Bankers and Credit/Chapter 2
When war comes there are five ways in which a modern Government can provide itself with the sinews thereof:—
1. It can take money, out of the citizens' pockets and bank balances by making them pay taxes.
2. It can get money from them by issuing loans which they subscribe for by saving.
3. It can borrow abroad.
4. It can get money from banks by issuing loans to them which they subscribe for by creating new credits; or it can get money by issuing loans to people who subscribe not by saving but by borrowing from banks which create new credit for this purpose.
5. It can print notes and issue them itself.
The ideal method is obviously number one. With it, the goods and services needed for the war are bought by the Government with money which the citizens, having paid it in taxes, are unable to spend on themselves. There is thus no increase in the aggregate demand for goods and services and there need be no rise in the general price level. Goods wanted for the war go up in price, but articles of luxury and all those commodities and comforts in which people have to stint themselves in order to pay the increased taxes, tend to go down, as happened when the war began. If a war's needs could be wholly met in this way, it would leave the nation with no debt and no debasement of currency. Producers of luxuries would be hit, but only for a time and until they adapted their activities to war production, the demands of which are now so great that they quickly absorb all available energy.
Number two—financing war out of loans subscribed with saved money—also has the great advantage of transferring the buying power of those who save to the Government for buying goods needed for the war. This method also should cause no rise in the general level of prices, because the Government's increased demand for goods would be offset by the reduced demand of those who saved to subscribe. This was the kernel of the doctrine preached, with astonishing success, by the War Savings Committee during the war. The objection to the system is that it leaves a debt behind, the interest and redemption of which have to be met from taxation. It thus postpones taxation and holds it over until after the war. This is not a good thing to do in the case of a people that is prepared to face war's burden at once, because taxation is more easily paid in war-time, when industry is fully occupied with turning out goods to meet an insatiable demand, than it is when peace comes and industry is faced with the difficult task of readjustment. The taxation needed for debt charge, when the debt is held at home, only distributes and does not lessen the nation's wealth; but it is not therefore any more pleasant to those who have to pay it. But from the point of view of politicians who want to make things look pretty, the borrowing system has the advantage that it gulls the nation with the belief that the war is not hurting its pocket very much. The Government hands out promises to pay in the shape of War Loans and the citizens are apt to forget that when the Government promises to pay it can only meet its promises out of their pockets.
This delusion would not do much harm, if all the nation were affected equally. If we preferred to leave the task of paying for the war to those who were patriotic enough to save, and everybody had the same chance of saving, in relation to their wealth, then it would be fair enough that we should all be taxed in relation to our wealth to pay interest to those who had made the patriotic effort when it was called for. But things do not happen so. In war time, the best of us, in strength and courage and endurance and manliness, are risking death and wounds in scenes of indescribable dirt and discomfort and strain, and are doing this for very low pay compared with the salaries and wages earned by those who, not being fit to fight, are left at home. And so the opportunity for subscribing to War Loans is much less for those who, because of the work they are doing at the front, have more right than anybody else to be enriched by the war. When they come back to civil life they find that a war debt, to which they had little chance of subscribing, lays on them a burden of taxation at a time when they have more than enough difficulty in fitting themselves into industrial and professional work.
Number three—borrowing abroad—is a costly and difficult method, because a nation at war naturally has to pay a high rate on loans that it issues in foreign countries, the citizens of which take a detached view of its chance of winning and of its probable solvency at the end of the struggle, and have no patriotic incentive to "feed the guns" that are not fighting their battle. It has the effect, very pleasant for the time being, of inducing the foreign subscribers to the loans to make the necessary sacrifice, in return for a rate of interest which has afterwards to be paid for out of taxation. But with this difference that the subsequent taxation, instead of being paid by the citizens of the borrowing nation and distributed among certain of their members, is paid to people in a foreign country and so is a much more effective drain on the national wealth. The interest and sinking fund, by which the loan is redeemed, can only be paid to the foreign creditors by the debtor nation's either selling abroad so much more of goods and services, or buying abroad so much less of goods and services. In either case its own enjoyment of goods and services is to that extent reduced.
Number four is easy and at first sight pleasant for everybody, but is, in fact, quite the worst way of raising money for war or any other purpose. When a Government borrows from banks it does not take money out of anybody's pocket or anybody's bank balance. In fact it increases bank deposits which have already been described as potential currency because they give their holders the power to draw cheques or to take out cash from the banks. As was shown in the last chapter, whenever the banks make loans they increase the deposits of themselves and of other banks, and when the Bank of England makes loans it increases the balances of the other banks in its books, and so gives them more "cash at the Bank of England" which is part of the foundation on which they build their fabric of credit. In the same way when the Government borrows from investors, not money that they have saved, but money that they have borrowed from their banks, there is again an increase in potential currency. So that what happens is that instead of the Government's spending power for the war being provided by the reduction of other people's spending power, it is provided by a creation of new spending power. By this process nobody is taxed or bothered to save or make any other sacrifice, but in fact a sacrifice is imposed on the community, and is likely to fall on those least able to bear it. When it taxes a Government can regulate the sacrifice required according to the relative wealth of the taxpayers: when it borrows saved money it gives the citizens the choice whether they will make the sacrifice; when it borrows from banks it creates fresh spending power, so lowering the value of all the money already in existence, including its own, and so perpetrating something very like a swindle, which robs those who are unable to increase their incomes and lines the pockets of those who have essential goods and services to sell.
To take a practical example let us suppose that the Government makes an issue of ten million pounds' worth of Treasury Bills which are taken up by the banks. The first result would be that ten millions would be transferred from the banks' balances in the Other Deposits at the Bank of England to the Government's balance in the Public Deposits, and the banks would have ten millions more Government securities or bills discounted, according to their system of book-keeping, and ten millions less cash at the Bank of England. But the Government would forthwith draw on its increased balance at the Bank, to pay for the fighting men's needs, and the contractors and others who received its cheques would pay them into their banks. Thus the ten millions would be transferred back from the Public Deposits to the Other Deposits at the Bank of England, the banks would get back their cash at the Bank of England and would still hold their ten million Treasury Bills with an addition of ten millions to the deposits of their customers. This fresh ten millions will be an addition to the spending power of the community: the contractors who had received it would pay it out in wages to manual workers, in salaries to managers or in payment to merchants and producers for raw material. But at the same time there would be no corresponding increase in the goods to be bought, and so the outpouring of all this new money would merely mean filercer competition for an unaltered mass of goods, on the part of the purchasers with new money in their pockets and purchasers with the previously existing money. And the only possible result is a rise in the prices of the goods, which is to say a fall in the buying power of the money.
The fifth method, by which the Government neither borrows nor taxes but just prints notes and pays its debts with them, produces the same evil results as number four, and more so, because it creates not only new credit but new cash which can be used as a basis for yet more credit; but it also has the great advantage of saving the expense of the interest paid to banks. Our Government printed notes, though to a quite small extent as compared with the thumping figures of war finance, but instead of using them directly for payments, preferred to issue them in response to demands from banks, in exchange for so much credit at the Bank of England, most of which was then lent by the Currency Department, which handled the note issue, to the Exchequer which finally paid it out through the spending departments. By this elaborate machinery and a nicely constructed weekly statement showing a balance sheet with gold, cash at the bank and securities held against the notes, our conscientious officials managed to give an appearance almost approaching respectability to some 300 odd millions of Governmental "shin-plasters."
Thus the ingenuities and elasticities of the Money Market were prostituted for the production of the same result that was achieved by mediaeval monarchs who debased their currency by putting in too much alloy and so making their stock of metal go further. The modern ruler by multiplying banking credits and paper money plays the same confidence trick much more easily and extensively.
So began the dreary and disgusting race between prices and wages, and between profiteers and Excess Profits tax-gatherers, which was to cause so much unrest and bitterness, which added so enormously to the cost of the war and the amount of debt that it left behind, which sowed the seeds of the after-war outburst with its feverish madness and of the subsequent collapse with its bankruptcies and disillusionments, which made it more profitable to squander than to save, which taught business men that economy in production was an irrelevant absurdity because the continuous rise in prices was certain to pour profits into their pockets if only they opened them wide enough, and taught the ignorant multitude to believe that producers, merchants and dealers were a set of ruthless extortioners who were wantonly flaying the skin off the nation in its need and off everybody else who had to buy goods. Mr. W. A. Orton in his very interesting work on Labour in Transition, in describing the workers' suspicions and apprehensions in the early years of the war, says that "by far the most potent factor of all was the question of the profits made by the armament firms; the suspicion—to quote an official report—'that while they (the workers) were called upon to be patriotic and refrain from using the strong economic position they occupied, employers, merchants and traders were being allowed perfect freedom to exploit to the fullest the nation's needs.'"
Could this disastrous system have been avoided altogether? The official attitude assumes that it was inevitable, and perhaps to a certain extent it was, with the financial leadership that we enjoyed. Neither the Government nor the people understood what was happening. Our rulers were not making Machiavellian use of monetary dodges to delude the people and dilute the currency, but were taking the line of least resistance through a difficult problem, and incidentally making reckless use of a delicate machine which they did not understand and producing consequences which they neither foresaw nor recognized. The public thought the rise in prices was a necessary consequence of war and naturally did not attempt to connect it with the expansion of bank deposits. Indeed, when this feature was noticed it was often hailed, even by men of business who might have known better, as a proof that we were somehow growing richer in spite of the war. If we had had a Government which understood finance and had courage enough to tell the people that war meant sacrifice, and if we, as a people, had had wit to understand, as we had, I believe, the courage and the will to face the sacrifice demanded, then the whole story of our war finance would have been very different.
A real statesman in charge of the war finance of an ideal people would have seen, and seen that the people saw, that, apart from what might be done by borrowing abroad, it could only win the war by its own efforts in producing more and consuming less, so that the goods needed to maintain and equip the fighters might be provided; that industrial effort on the one hand and abstinence in consumption on the other were essentials to success; that what was needed for the fighters must be taken from the citizens, and that the simplest, cheapest and fairest way of doing this was by taxation, so that for every pound spent on the fighters there should be a pound less in the pocket of a civilian. For the devious devices and dodges of borrowing and currency creation do not make the sacrifice a whit less. The fact still remains that whatever the fighters consume the civilians have to go without, always excepting what can be done by borrowing abroad and selling securities and other assets to foreigners. A Government and a people that recognized these things at the beginning of a war and had sense and courage to apply them would pay for the war as it happened.
But neither here nor in any other country was there even a distant likeness to an ideal statesman in charge of war finance:
They swayed about upon a rocking-horse,
And thought it Pegasus.
In France and Germany no attempt was made in the early years of the war to meet any part of its cost by taxation. France with her richest provinces invaded had plenty of excuse. In Germany the docility, discipline and intense patriotism of the people gave a wonderful opportunity to its Government for financing the war soundly: but it was not taken because the Government preferred to finance by borrowing on the assumption that it was certain to win the war and recover its cost, and a great deal more, from its vanquished foes, rather than by "increasing the burdens of the people." Apparently it thought in its wisdom that it could lighten these burdens by bad finance. In fact the event inevitably showed that in Germany, in spite of the absence of taxation for the war, what the fighter needed the people had to provide by stinting.
So it was that our Chancellors of the Exchequer had such examples set them both by friend and foe that whatever they did in the way of war taxation they were able to ascribe to an excess of virtue which made their war finance to that extent sounder than that of Germany or France. Judged by this standard of failure their achievement shone like "a good deed in a naughty world." Judged by what might have been, what ought to have been, and what was actually done in the course of the Napoleonic and Crimean wars, when nearly half the cost of the war was met by taxation[1] it was not a great performance. Mr. Lloyd George was our first War Chancellor and his most ardent admirers will probably admit that he is more successful in distributing the contents of the public purse than in calling on the general tax-paying public to stint themselves in order to fill it. It is difficult to exaggerate the evil effects of the economic crime that he committed when in the Spring of 1915 he imposed no taxation whatever to meet the deficit that faced him. Most eloquently he put the facts of the financial position before the country but made no attempt to apply even a moderate dose of the true remedy. And yet the bad eminence that he then reached as a War Chancellor defaulting in his evident duty was perhaps overtopped by Mr. Bonar Law in 1917 when he brought in a Budget which was expected to add £1,600,000,000 to the debt and added only £6,000,000 to permanent taxation. (He got £20,000,000 more from Excess Profits tax, which was then supposed to be an impost which would cease with the war.) Which of these two efforts was the worse, we may leave the two champions who achieved them to decide. Mr. Lloyd George did not tax at all. But he had an excuse (rather weak on its legs) in that he had taxed a good deal in the Budget that he brought in in the previous autumn, and a still feebler one in the belief, which most of us then cherished, that the war would be short. Mr. Bonar Law, whose contribution to taxation was so pitiful in comparison to his addition to debt, had neither of these excuses. On the contrary, between his rule and that of Mr. Lloyd George, Mr. McKenna had really tried to do all that he could to finance by taxation. The effort that he made was not too heroic, brilliant as it was when compared with those of our other War Chancellors. His Budget speeches generally produced a sense of relief in the House of Commons and among the income tax paying class because he had not made a greater addition than he did to the income tax; and it may surely be argued that in war time it is not the business of a Chancellor to produce a sense of relief but to brace the taxpayers to an effort which might at least be a faint reflection of what the fighting men were doing for them at the front.
It may be that the taxpayer would have jibbed and kicked if Mr. McKenna, who at least set a sound standard of aiming each year at covering out of taxation the service of the anticipated addition to debt, had tried to do more. The view has been expressed by experienced tax-gatherers that the great industrial effort which was certainly made by our people was only possible because the wage earners were stimulated by high wages and the organizers by big profits. But as everyone now knows industrial unrest was almost chronic in the later years of the war, partly because the wage earners believed that their high wages were fully offset by high prices and partly because they knew that their employers were making enormous profits, as shown by the passage quoted above.
Danger of an upheaval which would have reduced output and led to defeat, was a sinister possibility, but surely it would not have been increased but lessened if the war had been paid for, as it might have been, out of the current income of the nation, and out of the sale or pledge of existing assets abroad. To suppose that there are funds which can be tapped by borrowing but are sealed to the tax-gatherer is a slur on the efficiency of the latter which our Inland Revenue Office does not deserve. You cannot get more out of a nation than it can produce in goods and services, an¢ if you deal bravely and intelligently with a brave and intelligent nation you get from it, for a great national purpose, all that it produces except what it must have to keep it alive. We could have met the whole cost of the war, which would not have been nearly so great if it had been better financed, without calling on ourselves to stint to that point. When we remember what the spirit of the country was like in the early days of the war, it is clear that if the right attempt had then been made to put the facts of war finance before the people they would have understood and accepted them and been prepared to face them, instead of being deluded by monetary will-o'-the-wisps, which were quite useless for lessening sacrifice but only too effective in distributing it unjustly and enabling a small minority to make fortunes out of the war that was bringing ruin to many, especially of those who were fighting for us.
These results were so far from being expected when the war began that the arrangement made by the Government with the railway companies, under which they were to be guaranteed their pre-war net revenue, was viewed with envy by the shipowning, coalowning and engineering firms and companies which afterwards wallowed up to their chins in the war profits in which bad war finance immersed them, but then saw nothing but bad times ahead. The capitalist class was fearful and tame and quite ready to be told, what it already believed, that war meant sacrifice and stinting, and probably ready to be convinced that taxation was the cheapest and fairest way of imposing and distributing the burden. I remember being told by a stockbroker in the first week of the war that of course the whole Stock Exchange saw nothing but ruin ahead of it. "But we don't care a damn," he added. "We know this war had to happen and we know we're going to win and that's all that matters."
At the same time the spirit of the manual workers was an example to the rest of us. Mr. Orton tells us that, "despite widespread unemployment and distress among the rank-and-file of labour and the many practical difficulties with which its leaders had as best they could to contend, not these things but the universal tide of active patriotism will remain the dominant impression of this momentous autumn. Volunteers from all trades and classes were enlisting at the rate of nearly 100,000 a week: 174,901 during the first week of September; so that many a regiment would make a favour of it to put your name on a long waiting list, and many a depot had to close its doors on a press of volunteers much as in peace time the dock gates used to close on a press of willing labourers. Outstanding industrial disputes were broken off, compromised, referred to arbitration or waived altogether. Already in the first fortnight of August, employers and trade unionists on Clyde and Tyne had mutually agreed to assist in every possible way the execution of all work essential to the war—in the latter area, had even recommended the removal of "all working restrictions." Other unions were taking up a similar attitude; and the Labour Conference of August 25, before it approached the Government for assistance for the union funds, had embodied the general opinion in a resolution, "that an immediate effort be made to terminate all existing disputes, whether strikes or lock-outs, and whenever new points of difficulty arise during the war-period, a serious attempt should be made by all concerned to reach an amicable settlement before resorting to a strike or lock-out." From 72,000 men involved in various disputes in mid-July the number fell to "practically nil "by the following February: for 99 new disputes originating in July there were only 14 in August. This was the industrial truce, loyally observed in spite of grave provocation during the first winter.
"And lest it be thought that this was a small matter, an obvious and unimportant concession, let it be recalled that the three years preceding the war were years of intense industrial struggle in which for the unions principles as well as pence were at stake; and that, even as regards wages alone, the truce involved spontaneous surrender of the essential factor in their bargaining power, in sheer reliance on the goodwill of employers and the State. Whatever amelioration of the average working-class standard of living the next few years might have brought was thus staked on the hazard; and it was a stake that the war-bonus principle of subsequent wage advances did not in fact redeem."
Such was the spirit of all classes in the first six months of the war. Such was the chance that Mr. Lloyd George missed in his 1915 Budget. Instead of a financial statesman we had an adroit politician who, seeing the people through the eyes of political agents and party wirepullers, thought it advisable not to ask them to pay any more taxes at present. Then, as so often throughout the war, the Government completely misunderstood the readiness of the people to bear the war's burdens and so undermined and impaired that readiness. Bad war finance, then introduced, and the consequent rise in prices brought with them competition among employers to make as much as possible out of the country's need and so invited the workers to join the game of grab; and so came suspicion and envy and bitterness, smouldering industrial unrest which seriously hampered the nation's productive effort, spendthrift extravagance, public and private, which wasted its resources and antagonism between classes of which the end is not yet.
During the war period, August 1 to November 16, the total spent by the Government, according to the Economist's weekly summary of war-time finance, published in its issue of November 23, 1918, was £8,656,000,000 and the amount that it raised by revenue was £2,220,000,000. Even if we could assume that the whole of the expenditure was for the war, and that the whole of the revenue was provided by war taxation, the latter is little better than 25 per cent. of the former, a sorry percentage compared with the 47 per cent. shown, according to Sir Bernard Mallet's calculation, in the Napoleonic and Crimean wars. But we are bound, of course, to deduct from each side the peace expenditure and revenue. If we assume this at £850,000,000 for the 4¼ years—a low estimate but therefore understating our case—the war expenditure becomes £7,806,000,000 and the war revenue £1,370,000,000, a percentage of just over 17½.
It need not be said that this is nothing like an exact calculation; war revenue and war expenditure went on long after the war period and it will probably never be possible to get two economists to agree as to the sum that was spent by our Government on the war. But at least it can be claimed that the financial effort made by our rulers through taxation was very much below the results achieved by their predecessors at times when the country was much poorer and much less united in its determination. And yet we know that these earlier and better precedents were in their minds. For in the speech which opened Mr. Lloyd George's Budget that imposed not one half-pennyworth of taxation he went out of his way, after calling the country's attention to the huge gulf between revenue and expenditure, to say that he could have filled it by taking less of the country's income than was taken at the end of the Napoleonic war. Thus he was of those that rebel against the light; for one can surely contend without being charged with idealistic rainbow-chasing, that what we did at the beginning of the nineteenth century we could have done again at the beginning of the twentieth.
It is not possible to guess how much of the money that the Government got by borrowing was real saved money contributed by investors and how much was new spending created by banks either through direct advances to Government or through loans to customers for the purpose of lending. Banking figures, ever discreet in their reticences, naturally drew no distinction between advances made to customers for purposes of production and those made to furnish them with funds to lend to Government. The figures of the Bank of England's return were more than usually obscure during the war period owing to a system then adopted by which any surplus balances that the other banks held were taken from them by the Bank of England and lent to the Government in the form of Ways and Means advances. According to strict book-keeping these operations should have been shown in the weekly return and would have greatly increased the Bank of England's liabilities and assets. But in fact this was not done and so the Bank return was more than ever a cryptogram rather than a guide, and those who patiently week by week worked out the proportion of its cash Reserve and its liabilities were at once the victims and publishers of a deception which was, if it effected anything towards maintaining our financial prestige abroad, justified by the seriousness of the struggle and the importance of financial prestige to its winning.
A more important effect of anxiety to maintain our financial prestige abroad was the necessity that it was believed to impose on those who guided our monetary policy to keep up the price of money in Lombard Street, when its cheapness would have enabled the Government to borrow at much lower rates and so would have left a much less onerous debt charge. The natural effect of the big creations of new credit involved by the war was to make money cheap and in the early months of 1915 the market rate of discount was below 1½ per cent. Since as the war went on the Government was practically the only borrower, exports of capital being forbidden and new issues at home being only permitted with the sanction of a most exacting Committee, it is clear that if the Government had chosen to adopt this policy it could have helped itself to all the available capital at any price that it chose to offer, especially if it had at the same time administered to capitalists the very broad hint of compulsion if they did not subscribe, to which they were treated by Mr. Bonar Law—as good a borrower as he was a bad taxer—when he was appealing to them to support his great and successful War Loan of 1917. But our rulers feared that if money was too cheap in Lombard Street, foreigners would withdraw their balances from London and so turn the exchanges against us by offers of sterling in foreign centres, though in fact the New York exchange, and others to a less extent, were kept "pegged" by borrowing for that purpose. And so money was made artificially dear by the rates at which Treasury Bills were offered and also by the measure already referred to by which the banks' surplus balances were borrowed by the Bank of England for the Government. And it was only in the last year of the war that a special rate was allowed on foreign balances and the market rate for home money was allowed to slacken slightly.
Another influence that made our war borrowing dearer than it need have been was a curious delusion long cherished by our financial rulers which made them think that in war time each loan issued by the Government must necessarily be offered with a higher rate of interest attached. In spite of the fact that the German Government was borrowing steadily with 5 per cent. loans issued in the neighbourhood of 98, our wiseacres insisted on an ever rising rate which culminated in the Autumn of 1916 when some 6 per cent. Exchequer bonds scored the high-water mark of this absurdity, and gave a quite unnecessary handle to well-meaning enthusiasts who were arguing that the capitalists were "doing their bit" by battening on the nation's life blood. In fact the capitalists were quite good and tame, as was shown in the following January when Mr. Bonar Law renounced this expensive delusion in a speech at the Guildhall, calling for support for his great 5 per cent. loan offered at 95, and so yielding 5¼ per cent.; he said that "the terms offered were as good as the Government was justified in giving; that as long as there was money in the country the conduct of the war would not be hindered for lack of it; that if the loan failed, which it would not, the resources of civilization would not be exhausted; and that if other measures were taken, the rate would certainly not be 5¼ per cent. The enthusiasm with which this frank threat of financial compulsion was received by the Guildhall audience was remarkable evidence of the readiness of the City to suffer all things for victory." (Economist, January 13, 1917).
On this occasion the banks were not bullied into subscribing to the loan themselves but, as was done whenever a loan was offered, everybody was urged to borrow from his bank in order to apply. Clearly this had to be done in order to secure the great success of the loan, which brought in over £1,000,000,000 in cash. But unless the advances were repaid as fast as the Government spent the money—which certainly did not happen—the result of this system was another addition to the volume of credit, expressed in increased bank deposits or potential spending power. The effects of the use made of our banking machine for war finance on banking figures may be studied by the curious in statistical compilations.[2] Here it may be noted that the total deposits of the Bank of England which stood at £71,000,000 at the end of 1913, were £155,000,000 at the end of 1914, and £241,000,000 at the end of 1918; the figures of the total securities at the same dates being £65,000,000, £145,000,000 and £231,000,000. The other banks of the United Kingdom showed the following movements:—
| In Millions. | End 1913. | End 1918. | Increase. |
|---|---|---|---|
| Deposits | 1,033 | 1,988 | 955 |
| Cash and Money at call | 294 | 612 | 318 |
| Investments | 191 | 520 | 329 |
| Discounts and Advances | 683 | 1,025 | 342 |
Thus was the bladder of credit blown out till it was, like Falstaff and his lies, "gross as a mountain," and might have seemed to be at bursting point had it not shown powers of still greater expansion in the after-war period, which clapped another £500,000,000 on to both sides of the balance sheet.
It may safely be assumed that most of the increase in investments was due to subscriptions by the banks to various forms of Government securities issued for war purposes and likewise a large part of the increase in discounts and advances, because many of them included their holdings of Treasury Bills under discounts. Treasury Bills grew from £21,000,000 at the end of 1913 to £1,095,000,000 at the end of 1918, and though many of the new bills were placed with shipowners, munition makers and others who wanted a liquid form of investment for the huge profits that they were earning, the banks also took a big share of them. Owing to these huge profits that the industrialists were earning they had little need to rely on their banks for credit, so that the increase in discounts and advances was probably due, apart from Treasury Bills, to loans to customers for taking up war loans.
Both these processes by which the banks were used to finance the war—direct investment, and loans to customers for investment, in war loans—were bad for the country and for the banks. For the country because they meant the production of fresh spending power instead of spending power being taken out of somebody's pocket, and for the banks because, except when the securities that they took were Treasury Bills or other investments with an early date of maturity, they were "locked up." When they subscribed to War Loans, as they were urged if not practically forced to do in the case of the earlier issues, they took over assets that they would not for patriotic reasons be able to dispose of as readily as they would wish, when the time came for them to return, after the war, to their real business of financing the requirements of trade. By lending to their customers to enable them to subscribe, they also got a more or less frozen security, because investors who had been stimulated to borrow from their banks in order to subscribe to War Loans could not well be pressed very hard to pay the loans off. If they were obliged to do so and had to throw stocks they had purchased upon the market in order to redeem the loans, the effect upon the market for Government securities and therefore upon bank balance sheets would not have been comfortable.
The question of the increase in the banks' holding of cash and money at call and short notice brings us to the currency expansion which was required to support this jerry-built addition to the fabric of credit. As was shown in Chapter I, the banks for their own safety maintained a certain proportion between their liabilities in the form of deposits and their holding of legal tender cash, plus "cash" at the Bank of England, which meant a credit in its books. Before the war legal tender cash could only be increased (apart from the inward and outward flow of the home circulation) by additions to the country's stock of gold. Cash at the Bank of England could be increased as fast as it chose to make loans and discount bills and this gave our system the necessary elasticity. The great expansion has already been shown (page 65) in the Bank of England's holding of securities and also in its deposits, by which its power to create credit was used for war purposes, and it was also shown that the figures did not do full justice to its achievement. The expansion in legal tender currency was as follows:—
Currency Movements, 1913–1918.
| Dec. 1913 | Dec. 1918 | Increase or Decrease | |
|---|---|---|---|
| Bank of England Circulation | 29.6 | 70.3 | +40.7 |
| Scottish Banks Circulation | 7.7 | 25.1 | +17.4 |
| Irish Banks Circulation | 8.0 | 30.8 | +22.8 |
| Gold Coin in Banks and in Circulation[3] | 123 | 40 | −83 |
| Currency Notes | — | 323 | +323 |
| Total | 168.3 | 489.2 | 320.9 |
Gossip says that the necessary committee which was to deal with this matter was just about to get to work upon it when the war broke out, but this story seems too good to be true. In any case when the threat of war happened certain excitable folk wanted more currency—some because they were stupid enough to think it would be safer in their own custody than in that of their bankers, others because they expected a rapid rise in prices and wanted a store of money ready to lay in a stock of food. Consequently the banks were asked to hand out cash to an extent that they found inconvenient and fell back on their undoubted right to pay the customers who made these demands in Bank of England notes; and because Bank of England notes were not in smaller denominations than five pounds the public went to the Bank of England to turn notes into sovereigns. As everybody remembers, this crisis was met by a four days' Bank holiday and a banking moratorium and by the issue of Treasury notes of one pound and ten shillings.[4]
It might have been thought that the more obvious course would have been to permit the Bank of England (if it had not the power, which is uncertain,) to issue notes of one pound and ten shillings and to have suspended for the course of the war the restriction upon the note issue imposed by the Bank Charter Act. This suspension was in fact made under the Currency Notes Act of 1914. But perhaps it was just as well that this course was not taken; as it was the Bank of England only availed itself of the suspension of the limit on its note issue during a few days (as was stated by Mr. Asquith in Parliament in November 1915) and in none of its published weekly returns is it apparent. In all of the Bank Returns issued during the war you find the £18,450,000 of Bank of England fiduciary issue maintaining its dignified immobility, while, at the same time the country was gradually being bespattered with a mass of paper money issued not by the Bank of England but by the Government. From the point of view of the Bank of England's prestige and even of the English Money Market as a whole it is possible that this fact may have been to some extent useful. Mankind wears such queer blinkers in looking at monetary matters that it is quite possible that some day the London Money Market may be able to point with pride to the fact that although paper money was poured out with a wanton hand during war it was a liability of the Government, and the Bank of England and the Money Market really had nothing to do with it. In fact this legend is already extant. So well informed an authority as Mr. Benjamin Strong, Governor of the Federal Reserve Bank of New York, told a Commission of the American Congress in August 1921, that "the Bank Act was not suspended in England" at the beginning of the war.[5]
The new notes were originally designed to be issued in the form of loans to bankers, who were empowered to borrow up to 20 per cent. of their liability on deposits in the form of Treasury notes, giving a floating charge upon their assets and paying 5 per cent. for the accommodation. (See the Currency and Bank Notes Act 1914, and explanatory Treasury Memorandum.) Naturally borrowing currency on these terms was not a process which the great English banks wished to carry on longer or to a greater extent than was necessary, and some of them never made use of it at all. From the beginning some of them did not borrow Treasury notes but paid for them with a draft upon their balances at the Bank of England, and in a very short time those which had borrowed paid the loans off from the same source, and simply held Treasury notes in place of so much credit at the Bank of England.
Thus the amount of Treasury notes that could be issued was without limit, seeing that the Bank of England's power to create credits in its books, described in our first chapter, was still more unlimited than it had been before. As was there shown the Bank of England's power to create credit was not in any way restricted by law and was only controlled by the effect that it had, directly and indirectly, on the proportion between its Reserve and liabilities and on foreign rates of exchange, and consequently upon foreign demands for gold. During the war these controls no longer had any but a sentimental effect. It is true that the gold standard was in law maintained; the Treasury note was convertible into gold on demand at the Bank of England, the convertibility of the Bank of England note into gold had not been in any way modified by the Currency and Bank Notes Act of 1914, and the right to export gold was not, in law, taken away. Ostensibly and on paper, anybody who had a claim on England could still turn that claim into gold and take the gold away without question. And these facts were of some use for propaganda purposes when put before neutral countries as an example of England's overwhelming financial strength, in that she had been able to maintain convertibility and her gold standard, as compared with the action of Germany, which immediately on the outbreak of war relieved the Reichsbank of the duty of meeting its notes in gold.
In fact this was all "eyewash"; the British public was appealed to on patriotic grounds not only not to ask for gold, but to pay all of its gold into the banks, and did so to a great extent. Anybody who had gone to the Bank of England with a £1,000,000 worth of Treasury notes or Bank of England notes would have found very great difficulty indeed in turning them into sovereigns and would probably never have succeeded in doing so. If he had, he would have had still more difficulty in sending the gold abroad. In the first place he would have known that even to attempt to do so would have marked him as a suspected person. In the second, the cost of doing so was so great, thanks to the activities of Admiral Tirpitz and his submarines, which made the risk very expensive to insure, that it would not have been worth his while at the rates of exchange which were current during the war and were officially maintained by borrowing operations carried out for that purpose. Though convertibility and the gold standard were thus ostensibly and officially maintained they did not count as part of the practical problem. There was thus no reason why the Bank of England should not multiply the figures in its books to any extent that was required of it, by increasing its holding of securities on one side of its Banking Department's balance sheet and its Public and Other Deposits on the other; and the convention by which Bank of England money had come to be regarded as just as good as cash, presented to the British Government a simple and easy method of financing the war. The Government borrowed from the Bank of England on Ways and Means advances and also by selling to it Treasury Bills, War Loans and other forms of securities created during the war. In so far as the Bank of England took these Government obligations it gave the Government a credit in its books which the Government passed on to shipowners, contractors and others to whom it owed money, and it was thus added to the amount of other deposits included in the balances of other banks. By this method not only did the Government get a certain amount of money in hand to meet current payments, but also, by increasing the volume of cash at the Bank of England which the other banks used as part of the basis of their operations it enabled the other banks to carry huge increases in their deposits without diminishing their proportion between cash and liabilities.
Other banks used this increased credit at the Bank of England either by leaving it there in their balance or by taking it out in the form of currency notes or Bank notes. Obviously, there are limits to which the ordinary joint stock banks can regard a credit with the Bank of England as just as good as cash. It is only so because they can rely, if sudden demands for cash come upon them, on turning this cash at the Bank of England into legal tender currency with which they can meet these demands. But this is a process which takes time and it is necessary for the other banks to be able to meet demands upon them on the spot. Consequently, it is true that the great expansion in bank deposits could not have been carried out if the increase in legal tender currency, provided through the issue of over £300,000,000 of currency notes, had not been available. To this extent it is true that the expansion of credit could not have been carried out without the expansion of currency and to this extent those people are right who maintain that the increase in currency, provided by the Treasury note issue, was the real cause of the credit expansion, which together with the currency increase had such a stimulating effect upon prices and consequently upon the cost of the war. But it is surely idle to spend time in arguing whether the credit increase or the currency increase was the real cause of the rise in prices. They were both causes, and, as the system was worked, neither could have happened without the other.
Such was the effect of the war on the London Money Market. The gold standard was a fiction and it worked on a basis of cash provided by the Government's borrowing from the Bank of England and the printing of Government paper currency. The evil effects upon the community were a great addition, through the consequent rise in prices, to the cost of the war, the violent redistribution of income that follows from the same cause, and the suspicion, suffering and misunderstanding that thence arose. On the other hand it was in favour of producers and of all who use borrowed money and may have helped to stimulate their efforts for war production.
This fact that rising prices are in favour of producers is, within very strict limits, unquestionably an argument on the side of currency expansion and a reason why most producers who think about currency matters are in favour of it. To make the matter clear let us consider what would happen if the volume of currency of all kinds were doubled over-night and the consequent doubled competition for an unchanged volume of goods doubled prices all round. Anybody who had borrowed a thousand pounds the day before this alteration happened would be very greatly benefited. If he were a bootmaker or a merchant or a retail dealer in boots he would find that, his stock of boots having doubled in price, he would only have to hand over half the amount which he would otherwise have calculated upon in order to satisfy his debt. The creditor, on the other hand, would inevitably to the same extent be at a disadvantage, because he would be paid back in money that had lost half its value. Thus currency depreciation is an advantage to debtors and is bad for creditors, while currency appreciation—or a fall in prices—has the contrary effect of putting a bonus into the pockets of creditors who are paid back, or receive interest, in money that has greater buying power than the money that they lent. As a general rule debtors are those who are engaged in active enterprise, production and distribution, industry and commerce. It is part of their business to work on borrowed money, while the creditor class are people who have saved money and rely on its interest to secure the support of themselves and their dependents in their old age, or the representatives of others who have carried out this saving principle in the past and have handed on the proceeds to their heirs.
At first sight the economic advantage of the community lies in making things comfortable for producers and distributors, in other words, for debtors, and if we cannot achieve perfect stability a moderate amount of currency depreciation has something to be said for it, as long as we can be certain of putting on the brake at the right time and as long as we do not inflict too much hardship upon the creditor class and frighten them out of existence. For though the economic service which they render to the community is less obvious than that of the producers and distributors—so much so that many of the rather hasty "reformers" of our economic system blandly dub the capitalist a thief—the fact remains that without the accumulation of capital economic progress is impossible; and it will not be wise to frighten the private capitalist out of existence until we are quite sure that we have secured a substitute that will do the work equally well of providing capital for the further expansion of industry.
Moreover, as will be seen later, the process of currency depreciation, once started, is very difficult to check, and if it is reversed with a jerk is likely to produce even worse disasters than when it was proceeding. If it cannot be checked it leads finally to economic chaos, as exemplified by a story, lately told by Mr. Lloyd George to a Lancashire deputation, of two men in Vienna, each of whom had 10,000 Kronen (Austrian crowns). "One paid 10,000 Kronen into the bank; the other put his into wine. He drank all the wine, but the empty bottles are now worth more than the 10,000 Kronen put into the bank." (Times, July 7, 1922.) Or is this another argument in favour of currency depreciation? Falstaff, that "globe of sinful continents" would swear very heartily that it is.
- ↑ British Budgets, by Sir Bernard Mallet, p. 201.
- ↑ Such as the very full and interesting British Finance 1914-21, edited by A. W. Kirkaldy. Published by Sir Isaac Pitman.
- ↑ As estimated by the First Report of the Cunliffe Committee on Currency, etc.
- ↑ The more technical details of this crisis are described in my book on "War and Lombard Street." H. W.
- ↑ Report of the Hearing before the Joint Commission of Agricultural Inquiry. Part 13, p. 533. Washington Government Printing Office.