War-Time Financial Problems

by Hartley Withers

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.

XVII

MEETING THE WAR BILL

January, 1919