so many
blunders in so few words.

But it is no disgrace at all to the Bank directors of that day to
have committed these blunders. They spoke according to the best
mercantile opinion of England. The City of London and the House of
Commons both approved of what they said; those who dissented were
said to be abstract thinkers and unpractical men. The Bank directors
adopted the ordinary opinions, and pursued the usual practice of
their time. It was this 'routine' that caused their moderation. They
believed that so long as they issued 'notes' only at 5 per cent, and
only on the discount of good bills, those notes could not be
depreciated. And as the number of 'good' billsbills which sound
merchants know to be gooddoes not rapidiy increase, and as the
market rate of interest was often less than 5 per cent, these checks
on over-issue were very effective. They failed in time, and the
theory upon which they were defended was nonsense; but for a time
their operation was powerful and excellent.

Unluckily, in the management of the matter before us--the management
of the Bank reserve--the directors of the Bank of England were neither
acquainted with right principles, nor were they protected by a
judicious routine. They could not be expected themselves to discover
such principles. The abstract thinking of the world is never to be
expected from persons in high places; the administration of
first-rate current transactions is a most engrossing business, and
those charged with them are usually but little inclined to think on
points of theory, even when such thinking most nearly concerns those
transactions. No doubt when men's own fortunes are at stake, the
instinct of the trader does somehow anticipate the conclusions of
the closet. But a board has no instincts when it is not getting an
income for its members, and when it is only discharging a duty of
office. During the suspension of cash paymentsa suspension which
lasted twenty-two yearsall traditions as to a cash reserve had died
away. After 1819 the Bank directors had to discharge the duty of
keeping a banking reserve, and (as the law then stood) a currency
reserve also, without the guidance either of keen interests, or good
principles, or wise traditions.

Under such circumstances, the Bank directors inevitably made
mistakes of the gravest magnitude. The first time of trial came in
1825. In that year the Bank directors allowed their stock of bullion
to fall in the most alarming manner:

On Dec. 24, 1824, the coin and bullion in the Bank was L10,721,000

On Dec. 25, 1825, it was reduced to L1,260,000

and the consequence was a panic so tremendous that its results are
well remembered after nearly fifty years. In the next period of
extreme trialin 1837, the Bank was compelled to draw for 2,000,000 L.
on the Bank of France; and even after that aid the directors
permitted their bullion, which was still the currency reserve as
well as the banking reserve, to be reduced to 2,404,000 L.: a great
alarm pervaded society, and generated an eager controversy, out of
which ultimately emerged the Act of 1844. The next trial came in
1847, and then the Bank permitted its banking reserve (which the law
had now distinctly separated) to fall to 1,176,000 L.; and so
intense was the alarm, that the executive Government issued a letter
of licence, permitting the Bank, if necessary, to break the new law,
and, if necessary, to borrow from the currency reserve, which was
full, in aid of the banking reserve, which was empty. Till 1857
there was an unusual calm in the money market, but in the autumn of
that year the Bank directors let the banking reserve, which even in
October was far too small, fall thus:

Oct. 10 4,024,000 L
" 17 3,217,000 L
" 24 3,485,000 L
" 31 2,258,000 L
Nov. 6 2,155,000 L
" 13 957,000 L

And then a letter of licence like that of 1847 was not only issued,
but used. The Ministry of the day authorised the Bank to borrow from
the currency reserve in aid of the banking reserve, and the Bank of
England did so borrow several hundred pounds till the end of the
month of November. A more miserable catalogue than that of the
failures of the Bank of England to keep a good banking reserve in
all the seasons of trouble between 1825 and 1857 is scarcely to be
found in history.

But since 1857 there has been a great improvement. By painful events
and incessant discussions, men of business have now been trained to
see that a large banking reserve is necessary, and to understand
that, in the curious constitution of the English banking world, the
Bank of England is the only body which could effectually keep it.
They have never acknowledged the duty; some of them, as we have
seen, deny the duty; still they have to a considerable extent begun
to perform the duty. The Bank directors, being experienced and able
men of business, comprehended this like other men of business. Since
1857 they have always kept, I do not say a sufficient banking
reserve, but a fair and creditable banking reserve, and one
altogether different from any which they kept before. At one period
the Bank directors even went farther: they made a distinct step in
advance of the public intelligence; they adopted a particular mode
of raising the rate of interest, which is far more efficient than
any other mode. Mr. Goschen observes, in his book on the Exchanges:
'Between the rates in London and Paris, the expense of sending gold
to and fro having been reduced to a minimum between the two cities,
the difference can never be very great; but it must not be forgotten
that, the interest being taken at a percentage calculated per annum,
and the probable profit having, when an operation in three-month
bills is contemplated, to be divided by four, whereas the percentage
of expense has to be wholly borne by the one transaction, a very
slight expense becomes a great impediment. If the cost is only 1/2 per
cent, there must be a profit of 2 per cent in the rate of interest,
or 1/2 per cent on three months, before any advantage commences; and
thus, supposing that Paris capitalists calculate that they may send
their gold over to England for 1/2 per cent expense, and chance their
being so favoured by the Exchanges as to be able to draw it back
without any cost at all, there must nevertheless be an excess of
more than 2 per cent in the London rate of interest over that in
Paris, before the operation of sending gold over from France, merely
for the sake of the higher interest, will pay.'

Accordingly, Mr. Goschen recommended that the Bank of England
should, as a rule, raise their rate by steps of 1 per cent at a time
when the object of the rise was to affect the 'foreign Exchanges.'
And the Bank of England, from 1860 onward, have acted upon that
principle. Before that time they used to raise their rate almost
always by steps of 1/2 per cent, and there was nothing in the general
state of mercantile opinion to compel them to change their policy.
The change was, on the contrary, most unpopular. On this occasion,
and, as far as I know, on this occasion alone, the Bank of England
made an excellent alteration of their policy, which was not exacted
by contemporary opinion, and which was in advance of it. The
beneficial results of the improved policy of the Bank were palpable
and speedy. We were enabled by it to sustain the great drain of
silver from Europe to India to pay for Indian cotton in the years
between 18621865. In the autumn of 1864 there was especial danger;
but, by a rapid and able use of their new policy, the Bank of
England maintained an adequate reserve, and preserved the country
from calamities which, if we had looked only to precedent, would
have seemed inevitable. All the causes which produced the panic of
1857 were in action in 1864the drain of silver in 1864 and the
preceding year was beyond comparison greater than in 1857 and the
years before itand yet in 1864 there was no panic. The Bank of
England was almost immediately rewarded for its adoption of right
principles by finding that those principles, at a severe crisis,
preserved public credit.

In 1866 undoubtedly a panic occurred, but I do not think that the
Bank of England can be blamed for it. They had in their till an
exceedingly good reserve according to the estimate of that timea
sufficient reserve, in all probability, to have coped with the
crises of 1847 and 1857. The suspension of Overend and Gurneythe
most trusted private firm in Englandcaused an alarm, in suddenness
and magnitude, without example. What was the effect of the Act of
1844 on the panic of 1866 is a question on which opinion will be
long divided; but I think it will be generally agreed that, acting
under the provisions of that law, the directors of the Bank of
England had in their banking department in that year a fairly large
reserve quite as large a reserve as anyone expected them to keepto
meet unexpected and painful contingencies.

From 1866 to 1870 there was almost an unbroken calm on the money
market. The Bank of England had no difficulties to cope with; there
was no opportunity for much discretion. The money market took care
of itself. But in 1870 the Bank of France suspended specie payments,
and from that time a new era begins. The demands on this market for
bullion have been greater, and have been more incessant, than they
ever were before, for this is now the only bullion market. This has
made it necessary for the Bank of England to hold a much larger
banking reserve than was ever before required, and to be much more
watchful than in former times lest that banking reserve should on a
sudden be dangerously diminished. The forces are greater and quicker
than they used to be, and a firmer protection and a surer solicitude
are necessary. But I do not think the Bank of England is
sufficiently aware of this. All the governing body of the Bank
certainly are not aware of it. The same eminent director to whom I
have before referred, Mr. Hankey, published in the 'Times' an
elaborate letter, saying again that one-third of the liabilities
were, even in these altered times, a sufficient reserve for the
Banking Department of the Bank of England, and that it was no part
of the business of the Bank to keep a supply of 'bullion for
exportation,' which was exactly the most mischievous doctrine that
could be maintained when the Banking Department of the Bank of
England had become the only great repository in Europe where gold
could at once be obtained, and when, therefore, a far greater store
of bullion ought to be kept than at any former period.

And besides this defect of the present time, there are some chronic
faults in the policy of the Bank of England, which arise, as will be
presently explained, from grave defects in its form of government.

There is almost always some hesitation when a Governor begins to
reign. He is the Prime Minister of the Bank Cabinet; and when so
important a functionary changes, naturally much else changes too. If
the Governor be weak, this kind of vacillation and hesitation
continues throughout his term of office. The usual defect then is,
that the Bank of England does not raise the rate of interest
sufficiently quickly. It does raise it; in the end it takes the
alarm, but it does not take the alarm sufficiently soon. A cautious
man, in a new office, does not like strong measures. Bank Governors
are generally cautious men; they are taken from a most cautious
class; in consequence they are very apt to temporise and delay. But
almost always the delay in creating a stringency only makes a
greater stringency inevitable. The effect of a timid policy has been
to let the gold out of the Bank, and that gold must be recovered. It
would really have been far easier to have maintained the reserve by
timely measures than to have replenished it by delayed measures; but
new Governors rarely see this.

Secondly. Those defects are apt, in part, or as a whole, to be
continued throughout the reign of a weak Governor. The objection to
a decided policy, and the indisposition to a timely action, which
are excusable in one whose influence is beginning, and whose reign
is new, is continued through the whole reign of one to whom those
defects are natural, and who exhibits those defects in all his

Thirdly. This defect is enhanced, because, as has so often been
said, there is now no adequate rule recognised in the management of
the banking reserve. Mr. Weguelin, the last Bank Governor who has
been examined, said that it was sufficient for the Bank to keep from
one-fourth to one-third of its banking liabilities as a reserve. But
no one now would ever be content if the banking reserve were near to
one-fourth of its liabilities. Mr. Hankey, as I have shown,
considers 'about a third' as the proportion of reserve to liability
at which the Bank should aim; but he does not say whether he regards
a third as the minimum below which the reserve in the Banking
Department should never be, or as a fair average, about which the
reserve may fluctuate, sometimes being greater, or at others less.

In a future chapter I shall endeavour to show that one-third of its
banking liabilities is at present by no means an adequate reserve
for the Banking Departmentthat it is not even a proper minimum, far
less a fair average; and I shall allege what seem to me good reasons
for thinking that, unless the Bank aim by a different method at a
higher standard, its own position may hereafter be perilous, and the
public may be exposed to disaster.


But, as has been explained, the Bank of England is bound, according
to our system, not only to keep a good reserve against a time of
panic, but to use that reserve effectually when that time of panic
comes. The keepers of the Banking reserve, whether one or many, are
obliged then to use that reserve for their own safety. If they
permit all other forms of credit to perish, their own will perish
immediately, and in consequence.

As to the Bank of England, however, this is denied. It is alleged
that the Bank of England can keep aloof in a panic; that it can, if
it will, let other banks and trades fail; that if it chooses, it can
stand alone, and survive intact while all else perishes around it.
On various occasions, most influential persons, both in the
government of the Bank and out of it, have said that such was their
opinion. And we must at once see whether this opinion is true or
false, for it is absurd to attempt to estimate the conduct of the
Bank of England during panics before we know what the precise
position of the Bank in a panic really is.

The holders of this opinion in its most extreme form say, that in a
panic the Bank of England can stay its hand at any time; that,
though it has advanced much, it may refuse to advance more; that
though the reserve may have been reduced by such advances, it may
refuse to lessen it still further; that it can refuse to make any
further dis counts; that the bills which it has discounted will
become due; that it can refill its reserve by the payment of those
bills; that it can sell stock or other securities, and so replenish
its reserve still further. But in this form the notion scarcely
merits serious refutation. If the Bank reserve has once become low,
there are, in a panic, no means of raising it again. Money parted
with at such a time is very hard to get back; those who have taken
it will not let it gonot, at least, unless they are sure of getting
other money in its place. And at such instant the recovery of money
is as hard for the Bank of England as for any one else, probably
even harder. The difficulty is this: if the Bank decline to
discount, the holders of the bills previously discounted cannot pay.
As has been shown, trade in England is largely carried on with
borrowed money. If you propose greatly to reduce that amount, you
will cause many failures unless you can pour in from elsewhere some
equivalent amount of new money. But in a panic there is no new money
to be had; everybody who has it clings to it, and will not part with
it. Especially what has been advanced to merchants cannot easily be
recovered; they are under immense liabilities, and they will not
give back a penny which they imagine that even possibly they may

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