Bankers and Credit/Chapter 4
It need hardly be said that the doctrine preached by the Cunliffe Committee and the Financial Facilities Report was not put into practice as soon as the war was ended. This could not have been expected, even if war's strained excitement had not been followed by an outburst of peace hysteria that was perhaps still more virulent. If we had all been sane and sober as judges, it would have taken some time to adjust our financial system to the circumstances involved by the rearrangement of industry on a peace basis. As it was there was an amazing outburst of political and economic optimism, followed by violent reaction; and these changes of sentiment were accompanied by monetary measures the effects of which are of special interest for the light that they throw on a monetary theory which has since become fashionable.
For this reason it is necessary to remind ourselves of the outlines of this curious and interesting chapter in our history.
As everyone knows the war was followed by a spell of delirious trade activity accompanied by a violent rise in prices, high wages, large profits and rampant extravagance on the part both of the Government and of the individuals composing the nation. The consequent collapse came much sooner than was generally expected and was so violent and headlong in its course that it left most of our financial institutions amazedly gasping at their own dexterity, or good fortune, in having survived it. It is easy to be wise in the light of what has since happened concerning the folly of the behaviour of most people during the after-war period, but in fact it was just a very human and natural reaction after the strain of the war, quickened and exaggerated by the promises held out by the Government during the General Election of 1918. During the course of this contest the country was persuaded that, if the Government which had won the war were returned to power, it would secure a just peace under which Germany up to the limit of her capacity should be made to pay for the whole cost of the war, that the Kaiser and those chiefly responsible for outrages during the war should be punished and that social and domestic reform should be carried out with a generous hand so as to make this country fit to be lived in by the heroes who had served it so well on the field of battle.
A great programme of reconstruction was thus to be taken in hand, largely at the expense of our defeated enemies, against whom a strongly vindictive feeling was still prevalent. The old-fashioned English habit of hammering your enemy as hard as ever you can when fighting, and then, when you have beaten him "thorough and thorough," of picking him up and shaking his hand and letting him off much too lightly was gone, except in the minds of a small minority, and had given place to a feeling of lingering hostility and vindictiveness.
Here again we have to remember the special circumstances of the war out of which we had emerged. Former wars had been fought by a comparatively small number of the population of countries engaged, with comparatively little interruption to the ordinary life of the greater part of the nation. This time the horrors of war had been brought home to nearly every inhabitant of the countries concerned owing to the enormous number of the combatants engaged and the consequent bereavement and loss spread over the whole population owing to the high proportion of casualties, also by the privation inflicted even upon the most prosperous members of the community by the impossibility of securing many comforts, necessaries and luxuries to which they had usually been accustomed, and finally by the effect of air raids which had inflicted actual physical suffering upon many civilians who had risked their lives without the satisfaction of being able to feel that they had a chance of endangering somebody else's. For these reasons it was evidently much more difficult to leave off the war spirit as soon as the war was over than it had been when war was a more or less gentlemanly business, with its most uncomfortable effects largely confined to the fighting forces, which at least had the pleasure of inflicting what they suffered. Moreover it was felt that the Germans in the matter of poison gas and many other things had introduced new and unnecessary beastlinesses into war, and that the destruction—much of it quite wanton—wrought by them in France and Belgium made it essential in the interests of international justice that retribution should be strict and severe.
Thus justice and vindictiveness joined together to show that Germany ought to pay every penny that could be wrung out of her. It is true that the Allies had agreed, before granting the Armistice, that the indemnity was only to cover damage to civilian property by land, sea and air. But legal ingenuity combined with poetic imagination in following out chains of consequential damage due to consequential losses and so ad infinitum could evidently put as many noughts on to the bill as would suffice to appease the groundlings. Nevertheless the inclusion of the cost of pensions in the Reparations bill always seemed to me to be an ugly blot on the scutcheons of the Allies; though it has been supported by authorities whose judgment and integrity are above question.
For this vindictiveness against the beaten enemy, un-English as it was, there was, as has been shown, a good deal of excuse, but the amazing thing is that there was so little readiness to show more forbearance to our Allies. On this point I am not, as we say in the City, "jobbing backwards," for before the end of 1918 I expressed in print the view that it would be a generous act, which would cost us nothing, to clean the slate of international indebtedness as far as we could by wiping out the whole of the debts due to us from our Continental Allies. They were poorer than we when the war began, had suffered much more from the war, were most unlikely ever to pay us a shilling, and if they did, would do so with a sense of grudging injustice that would embitter their hearts against us. If our Government had only then had the sense to make a bonfire of the promises to pay of our Allies, they would not have cost us a Stiver and they would have made a gesture of generosity which would have had a quite immeasurable effect on the economic atmosphere in Europe, in America, in the rest of the world and at home in England.
As it was, the fashionable sentiment, both in international affairs, home politics and in industrial matters, favoured getting as much as possible out of anybody who could be squeezed. Abroad this sentiment was one of the reasons why it took a most unconscionable time to put together a Peace Treaty, which when it was put together produced anything but peace, and that the Reparations problem developed into that dreary mixture of tragedy and farce of which more will have to be said later.
At home the Government instead of telling us, what it ought to have known if it did not, that in some ways the most difficult part of the war began when it was over, encouraged us in the belief, already much too prevalent, that the country's wealth was unlimited and there was a bottomless purse into which everybody could dip for the purpose of carrying out any reform that he thought desirable for himself or for the community apart from any question of the energy and efficiency with which the community did its work. It has been shown above that the war revealed a quite astonishing capacity for production on the part of this country when the working power of the community was really set to work as hard, or nearly as hard, as it could. Under these circumstances we had apparently performed economic miracles, and the very dangerous delusion was rife during the after-war period which taught that economic miracles could be continued without the tremendous effort and whole-hearted co-operation which had marked our productive achievements during the war. If the land was to be made fit for heroes to live in, it could only be made by a continuance of the hard work and goodwill which had made it victorious during the war. The assumption that it could be done at the expense of some fund already in existence and that the rock only had to be struck hard enough in order to produce a stream of prosperity led the working classes of this country along a path which ended in grievous disillusionment.
It was shown only too clearly that the Government's purse very soon reaches bottom unless it is filled by a stream of goods and services provided by the community or by some foreign lender or debtor. We had ceased to borrow abroad and Germany had not begun to pay. It was not really possible for us all to be happy and prosperous by deciding not only to work shorter hours but also to work with much less enthusiasm during the time we spent at our job, and by also insisting on the restoration of many regulations and controls which before the war had hindered the output of industry. A system under which each worker, while making a smaller contribution to the general output, should at the same time receive a larger share of it in return for his lessened work was really too good to be true. These platitudes had to be brought home to the working-class community through a series of disastrous industrial disputes which very seriously hindered the economic recovery of the country.
Here, again, the accusations freely brought against the working classes of some special spice of villainy or of an abysmal ignorance of economic conditions are by no means justified. The inferences that they drew from their war experience were quite reasonable and natural. With the country engaged in a fearful and costly struggle, they had seen a very large number of the employing class amassing enormous profits in spite of taxation designed to prevent their doing so; they had seen amazing things happen in their own class, as when one member of the family faced all the hardships and dangers of exposure and of warfare in a mine sweeper, for pay which left him very little better off than an ordinary seaman before the war, while his brother or his cousin who stayed at home because he was not physically fit to fight, earned wages which may have ranged from £15 to £20 a week in a munition factory, or, if he happened to be a shopkeeper, might amass a fortune which enabled him to start a county family. Such had been some of the economic effects of the war, contrary to all logic or common sense, and largely due to bad war finance.
It is not to be wondered at that having seen such things before their eyes the working classes of the country should come to the conclusion that practical sense did not count in money matters, and that anything was possible for those who only persisted in demanding it with a sufficiently loud voice. They believed, and with good reason, that immeasurable economic injustice had been inflicted during the war especially upon the best men of the community who were fighting its battles at the front; and they argued that it was at any rate worth trying whether they could not, by insisting on a larger share of the national output in return for much less work, put some injustices right by securing for those who did the hard, dirty and uninteresting work of the world a better share of the goods which they helped to produce. They had to find out by bitter experience that it is only by increasing output and making trade prosperous that they could make their demands for better conditions felt. But there is nothing strange about economic mistakes made by uneducated folk, at a time when our leaders, who believed themselves to be the fine flower of the nation's intellect, were wallowing up to their eyebrows in economic and political error, and the mighty brains that directed industry and finance were making enormous miscalculations about the staying power of the after-war demand for goods.
In fact, as we all know, it is human to err; and in the after-war reaction we were all very human indeed and erred with hearty and unanimous vigour, with a few very select exceptions who were not quite human and so did not join in the erroneous orgy. The rest of us, fired by determination to go on beating the enemy after the end of the war, to create an earthly Paradise at home at the expense of somebody else, to pocket big profits, big salaries or big wages while doing as little as possible to earn them, and generally to have a glorious time because peace and plenty had returned and there were cakes and ale, and ginger, by Saint Anne, was hot in the mouth, naturally and inevitably spent, collectively and individually, extravagantly and recklessly.
Any attempt to balance expenditure and revenue was felt to be unsuited to the atmosphere. The national debt, in fact, went on increasing from the Armistice date, November 1918, until the end of December 1919. Even if Mr. Gladstone and Lord Welby had been in charge of the national finances, it would have been impossible, as soon as the war was over, to bring outlay within income. Very heavy expenses were involved by demobilization of the army and by the problem of returning to ordinary industry the millions of men who had been in the fighting line and in the field or on the lines of communication, or who had been employed directly or indirectly on work for war purposes. On the whole it may be said that this business of getting the great majority of them back into ordinary industry was carried out with astonishing rapidity and success, for which the Government, in the midst of the chorus of criticism which began to arise under the pressure of disillusionment, did not receive the credit to which it was entitled. And there can be no doubt that official extravagance, commercial recklessness and miscalculations, private profligacy and the inflation that they all helped to produce, at least did something to ease and quicken the work of demobilization in the widest sense of the word, and the adjustment of industry from war to peace conditions.
So much had to be said about the temper and sentiment that ruled in the after-war period, because their effect upon the monetary matters which are the subject of this inquiry were like Sam Weller's knowledge of London, extensive and peculiar. Under their influence the expansion of currency and credit that have been shown to have been one of the most aggravated symptoms of bad war finance, continued with quickened inflammation, produced at once by the needs of a spendthrift Government, the cravings of industry and commerce, intoxicated by the prospect of a world-wide insatiable demand for goods at any price that might be asked, and the clamours of eager consumers, in full reaction from the privations, enforced and voluntary, of the war period. And so prices, after a momentary dip after the Armistice, went rollicking ahead for nearly a year and a half, before they dropped like a stone in the last three quarters of 1920.
In the Money Market, in the strict sense of the phrase, the outstanding event of the after-war period was the formal abandonment by England of the gold standard in March 1919 by the prohibition of gold exports except under licence. By this measure we went legally and definitely on to the paper currency basis, on which we had actually been standing, or rocking, all through the war. Convertibility of our legal tender currency into gold on demand was and is still the law of the land, but a very interesting example of the enormous power and prestige of the Bank of England is the ease with which on this point it ignores the law and goes scatheless. When a Home Secretary packs off some people to Ireland in the belief that he is acting legally and then finds that he is not, he is made to produce their persons and is put into a very uncomfortable position, from which he has to be rescued by a Bill of Indemnity. When people present a five pound note to the Bank and ask for gold which it is legally bound to pay, it reasons with them kindly and points out the error of their ways, and they go away with no gold in their pockets but a virtuous glow in their hearts, as if they had had their souls shampooed by a bishop. But such attempts to get gold, even if likely to be successful, would be quite futile for practical purposes, unless any gold so secured could be dealt with according to the desires of him who gets it. It is of no use to be able to take gold out of the Bank of England unless one can send it abroad, if this happens to be the cheapest method of paying a debt to a foreign creditor. For purposes of hoarding at home it might offer attractions to a few feeble-minded people; but the practical benefit of the gold standard is the fact that thereby you link your currency with those of other gold standard countries and in effect use the same currency as they do. When once the right to send gold abroad is taken away there is no link between the world's currencies, and variations in the price levels in different countries are no longer restrained by the fact that currency can move from one country to another, raising prices in the country to which it goes and lowering prices in the country which it leaves. And it also follows that when once the golden link is snapped, the prices of different currencies as expressed in one another through rates of exchange, can vary down to zero and up to an astronomical zenith.
It was generally admitted that the Government had no choice in making this regulation. The New York exchange which expresses the sterling price of money in New York had been, as we all remember, "pegged" since January 1916 in the neighbourhood of $4.76½ to the £. This peg was withdrawn in the Spring of 1919 and the American exchange immediately began to move against London owing to the great demand for American goods at high prices, not only in this country but all over Europe—and Europe's demand for dollars was, then as at other times, largely financed through London—and also owing to the rapidity with which inflation was proceeding here. Under such circumstances, since the submarine danger was no longer protecting the English gold standard, it was inevitable that people abroad who had balances in London should want to turn them into gold and send the gold to America to be converted into dollars and so miake the handsome profit which was offered by the rate of exchange. English bankers, when these demands for withdrawal came upon them naturally asked the Government what they were to do and the Government met the situation by prohibiting the export of gold except under licence.
Most people thought that it had to be done, but it is interesting to wonder whether it would not have been possible for England to meet the situation by the good old banking rule for meeting a drain—that is by saying, with a stiff upper lip and an air of calm confidence, "Take your money as fast as you like." It is usually said that if we had attempted to do this all our gold would have immediately left the country and gone over to America; but this is by no means certain. In the first place it could not all have gone at once because even without the submarine danger there are very decided limits to the possibility of insuring gold shipments against ordinary marine risks. It is not possible to dogmatize about this because to a certain extent it is a question of the price that will be paid. I am told by those who ought to know that any shipment of more than £4,000,000 of gold in one bottom would have been very difficult to underwrite in the ordinary course of business in London and other centres, and that the insurance of such a shipment would only have been even considered on a first class liner, of which probably not more than two, and sometimes not so many, would have left a possible port of shipment during a week. Thus the process of draining away our gold supply, which stood at the end of the war at about £150,000,000, would necessarily have been slow. If we had shown that we had meant to allow it, it would certainly have been a cause of considerable apprehension to the authorities of the United States Federal Reserve Board. They were already embarrassed by the great mass of gold which they had accumulated during the war and by the enormous possibilities of credit expansion which their system allowed to be built up upon this basis. Indeed, it may be said that since the war the Federal Reserve Board has been chiefly anxious to prevent America's huge holding of gold from having its natural economic effect, by producing an enormous expansion of credit and currency and so turning the exchanges of the world against America and driving some of the gold out.
Given a mountain of gold and the American temperament, an outburst of Gargantuan consumption indulged in by the latter might soon be relied on to disperse the former, unless artificial checks had been applied, and such an outburst might have been best in the long run for all parties concerned. But the Federal Reserve authorities working an untried machine along an unknown road, with an extremely suspicious and critical public ready to pelt them if they made a mistake, were not at all inclined to take risks. And big risks would have been involved if they had allowed their gold to work its own cure, through an expansion of credit and currency, with an orgy of extravagance and speculation and consumption of the goods and securities of other countries, ending in adverse exchanges and exports of gold.
This natural solution of the question being too exciting a "proposition" for the nerves of the Federal Reserve Board, America has had to sit on an enormous mountain of gold while its financial rulers have done their best to prevent it producing the economic results which its presence would naturally have worked. Their task would evidently have been made much more difficult if gold had begun to come from England at the rate of 8 or 10 millions a week; and it is certainly possible that in any case, if England had shown a sufficiently stiffnecked determination to pursue the policy of allowing gold to go, the result might have been a working agreement between ourselves and America by which exchange equilibrium between the two countries would have been maintained at a point which would have prevented a continuance of the drain of gold.
There is, as least, something to be said for the view that the Government, rather than hauling down its colours on the matter of the gold standard much sooner than it need have done, might have tried a bluff and let a certain amount of gold go, and waited to see what happened. We might possibly have held the gold standard and been brought back, much sooner than we were, to sanity in money matters. As it was, we kept our gold and lost our gold standard definitely though temporarily, when the export of gold was forbidden. At the same time an arrangement by which the output of the South African mines had been taken over by the Bank of England at the mint price was dropped and the market was freed for any gold, for the export of which a licence could be obtained. The consequence of this has been that the gold from the South African mines has gone regularly week by week to New York, except on rare occasions when a demand on account of India or China has diverted a fragment.
Less important changes in the working of the Money Market were the dropping in May 1919 of the system by which the Bank of England borrowed from the Clearing and other banks their surplus cash balances, and later in the same year, in October, the special rate given for foreign money was also dropped. This was a war time measure which could not possibly have been continued into peace. In war time the censorship of telegrams and letters made it more or less possible to trace the actual purpose of financial transactions, and to see that money which earned the higher rate as foreign, really was so. In peace there was no such safeguard, and in any case the differential rate is not wanted in peace time. It was less wanted than ever in the after-war period, since the movements of credits to and from this country was then largely regulated by movements in exchange which were already sufficiently erratic and violent to make the question of the rate earned by sums left here an almost negligible item in the consideration of those who controlled them.
Attention has already been called to the change in the working of our Money Market that had been produced by the enormous total of the floating debt created during the war. The existence at the end of the war of over a thousand million of Treasury Bills outstanding, of which between £300,000,000 and £400,000,000 were probably in the hands of the banks and other professional dealers in credit, clearly made it difficult for the Bank of England to secure real control of the monetary position. If these professional holders of Treasury Bills took it into their heads to want more credit, at a time when the bank wanted them to have less, they had only to present them day by day for payment instead of renewing them on maturity and they could compel the Government to create the necessary credit for meeting them by borrowing from the Bank of England on Ways and Means advances and so increasing the amount of cash at the Bank of England held by the other banks.
For this and other reasons it seemed that the volume of outstanding Treasury Bills should somehow be reduced, and with this intention a funding loan was offered in June 1919. All the organization and energy which had been so successfully developed during the war for encouraging subscribers to war loans to lend as much as they possibly could and as much more as they could borrow from their bankers was put into commission to secure the success of the funding loan, but this success was conspicuous by its absence. Already the country was decidedly anxious about the scale of Government expenditure and investors had become imbued with the belief that the only way to make the Government economize was to refuse to provide it with money. They were decidedly sceptical as to whether the sums which they lent would be used for the alleged purpose of reducing the floating debt and openly expressed the opinion that the Government was almost certain to expend it upon other objects. This contention was proved to be almost exactly correct by one of the most curious arithmetical coincidences on record, namely, the fact that the amount of cash produced by the loan was £473,000,000 and that £473,000,000 was also the amount of the deficit for the financial year, estimated by Mr. Chamberlain in a speech which he made in the Autumn.
This failure of the funding loan was interesting as the first indication of the growing wrath of the taxpayer concerning Government expenditure and the suspicion of investors concerning official promises. This suspicion was increased by a rather absurd attempt to continue war camouflage into peace finance. Mr. Chamberlain's reputation for an integrity quite unusually high among politicians makes it all the more remarkable that he should have brought pressure on the banks to make the success of this loan look much greater than it was, while at the same time impairing its real effectiveness. The result that was really wanted from the loan was that Treasury Bills in the hands of the banks and other official dealers in credit should be paid off out of money genuinely subscribed by the public for that purpose. Yet when the loan was found not to be going as well as was hoped, pressure was brought upon the banks that they should themselves subscribe money out of which their Treasury Bills were to be paid off with the result that they, instead of holding Treasury Bills, would merely have held a longer dated security. It is true that if they had done so their power to call upon the Government to manufacture fresh money for them would have been reduced; but one of the chief purposes of the loan was to restore order into chaotic money conditions and enable the banks to get back to their real business of financing industry; this was to be done by paying back to them money which they had lent for the war, and this purpose was defeated in so far as the banks themselves were asked to contribute money to pay themselves off with. It was suggested that the banks should underwrite a certain amount of the loan and one of the last acts of Sir Edward Holden, just before he left for the holiday from which he never returned alive, was to refuse to do anything of the kind and at the same time to make application for an amount of the loan which was very much less than the Government had asked him to underwrite. The final result of these proceedings was that out of the £473,000,000 secured by the operation £92,000,000 were provided by the banks.
As the year 1919 went on our rulers began to wake out of the dreams into which they had drugged themselves and the country. In August Mr. Chamberlain made a speech in the House of Commons in which he called emphatic attention to the unsatisfactory state of the Government finances and went so far as to include the phrase "national bankruptcy" in his sketch of what was going to happen if extravagance in expenditure was allowed to proceed at a pace so much faster than the inflow of revenue. The country was startled and alarmed by the statement, and some of us wondered why, if these things were so, the Chancellor of the Exchequer did not either cut down expenditure or raise fresh revenue. But Parliament adjourned with nothing done, and in November there came a rise in Bank Rate and a Treasury Minute. Bank Rate had stood at 5 per cent. ever since the Armistice and was put up to 6 per cent. in November 1919 with a consequent advance in the rate at which Treasury Bills were sold.
The Money Market was bewildered and puzzled by this movement. There would have been no mystery about nt if the Government had found any difficulty in selling Treasury Bills at the current rate and so had thought it necessary to offer a higher rate on them; or if large demands for credit had been made on the Bank of England; but in the previous two weeks the securities in the Bank return had dwindled by £35,000,000, and at the time when the rate was raised Treasury Bills were in fact being sold with quite satisfactory ease, so the effect of putting the rate up was rather to check the demand both for them and for commercial bills, because it was felt that with the Bank Rate rising on this apparently quite illogical system another rise in Bank Rate might happen at any moment. The old reasons for movements in Bank Rate to protect the gold stock, so strongly insisted on by the Cunliffe Committee Report, had all been destroyed for the time being by the prohibition of the export of gold. Consequently, the market had no bearings to steer by in the matter of Bank Rate and could only cherish an uncomfortable feeling that since a rise had taken place when there was apparently nothing special to warrant it, a further rise on equally obscure grounds might be expected at any time. In fact, there was for a time a serious risk of something like panic, because Lombard Street, very naturally under the circumstances, practically retired from its bill discounting business, and a very awkward deadlock was only stopped by special measures taken by the Bank of England, which expressed its readiness to discount sixty days' bills (instead of the customary ten or fifteen days) for the bill brokers if they needed such accommodation, and otherwise coaxed and wheedled them back to business.
At about the same time a Treasury Minute was produced imposing a limit upon the fiduciary issue of Currency Notes, that is to say on the issue of Currency Notes which were not backed by gold or by Bank of England Notes, this limit being fixed at £320,000,000, in accordance with the recommendations of the Final Report of the Cunliffe Committee. The Treasury had no real power to control the note issue because holders of the Treasury Bills could at any time insist upon their repayment, and could thereby secure either Currency Notes or Bank of England notes or a credit at the Bank of England which they could turn into Currency Notes. Nevertheless the issue of this Minute and the raising of Bank Rate probably had a certain amount of psychological effect and brought home to men's minds a few facts which had been forgotten by many people engaged in finance, industry, commerce and politics; such as, that unlimited expansion of currency and credit was not part of the scheme of the universe, that British industry had worked before the war and with considerable success with a monetary system which had been limited by the amount of gold in the country and that the issue of unlimited paper money—inconvertible in fact because gold could not be exported—could not be allowed to pursue its riotous way unchecked, unless the country was prepared to face the final result in total worthlessness of the currency.
Thus the Treasury Minute and the rise in Bank Rate, which thus made its first appearance as a sort of moral weapon, to be moved up or down for the good of our souls, were a timely reminder of forgotten truths, but their doctrine had little immediate effect. For several more months extravagance, inflation and hysterical business continued, and when the check came at last in the spring of 1920, it was rather because the pace was too hot for the home and foreign consumer, than because the producer and the merchant were frightened by a rise of a couple of points in the price of money.
In fact, as will be shown, the contraction in credit which is supposed to be caused by a higher price of money and to cause a lower price of goods, did not make its appearance until long after the bottom had fallen out of the price of goods, and some time after the price of money had begun to come down again. Up till the end of 1919 prices and money—as far as we can trace the latter's movements—moved together with a harmony most satisfying to a statistical mind and to constructors of charts and curves. As the Government continually outran the constable, it created new credit by borrowing directly and indirectly from banks, and new currency was poured out as backing for the new credit and prices went, with occasional slight hesitations, steadily ahead. But after 1919 the disagreements and discords between money and prices are as consistent as the previous harmony and need very careful consideration in view of the fashionable belief that credit, contracted and expanded like a concertina by a consortium of banks of issue, will suffice to draw a nice straight line of stabilization across the once untidily see-sawing price chart of human enterprise.