Bankers and Credit/Chapter 3
In the meantime the disorganization of our monetary system had given a new chance to those who had, in days before the war, charged it with lack of elasticity and thought it should now be rebuilt on a new plan. These schemes of reform ranged, as will be shown, from a remodelling of our system according to the pattern devised in Germany and copied in America, to proposals which were based on visions too vague and shadowy to be grasped by an ordinary mind. To sucha mind it would naturally seem that the machinery of business had already been turned upside down quite far enough and that there was no need to make confusion worse confounded by monetary changes the results of which might be surprising to their authors; but it must be remembered that towards the end of the war there was still a very general hope that peace would bring with it a new world, which would be more comfortably arranged for all its members than the one in which we had struggled for an existence in the old Victorian times.
These dreams and aspirations were not altogether as foolish as they seem to be now, when a return to pre-war prosperity looks like a far distant goal, which we can only win with a great effort. We have to remember that the war had astonished us all by showing us how great had been the increase in man's power of production, and in his control over the forces of nature. In this country we had shown that we were able to do far more than everything which we had contracted to do before the war happened, namely, to maintain the mastery of the Allies at sea, to finance our poorer comrades in arms, and to supply an expeditionary force to act on the flank of the French Army. Not only had we done all these things, but we had also created and put into the field an army on a Continental scale; we had provided it with equipment and munitions to an extent that had never been dreamt of as necessary when the war began; and at the same time there had been an appreciable improvement in the standard of living of the working classes.
These things had not been done without making considerable drafts on our capital resources. We had borrowed abroad, though not nearly as much as we had lent to our Allies. We had sold perhaps a thousand millions' worth of the investments which our thrifty forefathers had made in the previous century, by lending money to foreign Governments, by financing the building of railways abroad, and by generally stimulating the production of the whole world by providing it with capital. We had also seriously impaired the efficiency of our industrial and distributive machinery, by being unable, largely owing to lack of labour and material, to maintain the usual rate of maintenance and up-keep that is year by year put into our industrial plant under the item of depreciation.
But after making allowance for all these facts, which account for much of the apparent economic miracle that we had worked during the war, it still remains true that we had shown that there were capacities and powers in this country, and in others, which had not been fully developed in the pre-war period. Perhaps this was because for the first time since the industrial revolution, machinery had been allowed to do its work as well as it possibly could, unhindered by restrictive regulations on the part of trade unions, and by the desire to control output, in order to maintain prices, on the part of producers and distributors. We had worked really hard, some few much harder than was good for them, nearly all of us a great deal harder than we had before the war, in order to provide the goods and services needed for the defeat of the enemy and the maintenance of the population at home. And the result had been that, in spite of the general belief when the war began that it could not last more than a few months owing to the financial exhaustion that it would inevitably bring with it, it had actually lasted for four years, though the demands that it had made on human production had been immeasurably greater than anybody imagined when it began.
There was then this solid material basis for the dreamings of those who had hoped for a new world when the war was over. Productive capacity was very much greater than anybody had believed, and, since man lives on what he produces, life might evidently have been made more generally comfortable, if, when the war was over, all nations and classes had worked together for production and exchange as well as they had worked together, or against one another, for destruction and slaughter. It was a question of good or bad temper, and bad temper won, as was perhaps inevitable after the trials to the temper of the human race which the war had inflicted on it. Bad temper kept the war spirit alive long after it had done its work and gave us neither peace nor war but chaos accompanied by a snarling obligato; and so disillusionment and disenchantment have made us look fools who cherished, during and after the war, hopes that the war would have taught us something. But in their day these hopes were not only real, but had as much justification as many of those with which we comfort ourselves. Moreover some of them may yet come true.
Like a trumpet call they stirred the blood of enthusiasts who thought that this was a good time for reforming our monetary system. Common sense with its stuffy conservatism might suggest that we should first restore our credit machine to its old-time health and efficiency, and then see what could be done towards improving it. But this humdrum policy did not commend itself to the many critics who had always complained of its inelasticity and rigidity. The attack was opened by the late Sir Edward Holden, in his speech to the Shareholders of the London Joint City and Midland Bank, on January 29, 1918. He called the admiring attention of his audience to the principles on which the United States had arranged their monetary system under the new Federal Reserve Banks. Before doing so, he stated that he wished to congratulate the Federal Reserve Board and the bankers of America on having succeeded in creating and building up a banking system which "surpasses in strength and in excellence any other banking system in the world." He showed that before the Reserve System was established national banks in New York, Chicago and St. Louis were required to maintain a minimum ratio of cash to liabilities of 25 per cent. "Under the new system the minimum was reduced to 18 per cent., and in June 1917 by an amendment to the Federal Reserve Act the required ratio was further reduced to 13 per cent. It was also provided that this minimum legal reserve of 13 per cent. should be held as a deposit in the Federal Reserve Bank, as against 7 per cent. formerly, and that cash in the hands of national banks in these cities should no longer rank as legal reserve for the purpose of calculating the ratio." These measures, as Sir Edward observed, very greatly increased the deposits and gold reserves of the Reserve Banks; and he added that, just as the Germans foresaw the alterations that were necessary in their banking law, and proceeded to make them without hesitation when war broke out, so the Americans have not hesitated to make alterations in their banking law since they joined the Allies in the war. The fact that really roused his enthusiasm, when he contemplated the Federal Reserve system, was the huge possibility of expansion that it brought with it.
After analysing the balance sheet of the Federal Reserve Banks, "Let us see," he said, "how much further the banks can extend their loans and create credits on their present cash reserves. The Law requires the notes to be covered by a minimum of 40 per cent. in gold, and the deposits by at least 35 per cent. in gold or lawful money. By reducing the present ratios to the legal minima of 4o per cent. and 35 per cent. respectively, the Reserve Banks would be able to create additional loans for member banks to the extent of about £400,000,000. These additional credits of £400,000,000 would form the base for the creation of additional loans and credits by the member banks of over £3,000,000,000, thus placing them in a position of being able to assist to a marvellous extent in the financing of the industries and any future War Loans."
Certainly, if the creation of more banking credit really makes it possible just by book-keeping entries in the banks of a country to increase its wealth and happiness, the system of the Federal Reserve Board seemed to offer most attractive possibilities; and as will be shown later, their came a time in the after-war period when those who maintain this simple proposition that continued multiplication and consequent depreciation of the currency really tends to a country's prosperity, in other words that bad money makes us all rich and happy, really had some practical experience to which they were able to point as bearing out this view; and the question whether bad money pays is one which will have to be quite seriously discussed before we have done with the subject.
Sir Edward Holden, of course, would not have admitted that the huge expansion made possible by the Federal Reserve system would have involved anything like bad money, even if it had been carried out to its full extent. He proceeded to argue that since Germany at the beginning of the war altered her Bank Act, and during the war America altered hers, we should do the same thing and repeal the Bank Act which," he said, "has been notorious for increasing our troubles" and has had to be suspended on four occasions. The rather relevant fact, that the last date before the war on which the Act had been suspended was in 1866, he did not mention. The principles for which he contended are those on which other national banks of issue, according to his account of them, worked. These principles are:—
"1. One bank of issue not divided into departments.
"2. Notes are created and issued on the security of bills of exchange and on the cash balance, so that a relation is established between the notes issued and the discounts.
"3. The notes are controlled by a fixed ratio of gold to notes, or of the cash balance to notes.
"4. This fixed ratio may be lowered on payment of a tax.
"5. The notes should not exceed three times the gold or the cash balance."
It will be seen that on these principles indefinite expansion can be secured. The basis of your note issue is not to be as it was in our case before the war—gold except for a fiduciary issue, the amount of which was fixed—but bills of exchange with a certain proportion of gold (one-third in Sir Edward's view), which proportion, again, can be reduced apparently at will by the payment of a tax. Thus, if the community will only draw enough bills of exchange and pay a certain amount of tax, it can have as much legal tender currency as it thinks it wants. Much was said, in the discussion that Sir Edward's proposal aroused. about the beauties of the bill of exchange as a "self liquidating" instrument; and it is true that a bill drawn on a solvent acceptor against goods on the way to market has outstanding merits as a short investment. But it was not quite right to assume, as happened, that currency based on bills of exchange cannot be multiplied to excess because there must necessarily be goods behind every bill, and so currency could not increase faster than goods. In fact bills are often drawn without goods behind them, on the credit of the parties; and even if it were possible to exclude such kites from being used as the basis of currency it is still possible that several bills might be drawn against one parcel of goods. Goods generally change hands many times on their way from the producer to the final consumer and if they are paid for each time that they are sold by the drawing of a bill at three months and all these bills could be discounted at the Bank and new notes created against them, a ship load of cotton or copper might easily have ten times its value in notes outstanding on its responsibility. And sometimes when goods do not find a final market bills drawn against them are renewed; and when this does not happen there could always be fresh batches coming forward produced in the same way.
Under these arrangements, if carried to their logical conclusion, the task of those who have to maintain the country's gold reserve, on the assumption that a gold reserve is a necessary basis of a monetary system, would be extremely difficult. In one of its exuberant moods the commercial community could demand the creation of fresh currency as fast as it liked, continually forcing up prices, and so putting further nominal profits into its pocket as the process continued. The question of the effect of such a development on the foreign exchanges is a consideration which any individual producer might consider less important than the maintenance of activity and rising prices which were making his profits look so comfortable, and enabling him to make everybody happy by maintaining and increasing the employment that he was giving. The arguments for a Paradise based on unlimited credit expansion are extremely attractive, as long as one does not look at the end of them. The end, when the system is worked to its logical conclusion, has been shown in Russia, and other countries where the currency has become practically worthless.
As it happened, at the very time when Sir Edward was making this attack upon the old system on which the country's monetary arrangements were based, a Committee had already been appointed under the Chairmanship of Lord Cunliffe, who was Governor of the Bank of England during the early period of the war, to consider "the various problems which will arise in connexion with currency and the foreign exchanges during the period of reconstruction, and to report upon the steps required to bring about the restoration of normal conditions in due course," and the following words were subsequently added to the terms of reference:— "and to consider the working of the Bank Act of 1844 and the constitution and functions of the Bank of England with a view to recommending any alterations which may appear to them to be necessary or desirable."
This Committee signed on August 18, 1918, its first interim report which was, in fact, the most important document that it produced. It practically recommended that the Bank Act of 1844 should be restored to full working order, with very slight modifications to meet the altered conditions. It did not admit any need whatever for altering the principles on which the Bank Act had been based.
After giving an interesting survey of the currency system before the war, in which it rather ignored the difficulty which, since the introduction of the Act, the Bank of England had experienced in maintaining its control of the market; and having touched on the changes which have affected the gold standard during the war, laying stress on the great increase in the volume of bank deposits and of legal tender currency; and pointing out that these issues could not be avoided, "given the necessity for the creation of bank credits in favour of the Government, for the purpose of financing war expenditure;" it then proceeded to discuss the measures for the restoration of conditions necessary to the maintenance of the gold standard.
"It will be clear," says the report, "that the conditions necessary to the maintenance of an effective gold standard in this country no longer exist, and it is imperative that they should be restored without delay. After the war our gold holdings will no longer be affected by the submarine danger, and it will not be possible indefinitely to continue to support the exchanges with foreign countries by borrowing abroad. Unless the machinery which long experience has shown to be the only effective remedy for an adverse balance of trade and an undue growth of credit is once more brought into play, there will be a very grave danger of a credit expansion in this country, and a foreign drain of gold, which might jeopardize the convertibility of our note issue and the international trade position of the country."
It will be noticed that in this and many other passages in the Committee's Report, it assumes that the right to export gold, which was ostensibly still existent during the war, would be maintained. This is an important point to bear in mind, because the trade depression of recent years is often laid at the door of the Cunliffe Committee and the policy that it is alleged to have recommended. In fact the right to export gold except under licence was abrogated by law in the Spring of 1919, and by this measure the whole basis of the policy of the Cunliffe Report was cut away.
The Committee proceeded to recommend that Government borrowings should cease at the earliest possible moment after the war, and that as soon as possible repayment should be begun of a large portion of the enormous amount of Government securities held by the banks. It accordingly recommended that at the earliest possible moment an adequate Sinking Fund should be provided out of revenue, so that there might be a regular annual reduction of capital liabilities, more especially of those which constitute the Floating Debt, and it went out of its way to remark that it was of the utmost importance that such repayment should not be offset by fresh borrowings for capital expenditure, that it was essential to the restoration of the effective gold standard that the money for such expenditure should not be provided by the creation of new credit, and that, in so far as this expenditure was undertaken at all, it should be undertaken with great caution, that this caution was particularly applicable to far-reaching programmes of housing and other development schemes. "The shortage of real capital must be made good by genuine savings, it cannot be met by the creation of fresh purchasing power in the form of bank advances to the Government, or to manufacturers under Government guarantee or otherwise, and any resort to such expedients can only aggravate the evil and retard possibly for generations the recovery of the country from the losses sustained during the war."
"Under an effective gold standard all export demands for gold must be freely met." This observation once more shows that the Committee's whole basis was free export of gold. It went on to point out that some machinery must exist to check foreign drains when they threaten to deplete the gold reserves; that the recognized machinery for this purpose is the Bank of England discount rate; and that when the exchanges are adverse, and gold is being drawn away, it is essential that the rate of discount in this country should be raised relatively to the rates ruling in other countries. It also sat heavily upon the suggestion that the differential rate for foreign money might be maintained after the war, so that money might be made cheap during the reconstruction period for the purpose of home development. Obviously, this differential rate was a war-time measure, which could not possibly be worked or justified under normal conditions.
The Report then went on to discuss the question of limitation of note issue, pointing out that it had been urged in some quarters that in order to secure the provision of a liberal supply of money at low rates during the period of reconstruction further new currency notes should be created, "with the object of enabling banks to make large loans to industry without the risk of finding themselves short of cash to meet the requirements of the public for legal tender money." This also, as the Committee very easily showed, was incompatible with the maintenance of an effective gold standard.
It next proceeded to consider the particular machinery in regard to the control of the note issue, and what modification, if any, might be desirable in the system in force before the war. In the first place, it considered that, though the obligation to pay both Bank of England notes and currency notes in gold on demand should, in its judgment, be maintained, it was not necessary or desirable that there should be an early resumption of the internal circulation of gold coin. It did not think that any legislation on this subject would be required, since the public have become so accustomed to handling paper money that it would not be likely to want to handle gold as long as it was made clear to it through informal action on the part of the banks that it would not be desirable to do so. If necessary, however, the Committee said that the circulation of gold coin could be prevented by making the notes convertible at the discretion of the Bank of England into either gold coin or into bar gold. It also suggested that the gold reserves of the country should be held by our one central institution, and that all banks should transfer any gold then held by them to the Bank of England. This recommendation was actually carried out, more or less completely, in the spring of 1920.
A more questionable suggestion was to the effect that, while the import of gold should be free from all restrictions, "it is not necessary to allow gold coin or bullion obtained otherwise than from the Bank of England to be exported." This provision would have given the Bank of England a control over the bullion market rather inconsistent with London's old claim to be a free gold market.
The most interesting part of the Cunliffe Report, however, was that in which it, in effect, answered Sir Edward Holden's criticisms and discussed the changes that he recommended. It did not mention Sir Edward by name, but observed that the Committee had carefully considered various proposals laid before it concerning the basis upon which the fiduciary note issue should in future be fixed. It had been urged that under the rigid restrictions of the Act of 1844 a famine of legal tender money might ensue, and that it was consequently desirable that these rigid restrictions should be transformed into something more elastic, and that the following principal proposals, either separately or in combination, had been put before it by various witnesses:—
"1. That the Banking and Issue Departments of the Bank of England should be amalgamated.
"2. That the issue of additional notes instead of being required to be covered pound for pound by gold should be freely allowed, subject only to the condition that a prescribed percentage of the total issue should be so covered.
"3. That while either an absolute figure for the maximum fiduciary issue, or a maximum determined on a proportionate basis, should be prescribed by law, provision should be made for increases beyond this maximum on condition of a tax being paid by the bank to the Government."
These suggestions the Committee proceeded to discuss, dismissing the proposal for the amalgamation of the two departments of the Bank of England on rather curious grounds. It argued that the effect of the amalgamation of the two departments would be to place deposits with the Bank of England in the same position as regards convertibility into gold as is now held by the note. Presumably there must be something in this argument, or the assembly of very learned and practical gentlemen who signed the Report would not have put it forward; but to the ordinary mind it seems to have very little validity. At present any depositor in the Bank of England can go and draw out his balance in cash, if he desires to do so. In normal times the bank will presumably give him notes or gold to suit his convenience. If the bank exercised its right of paying him in its banking department in its own notes, all that he would have to do would be to go to the issue department and turn the notes into gold.
In the opinion of the Committee it is desirable that the issue of currency, by which presumably they mean legal tender currency, should be subject to strict legal regulation, wherein everybody will agree with them. If a nation says that a certain kind of money must be accepted by all creditors in payment of all debts, it certainly has to see to it that that currency is made as good as regulation can make it. But the Report went on to say that the management of banking should be left as free as possible from State interference. Here also it will carry with it the opinion of the great majority of people, especially since experience during and since the war has had the effect of disgusting most people with the results of Government control of everything. But naturally State socialists and others who believe in State control are in favour of putting the whole banking machinery into the hands of the Government, and this is now said to be one of the recognized planks in the platform of the Labour Party. Continental experience, however, seems to show that the last thing which Socialist Governments do is to nationalize anything.
The Committee stated its belief that the amalgamation of the two departments would inevitably lead in the end to State control of the creation of banking credit generally, "a contingency which we are convinced would actually hamper the elasticity and efficiency with which the banks are able to meet the requirements of industry." It is rather difficult to see why the amalgamation of the two departments of the Bank of England should necessarily promote the institution of State control over the creation of credit, but, as has been said, most people will agree with the Committee's view that any such control would have a hampering effect. It is, in fact, very difficult to rouse much enthusiasm on either side concerning this question of the amalgamation of the two departments of the Bank of England. Their existence makes the Bank of England's return rather clumsy and eccentric, but the mere amalgamation would not make the return any more illuminating, unless it were accompanied by very great modification in the direction of more detail and fullness. On the whole it may be said that since the return has been published in its double form for more than three-quarters of a century, and since the proposed change would increase the difficulties of those who have to use it by way of statistical record and would produce little or no practical result, there is a good deal to be said for leaving the statement in its old form.
The much more important question of allowing the issue of fiduciary notes without limit, subject only to a fixed percentage of the total issue being held in gold, was argued as follows by the Committee. "If," it said, "the actual note issue is really controlled by the proportion, the arrangement is liable to bring about very violent disturbances. Suppose, for example, that the proportion of gold to notes is actually fixed at one-third and is operative. Then, if the withdrawal of gold for export reduces the proportion below the prescribed limit, it is necessary to withdraw notes in the ratio of three to one. Any approach to the conditions under which the restriction would become actually operative would then be likely to cause even greater apprehension than the limitations of the Act of 1844." It therefore unanimously decided that there were substantial objections to basing the note issue of this country on any proportionate holding of gold.
With regard to the plan of fixing a maximum absolute limit subject to the condition that this limit might be exceeded on payment of a tax, the Committee argued that unless the tax were fixed at a sufficiently penal rate to secure that the normal fiduciary issue is not exceeded except in the circumstances of real emergency, and then only for a strictly limited period, the system might afford dangerous possibilities of excessive speculation and lend itself to the development of crises which more stringent safeguards might have averted altogether.
Criticism on these lines had often before been applied to the German plan and also to the arrangements recently adopted by the United States. The Committee pointed out that the latter had not yet been tested by experience, and that it was impossible to say how they would actually operate. Certainly most people will agree that the argument from the experience of the Federal Reserve Board of the United States is not yet one which could be admitted as a practical one for English purposes. Since the Federal Reserve Board came into existence America's financial position has been quite abnormal, owing to the huge profits that were poured into the country by the clamouring demand of the warring powers for goods and services that America was able to produce at an enormous profit to herself. In payment for these goods and services a mountain of gold has been piled up by the United States, and the chief pre-occupation of the Federal Reserve Board now appears to be to prevent the expansion of credit which this great addition to the country's gold store makes possible and would have brought into being if its effect had not been checked by deliberate control.
The Committee also observed that, in view of the comparison with the systems prevailing in foreign countries which have been put forward by various witnesses, it wished to point out that these countries did not in practice maintain the absolutely free gold market which this country by reason of the vital importance of its position in international finance was bound to do.
It then summed up strongly in favour of the old system—absolute restriction of legal tender except in so far as it could be increased by an addition to the gold stock of the country by imports from abroad. In doing so it decided in favour of a policy which is naturally disconcerting to bankers, producers and distributors in so far as they regard their own convenience merely. Those who want to do business and finance business could do so much more comfortably if it is always possible to expand the supply of currency and credit whenever their convenience makes it desirable to do so. On the other hand unlimited expansion when carried to its logical conclusion produces economic chaos, and therefore obviously some sort of regulation is essential. The convention by which mankind used the precious metals as a medium of payment imposed the rough and ready regulation arising from the limit on their supply. By the use of paper money convertible into metal, it has been possible to combine this regulation with great expansion and elasticity; and as long as convertibility is retained as the foundation stone of the monetary edifice, the only question that is open to argument is the extent to which this expansion and elasticity should be allowed to proceed.
Sir Edward Holden wanted a greater degree of expansion to be secured by a note issue, not limited absolutely by the amount of gold in the country, but expanding in proportion to the amount of gold. As the Committee was able to show, this system, if really effectively working, raises possibilities of disturbance and dislocation much greater than under the system of an absolute limit. With an absolute limit as we had before the war, if a million pounds' worth of gold is taken from the Bank of England a million pounds' worth of notes have to be cancelled. Under Sir Edward's proposal of a three to one proportion, if a million pounds' worth of gold were exported three million pounds' worth of notes would have to be cancelled. The Committee were surely right in pointing out that the apprehension of this possibility would be very much more disturbing to the business community.
Sir Edward's further suggestion that the proportion of gold to notes might be lowered by the payment of a tax takes away regulation altogether, except the regulation implied by expense, which at times of exuberant gaiety or desperate need is a negligible consideration; this system allows the community to insist on the creation of legal tender currency to any extent that it is prepared to pay for.
On the whole it seems that the arguments used by the Committee in favour of the absolute limit have a balance in their favour, especially when we remember that by the altogether uncontrolled right of the Bank of England to create credit in its books for any borrowers to whom it chooses to lend, and the convention which allows the other banks to regard a credit at the Bank of England as "cash," the apparently hard and fast restrictions of the Bank Charter Act have been made much less tyrannical in their working than they might appear to be on paper to those who do not understand the true inwardness of the British monetary system.
Having thus decided in favour of the maintenance of the principle of the Act of 1844, the Committee proceeded to recommend that the Act should be modified so as to make provision for the issue of emergency currency in times of acute difficulty, and it came to the conclusion that the provisions of the Currency and Bank Notes Act of 1914 should be continued in force, under which the Bank of England may, with the consent of the Treasury, temporarily issue notes in excess of the legal limit. Thus, instead of the Bank of England being unable to issue any un-covered notes beyond the statutory limit without breaking an Act of Parliament, and consequently having to get a letter from the Chancellor of the Exchequer promising them that he would secure for them an indemnity from Parliament for so doing, they will in future only have to get the consent of the Treasury. There seems to be very little real meaning in this alteration, seeing that under the existing system the Chancellor would naturally not meet the request of the Bank of England for the power to break the law, without consulting his official advisers at the Treasury. This change is therefore merely one of form rather than of principle. The essential thing is that before the Bank can break the statutory limit it will still have to get permission from Whitehall. This necessity, we may be sure, it will move heaven and earth to avoid.
The Committee also observed that it will of course be necessary "that the Bank Rate should be raised to and maintained at a figure sufficiently high to secure the earliest possible retirement of the excess issue." It will be remembered that before the war began the nerves of the public, already quite sufficiently harassed by the closing of the Stock Exchange and other untoward events, were disagreeably startled by a sensational rise in the Bank Rate from 4 per cent. to 10 per cent. in the course of a week. This was because according to precedent the Bank Act could not be suspended without a 10 per cent. Bank Rate, and so, though the rise in Bank Rate did not do anybody any good at the time, and had not the smallest effect in checking demands for credit, it had to be carried out, in order to fulfil the requirements of the dreamy archeologists in whose eyes it was above all important, when Europe rocked, that a monetary crisis should be carried out strictly according to precedent and with due observance of the ceremonial hallowed by tradition.
After prolonged calculations the Committee came to the conclusion that the normal minimum amount of the central gold reserve to be aimed at in the first instance in the after-war period should be £150,000,000—an amount which was at that time already practically available in the hands of the Bank of England, the currency note department and of the other banks—and that until this amount had been reached and maintained concurrently with a satisfactory foreign exchange position for at least a year, the policy of reducing the un-covered note issue as and when opportunity offered should be consistently followed; that the currency note issue should be finally replaced by a Bank of England issue, but not until the future dimensions of the fiduciary issue had been ascertained; that during the transitional period the issue should remain a Government issue, but new notes should be issued, not against Government securities, but against Bank of England notes; and furthermore that when opportunity arose for providing cover for existing un-covered notes, Bank of England notes should be used for this purpose also. Demands for new currency would then fall in the normal way on the banking department of the Bank of England. Finally, when the fiduciary portion of the issue had been reduced to an amount which experience showed to be consistent with the maintenance of a central gold reserve of £150,000,000, the outstanding currency notes should be retired and replaced by Bank of England notes of low denomination.
Just after the issue of the Cunliffe Committee Report another important Report was produced by a Committee appointed at the end of 1917 to consider whether the normal arrangements for the provision of financial facilities for trade by the existing banking and other financial institutions would be adequate to meet the needs of British industry during the period immediately following the end of the war, and, if not, by what emergency arrangement they should be supplemented. This Committee's report was dated November 21, 1918, and it made some interesting observations concerning the working, not of our monetary system as a whole as regulated by the Bank Charter Act, but of our banking system in its relation to the provision of the needs of its customers for credit.
"Having regard," it said, "to the fact that the very great expansion in credit which has taken place during the war will probably persist for a considerable period after its termination, we are unanimously of opinion that, if the reconstitution of industry and commerce is to be achieved on permanent and sound economic lines, some restriction must be imposed at as early a date as possible upon the creation of additional credit by the restoration of an effective gold standard. To attempt to re-build industry by means of a further indiscriminate expansion of credit would not only endanger our position as the financial centre of the world, but would inevitably lead before long to grave disaster."
It also laid stress on the need for the immediate cessation of State borrowing after the end of the war. It pointed out that commercial capital issues had been largely in abeyance since the beginning of the war, and that consequently there would be a very heavy demand by trade and industry for new capital, and that State borrowing could only be undertaken in competition with these demands. It further expressed the opinion that any Government guarantee to bankers to enable them to provide by means of credit the fixed capital expenditure necessary for the re-constitution of industry was undesirable as being likely to cause a further expansion of credit, together with an additional rise in prices.
This Committee by laying down these principles thus took a firm stand against the many prophets who were proposing to lead us into a new economic Paradise, merely by the unlimited expansion of credit. It pointed out that for capital purposes what was required was not credit but capital, and that capital could best be provided, not by making entries in the books of bankers, but by somebody saving money and handing it over to industry to be used for purposes of development. As to banking facilities, it defined them as the normal requirements for carrying on the ordinary business of the country, "which assumes the granting of loans which do not constitute a lock-up of funds such as would impair the liquidity of the resources of the banks." For this purpose it was informed that the banks would be able to provide all the necessary facilities during the transition period. In fact, only the most embittered critics of the English banking system have maintained that it showed any inability to provide credits of this kind, that is to say, real banking credit involving no long lock-up. His more moderate assailants have only charged the English banker with being too much inclined to insist on confining his activity to this kind of business, though it is clearly the right business for a banker who has an enormous amount of liability in the shape of current and deposit accounts, which may be called from him on demand or on short notice. For such a banker to indulge in giving long credit and so locking up his funds in enterprises which cannot be called liquid is clearly a policy involving very great danger. The critics of the English banks have never been tired of proclaiming that the German banks, for example, have been able to assist industry much more readily and extensively than their English rivals, by making advances to it on terms which were not strictly of a banking character, according to English ideas. The German banks work with their own capital, as opposed to their customers' deposits, much more than the English. In so far as they do so they are not doing what we call banking, the essence of which is that you borrow money, repayable practically at call, and lend it. Lending shareholders' money which you have got for all time is quite a different business.
This contention was dealt with and to a certain extent admitted by the Financial Facilities Committee. Under the heading of Extended Credit Facilities it included "loans involving a lock-up of funds for a more or less extended period and secured upon assets not readily realizable, including loans required for giving long trading credit, either at home or abroad, and loans secured against capital goods which are either dependent upon future profits for repayment, or will be replaced ultimately by an issue of new capital."
It considered that the banks as at present constituted, however willing they might be, would only be able to provide credit of this kind to a limited extent owing to the necessity for keeping a large part of their funds in a liquid state. It accordingly suggested that it would be necessary for the banks "to exercise discretion upon rather broader lines," and in order to enable them to do this with some safety and confidence, it was strongly of opinion that the banks should make a considerable increase in their paid-up capital. The Committee also made the curious suggestion that bankers should make more widely known their willingness to accept deposits for long periods at fixed rates of interest, and expressed the belief that if they were encouraged to do so a number of depositors would be willing to deposit their money at fixed rates of interest at periods of from one to five years without the right of withdrawal.
Presumably the Committee had some good ground for making this statement, but it seems that any depositor who was asked to lock his money up definitely for five years, during which time he would have no opportunity of getting his cash back in case of an emergency, unless somehow or other a market could be established in bankers' deposit receipts, would think twice or thrice before he did so. The Committee also considered that the principal manufacturing establishments of the country should increase their capitals by appeals to the public for subscription, thus enabling themselves to rely less upon banking credit for their operations. But, besides all this, it thought that institutions to provide additional assistance for trade and industry by developing similar facilities to those which have been given by the German banks were necessary. In this connection it noted the formation of the British Trade Corporation, whose career has since provided the City, always suspicious of semi-official enterprise, with some malicious satisfaction. Launched on a career of expansion in the after-war fever, with no solid mass of sound old business to lean on, with no hidden reserves to be used for concealing unfortunate slips, it showed some considerable losses when the fever gave way to anemic debility.
The Committee also made some sound and practical suggestions for an improvement in the machinery for promoting enterprise, and offering for public subscription new issues of capital. It pointed to the machinery already in existence, consisting of a group of financial houses, comprising investment trust companies, well-known issuing houses, merchant bankers and others, and it thought that it was within the power of this important group to render further assistance by identifying themselves with productive industries in this country, and rendering financial support in the early stages of development, ultimately undertaking the placing of the issue of new capital with the investor, and that the institution of a system of working arrangements between the members of this group and the various joint stock banks would be of great assistance.
These two documents, the Cunliffe Report and the Financial Facilities Report, thus pointed the way back to sanity in money matters along safe and cautious lines. In effect they told the Government to leave off the manufacture of new currency and credit and to re-establish our legal tender currency on the foundation laid by the Bank Act of 1844, and they told industry that the capital that it required should be found through the process of saving and investment instead of through the extension of bank credits. But they were very far from preaching drastic deflation and rapid contraction of credits. The Financial Facilities Report, as quoted above, only urged "some restriction" upon the creation of additional credit. The Cunliffe Report spoke of an "interim period beginning after the completion of demobilization, during which it is probable that the present issue of Currency Notes will have to be gradually reduced." It referred to a suggestion put before it in evidence that the un-covered issue should be reduced at the rate of not less than 3 per cent. per annum of the outstanding amount, and doubted whether it would be possible to work to any precise rule. It concurred however in the suggestion that, when reductions have taken place, the actual maximum fiduciary circulation in any year should become the legal maximum for the following year, subject only to the emergency regulations already described, by which in future what used to be called suspensions of the Bank Act would be carried out with the permission of the Treasury.
The Cunliffe Report was dated August 15, and the Financial Facilities Report November 21, 1918. Thus by the time the Armistice came a body of sound doctrine was in existence, reminding us of some of the common sense facts that had once been regarded as platitudes, but had been lifted into the position of almost forgotten ideals by the financial crimes and futilities committed by our War Governments.