XVI
THE CURRENCY REPORT December, 1918
Currency Policy during the War—Its Disastrous Mediaevalism—The
Report of the Cunliffe Committee—A Blast of Common Sense—The
Condemnation of our War Finance—Inflation and the Rise in Prices—The
Figures of the Present Position—The Break in the Old Relation between
Legal Tender and Gold—How to restore it—Stop Borrowing and reduce
the Floating Debt—Return to the Old System—The Committee's Sane
Conservatism—A Sound Currency vital to National Recovery.
Among the many features of the late war (how comfortable it is to talk about the "late war"!) that seem likely to astonish the historian of the future, perhaps the thing that will surprise him most is the behaviour of the warring Governments in currency matters. It is surely, a most extraordinary thing after all that has been thought, said and written about monetary policy since money was invented that as soon as a great economic effort was necessary on the part of the leading civilised Powers, they should all have fallen back on the old mediaeval dodge of depreciating the currency, varied to suit modern needs, in order to pay part of their war bill, and should have continued this policy throughout the course of the war, in spite of the obvious results that it was producing in the shape of unrest, suspicion and bitterness on the part of the working classes, who very naturally thought that the consequent rise in prices was due to the machinations of unscrupulous capitalists who were exploiting them. It is even possible that the historian of a century hence may ascribe to this cause the beginning of the end of our present economic system, based on the private ownership of capital, for it is very evident that we have not yet seen the end of the harvest that this bitterness and discontent are producing.
A less important but still very objectionable consequence of the flood of currency and credit that the Government has poured out to fill a gap in its war finance is the encouragement that it has given to a host of monetary quacks who believe that all the financial ills of the world can be saved if only you give it enough money to handle, oblivious of the effect on prices of mere multiplication of claims to goods without a corresponding increase in the volume of goods. These enthusiasts have seen that during war a Government can produce money as fast as it likes, and since they think that producing money makes every one happy they propose to adopt this simple method for paying off war debt, restarting trade and generally creating a monetary millennium. How far their nostrums are likely to be adopted, no one can yet say, but some of the utterances of our rulers make one shudder.
Into this atmosphere of quackery and delusion the report of the Committee on Currency and Foreign Exchanges breathes a refreshing blast of sound common sense. Everybody ought to read it. It costs but twopence; it is only a dozen pages long, and it is described (if you want to order it) as Cd. 9182. In view of the many attacks that have been made on our banking system—especially the Bank Act of 1844—by Chambers of Commerce and others before the war, it is rather surprising that so little criticism should have been heard of this Report, which practically advocates a return, as rapidly as possible, to the practice and principles imposed by that Act. It may be that peace, and all the preoccupations that have followed it, have absorbed men's minds so entirely that questions of currency seem to be an untimely irrelevance; or possibly the very heavy weight of the Committee's authority may have silenced the opposition to its recommendations. Presided over by Lord Cunliffe, the late Governor of the Bank, and including Sir John Bradbury and Professor Pigou and an imposing list of notable bankers, it was a body whose opinion could only be challenged by critics gifted with the most serene self-confidence.
One of the most interesting—especially to advocates of sound finance—points in its Report is the implied condemnation that it pronounces on the methods by which the war has been financed by our rulers. It points out that "the need of the Government for funds wherewith to finance the war in excess of the amounts raised by taxation or by loans from the public has made necessary the creation of credits in their favour with the Bank of England…. The balances created by these operations passing by means of payments to contractors and others to the Joint Stock banks have formed the foundation of a great growth in their deposits, which have also been swelled by the creation of credits in connection with the subscriptions to the various War Loans…. The greatly increased volume of bank deposits, representing a corresponding increase of purchasing power and, therefore, tending in conjunction with other causes to a great rise of prices, has brought about a corresponding demand for legal tender currency which could not have been satisfied under the stringent provisions of the Act of 1844." Here we have the story of bad war finance put as clearly as it can be. Because the Government was not able to raise all the money needed for the war on sound lines—that is, by taxation and loans to it of money saved by investors—it had recourse to credits raised for it by the Bank of England and the other banks against Treasury Bills, Ways and Means Advances, War Loans, War Bonds, and loans to customers who were taking up War Loans, etc. Thereby as these credits created fresh deposits there was a huge increase in the community's purchasing power; and since the supply of goods to be purchased was stationary or reduced, the only result was a great increase in prices which made the war, perhaps, nearly twice as costly as it need have been and produced all the suspicion and unrest that has already been referred to. Considering that the Committee included an ex-Governor of the Bank and the Permanent Secretary to the Treasury it could hardly have been expected to use much plainer language concerning the failure of our rulers to get money out of us in the right way for the war and the vigour with which they made use of the demoralising weapon of inflation.
It followed as a necessary consequence that the volume of legal tender currency had to be greatly increased. As prices rose wages rose with them, and so much more "cash" was needed in order to pay for a turnover of goods which, fairly constant in volume, demanded more currency because of their inflated prices. As the Committee says in its Report (page 5): "Given the necessity for the creation of bank credits in favour of the Government for the purpose of financing war expenditure, these issues could not be avoided. If they had not been made, the banks would have been unable to obtain legal tender with which to meet cheques drawn for cash on their customers' accounts. The unlimited issue of currency notes in exchange for credits at the Bank of England is at once a consequence and an essential condition of the methods which the Government have found necessary to adopt in order to meet their war expenditure."
The effect of these causes upon the amount of legal tender currency (other than subsidiary coin) in the banks and in circulation is summarised by the Committee in the following table:—
"The amounts on June 30, 1914, may be estimated as follows:—
"Fiduciary Issue of the Bank of England £18,450,000
"Bank of England Notes issued against gold coin or bullion 38,476,000
"Estimated amount of gold coin held by Banks (excluding gold coin held in the Issue Department of the Bank of England) and in public circulation 123,000,000 ___________ "Grand total £179,926,000 ___________
"The corresponding figures on July 10, 1918, as nearly as they can be estimated, were:—
"Fiduciary Issue of the Bank of England 18,450,000 Currency Notes not covered by gold 230,412,000 ___________ "Total Fiduciary Issues [1] £248,862,000 Bank of England Notes issued against coin and bullion 65,368,000 Currency Notes covered by gold 28,500,000 Estimated amount of gold coin held by Banks (excluding gold coin held by Issue Department of Bank of England), say 40,000,000 ___________ "Grand total £382,730,000
"[Footnote 1: The notes issued by Scottish and Irish banks which have been made legal tender during the war have not been included in the foregoing figures. Strictly the amount (about £5,000,000) by which these issues exceed the amount of gold and currency notes held by those banks should be added to the figures of the present fiduciary issues given above.]
"There is also a certain amount of gold coin still in the hands of the public which ought to be added to the last-mentioned figure, but the amount is unknown."
It will be noted that the gold held by the banks (other than the Bank of England) and by the public has declined from £123 to £40 millions, according to the Committee's estimate, while, on the other hand, the circulation of bank notes has risen by £27 millions and the issue of currency notes has taken place to the tune of £259 millions (at the date of the Report; it is now nearly £300 millions), making a net addition to legal tender currency of over £200 millions. When we also remember that there has been a very heavy coinage of silver and copper, that the Bank of England's deposits have risen by over £100 millions and the deposits of the other banks by nearly £700 millions, and all this at a time when most of the industrial activity of the country was going into the production of destructive weapons and the support of those who were using them, the behaviour of commodities of ordinary use in rising by nearly 100 per cent. seems to be an example of remarkable moderation. With all this new buying power in the hands of the community there is little wonder that some people should think that we have enormously increased our wealth during this most destructive and costly war, and should then feel hurt and disappointed when they find that this new buying power is robbed of all its beauty by the fact that its efficiency as buying power is seriously diminished by its mere quantity.
Such being the state of affairs—a great mass of new credit and currency based on securities—it is clear that our currency has been deprived for the time being of that direct relation with its gold basis that used in former time to regulate its volume according to world prices and our international trade position. As the Committee says, "It is not possible to judge to what extent legal tender currency may in fact be depreciated in terms of bullion. But it is practically certain that there has been some depreciation, and to this extent therefore the gold standard has ceased to be effective." Very well, then, what has to be done to get back to the old state of things under which there was a more or less automatic check on the creation of credit and the issue of currency? This check worked by a system which was elastic and simple. It was not entirely automatic, because its working had to be controlled by the Bank of England, which, by the action of its discount rate, could, more or less, quicken or check the working of the machine. Legal tender currency could only be increased by imports of gold; and exports of gold reduced the available amount of legal tender currency; and since a stock of legal tender currency was essential to meet the demands upon them that bankers made possible by creating credits, there was thus an Indirect and variable connection between the country's gold stock and the extent to which bankers would think it prudent to multiply credits. If credits were multiplied too fast, our currency was depreciated in value as compared with those of other countries and the exchanges went against us and gold either was exported or began to look as if it might be exported. If it was exported the legal tender basis of credit was reduced and the creation of credit was checked. If the Directors of the Bank of England thought it inadvisable that gold should be exported they could, by raising the rate of discount and taking artificial measures to control the supply of credit, produce, without the actual loss of gold, the effects which that loss would have brought about.
The keystone of the system was the rigid link between legal tender currency and gold. This was secured by the provisions of the Bank Act of 1844, which laid down that above a certain line—which was before the war roughly £18-1/2 millions—every Bank of England note issued should have gold behind it, pound for pound. In other words, the Bank of England note was, for practical purposes, a bullion certificate. The legal limit on the fiduciary issue (that is, the issue of £18-1/2 millions against securities, not gold) could only be exceeded by a breach of the law. The many critics of our banking system seized on this hard-and-fast restriction and accused it of making our system inelastic as compared with the German arrangement, under which the legal limit could at any time be exceeded on payment of a tax or fine on any excess perpetrated. These critics might have been right if legal tender currency had been the only, or even the predominant, means of payment in England. But, as every office boy knows, it was not. Legal tender—gold and Bank of England notes—was hardly ever seen in commercial and financial transactions on a serious scale. We paid, sometimes, our retail purchases of goods and services in gold; and Bank notes were a popular mode of payment on racecourses and in other places where transactions took place between people who were not very certain of one another's standing or good faith. But the great bulk of payments was made in the cheque currency which our bankers had developed outside of the law and could create as fast as prudence—and an eye to the supply of legal tender which every holder of a cheque had a right to demand—allowed them to do so. While cheques provided the currency of commerce, another form of "money" was produced, again without any restriction by the Act, by the pleasant convention which caused a credit in the Bank of England's books to be regarded as "cash" for balance-sheet purposes by the banks. These advantages gave the English system a freedom and elasticity, in spite of the strictness of the law that regulated the issue of paper currency, that enabled it to work in a manner that, judged by the test of practical results, had one great advantage over that of any of the rival centres. It alone in days before the war fulfilled the functions of an international banker by being ready at all times and without question to pay out the gold that was, in the last resort, the final means of settling international balances.
It is the object of Lord Cunliffe's Committee to restore as quickly as possible the system which, has thus been tried by the test of experience, "After the war," they say in their Report, "our gold holdings will no longer be protected 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 very grave danger of a credit expansion in this country and a foreign drain of gold which might jeopardise the convertibility of our note issues and the international trade position of the country…. We are glad to find that there was no difference of opinion among the witnesses who appeared before us as to the vital importance of these matters." The first measure that they put forward as essential to this end is the cessation at the earliest possible moment of Government borrowings. "A large part of the credit expansion arises, as we have shown, from the fact that the expenditure of the Government during the war has exceeded the amounts which they have been able to raise by taxation or by loans from the actual savings of the people. They have been obliged therefore to obtain money through the creation of credits by the Bank of England and the Joint Stock banks, with the result that the growth of purchasing power has exceeded that of purchasable goods and services." It is therefore essential that as soon as possible the State should not only live within its income but should begin to reduce indebtedness, especially the floating debt, which, being largely held by the banks, has been a cause of credit creation on a great scale. "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." With these weighty words the Committee brushes aside a host of schemes that have been urged for putting everything right by devising new machinery for the manufacture of new credit. That new credits will be needed for industry after war is obvious, but what else are our banks for, if not to provide it? They can only be set free to provide it on the scale required if, by the necessary reduction of the floating debt, they are relieved of the locking up of their funds in Government securities, which has been one of the bad results of our bad war finance.
It goes without saying that the Committee does not recommend the continuance in peace of the differential rates for home and foreign money that were introduced as a war measure with a view to lowering a rate at which the Government borrowed at home for war purposes. It would evidently be too severe a strain on human nature to attempt to work such a system, except in war-time, when the artificial conditions by which the market was surrounded made it both feasible and desirable to do so. With regard to the note issue, the Committee proposes a return to the old system and a strictly drawn line for the amount of the fiduciary note issue, the whole note issue (with the exception of the few surviving private note issues) being put into the hands of the Bank of England, all notes being payable in gold in London only and being made legal tender throughout the United Kingdom. These suggestions are subject to any special arrangements that may be made with regard to Scotland and Ireland. An early resumption of the circulation of gold for internal purposes is not contemplated. The public has become used to paper money, which is in some ways more convenient and cheaper; and the luxury of a gold circulation is one that we can hardly afford at present. Gold will be kept by the Bank of England in a central reserve, and all the other banks should, it is suggested, transfer to it the whole of their present holdings of the metal. In order to give the Bank of England a closer control of the bullion market the Committee thinks it desirable that the export of gold coin or bullion should, in future, be subject to the condition that such coin or bullion had been obtained from the Bank for the purpose. This measure would give the Bank of England a very close control of the bullion market, so close that there is a danger that if this control were too rigorously exercised, gold that now comes to this country might be diverted, with a view to more advantageous sale, to other centres. The amount of the fiduciary issue is a matter that the Committee leaves open to be determined after experience of post-war conditions. They "think that the stringent principles of the Act (of 1844) have often had the effect of preventing dangerous developments, and the fact that they have had to be temporarily suspended on certain rare and exceptional occasions (and those limited to the earlier years of the Act's operation, when experience of working the system was still immature) does not," in their opinion, invalidate this conclusion. So they propose that the separation of the Issue or Banking Departments should be maintained, but that in future if an emergency arose requiring an increase in the amount of fiduciary currency, this should not involve a breach of the law, but should be made legal (as it is now under the Currency and Bank Notes Act of 1914), subject to the consent of the Treasury.
It is not proposed at present to secure the circulation of paper instead of gold by legislation. The Committee considers that "informal action on the part of the banks may be expected to accomplish all that is required." If necessary, however, it points out that the circulation of gold could be prevented by making the notes convertible, at the discretion of the Bank of England, into coin or bar gold. The amount which, in the opinion of the Committee, should be aimed at for the central gold reserve is £150 millions (a sum which is already almost in sight on its figures quoted above); and "until this amount has been reached and maintained concurrently with a satisfactory foreign exchange position for a period of at least a year," it thinks that the policy of reducing the uncovered note issue "as and when opportunity offers" should be consistently followed. How this opportunity is going to "offer" is not made clear; but presumably a reflow of notes from circulation can only happen through a fall in prices or a reduction in bank deposits by the liquidation of advances made to the Government, directly or indirectly, by the banks.
Concerning the difficult problem of replacing the Bradbury notes by Bank of England notes of £1 and 10s., an ingenious suggestion is made by the Committee. It observes that there would be some awkwardness in transferring the issue to the Bank of England before the future dimensions of the fiduciary issue have been arrived at; and it suggests that during the transitional period any expansion in Treasury notes that may take place should be covered, not as now, by Government securities, but by Bank of England notes taken from the Bank. By this means any demands for new currency would operate in the normal way to reduce the reserve of the Banking Department, "which would have to be restored by raising money rates and encouraging gold imports," and so a step would have been taken to getting back to a business basis in the currency system and away from the profligate printing-press policy of the war period.
Such are the suggestions made by this distinguished body for the restoration of our currency. Little has been said against them in the way of serious criticism, but their conservative tendency and the fact that they practically recommend a return to the status quo has caused some impatience among the financial Hotspurs who proposed to begin to build a new world by turning everything upside down. In matters of finance this process is questionable, interesting as the result would undoubtedly be. To get to work on tried lines and then, when once industry and finance have recovered their old activity, to amend the machine whenever it is creaking seems to be a more sensible plan than to delay our start until we have fashioned a new heaven and earth, and then very probably find that they do not work. If the machine is to be set moving, it can only be done by close co-operation between the Bank of England and the other banks which have grown by amalgamation into institutions the size of which seem likely to make the task of central control more difficult than ever. On this important point the Committee is curiously silent. But it recommends the adoption of a suggestion made by a Committee of Bankers, who proposed that banks should in future be required "to publish a monthly statement showing the average of their weekly balance-sheets during the month." (Will this requisition apply to the Bank of England?) This is a welcome suggestion as far as it goes, but unless something is done by co-operative action to make the Bank rate more automatic in its influence on the actions of the other banks, the difficulty of making it effective seems likely to be considerable.
Getting the currency right is a most important matter for the future of our financial position. Another is the question of our debt to foreigners. Most of this debt we owe to America, and we only owe it because we had to finance our Allies. We surely ought to be able to arrange with America that anything that we have to do in giving our Allies time before asking for repayment they also should do for us—within limits, say, up to thirty years. In view of all that they have made and we have lost by this war waged for the cause of all mankind, this would seem to be reasonable concession on America's part.